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Brad DeLong says the cure for a financial crisis depends upon why the crisis
Three cures for three crises, by J. Bradford Delong, Project Syndicate: A
full-scale financial crisis is triggered by a sharp fall in the prices of a
large set of assets that banks and other financial institutions own, or that
make up their borrowers' financial reserves. The cure depends on which of three
modes define the fall in asset prices.
The first -- and "easiest" -- mode is when investors refuse to buy at normal
prices not because they know that economic fundamentals are suspect, but because
they fear that others will panic, forcing everybody to sell at fire-sale prices.
The cure for this mode -- a liquidity crisis caused by declining confidence
in the financial system -- is to ensure that banks and other financial
institutions with cash liabilities can raise what they need by borrowing from
others or from central banks.
This is the rule set out by Walter Bagehot more than a century ago: Calming
the markets requires central banks to lend at a penalty rate to every distressed
institution that would be able to put up reasonable collateral in normal times.
Once everybody is sure that, no matter how much others panic, financial
institutions won't have to dump illiquid assets at a loss, the panic will
subside. And the penalty rate means that financial institutions can't profit
from the investment behavior that left them illiquid -- and creates an incentive
to take due care to guard against such contingencies in the future.
In the second mode, asset prices fall because investors recognize that they
should never have been as high as they were, or that future productivity growth
is likely to be lower and interest rates higher. Either way, current asset
prices are no longer warranted.
This kind of crisis cannot be solved simply by ensuring that solvent
borrowers can borrow, because the problem is that banks aren't solvent at
prevailing interest rates. Banks are highly leveraged institutions with
relatively small capital bases, so even a relatively small decline in the prices
of assets that they or their borrowers hold can leave them unable to pay off
depositors, no matter how long the liquidation process.
In this case, applying the Bagehot rule would be wrong.
The problem is not illiquidity but insolvency at prevailing interest rates.
But if the central bank reduces interest rates and credibly commits to keeping
them low in the future, asset prices will rise. Thus, low interest rates make
the problem go away, while the Bagehot rule -- with its high lending rate for
banks -- would make matters worse.
Of course, easy monetary policy can cause inflation, and the failure to
"punish" financial institutions that exercised poor judgment in the past may
lead to more of the same in the future. But as long as the degree of insolvency
is small enough that a relatively minor degree of monetary easing can prevent a
major depression and mass unemployment, this is a good option in an imperfect
The third mode is like the second: A bursting bubble or bad news about future
productivity or interest rates drives the fall in asset prices. But the fall is
larger. Easing monetary policy won't solve this kind of crisis, because even
moderately lower interest rates cannot boost asset prices enough to restore the
financial system to solvency.
When this happens, governments have two options. First, they can simply
nationalize the broken financial system and have the Treasury sort things out --
and reprivatize the functioning and solvent parts as rapidly as possible.
Government is not the best form of organization of a financial system in the
long term, and even in the short term it is not very good. It is merely the best
The second option is simply inflation. Yes, the financial system is
insolvent, but it has nominal liabilities and either it or its borrowers have
some real assets. Print enough money and boost the price level enough, and the
insolvency problem goes away without the risks entailed by putting the
government in the investment and commercial banking business.
The inflation may be severe, implying massive unjust redistributions and at
least a temporary grave degradation in the price system's capacity to guide
resource allocation. But even this is almost surely better than a depression.
Since late summer, the US Federal Reserve has been attempting to manage the
slow-moving financial crisis triggered by the collapse of the US housing bubble.
At the start, the Fed assumed that it was facing a first-mode crisis -- a
mere liquidity crisis -- and that the principal cure would be to ensure the
liquidity of fundamentally solvent institutions.
But the Fed has shifted over the past two months toward policies aimed at a
second-mode crisis -- more significant monetary loosening, despite the risks of
higher inflation, extra moral hazard and unjust redistribution.
As Fed Vice Chair Don Kohn recently put it: "We should not hold the economy
hostage to teach a small segment of the population a lesson."
No policymakers are yet considering the possibility that the financial crisis
might turn out to be in the third mode.
And, as if on cue, from the WSJ Economics blog:
Liquidity Threat Eases; Solvency Threat Still Looms, WSJ Economics Blog: As 2007 winds down, the much-feared year-end liquidity crisis appears to have
been averted thanks to aggressive action by central banks. ... [A]s 2008 begins, it's solvency, not liquidity, that threatens
the economy and the financial system. And at the root of the solvency threat is
a likely decline in housing prices that will further undermine credit quality.
Making banks more confident of their own ability to raise funds is not going to
resolve a generalized shrinkage of lending driven by declining collateral
Posted by Mark Thoma on Monday, December 31, 2007 at 12:15 PM in Economics, Financial System, Monetary Policy |
Almost all of the Republican presidential candidates have embraced discredited voodoo economic
policies, sometimes in contradiction to their previous policy positions. What does this tell us?:
The Great Divide, by Paul Krugman, Commentary, NY Times: Yesterday The Times
published a highly informative chart laying out the positions of the
presidential candidates on major issues. It was, I’d argue, a useful reality
check for those who believe that the next president can somehow usher in a new
era of bipartisan cooperation...
On one side, the Democrats are all promising to get out of Iraq and offering
strongly progressive policies on taxes, health care and the environment. That’s
understandable: the public hates the war, and public opinion seems to be running
in a progressive direction.
What seems harder to understand is ... the degree to which almost all the
Republicans have chosen to align themselves closely with the unpopular policies
of an unpopular president. And I’m not just talking about ... the Iraq war. The
G.O.P. candidates are equally supportive of Bush economic policies. ...
The “Bush boom,” such as it was, bypassed most Americans... Meanwhile,
insecurity has increased... And things seem likely to get worse as the election
approaches... All in all, ... you’d expect Republican politicians ... to
distance themselves from the current administration’s economic policies and
In fact, however, ... Republican contenders ... assure voters that they will
not deviate an inch from the Bush path. Why? Because the G.O.P. is still
controlled by a conservative movement that does not tolerate deviations from
tax-cutting, free-market, greed-is-good orthodoxy.
To see the extent to which Republican politicians still cower before the
power of movement conservatism, consider the sad case of John McCain.
Mr. McCain’s lingering reputation as a maverick straight talker comes largely
from his opposition to the Bush tax cuts of 2001 and 2003, which he said at the
time were too big and too skewed to the rich. Those objections would seem to
have even more force now, with America facing the costs of an expensive war —
which Mr. McCain fervently supports — and with income inequality reaching new
But Mr. McCain now says that he supports making the Bush tax cuts permanent.
Not only that: he’s become a convert to crude supply-side economics, claiming
that cutting taxes actually increases revenues. That’s an assertion even Bush
administration officials concede is false.
Oh, and what about his earlier opposition to tax cuts? Mr. McCain now says he
opposed the Bush tax cuts only because they weren’t offset by spending cuts.
Aside from the logical problem here — if tax cuts increase revenue, why do
they need to be offset? — even a cursory look at what Mr. McCain said at the
time shows that he’s ... clearly decided that it’s better to fib about his
record than admit that he wasn’t always a rock-solid economic conservative.
So what does the conversion of Mr. McCain into an avowed believer in voodoo
economics — and the comparable conversions of Mitt Romney and Rudy Giuliani —
tell us? That bitter partisanship and political polarization aren’t going away
There’s a fantasy, widely held inside the Beltway, that men and women of good
will from both parties can be brought together to hammer out bipartisan
solutions to the nation’s problems.
If such a thing were possible, Mr. McCain, Mr. Romney and Mr. Giuliani — a
self-proclaimed maverick, the former governor of a liberal state and the former
mayor of an equally liberal city — would seem like the kind of men Democrats
could deal with. (O.K., maybe not Mr. Giuliani.) In fact, however, it’s not
possible, not given the nature of today’s Republican Party, which has turned men
like Mr. McCain and Mr. Romney into hard-line ideologues. On economics, and on
much else, there is no common ground between the parties.
Posted by Mark Thoma on Monday, December 31, 2007 at 12:33 AM in Economics, Politics |
When are people most likely to voluntarily redistribute income?:
Playing fair, even when it hurts in the pocketbook, by Mark Roth, Pittsburgh
Post-Gazette: ...Why do people support economic systems that seem to be against their
self-interest? ... "Why do we see ... poor people ... who don't buy into an
egalitarian system and ... rich people... who support it?" [Christina Fong of
Carnegie Mellon University] asked. "That's a big puzzle in economics."...
"If only income mattered and beliefs about fairness didn't matter at all,
then you should expect to see ... poor people demand redistribution [of tax
revenue] and rich people oppose it. "The fact that we don't see that requires
some explanation, and a big part of the explanation is that these beliefs about
fairness matter a lot. So if you're poor but you think that the rich people
really deserve to be rich, then you'll accept having less."
Much of Americans' beliefs revolve around whether they think the free-market
economy is fair -- "in other words, people who work hard get more and people who
don't get less" -- or whether they think it is basically unfair, so that "people
are working really hard and not getting enough compensation."
Continue reading ""Why Do People Support Economic Systems That Seem To Be Against Their Self-Interest?"" »
Posted by Mark Thoma on Monday, December 31, 2007 at 12:24 AM in Economics, Income Distribution |
Posted by Mark Thoma on Monday, December 31, 2007 at 12:06 AM in Links |
Is the idea that more government intervention is needed to regulate markets
and redistribute income gaining wider acceptance?
The Free Market: A False Idol After All?, by Peter S. Goodman, NY Times: For more than a quarter-century, the dominant idea guiding economic policy
... has been that the market is unfailingly wise. So wise that the proper role
for government is to steer clear and not mess with the gusher of wealth that
will flow, trickling down to the every level of society, if only the market is
left to do its magic.
That notion has carried the day as industries have been unshackled from
regulation, and as taxes have been rolled back, along with the oversight powers
of government. Faith in markets has held sway as insurance companies have fended
off calls for more government-financed health care, and as banks have engineered
webs of finance that have turned houses from mere abodes into assets traded like
But lately, a striking unease with market forces has entered the
conversation. ... Regulation — nasty talk in some quarters, synonymous with
pointy-headed bureaucrats choking the market — is suddenly being demanded from
The Bush administration and the Federal Reserve have in recent weeks put
aside laissez-faire rhetoric to wade into real estate, wielding new rules and
deals they say are necessary to protect Americans from predatory bankers... Were
the market left to its own devices, millions could lose their homes, the
administration now says.
Central banks on both sides of the Atlantic are coordinating campaigns to
flush cash through the global economy, lest frightened lenders hoard capital and
suffocate growth. In Bali this month, world leaders gathered in the name of
striking agreement to slow climate change. ...
Throughout history, regulation has tended to gain favor on the heels of free
enterprise run amok. The monopolistic excesses of the Robber Barons led to
antitrust laws. Not by accident did strict new accounting rules follow the
unmasking of fraud at Enron and WorldCom. Now, the subprime fiasco and a still
unfolding wave of home foreclosures are prompting many to call for new rules.
[I]n Washington, and under the roofs of many homes now worth less than a year
ago, there appears to be a shift in the nation’s often-ambivalent attitude about
Liberal critics have long asserted that dogmatic devotion to market forces
has skewed American society toward those of greatest means. More wealth is being
concentrated in fewer hands, with rich people capturing the best housing,
private education and health care services...
That critique informs proposals from Democrats vying for the presidency, as
they debate how best to expand access to health care and ways to shift the tax
burden to the rich. They are in essence calling for market intervention to
redress imbalances. With the gap between the richest and poorest now greater
than it has been since the 1920s, these pitches have emerged as central
components of their campaigns
More notable, though, is how fervent proponents of unfettered market forces
have lately come to embrace regulation.
The Bush administration, in seeking to freeze mortgage rates for some
homeowners... Treasury Secretary Henry Paulson Jr. ... is demanding that banks
accept smaller payments than promised, while describing the market as a fallible
thing in need of supervision. “The government acted to prevent a market failure and to try to avoid
unnecessary harm,” he said...
[W]hen things go wrong, demands grow for the government to step in and make them
right. “Untethered market forces lead to bad things,” said [Jared] Bernstein of the
Economic Policy Institute. “You simply can’t run an economy as complicated as
ours on ideology alone.”
The statement "Democrats vying for the presidency ... debate how best to
expand access to health care and ways to shift the tax burden to the rich."
contains different types of intervention, one that addresses a market failure
and another that redistributes the outcome of the market process.
Some types of government intervention - weights and measures, disclosure
requirements, truth in advertising, safety requirements, etc., are intended to
make markets work more efficiently by creating conditions that better approximate
competitive ideals. The debate over health care can be cast in this light, i.e.
as a debate about how best to solve a market failure that prevents broader
coverage at lower prices.
As second type of intervention redistributes income ex-post, i.e. after the
market process has occurred, often through taxation and spending programs. In an
economy with significant market failures that cause an inequitable distribution
of income and wealth, ex-post redistribution may be justified to redress the
imbalances caused by the market failures (and to create equal opportunity).
Thus, the first two types of intervention occur due to market failures, in
the first case the intervention is to correct the failures and improve market
efficiency, and in the second case the intervention redistributes income ex-post
to make-up for inequities caused by existing market failures.
There is also a third possibility, intervening when markets are working
reasonably well. Here, the assumption is that even well-functioning markets can
produce inequitable outcomes and hence ex-post redistribution is required.
Unlike the first type of intervention which corrects market failures, this type
of intervention often leaves markets functioning less efficiently. Much of the
objection to government intervention is made on this basis.
Here is what I am trying to argue. One type of intervention attempts to
correct market failures so that they function more efficiently. The recent calls
for financial market regulation, for example, largely fall under this umbrella.
Another type of intervention attempts to redress inequities brought about by
markets that are not functioning properly, e.g. not rewarding capital and labor
in the correct proportions. Calls for redistribution can arise from this type of
The last type of intervention redistributes income even though there are no
market failures. Here, even when the economic system functions perfectly, i.e.
according to competitive ideals, the outcome is still deemed inequitable and
hence redistribution is needed. Some of this is out there, i.e. this type of
intervention has its advocates, but of the three types of intervention I think
this is the least important factor. I don't think people have much problem
accepting economic outcomes if they think the game was fair, even if the outcome
is lopsided. It's when the game is unfair that there are objections and calls
for intervention to correct the inequitable outcome, and to fix the game so the
problems don't happen again in the future.
Posted by Mark Thoma on Sunday, December 30, 2007 at 02:07 AM in Economics, Market Failure, Regulation |
Posted by Mark Thoma on Sunday, December 30, 2007 at 12:06 AM in Links |
In an introduction to a
Paul Krugman wrote:
Broadly speaking, the serious contenders for the Democratic nomination are
offering similar policy proposals... But there are large differences among the
candidates in their beliefs about what it will take to turn a progressive agenda
At one extreme, Barack Obama insists that the problem with America is that
our politics are so “bitter and partisan,” and insists that he can get things
done by ushering in a “different kind of politics.”
At the opposite extreme, John Edwards blames the power of the wealthy and
corporate interests for our problems, and says, in effect, that America needs
another F.D.R. — a polarizing figure, the object of much hatred from the right,
who nonetheless succeeded in making big changes.
Thomas Palley agrees that, for Obama, "change is a
matter of political style," but he says there are key policy differences among the candidates that have not
received the attention they deserve, partly due to intentional "bunching" of policy by the Clinton campaign:
Democrats and the Meanings of Change, by Thomas I. Palley [via email, no link yet]: Many people now believe the United States cannot afford to continue with
the policies of the Bush – Cheney administration. Those policies have undermined
global support for America that is a key part of national security, and have
produced an economic expansion that has by-passed working families and looks
like bequeathing years of house price pain.
However, if there is agreement that the heavy-fisted Bush-Cheney agenda is no
longer acceptable, the question remains what will follow. Among Democratic
presidential candidates, though there is much talk of change, its meaning
Beginning some thirty years ago, Ronald Reagan initiated a fundamental
re-positioning of American politics that was later completed by Newt Gingrich,
Dick Armey, and Tom Delay. That re-positioning shifted the entire political
spectrum to the right.
This raises the question does change mean sticking with the political playing
field we now have and just giving control of the football to new Democrats like
Senator Hilary Clinton? Or does it mean re-positioning the playing field and
shifting the political spectrum as proposed by progressive Democrats like
Senator John Edwards?
Behind this difference lie vital real world consequences that will profoundly
impact America’s working families. For Clinton-style centrists, today’s economy
works reasonably well. Globalization delivers prosperity by providing cheap
imports that lower prices; financial boom on Wall Street benefits all by raising
stock prices; and higher corporate profits drive investment that increases
growth and incomes. However, growth also creates losers which means the market’s
“invisible hand” must be accompanied by a “helping hand”. Consequently, there is
need for policies to supplement the incomes of the working-poor and to assist
workers who lose their jobs because of trade.
For Edwards-style progressives the picture is very different. Globalization
has created a divide between country and corporations, with companies abandoning
the U.S. by shifting jobs and investment offshore. That maximizes profits but
undermines wages and future prosperity. Higher profits have not raised growth,
but have instead come at the expense of wages and increased income inequality.
And Wall Street has spearheaded these changes by demanding that companies raise
rates of return and rip up the old social contract with workers and their
From a progressive standpoint the problem with new Democrats is they tackle
symptoms, not causes. Though helping hand social policies are welcome,
progressives believe such policies are not up to the challenge confronting
America’s working families. Meeting that challenge requires deeper change, which
is what the 2008 election is all about.
Yet, surfacing this difference has proved difficult. That is because the
Clinton campaign has used the political tactic of “bunching” to obscure
differences. That holds for every major issue from healthcare, to trade policy,
to taxing Wall Street hedge fund incomes. On each issue the Clinton campaign has
bunched up and signed-on, but always reluctantly and late.
This tactical effectiveness of bunching requires progressives to raise
directly the question of change and its meaning. For Senator Obama change is a
matter of political style. For Senator Clinton it means restoring the economic
policies of the 1990s. However, with the exception of tax cuts, those policies
are the policies of today. Thus, the 1990s ushered in NAFTA and free trade with
China, and cemented trends from the 1980s regarding trade deficits, the
separation of wages from productivity growth, and the dominance of Wall Street.
What really saved the 1990s were the Internet and stock market bubbles, which is
not a sustainable foundation for prosperity.
The 21st century has gotten off to a rocky start with America squandering
much political and economic capital. Now, Americans want change. The Democratic
primaries offer competing visions of change. One changes possession of the
political football, the other changes the football field. That’s the debate the
country needs, and it seems to be finally bubbling to the surface in the last
days if the Iowa campaign.
I think the important distinction is between tackling symptoms (outcomes) and
tackling causes. Is it enough to revamp the social safety net within the current economic
structure, or does the structure itself need to be changed?
I think action on both fronts is needed, but my preference is to let market
processes work without interference and then use the social safety net and other
devices to correct distributional inequities ex-post.
But that is not to say that the structure itself does not need to be changed.
When I say "market processes", I mean competitive markets, I don't mean
monopolized markets, or markets that do not fully internalize costs, or markets
that are manipulated through the political process, etc. Broadly, I am
particularly concerned about the balance of power between firms and workers,
i.e. that the labor market is not competitive and hence does not have the
optimality properties we expect from well-functioning markets, that more should
be done to cause firms to internalize environmental externalities, that firms
have more political clout than workers, that opportunity is not equal,
particularly educational opportunities and this limits mobility between economic
classes, that there is too much concentration of ownership in key industries
such as (but not limited to) the media, and that we are not paying enough
attention to our domestic infrastructure needs. Plus all the ones I forgot.
Structural change to the economy, along with needed reform of the social safety net in areas such as health care, won't come without fierce resistance from the other side. Change, even change that is centrist in nature, will require a difficult political battle and there won't be a lot of time for learning on the job. I don't believe that a cooperative, compromise approach to policy will be successful in bringing about the change that is needed and I hope the Democratic nominee, whoever that might be, will be prepared to begin the difficult battle ahead of them from day one of their administration.
Update: From Paul Krugman, a link to more discussion along these lines:
I won’t write any more about this, by Paul Krugman: But I’ll link to Lambert, who channels me admirably.
Posted by Mark Thoma on Saturday, December 29, 2007 at 01:17 PM in Economics, Politics |
The costs of capping malpractice payments fall disproportionately on
low-income workers, children, and the elderly:
Lacking lawyers, justice is denied, by Daniel Costello, Los Angeles Times: ...In 1975, California enacted legislation capping malpractice payments after
an outcry ... that oversized awards and skyrocketing insurance rates were
driving physicians out of the state.
The law limited the amount of money for "pain and suffering" ... to $250,000.
There is no limit on what patients can collect for loss of future wages or other
Over the years, it has been easy to quantify the effects of the law, known as
the Medical Injury Compensation Reform Act, or MICRA. In the years since the law
was enacted, malpractice premiums in California have risen by just a third of
the national average, and doctors say the law now helps attract physicians to
the state. Proponents also say it discourages frivolous lawsuits.
Thirty states have enacted similar legislation. Two Republican presidential
candidates -- Mitt Romney and Rudolph W. Giuliani -- have recently endorsed the
approach as a possible national model.
It's been harder to tally the law's costs. Critics say it is increasingly
preventing victims and their families from getting their day in court,
especially low-income workers, children and the elderly. Their reasoning: The
cap on pain and suffering has never been raised nor tied to inflation.
Meanwhile, the costs of putting on trials are often paid by attorneys and
continue to rise each year. That means those who rely mainly on pain and
suffering awards -- typically people who didn't make much money at the time of
their injury -- are increasingly unattractive to lawyers.
Several states have set their malpractice caps considerably higher than
California's because of worries that they affected poorer patients the most.
Some state courts have begun to examine the fairness of their malpractice laws,
especially those not tied to inflation. ...
A 2003 Rand Corp. report found that the law has reduced jury awards by 30%,
and that the savings have come largely at the expense of severely injured or
On average, California juries (which are rarely informed of the cap during
trials) awarded $800,000 in malpractice death cases from 1995 to 1999, but the
amounts were later reduced to $250,000 under the law. This suggests that medical
malpractice victims and their families could be reaping much larger payouts...
But proponents of MICRA say raising the cap could harm patients.
"Raising the MICRA cap would significantly increase healthcare costs,
limiting patient access to doctors, hospitals and clinics throughout
California," said Lisa Maas, executive director of ... a trade group. "MICRA
protects patient access to healthcare." ...
The link between malpractice payouts and increases in doctors' insurance
premiums, though, remains unclear. One of the largest studies done on the topic
-- by Dartmouth College researchers in 2003 -- concluded that malpractice
payments had risen in line with medical care costs, whereas doctors' insurance
premiums grew far faster -- by double-digit percentages annually for some
To some, that suggests that recent malpractice premium increases may have had
more to do with insurers' business models and financial investments -- including
documented losses in their investment portfolios in recent years -- than with
their core businesses. ...
Do malpractice awards increase healthcare costs? From the CBO:
Liability for Medical Malpractice: To curb the growth of premiums, the
Administration and Members of Congress have proposed several types of
restrictions on malpractice awards. ... Limits of one kind or another on
liability for malpractice injuries, or "torts," are relatively common at the
state level: more than 40 states had at least one restriction in effect in 2002.
Evidence from the states indicates that premiums for malpractice insurance
are lower when tort liability is restricted than they would be otherwise. But
even large savings in premiums can have only a small direct impact on health
care spending--private or governmental--because malpractice costs account for
less than 2 percent of that spending. Advocates or opponents cite other possible
effects of limiting tort liability, such as reducing the extent to which
physicians practice "defensive medicine" by conducting excessive procedures;
preventing widespread problems of access to health care; or conversely,
increasing medical injuries. However, evidence for those other effects is weak
So the argument that lack of malpractice limits "would significantly increase
healthcare costs" seems fairly weak.
The CBO report also summarizes the efficiency and equity issues involved in
Issues surrounding the effects of the malpractice system and of possible
restrictions on it can be viewed as questions of economic efficiency (providing
the maximum possible net benefits to society) and equity (distributing the
benefits and costs fairly).
Fairness is ultimately in the eye of the beholder. But the common
equity-related argument for malpractice liability is that someone harmed by the
actions of a physician or other medical professional deserves to be compensated
by the injuring party.
The efficiency argument is that, in principle, liability (as a supplement to
government regulations, professional oversight, and the desire of health care
providers to maintain good reputations) gives providers an incentive to control
the incidence and costs of malpractice injuries. In practice, however, the
effect on efficiency depends on the standards used to distinguish medical
negligence from appropriate care and on the accuracy of malpractice judgments
and awards. If malpractice is judged inaccurately or is not clearly defined,
doctors may carry out excessive tests and procedures to be able to cite as
evidence that they were not negligent. Likewise, if malpractice is defined
clearly but too broadly or if awards tend to be too high, doctors may engage in
defensive medicine, inefficiently restrict their practices, or retire.
Conversely, if doctors face less than the full costs of their
negligence--because they are insulated by liability insurance or because
malpractice is unrecognized or undercompensated--they may have too little
incentive to avoid risky practices. For all of those reasons, it is not clear
whether trying to control malpractice by means of liability improves economic
efficiency or reduces it.
The report concludes with:
In short, the evidence available to date does not make a strong case that
restricting malpractice liability would have a significant effect, either
positive or negative, on economic efficiency. Thus, choices about specific
proposals may hinge more on their implications for equity--in particular, on
their effects on health care providers, patients injured through malpractice,
and users of the health care system in general.
There is reason to be concerned about the equity of limiting award payments as
compensation for injuries, i.e. of having payments that are too low when injury
or impairment is severe, particularly since there are no discernible efficiency
gains from the restrictions. But there is also another reason to be concerned
about equity. If, as claimed above, there are costs from the restrictions on
awards that fall mainly on low-income workers, children, and the elderly, then that should also raise
questions about the fairness of the restrictions.
Posted by Mark Thoma on Saturday, December 29, 2007 at 01:53 AM in Economics, Health Care, Regulation |
Posted by Mark Thoma on Saturday, December 29, 2007 at 12:06 AM in Links |
Wow. What's up with this?:
Bill Kristol To Become New York Times Columnist, by Danny Shea, Huffington Post:
The Huffington Post has learned that, in a move bound to create controversy, the
New York Times is set to announce that Bill Kristol will become a weekly
columnist in 2008. Kristol, a prominent neo-conservative who recently departed
Time magazine in what was reported as a "mutual" decision, has close ties to the
White House and is a well-known proponent of the war in Iraq. Kristol also is a
regular contributor to Fox News' Special Report with Brit Hume.
Posted by Mark Thoma on Friday, December 28, 2007 at 04:32 PM in Economics, Press |
This is from Danielle DiMartino, John V. Duca, and Harvey
Rosenblum of the Dallas Fed. The main theme of this thorough discussion is that financial market risk has been underpriced
recently and, although the current financial market problems may be painful, if
the long-run outcome is that risk is priced correctly, then we will have
salvaged something from the turmoil:
From Complacency to Crisis: Financial Risk Taking in the Early 21st Century, by Danielle DiMartino, John V. Duca and Harvey Rosenblum,
Federal Reserve Bank of Dallas: During the first half of this decade, the belief that
new financial products would adequately shield investors from risk encouraged
financial flows to less creditworthy households and businesses. By late 2006,
U.S. financial markets were flashing warning signals of a potential financial
In a sign that investors had become too complacent, risk
premiums had all but vanished in junk bond and emerging-market interest rate
spreads. Then, conditions changed abruptly. In the important and usually stable
market for asset-backed commercial paper, premiums on three-month paper over
Treasury bills jumped from 0.17 percentage point in February 2007 to 2.15 points
in August. Meanwhile, rising subprime mortgage defaults led investors to abandon
their sanguine beliefs about the risk of many mortgage and nonmortgage products.
The backdrop for these events was a period of
macroeconomic stability that fed complacency about risk. This relatively benign
economic environment, when combined with the new, structured financial products,
increased financial flows to nonprime mortgage and business borrowers. The
result was an overeager acceptance of risk taking that began correcting itself
only after mounting subprime mortgage defaults reverberated through the broader
Continue reading ""From Complacency to Crisis: Financial Risk Taking in the Early 21st Century"" »
Posted by Mark Thoma on Friday, December 28, 2007 at 01:08 PM in Economics, Financial System |
Thought I'd pass these along:
Felix Salmon has a
nice explanation of CDOs and overcollaterilization.
Calculated Risk has
More on New Home Sales.
Taylor Clark at Slate says
Don't Fear Starbucks because having one open nearby - next door even - helps existing coffee shops. [Update] Why are there no Starbucks in Italy?
[Update] Paul Krugman looks at the big bubble in the price-rent ratio and wonders
How far is down? for housing prices. [Update] Brad DeLong qualifies Paul Krugman's conclusion on the fall in housing prices. [Update] Richard Green says "Krugman thinks a 50 percent fall along the coasts is possible. I am doubtful." He also links to a paper on the problems with using PE ratios.
[Update] Paul Krugman says "It occurs to me that some readers might want to know a bit more about the
history behind what I’m saying currently on trade." [Update] knzn continues the discussion. He says, "It helps, I think, to separate the positive question from the normative
question. The positive question is, 'Who is helped by trade, and who is harmed?' The normative question, in the abstract, is, 'How much weight should we give to
the interests of the various parties that are helped and harmed by trade?'"
Posted by Mark Thoma on Friday, December 28, 2007 at 09:09 AM in Economics |
The consequences of increased trade with countries that are much poorer than
Trouble With Trade, by Paul Krugman, Commentary, NY Times: While the United
States has long imported oil and other raw materials from the third world, we
used to import manufactured goods mainly from other rich countries like Canada,
European nations and Japan.
But recently we crossed an important watershed:... a majority of our
industrial trade is now with countries that are much poorer than we are and that
pay their workers much lower wages.
For the world economy as a whole — and especially for poorer nations —
growing trade between high-wage and low-wage countries is a very good thing.
Above all, it offers backward economies their best hope of moving up the income
But for American workers the story is much less positive. In fact, it’s hard
to avoid the conclusion that growing U.S. trade with third world countries
reduces the real wages of many and perhaps most workers in this country. And
that reality makes the politics of trade very difficult.
Let’s talk for a moment about the economics.
Trade between high-wage countries tends to be a modest win for all, or almost
all, concerned. ... By contrast, trade between countries at very different
levels of economic development tends to create large classes of losers as well
Although the outsourcing of some high-tech jobs to India has made headlines,
on balance, highly educated workers in the United States benefit from higher
wages and expanded job opportunities because of trade. For example, ThinkPad
notebook computers are now made by a Chinese company, Lenovo, but a lot of
Lenovo’s research and development is conducted in North Carolina.
But workers with less formal education either see their jobs shipped overseas
or find their wages driven down ... as other workers ... crowd into their
industries and look for employment to replace the jobs they lost to foreign
competition. And lower prices at Wal-Mart aren’t sufficient compensation.
All this is textbook international economics:... economic theory says that
free trade normally makes a country richer, but it doesn’t say that it’s
normally good for everyone. Still, when the effects of third-world exports on
U.S. wages first became an issue in the 1990s, a number of economists — myself
included — looked at the data and concluded that any negative effects on U.S.
wages were modest.
The trouble now is that these effects may no longer be as modest ... because
imports of manufactured goods from the third world have grown dramatically... And the biggest
growth in imports has come from countries with very low wages. ...
So am I arguing for protectionism? No..., keeping world markets relatively
open is crucial to the hopes of billions of people.
But I am arguing for an end to the finger-wagging, the accusation either of
not understanding economics or of kowtowing to special interests that tends to
be the editorial response to politicians who express skepticism about the
benefits of free-trade agreements.
It’s often claimed that limits on trade benefit only a small number of
Americans, while hurting the vast majority. That’s still true of things like the
import quota on sugar. But when it comes to manufactured goods, it’s at least
arguable that the reverse is true. The highly educated workers who clearly
benefit from growing trade with third-world economies are a minority, greatly
outnumbered by those who probably lose.
As I said, I’m not a protectionist. For the sake of the world as a whole, I
hope that we respond to the trouble with trade not by shutting trade down, but
by doing things like strengthening the social safety net. But those who are
worried about trade have a point, and deserve some respect. ["Wonkish" follow up
Posted by Mark Thoma on Friday, December 28, 2007 at 12:33 AM in Economics, Income Distribution, International Trade, Unemployment |
Posted by Mark Thoma on Friday, December 28, 2007 at 12:06 AM in Links |
Here is a new Maxwell Poll on inequality. The
brief describing the poll:
The Maxwell Poll on Inequality is an annual survey of a
representative sample of over 600 Americans on their perceptions of inequality and government
action. The November 2007 Poll reveals that most Americans see inequality as growing. While
trends are leveling in perceptions of the increase and the seriousness of the problem, the American
public in general remains concerned. The Poll reveals that perceptions of inequality and
desire for government action to address it are tied to party affiliation. This reveals the
potential for the wealth gap to be an important election campaign issue with Democrats supporting
candidates who promise to take more government action.
full report is here, and, as just noted, there is also a
brief summarizing the results.
Continue reading "The Maxwell Poll on Inequality" »
Posted by Mark Thoma on Thursday, December 27, 2007 at 12:06 PM in Economics, Income Distribution, Politics |
Posted by Mark Thoma on Thursday, December 27, 2007 at 12:24 AM in Links |
John Berry says losses from the subprime mess will be big, but "not nearly
enough to sink the U.S. economy":
Subprime Losses Are Big, Exaggerated by Some, by John M. Berry, Commentary,
Bloomberg: As the U.S. savings and loan crisis worsened in the 1980s,
analysts tried to top each other's estimates of the debacle's cost... Much the
same thing is happening now with losses linked to subprime mortgages, with
figures of $300 billion to $400 billion being bandied about.
A more realistic amount is probably half or less than those exaggerated
projections -- say $150 billion. That's hardly chicken feed, though not nearly
enough to sink the U.S. economy. ...
There are two reasons why the losses aren't likely to be so large.
First, the mortgages are backed by collateral, a house or condominium, and in
a foreclosure a home typically retains significant value. When it is sold, the
lender often will get 50 percent to 60 percent or more of the loan amount after
Second, most subprime borrowers aren't going to default. ...
What does that mean for the broader economy, particularly consumer spending?
The economic repercussions of the housing bust and mortgage woes are limited
to a great extent because less than half of American families own a home with a
mortgage... Almost a third of all families rent their house or apartment, almost
a fourth own and have no mortgage and the vast majority with a mortgage are
current in their payments.
Even with about a tenth of all subprime mortgages now in foreclosure, only a
small share of all American families -- about 0.3 percent -- own a home in
Comparisons in dollars of constant value between likely subprime losses and
those incurred during the S&L crisis indicate the 1980s hit was significantly
greater, though the current episode still has a long way to run. ...
Posted by Mark Thoma on Thursday, December 27, 2007 at 12:15 AM in Economics, Housing |
Paul Krugman says Democrats "need to be ready to fight some very nasty
Progressives, To Arms!
Forget about Bush—and the middle ground, by Paul Krugman, Slate: Here's a
thought for progressives: Bush isn't the problem. And the next president should
not try to be the anti-Bush. ...
I'm not saying that we should look kindly on the
Worst President Ever... Nor ... that we should forgive and forget; I
very much hope that the next president will open the records and let the full
story of the Bush era's outrages be told.
But Bush will soon be gone. What progressives should be focused on now ...
isn't Bush bashing—what we need is partisanship. ...
Progressives have an opportunity, because American public opinion has become
a lot more liberal.
Not everyone understands that. In fact, the reaction of the news media to the
first clear electoral manifestation of America's new liberalism—the Democratic
sweep in last year's congressional elections—was almost comical in its denial.
Thus, in 1994, Time celebrated the Republican victory in the midterm
elections by putting a herd of charging elephants on its cover. But its response
to the Democratic victory of 2006 ... was a pair of overlapping red and blue
circles, with the headline "The center is the place to be."
Oh, and the guests on Meet the Press the Sunday after the Democratic sweep
were, you guessed it, Joe Lieberman and John McCain.
More seriously, many pundits have attributed last year's Republican defeat to
Iraq, with the implication that once the war has receded as an issue, the right
will reassert its natural political advantage—in spite of polls that show a
large Democratic advantage on just about every domestic issue. ...
The question, however, is whether Democrats will take advantage of America's
new liberalism. To do that, they have to be ready to forcefully make the case
that progressive goals are right and conservatives are wrong. They also need to
be ready to fight some very nasty political battles.
And that's where the continuing focus of many people on Bush, rather than the
movement he represents, has become a problem.
A year ago, Michael Tomasky wrote a perceptive piece titled "Obama the
anti-Bush," in which he described Barack Obama's appeal: After the bitter
partisanship of the Bush years, Tomasky argued, voters are attracted to "someone
who speaks of his frustration with our polarized politics and his fervent desire
to transcend the red-blue divide." People in the news media, in particular, long
for an end to the polarization and partisanship of the Bush years—a fact that
probably explains the highly favorable coverage Obama has received.
But any attempt to change America's direction, to implement a real
progressive agenda, will necessarily be highly polarizing. Proposals for
universal health care, in particular, are sure to face a firestorm of partisan
opposition. And fundamental change can't be accomplished by a politician who
I like to remind people who long for bipartisanship that ... we got Social
Security because FDR wasn't afraid of division. In his great Madison Square
Garden speech, he declared of the forces of "organized money": "Never before in
all our history have these forces been so united against one candidate as they
stand today. They are unanimous in their hate for me—and I welcome their
So, here's my worry: Democrats, with the encouragement of people in the news
media who seek bipartisanship for its own sake, may fall into the trap of trying
to be anti-Bushes—of trying to transcend partisanship, seeking some middle
ground between the parties.
That middle ground doesn't exist—and if Democrats try to find it, they'll
squander a huge opportunity. Right now, the stars are aligned for a major change
in America's direction. If the Democrats play nice, that opportunity may soon be
Posted by Mark Thoma on Wednesday, December 26, 2007 at 09:36 AM in Economics, Politics |
Edward Glaeser notes that evidence on the relationship between trade openness and
economic growth is murky and thus doesn't
help much with the debate over how open trade should be:
Those Who Do Not Know the Past,
by Edward Glaeser, Commentary, NY Sun: Should developing countries embrace
free trade or shelter their nascent industries behind protectionist walls? This
debate has been going on for two centuries since Adam Smith faced off against
the mercantilists. Ha-Joon Chang's "Bad Samaritans" ... is a lively addition to
the protectionist side of the debate. ...
Mr. Chang's main charge is that free trade advocates from wealthy countries
are hypocrites, because the history of America and the United Kingdom is full of
protectionism. Mr. Chang alleges, with scant evidence, that the two nations grew
great because of these tariff barriers. First world economists have reaped the
benefits of protection, he suggests, but are now trying to deprive the world's
poor of the wonders of tariffs.
Mr. Chang also takes aim at other free market policies such as privatization
and fiscal prudence. Again he argues that since rich countries have public
ownership and deficits, it is rank hypocrisy for us to try to forbid them to the
poor. An alternative view is that economists shouldn't be required to endorse
the worst policies of their own countries. ...
The book would have made a more serious contribution if it shed more light on
whether American or English protectionism helped or harmed these countries. ....
Nineteenth-century America was protectionist, but that doesn't mean that
protectionism played a positive role in our nation's growth. Did American
protectionism really give us the textile mills of Lowell and the steel mills of
Pittsburgh? Did English tariffs really foster the spinning jenny and the steam
engine? The high physical costs of crossing the Atlantic in the age of sail made
it natural, with or without tariffs, for the Lowells to want to weave cotton on
this side of the pond.
Mr. Chang is going to have to do better than just point out that Americans
and Englishmen had tariffs to make the case that tariffs produced rowth. There
is a substantial empirical literature that looks at the relationship between
trade openness and economic development over the last 40 years. An early wave of
research, associated with Jeffrey Sachs among others, claimed that trade
openness increased growth. A second wave of research, led by Francisco Rodriguez
and Dani Rodrik ..., suggested that there was little robust connection across
countries between trade and growth. My own research in this area found that
openness had little impact on middle income places, but is particularly valuable
for the poorest places. Certainly, there is no empirical consensus that openness
is either good or bad for growth.
The lack of consensus on the connection between growth and openness does not
imply that Mr. Chang's protectionism is equally attractive as the open borders
urged by the Washington consensus. Adam Smith and David Ricardo didn't urge free
trade because trade begets growth, but because trade makes goods cheaper for
ordinary people. Smith's argument is still the strongest case for open borders.
Even if protectionism does encourage industrial growth, it only does so by
hurting ordinary people, who have to pay more to buy the goods of inefficient
Mr. Chang's protectionist brief suggests that the costs that tariffs impose
on ordinary consumers are worth paying since the government can use tariffs to
promote the right industries. Smith would have been skeptical about putting such
faith in the government, and today's developing countries certainly deserve no
more trust than the government of George III. Even if an incredibly wise tariff
policy could protect future economic dynamos, the history of tariffs suggests
that they are used more often to protect less than dynamic cronies.
The best thing to come out of this book is its challenge to the advocates of
free markets to explain why England and America did so well despite embracing
policies that were not always that free. Mr. Chang has not made the case that
those policies were helpful, but free marketers have an obligation to help us
understand why those policies did not do more harm.
Posted by Mark Thoma on Wednesday, December 26, 2007 at 12:33 AM in Economics, International Trade, Policy |
Robert Samuelson says the strong post World War II push toward open markets is beginning to fade:
The End of Free Trade, by Robert J. Samuelson, Commentary. Washington Post:
...[T]he "new mercantilism." [is] an ominous development affecting the world
economy. Even as countries become more economically interdependent, they're also
growing more nationalistic. They're adopting policies intended to advance their
own economic and political interests at other countries' expense. As practiced
until the mid-19th century, mercantilism aimed to do just that.
It was an economic philosophy that favored large trade surpluses. At the
time, this had some logic. Trade was an adjunct to military power. Exports
earned gold and silver coin, which financed armies and navies. But mercantilism
fell into disfavor as a way to promote national prosperity. Free trade, argued
Adam Smith and David Ricardo, would benefit all countries... The post-World War
II economic order took free trade as its ideal, even though trade barriers were
lifted slowly. Now mercantilism is making a comeback, as governments try to
manipulate markets to their advantage. ...
The paradox is that as the Internet and multinational companies strengthen
globalization, its political foundations are weakening. Of course, opposition is
not new. Even if free trade benefits most countries, some firms and workers lose
from added competition. But for most of the postwar era, a pro-trade consensus
neutralized this opposition. That consensus is now fraying.
Two powerful forces had shaped it, notes Harvard political scientist Jeffry
Frieden. First was the belief that protectionism worsened the Great Depression.
Everyone wanted to avoid a repetition of that tragedy. The second was the Cold
War. Trade was seen as a way of combating communism by promoting the West's
mutual prosperity. Both ideas bolstered political support for free trade. For
years the global trading system flourished on the inertia of these impulses,
whose relevance has faded.
In a booming world economy, the resulting tensions have so far remained
muted. China's discriminatory trade practices, for example, have excited angry
rhetoric, but not much else. ...
But would a global slowdown change that if other countries blamed Chinese
exports for destroying their domestic jobs? Would import quotas or tariffs
follow? ... In the United States, the present pattern of global trade is viewed
with increasing hostility: U.S. deficits are seen as eroding industrial jobs
while providing surplus countries with the dollars to buy large pieces of
The world economic order depends on a shared sense that most nations benefit.
The more some countries pursue narrow advantage, the more others will follow
suit. ... It's an open question whether these conflicting forces -- growing
economic interdependence and rising nationalism -- can coexist uneasily or are
on a collision course.
Posted by Mark Thoma on Wednesday, December 26, 2007 at 12:15 AM in Economics, International Trade, Policy, Regulation |
Posted by Mark Thoma on Wednesday, December 26, 2007 at 12:06 AM in Links |
Nouriel Roubini sees a hard landing ahead (though Jim Hamilton says "The
bears must wait another quarter"):
The Global Economy’s
Inevitable Hard Landing, by Nouriel Roubini, Project Syndicate: In recent
weeks, the global liquidity and credit crunch that started last August has
become more severe. ... To be sure, major central banks have injected dozens of
billions of dollars of liquidity into the commercial banking sector, and the US
Federal Reserve, the Bank of England, and the Bank of Canada have lowered their
interest rates. But worsening financial conditions prove that this policy
response has failed miserably.
So it is no surprise that central banks have become increasingly desperate...
The recent announcement of coordinated liquidity injections by the Fed and four
other major central banks is, to be blunt, too little too late.
These measures will fail ... because monetary policy cannot address the core
problems underlying the crisis. The issue is not just illiquidity – financial
institutions with short-term liabilities and longer-term illiquid assets. Many
more economic agents face serious credit and solvency problems, including
millions of households in the US, UK, and the Eurozone with excessive mortgages,
hundreds of bankrupt sub-prime mortgage lenders, a growing number of distressed
homebuilders, many highly leveraged and distressed financial institutions, and,
increasingly, corporate-sector firms.
At the same time, monetary injections cannot resolve the generalized
uncertainty of a financial system in which globalization and securitization have
led to a lack of transparency that has undermined trust and confidence. When you
mistrust your financial counterparties, you won’t want to lend to them, no
matter how much money you have.
The US is now headed towards recession, regardless of what the Fed does. ... Other economies will
also be pulled down as the US contagion spreads.
To mitigate the effects of a US recession and global economic slump, the Fed
and other central banks should be cutting rates much more aggressively... The
Fed’s 25-basis-point cut in December was puny relative to what is needed;
similar cuts by the Bank of England and Bank of Canada do not even begin to
address the increase in nominal and real borrowing rates that the sharp rise in
Libor rates has induced. Central banks should have announced a coordinated 50
basis-point reduction to signal their seriousness about avoiding a global hard
Likewise, the European Central Bank’s decision not to cut rates ... is
mistaken..., the ECB is virtually ensuring a sharp euro-zone slowdown.
In any case, the actions recently announced by the Fed and other central
banks are misdirected. Today’s financial markets are dominated by non-bank
institutions – investment banks, money market funds, hedge funds, mortgage
lenders that do not accept deposits, so-called “structured investment vehicles,”
and even states and local government investment funds – that have no direct or
indirect access to the liquidity support of central banks. All these non-bank
institutions are now potentially at risk of a liquidity run.
Indeed, US legislation strictly forbids the Fed from lending to
non-depository institutions, except in emergencies. But this implies a complex
and cumbersome approval process and the provision of high-quality collateral.
And never in its history has the Fed lent to non-depository institutions.
So the risk of something equivalent to a bank run for non-bank financial
institutions, owing to their short-term liabilities and longer-term and illiquid
assets, is rising – as recent runs on some banks (Northern Rock), money market
funds, state investment funds, distressed hedge funds suggests. There is little
chance that banks will re-lend to these non-banks the funds they borrowed from
central banks, given these banks’ own severe liquidity problems and mistrust of
Major policy, regulatory, and supervisory reforms will be required to clean
up the current mess and create a sounder global financial system. Monetary
policy alone cannot resolve the consequences of inaction by regulators and
supervisors amid the credit excesses of the last few years. So a US hard landing
and global slowdown is unavoidable. Much greater and more rapid reduction of
official interest rates may at best affect how long and protracted the downturn
Posted by Mark Thoma on Tuesday, December 25, 2007 at 03:42 PM in Economics, Housing, Monetary Policy, Regulation |
The transformation of St. Nicholas:
St. Nick in the Big City, by John Anthony McGuckin, Commentary, NY Times:
St. Nicholas was a super-saint with an immense cult for most of the Christian
past. There may be more icons surviving for Nicholas alone than for all the
other saints of Christendom put together. So what happened to him? Where’s the
fourth-century Anatolian bishop who presided over gift-giving to poor children?
And how did we get the new icon of mass consumerism in his place?
Well, it’s a New York story.
In all innocence, the morphing began with the Dutch Christians of New
Amsterdam, who remembered St. Nicholas from the old country and called him Sinte
Klaas. They had kept alive an old memory — that a kindly old cleric brought
little gifts to the poor in the weeks leading up to the Feast of the Nativity.
While the gifts were important, they were never meant to overshadow the message
of Jesus’s humble birth.
But today’s chubby Santa is not about giving to the poor. He has had his
saintly garb stripped away. The filling out of the figure, the loss of the
vestments, and his transformation into a beery fellow smoking a pipe combined to
form a caricature of Dutch peasant culture. Eventually this Magic Santa (a
suitable patron saint if there ever was one for the burgeoning capitalist
machinery of the city) was of course popularized by the Manhattanite Clement
Clarke Moore published in “A Visit From St. Nicholas,” in The Troy (New York)
Sentinel on Dec. 23, 1823.
The newly created deity Santa soon attracted a school of iconographers:
notable among them were Thomas Nast, whose 1863 image of a red-suited giant in
Harper’s Weekly set the tone, and Haddon Sundblom, who drew up the archetypal
image we know today on behalf of the Coca-Cola Company in the 1930s. This Santa
was regularly accompanied by the flying reindeer: godlike in his majesty and
presiding over the winter darkness like Odin the sky god returned.
The new Santa also acquired a host of Nordic elves to replace the small
dark-skinned boy called Black Peter, who in Christian tradition so loved St.
Nicholas that he traveled with him everywhere. But, some might say, wasn’t it
better to lose this racially stereotyped relic? Actually, no, considering the
real St. Nicholas first came into contact with Peter when he raided the slave
market in his hometown and railed against the trade. The story tells us that
when the slavers refused to take him seriously, he used the church’s funds to
redeem Peter and gave the boy a job in the church.
And what of the throwing of the bags of gold down the chimney, where they
landed in the stockings and little shoes that had been hung up to dry by the
fireplace? Charming though it sounds, it reflected the deplorable custom, still
prevalent in late Roman society when the Byzantine church was struggling to
establish the supremacy of its values, of selling surplus daughters into
bondage. This was a euphemism for sexual slavery — a trade that still blights
As the tale goes, Nicholas had heard that a father in the town planned to
sell his three daughters because his debts had been called in by pitiless
creditors. As he did for Black Peter, Nicholas raided his church funds to secure
the redemption of the girls. He dropped the gold down the chimney to save face
for the impoverished father.
This tale was the origin of a whole subsequent series of efforts among the
Christians who celebrated Nicholas to make some effort to redeem the lot of the
poor — especially children, who always were, and still are, the world’s
front-line victims. Such was the origin of Christmas almsgiving: gifts for the
poor, not just gifts for our friends.
I like St. Nicholas. You can keep chubby Santa.
Posted by Mark Thoma on Tuesday, December 25, 2007 at 12:33 AM in Economics, Miscellaneous |
Menzie Chinn is worried that the regulatory effort to prevent problems in mortgage markets from reemerging is failing to adequately address part of the
A Thought on the Sub-prime Debacle, by Menzie Chinn: Most of the
coverage of the subprime mess focused on Greenspan and the Federal Reserve
System. However, it's clear that regulation was deficient along other fronts.
From the NYT:
... The Fed was hardly alone in not pressing to clean up the mortgage
industry. When states like Georgia and North Carolina started to pass tougher
laws against abusive lending practices, the Office of the Comptroller of the
Currency successfully prohibited them from investigating local subsidiaries of
nationally chartered banks.
Virtually every federal bank regulator was loathe to impose speed limits on a
booming industry. But the regulators were also fragmented among an alphabet soup
of agencies with splintered and confusing jurisdictions. Perhaps the biggest
complication was that many mortgage lenders did not fall under any agency's
authority at all. ...
Ms. Bair was an exception, especially for the deregulation-minded Bush
administration. As a former assistant secretary of the Treasury in 2001 and
2002, she had worked with Mr. Gramlich to raise concerns about abusive lending
practices. Indeed, she tried to hammer out an agreement with mortgage lenders
and consumer groups over a tough set of "best practices" that would have covered
But that effort largely stalled because of disagreement. Though some big
lenders did endorse a broad code of conduct, she recalled, they soon began
loosening standards as competition intensified. ...
I think that as we learn more and more about the run-up to current situation,
we will find out that
"looting" was the relevant phenomenon. From
Akerlof and Paul Roemer's 1993 discussion of the S&L crisis, in the Brookings
Papers in Economic Activity:
"Our theoretical analysis shows that an economic underground can come to life
if firms have an incentive to go broke for profit at society's expense (to loot)
instead of to go for broke (to gamble on success). Bankruptcy for profit will
occur if poor accounting, lax regulation, or low penalties for abuse give owners
an incentive to pay themselves more than their firms are worth and then default
on their debt obligations.
Bankruptcy for profit occurs most commonly when a government guarantees a
firm's debt obligations. The most obvious such guarantee is deposit insurance,
but governments also implicitly or explicitly guarantee the policies of
insurance companies, the pension obligations of private firms, virtually all the
obligations of large or influential firms. ...[B]ankruptcy for profit can easily
become a more attractive strategy for the owners than maximizing true economic
Unfortunately, firms covered by government guarantees are not the only ones
that face severely distorted incentives. Looting can spread symbiotically to
other markets, bringing to life a whole economic underworld with perverse
incentives. The looters in the sector covered by the government guarantees will
make trades with unaffiliated firms outside this sector, causing them to produce
in a way that helps maximize the looters' current extractions with no regard for
Now instead of arguing against Fed intervention to try to mitigate the credit
crunch, on the grounds of discouraging "moral hazard", (in Krugman's lexicon,
that horse is already out the barn door) I would say we need to think now about
how to prevent the next bout of "looting".
That involves a much more complicated and difficult task of insulating the
regulatory authorities from political pressures (see "avoiding
It also probably requires expanding and integrating regulatory charters.
I'm not sure how one would do that. But I know how not to do it. From
Regulators appointed by President Bush often have been more sympathetic to
industry concerns about red tape than their Clinton administration predecessors.
When James Gilleran, a former California banker and bank supervisor, took over
the OTS in December 2001, he became known for his deregulatory zeal. At one
press event in 2003, several bank regulators held gardening shears to represent
their commitment to cut red tape for the industry. Mr. Gilleran brought a chain
He also early on announced plans to slash expenses to resolve the agency's
deficit; 20% of its work force eventually left. When he left in 2005, Mr.
Gilleran declared that the OTS had "exercised increased diligence in its review
of abusive consumer practices" while reducing thrifts' regulatory burden. ...
So, let's think constructively about preventing the next bout of looting,
even as we deal with the after-effects of the current bout.
Posted by Mark Thoma on Tuesday, December 25, 2007 at 12:24 AM in Economics, Financial System, Regulation |
Dean Baker on the similarities and differences among Democratic presidential
Challenging the powers that be, by Dean Baker, Comment is Free: It would be
difficult to identify much difference between the three leading Democratic
presidential candidates' positions on major economic issues. They have come
forward with comparable positions on taxes, healthcare and trade. ...
On taxes, all three candidates have said they want the wealthy to pay a
larger portion of the bill, which starts with taking back the Bush tax cuts on
families earning more than $200,000 a year. All three have proposed eliminating
various loopholes that primarily benefit the wealthy. Edwards has gone the
furthest in this respect, calling for raising the capital gains tax rate back to
the pre-Clinton level of 28%. This tax increase almost exclusively affects the
All three contenders have proposed a national healthcare system... Both
Clinton and Edwards would impose a mandate that everyone buy into this system.
Obama has claimed that he would not require a mandate. As a practical matter,
the healthcare system that any of them are able to put in place will depend on
the arms they twist and the pressure they can bring to bear against the
insurance companies, the pharmaceutical industry and other powerful actors who
will be hurt by real reform.
Any serious plan will require a mandate - this directly follows from its
requirement that insurers take all comers. Without a mandate, no one would buy
insurance until they had serious bills. This would be like letting people buy
car insurance after an accident, and then sending the company the bill. That
All three contenders have said that they want to break with the
Bush-Clinton-Bush trade agenda. ... What their position means in practice
remains to be seen. ... As a practical matter, the country has already gone
about as far as it can in placing its manufacturing workers in competition with
low-wage workers in the developing world. The impact of any future trade deals
on the US economy will be almost imperceptible.
A decline of the dollar by an additional 10% against the currencies of our
trading partners would swamp the impact of all currently pending trade deals. On
this issue there are likely to be substantial differences among the candidates.
Former Treasury secretary Robert Rubin is likely to be the guiding light for
economic policy in a Clinton or Obama administration. Rubin was the architect of
the high dollar policy of the 1990s... He remains an enthusiastic supporter of a
high dollar. Therefore Clinton or Obama would be more likely than Edwards to
sacrifice the jobs and wages of manufacturing workers in order to prop up the
Rubin's Wall Street agenda would also apply to other areas of economic
policy, most importantly the budget. Rubin places balanced budgets and even
budget surpluses at the centre of his economic vision. A push to a balanced
budget will seriously curtail the ability to extend healthcare coverage, promote
access to childcare, promote clean technologies and address other neglected
priorities. By contrast, Edwards has clearly stated that he does not view a
balanced budget as a priority... The willingness to accept deficits may prove
especially important in the context of an economy that could be in recession
when the next president takes office.
In short, Edwards has set himself apart from the other two top candidates by
indicating a clear willingness to challenge an agenda set on Wall Street. If a
President Edwards actually carried through with this course, he would pursue a
very different economic agenda than his two leading rivals.
Posted by Mark Thoma on Tuesday, December 25, 2007 at 12:15 AM in Economics, Politics |
Posted by Mark Thoma on Tuesday, December 25, 2007 at 12:06 AM in Links |
Is it smart, in the current political and economic environment, for Democrats
to distance themselves from unions?:
State of the Unions, by Paul Krugman, Commentary, NY Times: Once upon a
time, back when America had a strong middle class, it also had a strong union
These two facts were connected. Unions negotiated good wages and benefits for
their workers, gains that often ended up being matched even by nonunion
employers. They also provided an important counterbalance to the political
influence of corporations and the economic elite.
Today, however, the American union movement is a shadow of its former self,
except among government workers. ... Yet unions still matter politically. And
right now they’re at the heart of a nasty political scuffle among Democrats. ...
It’s often assumed that the U.S. labor movement died a natural death, that it
was made obsolete by globalization and technological change. But what really
happened is that beginning in the 1970s, corporate America ... in effect
declared war on organized labor. ...
But the times may be changing. A newly energized progressive movement seems
to be on the ascendant, and unions are a key part of that movement. Most
notably, the Service Employees International Union has played a key role in
pushing for health care reform. And unions will be an important force in the
Democrats’ favor in next year’s election.
Or maybe not — which brings us to the latest from Iowa.
Whoever receives the Democratic presidential nomination will receive labor’s
support in the general election. Meanwhile, however, unions are supporting
favored candidates. Hillary Clinton ... has received the most union support.
John Edwards, whose populist message resonates with labor, has also received
considerable labor support.
But Barack Obama, though he has a solid pro-labor voting record, has not — in
part, perhaps, because his message of “a new kind of politics” that will
transcend bitter partisanship doesn’t make much sense to union leaders who know,
from ... confronting corporations and their political allies head on, that
partisanship isn’t going away anytime soon.
O.K., that’s politics. But now Mr. Obama has lashed out at Mr. Edwards
because two 527s — independent groups ...— are running ads on his rival’s
behalf. They are, Mr. Obama says, representative of the kind of “special
interests” that “have too much influence in Washington.”
The thing, though, is that both of these 527s represent union groups — in the
case of the larger group, local branches of the S.E.I.U. who consider Mr.
Edwards the strongest candidate on health reform. So Mr. Obama’s attack raises a
couple of questions.
First, does it make sense, in the current political and economic environment,
for Democrats to lump unions in with corporate groups as examples of the special
interests we need to stand up to?
Second, is Mr. Obama saying that if nominated, he’d be willing to run without
support from labor 527s, which might be crucial to the Democrats? If not, how
does he avoid having his own current words used against him by the Republican
Part of what happened here, I think, is that Mr. Obama, looking for a stick
with which to beat an opponent who has lately acquired some momentum,... failed to think about how his rhetoric would affect the
eventual ability of the Democratic nominee, whoever he or she is, to campaign
effectively. In this sense, his latest gambit resembles his previous echoing of
G.O.P. talking points on Social Security.
Beyond that, the episode illustrates what’s wrong with campaigning on
generalities about political transformation and trying to avoid sounding
It may be partisan to say that a 527 run by labor unions supporting health
care reform isn’t the same thing as a 527 run by insurance companies opposing
it. But it’s also the simple truth.
Update: Krugman has two follow ups posts to this column, Obama goes Harry and Louise and Oy,
Posted by Mark Thoma on Monday, December 24, 2007 at 12:24 AM in Economics, Unemployment |
Richard Green wonders if there are measures of the cost of living that vary
according to income group:
Different Market Baskets for Different Income Levels, by Richard Green: I
keep reading stories about food pantries being under particular pressure this
year. The stories would be more helpful if they could explain explicitly why the
food stamp program (perhaps the most successful anti-poverty program in the US)
isn't sufficient to prevent this. We do know that not everyone eligible for food
stamps uses them, but this has always been true, and so wouldn't explain a
change in demand at the pantries; we need to look elsewhere for an explanation.
My suspicion is that an accurate measure of CPI would vary by income group.
The most obvious example is that low income people spend a higher fraction of
income on heat, electricity and transportation than higher income people. Even
if the entire CPI is flat, if the energy and transportation sectors see large
rises in prices, it will likely have a particularly large impact on the bottom
quintile of the income distribution, and hence cause real incomes within this
group to fall. Of course, gas and heating oil prices gave risen a lot over the
past couple of years.
When I look at the BLS web site, I don't find anything about different market
baskets for different income classes--I do wonder if there is something out
Anyone? The best I can do is this 1998 working paper from the IMF ("Is
the United States CPI Biased Across Income and Age Groups?," by S. Nuri
Erbas and Chera L. Sayers) showing that the CPI understates the true cost of
living for older and/or poorer households, and overstates the rate for younger
and/or richer households. See, in particular, Table 3, Tables I2 and I3 in the
appendix, and Chart 1.
I can think of public policy reasons to avoid having more
than one measure, e.g. the potential for perverse incentives when earning
additional income can change the CPI used to adjust income for changes in the cost of living, the cost of
calculating more than one measure, and the difficult theoretical, statistical, and political problem of defining official income classes (how many income classes, where to draw the line between classes, what income measure to use, what exclusions to allow, etc.). But even if problems such as these prevent us from actually implementing cost of living measures that differ by income group, the extent to which the market basket and the associated cost of living varies across income (and other) groups is an interesting and important question.
Posted by Mark Thoma on Monday, December 24, 2007 at 12:15 AM in Economics, Income Distribution, Inflation |
Posted by Mark Thoma on Monday, December 24, 2007 at 12:06 AM in Links |
I don't think Aaaron Edlin is a big fan of the market power
exploiting profit maximizers at Microsoft:
System That Stole Christmas, by Aaron Edlin, Project Syndicate: Before
asking for a new Windows PC this holiday season, remember the old adage: ''Be
careful about what you wish for."
In the best of all worlds, we would all benefit from the so-called ''network
effects'' that result from most people using the same software: everyone could
easily communicate with each other and teach each other how to use the software
efficiently. Unfortunately, since Microsoft uses network effects to maximize its
profits rather than to benefit users, the world it delivers is far from the
Consider Vista, yet another "great" new operating system that Microsoft
rolled out this year, together with Office 2007. The first person at my company
to use Vista was our Executive Vice-President. He was furious. Vista and Office
2007 came with his new Dell computer by default. Dell didn't ask: "Would you
prefer the old versions of the operating system and MS Office that you know how
to use?" So our VP got a shiny new computer that he didn't know how to use:
functions were rearranged, and keyboard shortcuts were different.
Think of the productivity cost of millions like him having to adjust to a new
system. Moreover, his coworkers couldn't read the Microsoft Word files that he
sent them in the new ".docx" format. They wrote back and asked him to resend
files in the older ".doc" format ― which might not have worked if he had
inadvertently used some new-fangled formatting feature.
To be sure, Microsoft does provide a patch that allows old versions of Office
to read the new ".docx" format. But Microsoft doesn't publicize it ― or warn you
if your Office 2007 file is about to become incompatible with older versions.
While Microsoft could have kept the traditional ".doc" as its default format
for MS Word, this would not have served its purpose: eventually, after enough of
the world pays for Office 2007, holdouts will be dragged along, kicking and
screaming. Then, in four or five years, Microsoft will begin our agony all over
Whenever Microsoft rolls out a new operating system, the question is not
whether you should switch, but when. Adding new features can speed the
transition, but what is necessary is only that the new system be incompatible
with existing systems in certain respects, and that a sufficient number of
people expect that it will become the new standard.
Of course, creating new software is costly. So why should Microsoft bother?
The Nobel laureate Ronald Coase answered that question long ago. According to
"the Coase Conjecture," a monopolist selling a durable good must sell it at
marginal cost. For Microsoft, the problem is that the marginal cost of software
is zero. As a result, Microsoft cannot extract anything close to its full
monopoly rents unless it sells upgrades. ...
So, by creating incompatibilities, some subtle and some obvious, that make
its old software obsolete, Microsoft can sell its operating systems at high
profit margins without fear that people will wait until the price drops. The
price will never drop, because Microsoft will just roll out a new system, again
at high profit margins.
Microsoft has been in antitrust trouble for 15 years, and ... it will
probably be in trouble again. When that happens, I hope the antitrust
authorities will consider a remedy that Ian Ayres, Hal Varian, and I devised.
Suppose Microsoft had to license its old software freely whenever it brings
out a new version. This would give the company an incentive to ensure that new
versions are compatible with and significantly better than old versions ―
otherwise the new versions wouldn't sell, or at least not easily. If Microsoft's
new software had to compete successfully at least against its old software, we
would know the world was improving.
In the meantime, I recommend installing the Microsoft
to your old computer and just suffering the devil you know.
Posted by Mark Thoma on Sunday, December 23, 2007 at 04:59 PM in Economics, Market Failure, Technology |
According to Gregory Clark, running out of fossil fuel may not reduce living
standards by as much as you might think:
Life after peak oil, by
Gregory Clark, Sacramento Bee: Oil prices have receded from their recent flirtation with $100 a barrel, but
... increased demand, high prices and the prospect of an eventual peak in oil
production has caught Americans paralyzed between ... the fear that rampant
consumption of oil and coal is irreversibly warming the Earth and the dread that
without cheap oil our affluent lifestyles will evaporate. ...
Study of the long economic history of the world suggests two things, however.
Cheap fossil fuels actually explain little of how we got rich since the
Industrial Revolution. And after an initial period of painful adaptation, we can
live happily, opulently and indeed more healthily, in a world of permanent
$100-a-barrel oil or even $500-a-barrel oil. ...
Many people think mistakenly that modern prosperity was founded on this
fossil energy revolution, and that when the oil and coal is gone, it is back to
the Stone Age. If we had no fossil energy, then we would be forced to rely on an
essentially unlimited amount of solar power, available at five times current
energy costs. With energy five times as expensive ... we would take a
substantial hit to incomes. Our living standard would decline by about 11
percent. But we would still be fantastically rich compared to the pre-industrial
world. ... Our income would still be above the current living standards in
Canada, Sweden or England. Oh, the suffering humanity! At current rates of
economic growth we would gain back the income losses from having to convert to
solar power in less than six years. ...
The ability to sustain such high energy prices at little economic cost
depends on the assumption that we can cut back from using the equivalent of six
gallons of gas per person per day to 1.5 gallons. Is that really possible? The
answer is that we know already it is.
The economy would withstand enormous increases in energy costs with modest
damage because energy is even now so extravagantly cheap that most of it is
squandered in uses of little value. Recently, I drove my 13-year-old son 230
miles round-trip ... to play a 70-minute soccer game. Had every gallon of gas
cost [considerably more], I am sure his team could have found opposition closer
The median-sized U.S. home is now nearly 2,400 square feet, for an average
family size of 2.6 people... Much of that heated, air-conditioned and lighted
square footage rarely gets used. Cities ... that were developed in the world of
cheap gas have sprawled across the landscape so that the only way to get to work
or to shops is by car...
Some countries in Europe, such as Denmark, which have by public policy made
energy much more expensive, already use only the equivalent of about three
gallons of gas per person. I have been to Copenhagen, and believe me the Danes
are not suffering a lot from those the daily three gallons of gas they gave up.
But can we get down to 1.5 gallons without huge pain? We can see even now
communities where for reasons of land scarcity people have been forced to adopt
a lifestyle that uses much less energy – places like Manhattan, London or
Singapore. ... Housing space per person is much smaller, people walk or take
public transit to work and to shop, and energy usage is correspondingly much
lower, despite the inhabitants being very rich.
So the future after peak oil will involve living in such dense urban settings
where destinations are walkable or bikeable, just as in pre-industrial cities
(the city of London in 1801 had 100,000 inhabitants in one square mile). Homes
will be much smaller... Nights will be darker. We will not have retail outlets
lit up like the glare of the midday sun in Death Valley.
Such a lifestyle is not only possible it will be much healthier. We are not
biologically adapted to the suburban lifestyle... – lots of cheap calories
delivered right to your seat in the SUV that shuttles you from your sofa at
home, to your chair at work, to the gym where you try and work on your weight
So life after peak oil should hold no terror for us – unless, of course, you
have invested in a lot of suburban real estate.
Posted by Mark Thoma on Sunday, December 23, 2007 at 02:16 AM in Economics, Oil |
An article in The Economist raises familiar objections to
evidence of rising inequality and claims that people such as Krugman have been
misled on the issue. Krugman, in response, explains the "four dodges" present in the article and I added a couple of points in rebuttal as well:
The new (improved) Gilded Age, The Economist: ...Paul Krugman ...
has recently argued that contemporary America's widening income gap is ushering
in a new age of invidious inequalities. But a peek at the numbers behind the
numbers suggests that Mr. Krugman has been misled: far from a new Gilded Age,
America is experiencing a period of unprecedented material equality.
This is not to deny that income inequality is rising... But measures of
income inequality are misleading because an individual's income is, at best, a
rough proxy for his or her real economic wellbeing. ... Consumption surveys,
which track what people actually spend, sketch a more lifelike portrait of the
material quality of life. According to one 2006 study, by Dirk Krueger ... and
Fabrizio Perri ..., consumption inequality has barely budged for several
decades, despite a sharp upswing in income inequality.
But consumption numbers, too, conceal as much as they illuminate. They can
record only that we have spent, but not the value—the pleasure or health—gained
in the spending. A stable trend in nominal consumption inequality can mask a
narrowing of real or “utility-adjusted” consumption inequality. Indeed,
according to happiness researchers, inequality in self-reported “life
satisfaction” has been shrinking in wealthy market democracies ... suggesting
that the quality of lives across the income scale are becoming more similar, not
You can see this levelling at work in markets for transport and appliances.
You no longer need be a Vanderbilt to own a refrigerator or a car. Refrigerators
are now all but universal in America, even though refrigerator inequality
continues to grow. The Sub-Zero PRO 48, which the manufacturer calls “a monument
to food preservation”, costs about $11,000, compared with a paltry $350 for the
IKEA Energisk B18 W. The lived difference, however, is rather smaller than that
between having fresh meat and milk and having none. Similarly, more than 70% of
Americans under the official poverty line own at least one car. And the distance
between driving a used Hyundai Elantra and a new Jaguar XJ is well nigh
undetectable compared with the difference between motoring and hiking through
the muck. ...
This compression is not a thing of the past. ... Wal-Mart's move into the
grocery business has lowered food prices. ... As a rule, when the prices of
food, clothing and basic modern conveniences drop relative to the price of
luxury goods, real consumption inequality drops. But the point is not that in
America the relatively poor suffer no painful indignities, which would be
absurd. It is that, over time, the everyday experience of consumption among the
less fortunate has become in many ways more similar to that of their wealthier
compatriots. A widescreen plasma television is lovely, but you do not need one
to laugh at “Shrek”. ... New technologies and knock-off fashions now spread down
the price scale too fast to distinguish the rich from the aspiring for long.
This increasing equality in real consumption mirrors a dramatic narrowing of
other inequalities between rich and poor, such as the inequalities in height,
life expectancy and leisure. ...
Some worrying inequalities, such as the access to a good education, may
indeed be widening, arresting economic mobility for the least fortunate and
exacerbating income-inequality trends. Yet even if you care about those aspects
of income inequality, the idea can send misleading signals about the underlying
trends in real consumption and the real quality of life. Contrary to Mr
Krugman's implications, today's Gilded Age income gaps do not imply Gilded Age
Here is Paul Krugman's response:
Inequality denial, by Paul Krugman: Well, there they go again. The Economist
has a piece
asserting, as a critique of Conscience of a Liberal, that rising
income inequality hasn’t translated into a big rise in social inequality. It’s
actually an argument I take on explicitly in Chapter 12 . But The Economist
nonetheless rounds up the usual suspects.
Inequality denial generally involves four dodges — all four of which are
present in this article.
Continue reading "The New Gilded Age" »
Posted by Mark Thoma on Sunday, December 23, 2007 at 01:17 AM in Economics, Income Distribution |
Posted by Mark Thoma on Sunday, December 23, 2007 at 12:06 AM in Links |
Greg Mankiw says the Fed doesn't need any help from fiscal policy in fighting a possible recession, not yet
How to Avoid Recession? Let the Fed Work, by N. Gregory Mankiw, Economic View,
NY Times: The economy is teetering on the edge. Many economists, as well as online
betting sites, put the risk of recession next year at about 50 percent. Once we
get the final numbers, we might even learn that a recession has already begun.
The question on the minds of many in Congress and in the White House is this:
What they should be doing now to keep the economy on track? The right answer:
This advice isn’t easy for politicians to follow. Because economic downturns
mean fewer jobs and falling incomes, they are painful... Voters can confuse
inaction with nonchalance and send incumbents packing. But..., voters should be
wary of politicians eager to treat every economic ill. Sometimes, ...
wait-and-see [is] the best we can do.
Congress made its most important contribution to taming the business cycle
back in 1913, when it created the Federal Reserve System. Today, the Fed remains
the first line of defense against recession.
The Fed’s control over the money supply is a powerful lever to move overall
demand for goods and services. ... The influence of interest rates on the
economy is particularly strong in housing, where buyers are rate-sensitive.
Because housing woes are the source of the current slowdown, the Fed’s tool kit
is well suited for the task at hand.
The recession-fighting effects of monetary expansion, however, are not
limited to the housing market. When lower interest rates make fixed-income
investments less attractive, investors turn to the equity market and bid up
stock prices. Higher stock prices, in turn, make consumers wealthier and more
eager to spend. They also make it easier for corporations to expand their
businesses with equity financing.
By making United States bonds less attractive to world investors, lower
interest rates from a monetary expansion also weaken the dollar in currency
markets. A depreciation of the currency is not in itself to be feared. ...
A weak currency is a problem if it results from investors losing confidence
in an economy. The most damaging cases are the episodes of sudden capital
flight... This outcome is unlikely for the fundamentally sound American economy,
but fear of it is one reason that Treasury secretaries maintain public fealty to
a strong dollar.
But if a weakened currency comes about because the central bank is trying to
stimulate a lackluster economy, ... depreciation is not a malady but just what
the doctor ordered. A weaker currency makes domestic goods more competitive...
The dollar’s falling value is one reason exports of goods and services have
grown more than 10 percent in the past year.
The Fed constantly monitors all these developments to ensure that the economy
has the stimulus it needs, but not too much. ... As the economy flirts with
recession, ... the ... Fed has cut its target for the benchmark federal fund
rates to 4.25 percent from 5.25 percent last summer. It is a good bet that we
will see further cuts... And if the chance of a recession turns into a real
recession, you can count on it.
Admittedly, monetary policy can sometimes use an assist from fiscal policy.
If an economic downturn is deep, if a recovery is anemic or if the Fed is
running out of ammunition, Congress can help raise aggregate demand for goods
and services. In 2003, the Fed had cut its target interest rate all the way to 1
percent, the economy was still suffering..., and there were increasing worries
about deflation. A tax cut was a good complement to monetary expansion to get
the economy going again...
Today’s situation is different. The Fed has plenty of room to cut rates
further, if it deems such cuts necessary. At the moment, recession is only a
possibility, and inflation is a bigger worry than deflation. In this
environment, there is no need for a short-run fiscal stimulus. Congress is
better off focusing on longer-term problems...
The Fed is now coming under heat for not having prevented the subprime
crisis, for not fully anticipating it once it was inevitable, and for not
responding more vigorously now that it has occurred. Daniel Gross ... has gone
so far as to liken the Fed and its chairman, Ben S. Bernanke, to FEMA and its
erstwhile head Michael Brown.
The truth is that the current Fed governors, together with their crack staff
of Ph.D. economists and market analysts, are as close to an economic dream team
as we are ever likely to see. They will make their share of mistakes, but it is
too easy to find flaws when judging with the benefit of hindsight. The best
Congress can do now is to let the Bernanke bunch do its job.
I am not as sure as Greg is that falling interest rate will provide the
needed stimulus in this economic environment, and thus I would think it prudent
to begin planning and setting contingency plans for fiscal policy, plans that
can be implemented immediately should things begin to look any worse. If we
wait, given the recognition, legislative, implementation, and effectiveness lags
in fiscal policy, it may be too late to react once the signs of a more severe
problem are evident. Hopefully, we won't need to use fiscal policy, but just in case, we should be ready.
Posted by Mark Thoma on Saturday, December 22, 2007 at 04:50 PM in Economics, Monetary Policy, Policy |
Should U.S. citizens be forced to vote?:
A vote rule to rein in the free riders, by Peter Singer, Project Syndicate:
As an Australian citizen, I voted in the recent federal election there. So did
about 95 per cent of registered Australian voters. That figure contrasts
markedly with elections in the United States, where the turnout in the 2004
presidential election barely exceeded 60 per cent. In congressional elections
that fall in the middle of a president's term, usually fewer than 40 per cent of
eligible Americans bother to vote. There is a reason why so many Australians
vote. In the 1920s, when voter turnout fell below 60 per cent, parliament made
voting compulsory. Since then, despite governments of varying political
complexions, there has been no serious attempt to repeal the law, which polls
show is supported by about 70 per cent of the population. ...
In practice, what is compulsory is not casting a valid vote, but going to the
polling place, having one's name checked off, and putting a ballot paper in the
box. The secrecy of the ballot makes it impossible to prevent people writing
nonsense on their ballot papers or leaving them blank. While the percentage of
invalid votes is a little higher where voting is compulsory, it comes nowhere
near offsetting the difference in voter turnout. Compulsory voting is not unique
to Australia. Belgium and Argentina introduced it earlier, and it is practised
in many other countries, especially in Latin America, although both sanctions
and enforcement vary. ...
When voting is voluntary, and the chance that the result will be determined
by any single person's vote is extremely low, even the smallest cost -- for
example, the time it takes to stroll down to the polling place, wait in line,
and cast a ballot -- is sufficient to make voting seem irrational. Yet if many
people follow this line of reasoning, and do not vote, a minority of the
population can determine a country's future, leaving a discontented majority.
If we don't want a small minority to determine our government, we will favour
a high turnout. Yet, since our own vote makes such a tiny contribution to the
outcome, each of us still faces the temptation to get a free ride, not bothering
to vote while hoping that enough other people will vote to keep democracy robust
and to elect a government that is responsive to the views of a majority of
But there are many possible reasons for voting. Some people vote because they
enjoy it... Others are motivated by a sense of civic duty that does not assess
the rationality of voting in terms of the possible impact of one's own ballot.
Still others might vote not because they imagine that they will determine the
outcome of the election, but because, like football fans, they want to cheer
their team on. They may vote because if they don't, they will be in no position
to complain if they don't like the government that is elected. Or they may
calculate that while the chances of their determining the outcome are only one
in several million, the result is of such importance that even that tiny chance
is enough to outweigh the minor inconveniences of voting.
If these considerations fail to get people to the polls, however, compulsory
voting is one way of overcoming the free-rider problem. The small cost imposed
on not voting makes it rational for everyone to vote and at the same time
establishes a social norm of voting.
Australians want to be coerced into voting. They are happy to vote, knowing
that everyone else is voting, too. Countries worried about low voter turnout
would do well to consider their compulsory model.
As much as I'd like to see turnout go up, I can't support compulsory voting.
It's not because of any worry that voters will be uninformed, irrational, or
anything like that, it's more that it seems like an impingement on freedom.
Posted by Mark Thoma on Saturday, December 22, 2007 at 01:08 AM in Economics, Politics |
Guido Tabellini presents new evidence on the role of morals for economic
Morality matters for
economic performance, Guido Tabellini, Vox EU: Economic backwardness is typically associated with a wide range of
institutional, organisational and government failures – and these along many
dimensions. In numerous poor or stagnating countries, politicians are
ineffective and corrupt, public goods are under-provided and public policies
confer rents to privileged élites, law enforcement is inadequate, and moral
hazard is widespread inside public and private organisations. There is not just
one institutional failure. Typically, the countries or regions that fail in one
dimension also fail in many other aspects of collective behaviour.
An influential body of research in economic history, political economics and
macroeconomics has shown that both economic and institutional backwardness are
often a by-product of history – appearing in countries or regions that were
ruled centuries ago by despotic governments, or where powerful élites exploited
uneducated peasants or slaves (North 1981, Acemoglu, Johnson and Robinson 2001).
But what is the mechanism through which distant political and economic history
shapes the functioning of current institutions?
In a recent working paper (Tabellini 2007), I argue that to answer this
question we have to look beyond pure economic incentives, and think about other
factors motivating individual behaviour. One of these factors is morality.
Conceptions of what is right or wrong, and of how one ought to behave in
specific circumstances, exert a strong influence on behavioural aspects that
directly affect economic outcomes. The list included voters' demands and
expectations, citizens' participation in group activities, the extent of moral
hazard inside public organisations, and the willingness of individuals to
provide public goods.
Values also evolve slowly over time, as they are largely inherited from
previous generations. Thus morality, defined as individual values and
convictions about the scope of application of norms of good conduct, is an
important channel through which distant political history can influence the
functioning of current institutions.
Continue reading "Morality and Economic Performance" »
Posted by Mark Thoma on Saturday, December 22, 2007 at 12:24 AM in Economics |
Posted by Mark Thoma on Saturday, December 22, 2007 at 12:06 AM in Links |
From Free Exchange, a discussion of immigration reform and guest worker programs:
Visitation rights, by Free Exchange: However one feels about the politics of immigration, there can be no question
that giving migrants from poor nations the ability to work in rich countries
constitutes a massive upward mobility event and a significant source of aid to
developing nations. It would therefore be a welcome turn of events if developed
nations could find a politically acceptable way to accommodate such labour
In next month's issue of Reason, Kerry Howley makes an important
to the discussion in constructing a compelling case for the adoption of a guest
worker programme. Using Singapore's system as a case study, she helpfully notes
the advantages and drawbacks of temporary residence visas in a piece that comes
across primarily as a challenge to pro-immigrant groups on the left, who tend to
oppose guest worker programmes as inimical to the American ideal and a poor
substitute for a general liberalisation of border policies.
Certainly there's something to that. The potential gains to invited labourers
should appeal to liberal sensibilities... Ms Howley ... recognises the potential for abuse--both of the
programme's terms and of workers themselves--in such a system, but she argues
convincingly that these difficulties can be overcome through appropriate
regulation of the process... Just
as important, she makes the point that an easier path into the American labour
market should facilitate the return of immigrant labourers to their home
country, as they needn't fear being shut out for good upon exiting.
Reading Ms Howley, one begins to bristle at the pettiness of liberal guest
worker critics, who place their moral qualms regarding the corrupting influence
of a large population of "second-class citizens" above concerns for the material
well-being of poor labourers. This, however, is ... not an accurate description of the state of anti-immigration sentiment
on the talk-show right. Rather, one hears again and again of the growing use of
Spanish, the questionable loyalties of incoming migrants, and the negative
effects they have on "traditional" American neighbourhoods. The most outspoken
nativists, like Republican presidential candidate Tom Tancredo, call for
reductions in legal immigration as well as illegal.
The conflict at the bottom of immigration disagreements, then, is not
primarily economic, but cultural. Immigration opponents on the right detest the
otherness of the immigrant, and a guest worker programme does nothing to
eliminate that sentiment. In the end, immigration reform did not fail in America
due to liberal quandaries on the ethics of guest worker programs; it failed
because the Republican Party took a hard right turn on the issue. It seems odd
to assume Republican intransigence and argue that Democratic politicians should
pursue a guest-worker middle ground, when the real angst on the right is not
over the status of the immigrants but their very presence.
Ms Howley does point out that the American public, in general, is amenable to
a guest worker program. In general, polling on the issue
indicates that a hardline position on immigration is a loser for Republican
candidates. All the same, it is the position which has come to dominate the
agenda of the national party. ... As it stands, I
think liberal politicians are justified in worrying that a willingness to
entertain a second-class role for immigrant labour may only empower the ugliest
elements of the nativist movement.
A guest worker programme also leaves some of the most troublesome policy
problems unaddressed. What, for example, should we do about the millions of
undocumented workers already in the country? Are we willing to issue enough
temporary visas to satisfy the demand for work in America? Otherwise, we can
expect the flow of undocumented workers to continue... Is it conceivable that
Americans could tolerate the strict, even ruthless rigorousness with which
Singapore polices its guest worker program? And if guest workers come, work
hard, and wish to stay, then what? ...
Given the large and growing immigrant population in this
country, and a demonstrated willingness among immigrant groups to stand up for
their interests, the debate over a guest worker program may soon enough be moot.
In 2006, Republican candidates running on a restrictionist platform performed
dismally... Ultimately, it seems probable that the Republicans will do the
compromising, or the losing, or perhaps both.
From an economic standpoint, as I believe Ms Howley would agree, a guest
worker programme is the second best-outcome. Constraints on labour mobility
reduce the efficiency of resource allocations and impede development, while
forcing governments to spend billions policing lines in the desert. If a guest
worker programme is also politically second best--if Democrats can increase
their majorities by letting Republicans hang themselves with a restrictionist
rope--then the best advice may well be to wait until next year and see if we
cannot do better than second best.
Posted by Mark Thoma on Friday, December 21, 2007 at 03:33 PM in Economics, Immigration, Policy, Unemployment |
Since I'm on the road today, this caught my attention. Apparently, there's a reason for traffic jams that seem to occur for no reason at all:
Traffic jam mystery solved by mathematicians, EurekAlert: Mathematicians ...
have solved the mystery of traffic jams by developing a model to show how major
delays occur on our roads, with no apparent cause. Many traffic jams leave
drivers baffled as they finally reach the end of a tail-back to find no visible
cause for their delay. Now, a team of mathematicians from the Universities of
Exeter, Bristol and Budapest, have found the answer and published their
Continue reading ""Traffic Jam Mystery Solved"" »
Posted by Mark Thoma on Friday, December 21, 2007 at 02:07 PM in Economics |
The ideological basis for the subprime crisis:
Blindly Into the Bubble, by Paul Krugman, Commentary, NY Times: When
announcing Japan’s surrender in 1945, Emperor Hirohito famously explained...:
“The war situation has developed not necessarily to Japan’s advantage.”
There was a definite Hirohito feel to the explanation Ben Bernanke ... gave
this week for the Fed’s locking-the-barn-door-after-the-horse-is-gone decision
to modestly strengthen regulation of the mortgage industry: “Market discipline
has in some cases broken down, and the incentives to follow prudent lending
procedures have, at times, eroded.”
That’s quite an understatement. In fact, the explosion of “innovative” home
lending ... was an unmitigated disaster. ... Apologists for the mortgage
industry claim, as Mr. Greenspan does..., that “the benefits of broadened home
ownership” justified the risks of unregulated lending.
But homeownership didn’t broaden. The great bulk of dubious subprime lending
took place from 2004 to 2006 — yet homeownership rates are already back down to
mid-2003 levels. With millions more foreclosures likely, it’s a good bet that
homeownership will be lower at the Bush administration’s end than it was at the
Meanwhile, during the bubble years, the mortgage industry lured millions of
people into borrowing more than they could afford, and simultaneously duped
investors into investing vast sums in risky assets wrongly labeled AAA. ... So
where were the regulators as one of the greatest financial disasters since the
Great Depression unfolded? They were blinded by ideology. ...
Mr. Greenspan... [is] a disciple of Ayn Rand, the high priestess of
unfettered capitalism... In a 1963 essay for Ms. Rand’s newsletter, Mr.
Greenspan dismissed as a “collectivist” myth the idea that businessmen, left to
their own devices, “would attempt to sell unsafe food and drugs, fraudulent
securities, and shoddy buildings.” On the contrary, he declared, “it is in the
self-interest of every businessman to have a reputation for honest dealings and
a quality product.”
It’s no wonder, then, that he brushed off warnings about deceptive lending
practices... In Mr. Greenspan’s world, predatory lending — like attempts to sell
consumers poison toys and tainted seafood — just doesn’t happen.
But Mr. Greenspan wasn’t the only top official who put ideology above public
protection. Consider the press conference held on June 3, 2003 — just about the
time subprime lending was starting to go wild — to announce a new initiative
aimed at reducing the regulatory burden on banks. Representatives of four of the
five government agencies responsible for financial supervision used tree shears
to attack a stack of paper representing bank regulations. The fifth
representative, James Gilleran of the Office of Thrift Supervision, wielded a
Also in attendance were representatives of financial industry trade
associations, which had been lobbying for deregulation. As far as I can tell...,
there were no representatives of consumer interests on the scene.
Two months after that event the Office of the Comptroller of the Currency,
one of the tree-shears-wielding agencies, moved to exempt national banks from
state regulations that protect consumers against predatory lending. If, say, New
York State wanted to protect its own residents — well, sorry, that wasn’t
Of course, now that it has all gone bad, people ... are rethinking their
belief in the perfection of free markets. Mr. Greenspan has come out in favor
of, yes, a government bailout. “Cash is available,” he says — meaning taxpayer
money — “and we should use that in larger amounts, as is necessary, to solve the
problems of the stress of this.”
Given the role of conservative ideology in the mortgage disaster, it’s
puzzling that Democrats haven’t been more aggressive about making the disaster
an issue for the 2008 election. They should be: It’s hard to imagine a more
graphic demonstration of what’s wrong with their opponents’ economic beliefs.
Posted by Mark Thoma on Friday, December 21, 2007 at 12:33 AM in Economics, Financial System, Housing, Regulation |
As noted below, lenders are concerned that there has been a change in the
willingness of homeowners to walk away from their mortgage contracts. Why is this happening? The decision to
walk away from a mortgage can be viewed as an unexercised option contract, and
that approach can shed light on the source the change in the number of homeowners choosing to default.
I'm sure most of you know what an option contract is, but just in case, here' a
quick review. There are two types of options, calls and puts. A
gives you the right to purchase an asset at a pre-specified price, called the
strike or exercise price. The purchase must be made on or before a specific
expiration date. For example, a March call option for Google stock with an
exercise price of $75 gives you the option to purchase Google stock for $75 at
any time up to and including the March expiration date. It doesn't matter what
the actual market price of the stock is, you can always purchase at $75 so long
as it's on or before the expiration date (there are actually two types of
options, an American call option gives you the option to purchase the stock up to and including the
expiration date, a European option can only be exercised on the expiration date,
Options do not have to be exercised, the holder of the option chooses whether to exercise it or not. When would this option be exercised?
Suppose the price of the stock increases to $100 after you purchase the option
(when the market price of the stock exceeds the strike price it is said to be
"in the money"). If you choose to exercise the option and purchase at $75, you
could then sell the stock at $100 on the market making a gross gain of $25.
Thus, whenever the market price exceeds the exercise price, the option is in the
money and can be redeemed for a gain.
The purchase price of the option is called the premium. There are ways to
value options and set the premium, and I will skip that, but let's just say that
the price of the option, i.e. the premium, is $10 for illustration.
Recapping, you purchase a call option for $10 that allows you to buy the
stock for $75 at any time between now and March. Then, after the option is
purchased but before the expiration date, the stock rises to $100 so you
exercise the option making a profit of $25-$10=$15. [If, on the other hand, the
price never rises above $75 before expiration date in March, the option will be left
unexercised and you will lose your $10.]
option is just the opposite, an option to sell rather than buy at a
specified price on or before a specified date. For example, you might pay $10
for the right to sell the stock at $75 at any time through March, i.e. you hold
a March put option. In this case, the option will be exercised only if the stock
price falls below the exercise price. Thus, if the price falls to $50,
you can buy the stock for $50 on the stock market, then turn around and sell it
for $75 according to the option contract realizing a profit of $25-$10=$15.
However, if the price stays above the exercise price, the option will remain
unexercised through the end of the contract. [If my quick explanations aren't clear, the Wikipedia explanations linked above might help.]
Now, how does this relate to walking away from a mortgage? A mortgage
contract grants an implicit call option contract to the borrower. [Any non-recourse
loan backed by collateral has this property. A non-recourse loan means the
lender may not sue the borrower for further payment beyond the value of the
collateral even if the collateral is not enough to cover the loan]. To put the mortgage in
option terms, think of the borrower as turning over the collateral (the house)
to the lender with the option to reclaim the collateral by repaying the loan. If
the loan is not repaid, if the borrower uses the option to walk away, then the
lender keeps the collateral (is stuck with the house).
When should the borrower walk away? If the value of the loan is less than the
value of the collateral, the best option for the borrower is to leave the option
unexercised, i.e. to walk away without using the option to repay the loan and claim the collateral (you want the house only if it's worth more than the loan). I should note,
however, that this abstracts from any future reputational effects (i.e. a bad
credit rating in the future represents a cost that must be considered) or ethical
behavior (you pay the loan even if it costs more than the collateral is worth to
honor the contract you signed). That is, this is the case where the borrower and lender
agree in advance that walking away is not a sign of bad faith. If that is not
true, if walking away has future costs or is constrained by ethics, this must be
considered in the analysis. But both the reputational and ethical effects are
easy to incorporate, it just means that the loan value must exceed the
collateral value by some critical amount (by the value of losing reputation or
behaving unethically) before the borrower will choose to walk away from the
Interestingly, there are indications that the reputational or ethical effects
are becoming less of a constraint to borrowers walking away:
Jingle mail, jingle mail, jingle mail — eek!, by Paul Krugman: Via
Calculated Risk: The
WSJ reports that homeowners whose mortgages are bigger than their houses are
worth are starting to walk away from their houses, even if they could afford the
mortgage payments. ...
Here's a bit
more from CR:
One of the greatest fears for lenders (and investors in mortgage backed
securities) is that it will become socially acceptable for upside down middle
class Americans to walk away from their homes.
See these comments from Bank of America CEO Kenneth Lewis via the WSJ:
Borrowers With Good Credit Pose Risks
"There's been a change in social attitudes toward default," Mr. Lewis says.
Bankers typically have believed that cash-strapped borrowers would fall behind
on their credit cards, car payments and other debts -- but would regard mortgage
defaults as calamities to be avoided at all costs. That isn't always so anymore,
"We're seeing people who are current on their credit cards but are defaulting
on their mortgages," Mr. Lewis says. "I'm astonished that people would walk away
from their homes." The clear implication: At least a few cash-strapped borrowers
now believe bailing out on a house is one of the easier ways to get their
finances back under control.
... there is a new class of homeowners in name only. Because these people
never put up much of their own money, they don't act like owners, committed to
their property for the long haul. ...
So, there are three separate factors that could contributing to the increase
in homeowners walking away from mortgage contracts, a fall in the price, a
decreased concern with future reputation, and a decline in ethical behavior.
Obviously the fall in price is a big factor, and it appears that an unexpected
fall in the ethical or reputational effects may be contributing as well.
The last question to ask, I suppose, is why has there been a decline in the
stigma from walking away? One potential reason is that the news media has played this
as largely arising from predatory behavior by lenders, and therefore going into
default is not seen as a personal failing as in the past, but rather as being a victim of
unscrupulous behavior. Second, mortgage problems are being reported as
widespread, not isolated, and the "everyone else is doing it" effect lessens the
stigma. Third, that a more general decline in social behavior has caused what's individually rational from an economic perspective to be valued more, and concerns based upon the social stigma from being a "deadbeat" valued less. That is, general societal changes have caused individualism to become more important, and social interactions (e.g. what other people think of you) less important. But I'm not so sure about the last one, or that the three together capture all of the reasons for the change in
behavior. Any other ideas?
Posted by Mark Thoma on Friday, December 21, 2007 at 12:24 AM in Economics, Housing |
Posted by Mark Thoma on Friday, December 21, 2007 at 12:06 AM in Links |
Menzie Chinn's post on the pro-cyclical nature of state and local government
that Four Reasons Why Recession May be Averted," reminded me of this
editorial written by a colleague exactly six years ago. Menzie is analyzing and
disputing a claim that robust state and local government spending will help to avert a
recession. As he notes, due to reasons such as balanced budget requirements at the state and local levels and borrowing constraints, in recessions revenues fall as income falls, and since the budget must be balanced, spending falls as well (and the fall in property taxes in the current case could make things worse than usual). This is about Oregon, but
the principles apply to all state and local government spending where
budgets are required to be in balance year by year. [For a bit of background, in
Oregon (where there is no sales tax) if state revenues are more than 2% above
the forecasted amount, the entire amount of the surplus must be refunded
to taxpayers - I received a check a couple of weeks ago since revenues have been
higher than anticipated this year even though future finances are in question if
the economy falls into a recession. It works the other way too - if revenues are too low there are automatic cuts in state spending. This editorial was written when state and local government services were being cut by quite a bit due to revenue problems from the 2001 recession.]:
Commentary: State badly needs a rainy day fund, by George Evans, Commentary, The
Register-Guard, December 20, 2001: Oregon's budget crisis is the direct
result of the lack of a rainy day fund and indirectly due to past tax kickers.
The principle of the rainy day fund is simple: income tax revenue automatically
rises in boom times and falls in recessions, so common sense and a sound
economic policy dictate that part of the revenue during periods of strong growth
be set aside in a special fund to finance expenditures in recessions.
This is common sense, because it is a principle that would be
followed by a prudent household facing systematic fluctuations in income. It is
sound economics because it helps to smooth government expenditures and stabilize
the state economy. Economists agree that government budgets should also be
balanced over the business cycle, running surpluses in booms and using them to
finance deficits in recessions. Such a policy acts as an automatic stabilizer,
restraining the economy during booms and stimulating the economy during
The way to implement this policy at the state level is through a
rainy day fund. The advantage of such a fund is painfully obvious now that we
have entered a recession, but it should have been anticipated by setting up a
rainy day fund in Oregon in the early 1990s.
What political forces prevented setting up a rainy day fund that
would have avoided the current budget crisis? The principal obstacle has been
the "tax kicker," which returns to households the "excess" tax revenues that are
generated during booms.
I understand the argument made in favor of the kicker, that it
prevents state spending from increasing if politicians are tempted to spend the
excess tax revenues. But this argument fails to apply if the excess tax funds
are instead set aside in a rainy day fund that can only be tapped during recessions. In contrast, the kicker operates with a perverse
and devastating cyclical timing. Because the kicker deprives us of the rainy day
fund, it in practice leads to downward pressure on state government spending
during recessions, and therefore acts to intensify the recession. ...
The current State budget crisis would have been much less acute,
and possibly entirely avoided, if a rainy day fund had been in place, and
tapping the rainy day fund would have also helped reduce the extent of the
recession in Oregon.
The current regime of balancing the budget year by year is bad
economics. At the national level this "Hoover economics" approach to fiscal
policy is widely understood to be discredited. The same principle applies at the
state level. Current budgetary choices remain critical, but we are operating
under artificial constraints. Not having a rainy day fund in place is subjecting
us to unnecessary economic distress. Surely we can at least now agree to change
our flawed budget policy design so that we are never again compelled to face a
recession so unprepared.
I wonder how much additional stabilization could be achieved at
the national level if all states had such a fund to stabilize their economies
over the business cycle.
Posted by Mark Thoma on Thursday, December 20, 2007 at 12:33 PM in Budget Deficit, Economics, Oregon, Policy, Taxes |
Treasury Secretary Paulson has been making the rounds selling his plan to help with the mortgage crisis, a plan that has "government facilitating the [financial] industry coming together to prevent a market failure." The plan is too limited in scope to have much of an effect, so the plan and the current sales blitz is more of a political effort than a means of averting a crisis.
This is part of a much longer interview Secretary Paulson did with the LA Times as part of the attempt to sell the policy. In this part of the interview, Paulson attempts to identify the market failure that justifies government intervention, but it's hard to call the attempt successful. He does talk about coordination failure among lenders that prevents private sector solutions from emerging, and he references resource constraints that prevent lenders from underwriting new loans on a case by case basis on better terms to prevent foreclosure, but he doesn't explicitly explain the market failure and he does not project the sense that he has a firm grasp of the nature of the market failure he is asserting:
These are Not Normal Times, Commentary, LA Times: ...Market failure defined
Peter Hong: Could you be a little clearer on what you mean by "market
Henry Paulson: As I've said, chaos. If ever there is a role for government
to bring the private sector together to deal with a situation that — when I say
market failure I say that we have an unprecedented situation, and the private
sector has to find a way to deal with that. Otherwise you're going to see them
drowning in people who can't make resets, whom they would ordinarily want to
keep in a home.
And again, I think if you take the time, call in servicers, talk to people
at Wells Fargo and others, take the time to really understand it, they'll see
that once you get into the process of underwriting a new loan — refinancing or
modification — and you go through all the paperwork they have to go through and
collect the data, that takes a long time. And they don't have the resources to
do that and handle the volume at the same time.
Continue reading "Paulson Sells His Plan for the Subprime Problem" »
Posted by Mark Thoma on Thursday, December 20, 2007 at 02:07 AM in Economics, Housing, Policy, Politics |
Currently, there are quite a few people advocating the use of tax cuts to
combat a potential slowdown in the economy due to the financial crisis. That is
certainly an option, if the tax cuts are well-targeted so that they do, in fact,
provide the intended stimulus to the economy, and if they can be put into place
quickly enough to hit before the economy recovers on its own. But there is
another aspect of using tax cuts for stabilization policy that needs to be in
place that would be difficult to achieve in the current political environment.
If we are going to use tax cuts as a fiscal policy tool to stabilize the
economy, we have to be willing to move the tax rate in both directions, up as
well as down. We are quite willing, currently, to move the tax rate down but
when people like Martin Feldstein call for a temporary tax cut to
stimulate the economy, if such a policy were to be enacted does anyone doubt the
difficulty of raising taxes again later even with automatic expiration
Backing up slightly, why do we need to increase taxes again instead of leaving them where
they are? This is stabilization policy, not growth policy, and the goal is to
keep the economy anchored as closely as possible to the target rate of output.
If in each successive business cycle the tax rate is lowered, but it is never
raised again, there will eventually come a time when the tax rate cannot be
lowered any further. If a severe recession then hits, and monetary policy isn't
providing the needed stimulus or interest rates are already so low that further
decreases will be ineffective, then fiscal policy will be unavailable as a
backup stimulus device, much to our detriment.
Instead, assuming as in most models that the target rate of output is
centrally located, the goal is to bring the economy up when the economy is
dragging (use tax cuts that increase the deficit) and to slow the economy down
when it begins to overheat (use tax increases that reduce the deficit). Managed
properly over business cycles, tax cuts in bad times, tax increases in good
times, the economy will stabilize around the target and there will be no
long-run consequences for the deficit or the size of government. But if we
insist that only tax cuts are available, that there is a ratchet effect in place
and taxes can never be increased again, then - abstracting for the moment from changes in government spending or assuming that changes in spending are infeasible for use as a stabilization tool - at some point we could well run out
Continue reading "Stabilization Policy" »
Posted by Mark Thoma on Thursday, December 20, 2007 at 12:42 AM in Economics, Macroeconomics, Policy |
Posted by Mark Thoma on Thursday, December 20, 2007 at 12:06 AM in Links |
David Roberts of Grist with an analysis of the EPA's decision to deny
California a waiver from federal fuel economy standards. California wants to
implement its own greenhouse gas emissions standards that force a reduction in tailpipe emissions, but the request was denied:
nuts, by David Roberts: As I mentioned below, today the
denied California's request for a waiver
exempting it from federal fuel economy standards, allowing it to implement its
own standards. EPA administrator Stephen Johnson announced the decision in a
rushed press conference following President Bush's signing of the energy bill.
The announcement came with a veritable torrent of dishonest spin. Let me try
to disentangle some of it.
Continue reading "EPA Denies California a Waiver" »
Posted by Mark Thoma on Wednesday, December 19, 2007 at 07:20 PM in Economics, Environment, Politics, Regulation |
Barkley Rosser at EconoSpeak asks "Who is a Populist":
Who is a "Populist"?, by Barkley Rosser: In recent election cycles the term
"populist" has been applied to such varied figures as John Edwards, Mike
Huckabee, Patrick Buchanan, and Ross Perot, arguably sharing a sort of economic
nationalism for the poor. Originating in anti-aristocratic agrarian movements in
Europe, especially the Russian Narodniki of the late 1800s, the movement in the
US attempted to encompass the urban working class as well, as symbolized by the
rural Scarecrow marching along with the urban Tin Woodman on the Yellow Brick
Road to defeat the Wicked Witch of the East, with populist heroine Dorothy and
the Cowardly Lion stand-in for fundamentalist and anti-imperialist populist
William Jennings Bryan, he of the "Cross of Gold" speech, in Baum's populist
fantasy novel. The movement would be partly absorbed by the later Progressive
and New Deal movements.
The movement has always had a deep divide, with race the central issue. So,
on the one hand we have the progressive wing, symbolized by the remnant
Democratic-Farmer-Labor Party of Minnesota and the presidential candidacy in
1948 of FDR's former Ag Secretary, Henry Wallace for the Progressive Party. On
the other, in the Deep South, we got "Pitchfork" Ben Tillman in South Carolina,
whose follower, Strom Thurmond, would run as the "Dixiecrat" in the 1948
presidential campaign. Today, this divide most clearly shows up in the struggle
Given recent discussions
here, I was thinking of doing a similar post discussing the term "populist",
but never made it past the
Wikipedia entry. [Update: Peter Dorman at EconoSpeak follows up.]
Posted by Mark Thoma on Wednesday, December 19, 2007 at 12:51 PM in Economics, Politics |
I just noticed the TypePad problem and will be approving comments caught in the spam filter, then deleting duplicates. There are currently about 80 comments in the filter, but a lot of these are multiple attempts (and none are actual spam). This is annoying - apologies.
[Please leave comments as always, and if it's caught in the filter (most aren't), I will approve it as soon as possible. Once I catch it - and I'll try to check often - it doesn't take long to move it out of the spam list.]
Update: See Moon of Alabama's "TypePad Sucks" for more on this. Update: Barry Ritholtz is also having problems. Update: TypePad tells me they've tweaked the filter and it ought to be better now.
Posted by Mark Thoma on Wednesday, December 19, 2007 at 08:56 AM in Weblogs |
Larry Summers is worried:
Secretary Calls For Tax Cut, Spending Plan, by Michael M. Phillips, WSJ:
Former Treasury Secretary Lawrence Summers, once a fiscal hawk among Clinton
Democrats, said the government should consider a $50 billion to $75 billion
tax-cut and spending package to stave off a deep recession.
Mr. Summers ... also urged the Federal Reserve to take more aggressive action
to ensure that its rate cuts actually reduce consumers' interest charges and
"Insufficient action to contain recessionary forces has much more serious
consequences than excessive action to contain recessionary forces," Mr. Summers
Mr. Summers's comments put him among the most pessimistic economic
prognosticators and were a slap at the Bush administration's handling of the
subprime-mortgage crisis and the constriction of U.S. credit markets. "The kind
of comprehensive approach that is necessary to minimize the risks is neither in
place nor in immediate prospect," he said. ...
"I believe that slow growth is a near certainty, that a recession is more
than a 50% chance, and that there's a distinct possibility of a more serious
recession that will lead to the worst economic performance since the late 1970s
and early 1980s," he said.
Even a mild recession, he said, would cost the average family of four between
$4,000 and $5,000 in lost income each year, while driving up the annual
government deficit by $100 billion.
The government, he said, should counter the downturn through targeted,
temporary spending, including a pre-emptive extension in unemployment benefits,
an increase in food stamps and a universal tax rebate. Taxpayers shouldn't have
to pay income taxes on the value of any mortgage reduction that lenders grant
them amid the current crisis, he said.
Mr. Summers's critique also extended to the Fed. He said the effect of the
central bank's rate-cutting has been blunted by the reluctance of financial
institutions to extend credit. ... To correct that, the Fed should pull its
monetary-policy levers to the extent necessary...
He leveled a similar broadside against the centerpiece of the Bush
administration's response... Treasury Secretary Henry Paulson has backed a
voluntary industry plan that would expedite new mortgages or rate freezes ...
over the next two years.
Mr. Summers projected that the plan -- aimed only at subprime borrowers who
are current on their payments -- would result in a total reduction in mortgage
payments of less than $5 billion and would miss the millions of other borrowers
whose payments are also expected to jump.
Instead, he proposed changes in bankruptcy laws to allow insolvent homeowners
to reduce their existing mortgage debt. He argued that such moves would allow
more borrowers to keep their homes, and ultimately cost lenders less money than
would a raft of foreclosures...
Posted by Mark Thoma on Wednesday, December 19, 2007 at 02:25 AM in Economics, Housing, Policy |