Wednesday, June 30, 2010
The Dallas Fed, like the rest of us, is having trouble figuring out where future growth in GDP is going to come from. What many people don't realize is how much of recent growth has been driven by inventory correction, and that this is coming to an end:
Risk of Slower Growth Ahead, by —Tyler Atkinson, Evan F. Koenig and Max Lichtenstein , National Economic Outlook, FRB Dallas: The U.S. economic recovery appears to have been solid through second quarter 2010. However, with fiscal stimulus measures and the inventory correction nearing an end, there are reasons to be concerned that growth will slow in the second half of the year. ...
An Unusual Recovery
The composition of growth so far in this recovery is a source of concern. During the recession, real GDP fell below final sales as firms sought to reduce bloated inventories. Once final sales began to recover, firms sought to moderate the pace of the inventory drawdown—they began to close the gap between production and sales. The recovery up to now, which began in third quarter 2009, has been unusual in how much it has relied on this production catch-up effect. Inventory investment has accounted for 57 percent of GDP growth in the first three quarters of the current recovery—the largest percentage in the past 60 years (Chart 2). In comparison, the fraction of GDP increase accounted for by residential investment during the first three quarters of the recovery, 2 percent, is a record low. This feeble contribution comes despite new home-purchase tax credits and Federal Reserve intervention in the market for mortgage-backed securities. Growth contributions from consumption and government purchases have been smaller than normal also, but well within the past range. Contributions from nonresidential fixed investment and net exports have been about average.
Unfortunately, it looks like this is coming to an end:
The Inventory Cycle Draws to a CloseIf inventory correction is ending, what will take its place?:
It appears the inventory correction has nearly run its course. Output has now caught up with final demand for domestic product, signaling that the main boost to GDP growth from inventory investment is coming to an end (Chart 3). Unless producers or retailers now want to add to their inventories, in coming quarters GDP growth will be tied to growth in final demand. However, the inventory-to-sales ratio is at a level that in the past has meant little or no change in inventories relative to GDP (Chart 4). ...
Where Will Growth Come From?
Increasing government purchases were an important early source of growth in final demand during the recovery but have gradually faded. Support for residential investment from special tax incentives is at an end. Business investment has been growing well in recent quarters but usually acts as an amplifier of growth that originates elsewhere, rather than an independent source of strength. Real consumption spending is growing at roughly the same 3 percent pace as before the recession but starting from a lower base (Chart 5). To replace inventory investment’s contribution to the recovery, this growth rate would have to increase to 5.5 percent—a pickup that is uncertain, at best, given still-tight credit and households’ aversion to debt. Such an acceleration might even be undesirable because it would risk an exacerbation of global imbalances (large U.S. trade deficits and rising U.S. international indebtedness).
Net Exports a Possible Bright Spot
Net exports provided a big boost to U.S. final demand in second quarter 2009 with a 1.6 percentage point growth contribution. Since then, net exports have contributed little to growth, but there is some reason to believe that this will change in the second half of 2010. Through the first quarter, leading indexes for the U.S. and for the major industrialized countries as a group suggested that economic prospects here and abroad were improving about equally rapidly—a neutral for our net exports’ prospects. Meanwhile, the U.S. gross domestic purchases price index has been rising relative to the U.S. gross domestic product price index (Chart 6). A growing purchases/product price ratio means that U.S. imports are becoming more expensive relative to U.S. exports, encouraging growth in exports relative to imports. Ordinarily, this relative-price effect would kick in during the second half of 2010. However, recent developments in Europe have added to financial strains there and increased calls for fiscal restraint. So, while some increase in the growth contribution from net exports in the second half is possible, it is by no means certain.
Slower Growth Likely, on Balance
In sum, GDP growth will continue in the second half of the year but quite possibly at a slower rate than we’ve seen during the recovery to date. Deceleration is likely because the boost to growth from rising inventory investment is near an end now that output has caught up with final demand. The inventory boost has accounted for over 50 percent of GDP growth so far during the recovery, so a substantial pickup in final demand growth will be necessary to keep gains in employment and output from slowing. That the required pickup will occur is far from obvious.
So net exports is the big hope, but troubles in Europe cloud this forecast. However, even if the troubles in Europe end, or had not occurred at all, I'm not very confident that net exports can carry the load. But what else can?
Given this worrisome short-run outlook for GDP growth, and hence for employment, why do some people think cutting stimulus, which is what cuts to the deficit do, is the way to enhance the recovery?
Output can be written as Y = C + I + G + NX (output = consumption + investment + government spending + net exports). If we cut the deficit through reductions in spending and increases in taxes, we know G will go down (as spending falls) and that C and I will also fall (from tax increases on consumers and businesses). But somehow, the story goes, as GDP and employment are falling, confidence will go up so much that C, I, and perhaps NX will go up more than enough to compensate for the fall, and then some. However, if the confidence effect doesn't appear and generate very strong effects, and it's unlikely that it will despite the wishful thinking from some, deficit reduction makes things worse in the short-run, not better.
I argue that financial reform legislation fails to remove an important advantage that large banks have over small banks:
If financial reform legislation passes in its present form, it will have positive features. It creates a relatively strong and independent consumer financial products protection agency, it forces most derivatives to be exchange traded or passed through clearinghouses -- though important exceptions remain -- and it provides regulators with resolution authority for large institutions in the shadow banking system. But overall, as with health care reform, the legislation is unsatisfactory in many ways -- it leaves much of the job yet to be done -- and it's not clear that Congress will have the will to follow through.
Brad DeLong wonders if we heading into the WABAC (or, "wayback") machine, and if we are, why we don't visit a better time period than 1937-1938:
It's 1937 Again!, by Brad DeLong: David Leonhardt:
Betting That Cutting Spending Won’t Derail Recovery: The world’s rich countries are now conducting a dangerous experiment. They are repeating an economic policy out of the 1930s — starting to cut spending and raise taxes before a recovery is assured — and hoping today’s situation is different enough to assure a different outcome. In effect, policy makers are betting that the private sector can make up for the withdrawal of stimulus over the next couple of years. If they’re right, they will have made a head start on closing their enormous budget deficits. If they’re wrong, they may set off a vicious new cycle, in which public spending cuts weaken the world economy and beget new private spending cuts. ...
Today, no wealthy country is an obvious candidate to be the world’s growth engine, and the simultaneous moves have the potential to unnerve consumers, businesses and investors, says Adam Posen, an American expert on financial crises now working for the Bank of England. “The world may be making a mistake, and it may turn out to make things worse rather than better,” Mr. Posen said. But he added — after mentioning China, India and the relative health of the financial system, today versus the 1930s — that, “The chances we’re going to come out of this O.K. are still larger than the chances that we aren’t.”
I think that Adam Posen has a different definition of "OK" than I do. A jobless recovery and prolonged unemployment above 8% is, to my way of thinking, definitely not OK.
[T}he initial stages of our own recent crisis were more severe than the Great Depression. Global trade, industrial production and stocks all dropped more in 2008-9 than in 1929-30, as a study by Barry Eichengreen and Kevin H. O’Rourke found. In 2008, though, policy makers in most countries knew to act aggressively. The Federal Reserve and other central banks flooded the world with cheap money. The United States, China, Japan and, to a lesser extent, Europe, increased spending and cut taxes. It worked. By early last year,... economies were starting to recover. The recovery has continued this year...
That optimistic take, however, is more debatable today than it would have been a month or two month ago. As is often the case after a financial crisis, this recovery is turning out to be a choppy one. ... The Senate has so far refused to pass a bill that would extend unemployment insurance or send aid to ailing state governments. Goldman Sachs economists this week described the Senate’s inaction as “an increasingly important risk to growth.”
The parallels to 1937 are not reassuring.... Given this history, why would policy makers want to put on another fiscal hair shirt today? The reasons vary by country. Greece has no choice.... Several other countries are worried — not ludicrously — that financial markets may turn on them, too, if they delay deficit reduction. ... Then there are the countries that still have the cash or borrowing ability to push for more growth, like the United States, Germany and China, which happen to be three of the world’s biggest economies. Yet they are also reluctant.... The reasons for the new American austerity are subtler, but not shocking. Our economy remains in rough shape, by any measure. So it’s easy to confuse its condition (bad) with its direction (better) and to lose sight of how much worse it could be. The unyielding criticism from those who opposed stimulus from the get-go — laissez-faire economists, Congressional Republicans, German leaders — plays a role, too. They’re able to shout louder than the data.
Finally, the idea that the world’s rich countries need to cut spending and raise taxes has a lot of truth to it. The United States, Europe and Japan have all made promises they cannot afford. Eventually, something needs to change. In an ideal world, countries would pair more short-term spending and tax cuts with long-term spending cuts and tax increases. But not a single big country has figured out, politically, how to do that. Instead, we are left to hope that we have absorbed just enough of the 1930s lesson.
Sometimes, if first you don't succeed try, try again is bad advice. Balancing the budget before the economy was ready to stand on its own didn't work last time we we trying to exit a severe recession, so why try the same thing again? The time to address budget issues will come, but that time is not here yet.
Some people get it -- too bad it's not the politicians in Congress:
Who Will Fight for the Unemployed?, Editorial, NY Times: Without doubt, the two biggest threats to the economy are unemployment and the dire financial condition of the states, yet lawmakers have failed to deal intelligently with either one.
Federal unemployment benefits began to expire nearly a month ago. Since then, 1.2 million jobless workers have been cut off. The House passed a six-month extension ... in May, but the Senate, despite three attempts, has not been able to pass a similar bill. The majority leader, Harry Reid, said he was ready to give up after the third try last week when all of the Senate’s Republicans and a lone Democrat, Ben Nelson of Nebraska, blocked the bill.
Meanwhile, the states face a collective budget hole of some $112 billion, but neither the House nor the Senate has a plan to help. The House stripped a provision for $24 billion in state fiscal aid from its earlier spending bill. The Senate included state aid in its ill-fated bill to extend unemployment benefits; when that bill failed, the promise of aid vanished as well.
As a result, 30 states that had counted on the money to help balance their budgets will be forced to raise taxes even higher and to cut spending even deeper in the budget year that begins on July 1. That will only worsen unemployment... Worsening unemployment means slower growth, or worse, renewed recession.
So if lawmakers are wondering why consumer confidence and the stock market are tanking (the Standard & Poor’s 500-stock index hit a new low for the year on Tuesday), they need look no further than a mirror.
The situation cries out for policies to support ... jobless benefits and fiscal aid to states. But instead of delivering, Congressional Republicans and many Democrats have been asserting that the nation must act instead to cut the deficit. The debate has little to do with economic reality and everything to do with political posturing. A lot of lawmakers have concluded that the best way to keep their jobs is to pander to the nation’s new populist mood and play off the fears of the very Americans whose economic well-being Congress is threatening.
Deficits matter, but not more than economic recovery, and not more urgently than the economic survival of millions of Americans. A sane approach would couple near-term federal spending with a credible plan for deficit reduction — a mix of tax increases and spending cuts — as the economic recovery takes hold.
But today’s deficit hawks — many of whom eagerly participated in digging the deficit ever deeper during the George W. Bush years — are not interested in the sane approach. In the Senate, even as they blocked the extension of unemployment benefits, they succeeded in preserving a tax loophole that benefits wealthy money managers... They also derailed an effort to end widespread tax avoidance by owners of small businesses organized as S-corporations. If they are really so worried about the deficit, why balk at these evidently sensible ways to close tax loopholes and end tax avoidance? ...
Congress leaves town on Friday for a weeklong break. What’s needed, and what’s lacking, is leadership, both in Congress and from the White House, to set the terms of the debate — jobs before deficit reduction — and to fight for those terms, with failure not an option.
Tuesday, June 29, 2010
Cutting government spending, raising taxes, raising interest rates, and hoping the rest of the world does the same as some have called for is not the answer to the threat of a depression. If people don't begin to see unemployment falling soon, or some strong signal that employment markets will improve soon, pessimism is going to build -- the optimism some people may have felt is fading and you can feel it building now, and that's one of Shiller's worries. Cutting monetary and fiscal stimulus at a time when people are becoming more pessimistic about the economy's prospects will make things worse, not better. As I've said before, and will continue saying so long as these misguided ideas persist, if anything, monetary and fiscal policy should be more aggressive right now.
Going back to the subject of modern macro and who should talk about it, and more particularly, the nature of discourse, I've been surprised to hear some critics of New Keynesian models -- those who have been quite critical of the discourse of their intellectual opponents -- explain that it's OK for them to be shrill, call the other side names, and so on because, you know, they're right and the other side is wrong. But I am going to leave that alone and try to turn the conversation elsewhere.
Rajiv Sethi says economics blogs are here to stay, and that's a good thing:
On Blogs and Economic Discourse, by Rajiv Sethi: I was making my way back from a conference yesterday and completely missed the uproar over Kartik Athreya's provocative essay on economics blogs. Athreya argued, in effect, that most such blogging is done by ill-informed hacks who ought to be ignored while properly trained experts (such as himself) are left in peace to do the difficult work of making progress in the field. The original post has been taken down but (as a telling reminder that no public statement can subsequently be made private in this day and age) a copy may be viewed here.
The response from the accused was swift and brutal (see Thoma, DeLong, Sumner, Rowe, Cowen, Kling, Avent, Yglesias and Wilkinson for a sample). I don't want to pile on, and there's little I can add to what others have already said. But I'd like to take this opportunity to reiterate and expand upon a couple of points that I have made in previous posts about the rapidly changing role of blogs in economic discourse.
My view of the matter is almost diametrically opposed to that of Athreya: I consider these changes to be both irreversible and potentially very healthy. In a post commemorating the birthdays of two excellent economics blogs, I made this point as follows (see also Andrew Gelman's follow-up):The community of academic economists is increasingly coming to be judged not simply by peer reviewers at journals or by carefully screened and selected cohorts of students, but by a global audience of curious individuals spanning multiple disciplines and specializations. Voices that have long been silenced in mainstream journals now insist on being heard on an equal footing. Arguments on blogs seem to be judged largely on their merits, independently of the professional stature of those making them. This has allowed economists in far-flung places with heavy teaching loads, or those who pursued non-academic career paths, to join debates. Even anonymous writers and autodidacts can wield considerable influence in this environment, and a number of genuinely interdisciplinary blogs have emerged...This has got to be a healthy development. One might persuade a referee or seminar audience that a particular assumption is justified simply because there is a large literature that builds on it, or that tractability concerns preclude reasonable alternatives. But this broader audience is not so easy to convince. Persuading a multitude of informed, thoughtful, intelligent readers of the relevance and validity of one's arguments using words rather than formal models is a far more challenging task than persuading one's own students or peers. If one can separate the wheat from the chaff, the reasoned argument from the noise, this process should result in a more dynamic and robust discipline in the long run.
In fact, the refereeing process for blog posts is in some respects more rigorous than that for journal articles. Reports are numerous, non-anonymous, public, rapidly and efficiently produced, and collaboratively constructed. It is not obvious to me that this process of evaluation is any less legitimate than that for journal submissions, which rely on feedback from two or three anonymous referees who are themselves invested in the same techniques and research agenda as the author.
I suspect that within a decade, blogs will be a cornerstone of research in economics. Many original and creative contributions to the discipline will first be communicated to the profession (and the world at large) in the form of blog posts, since the medium allows for material of arbitrary length, depth and complexity. Ideas first expressed in this form will make their way (with suitable attribution) into reading lists, doctoral dissertations and more conventionally refereed academic publications. And blogs will come to play a central role in the process of recruitment, promotion and reward at major research universities. This genie is not going back into its bottle.
Conventional research is mostly backward looking. Academic economists look at an event like the 73-74 recession, ask what caused it, build models to try to understand it, and they try to find policies that would have worked better than the ones that were actually implemented at the time.
That's fine for many issues, but when big shocks hit the economy that do not fit into the standard models, there's no time to wait for academic economists to take their usual approach -- it can be several years or more before the research is complete.
This is one place blogs have an advantage. When the current crisis hit and economists looked into their tool boxes for models and policies that could effectively offset the problems we were seeing -- or at least explain what was happening -- we came up empty. The models weren't there and there was no time to wait before deciding what to do in terms of monetary and fiscal policy. Action was needed, that was clear, but without a model to rely upon, what type of action is best?
Suddenly, it was like being in an emergency room when a very sick patient shows up, and you are not quite sure what the cause is, or what to do about it. Blogs stepped in and began analyzing these issues in real time in a way conventional research never could have done. Online conversations among the best macroeconomists in the business, among others, were very helpful in understanding what was going on and in developing policy responses to it. Was it a solvency issue? A liquidity issue? Both? Should banks be nationalized, should we buy bad assets from them, should they be bailed out or allowed to fail, etc., etc., etc. There were so many answers that were needed and very little time to wait. The ability of blogs to step in and fill this void is a good and helpful development, one that the profession ought to embrace more than they have. It's not easy at all coming up with new theory and policy recommendations on the fly, especially when the answer is as important as it was -- the proper response could make a big difference in the outcome, and the wrong response could be devastating -- and blogs were very helpful in filling the void.
James Morley discusses modern macroeconomics, and defends the use of large-scale econometric models that have been discarded by adherents to the DSGE framework (this is a bit wonkish, even more so in parts I left out):
The Emperor has no Clothes: The state of "modern" macro, by James Morley: [pdf]: Much has been made of the failure of modern macroeconomics to predict or understand the Great Recession of 2007–2009. In this Macro Focus, our resident time-series econometrician, James Morley*, explains what is currently meant by “modern” macroeconomics, what is behind its failure, and what can be done to rehabilitate its reputation.“Modern” Macroeconomics
In a recent essay, Narayana Kocherlakota, President of the Federal Reserve Bank of Minneapolis, acknowledged that modern macroeconomics failed during the recent financial crisis. However, his essay misses the point of why it failed.
Like many in academia, Kocherlakota associates modern macroeconomics with a particular school of thought that takes something called the “Lucas critique” as its guiding principle. The Lucas critique refers to an argument put forth by the Nobel Prize-winning macroeconomist Robert Lucas about how the changing expectations of economic agents will confound forecasting and policy analysis based on macroeconomic data. Its main implication is that an economic model with “deep structural parameters” related to preferences and technology for households and firms should provide more reliable forecasts, especially when predicting the effects of policy, than a model based more on the apparent historical correlations between macroeconomic variables. This is sometimes referred to as the “microfoundations” approach to macroeconomics because it presumes that a microeconomic structure — in particular, the metaphor of optimizing economic agents— is more robust to changes in the policy environment than macroeconomic correlations.
Rather than question the relevance of the Lucas critique, Kocherlakota explains the recent failure of modern macroeconomics as due to much narrower issues. In his view, the micro-founded models failed because they lack sufficient complexity, especially in terms of their treatment of financial markets. Also, he points out, rightly, that the models are driven by “patently unrealistic shocks”.
However, the rehabilitation of modern macroeconomics requires a different tack than suggested by Kocherlakota. In particular, macroeconomists need to do more than simply add complexity to their models. They should also remember that it is empirically testable whether models that put most of their weight on “deep structural parameters” produce more accurate predictions than models that put more weight on historical correlations. In doing so, it may be found that some macroeconomic relationships are useful even if they cannot be easily motivated as the literal outcome of a micro-founded model. This is not to deny the important role that economic theory plays... However, there is no reason for models to take theory quite so literally as is typically done in modern macroeconomics. Instead, the data should be taken more seriously.
History Repeats Itself
The idea of the Lucas critique arose out of the 1970s. It was a time when large-scale macroeconometric models that relied heavily on historical correlations — especially the traditional Phillips curve tradeoff between unemployment and inflation — failed to predict or even explain “stagflation” in the form of simultaneously high rates of unemployment and inflation. ...
Ironically, this historical episode should remind us somewhat of the present. Now it is “dynamic stochastic general equilibrium” (DSGE) models inspired by the Lucas critique that have failed to predict or even explain the Great Recession of 2007–2009. ...
So can the reputation of modern macroeconomics be rehabilitated...? As discussed below, the problems for DSGE models run deeper than a lack of complexity, while the large-scale macroeconometric models have improved considerably since the 1970s. ...
The Lucas Critique and Large-Scale Macroeconometric Models
Before discussing the details of large-scale macroeconometric models, it is perhaps useful to revisit Kocherlakota’s essay on modern macroeconomics. ... An immediately noticeable thing about ... Kocherlakota’s discussion of the Lucas critique is that he presents it as some sort of universal truth that estimated demand and supply relationships will be unstable and of limited use for policy analysis. This might be valid if a DSGE model were reality. But DSGE models are models, not reality. Thus, the relevance of the Lucas critique is testable and the tests have not been favorable. Meanwhile, according to a meta-critique of the Lucas critique by Christopher Sims, the lack of practical relevance should come as no surprise. ...
Thus, contrary to the precepts of “modern” macroeconomics, the Lucas critique in no way proves that DSGE models will predict the effects of policy better than large-scale macroeconometric models based more on historical correlations.
This is a graph of state and local expenditures and taxes since the 1970s showing how much both spending and taxes have fallen in the current recession (it's part of a more general discussion of the causes and consequences of the fiscal crisis in state and local government from the SF Fed):
In both the 73-74 and 2001 recessions, revenues fell sharply. Not as much as in the current recession, but the fall in both cases is still steep and pronounced. Yet, unlike in the present recession, expenditures stayed relatively constant during the recession. After the 73-74 and 2001 recessions, when the economy had recovered, expenditures did fall noticeably and the deficit flips from negative to positive, but this is exactly how countercyclical policy should work so that is not a problem, it's a feature. But in the present recession, spending has fallen quite a bit which is not desirable.
The failure to offset the fall in spending at the state and local level with help from the federal government is, I think, a large policy error. Even now, it's not too late to help, but Congress has decided not to provide any additional help to state and local governments. When this is finally over, we need to figure out how to do better the next time a severe recession hits. But, unfortunately, it doesn't seem likely that such a discussion will take place, or even if it does, that there will be any action in response.
Tyler Cowen suggests:
The real fiscal problem is spending contraction at the state level (expanding and contracting spending are not symmetric in their effects; contracting spend hurts more than expanding spending helps). The correct fiscal policy move would have been, and still is, to take Medicaid away from the states and make it fully federal. This would give state budgets a huge break, and help employment, yet as a one-time change it reduces the moral hazard problems from ongoing outright grants.
The moral hazard issue is the difficult hurdle. You don't want states to simply substitute federal for state spending, or intentionally make their budgets look worse in order to get more federal help. Many policies that can be set in advance to help state and local governments give them the incentive to do one or the other. However, mechanisms to offset the bad incentives exist, and that's why it's important to discuss how we can improve the next time this happens. We can design policies that minimize these problems, but that won't happen if we don't take the time and effort to design and implement effective strategies to overcome the unfortunate tendency of state and local governments to make recessions worse.
Monday, June 28, 2010
This essay by Kartik Athreya criticizing the economics blogosphere is making the rounds, and I am late commenting on it (links to other comments at the end), so here are a few quick responses.
Let me start by noting that the essay is not even digitized in a convenient form -- it is a pdf -- and to me that says a lot about the writers knowledge of how the digital world works. Why not make it available in a convenient form (unless the goal is to overcome the fact that federal reserve work cannot be copyrighted by making it difficult to reproduce)? (This is an irritation more generally, and the Kansas City Fed is the worst. Even the president's speeches are offered only as pdfs -- and they are locked to prevent copying -- rather than in a more convenient digital form. Are they trying to discourage this information from more general circulation? If so, why?) [Update: I added a few follow up comments on pdfs at the end of the post.]
OK, on to the essay:
Economics is Hard. Don’t Let Bloggers Tell You Otherwise, by Kartik Athreya, Federal Reserve Bank of Richmond: The following is a letter to open-minded consumers of the economics blogosphere. In the wake of the recent financial crisis, bloggers seem unable to resist commentating routinely about economic events. It may always have been thus, but in recent times, the manifold dimensions of the financial crisis and associated recession have given fillip to something bigger than a cottage industry. Examples include Matt Yglesias, John Stossel, Robert Samuelson, and Robert Reich. In what follows I will argue that it is exceedingly unlikely that these authors have anything interesting to say about economic policy. This sounds mean-spirited, but it’s not meant to be, and I’ll explain why.
Hmm. I wonder what he thinks about the fact that Greg Mankiw -- someone he cites approvingly later as an example to emulate -- sends people to read Robert Samuelson and John Stossel regularly? (See here for just one example. The post has two links, one to Samuelson and one to Stossel.)
Before I continue, here’s who I am: The relevant fact is that I work as a rank-and-file PhD economist operating within a central banking system. I have contributed no earth-shaking ideas to Economics and work fundamentally as a worker bee chipping away with known tools at portions of larger problems. It is precisely from this low-level vantage point that I am totally puzzled by the willingness of many who fearlessly and breathlessly opine about economics, especially macro- economic policy. Deficits, short-term interest rate targets, sovereign debt are all chewed over with a level of self-assuredness that only someone who doesn’t know more could. The list of those exhibiting this zest also includes, in addition to those mentioned above, some who might know better. They are the patron saints of the “Macroeconomic Policy is Easy: Only Idiots Don’t Think So” movement: Paul Krugman and Brad Delong. Either of these men will assure their readers that it’s all really very simple (and may even be found in Keynes’ writings). Lastly, before you dismiss me as a right- or left-winger, I am not. I’m simply less comfortable with ex cathedra pronouncements and speculations than the people I have named.
Is the author saying that he is unable to read the academic literature, weigh the evidence, and then come to a conclusion? And if he can do this, is he saying that someone in possession of, say, a Nobel prize shouldn't then boil this down to a comprehensible form that can be shared with the public? Paul Krugman does take one-side positions based upon his reading of the academic literature, some of which he helped to create. But he has qualified things on his blog. He has explained when, for example, monetary and fiscal policy should have large or small effects, he's linked to the appropriate research, and so on. Somebody has to explain these things to the public, and do so in a way that highlights the essential elements while leaving everything else aside, and Paul Krugman is a master at this. Krugman and others, myself included, do pass along their digested views of the academic literature in a simple, readable form. We also point to non-professionals when we think they have something worthwhile to say. What's wrong with that? (To me, this whole essay reads like it was driven by a touch of Krugman-DeLong Derangement Syndrome).
The main problem is that economics, and certainly macroeconomics is not, by any reasonable measure, simple. Macroeconomics is most narrowly concerned with the tracing of individual actions into aggregate outcomes, and most fatally attractive to bloggers: vice versa. What makes macroeconomics very complicated is that economic actors... act. Firms think about how to make profits, households think about how to budget their resources. And both sets of actors forecast. They must. One has to take a view on one’s future income, health, and familial obligations to think about what to set aside for retirement, how much life insurance to buy, and so on. Of course, all parties may be terrible at forecasting, that’s certainly a possibility, but that’s not the issue. Even if one wanted to think of all economic actors as foolish and purposeless organisms making utterly random choices, one must accept that their decisions will still affect, and be affected by what others do. The finitude of resources ensures this “accounting” reality.
Beyond this, some may recall that Economics 101 is usually insistent on reminding students of the Fallacy of Composition: what is true for some may not be true for all. Much of macroeconomics is dedicated precisely making sure that when we talk about the “economy”, we don’t fall afoul of this fallacy. It is therefore not surprising that the majority of the training of new PhDs in their macroeconomic coursework is giving them a way to come to grips with the feedback effects that are likely present. Some of this is nothing more than (valuable) exercises in book-keeping. So much of my 1st year homework involved writing down tedious definitions of internally consistent outcomes. Not analyzing them, just defining them, and so trying to convincing my instructors that I wasn’t inadvertently describing something nonsensical, where resources were being allowed to “fly in (or out) through a window.” In discussions of fiscal policy, such as those regarding deficits, for example, the discipline imposed by an insistence on doing the accounting correctly helps focus economists on the real issue (total spending, and the expected future path of spending), and also learn what might be peripheral (the deficit at any given moment).
Uhm, Krugman and DeLong weren't the ones doing the accounting incorrectly by mixing up definitions, identities, and equilibrium equations, that was the economists the author nods to approvingly later on. Is there some example where Krugman and DeLong were not internally consistent in the things they have written on this topic? Or is this just an objection to the way things are said as opposed to the content? (I realize this is directed in part at non-economist bloggers, but I will focus on the shots taken at academic economists.)
The punchline to all this is that when a professional research economist thinks or talks about social insurance, unemployment, taxes, budget deficits, or sovereign debt, among other things, they almost always have a very precisely articulated model that has been vetted repeatedly for internal coherence. Critically, it is one whose constituent assumptions and parts are visible to all present, and can be fought over. And what I certainly know is that to even begin to talk about the effects of unemployment, debt, deficits, or taxes, one has to think very hard about many, many things. Examples of this approach done right in the context of some of the topics mentioned above are recent papers by Robert Lucas of the University of Chicago, Jonathan Heathcote of the Minneapolis Fed, or Dirk Kreuger and his co-authors. Comparing, even momentarily, such careful work with its explicit, careful reasoning, its ever-mindful approach to the accounting for feedback effects, and its transparent reproducibility, with the sophomoric musings of auto-didact or non-didact bloggers or writers is instructive. For those who want to really know what the best that economics has to offer is, you must look here. And this will be hard.
And, because it's hard, wouldn't it be nice to have the best economists in the business interpreting this work and boiling it down to its essential elements for the public? And when the non-economist bloggers trust these individuals based upon a long history of getting it right and echo what they are saying, why is that a problem?
But why should it be otherwise? Why should anyone accept uncritically that Economics, or any field of human endeavor, for that matter, should be easy either to process or contribute to? To some extent, people don’t. Would anyone tolerate the equivalent level of public discussion on cancer research? Most of us readily accept the proposition that Oncology requires training, and rarely give time over to non-medical-professionals’ musings.
I'm sorry, but that's just wrong. Many, many people are susceptible to quack medicine, promises of miracle cures and the like (especially with cancer).
Do we expect advances in cell-biology to be immediately accessible to anyone with even a college degree? Science journalists routinely cite specific studies that have appeared in specific journals. They generally do not engage in passing their own untrained speculations off as insights.
Yeah, you hardly ever see a Charles Krauthammer or a George Will (the equivalents of Robert Samuelson) saying uninformed things about global warming. Give me a break. Also, I do see non-economist bloggers citing academic papers regularly (e.g., from last night) so I don't think this is a valid complaint.
But economic blogging and much journalism largely does not operate this way. Naifs write books, and sell many of them too. People as varied as Matt Ridley and William Greider make book-length statements about economics. I’ve never done that, and this is my job. This is, to say the very least, bizarre. The response of the untrained to the crisis has been even more startling. Many books have already been written about the nature of financial markets by non-economist writers, and I listen to Elizabeth Warren on the radio fearlessly speculating about the nature of credit market dysfunction, and so on.
Why is it bizarre that he has never written a book? Lots of professional economists have written books for the general public (e.g. Krugman for one). If he hasn't even though it's his job, that's something he should fix (I actually think his job is something else, but I'll take his word for it). And the shot at Elizabeth Warren is ill-informed (and makes me wonder why I should listen to him about anything, credentials or not). Yeah, we wouldn't want a lawyer from Harvard who specializes in contract law, bankruptcy, and commercial law to talk about problems in credit markets. Better to have economists discussing the legal issues? And we certainly don't want people like Warren who hold important government positions to explain to the public the reasoning behind the things they are doing?
I find the comparison between the response of writers to the financial crisis and the silence that followed two cataclysmic events in another sphere of human life telling. These are, of course, the Tsunami in East Asia, and the recent earthquake in Haiti. These two events collectively took the lives of approximately half a million people, and disrupted many more. Each of these events alone, and certainly when combined, had larger consequences for human well-being than a crisis whose most palpable effect has been to lower employment to a rate that, at worst, still employs fully 85% of the total workforce of most developed nations. However, neither of these events was met by (i) a widespread condemnation of seismology, the organized scientific endeavor most closely “responsible” for our understanding of these events or (ii) a flurry of auto-didacts rushing to offer their own diagnosis for what had happened, and advice for how to avoid the next big one.
Yep, not a single religious nut blamed it on god's anger at one group or another. All those stories about how someone's cat or their uncle's arthritic knee predicted the earthquake? I must have imagined those. As for blaming seismologists, unlike economists, they have never claimed to be able to forecast these events. Seismologists weren't claiming that they had solved the earthquake problem and that due to their valiant efforts we were now in the Great Earthquake Moderation.
Everyone understands that seismology is probably hard enough that one probably has little useful to say without first getting a PhD in it. The key is that macroeconomics, which involves aggregating the actions of millions to generate outcomes, where the constituents pieces are human beings, is probably every bit as hard. This is a message that would-be commentators just have to learn to accept. For my part, seventeen years after my first PhD coursework, I still feel ill at ease with my grasp of many issues, and I am fairly confident that this is not just a question of limited intellect.
Is there no issue that the author would be willing to take a position on and advocate for it in public? Is the state of theory and the accompanying empirical work so bad that there is no issue where we can take one side or the other? If so, why the give the instruction to rely upon experts?
So far, I’ve claimed something a bit obnoxious-sounding: that writers who have not taken a year of PhD coursework in a decent economics department (and passed their PhD qualifying exams), cannot meaningfully advance the discussion on economic policy. Taken literally, I am almost certainly wrong. Some of them have great ideas, for sure. But this is irrelevant. The real issue is that there is extremely low likelihood that the speculations of the untrained, on a topic almost pathologically riddled by dynamic considerations and feedback effects, will offer anything new. Moreover, there is a substantial likelihood that it will instead offer something incoherent or misleading.
Then quit complaining, learn how to do things digitally instead of as pdfs, and join in and help to correct bad information that is circulating. The economy is important to people and they are going to discuss it. And just as with medicine, there will be a lot of bad ideas that circulate. Is the answer to this to shut down all public conversation except that which exists in private between people and their doctors? Of course not, the answer is for doctors and (not doctor) journalists to take to the airways and correct the misinformation (there is also, of course, a role for regulation here). The answer to bad information is not less information, it's more.
This didn't start with the blogoshpere, people have been trying to sway the public one way or the other on policy issues from day one. In my view, the blogosphere has helped to counter bad information like "tax cuts pay for themselves." Prior to blogs, it was much harder to counter this stuff in real time but now, with non-professionals able to access the blogging of academics and others, it's much easier (though still far too hard) to rebut foolish policy ideas. So yes, bad information gets in the public arenas. It has always been so. The question is how fast it can be corrected and it is easier now than ever. In fact, the author is attempting to take advantage of this new capability with this essay.
Note also that intelligence is not the issue. Many of those I am telling you not to listen to will more than successfully be able to match wits, in any generalized sense, with me. This is irrelevant. The question is: can they provide you, the reader, with an internally consistent analysis of a dynamic system subject to random shocks populated by thoughtful actors whose collective actions must be rendered feasible? For many questions, I and my colleagues can, and for those that the profession cannot, the blogging crowd probably can’t either.
You might say, “you’re telling us to leave everything to the experts, so why should I believe you are adequately policed?” This is a fair question, but as someone who has worked for a decade to publish in leading academic journals (with some, but hardly overwhelming, success), I now have the referee reports to prove that I live in a world where people are not falling over themselves to believe my assertions. The reports are often scathing, but usually very insightful, and have over the years pointed out all manner of incoherence in my work. The leading journals have rejection rates in the neighborhood of 80%, and I’ve had my share of them.
I have had errors corrected in the blogosphere, e.g. to name just one, when I first started David Altig corrected something I had said wrong about growth theory. So the mere fact that journals point out incoherence in work does not, by itself, make the case for journals over the blogosphere. Both are error-correction mechanisms. And when it comes to civility, anonymous referee reports can be as petty and obnoxious as anything you will read in blogland. And they can also be flat wrong too (and unlike the public sphere, there is very little one can do to correct it). So yes, journals sometimes correct things, but it's a very imperfect process.
In summary, what I’d like to convince the public that economics is far, far, more complicated than most commentators seem to recognize. Because if they did, they could not honestly write the way they now do. Everything “depends”, and this is just the way it is. And learning what “it” depends on, exactly, takes enormous effort. Moreover, just below the surface of all the chatter that appears in blogs and op-ed pages, there is a vibrant, highly competitive, and transparent scientific enterprise hard at work. At this point, the public remains largely unaware of this work. In part, it is because few of the economists engaged in serious science spend any of their time connecting to the outer world (Greg Mankiw and Steve Williamson are two counterexamples that essentially prove the rule), leaving that to a group almost defined by its willingness to make exaggerated claims about economics and overrepresent its ability to determine clear answers.
Is this what he has in mind from Williamson? That's as petty as anything I've read in along time (and there are other posts like this). He calls Krugman a lot of names, e.g. an "ignoramus," and there is lots of evidence of Krugman Derangement Syndrome. But how much information about macroeconomics does he actually convey? Almost none. Certainly less than Krugman conveys almost daily on his blog (and the fact that Krugman does this is routinely ignored by his critics).
How can this be changed? A precondition for the market delivering this is a recognition by the general public that they are simply being had by the bulk of the economic blogging crowd. I hope to have alerted you to the giant disconnect that exists between the nuanced discussion that occurs between research economists and the noise (some of it from economists!) that one sees in the web or the op-ed pages of even the very best newspapers of the US. As a result, my hope is that the broader public will ask for a slightly higher bar when it comes to economics, rather than self-selecting into blogs that merely confirm half-baked views that might have been acquired from elsewhere. And I hope that non-economists who write about economics start routinely to do so in a way that references and discusses the premises that lead to particular conclusions about a given issue. Economics is full of this sort of “if-then” knowledge, which, if communicated well, could significantly sharpen the public discussion. This is not asking a lot, it is asking just enough.
1 Somewhat strangely, in an earlier era Paul Krugman very effectively took the same sort of “accidental theorist” to task, so what I’m saying is really a bit of a rehash of his arguments.
The views expressed are my own, and do not necessarily represent those of the Federal Reserve Bank of Richmond, or Federal Reserve System.
For more, and probably better comments since I did this far too fast and didn't really address the parts directed at non-professional economists, see Brad DeLong, Scott Sumner, Mathew Yglesias, Arnold Kling, Tyler Cowen, and Nick Rowe.
Update: See also Economists behaving foolishly, by Ryan Avent, and something I didn't talk enough about, the state of modern macro (DeLong covers this when he quotes Federal Reserve Bank of Minneapolis President Narayana Kocherlakota): Are We Better Off Getting Advice from the IMF than a Drunk in the Street?, by Dean Baker.
[Update: In comments, some people are puzzled by the statements on pdfs (though one person did defend them). It's mostly me venting a long-held frustration about the KC Fed practice, and also partly in response to an email conversation last night where one person who wanted to comment on the article was having trouble extracting text to post. He's not all that familiar with the technical side of blogging, and all of the junk that appears when text from a pdf is cut and then pasted into a blog was causing difficulties. A pdf is not a very convenient form for blogs, far from it -- the CBO offers both pdfs and html versions of many of its documents for this reason -- but I probably should have left these comments out since it appears to be distracting from the main points I wanted to make.]
Brad DeLong seems pessimistic about our political system:
Listening to Arsonists, by J. Bradford DeLong, Commentary, Project Syndicate: I had always thought that Barack Obama made a significant mistake in naming the Republican ex-senator Alan Simpson to co-chair the president’s deficit-reduction commission. Simpson was a noted budget arsonist when he was in the Senate. Indeed, he never met a budget-busting, deficit-increasing initiative from a Republican president that he would not lead the charge to pass. Nor did he ever meet a sober deficit-reducing initiative from a Democratic president that he did not oppose with every fiber of his being.
You don’t pick an arsonist to head the fire department... But perhaps I am ungenerous. Perhaps Simpson has had a change of heart. ... Even in that case, however, naming those who misbehave to important positions of high trust and acclaiming them as bipartisan statesmen gives the next generation really lousy incentives. And it’s not as though Congressional Republicans think they owe enough to Simpson for him to swing a single vote in either chamber of the legislature.
Obama officials assured me that Simpson had, indeed, had a change of heart; that he was a smart man with a sophisticated understanding of the issues; that he could sway reporters and get them to describe the commission’s advice as “bipartisan” (even though he could not sway actual legislators); and that he would be a genuine asset to the substantive work of the commission.
John Berry recently wrote in the online journal The Fiscal Times that not even that is true. Simpson is “condescending and derisive – and wildly wrong about important parts of the Social Security system's past.” ...
Four centuries ago, the consensus, in Western Europe at least, was that good and even adequate government in this fallen world was inevitably a rarity. Democracy always degenerated into mob rule, monarchy into tyranny, and aristocracy into oligarchy. Even when well run, democracy took little interest in the distant future, aristocracy took little interest in the well-being of those whom Simpson calls the “little people,” and monarchy took little interest in anything other than legitimate succession.
Then, at the end of the eighteenth century, the founders of the United States of America and their intellectual successors claimed that this pessimism about government was unwarranted. “The science of politics...like most other sciences,” claimed Alexander Hamilton, “has received great improvement....The regular distribution of power into distinct departments...legislative balances and checks...judges holding their offices during good behavior; the representation of the people in the legislature by deputies of their own election...are means, and powerful means, by which the excellences of republican government may be retained and its imperfections lessened or avoided...”
Perhaps Hamilton was too much the optimist. When I look at Barack Obama’s deficit commission – indeed, look at governance worldwide – I see many imperfections, but few or no examples of excellence.
I get pessimistic too, especially when I see Simpson types put in charge of things they have no business overseeing. But when I step back and look at the U.S., I see progress over time on important economic and social issues. The progress is not linear, or even always positive, it's excruciatingly slow, and that can be pretty frustrating when you are fighting the battle of the moment. But things are better now than they once were, and we continue to make progress on important social issues (though, again, it is frustratingly slow). Don't get me wrong, we are far from the end of the process, there is much, much more to do before our job is complete, but if you are a anything but a wealthy white male, things are relatively better now than they once were.
Will things continue to get better? I think so, but the system must continue to evolve over time so it can match the rise of economic and political power with institutions and mechanisms that will blunt their influence and reassert core principles. People with power will find a way to capture the system for themselves, and as their economic and political power increases as a result of their efforts, they will be increasingly successful at this task. I believe that we have allowed far too much capture of government by the powerful in recent decades -- the current state of campaign finance is one reflection of this -- and that this is the biggest danger we face going forward.
Political power is derived in large part from economic power, and a good place to start would be to begin asking harder questions about the costs and benefits of having businesses as big and influential as they are presently. If the economic efficiencies from size do not justify the costs from having such large and powerful firms, and I suspect in most cases they will not, then we need to reduce the power that these firms have (by breaking them if that is the best way to accomplish this). And even when size is justified by efficiency considerations, we need to do a much better job of regulating these firms so that they cannot exert undue influence on politics and the economy. If we don't, if we continue to allow the biggest among us to have the most say as has happened more and more in recent decades, if being big means you will mostly get your way, then we should worry about the future of our political system. I've been optimistic that we'll see the light, but that optimism has been shaken a bit by the outcome of legislation to reform the financial system. This legislation did very little to blunt the power that large firms can exert on our political system. That must change.
A failure of policy, in particular a "stunning resurgence of hard-money and balanced-budget orthodoxy," increases the likelihood that we are headed for a third depression:
The Third Depression, by Paul Krugman, Commentary, NY Times: Recessions are common; depressions are rare. As far as I can tell, there were only two eras in economic history that were widely described as “depressions” at the time: the years of deflation and instability that followed the Panic of 1873 and the years of mass unemployment that followed the financial crisis of 1929-31.
Neither the Long Depression of the 19th century nor the Great Depression of the 20th was an era of nonstop decline — on the contrary, both included periods when the economy grew. But these episodes of improvement were never enough to undo the damage from the initial slump, and were followed by relapses.
We are now, I fear, in the early stages of a third depression. It will probably look more like the Long Depression than the much more severe Great Depression. But the cost — to the world economy and, above all, to the millions of lives blighted by the absence of jobs — will nonetheless be immense.
And this third depression will be primarily a failure of policy. Around the world ... governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending. ... After all, unemployment — especially long-term unemployment — remains at levels that would have been considered catastrophic not long ago, and shows no sign of coming down rapidly. And both the United States and Europe are well on their way toward Japan-style deflationary traps.
In the face of this grim picture, you might have expected policy makers to realize that they haven’t yet done enough to promote recovery. But no: over the last few months there has been a stunning resurgence of hard-money and balanced-budget orthodoxy.
As far as rhetoric is concerned, the revival of the old-time religion is most evident in Europe, where officials seem to be getting their talking points from the collected speeches of Herbert Hoover, up to and including the claim that raising taxes and cutting spending will actually expand the economy, by improving business confidence. As a practical matter, however, America isn’t doing much better. The Fed seems aware of the deflationary risks — but what it proposes to do about these risks is, well, nothing. The Obama administration understands the dangers of premature fiscal austerity — but because Republicans and conservative Democrats in Congress won’t authorize additional aid to state governments, that austerity is coming anyway, in the form of budget cuts at the state and local levels.
Why the wrong turn in policy? The hard-liners often invoke the troubles facing Greece and other nations around ... Europe to justify their actions. And it’s true that bond investors have turned on governments with intractable deficits. But there is no evidence that short-run fiscal austerity in the face of a depressed economy reassures investors. ...
It’s almost as if the financial markets understand what policy makers seemingly don’t: that while long-term fiscal responsibility is important, slashing spending in the midst of a depression, which deepens that depression and paves the way for deflation, is actually self-defeating.
So I don’t think this is really about Greece, or indeed about any realistic appreciation of the tradeoffs between deficits and jobs. It is, instead, the victory of an orthodoxy that has little to do with rational analysis, whose main tenet is that imposing suffering on other people is how you show leadership in tough times.
And who will pay the price for this triumph of orthodoxy? The answer is, tens of millions of unemployed workers, many of whom will go jobless for years, and some of whom will never work again.
Sunday, June 27, 2010
Is monetary policy too expansionary or not expansionary enough?, by Martin Wolf: People with a free-market orientation believe that the economy has a strong tendency towards equilibrium. Over the long term money is “neutral”: a rise in the money supply merely raises the price level. In the short term, however, monetary policy may have a big impact on the economy. A big question, however, is over how to measure the impact of monetary policy in an environment such as the present one, when short-term interest rates are close to zero and the credit system is damaged.
The difficulty arises because of the huge divergence between what is happening to the monetary base (the monetary liabilities of the government, including the central bank) and what is happening to broader measures of money (principally the liabilities of the banking system). The former has exploded. But the growth rate of the latter is extremely low. ...
The ... inflationary impact of “money printing” can ... only happen if the overall money supply starts to grow rapidly. This is not now happening. Only the monetary base is expanding rapidly. Should such a broader expansionary impact emerge, monetary policy will have been successful, the central bank can then raise rates, thereby preventing a rapid growth in credit and so constraining the growth of broad money.
My conclusion is that what is happening to the balance sheet of the central bank is unimportant, except to the extent that it has prevented a collapse of credit and money. What matters is the overall supply of credit and money in economies. This continues to be stagnant in the developed world. Concern about an imminent outbreak of inflation is consequently a grave mistake. To the extent that there is a danger of “monetization” of debt, it will emerge only if we fail to return to growth, because that is the situation in which it is most likely that public sector deficits will fail to close. It follows that strong monetary tightening now may increase the long-term threat of inflation, rather than reduce it.
What do you think?
There is no evidence of worry over the threat of inflation in financial markets. To repeat a point that's been made here many, many times, increasing interest rates too soon would be a mistake since it will make it more difficult for the economy to recover. If anything, given the weakness that still exists in the economy, more ease is called for.
A Pendulum Swing Toward Austerity, by Tyler Cowen, Commentary , NY Times: “The Road to Serfdom,” the critique of socialism written 65 years ago by ... Friedrich von Hayek, was recently No. 1 in nonfiction sales at Amazon.com. Many people, including ... Glenn Beck, have contended that growth of government power has, indeed, set us on such a road today. But ... the expansionary phase of big government is coming to an end, and quickly.
In the last few years, we have seen ... huge financial bailouts, a $787 billion stimulus plan and legislation for near-universal health insurance coverage. But the policy mood in Washington is now much more modest: no second major stimulus is forthcoming and ... a cap-and-trade system for greenhouse gas emissions is unlikely to move forward. ...
If any financial policy idea is taking a major place on the American and global stages, it is fiscal austerity. ... In the United States, we face rising health care costs and pension problems in state governments, with no clear long-run solution for bringing the books into balance.
That makes responsible politicians reluctant to undertake major new commitments. ... In short, it’s not that ideas of government interventionism and free markets are fighting a titanic intellectual struggle. The reality is more mundane. The ascendancy of one view often creates the conditions for an economic counterreaction. ...
During the 1980s and 1990s, history seemed to be on the side of freer markets..., and a wide range of governments adopted privatization. ... Eventually, things started to go wrong, in part because investors ... became complacent about systemic risk. ... The weak economy brought victory for the Democrats in 2008... Now the pendulum is swinging back. The economy will now likely make Congress much more Republican, as voters overreact to whatever is not working at the moment.
The unfolding of the financial crisis has also changed the public’s sense of where change is needed.... The ... 2008 crises were attached more directly to market institutions, while the 2010 crises are more closely linked to governments [such as Greece]. Because politicians and voters are more influenced by the latest developments..., a cautious attitude toward public-sector spending has been further cemented. ...
The lessons are straightforward. First, to paraphrase the French moralist La Rochefoucauld, things are never as good, or as bad, as they seem. Second, the Obama reforms, like the Reagan revolution, are turning out to be radically incomplete, which should come as no surprise.
Finally, effective political ideas are those that can still do good in half-baked form. We have neglected this insight in designing financial reform, and it remains to be seen if we can apply it successfully to climate change.
And when it comes to the budget? Even if our real fiscal problems lie in the more distant future, it’s important to start worrying about them now, because we cannot count on a grand plan later to save the day.
I'm not sure the timing fits as far as the second stimulus package goes. Long before anyone had ever uttered the word austerity or started to worry about Greece, the administration had already decided that it was not going to put any political capital behind trying to get a second package through Congress. There were a few remarks thrown in this direction, but nothing of the sort that provides the leadership necessary to get such a program passed. For whatever reason, the administration gave up and moved on to other issues. I suppose it thought the votes just weren't there, but that outcome is not at all independent of the effort the administration puts into getting a bill passed. Right now, we have nothing, no jobs or second stimulus bill at all. But if the administration had started a serious campaign six months or more ago when talk of a first stimulus package began, the outcome would, I think, have been different. I'd still be complaining it wasn't enough, but at least we would have gotten something.
In any case, I think opposition to the second stimulus package began long before Greece and the austerity movement. I also think leadership from the administration and key members of Congress matters, and when it comes to a second stimulus package with a large job creation component, something that is very much needed, it wasn't there.
Via email (from a well known and economist):
I don't know if you follow radio and podcasts much or link to them, but there is a recent This American Life program on structural adjustment in Barbados in the 1990s that is quite interesting, particularly in light of difficulties in Greece.
It explains how the nation adopted across-the-board wage cuts in the government and in the private sector, agreed to by unions rather than devalue as recommended by the IMF. As usual for this program, it is very accessible, but even for professional economists, it provides some details and context about policy outcomes and the actual process that leads to policy decisions that we often lack. The second half of the story, on Jamaica, is more familiar and takes much less time.
The second act, on Barbados and Jamaica, starts at about 36 minutes into the 1 hour podcast.
Saturday, June 26, 2010
Budget Hawk, Stimulus Dove, by Arnold Kling: It's not my position. But I would think someone would articulate it. It sounds like what Mark Thoma would advocate, for example. That is, someone could advocate:
1 A larger deficit in the short term.
2. Specific, clear measures to reduce deficits over the next ten years, by trimming entitlements and raising taxes.
3. Linking (1) and (2) in a single piece of legislation.
This sort of approach might satisfy doves who complain about austerity as well as Europeans and domestic hawks who worry about the U.S. fiscal outlook. If (2) included some serious structural changes in entitlements I might endorse it.
But my point is not whether this compromise is something I could get excited about. My point is that it represents a missing position in the media. Why are the hawks and doves more interested in trying to score debating points against one another than in achieving their objectives?
Some day another severe recession will hit the economy, and taking the interest rate down to the zero bound won't be enough to turn things around -- fiscal policy will be needed. But will it be available to future policymakers?
It's true that I am dovish in the short-run. I think we should move aggressively to stabilize the economy, but it's important that we follow through when things get better and pay for stimulus programs that were put into place. In essence, we shave the peaks of the business cycle to fill the troughs (note that this is not "trying to spend our way to prosperity" as the WSJ likes to accuse the Keynesians of trying to do -- this is stabilization policy, not growth policy -- growth policies are a different, and it's economic growth that is connected to long-run prosperity).
If we cut taxes and increase government spending to cure the economy, then these measures must be reversed when things are better. If we don't reverse them and the stimulus package is seen ex-post as a drain on the budget or an excuse to increase the size of government, then policymakers of the future will be less willing (or less politically able) to implement a fiscal stimulus package. When many of us said the packages should be timely, targeted, and temporary, we meant the temporary part. The ability to put temporary programs into place during bad times must be maintained if we don't want to limit the options future policymakers have to fix the economy.
But it's not just the reversal of these temporary programs that is important for fiscal policy in the future. The response to this recession provides a good example of why. When the recession hit, the budget was already in poor shape, and it wasn't politically possible to put a stimulus package of sufficient size into place. Thus, we ended up with a package about half the size we needed, and no ability to augment it later. Had the budget been near balance or in surplus when the recession hit, I think the response would have been much more aggressive.
So I am hawkish in the long-run, and one big reason is to preserve our ability to do fiscal policy going forward. Fiscal policy is a valuable stabilization tool in severe recessions, and it would be unfair to all future generations for us to take away their ability to conduct fiscal stabilization policy by failing to reverse the policies we have put into place, and by failing to bring the long-run budget closer to balance.
With that said, however, I should note that the economy is still struggling and it's not time to begin reversing policy yet -- more, not less is needed right now. But when unemployment crosses some threshold, 7% seems reasonable, it ought to trigger the beginning of the end for the stabilization policies that we have implemented.
Friday, June 25, 2010
Here's my reaction to the agreement between the House and Senate of financial reform:
I am not convinced the most important problem has been addressed -- leadership within the regulatory agencies.
Paul Krugman says "China needs to stop giving us the runaround and deliver real change" in its currency policy:
The Renminbi Runaround, by Paul Krugman, Commentary, NY Times: Last weekend China announced a change in its currency policy, a move clearly intended to head off pressure from the United States and other countries at this weekend’s G-20 summit meeting. Unfortunately, the new policy doesn’t address the real issue, which is that China has been promoting its exports at the rest of the world’s expense.
In fact, far from representing a step in the right direction, the Chinese announcement was an exercise in bad faith... In short, they’re playing games.
To understand what’s going on, we need to get back to the basics of the situation. China’s exchange-rate policy is neither complicated nor unprecedented, except for its sheer scale. It’s a classic example of a government keeping the foreign-currency value of its money artificially low by ... buying foreign currency. ...
There have been all sorts of calculations purporting to show that the renminbi isn’t really undervalued, or at least not by much. But if the renminbi isn’t deeply undervalued, why has China had to buy around $1 billion a day of foreign currency to keep it from rising?
The effect of this currency undervaluation is twofold: it makes Chinese goods artificially cheap to foreigners, while making foreign goods artificially expensive to the Chinese. That is, it’s as if China were simultaneously subsidizing its exports and placing a protective tariff on its imports.
This policy is very damaging at a time when much of the world economy remains deeply depressed. In normal times, you could argue that Chinese purchases of U.S. bonds, while distorting trade, were at least supplying us with cheap credit... But right now we’re awash in cheap credit; what’s lacking is sufficient demand for goods and services to generate the jobs we need. And China, by running an artificial trade surplus, is aggravating that problem.
This does not, by the way, mean that China gains from its currency policy. The undervalued renminbi is good for politically influential export companies. But these companies hoard cash rather than passing on the benefits to their workers, hence the recent wave of strikes. Meanwhile, the weak renminbi creates inflationary pressures and diverts a huge fraction of China’s national income into the purchase of foreign assets with a very low rate of return.
So where does last week’s policy announcement fit into all this? Well, China has allowed the renminbi to rise — but barely. As of Thursday, the currency was only about half a percent higher than its typical level before the announcement. ... Chinese officials are still making statements denying that a rise in their currency will do anything to reduce trade imbalances, and ... suggest a rise of only about 2 percent ... by the end of this year. This is basically a joke.
What the Chinese have done, they claim, is to increase the “flexibility” of their exchange rate: it’s moving around more from day to day than it did in the past, sometimes up, sometimes down.
Of course, Chinese policy makers know perfectly well that although U.S. officials have indeed called for more currency flexibility, that was just a diplomatic euphemism for what America, and the world,... has the right to demand...: a much stronger renminbi. Having the currency bob up or down slightly makes no difference to the fundamentals.
So what comes next? China’s government is clearly trying to string the rest of us along, putting off action until something — it’s hard to say what — comes up.
That’s not acceptable. China needs to stop giving us the runaround and deliver real change. And if it refuses, it’s time to talk about trade sanctions.
The definition of "onshore" changes when you are a regulator captured by the industry you are supposed to monitor:
Will this well end well?, by Eric Rauchway: There oughta be an axiom of regulation, that if you’re changing the rules in such a way that will make you sound grossly culpable when something goes wrong, you shouldn’t do it.
The future of BP’s offshore oil operations in the Gulf of Mexico has been thrown into doubt by the recent drilling disaster and court wrangling over a moratorium.
But about three miles off the coast of Alaska, BP is moving ahead with a controversial and potentially record-setting project to drill two miles under the sea and then six to eight miles horizontally to reach what is believed to be a 100-million-barrel reservoir of oil under federal waters.
All other new projects in the Arctic have been halted by the Obama administration’s moratorium on offshore drilling, including more traditional projects like Shell Oil’s plans to drill three wells in the Chukchi Sea and two in the Beaufort.
But BP’s project, called Liberty, has been exempted as regulators have granted it status as an “onshore” project even though it is about three miles off the coast in the Beaufort Sea. The reason: it sits on an artificial island — a 31-acre pile of gravel in about 22 feet of water — built by BP.
Then the article quotes some scientists saying this doesn’t sound like such a hot idea. So wait, why is it okay? “BP has defended the project in its proposal, saying it is safe and environmentally friendly.” Well, okay then.
I hope very much I have no future interest in returning to this link.
More from the article linked above:
Rather than conducting their own independent analysis, federal regulators, in a break from usual practice, allowed BP in 2007 to write its own environmental review for the project as well as its own consultation documents relating to the Endangered Species Act... The environmental assessment was taken away from the agency’s unit that typically handles such reviews, and put in the hands of a different division that was more pro-drilling, said ... scientists, who discussed the process because they remained opposed to how it was handled. “The whole process for approving Liberty was bizarre,” one of the federal scientists said.
Thursday, June 24, 2010
I thought the plan was to have death panels decide which of our seniors to send away on icebergs, but Dean Baker says to help with the budget, we should pay retirees to leave the country:
When the initial stimulus package was put into place, we threw out a life rope that was too short to save everyone. Some people were able to get to it, and they were helped, but others were left treading water or, worse, sinking. So do we circle back and throw out more rope in order to save the people left out the first time around? Ezra Klein brings the bad, but not unexpected news [Update: scratch the word unlikely in the title, the bill failed.]:
The Senate unemployment bill founders: Before talking about what's happened to the Senate jobs bill, it's worth first talking about what's in the Senate jobs bill.
The biggest and most important item is the extension of unemployment insurance. ...Then there's the extension of the federal government's program to help states pay for Medicaid costs. During recessions, more people need Medicaid, which increases the program's cost, but state revenues drop, which reduces their ability to pay for the program. ...
The bill also has a raft of tax cuts and investments, including billions for the Small Business Administration to offer more loans to small businesses, bonds to fund infrastructure development, money to encourage private-sector R&D. and more. A full list of the bill's provisions, and its subsequent modifications, can be found here.
Those modification documents are important, because Democrats have made a lot of changes to the bill in response to Republican opposition. The total cost went from $200 billion to about $110 billion. The bill went from being deficit-funded -- which is what you want for stimulus -- to largely paid for, with only the $30 billion or so in unemployment benefits adding to the deficit. The $25 addition to unemployment checks was eliminated, and states now have to pay more for Medicaid, adding to their budget woes. The bill, in other words, has been made smaller and weaker. And that's despite 9.7 percent unemployment.
And still, it looks like Democrats might lose the vote today. And when I say "lose the vote," I don't mean that a majority of the Senate will vote against it. I mean that 58 senators, rather than 60, will support the legislation. All Republicans, and possibly Ben Nelson, appear to remain opposed. And why not? The less that Democrats appear to be doing on jobs -- and the fewer jobs that Democrats actually create -- the better Republicans will do in November. ...
Looks like the "you're on your ownership society" is on its way.
A couple of days ago, Room for Debate at the NY Times asked about the need for further stimulus, and part of my response said the following (It hasn't run yet since they decided to cover McChrystal first):
But the most important change that is needed is in the attitude of the public and politicians toward using deficit spending to stabilize the economy. Even though it’s the correct response, deficit spending goes against our instincts. When times are tough, our natural response is to cut back on consumption. We may dip into savings or borrow money to prevent too large a fall in consumption, but our overall consumption falls. To see government not only failing to reduce its spending as its income (tax revenue) falls, but actually increasing spending by a large magnitude, cutting taxes, and financing it by taking on debt, and then saying even more is needed runs counter to those instincts. And starting with a budget that is already in the red doesn't help at all.
I see Paul Krugman is making a similar point. Here's Brad DeLong:
Against The Super-Asinine, The Gods Themselves Contend in Vain: Brad DeLong wonders how the proponents of tight budgets and tight money are prevailing in the midst of mass unemployment, low interest rates, and incipient deflation. It’s actually not all that surprising. Horrifying, but not surprising. The case for expansionary policies in the face of a slump is intellectually difficult; Keynes described the writing of the General Theory as a painful process of discovery, and so it is. The natural instinct of almost everyone is to think that tough times require tough measures, and that if the economy is suffering, the government should tighten its own belt. It would take a clear consensus from economists to overcome that natural bias. And that consensus has, of course, been lacking — largely because a significant proportion of the economics profession has spent the last three decades systematically destroying the hard-won knowledge of macroeconomics. It’s truly a new Dark Age, in which famous professors are reinventing errors refuted 70 years ago, and calling them insights.
On top of that, anti-stimulus appeals to a fundamental meanness of spirit that is always present in the political world. The super-asinine we shall always have with us.
May I say that I expected something like this? It’s part of the reason I was so anxious to see Obama go for the maximum stimulus possible: it seemed obvious that he would have only one shot...
Not obvious to me--not at the time.
I do say that if, as appears to be the case, Paul Krugman is always right, it would be really, really, really, really helpful if he were more optimistic...
Robert Stavins says climate change legislation is still possible and, after an extensive review of all the "real options for climate policy in the United States," he concludes that the best available alternative is an economy-wide cap-and-trade system. (It's hard for me to envision an economy-wide cap-and-trade system finding the political support it needs to be enacted, but I hope I'm wrong. This is quite a bit shorter than the original and, in addition, the original is dense with links to supporting documentation.):
The Real Options for U.S. Climate Policy, by Robert Stavins: The time has not yet come to throw in the towel regarding the possible enactment in 2010 of meaningful economy-wide climate change policy... Meaningful action of some kind is still possible, or at least conceivable. But with debates regarding national climate change policy becoming more acrimonious in Washington as midterm elections approach, it is important to ask, what are the real options for climate policy in the United States – not only in 2010, but in 2011 and beyond. That’s the purpose of this essay.
Federal Policy Options Let’s begin my considering Federal policy options under two distinct categories: pricing instruments and other approaches. Carbon-pricing instruments could take the form of caps on the quantity of emissions (cap-and-trade, cap-and-dividend, or baseline-and-credit), or approaches that directly put carbon prices in place (carbon taxes or subsidies). Beyond pricing instruments, the other approaches include regulation under the Clean Air Act, energy policies not targeted exclusively at climate change, public nuisance litigation, and NIMBY and other public interventions to block permits for new fossil-fuel related investments. I will discuss each of these in turn. ...
A Quick Reminder about Cap-and-Trade In brief, there are four principal merits of the cap-and-trade approach to achieving significant reductions of carbon dioxide (CO2) emissions. First, this approach achieves overall targets at minimum aggregate cost... Second, the allowance allocation under a cap-and-trade system can be used to build a constituency of political support across sectors and geographic areas without driving up the cost of the program or reducing its environmental performance. Third, we have significant experience in the United States with the use of this approach, including during the 1980s to phase out leaded gasoline from the marketplace, and since the 1990s to cut acid rain by 50 percent. Fourth, and of great importance, a domestic cap-and-trade system can be linked directly and cost-effectively with cap-and-trade systems and emission-reduction-credit systems in other parts of the world...
Three principal concerns have been voiced about cap-and-trade systems in U.S. debates. First, while a cap-and-trade system constrains the quantity of emissions, the costs of control are left uncertain (although such cost uncertainty can be limited — if not eliminated — through the use of safety valves, price collars, or related mechanisms). Second, in the wake of concerns regarding the role that financial markets played in the global recession, there have been many fears about the possibilities of market manipulation in a cap-and-trade system. A third concern – in a political context – is that this cost-effective approach to environmental protection, pioneered by the Republican administration of President George H. W. Bush, has – ironically — been demonized by conservatives in current debates. ...
A Populist Approach? Populism has emerged as a major theme in recent electoral politics in the United States, both from the left and from the right. What might be characterized as a populist approach would be a cap-and-trade system with 100% of the allowances auctioned and the auction revenue returned directly “to the people.” Although this is a standard variant of cap-and-trade design, contemporary politics — with its demonization of the phrase “cap-and-trade” — might well argue for a name change: how about “cap-and-dividend?”...
The merits of this approach include its simplicity, appearance of fairness, and related appeal to the populist mood. Concerns, however, include the proposal’s relatively modest environmental achievements (according to an analysis by the World Resources Institute), its overall cost due to restrictions on trading, and its apparent political infeasibility, given its lack of visible support in the Congress. ...
Direct Carbon Pricing A carbon tax system would be similar in design to an upstream cap-and-trade approach. There is some real interest in this approach, mainly from academics, and there is also what I would characterize as “strategic interest,” principally from those who recognize that once the focus is on carbon taxes rather than other instruments, political debates will inevitably result in less ambitious targets or, in fact, no policy at all. ...
In this regard, it is important to note that what has frequently been interpreted as hostility to cap-and-trade in the U.S. Senate is actually – on closer inspection — broader hostility to the very notion of carbon pricing (or any climate change policy). Surely, the political reception to a carbon tax would be even less enthusiastic than the reception that has greeted recent cap-and-trade proposals. ...
Climate Change Regulation under the Clean Air Act Regulations of various kinds may soon be forthcoming – and in some cases, will definitely be forthcoming – as a result of the U.S. Supreme Court decision in Massachusetts v. EPA and the Obama administration’s subsequent “endangerment finding” that emissions of carbon dioxide and other greenhouse gases endanger public health and welfare. This ... identified carbon dioxide as a pollutant under the Clean Air Act...
However, regulatory action on carbon dioxide under the Clean Air Act will accomplish relatively little and do so at relatively high cost, compared with carbon pricing. ... Indeed it is reasonable to ask whether this is a credible threat, or will instead turn out to be counter-productive (when stories about the implementation of inflexible, high-cost regulatory approaches lend ammunition to the staunchest opponents of climate policy). ...
Does the Path to National Climate Policy Need to Go through Washington? With political stalemate in Washington, attention may increasingly turn to regional, state, and even local policies intended to address climate change. The Regional Greenhouse Gas Initiative (RGGI) in the Northeast has created a cap-and-trade system among electricity generators. More striking, California’s Global Warming Solutions Act will likely lead to the creation of a very ambitious set of climate initiatives, including a statewide cap-and-trade system... The California system is likely to be linked with systems in other states and Canadian provinces under the Western Climate Initiative. ...
An important question is whether there can be sensible sub-national policies even in the presence of an economy-wide Federal carbon-pricing regime? The answer is surely yes, partly because other market failures will continue to exist that are not addressed by carbon pricing. ...
In the meantime, in the absence of meaningful Federal action, sub-national climate policies could well become the core of national action. ...
The Path Ahead Conventional politics clearly disfavors market-based (pricing) environmental policy approaches that render costs obvious or at least somewhat transparent, despite the fact that the costs of these same policies are actually less than those of alternative approaches. Instead, conventional politics favors approaches to environmental protection that render costs less obvious (or better yet invisible), such as renewable portfolio standards, and — for that matter — all sorts of command-and-control performance and technology standards.
But carbon pricing will be necessary to address the diverse economy-wide sources of CO2 emissions effectively and at sensible cost, whether the carbon pricing comes about through an economy-wide Federal cap-and-trade system or through a Federal carbon tax. It is inconceivable that truly meaningful reductions in CO2 emissions could be achieved through purely regulatory approaches, and it remains true that whatever would be achieved, would be accomplished at excessively high cost.
So, although it is true – as I have sought to explain in this essay – that there are a diverse set of options for future climate policy in the United States, the best available alternative to an economy-wide cap-and-trade system enacted in 2010 may be an economy-wide cap-and-trade system enacted in 2011!
Wednesday, June 23, 2010
This is a good example of what's going on with economic policy right now. Marty Feldstein thinks that people ought to be worried about inflation and budget deficits, and the fact that he can't find evidence of this worry puzzles him:
while inflation is very likely to remain low for the next few years, I am puzzled that bond prices show that investors apparently expect inflation to remain low for ten years and beyond, and that they also do not require higher interest rates as compensation for the risk that the fiscal deficit will cause real interest rates to rise in the future.
Instead of questioning his own assumptions in light of evidence that they are incorrect, he suggests implicitly that investors collectively -- i.e. the vaunted market with its ability to incorporate all relevant information into prices -- is wrong. So my question for the deficit and inflation hawks, who are generally those who believe markets to outperform humans in every conceivable way, is this. When do we abandon what markets are actually telling us and instead react to what we -- the less capable humans -- think markets ought to be telling us?
As expected, the FOMC tells us how weak the economy is, and that it may be getting weaker. But it expresses confidence that the economy will somehow take care of itself, and decides to stay on hold rather than moving toward a more aggressive monetary policy stance. Here's the Press Release on the decision:
The only good news I can find here is that we have a chance to be "most improved player." But that won't happen unless we continue to reform the health care system:
US ranks last among 7 countries on health system performance, EurekAlert: New York, NY, June 23, 2010—Despite having the most expensive health care system, the United States ranks last overall compared to six other industrialized countries—Australia, Canada, Germany, the Netherlands, New Zealand, and the United Kingdom—on measures of health system performance in five areas: quality, efficiency, access to care, equity and the ability to lead long, healthy, productive lives, according to a new Commonwealth Fund report. While there is room for improvement in every country, the U.S. stands out for not getting good value for its health care dollars, ranking last despite spending $7,290 per capita on health care in 2007 compared to the $3,837 spent per capita in the Netherlands, which ranked first overall.
Provisions in the Affordable Care Act that could extend health insurance coverage to 32 million uninsured Americans have the potential to promote improvements to the United States' standing when it comes to access to care and equity, according to Mirror Mirror On The Wall: How the Performance of the U.S. Health Care System Compares Internationally 2010 Update, by Commonwealth Fund researchers Karen Davis, Cathy Schoen, and Kristof Stremikis. The United States' low marks in the quality and efficiency dimensions demonstrate the need to quickly implement provisions in the new health reform law and stimulus legislation that focus on realigning incentives to reward higher quality and greater value, investment in preventive care, and expanding the use of health information technology.
"It is disappointing, but not surprising that, despite our significant investment in health care, the U.S. continues to lag behind other countries," said Commonwealth Fund President and lead author Karen Davis. "With enactment of the Affordable Care Act, however, we have entered a new era in American health care. We will begin strengthening primary care and investing in health information technology and quality improvement, ensuring that all Americans can obtain access to high quality, efficient health care."
Earlier editions of the report, produced in 2004, 2006, and 2007, showed similar results. This year's version incorporates data from patient and physician surveys conducted in seven countries in 2007, 2008, and 2009.
Key findings include:
On measures of quality the United States ranked 6th out of 7 countries. On two of four measures of quality—effective care and patient-centered care—the U.S. ranks in the middle (4th out of 7 countries). However, the U.S. ranks last when it comes to providing safe care, and next to last on coordinated care. U.S. patients with chronic conditions are the most likely to report being given the wrong medication or the wrong dose of their medication, and experiencing delays in being notified about an abnormal test result.
On measures of efficiency, the U.S ranked last due to low marks when it comes to spending on administrative costs, use of information technology, re-hospitalization, and duplicative medical testing. Nineteen percent of U.S. adults with chronic conditions reported they visited an emergency department for a condition that could have been treated by a regular doctor, had one been available, more than three times the rate of patients in Germany or the Netherlands (6%).
On measures of access to care, people in the U.S. have the hardest time affording the health care they need—with the U.S. ranking last on every measure of cost-related access problems. For example, 54 percent of adults with chronic conditions reported problems getting a recommended test, treatment or follow-up care because of cost. In the Netherlands, which ranked first on this measure, only 7 percent of adults with chronic conditions reported this problem.
On measures of healthy lives, the U.S. does poorly, ranking last when it comes to infant mortality and deaths before age 75 that were potentially preventable with timely access to effective health care, and second to last on healthy life expectancy at age 60.
On measures of equity, the U.S. ranks last. Among adults with chronic conditions almost half (45%) with below average incomes in the U.S. reported they went without needed care in the past year because of costs, compared with just 4 percent in the Netherlands. Lower-income U.S. adults with chronic conditions were significantly more likely than those in the six other countries surveyed to report not going to the doctor when they're sick, not filling a prescription, or not getting recommended follow-up care because of costs. ...
Why doesn't the Fed take more aggressive action to help the economy?:
When Caution Carries Risk, by David Leonhardt, NY Times: Ben Bernanke believes that he and his Federal Reserve colleagues have... “...considerable power to expand aggregate demand and economic activity, even when its accustomed policy rate is at zero,” as it is today. Mr. Bernanke also believes that the economy is growing “not fast enough”... He has predicted that unemployment will remain high for years and that “a lot of people are going to be under financial stress.”
Yet he has been unwilling to use his power to lift growth and reduce joblessness from near a 27-year high... How can this be? How can Mr. Bernanke simultaneously think that growth is too slow and that it shouldn’t be sped up? There is an answer — whether or not you find it persuasive. ...
Fed officials are ... not so much worried about inflation, the traditional source of Fed angst, as they are about upsetting the markets’ confidence in Washington. Yes, investors remain happy to lend the United States money at rock-bottom interest rates, despite our budget deficit and all of the emergency Fed programs that will eventually need to be unwound. But no one knows how long that confidence will last.
In effect, Mr. Bernanke and his colleagues have decided to accept ... high unemployment ... for years to come — rather than risk an even worse situation — a market panic, a spike in long-term interest rates and yet higher unemployment. As the last few years have shown, market sentiment can change unexpectedly and sharply.
Still, you have to wonder if the Fed is paying enough attention to the risks of its own approach. ... The main historical lesson of financial crises is that governments are usually too passive. They respond in dribs and drabs, as Japan did in the 1990s and Europe did in 2008. Or they remove support too quickly, as Franklin Roosevelt did in 1937, and then the economy struggles to escape its funk.
Look around at the American economy today. Unemployment is 9.7 percent. Inflation ... has been zero. States are cutting their budgets. Congress is balking at spending the money to prevent state layoffs. The Fed is standing pat, too. Bond investors, fickle as they may be, show no signs of panicking.
Which seems to be the greater risk: too much action or too little? ... In the end, Mr. Bernanke’s ... decision comes down to weighing the probabilities and the possible outcomes. Let’s just be clear about the risks and costs that the Fed has chosen. It is ... willing to accept a jobless rate of almost 10 percent, with all of the attendant human costs.
“About half of the unemployed have been unemployed for six months or more, which means that they are losing skills, they’re losing contact with the job market,” a prominent economist said at a public dinner in Washington this month. “If things go on and they simply sit at home or work very irregularly, when the economy gets back to a more normal state, they’re not going to be able to find good work.”
That economist happened to be Ben Bernanke, one of the few people with the power to do something about the situation.
I wish I had a better sense why the Fed is so worried about a market panic when there is no evidence indicating that financial markets are near the tipping point. Is there actual evidence that has them worried -- if there is, how about sharing it? -- or is it just some general sense that we must be getting near the threshold?
I think the economy needs more help, and that fiscal policy is the best choice right now. But given the present inclination toward policy timidity, I'll take what I can get, and I wish that the Fed would be more aggressive. However it doesn't look at all likely that monetary or fiscal policy policymakers are going to make any significant moves toward further stimulus, we'll be lucky if they don't do the opposite before the economy is ready, so it appears that Bernanke's forecast that unemployment will remain high for years may come true. But unworried financial markets -- and those who benefit the most from them -- won't have to worry about worrying.
Tuesday, June 22, 2010
I will be on the Paul Mann Show (KHSU), Arcata, CA from 7:30-8:30 p.m. Tim Duy will be on the show as well.
Was Keynes in favor of big government? Do Keynesian policies necessarily lead to big government?:
Keynes and Social Democracy Today, by Robert Skidelsky, Commentary, Project Syndicate: For decades, Keynesianism was associated with social democratic big-government policies. But John Maynard Keynes’s relationship with social democracy is complex. Although he was an architect of core components of social democratic policy – particularly its emphasis on maintaining full employment – he did not subscribe to other key social democratic objectives, such as public ownership or massive expansion of the welfare state. ...
Until The General Theory was published in 1936, social democrats did not know how to go about achieving full employment. Their policies were directed at depriving capitalists of the ownership of the means of production. How this was to produce full employment was never worked out. ...
Keynes demonstrated that the main cause of bouts of heavy and prolonged unemployment was ... fluctuating prospects of private investment in an uncertain world. Nearly all unemployment in a cyclical downturn was the result of the failure of investment demand.
Thus, the important thing was not to nationalize the capital stock, but to socialize investment. Industry could be safely left in private hands, provided the state guaranteed enough spending power in the economy to maintain a full-employment level of investment. This could be achieved by monetary and fiscal policy: low interest rates and large state investment programs.
In short, Keynes aimed to achieve a key social democratic objective without changing the ownership of industry. Nevertheless, he did think that redistribution would help secure full employment. A greater tendency to consume would “serve to increase at the same time the inducement to invest.” ...
Moderate re-distribution was the more politically radical implication of Keynes’s economic theory, but the measures outlined above were also the limits of state intervention for him. As long as “the state is able to determine the aggregate amount of resources devoted to augmenting the instruments [i.e., the capital base] and the basic reward to those who own them,” there is no “obvious case” for further involvement. ...
Today, ideas about full employment and equality remain at the heart of social democracy. But the political struggle needs to be conducted along new battle lines. Whereas the front used to run between government and the owners of the means of production – the industrialists, the rentiers – now, it runs between governments and finance. ...
Being too big to fail simply means being too big. Keynes saw that “it is the financial markets’ precariousness which creates no small part of our contemporary problem of securing sufficient investment.” That rings truer today – more than 70 years later – than in his own day. ...
This, once again, calls for an activist government policy. ... Keynes’s main contribution to social democracy, however, does not lie in the specifics of policy, but in his insistence that the state as ultimate protector of the public good has a duty to supplement and regulate market forces. If we need markets to stop the state from behaving badly, we need the state to stop markets from behaving badly. Nowadays, that means stopping financial markets from behaving badly. That means limiting their power, and their profits.
On Keynesian policy and big government, as I've explained many times (e.g.), there is no necessary connection between the size of government and Keynesian stabilization policy. Want the government to grow? Then cure recessions by increasing spending, and pay for it by raising taxes during the good times. After a few business cycles under this policy, government will be larger. This is the strategy that Democrats are accused of playing.
Want the opposite result? No problem, just use tax cuts to stimulate the economy during a recession, then pay for the cuts by reducing government spending during the subsequent boom. A few cycles later, and government is much smaller. This is the Republican starve the beast strategy that they fully admit to playing (I am abstracting, of course, from the political difficulties with either strategy).
Want to keep government the same size? Then simply use the same policy tool on both sides of the business cycle. Increase government spending in a recession, then reverse it in the good times, or, alternatively, cut taxes during the bad times, then raise them when things improve.
Summarizing: Using a different policy tools on each side of as recession changes the size of government, while using the same policy tool does not. But the main point is that, contrary to what you may have been led to believe, there is nothing inherent in Keynesian economics that connects stabilization policy to the size of government. There are, I think, political considerations that make it easier to cut taxes or raise spending when times are bad than to do the opposite when things improve (e.g. the argument that it will kill job growth!). But there is nothing in the underlying economics that says Keynesian policy necessarily leads to a change in the size of government.
Calling all budget hawks:
Time to get tough on defense spending, by Katrina vanden Heuvel, Commentary, Washington Post: With the fixation on shrinking the budget deficit, why is over $700 billion in annual defense spending almost always off-limits for discussion? The ... bipartisan Sustainable Defense Task Force's June 11 report recommending over $1 trillion in Pentagon cuts over the next 10 years is an indication that some sanity might arrive inside the Beltway. ... Some of the report's big-ticket items for savings over a 10-year period include $113 billion by reducing the U.S. nuclear arsenal; $200 billion by reducing U.S. military presence abroad and total uniformed military personnel; $138 billion by replacing unworkable, costly weapons systems with better alternatives; and $100 billion by cutting unnecessary command, support and infrastructure funding.
But, the report argues, "significant savings" may depend on rethinking "our national security ... goals..." It goes on to describe "a strategy of restraint -- one that reacts to danger rather than going out in search of it.... We need not stick around in foreign lands often. "Our military budget should be sized to defend us. For this end, we do not need to spend $700 billion a year... We can be safe for much less... Our principal enemy, al-Qaeda, has no army, no air force, and no navy . . . . The hunt for anti-American terrorists is mostly an intelligence and policing task."
A reorientation of security policy will not come easily in light of ... the hawkish Democratic foreign policy advisers, the neocons, the think-tank specialists, and pundits who ... crowd out alternative policies and arguments. Lobbyists for defense contractors with hundreds of billions of dollars at stake are also formidable opponents to change.
This ... is abetted by a mainstream media that offer little exposure to new security ideas... Indeed, few in the media have covered the task force's report. Add to that mix the oft-used argument -- especially potent in an economy with double-digit unemployment -- that defense cuts are a jobs killer, and the prospect for the broader debate Americans need and deserve are dim. Defense spending, however, is one of the worst ways to create jobs per dollar spent. It makes far more sense to cut an increasingly bloated Pentagon budget than to reduce much-needed investment in jobs, clean energy, transportation and support for state and local governments...
Making significant cuts in defense spending will ... require rethinking our role in the world, as the task force report suggests. Is America Globocop or responsible Republic? As Globocop, we have spent over $1 trillion on the wars in Afghanistan and Iraq alone. Isn't it time we had an honest and open debate on that question?
Seniors will trade chickens for health care and have their Social Security payments reduced before "hawkish Democratic foreign policy advisers, the neocons, the think-tank specialists, and pundits" will even consider rethinking our military strategy. Even then, they'd likely conclude that there are many other things that must be cut first.
More on 30 year fixed rate mortgages. Nick Rowe disagrees with Richard Green:
US fixed rate mortgages aren't fixed rate mortgages; they are weird, stupid, and dangerous, by Nick Rowe: Americans aren't really insular, like the English. But they live in a very big country, and that can have the same effect. If there's something peculiar about the US, Americans sometimes won't realise how peculiar it is. US mortgages are peculiar. "Weird" is a better term.
Patrick Lawler, as described by James Hagerty, has tried to explain to Americans that their 30-year fixed rate mortgages aren't 30-year fixed rate mortgages, and that they are weird, stupid, and dangerous. He failed, perhaps because he ran out of time. Richard Green didn't get his point (H/T Mark Thoma). So I'm going to try.
First off, American 30-year fixed rate mortgages aren't 30-year and aren't fixed rate. The term is variable, and the rate is variable. That's because they are "open" mortgages, rather than "closed" mortgages. A 30-year 6% closed mortgage really does have a fixed term and a fixed rate. You know exactly how much you will be paying per month for the next 30 years. An open mortgage means you have the option to pay off or refinance that mortgage at any time over the next 30 years. And you will of course exercise that option at any time when the market interest rate for the remaining term falls below the rate you are currently paying. And exercise it again, if the market rate falls again. So the actual term is whatever you want it to be, and the interest rate you actually pay will vary, if market rates for the remaining term ever fall below the initial rate, as they almost certainly will (as I shall explain).
The option to renew sounds good. It's like a one-way bet. Heads, and interest rates fall, you exercise the option and win the bet. Tails, and interest rates rise, you stay locked in and the bet's off.
If the option were free, of course you would want an open mortgage. You can't lose. But, of course, there must be someone taking the other side of the bet. The lender won't sell you that option for free. You have to pay for it, and you pay for it in higher interest rates.
The longer the remaining term to maturity of the mortgage, the greater the chance that market rates will fall, the more that option is worth, and the higher the interest rate premium you would pay to buy that option. If you only have a couple of months left on the mortgage, interest rates won't move very far in that short time, so an open mortgage will have only a slightly higher interest rate than a closed mortgage. So even if interest rates on closed mortgages have no trend up or down as the remaining term to maturity shortens over time, interest rates on open mortgages will tend to trend down as the remaining term to maturity shortens. So the option to refinance will probably be exercised again and again.
I can understand the argument in favour of 30-year fixed rate mortgages, if they are truly 30-year and fixed rate. Which means a closed mortgage. A risk-averse person borrowing to buy a house knows exactly what he will be paying until the mortgage is paid off. But why would such a risk-averse person ever want to buy an option that interest rates will fall?
That's what's so weird about open mortgages. It's not just weird, it's stupid. It's like an insurance company bundling lottery tickets with its insurance. "Sorry, but you can't buy fire insurance unless you buy a lottery ticket at the same time". Actually, it's even stupider than that, because at least the lottery and fires are independent probabilities. The reason you didn't chose a variable rate mortgage is presumably because you wanted to insure against interest rate risk. So why buy a one-way bet on interest rate risk at the same time?? It's really stupid.
It's equally weird and stupid from the lender's point of view. Lenders aren't always risk-neutral; they care about interest rate risk and liquidity risk. If you are about to retire, and want a safe income for the next 30 years, or if you are a pension plan looking for an asset that provides a safe return to match your fixed payouts to retiring clients, a 30-year fixed rate mortgage looks like a good investment, if it were truly 30-year and truly fixed. Why would you ever at the same time want to write an option on interest rates? Why would you ever agree to write a one way bet that you lose if interest rates fall? Falling interest rates are the one thing that retirees and pension plans want to insure against, not bet that they won't happen! It's really stupid.
It's equally stupid from the liquidity risk point of view. The job of banks is to convert illiquid assets into liquid liabilities. It's not an easy job. But it's an even harder job if you don't know how liquid your assets are. You know in advance when a closed mortgage will be paid off, assuming no default. With an open mortgage you have no idea when it will be paid off, even assuming no default. Plus, banks borrow short and lend long. A fall in interest rates is good for banks, because the value of their long assets rises more than the value of their short liabilities. But a fall in interest rates is just the time when people will pay off their open mortgages, so banks get lots of liquidity when they least need it. It's really stupid.
Stupid, and also I think dangerous. But this is the bit I don't understand too well. As I understand it, one of the main reasons behind the securitisation of mortgages in the US was because of the interest rate risk and liquidity risk I have talked about above. Banks didn't want to hold risky open mortgages on their books. So they securitised them and sold them off. Then the default risk turned out to be higher than the buyers of those securities thought it would be. And because the mortgages were sliced and bundled, it was impossible in practice for the lender to renegotiate terms with a borrower in difficulties. (Plus, there's the other weird and stupid feature of US mortgages [edit: in many states] that they are non-recourse, so the borrower can just hand in the keys and walk away, but that's a whole other subject). And then everything went pear-shaped when house prices fell.
Understandably, Americans don't like foreigners interfering in their internal affairs. But dammit, the US is big, rich, powerful and important, not some piddling little country that doesn't really matter to the rest of the world. When the US financial system catches a cold, other countries will at least sneeze. US 30-year fixed rate mortgages are not 30-year and not fixed rate. They are are weird, stupid, and dangerous. They need to know that.
30-Year Fixed-Rate Mortgage Debate, by Arnold Kling: Richard Green likes them. Nick Rowe does not. I can understand Green's antipathy toward the most common forms of adjustable-rate mortgages in the United States. However, I think that a mortgage that amortizes over 30 years, with an interest-rate adjustment every five years, and no teaser rate would be better than any of the common mortgages here. The five-year fixed term would suit many people, since many people move in less than ten years.
In any case, regardless of what Green or Rowe or I believe is the right mortgage, I think that the market ought to decide. It is my hypothesis that, in the absence of government support (including loading the tail risk onto taxpayers), the thirty-year fixed-rate mortgage with no penalty for either prepayment or default would be priced too expensively to attract borrowers.
I'm trying to meet a deadline, so I'll have leave comments to you.
Tim Duy follows up on his post expressing skepticism about China's announcement that it intends to increase the RMB exchange rate flexibility:
“The announcement out of China elicited an emotional response from the market,” said Alan Gayle, senior investment strategist at RidgeWorth Investments in Richmond, Virginia, which oversees $63 billion. “A closer look at the announcement suggests China’s approach is very gradual and it is continuing at its own pace. It’s a less dramatic move when looked at more closely.”
The muted reaction was not limited to equities:
Treasuries pared losses on speculation the drop in debt in response to China’s decision to allow a more flexible yuan was too big to be sustained.
“The market is coming to the conclusion that it had overreacted to the news out of China,” said Charles Comiskey, head of Treasury trading at Bank of Nova Scotia in New York. “The policy and what it ultimately means is an open question. It’s so vague.”
The yuan "surged" to just below its existing trading range, while the parity rate was adjusted slightly in response to Monday's moves. This fostered a yuan decline:
China’s yuan declined the most since December 2008 on speculation the central bank will encourage more two-way fluctuations in the exchange rate after it pledged to expand flexibility.
The People’s Bank of China set the reference rate for yuan trading 0.43 percent stronger, the biggest gain in five years, reflecting appreciation yesterday. China’s reforms don’t necessarily mean the currency will appreciate, the official People’s Daily reported yesterday.
“There is bigger two-way fluctuation, which is quite normal,” said Lu Zhengwei, an economist at Industrial Bank Co. in Shanghai. “The reference rate shows it is now based on market demand and supply, and no longer strictly controlled.”
The yuan declined 0.2 percent to 6.8111 per dollar as of 10:17 a.m. in Shanghai, from 6.7976 yesterday, according to the China Foreign Exchange Trade system. That was the biggest loss since December 2008. It strengthened as much as 0.1 percent to 6.79 earlier today.
In any event, the today's market response to the Chinese announcement suggests that this is a considerably less dramatic event than the press would like you to believe. Of course, the press is being spoon-fed the news by Washington. From the Wall Street Journal:
President Barack Obama, badly in need of good news, got some over the weekend from the most unlikely of sources: China, which said it would allow the value of its currency to rise, thereby answering the single most fervent prayer U.S. officials utter when seeking divine intervention to help with America's big trade deficit.
...the two moves show that the U.S.-Chinese relationship has a healthier glow than it did just a few months ago, when the two nations were arguing about global warming, a visit by the Dalai Lama to the White House and American arms sales to Taiwan.
More importantly, the steps suggest a certain maturing of China's view of its role in global affairs—and a more deft touch by the Obama administration in coaxing China into playing that role responsibly.
Note the spin - China's decision represents a "maturing," aided by the "deft touch" of the Obama Administration. Now, what did China exactly do to "mature?" China has not unpegged their currency. At best, they resumed a crawling peg policy put on hiatus two years ago. At worst, they simply uttered empty words that have no real economic relevance, whose only intention was to divert attention from China at the upcoming G20 meeting, allowing for a full court press on Germany. German Chancellor Angel Merkel should take a hint and issue the following statement: "The focus of German fiscal policy will be consistent with G20 goals of promoting global growth." Of course, German policymakers believe that means fiscal austerity, but no matter. It is the words that are important. Actions less so.
The PR overload suggests the Administration is desperately in need of a "win," no matter how trivial. After all, there is a hole in the Gulf of Mexico that is leaking oil uncontrollably, creating an environmental disaster that may rival what, Chernobyl? And it is clear the Administration was late in the game realizing the magnitude of the crisis. Meanwhile, unemployment hovers around 10%, and no one expects it to be much different in six months. While likely sustainable, economic growth is anemic compared to previous recoveries from deep recessions, and appears to guarantee a substantial output gap for years to come. The Administration has no real plan to close that gap, nor do they appear particularly troubled by it. Policymakers can’t even push through a low cost jobs bill.
But these are lesser problems. The full effort of American power can instead come to bear on Chinese currency policy and walk away with a monumental commitment to allow the dollar-renminbi rate to fluctuate within its existing trading band and perhaps appreciate imperceptibly.
While China appears willing to adjust the parity rate, changes are likely to be more window dressing than anything else. The industrial base shifted from the US to China over the past twenty years, a transition aided by the Clinton Administration's commitment to a strong dollar, and it is not going to come rushing back for a for percentage points of currency value. The structural shift has happened, and it won't reverse easily. Still, the story is not over yet. With this much praise, the Administration is clearly looking for something else from China. Further support on Iran? North Korea? Time will tell.
Richard Green says "If we do away with Fannie and Freddie, we may also do away with the 30-year fixed rate mortgage," and that may not be good for home buyers:
Allotted only about 10 minutes to share his vision, Mr. Lawler....first made the obligatory statement that he was expressing his own views and not those of his federal agency. Yeah, right, I thought, and reached for my triple espresso.But then Mr. Lawler launched a frontal assault on the most sacred element in U.S. housing-policy dogma: the 30-year fixed-rate mortgage loan, providing the right to refinance at any time, with no prepayment penalty. If more members of the audience had been fully awake at this moment, I feel sure that their gasps would have been audible.Now, Americans are very attached to their 30-year fixed-rate freely prepayable mortgages. They like not having to fuss about the possibility of 28% interest rates in 2032, even though most of us will move or die long before then. They love to refinance every time rates drop and then brag to their neighbors about how much they are saving per month.What they don’t stop to realize often enough is that they are paying a very large price for that privilege– twice.The context is important. One of the reasons the 30 year fixed rate mortgage is ubiquitous is the United States may be the existence of Fannie and Freddie. If we do away with FF, we may also do away with the 30-year fixed rate mortgage. So let me defend the 30-year fixed a bit with something I wrote about 3 years ago:The problem with advising people to use adjustable rate mortgages, however, is that ARMs give households liabilities that have short duration--that is, liabilities whose market value remains close to face value at all times. This is because the rates on ARMs by definition change to meet market rates on a regular basis. Houses, on the other hand, are assets with lots of duration. The services they give to homeowners (shelter and a set of amenities) is pretty much invariant to market conditions. Consequently, house values change with market conditions, such as changing interest rates.Good financial management practice suggests that to minimize risk, the duration of of assets and liabilities for any institution, including households, should be matched. In the case of houses, this means that households looking to minimize risk should use a fixed rate mortgage to finance their house. There are exceptions--if one buys a house and expects to sell it in five years, a five year ARM makes lots of sense, because the duration of the asset (housing services over five years) and the liability would match.This is not to say there is anything wrong per se with people getting ARMS, so long as they explicitly understand the risk embedded in them. But a principle I have been pushing for years is that if people can't afford a house with a fixed-rate mortgage, they probably shouldn't buy a house. It is one thing to have the option of the FRM, and then decide to take the risk of the ARM anyway. One of the nice things about the United States is that FRMs are easy to come by--this is not true in most countries around the world. It is something else to be forced into taking a risk in order to buy. Under these circumstances, buying probably isn't worth it.
Monday, June 21, 2010
Dean Baker says there's more than one way to reassure bond markets, and cutting benefits for retirees in need of the money is one of the worst options available:
How to impress the bond markets, by Dean Baker, Commentary, CIF: The deficit hawks have been pushing the line in recent months that we have to make cuts in social security, along with some revenue increases, in order to reassure the bond markets about the creditworthiness of the US government. According to this argument, by taking tough steps (i.e. cutting social security benefits) we will have shown the bond markets that we are prepared to do what is necessary to keep our budget deficits within manageable levels.
There is some reason to question the merits of this argument. First off, the deficit hawks don't have an especially good track record in the insight category. Not one person among the leading crusaders was able to see the $8tn housing bubble that wrecked the economy. ...
Furthermore, the fixation on social security is peculiar. The Congressional Budget Office shows the program can pay all future benefits through the year 2044 with no changes whatsoever. Even after that date the shortfalls are relatively minor. ...
Furthermore, cutting benefits for near-retirees (workers in their late 40s and 50s) seems cruel and unwarranted. These people paid for their benefits through decades of work. Also, this cohort has seen most of the wealth that they did manage to accumulate destroyed with the collapse of the housing bubble and the plunge in the stock market. The bulk of this cohort will therefore be relying on social security for the overwhelming majority of their retirement income.
For these reasons, the determination to cut social security has the feeling of the class bullies telling the rest of us that we have beat up the weakest kid in the class in order to be admitted to the club. That may be the way things work in Washington, but this doesn't mean it is right.
If the issue is assuaging the bond markets by convincing them that we are prepared to take tough choices to limit long-term deficits, let's put a few other items on the table. For item number 1: how about a financial speculation tax? Wouldn't the bond markets be impressed by seeing Congress crack down on the Wall Street hot shots whose recklessness helped fueled the housing bubble? That one would show real courage given the power of Goldman Sachs-Citigroup gang.
As a second item, Congress could go after the pharmaceutical industry. By 2020 we are projected to be spending almost $500bn a year on prescription drugs. We pay close to twice as much for our drugs as people in other wealthy countries and about 10 times as much as the drugs would cost if they could be sold in competitive market without government patent monopolies.
Suppose Congress decided to pay for the clinical testing of drugs directly and then allowed all new drugs to be sold as generics. This could save taxpayers hundreds of billions of dollars a year. Wouldn't the bond markets be impressed by seeing Congress stand up to the pharmaceutical industry?
As a third item, suppose Congress revisited plans for a public insurance option. The Congressional Budget Office projected that this would save over $100bn by 2020 and certainly much more in future decades. Wouldn't the bond markets be impressed if Congress stood up to the insurance industry?
These are three clear ways in which Congress can take big steps towards reducing long-term budget deficits by standing up to powerful interest groups. In each case Congress would be reducing the deficit in ways that would likely make most people better off, not worse off. If bringing the long-term deficit into line is the issue, all three of these measures should be at the top of everyone's list.
Remarkably, the leading budget hawks never discuss these measures when they push their deficit-cutting agenda. Somehow we are supposed to believe that cutting social security will do the trick with the markets, even though this will hurt tens of millions of people who actually need the money. ...[W]e should just view them as people who want to cut social security and are putting out some nonsense to rationalize beating up on retirees.
The good news is that Alan Simpson appears to have neutered the Deficit Commission:
It must have sounded like a good idea (although not to me): establish a bipartisan commission of Serious People to develop plans to bring the federal budget under control. But the commission is already dead — and zombies did it.
OK, the immediate problem is the statements of Alan Simpson, the commission’s co-chairman. And what got reporters’ attention was the combination of incredible insensitivity – the “lesser people”??? — and flat errors of fact.
But it’s actually much worse than that. On Social Security, Simpson is repeating a zombie lie — that is, one of those misstatements that keeps being debunked, but keeps coming back.
Specifically, Simpson has resurrected the old nonsense about how Social Security will be bankrupt as soon as payroll tax revenues fall short of benefit payments, never mind the quarter century of surpluses that came first.
We went through all this at length back in 2005, but let me do this yet again.
Social Security is a government program funded by a dedicated tax. There are two ways to look at this. First, you can simply view the program as part of the general federal budget, with the the dedicated tax bit just a formality. And there’s a lot to be said for that point of view; if you take it, benefits are a federal cost, payroll taxes a source of revenue, and they don’t really have anything to do with each other.
Alternatively, you can look at Social Security on its own. And as a practical matter, this has considerable significance too; as long as Social Security still has funds in its trust fund, it doesn’t need new legislation to keep paying promised benefits.
OK, so two views, both of some use. But here’s what you can’t do: you can’t have it both ways. You can’t say that for the last 25 years, when Social Security ran surpluses, well, that didn’t mean anything, because it’s just part of the federal government — but when payroll taxes fall short of benefits, even though there’s lots of money in the trust fund, Social Security is broke.
And bear in mind what happens when payroll receipts fall short of benefits: NOTHING. No new action is required; the checks just keep going out.
So what does it mean that the co-chair of the commission is resurrecting this zombie lie? It means that at even the most basic level of discussion, either (a) he isn’t willing to deal in good faith or (b) the zombies have eaten his brain. And in either case, there’s no point going on with this farce.
Speaking of zombies, on Facebook, John Quiggin, author of the forthcoming Zombie Economics (i.e., dead ideas finding new life), says:
Would have been great to have a section on the revival of balanced budget ideology in the European crisis, but that's bookbiz.
It's not just Europe. But in any case, how the words "Deficit Commission" and "cuts to Social Security" became roughly equivalent is a bit of a mystery since the rising cost of health care not Social Security, is the primary problem. The focus on Social Security does speak to the ability of those with power and influence to affect the public debate on these issues, but the simple truth is that if we fix the health cost problem then almost all of the long-run deficit problem goes away. But as others have pointed out, the deficit hawks block any attempts in this direction with charges like "death panels," and that raises questions about the true agenda behind these efforts.
Starving the economy during the recovery period risks a relapse and, further, this can cause long-run damage. Getting the economy back to the best possible health will require addressing our long-run budget issues, but best to wait until the economy has recovered its health before starting it on a strict diet:
Now and Later, by Paul Krugman, Commentary, NY Times: Spend now, while the economy remains depressed; save later, once it has recovered. How hard is that to understand?
Very hard, if the current state of political debate is any indication. All around the world, politicians seem determined to do the reverse. They’re eager to shortchange the economy when it needs help, even as they balk at dealing with long-run budget problems. But maybe a clear explanation of the issues can change some minds. So let’s talk about the long and the short of budget deficits. ...
America has a long-run budget problem. Dealing with this problem will require, first and foremost, a real effort to bring health costs under control — without that, nothing will work. It will also require finding additional revenues and/or spending cuts. As an economic matter, this shouldn’t be hard..., a modest value-added tax, say at a 5 percent rate, would go a long way toward closing the gap, while leaving overall U.S. taxes among the lowest in the advanced world.
But if we need to raise taxes and cut spending eventually, shouldn’t we start now? No, we shouldn’t.
Right now,... a severely depressed economy ... is inflicting long-run damage. Every year that goes by with extremely high unemployment increases the chance that many of the long-term unemployed will never come back to the work force, and become a permanent underclass. Every year that there are five times as many people seeking work as there are job openings means that hundreds of thousands of Americans graduating from school are denied the chance to get started on their working lives. And with each passing month we drift closer to a Japanese-style deflationary trap.
Penny-pinching at a time like this isn’t just cruel; it endangers the nation’s future. And it doesn’t even do much to reduce our future debt burden, because stinting on spending now threatens the economic recovery, and with it the hope for rising revenues.
So now is not the time for fiscal austerity. ...[B]udget deficit should become a priority when, and only when, the Federal Reserve ... can offset the negative effects of tax increases and spending cuts by reducing interest rates.
Currently, the Fed can’t do that, because the interest rates it can control are near zero, and can’t go any lower. Eventually, however, as unemployment falls ... the Fed will want to raise rates to head off possible inflation. At that point we can make a deal: the government starts cutting back, and the Fed holds off on rate hikes so that these cutbacks don’t tip the economy back into a slump.
But the time for such a deal is a long way off — probably two years or more. The responsible thing, then, is to spend now, while planning to save later.
As I said, many politicians seem determined to do the reverse. Many members of Congress, in particular, oppose aid to the long-term unemployed, let alone to hard-pressed state and local governments, on the grounds that we can’t afford it. ... Yet efforts to control health costs were met with cries of “death panels.”
And some of the most vocal deficit scolds in Congress are working hard to reduce taxes for ... heirs to multimillion-dollar estates. This would do nothing for the economy now, but it would reduce revenues by billions of dollars a year, permanently.
But some politicians must be sincere about being fiscally responsible. And to them I say, please get your timing right. Yes, we need to fix our long-run budget problems — but not by refusing to help our economy in its hour of need.
Is China's announcement that it intends to increase the RMB exchange rate flexibility "more smoke than fire"?:
China Moves. Or Not., by Tim Duy: Futures markets are abuzz with excitement over the Chinese currency proclamation issued this weekend. The announcement was quickly hailed by observers worldwide as a major policy shift, yet I am inclined to side with the analysis provided by Yves Smith - the statement leaves plenty of wiggle room, and never really promises to do much of anything. At the moment, the Chinese announcement feels like more smoke than fire.
The Wall Street Journal's initial reporting was just want the Bejing and Washington wanted you to believe:
China's decision to abandon its currency peg is a victory of pragmatism over divisive politics, the result of careful diplomacy by leaders in Beijing and in Washington, each side vulnerable to powerful domestic lobbies.
In the end, both sides agreed that a more flexible exchange rate was good for China, good for the U.S. and good for the global economy. Yet timing was everything.
The implication is that hard-working policymakers on both sides of the Pacific have risked all to foster the greater good. But what exactly has changed? From the Chinese statement:
It is desirable to proceed further with reform of the RMB exchange rate regime and increase the RMB exchange rate flexibility.
In further proceeding with reform of the RMB exchange rate regime, continued emphasis would be placed to reflecting market supply and demand with reference to a basket of currencies. The exchange rate floating bands will remain the same as previously announced in the inter-bank foreign exchange market
What exactly will be the basket of currencies? On what timetable? Is this really a change? And why not widen the floating bands? I see no commitments here, vague or otherwise. Of course, there are not meant to be. From the Wall Street Journal:
Yet, by returning the yuan to a managed float against a basket of currencies, Beijing won't have to cede too much in the near term when it comes to the bilateral dollar/yuan rate. The euro's weakness-the yuan is up 14% against the euro this year-should mitigate the speed of any yuan appreciation against the dollar.
Looks like China is picking a policy direction that requires little deviation from current policy. Nor do they even admit there is a need for significant change. The Chinese announcement appears to preclude the possibility of meaningful adjustments.
China´s external trade is steadily becoming more balanced. The ratio of current account surplus to GDP, after a notable reduction in 2009, has been declining since the beginning of 2010. With the BOP account moving closer to equilibrium, the basis for large-scale appreciation of the RMB exchange rate does not exist.
Is "large-scale" 5%? 10%? 20%? The tone of subsequent reporting changed as journalists not sourced directly by Washington and Bejing began to realize the thinness of the Chinese announcement. From the Wall Street Journal:
China's announcement that it will let its currency appreciate puts it in a strong position going into a summit of the Group of 20 on Saturday, but does little to ease pressure from the U.S. Congress.
...But China's announcement was short on details about how much it would let the yuan appreciate. In Brazil, the central bank governor, Henrique Meirelles, said he welcomed the Chinese announcement, but wanted to see results. "It is necessary to await further developments," he said in a statement.
Is the Chinese announcement anything more than an effort to buy time ahead of next weekend's G-20 meeting? The yuan was likely to be a primary topic, but the announcement now provides cover for Chinese officials, pushing the attention on fiscal policy in Germany and Japan. A clever diplomatic trick, but will China follow through with anything more than a token rate change? They need to, as Congress will not be held at bay much longer:
In the U.S., New York Democratic Sen. Charles Schumer, who has spent a decade ramping up pressure on China over currency issues, remains skeptical that Beijing's announcement will make an appreciable difference. On Sunday, reacting to Chinese suggestions that change would be gradual, Mr. Schumer said he would move forward on legislation to penalize China for undervaluing its currency.
"Just a day after there was much hoopla about the Chinese finally changing their policy, they are already backing off," he said in a statement.
Schumer's skepticism is justified. Where is the yuan going, and how quickly will it get there? Estimates are all over the map. From Bloomberg:
The yuan’s appreciation may be limited to 1.9 percent against the dollar this year, a survey of economists showed. The currency will climb to 6.7 per dollar by Dec. 31, according to the median estimate of 14 analysts.
Later in the same article:
“We can’t exclude the possibility of yuan depreciation,” said Shen Jianguang, Mizuho Securities Asia Ltd.’s chief economist for Greater China, who said a 2.5 percent drop is possible this year if the dollar-euro rate is unchanged.
From the Wall Street Journal:
U.S. government officials expect a slow, steady increase, similar to the way China boosted the value of the yuan between 2005 and 2008.
Another opinion from the same article:
Eswar Prasad, a Cornell University economist who was formerly the IMF's top China expert, said the size of the increase during the coming month will give a hint at the "trajectory" Beijing is anticipating.
He says that in periods of economic calm, China "is comfortable with" an increase in the value of the yuan of about 10% to 15% a year.
Congress will be closely watching for any signs of foot dragging on the part of China. I am not confident they will tolerate anything less than a 15% move this year. Note too that China is not the only one buying time with this announcement. US Treasury Secretary Timothy Geithner can now release the delayed report on currency practices, which will surely not label China a manipulator. That hot potato can go back into the oven for another six months. Geithner is clearly betting the Chinese will have shown enough results between now and then to placate Congress. If not, Congress will start sharpening the knives; the tolerance for Chinese resistance will be almost negligible of this announcement is revealed to be nothing more than smoke and mirrors.
Bottom Line: On the surface, the Chinese announcement looks like just what the doctor ordered - a step toward a meaningful effort at rebalancing global activity. But the details are thin, very, very thin. Thin enough that one can reasonably look straight through the statement and conclude it is little more than an effort to keep China off the hot seat at the next G20 meeting. Time will tell if China actually intends a substantial change in currency policy. I hope this is in fact their intention, as the probability of a disastrous trade war will skyrocket if Congress believes they have been the victim of a classic bait and switch.
Update: Reality sets in quickly. From the Wall Street Journal:
China kept the yuan's exchange rate unchanged against the dollar Monday, surprising markets after announcing over the weekend it was unhitching its de facto peg.
Underscoring its vow to move gradually in liberalizing its rigid foreign-exchange regime, the central bank set the yuan's central parity rate, an official reference level for daily trading, at 6.8275 yuan to the dollar, exactly the same as Friday's central parity rate. The fixing put the yuan slightly weaker than Friday's close in over-the-counter trading of 6.8262 yuan to the dollar.
Sunday, June 20, 2010
There's been a lot of speculation about the motives of the Austerians -- those who want to begin balancing budgets now because they believe that's what markets want. For example, Paul Krugman attributes it, in part, to
moralizing and posturing. Germans tend to think of running deficits as being morally wrong, while balancing budgets is considered virtuous, never mind the ... economic logic. “The last few hours were a singular show of strength,” declared Angela Merkel ... after a special cabinet meeting agreed on the austerity plan. And showing strength — or what is perceived as strength — is what it’s all about.
But there is another argument based upon the notion of "never let a crisis -- or the manufactured threat of one -- go to waste." This is an opportunity to "starve the European Beast" in the eyes of many European conservatives, and there are those who are using the "that's what markets want" argument as cover for an ideological agenda:
The spectre of laissez-faire stalks Britain, by Jeremy Seabrook, CIF: The relish with which David Cameron announced that our whole way of life would be affected for years by impending cuts, and no one in the land would be exempt from the asperities about to be inflicted, suggested to many that he and his fellow cabinet-millionaires will probably weather the coming storm better than the rest of us.
His parade of Margaret Thatcher, who resembled nothing so much as a faded kabuki performer, outside 10 Downing Street, was also highly symbolic. It was a redemptive moment, the "ultimate" triumph of policies she advocated (but did not entirely follow) 30 years ago. It exhibited the qualities of purification ritual, reversion to a more severe form of capitalism; and in the process a transformation of nanny state into stepmother state.
Nick Clegg's pious assertion that cuts would be fair and compassionate was at odds with Cameron's gusto, which is familiar enough in Conservative rhetoric: Cameron confronting an overweening state, which will be shrunk so the private sector might flourish once more. When he said the effects of his policies would be felt for decades to come, he meant something more than a mere diminution of the structural deficit. He admitted as much...
While cutting back big government may appear a matter of severe practicality,... this is also a declaration of faith, a solemn renewal of Conservative vows. ... The right continues to yearn with insistent nostalgia for a free market, burdened only by minimal demands of government, defense and law and order. The greatest obstacle to this state of perfection is, of course, the poor, whose demands upon the state have always been seen as an encumbrance to its sublime mechanism.
"Pauperism" long ago took on the color of culpability. The distinction between the idle and improvident poor and the "deserving" goes back at least to the Elizabethan poor law. It took on a new force in the early industrial era, which saw an unprecedented growth in pauperism. The enthusiasts of laissez-faire concluded that the evil was compounded by efforts to relieve it, and helping the poor only increased their number. Everything indicated that "natural" processes should be allowed to take their course.
Today's detestation of "big government" stems from this same source, and the affection of Cameron and his colleagues for the "big society" is a euphemism for the reduction of public funds in assisting the poor: rolling back the state, leaving the market to distribute its rewards in accordance with the natural order of things. Those who have rarely come closer to nature than on a golf course depend heavily for their ideological rationale upon an archaic natural imagery...
In this version of the world, the market mechanism is as flawless a creation as the earth, and should remain untouched by the hand of meddlers, whose only effect is to upset its power to enrich us all. ...
Whatever the real extent of the "structural deficit", the Conservatives, true to their faith in the economy-as-nature, have a powerful urge to wield the axe to dead wood; as they do so, they are bound to exaggerate the pruning required to cut back the luxuriant growth of Labour's state. ...
[Just to be clear about my own views on the role of government, I am advocate of government intervention to fix important market imperfections (and I don't think markets fix these on their own), and I don't think we are aggressive enough in this area. I also think government has a large role to play in stabilizing the economy, and that's where the deficit spending discussed above comes in, at least in part. But I am not much of a redistributionist. I would rather have the playing field be level so that everyone has a relatively equal chance at success, and the chips will fall where they fall. Some people may still need assistance under such a system, but mostly the outcome would be fair. That's the first best choice for me, government intervention to ensure that everyone has a relatively equal chance in life. But we are far from that outcome, important inequities still exist that disadvantage some people relative to others, and so long as those inequities persist government has a role to play in correcting them. This may necessarily involve some redistribution of income, especially the income earned as a result of the unfair advantage.]
I don't have anything to post, so until I do, here's something I posted at MoneyWatch a few days ago. The post addresses the latest proposal for financial reform, in particular the proposal to change the way the District Bank presidents are chosen in an attempt to reduce the power banks have over monetary policy. One part of the proposal was to have the NY Fed president chosen by the president rather than the NY Fed's Board of Directors because of the NY Fed's special role in the implementation of national monetary policy. One question I ask at the end of this post is whether the NY Fed needs to have a special role in monetary policy and be elevated above all other District Banks. Why can't the execution of monetary policy be housed in a separate agency under the control of the FOMC (or, alternatively, the Board of Governors)? There was a time when proximity to Wall Street was essential, but that has changed in the last 70 years, and, in any case, the agency could be located as close to Wall Street as needed. Communication with Washington, to the extent it's needed, could us digital technology. This would put the NY Fed on a more equal footing with the other Fed's, and solve the problem of how to represent both regional and national interests in the selection of the NY Fed president:
Reducing the Influence Banks Have over Monetary Policy: There's some news on the Dodd proposal for financial reform, something I wrote about when the details of the proposal initially came out.