links for 2008-12-04

• The Role of Recourse in Foreclosures - Credit Slips
• Even more on nominal wages - Paul Krugman
• The Non-Crisis of the Euro - Eichengreen - Project Syndicate
• Monetary aggregates play little role in conduct of monetary policy - EurekAlert
• Insidious MBAs - Free exchange
• Health-Care Reform Could Kill the GOP - WSJ.com
• Fed survey offers bleak outlook - FT.com
• Bad banks briefly explained - The Economist

Comments

[anne]

http://krugman.blogs.nytimes.com/2008/12/04/worries-about-next-year/

December 4, 2008

Worries About Next Year
By Paul Krugman

I’ve been ruminating over economic prospects for next year, and I’m getting scared.

Two points:

1. The economy is falling fast. We’ll see what tomorrow’s employment report says, but we could well be losing jobs at a rate of 450,000 or 500,000 a month.

2. Infrastructure spending will take time to get going — a new Goldman Sachs report suggests that projects that are “shovel-ready” are probably only a few tens of billions worth, and that a larger effort would take much of a year to get going. Meanwhile, it’s very questionable how much effect tax rebates will have on consumer demand. So it may be hard for stimulus to get much traction until late 2009 — and that’s even if Congress goes along, which may be a problem given all the bad analysis and disinformation out there.

So here’s what I’m wondering: will it, in fact, even be possible to pull the economy out of its nosedive before unemployment goes into double digits? I’m starting to wonder.

[anne]

http://krugman.blogs.nytimes.com/2008/12/04/real-balance-effects-wonkish/

December 4, 2008

Real Balance Effects (Wonkish)
By Paul Krugman

I’m continuing to indulge myself over Depression economics. So here’s a reply to people wondering why I dismissed * the real balance effect — the fact that a fall in the price level raises the real value of the money supply (or more strictly the monetary base) and hence makes people wealthier, possibly raising aggregate demand even if interest rates are stuck at zero.

The answer is, think about the numbers.

Since I’m rushing off to class, let me do this from memory. Before the world went crazy, the US monetary base was about $800 billion. Suppose that the price level fell 20 percent. This would raise the real value of that base by $160 billion. Right there you can see the problem — the housing bust has wiped out something like $6 trillion of wealth; compare that with the effects of even a drastic fall in the aggregate price level.

But let’s pursue this. A rather high estimate of the marginal propensity to spend out of wealth is .05. So our 20% price level fall might increase spending by .05 times $160 billion or $8 billion, which is .06% of GDP. Give me a multiplier of 2, again on the high side, and we’ve got a 20% fall in the price level raising aggregate output by .12%. That looks pretty near vertical to me.

Then add in the debt deflation issue: deflation redistributes wealth from debtors to creditors. If the debtors have a higher marginal propensity to spend out of wealth than the creditors, which is what Irving Fisher thought, then this could easily swamp the tiny real balance effect.

Bottom line: without the usual interest rate channel, forget about the downward-sloping AD curve.

* http://www.princeton.edu/~pkrugman/nominal_wage.pdf

[anne]

http://www.princeton.edu/~pkrugman/nominal_wage.pdf

December 2, 2008

Notes on Nominal Wages and Employment
By Paul Krugman

Keynes's chapter on money-wages and employment is hard for modern economists to read. So I thought it might be helpful to restate it in terms of the standard textbook aggregate-demand-aggregate-supply framework.

We start with a production function, determining output as a function of employment:

Y = F(N)

With competitive markets, workers will be hired up to the point at which the real wage equals the marginal product of labor. (In the real world things are more complicated, but never mind.) If workers' contracts directly determined real wages, that would be the end of the story. But if workers negotiate a nominal wage instead, what we get is an aggregate supply curve that depends on the ratio of the aggregate price level to the wage rate:

Y = S(P/W)

Our standard model then says that macroeconomic equilibrium is determined by the intersection of this AS curve with an AD curve, representing the demand side of the economy. So we get a diagram like this:

[Diagram]

Now suppose that the evil New Deal pushes up nominal wages. This shifts the AS curve up, which leads to a higher price level and lower output:

[Diagram]

And that's the story as people like Amity Shlaes tell it, although probably without really understanding the logic.

But what is the crucial feature of this story? It requires that the aggregate demand curve be downward sloping. And why should that be true?

Well, in normal times the AD curve slopes down, we think, because other things equal a higher price level increases the demand for money, which drives up interest rates, which reduces desired spending. (In terms of IS-LM analysis, higher P leads to lower M/P which shifts LM left.)

But in liquidity trap conditions, the interest rate isn't affected at the margin by either the supply or the demand for money – it's hard up against the zero bound. And as a result the usual explanation for the downward slope of the AD curve doesn't work. You can appeal to the Pigou effect, I guess – but against that you have to put Fisherian debt deflation. In a liquidity trap, the AD curve is at least as likely to be upward-sloping as it is to be downward-sloping.

And in the mid-1930s America was very much in a liquidity trap, with the interest rate on 3-month T-bills * only 0.14 percent.

Suppose that the AD curve is vertical. Then the picture looks like this:

[Diagram]

And there's no adverse effect at all of the wage increase on output.

The key point, then, is that the reality of a liquidity trap in the 1930s has crucial implications for what we think about the effects of policies like the National Industrial Recovery Act. People who assert that New Deal support for wages made the Depression much worse aren't thinking it through. They're implicitly assuming – not demonstrating – that the AD curve had a "normal" slope, even in the depths of the Depression. But it didn't.

* http://www.census.gov/statab/hist/HS-39.pdf

[anne]

http://krugman.blogs.nytimes.com/2008/12/03/even-more-on-nominal-wages/

December 3, 2008

Even More on Nominal Wages
By Paul Krugman

A few more notes on the did-FDR-prolong-the-Depression front:

1. Gauti Eggertsson has an interesting paper * arguing that National Industrial Recovery Act policies, by reducing the expected rate of deflation, were actually expansionary.

2. There have been a lot of responses to my demonstration ** that the usual argument about the contractionary effects of wage increases doesn't apply in a liquidity trap. I think it's important to remember where we started — with the flat claim that FDR made things worse because he kept nominal wages too high. That's a pretty simple argument, which happens to be wrong.

Might there have been some more subtle, complex mechanism at work? Maybe, but this is starting to feel like a conclusion in search of an argument to support it.

That said, Greg Mankiw makes an interesting point: he argues that the NIRA, by increasing workers' bargaining power in the long run, might have discouraged business investment. In principle, this could be right. But my question is, do we need this to explain weak investment in the 1930s? Look at industrial production:

[Chart] Would you invest?

It stayed far below its 1929 peak for almost the whole decade, so that there must have been huge excess capacity almost everywhere. Why would businesses have wanted to invest, even if the labor movement had stayed down and out?

* http://www.ny.frb.org/research/economists/eggertsson/WastheNewDealContractionary.pdf

** http://www.princeton.edu/~pkrugman/nominal_wage.pdf

[anne]

http://www.economagic.com/em-cgi/data.exe/fedstl/indpro+1

December 3, 2008

Industrial Production Index, 1927-1945

Year, Month, Index *

1927 01 ( 7.4553)
1927 07 ( 7.3651)

1928 01 ( 7.2749)
1928 07 ( 7.6056)

1929 01 ( 8.3872)
1929 03 ( 8.3872) Hoover
1929 07 ( 8.8682) High

1930 01 ( 7.7860)
1930 07 ( 6.9142)

1931 01 ( 6.1326)
1931 07 ( 5.9823)

1932 01 ( 5.0504)
1932 07 ( 4.1185) Low

1933 01 ( 4.4792)
1933 03 ( 4.2387) Roosevelt
1933 07 ( 6.6737)

1934 01 ( 5.6215)
1934 07 ( 5.7418)
1934 09 ( 5.3510)

1935 01 ( 6.4933)
1935 07 ( 6.5534)
1935 08 ( 6.7939)

1936 01 ( 7.3050)
1936 07 ( 8.1167)
1936 11 ( 8.7480)
1936 12 ( 9.0185) Recovery above 1929 high

1937 01 ( 8.9884)
1937 05 ( 9.3492) High
1937 07 ( 9.2891)

1938 01 ( 6.6436)
1938 05 ( 6.3130) Low
1938 07 ( 6.7338)

1939 01 ( 7.8762)
1939 07 ( 8.3271)
1939 08 ( 8.4473)
1939 09 ( 8.9584) Recovery above 1929 high

1940 01 ( 9.5296)
1940 07 ( 9.8903)

1941 01 (11.1829)
1941 07 (12.6860) High

[Visualizing Paul Krugman's argument.]

[anne]

http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=121&ViewSeries=NO&Java=no&Request3Place=N&3Place=N&FromView=YES&Freq=Year&FirstYear=1929&LastYear=1941&3Place=N&Update=Update&JavaBox=no#Mid
http://www.bea.gov/national/nipaweb/SelectTable.asp?Selected=N

December 3, 2008

Gross Private Domestic Investment Index, 1929-1945 *

1929 ( 5.259) High

1930 ( 3.508)
1931 ( 2.204)
1932 ( 0.665) Low
1933 ( 0.981)
1934 ( 1.771)

1935 ( 3.279)
1936 ( 4.203)
1937 ( 5.249) Recovery below 1929 high
1938 ( 3.469) Low
1939 ( 4.461)

1940 ( 6.215) Recovery above 1929 high
1941 ( 7.590) High

[anne]

Understanding Paul Krugman's worry about the sense we have of the seriousness of the economic crisis, takes looking to what has been a tepid employment market for nearly 8 years. Through these 94 months, there have been 7.3 million jobs created or less than about 80,000 jobs a month, but we need to create about 150,000 jobs a months just to keep even with population growth. Even through the finest 52 months of the Bush Presidency, only 160,000 jobs a month were being created leaving no reasonable cushion for jobs losses to come or making up for jobs losses that had come before.

Missing 70,000 jobs created a month for 94 months, means we are about 6.6 million jobs short of where we should be for a healthy economy with high employment levels and decent wage and benefits gains for ordinary workers.

[Down]

Credit Slips..."The obvious explanation for why those European countries that do not have negative equity problems...has to do with Europe’s generally much higher down-payment requirements..."

Yes, this is the important one. No/low down-payment mortgages destroy the credit system.

[Debt]

Paul Krugman..."It stayed far below its 1929 peak for almost the whole decade, so that there must have been huge excess capacity almost everywhere."

The world recovered from WWI, and didn't need our exports of basics anymore. We needed to shift over to producing alternative products. Unfortunately, the myriad bad loans in the system made the public afraid to loan to business (buy capital goods). It was the excessive build up of unpayable debt (stock margin, Axis borrowing for war reparations) in the prior years that destroyed the credit system. This prevented the switch over, and thus ultimately fomented the Great Depression.

Excessive debt must be avoided to preserve the credit system. This means 50% margin on equities (not 40 to one), 20% down on homes (not NINJA), and insurance products (futures) can only be written by those who have the assured ability to pay (large reserves per contract). A bit of regulation please.

[anne]

"The world recovered from WWI, and didn't need our exports of basics anymore. We needed to shift over to producing alternative products. Unfortunately, the myriad bad loans in the system made the public afraid to loan to business (buy capital goods)."

Care to set down a reference for what I say is rubbish or worse? What is this, the idiocy of Austrianism (the economic idiocy but not the people)?

[Cap]

Project Syndicate..."They see how, if there was still a lira or a peseta, they would be experiencing capital flight."

Maybe the US should adopt the Euro, since the US is now totally dependent upon a steady influx of foreign capital. If the calls for 20% inflation come to pass, foreign capital may flee the public sector as it has already flown the private sector. (What foreign entity will loan at 2% when inflation periodically rises to 20%?)

[oops]

re: mba's

rather than insist on higher math for mba's couldn't we insist that they simply answer the following question on each and evey exam they take during business school:

if the yield is higher than t-bills, is an investment actually as good as cash or is there risk proportional to return?

i've had investment people try to sell me auction rate preffereds, investment bank preffereds, agency bonds and the like while telling me that they are "safe". Yet all yielded well above the t-bill rate.

i really don't think all these people were unethical or bad people. they have been given information from above, take it at face value and repeat it to the customer without thinking "hey, the yield is higher than the risk free rate, so where is the risk here?".

any "ownership society" speeches from on high should come with the same risk warning. after ten years of "speculation society" we've got zilch to less than zero to show for it.

that's pathetic.

[Reform]

WSJ..."Or their larger effort to demonstrate, by means of egregious misrule, that government is incapable of delivering the most basic services."

It was so bad, the many citizens must be wondering if their form of government is completely dysfunctional. The Dems will have to come up with something sensible real fast to restore confidence. Let us hope the Dems can rise above the lobby demands, and actually come up with an efficient and effective national health care plan. A further lobby influenced fiasco with health care could make citizens lose hope, and accept the Republican mantra that dysfunctional large scale public projects are inevitable here.

[kthomas]

@oops "any "ownership society" speeches from on high should come with the same risk warning. after ten years of "speculation society" we've got zilch to less than zero to show for it."

Hear, hear, sir. Still, some people made out like bandits. Especially President Bush's constituency. The REAL constituency, not the lemmings.

[anne]

http://www.epi.org/printer.cfm?id=3183&content_type=1&nice_name=webfeatures_snapshots_20081203

December 3, 2008

Downward Economic Mobility Among Mexican Americans
By Algernon Austin

The American Dream holds out the prospect that the children of immigrants to the United States will be better off economically than their parents. This expectation is realized for second-generation * Mexican Americans, but upward economic mobility stalls in the third generation and begins to reverse in subsequent generations.

Average family income of Mexican American children by generation:

$53,174 (2nd generation)
$53,634 (3rd generation)
$43,891 (4th generation)

2000 $

In "Generations of Exclusion: Mexican Americans, Assimilation, and Race, ' Edward E. Telles and Vilma Ortiz show that, measured by average family income, third-generation Mexican Americans are not much better off than those who are second-generation. Even more surprisingly, fourth-generation Mexican Americans have substantially lower family incomes than their second- and third-generation peers. The authors conclude that the first- and second-generation's optimism about life in the United States fades by the third-generation, and third- and later-generations finally succumb to the lower-quality education and prejudice that they experience.

* The first generation is the foreign-born immigrant generation. The second generation is the U.S.-born children of the first generation. Each generation of children is one generation higher than their parents. Telles and Ortiz use the respondent parent to determine the parents' generation.

References

Austin, Algernon, and Marie Mora. 2008. Hispanics and the Economy: Economic Stagnation for Hispanic American Workers, Throughout the 2000s. Briefing Paper, Washington, D.C.: EPI.

Telles, Edward E., and Vilma Ortiz. 2008. Generations of Exclusion: Mexican Americans, Assimilation, and Race. New York: Russell Sage Foundation.

[Wow.]

[Patricia Shannon]

Maybe this is just a reflection of decline of the economy for most of us in recent years, or at least partly?

[anne]

http://www.bloomberg.com/apps/news?pid=20601103&sid=aeccssj92qFU&refer=us

December 4, 2008

Geithner Seeks to Push FDIC’s Bair Out After Clashes
By Robert Schmidt

Timothy Geithner, President-elect Barack Obama’s choice for U.S. Treasury Secretary, is seeking to push Federal Deposit Insurance Corp. Chairman Sheila Bair out of office.

Geithner, president of the Federal Reserve Bank of New York, has argued Bair isn’t a team player and is too focused on protecting her agency rather than the financial system as a whole, according to two congressional officials and a person familiar with his thinking. Bair has battled with Geithner and fellow regulators over aid to Citigroup Inc. and other emergency actions, making her enemies in the Bush administration.

“The idea of having an independent actor on the stage with you who might not be singing the same tune can make you nervous,” said Wayne Abernathy, a former Treasury official who is now executive vice president with the American Bankers Association in Washington. “They recognize that she’s a very independent person.”

It isn’t clear that Obama would ask Bair to step down. Such a move would be fraught with political risk for the new administration, especially on Capitol Hill, where Bair’s campaign to rework mortgages for struggling homeowners has won respect from top lawmakers, including Senate Banking Committee Chairman Christopher Dodd and Barney Frank, his counterpart in the House....

[anne]

Warren Buffett has several times commented on how fine a job Sheila Bair has been doing, as the New York Times has several times noted as well, so of course the most reliable and creative Administration member becomes a problem for Obama's Secretary of the Treasury who has as far as I can tell shown no reliability or creativity through the financial system rescue procedures.

[anne]

http://www.bloomberg.com/apps/news?pid=20601103&sid=aeccssj92qFU&refer=us

December 4, 2008

Geithner Seeks to Push FDIC's Bair Out After Clashes
By Robert Schmidt

"I think part of the problem now, to be honest, is Sheila Bair has annoyed the 'old boys' club,'" [Barney] Frank said today. "To some extent, bank regulation and mortgage foreclosure have made a situation where we have several regulators up in the tree house with a 'no girls allowed' sign -- and it's aimed at Sheila Bair - - who's been really good." ...

[Get it? I get it.]