Monday, January 31, 2011
I know there are some big fans of using short-time work programs to combat unemployment during recessions. Here's some mostly favorable evidence:
Is short-time work a good method to keep unemployment down?, by Pierre Cahuc and Stéphane Carcillo, Vox EU: Short-time compensation (or short-time work) aims at reducing lay-offs by allowing employers to temporarily reduce hours worked while compensating workers for the induced loss of income. At present, short-time work schemes are widespread among OECD countries, having grown in popularity during the Great Recession. As shown by Figure 1, they are now used in 25 of the 33 OECD countries.1
Figure 1. Short-time work take-up rates in the OECD countries (as a percentage of employees)
Source: OECD (2010), Hijzen and Venn (2010), data completed by the authors.
And these short-time work schemes appear to have been successful. European countries with widespread and generous short-time compensation experienced a smaller rise in unemployment in the recent recession than those without. The leading example is Germany that makes a particularly intensive use of a short-time work program (the Kurzarbeit).
This success has renewed interest in short-time work. But the idea itself is nothing new. The suggestion that it could be more efficient and more equitable to share jobs with short-time compensation rather than destroying jobs during has been repeatedly put forward by advocates of work-sharing. For instance, Abraham and Houseman (1994) argued that short-time work arrangements can be more equitable since they spread the costs of adjustment more evenly across members of the work force instead of concentrating it on a small number of laid-off workers.
But short-time compensation programs are no panacea. They can induce inefficient reductions in working hours. Moreover, workers in permanent jobs have incentives to support such schemes in recessions in order to protect their jobs. Employers also have incentives to support short-time compensation programs in countries where stringent job protection induces high firing costs. Therefore, there is a risk attached with using these programs too intensively. The benefits of insiders can be at the expense of the outsiders whose entry into employment is made even more difficult.
Jeff Sachs argues that we must raise taxes:
America’s Ungovernable Budget, by Jeffrey D. Sachs, Commentary, Project Syndicate: ...In his recent State of the Union address, President Barack Obama ... rightly emphasized that competitiveness in the world today depends on an educated workforce and modern infrastructure. ...
That is why Obama called for an increase in US public investment in three areas: education, science and technology, and infrastructure... He spelled out a vision of future growth in which public and private investment would be complementary, mutually supportive pillars. ...
But Obama’s message lost touch with reality when he turned his attention to the budget deficit. Acknowledging that recent fiscal policies had put the US on an unsustainable trajectory of rising public debt, Obama ... called for a five-year freeze on what the US government calls “discretionary” civilian spending.
The problem is that more than half of such spending is on education, science and technology, and infrastructure – the areas that Obama had just argued should be strengthened. After telling Americans how important government investment is for modern growth, he promised to freeze that spending for the next five years! ...
The truth of US politics today is simple. ... Both political parties ... would rather cut taxes than spend more on education, science and technology, and infrastructure. And the explanation is straightforward: the richest households fund political campaigns. Both parties therefore cater to their wishes.
As a result, America’s total tax revenues as a share of national income are among the lowest of all high-income countries..., not enough to cover the needs of health, education, science and technology, social security, infrastructure, and other vital government responsibilities.
One budget area can and should be cut: military spending. But even if America’s wildly excessive military budget is cut sharply (and politicians in both parties are resisting that), there will still be a need for new taxes..., and that – as George H. W. Bush learned in 1992 – is no way to get re-elected.
Central bank authorities should not give in to demands for higher interest rates:
A Cross of Rubber, by Paul Krugman, Commentary, NY Times: Last Saturday, reported The Financial Times, some of the world’s most powerful financial executives were going to hold a private meeting with finance ministers in Davos... The principal demand of the executives ... would be that governments “stop banker-bashing.” Apparently bailing bankers out after they precipitated the worst slump since the Great Depression isn’t enough — politicians have to stop hurting their feelings, too.
But the bankers also had a more substantive demand: they want higher interest rates ... because they say that low rates are feeding inflation. And what worries me is the possibility that policy makers might actually take their advice.
To understand the issues, you need to know that we’re in the midst of ... a “two speed” recovery, in which some countries are speeding ahead, but ... advanced nations — the United States, Europe, Japan — have barely begun to recover. ... To raise interest rates under these conditions would be to undermine any chance of doing better; it would mean, in effect, accepting mass unemployment as a permanent fact of life.
What about inflation? High unemployment has kept a lid on the measures of inflation that usually guide policy. ... But food and energy prices — and commodity prices in general — have ... been rising lately. Corn and wheat prices rose around 50 percent last year; copper, cotton and rubber prices have been setting new records. What’s that about?
The answer, mainly, is growth in emerging markets ... — China in particular — ... has created ... sharply rising global demand for raw materials. Bad weather ... has also played a role in driving up food prices.
The question is, what bearing should all of this have on policy at the Federal Reserve and the European Central Bank? First of all, inflation in China is China’s problem, not ours. ... Neither China nor anyone else has the right to demand that America strangle its nascent economic recovery just because Chinese exporters want to keep the renminbi undervalued.
What about commodity prices? The Fed normally focuses on “core” inflation, which excludes food and energy... And this focus has served the Fed well in the past. ... It’s hard to see why the Fed should behave differently this time...
So why the demand for higher rates? Well, bankers have a long history of getting fixated on commodity prices. Traditionally, that meant insisting that any rise in the price of gold would mean the end of Western civilization. These days it means demanding that interest rates be raised because the prices of copper, rubber, cotton and tin have gone up, even though underlying inflation is on the decline.
Ben Bernanke clearly understands that raising rates now would be a huge mistake. But Jean-Claude Trichet, his European counterpart, is making hawkish noises — and both the Fed and the European Central Bank are under a lot of external pressure to do the wrong thing.
They need to resist this pressure. Yes, commodity prices are up — but that’s no reason to perpetuate mass unemployment. To paraphrase William Jennings Bryan, we must not crucify our economies upon a cross of rubber.
Tim Duy sees optimistic signs in the 4th quarter GDP report:
Underappreciated Data, by Tim Duy: I must admit that I surprised by the tepid response to the advance release of the 4q2010 GDP data. Mark Thoma catalogues the most common critiques – the negative contribution from government spending and the minimal reduction in the output gap. My review of the data differs. In my opinion, this is the first GDP report since the recession “ended” that offers a certain optimism, a glimmer of hope that perhaps that light at the end of the tunnel is not simply an oncoming train. If it is an oncoming train, it not the train of sagging government spending, but instead a train of imports blasting forward.
It is no secret that this recovery, to date, has been anything but vigorous. Certainly nothing like the “Morning in America” of the mid-80’s. Real final sales – GDP excluding inventory effects – outperformed for quarter after quarter during that period as demand clearly outstrip the pace of capacity growth. In comparison, real final sales during the most recent recovery has been almost laughable:
But real final sales surged in the final quarter of 2010:
A 7.1 percent gain is nothing to sneeze at – and, realistically, in the scope of that kind of surge in final demand, the 0.11 percentage point reduction from the government sector is little more than a rounding error (I would be more worried about the loss of services than the contractionary impact in the context of 7.1 percent final demand growth). This is exactly the kind of final demand growth needed to lift us out of this morass.
But is it sustainable? What is apparent from this report is the potential for external support to generate real improvement in the US economy. The sharp drop in imports meant that firms were forced to sharply reduce the pace of inventory growth. Will those inventories be replenished with domestic or foreign production? James Hamilton is not optimistic:
But the fact that a huge negative contribution of inventories coincided with a huge positive contribution of imports does not seem to be a coincidence. There's a clear pattern in the recent data that when one of these makes a positive contribution to GDP growth, the other makes an offsetting negative contribution. Although we often think of inventories as a substitute for production (you could either produce a good or sell it out of inventories), in the current environment inventories seem to act more as a substitute for imports (you could either import the good, or sell it out of inventories). So although inventories shouldn't be the same drag on GDP in 2011, I expect imports to go back up and exert a drag of their own.
Sadly, the story of this recovery continues to circle around the external accounts. Absent a resolution of the global rebalancing story, faith in fiscal stimulus is somewhat misplaced – much government spending will simply leak abroad as evident in previous GDP reports. Of course, the alternative, fiscal policy that ignores the recession, is not exactly an endearing policy course. If rebalancing continues to be delayed in the months ahead, US policymakers simply must accept the trade deficit will reduce the effectiveness of their efforts.
Moreover, the resistance to rebalancing is nothing less than sadly ironic, as rebalancing produces the only possible win-win scenario in the global economy. Consider that concerns of emerging market inflation suggest that demand is surging ahead of capacity, while deflation in the US suggests the opposite, excess capacity. It seems that these problems are two sides of the same coin, with an obvious optimal solution – greater currency flexibility. Emerging markets could satisfy higher rates of domestic demand growth via declining net exports, while rising net exports allows for higher capacity utilization in the US. In effect, global consumption power would be redirected toward relatively poor economies and away from a relatively rich economy. It seems quite reasonable.
Alas, instead we are faced with the challenges of rising inflation in some nations, and increasingly disturbing hoarding behavior in others. While stories of a massive stock of empty housing in China have long circulated, the Wall Street Journal reports that the hoarding has reached a new level:
The amount of cotton held in hamlets throughout China is unknown, but, with 25 million cotton farmers, a Chinese cotton agency estimates it could amount to about 9% of the world's cotton supply. And the situation is occurring throughout the supply chain. Many ginners and merchants in China are keeping warehouses full, according to the agency, in an attempt to obtain higher prices.
Expectations that prices will rise are driving the apparent stockpiling, which causes short-term shortages and leads prices to rise further. The situation is complicating an already volatile picture for cotton, which has jumped to 140-year highs in the U.S. and has become a symbol of brewing commodity inflation around the globe.
Included in the story is a picture of a farmer storing 7,700 pounds of cotton in his home (I suspect my wife would object should I start taking a long position in hog bellies via physical possession in the living room). To be sure, such behavior, like stockpiling empty houses, makes sense in an inflationary environment in which agents are desperate to find adequate stores of value.
Regarding other data, last week we also saw the December durable goods report. While there was some concern over the headline numbers, it is generally safer to go straight to the core figures, capital goods excluding defense and air:
Looks like the economy shook off the summer slowdown, putting order back on the uptrend. Somewhat disappointing was the partial reversal of recent improvement in initial unemployment claims. That said, looking at the four-week moving average, the downtrend looks intact:
Of course, if final demand is growing at a 7.1 percent pace, the overall improvement in the final months of 2010 should come as no surprise. Finally, also not surprisingly, the Case-Shiller Index reported ongoing home price weakness. Housing has offered almost nothing to the recovery and, quite frankly, is yesterday’s story. Housing is returning to its appropriate place in the economy – a product that provides a service, not an investment or, worse yet, a gamble.
Bottom Line: The GDP report revealed what could be, the glimmers of hope of a V-shaped recovery. If final demand even near the 4q2010 could be maintained, Federal Reserve policymakers makers would be forced to take notice by mid-year. Still, setting aside the usual risk factors (including the fresh possibility that Mideast unrest triggers a fresh oil shock) the sustainability of this final demand is directly dependent upon the evolution of the external accounts. If this demand surge is satisfied with an import surge in coming quarters, we can expect the recovery will remain tepid in comparison to previous deep recessions. If rebalancing were to maintain some traction, this could be simply the first in a long-waited string of data that would proved a clear exit to the current period of relative economic stagnation.
Sunday, January 30, 2011
Vernon Smith, who is not a fan of government intervention, makes familiar arguments about how to escape from balance sheet recessions:
Mired in Disequilibrium, by Vernon Smith, Newsweek: ...Some 23 percent of homeowners owe more than their home is worth on the market, and their demand for goods is restrained by the need to pay down debt. This is the essence of a balance-sheet recession, and is what underlies the so-called Keynesian liquidity trap. ...
There are three routes to restoring equilibrium:
• Inflate the prices of all other goods, including labor, while housing demand remains stuck in its negative equity loop. Fed policy has been consistent with this objective since 2008 with no evidence of success, as is typical in severe balance-sheet recessions.
• Allow the household deleveraging process to grind through an extended period of low GDP growth and high unemployment until we gradually recover. This option will surely succeed in due course, but not without high annual opportunity cost in terms of lost wealth creation. This was the path followed in the Depression.
• Do for households what the Fed sought for the banks: the Treasury (facilitated by Fed monetary ease and bank capital requirements) finances the banks to restate the principal on current negative-equity mortgage loans, restoring them to new mark-to-market zero-equity baselines.
The last option, in principle, seeks to reboot homeowners’ damaged balance sheets in an effort to arrest a prolonged deleveraging process and more quickly restore household demand to levels no longer dominated by negative home equity. It is analogous to a mortgage “margin call” with public funding of the restored household balance sheets.
I regard the third option as far better than the stimulus, while recognizing that forgiving debt—whether bank or household debt—is never good policy. But please keep in mind that we have had no good options. (Since total negative equity is now about $700 billion, it is cheaper than was the stimulus.) ...
Where we differ is that I would do this in addition to fiscal policy, rather than dropping fiscal stimulus and doing this instead. That is, I see this as a complement rather than a substitute for other policies.
One more note. I have made similar arguments, but I've come to believe that household relief must be broad based in order to receive the public support it needs (the proposal above addresses all households that are in a negative equity position, not just those near or at default, so it is broader based than many competing proposals along these lines). If we only bail out the households who made the worst choices and are in danger of default, and do nothing for the households who have taken large losses through no fault of their own, but are still surviving and making payments, the public resentment will undermine the policy.
Taxes and labour supply: more evidence, by Chris Dillow: Do tax cuts boost labour supply and hence tax revenues? Here’s some evidence that they don’t. Pierre Cahuc and Stephane Carcillo report on an experiment in France:
The detaxation of overtime hours introduced in October 2007 was intended to allow individuals in France to work more so as to earn more. The evaluation conducted in this article indicates that the detaxation of overtime hours has not, in fact, had any significant impact on hours worked…
Detaxation is a measure costly for the public purse, without any ascertained impact on hours worked.
Now, this is not to deny that Laffer curves exist. No doubt, there is a point at which higher taxes would be counter-productive and tax cuts would pay for themselves. ... But where is the hard evidence that, at tax rates around current levels, there are such effects? Do the glibertarians have anything more than prejudice, half a theory, and the post hoc ergo propter hoc fallacy?
Saturday, January 29, 2011
I need to think about this more before responding:
Innovation Is Doing Little for Incomes, by Tyler Cowen, Commentary, NY Times: My grandmother, who was born in 1905, spoke often about the immense changes she had seen, including the widespread adoption of electricity, the automobile, flush toilets, antibiotics and convenient household appliances. Since my birth in 1962, it seems to me, there have not been comparable improvements. ...[C]ompared with what my grandmother witnessed, the basic accouterments of life have remained broadly the same.
The income numbers for Americans reflect this slowdown in growth. From 1947 to 1973 — a period of just 26 years — inflation-adjusted median income in the United States more than doubled. But in the 31 years from 1973 to 2004, it rose only 22 percent. And, over the last decade, it actually declined. ...
Although America produces plenty of innovations, most are not geared toward significantly raising the average standard of living. It seems that we are coming up with ideas that benefit relatively small numbers of people, compared with the broad-based advances of earlier decades, when the modern world was put into place. ...
Sooner or later, new technological revolutions will occur, perhaps in the biosciences, through genome sequencing, or in energy production, through viable solar power, for example. But these transformations won’t come overnight, and we’ll have to make do in the meantime. Instead of facing up to this scarcity, politicians promote tax cuts and income redistribution policies to benefit favored constituencies. Yet these are one-off adjustments and, over time, they cannot undo the slower rate of growth in average living standards.
It’s unclear whether Americans have the temperament to make a smooth transition to a more stagnant economy. After all, we’ve long thought of our country as the land of unlimited opportunity. In practice, this optimism has meant that we continue to increase government spending, whether or not we can afford it.
In the narrow sense, the solution to the stagnation of median income will not be a political one. And one of the hardest points to grasp about this quandary is that no one in particular is to blame. Scientific progress has never proceeded on an even, predictable basis, even though for part of the 20th century it seemed that it might.
Science should be encouraged with subsidies for basic research, as well as private charity, educational reform, a business culture geared toward commercializing inventions, and greater public appreciation for the scientific endeavor. A lighter legal and regulatory hand could ease the path of future innovations.
Nonetheless, advancing discovery is not a goal to be reached by the mere application of will. Precisely because there is no obvious villain and no simple fix, and many complex factors behind success, science as a general topic doesn’t play a big role in American political discourse. When it comes to understanding our macroeconomic predicament, we often seem to be missing the point.
Until science has a greater impact again on average daily living standards, the political problem will be in learning to live within our means. Because neither major party seems to support a plausible path to fiscal balance, or to acknowledge how little control politicians actually have over future income growth, we unscientifically keep living in an age of denial.
I can't help myself -- one quick response: The uneven technological progress described above seems to provide a good reason for the government to be the agent of intertemporal transfers from the booming times to the times that are stagnating. In essence, this is just a business cycle with a long and uncertain periodicity, so the same types of stability arguments apply (particularly since "Scientific progress has never proceeded on an even, predictable basis," i.e. being alive during a boom time is mostly due to luck, not an individual's superior skill). Thus, while the argument above is that we are at a low point of the cycle, therefore the government should be less active, I think there is just as strong or stronger argument on the other side, i.e. that this is when government needs to become more active (both in terms of promoting innovation and in terms of smoothing the income variation due to uneven growth in productivity). The difference between us, perhaps, is that Tyler sees the technological plateau as permanent, or at least very long-lived (though he does say that sooner or later technological advances will come). I do not, I see the plateau -- if it exists at all -- as part of a longer up and down cycle.
Okay, that's not the strongest argument ever made, so one more quick response: More importantly, I also can't resist wondering whose incomes are stagnating and why. The economy will continue to grow. Yes, we've had a recent recession. But GDP has not and will not be stagnant over a longer time frame. Productivity increases will still drive economic growth. The question is how that growth will be shared.
The stagnation of income for typical (median) households in recent decades has little to due with stagnating productivity -- productivity has still been rising. It has much more to do with how the gains from rising productivity have been divided up. This is yet another reason why complaints about active government and "income redistribution policies to benefit favored constituencies" ring hollow. When you leave out that a mal-distribution of income already exists, i.e. when your implicit underlying assumption is that the people who did get the growth over the last few decades deserved every penny of it (despite bubbles giving false gains to people at the top, and many other problems), of course you'll oppose redistributive policies. But I tend to think that the gains were not distributed according to changes in productivity -- labor did not get its share -- and government intervention to correct that is appropriate.
John Taylor says the Fed should adopt a single mandate. In his view, which seems to be fairly common on the political right, the Fed should abandon targeting the output gap and restrict its attention it keeping the inflation rate stable:
Former U.S. Treasury Department undersecretary John Taylor on Wednesday called for overhauling the Federal Reserve’s dual mandate of ensuring stable prices and maximum employment, saying that the central bank should focus on prices.
“It would be better for economic growth and job creation if the Fed focused on the goal of “long run price stability within a clear framework of economic stability,’” Taylor told the House Financial Services Committee. ...
Taylor said that “too many goals blur responsibility and accountability.” ...
Robert Barbera, a fellow at John Hopkins, sends an email making the case that a single mandate is a bad idea, particularly near the zero bound. It is based upon an IMF paper showing that deflation does not generally occur when there are large output gaps. Instead, downward price and wage rigidities cause inflation to stabilize at low rates, and this is part of the reason for a suboptimal response under a single mandate.
Note that the term "divine coincidence" used in the email refers to a situation where stabilizing inflation is the same as stabilizing output. When particular assumptions are imposed on theoretical NK DSGE models, there is no difference in terms of household welfare between a single and a dual mandate. Unfortunately, the assumptions that are required for the existence of divine coincidence are relatively strict and we shouldn't expect it to hold generally. (The wide adoption of a single mandate in Europe is due, in large part, to the difficulties of targeting output gaps when multiple countries are involved. Thus, it's based more on politics than on economics. Suppose, for example, that Germany is doing well and does not favor expansionary policy, but Ireland is struggling and wants help. Whose interests should prevail?).
Here's Robert's email:
IMF did a bang up working paper on Persistent Large Output Gaps, looking at 20 or so nations over 30 years. A super short version of their conclusions? PLOGS weigh on price pressures for years, even amid strong recoveries--a standard Keynesian conclusion. Two, PLOGS lose much of their deflationary power, the closer inflation gets to zero--a not so common conclusion. It seems slowing pay and price increases is much easier than actually cutting wages and prices...
Now imagine a two nation world near zero inflation amid PLOG circumstances. Imagine further that one nation has a dual mandate and the other is an inflation targeter. What happens?
The dual mandate CB sees high joblessness keeps pedal to the metal till strong growth arrives. The other CB fails to see deflation appear and therefore is less stimulative. As the big ease in nation #1 succeeds, stronger growth lifts it's currency. A touch of adverse terms of trade lifts price pressures in nation #2 just enough to confirm, in the CB inflation nutter one track minds, that they are doing "the right thing". They stick to their guns, and over time cyclical joblessness becomes structural. In other words, they are unwitting agents of hysteresis.
Thus the divine coincidence categorically fails amid near zero inflation. More to the point, single focused CBs are quite likely to pursue suboptimal policy.
The argument is not that the Fed will remain passive under a single mandate. When inflation is below target -- as it would be near the zero bound -- there is still a response from the Fed. The Fed will still try to hit its inflation target and hence should ease up. However, because the Fed pursues a single rather than a dual target, and because of the effects on the terms of trade, the response will be smaller than it would be under a dual mandate, and hence suboptimal (there is a result in the background showing that the variance of output is lower under the dual mandate unless, again, restrictive assumptions are made).
Note: A good description of the special conditions that are needed for divine coincidence comes from this paper by Jordi Gali and Olivier Blanchard:
...In this paper, we show that this divine coincidence is tightly linked to a specific property of the standard NK model, namely the fact that the gap between the natural level of output and the efficient (first-best) level of output is constant and invariant to shocks. This feature implies that stabilizing the output gap the gap between actual and natural output is equivalent to stabilizing the welfare-relevant output gap the gap between actual and efficient output. This equivalence is the source of the divine coincidence: The NKPC implies that stabilization of inflation is consistent with stabilization of the output gap. The constancy of the gap between natural and efficient output implies in turn that stabilization of the output gap is equivalent to stabilization of the welfare-relevant output gap.
The property just described can in turn be traced to the absence of non trivial real imperfections in the standard NK model. This leads us to introduce one such real imperfection, namely real wage rigidities. The existence of real wage rigidities has been pointed to by many authors as a feature needed to account for a number of labor market facts (see, for example, Hall ).We show that, once the NK model is extended in this way, the divine coincidence disappears.
The reason is that the gap between natural and efficient output is no longer constant, and is now affected by shocks. Stabilizing inflation is still equivalent to stabilizing the output gap, but no longer equivalent to stabilizing the welfare-relevant output gap. Thus, it is no longer desirable from a welfare point of view. ...
Suppose, for example, that firms have market power. Then the natural rate of output will be lower than the welfare maximizing level (because market power leads to lower output and higher prices than is socially optimal). So long as the gap between the two stays constant, then divine coincidence will exist. However, it is very easy to make this gap variable and, in fact, realism within our models demands it (divine coincidence can fail for reasons besides a variable gap due to wage rigidities, so this does not exhaust the resons why divine coincidence can fail).
Thus, theory tells us that a single mandate is a bad idea except under conditions that are unlikely to exist. Since the conditions are special, and since inappropriately adopting a single mandate leads to too much unemployment and potential hysteresis, the burden of proof that the special conditions required for a single mandate are present, at least approximately, is on the proponents of the single mandate -- and they simply have not made the case.
Update: I forgot that Paul Krugman wrote about "PLOGS" in August:
The Price Stability Trap, by Paul Krugman: There’s an important new paper from the IMF about inflation in the face of Prolonged Large Output Gaps — yes, PLOGs. You can think of it as a careful, multi-country version of the quick-and-dirty analysis of US experience I did recently, with an assist from Tim Duy. What the analysis shows is that prolonged periods of economic weakness are, with almost no exceptions, associated with falling inflation rates.
The analysis also suggests something else, however: as the inflation rate goes toward zero, it seems to become “sticky”: in the modern world, rapid deflation doesn’t happen, and in fact slight positive inflation often persists in the face of an obviously depressed economy:
The authors discuss several possible explanations, but it does seem as if downward nominal rigidity is playing a role.
And this raises the specter what I think of as the price stability trap: suppose that it’s early 2012, the US unemployment rate is around 10 percent, and core inflation is running at 0.3 percent. The Fed should be moving heaven and earth to do something about the economy — but what you see instead is many people at the Fed, especially at the regional banks, saying “Look, we don’t have actual deflation, or anyway not much, so we’re achieving price stability. What’s the problem?”
And the slump will just go on.
I'm hoping your comments will help me to understand what is going in in Egypt, and how it is realted to more general political developments in the area, e.g. the protests in Iran:
- Five Things To Understand About The Egyptian Riots - Heather Hurlburt
- Marc Lynch's blog - Mark Lynch
- What the Protesters Want in Egypt - Brookings Institution
- Reporting a Revolution in Cairo - CJR
- Time to Rethink U.S.-Egyptian Relations - Brian Katulis
- Egypt's protests erupt - Al Jazeera Blogs
- Mubarak Vows Cabinet Shift as Revolt Sweeps Egypt - NYTimes.com
- Egypt’s Military Pivotal in Next Step - NYTimes.com
- Egyptians’ Protest in Cairo Focuses on Fight for Bridge - NYTimes.com
- Cairo in near-anarchy as protesters push to oust president - Washington Post
- Egypt's Mubarak Digs In as Mobs Battle Police - WSJ.com
- Mubarak pledges new government - FT.com
Update: There are many more good links in the comments.
Friday, January 28, 2011
Martin Feldstein argues that China's current-account surplus is likely to shrink dramatically over the next few years:
The End of China’s Surplus, by Martin Feldstein, Commentary, Project Syndicate: China’s current-account surplus ... is the largest in the world. ...China’s external surplus stands at $316 billion, or 6.1% of annual GDP.
Because the current-account surplus is denominated in foreign currencies, China must use these funds to invest abroad, primarily by purchasing government bonds issued by the United States and European countries. As a result, interest rates in those countries are lower than they would otherwise be.
That may all be about to change. ... It is possible that, before the end of the decade, China’s current-account surplus will move into deficit... If that happens, China will no longer be a net buyer of US and other foreign bonds, putting upward pressure on interest rates in those countries.
Although this scenario might now seem implausible, it is actually quite likely to occur. ... China’s national saving rate ... is now about 45% of its GDP, which is the highest rate in the world. But, looking ahead, the five-year plan will cause the saving rate to decline...
The plan calls for a shift to higher real wages so that household income will rise as a share of GDP. Moreover, state-owned enterprises will be required to pay out a larger portion of their earnings as dividends. And the government will increase its spending on consumption services like health care, education, and housing....
Since China’s current-account surplus is now 6% of its GDP, if the saving rate declines from the current 45% to less than 39% – still higher than any other country – the surplus will become a deficit.
This outlook for the current-account balance does not depend on what happens to the renminbi’s exchange rate... But the fall in domestic saving is likely to cause the Chinese government to allow the renminbi to appreciate more rapidly. Higher domestic consumer spending would otherwise create inflationary pressures. ... A stronger renminbi would ... cause a shift from exports to production for the domestic market, thereby shrinking the trade surplus, in addition to curbing inflation.
...Americans are eager for China to reduce its surplus and allow its currency to appreciate more rapidly. But they should be careful what they wish for, because a lower surplus and a stronger renminbi imply a day when China is no longer a net buyer of US government bonds. The US should start planning for that day now.
Plans are not action. I hope the Chinese government moves to raise the standard of living and to provide more social services, but I'll believe it when I see it happen. For now, interest rates remain very low -- markets are not worried about this -- and it's not the time to panic about the deficit, impose large budget cuts, and endanger the recovery.
The advance estimate from the BEA has GDP growing by 3.2% in the third quarter:
Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 3.2 percent in the fourth quarter of 2010, (that is, from the third quarter to the fourth quarter), according to the "advance" estimate released by the Bureau of Economic Analysis.
That's better than slower growth, but not enough to make up for past losses. Paul Krugman puts it this way:
growth at 3.2 percent closes less than 1 percentage point of that gap each year. So, yippee: we’re on track to restore full employment circa 4th quarter 2018. Why am I not happy?
Of the 3.2% total growth pace, 3.02 percentage points were contributed by personal consumption. Gains were also attributable to a nice improvement in exports. Net exports contributed positively to growth for the first time all year. But for the first time in almost two years, federal government spending joined state and local spending as a drag on growth. This trend will continue; generally speaking, future growth will have to come despite government cuts rather than thanks to government supports.
Cutbacks in federal, state, and local spending will provide a strong headwind to growth. We have a large gap to make up, and growth is not yet fast enough to get the job done in a reasonable amount of time. Thus, we need help with growth from the federal government -- balanced budget requirements and poor economic conditions tie the hands of state and local governments -- not a strong headwind working against us. So let's hope Congressional gridlock or good sense (unlikely) prevails and forestalls deficit reduction until the economy is on more robust footing.
[Also posted at MoneyWatch.]
Contrary to claims by Paul Ryan in his response to President Obama's State of the Union address, the experience in Europe "actually refutes the current Republican narrative":
Their Own Private Europe, by Paul Krugman, Commentary, NY Times: President Obama’s State of the Union address was a ho-hum affair. But the official Republican response, from Representative Paul Ryan, was really interesting. And I don’t mean that in a good way.
Mr. Ryan made highly dubious assertions about employment, health care and more. But what caught my eye, when I read the transcript, was what he said about other countries: “...Greece, Ireland, the United Kingdom and other nations in Europe ... didn’t act soon enough; and now their governments have been forced to impose painful austerity measures: large benefit cuts to seniors and huge tax increases on everybody.”
It’s a good story: Europeans dithered on deficits, and that led to crisis. Unfortunately, while that’s more or less true for Greece, it isn’t at all what happened either in Ireland or in Britain, whose experience actually refutes the current Republican narrative. ...
American conservatives have long had their own private Europe of the imagination... So we shouldn’t be surprised by ... tall tales about European debt problems. Let’s talk about what really happened in Ireland and Britain.
On the eve of the financial crisis, conservatives had nothing but praise for Ireland... Ireland was running a budget surplus, and had one of the lowest debt levels in the advanced world.
So what went wrong? The answer is: out-of-control banks; Irish banks ran wild ... creating a huge property bubble. When the bubble burst, revenue collapsed, causing the deficit to surge, while public debt exploded because the government ended up taking over bank debts. And harsh spending cuts, while they have led to huge job losses, have failed to restore confidence.
The lesson of the Irish debacle, then, is very nearly the opposite of what Mr. Ryan would have us believe. It doesn’t say “cut spending now, or bad things will happen”; it says that balanced budgets won’t protect you from crisis if you don’t effectively regulate your banks... Have I mentioned that Republicans are doing everything they can to undermine financial reform?
What about Britain? Well, contrary to what Mr. Ryan seemed to imply, Britain has not, in fact, suffered a debt crisis. True, David Cameron ... has made a sharp turn toward fiscal austerity. But that was a choice...
And underlying that choice was ... adherence to the same theory offered by Republicans to justify their demand for immediate spending cuts here — the claim that slashing government spending in the face of a depressed economy will actually help growth rather than hurt it.
So how’s that theory looking? Not good..., there’s certainly no sign of the surging private-sector confidence that was supposed to offset the direct effects of eliminating half-a-million government jobs. ...
American conservatives have long used the myth of a failing Europe to argue against progressive policies in America. More recently, they have tried to appropriate Europe’s debt problems on behalf of their own agenda, never mind the fact that events in Europe actually point the other way.
But Mr. Ryan is widely portrayed as an intellectual leader within the G.O.P., with special expertise on matters of debt and deficits. So the revelation that he literally doesn’t know the first thing about the debt crises currently in progress is, as I said, interesting — and not in a good way.
Improvements in welfare occur when there are improvements in utility, and those occur only when an individual gets an option that wasn’t previously available. We typically prove that someone’s welfare has increased when the person has an increased set of choices.When we make that assumption (which is hotly contested by some people, especially psychologists), we essentially assume that the fundamental objective of public policy is to increase freedom of choice.
I will leave to others to dispute the notion that more choices are always better than fewer. But I can't help but think that it is to easy for those of us who are tenured professors to extoll the virtue of free choice, for the simple reason that we get so many, well choices. We get to choose what we write, we to a large extent get to choose what we teach inside our classes, and we can piss our deans off and pay fairly little in the way on consequences. We might not get a raise or we might have to teach a class that we would rather not, but this is all small beer. We can make an awful lot of choices and still be economically secure.
Now consider the administrative assistant at a corporation who has a boorish boss and a sick kid. The company she (he) works for has a good health insurance plan, but if she were to leave, she would find herself unable to get coverage at a reasonable price. Does she really have choice?
Consider the West Virginia coal miner who goes into a dangerous mine every day, and whose life expectancy is shortened with each hour worked underground. Now consider the fact that the miner grew up in a West Virginia town with a poor school in an environment where going to college was a rare phenomenon. Does that miner have a choice?
I could go on, but I think the point is fairly clear. There are times when government intervention could expand the choice set up a large number of people.
Ed does point out how government can improve choice sets, and for that he deserves credit. But the more fundamental problem is that market economies produce large institutions that have limited markets inside of them, and therefore sometimes have hierarchies that can be as inhospitable to personal liberty as government bureaucracies. Elinor Ostrom's Nobel win in 2009 shows that the economics profession is beginning to recognize this problem, but I am not sure Ph.D. students are broadly encouraged to study it.
Thursday, January 27, 2011
Brad DeLong on the "debate over whether its economy evolves or is designed":
Intelligent Economic Design, by J. Bradford DeLong, Commentary, Project Syndicate: As Stephen Cohen, with whom I wrote The End of Influence: What Happens When Other Countries Have the Money, likes to say, economies do not evolve; they are, rather, intelligently designed. He also likes to say that, though there is an intelligence behind their design, this does not mean that the design is in any sense wise.
The first claim is, I think, incontrovertible. Since long before Croesus, King of Lydia, came up with the game-changing idea of standardized “coinage,” what governments have done and not done to structure, nudge, and put their thumbs on the scales has been decisively important for economic development.
Just look around you. Notice the hundred-fold divergence across political jurisdictions in relative levels of economic productivity and prosperity? I dare anyone to claim that the overwhelming bulk of that disparity springs from causes other than history and the current state of governance.
The second claim is also, I think, true. To say that economies are the products of intelligent design means only that some human intelligence or intelligences lies behind the design. It does not mean that the design is smart or optimal. ...[continue reading]...
Here's a reaction to today's news that new claims for unemployment insurance increased substantially last week:
Bill Thomas, Keith Hennessey, and Douglas Holtz-Eakin have a dissenting statement in response to the final report of the Financial Crisis Inquiry Commission:
What Caused the Financial Crisis, by Bill Thomas, Keith Hennessey, and Douglas Holtz-Eakin, Commentary, WSJ: Today, six members of the Financial Crisis Inquiry Commission ... are releasing their final report. Although the three of us served on the commission, we were unable to support the majority's conclusions and have issued a dissenting statement. ...
We recognize that ... other ... narratives have popular appeal:... Had the government not supported housing subsidies (the first narrative) or had policy makers implemented more restrictive financial regulations (the second) there would have been no calamity.
Both of these views are incomplete and misleading. ... We believe the crisis was the product of 10 factors. Only when taken together can they offer a sufficient explanation of what happened:
Starting in the late 1990s, there was a broad credit bubble in the U.S. and Europe and a sustained housing bubble in the U.S. (factors 1 and 2). Excess liquidity, combined with rising house prices and an ineffectively regulated primary mortgage market, led to an increase in nontraditional mortgages (factor 3) that were in some cases deceptive, in many cases confusing, and often beyond borrowers' ability to pay.
However, the credit bubble, housing bubble, and the explosion of nontraditional mortgage products are not by themselves responsible for the crisis. Our country has experienced larger bubbles—the dot-com bubble of the 1990s, for example—that were not nearly as devastating... Losses from the housing downturn were concentrated in highly leveraged financial institutions. Which raises the essential question: Why were these firms so exposed? Failures in credit-rating and securitization transformed bad mortgages into toxic financial assets (factor 4). Securitizers lowered the credit quality of the mortgages they securitized, credit-rating agencies erroneously rated these securities as safe investments, and buyers failed to look behind the ratings and do their own due diligence. Managers of many large and midsize financial institutions amassed enormous concentrations of highly correlated housing risk (factor 5), and they amplified this risk by holding too little capital relative to the risks and funded these exposures with short-term debt (factor 6). They assumed such funds would always be available. Both turned out to be bad bets.
These risks within highly leveraged, short-funded financial firms with concentrated exposure to a collapsing asset class led to a cascade of firm failures. ... We call this the risk of contagion (factor 7). In other cases, the problem was a common shock (factor 8). A number of firms had made similar bad bets on housing...
A rapid succession of 10 firm failures, mergers and restructurings in September 2008 caused a financial shock and panic (factor 9). Confidence and trust in the financial system evaporated, as the health of almost every large and midsize financial institution in the U.S. and Europe was questioned. The financial shock and panic caused a severe contraction in the real economy (factor 10). ...
[I]t is dangerous to conclude that the crisis would have been avoided if only we had regulated everything a lot more, had fewer housing subsidies, and had more responsible bankers. Simple narratives like these ignore the global nature of this crisis, and promote a simplistic explanation of a complex problem. Though tempting politically, they will ultimately lead to mistaken policies.
I don't think the conclusion that better regulation would not have stopped the crisis follows from the factors they list.
By their own admission, the reason that factors 1 and 2 led to factor 3 was "an ineffectively regulated primary mortgage market." So right away better regulation could have stopped the chain of events the led to the crisis.
Factor 3 was "nontraditional mortgages that were in some cases deceptive, in many cases confusing, and often beyond borrowers' ability to pay." Sure seems like regulation might help to prevent deception and confusion (through, among other things, a financial protection agency). One thing is clear in any case. The market didn't prevent these things on its own.
On to factor 4: Securitizers lowering credit standards, a failure of credit agencies, and buyers failing to do their own due diligence. Once again, regulation can help where the private market failed. The ratings agencies exist because they help to solve an asymmetric information problem. The typical purchaser of financial assets does not have the resources needed to assess the risk of complex financial assets (which is why saying that they should have performed their own due diligence misses the mark). Instead, they rely upon ratings agencies to do the assessment for them. Unfortunately, the ratings agencies didn't do their jobs -- perhaps due to bad incentives arising from to how they were paid -- and this is where regulation has a role to play.
Factor 5 is the accumulation of correlated risk -- again something a regulator can stop once the accumulation or risk is evident. This seems like an easy one -- when regulators see this type of risk building up, they should do something about it. The question, however, is how to give regulators better tools for assessing these risks. Backing off on regulation, as implied above, won't help with this.
Factor 6 is "holding too little capital relative to the risks and funded these exposures with short-term debt." Too little capital? Mandating higher capital requirements is the solution to this problem. Basel II is one example, but it doesn't go far enough. (The other part of factor 6 is essentially too much exposure to risk which is covered in the previous paragraph.)
Factors 7 and 8 are risk contagion and widespread exposure to a common shock. The private sector didn't prevent these risks from getting too high so, again, why wouldn't we want a regulator to do something about excessive risks of this type? False positives is one worry -- reacting to problems that aren't there -- but that is a matter of how high to set the threshold for action, not an argument against regulation itself. If anything, the threshold for action was too low prior to the crisis.
Factor 9 is "A rapid succession of 10 firm failures, mergers and restructurings in September 2008 that endangered the financial system." Too big to fail? Guess who can fix that?
Finally, factor 10 is the effects on the real economy. I'll concede that regulation could not have helped much here. Once the financial system crashed in the way that it did, the real economy was sure to follow. But remember, these factors are, for the most part, a chain of events. If the chain had been broken by more effective regulation anywhere along the way, the chain of events is interrupted and factor 10 does not come into play.
For almost every factor mentioned above, regulation could have reduced or completely eliminated the risk. Thus, it's hard to see how a conclusion that " it is dangerous to conclude that the crisis would have been avoided if only we had regulated everything a lot more" can possibly follow.
Wednesday, January 26, 2011
Bill Craighead at Twenty Cent Paradigms:
SOTU, by Bill Craighead: A couple of thoughts on the "State of the Union"-
As an economist, I don't find the rhetoric of "competitiveness" very appealing (see Paul Krugman's classic on this). International trade is mutually beneficial* - not a zero sum struggle to beat other countries to the "good jobs." From an economist's point of view, the rapid growth in China is a great story about an dramatic increase in human welfare. However, while competitiveness rhetoric can be used to justify bad policies like subsidies and tariffs, Obama is employing it to promote policies like investment in infrastructure, basic research and education that are beneficial regardless of what is going on in other countries. Though it is a mistake to feel threatened by the success of other countries, Obama seems to be exploiting this sentiment to embarrass us into getting our act together, which isn't entirely a bad thing. He's like our national "Tiger mother."
Unfortunately, President Obama appears to have conceded the rhetorical war on two important fronts: global warming and the budget deficit.
On global warming, which is the most important policy issue we face, the President chose not to even mention it directly. So much for having "adult conversations" in our politics... Even if the towel has been thrown in on cap-and-trade, the administration does appear to be trying to confront the problem, sotto voce, in other, less efficient ways. At least, that is how I interpret the call that 80% of energy should come from "clean sources" by 2035.
As for the deficit, the idea that the government is like a family that needs to "tighten its belt" seems to have won out. That's simple, intuitive and wrong. The basic principle of countercyclical fiscal policy - that when households are cutting back, government needs to step in and make up for it with offsetting spending increases or tax cuts - also seems simple and intuitive. But apparently not enough so. President Obama is a very good speech-maker, but has proven not to be enough of a great communicator to get the public thinking correctly about this.
It looks like we'll get some "cuts" and "freezes." These may manage to be a drag on the recovery and damage some important government functions without making much of a dent in the real long run problem because domestic discretionary spending is a fairly small part of the overall budget (as Howard Gleckman says: "that makes Obama the anti-Willie Sutton. He is going whether the money isn’t"). It seems that we're done with counter-cyclical fiscal policy and its all up to the Fed now. With 14.5 million still unemployed, that is a mistake, and a real shame. While I hope (and believe) the President is correct in presuming the recovery will continue, it still could benefit from a fiscal push.
See also: Paul Krugman, ... and Ezra Klein.
*There are number of possible caveats on that, including that while a country as a whole benefits, some within it are hurt (Stolper-Samuelson theorem) and that a trade deficit can reduce aggregate demand which is bad for employment in the short-run.
A quick reaction to the FOMC's decision to maintain current policy objectives. There wasn't much to say -- the Fed did just as expected -- but I said it anyway:
Update: From Tim Duy:
Quick FOMC Response, by Tim Duy: The FOMC statement was largely as expected – sticking to the current policy path. That means maintaining the current asset purchase program while holding interest rates low for an extended period. Some specifics:
No Dissents: Kansas City Fed President Thomas Hoenig is no longer a voting member, and none of the new voting members took up his dissent. Completely unsurprising. While some policymakers such as Philadelphia Fed President Charles Plosser believe that QE2 was a mistake, they see the costs –market disruption and loss of credibility – of undoing that mistake as greater than the benefits.
Additional Flexibility: Note the change in the first sentence. From:Information received since the Federal Open Market Committee met in November confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring down unemployment.To:Information received since the Federal Open Market Committee met in December confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions.
A focus on a specific data point – unemployment – was replaced with the more general “labor market conditions.” This could signal a willingness to roll back the balance sheet expansion if nonfarm payrolls were growing rapidly but, as workers return to the labor force, unemployment rates remain persistently high. I have difficulty seeing the Fed raise rates as long as unemployment is high, but a return to allowing the balance sheet to contract naturally or directly would not be out of the question.
Commodity Prices: As expected, the FOMC is not poised to follow the path of ECB Head Jean-Claude Trichet and fret about headline inflation. In contrast, the FOMC will focus on the pass-through to core inflation, if any, and the path of longer term inflation expectations.
Bottom Line: No real surprises in this FOMC statement, with the exception of a slight change in language on labor markets that suggests an effort to create additional flexibility.
When Paul Krugman talks about a great and unbridgeable moral divide, this is the kind of thing he's talking about. There's no middle ground here, and no room for compromise (I left the highlighted passage out in the excerpt from Glaeser in the post below this one). This is Robert Higgs from the Independent Institute:
Freedom Is Not Compatible with Government’s Initiation of Force against Innocent People, by Robert Higgs: In yesterday’s New York Times appears an op-ed article by Edward L. Glaeser... Glaeser’s article is remarkable because arguments in favor of freedom, insisting that economic analysis implicitly rests on a moral presumption that individual freedom has fundamental value, do not appear every day — or every month — in “the newspaper of record.” So, I am glad to give two cheers to Glaeser, one for his theme and another for his courage in placing the argument in such a hostile outlet.
I cannot give Glaeser a third cheer, however, because toward the end of the article he inserts a concession that I find wholly inconsistent with the rest of the argument. He writes:
Economists’ fondness for freedom rarely implies any particular policy program. A fondness for freedom is perfectly compatible with favoring redistribution, which can be seen as increasing one person’s choices at the expense of the choices of another, or with Keynesianism and its emphasis on anticyclical public spending.
Many regulations can even be seen as force for freedom, like financial rules that help give all investors the freedom to invest in stocks by trying to level the playing field.
To be sure, many mainstream economists do think about policy just as Glaeser says they do. But in doing so, they are mistaken. I find it difficult to believe that a man of Glaeser’s intelligence has really given much thought to what he is saying in these passages.
In fact, a presumption in favor of freedom rules out virtually everything that modern governments do, certainly nearly everything they do in interfering in economic affairs. Redistribution of income, for example, requires that the government rob Peter in order to benefit Paul (and its own functionaries, who serve as middlemen in this transfer). This action is not freedom; it is a crime against Peter, a raw violation of his right to his own legitimate property. Keynesian countercyclical spending requires the government to spend borrowed money whose acquisition is premised on future taxation (that is, robbery) of taxpayers in order to service the debt and repay the principal. Again, innocent persons have their rights violated. How can anyone fail to see that robbery is incompatible with freedom? Finally, the financial rules that Glaeser finds compatible with freedom entail threats of violence against financial transactors who do not follow arbitrary government rules — often extremely foolish and even destructive rules — in making their transactions, notwithstanding the fact that the parties to the transaction may be perfectly willing to proceed without such regulatory compliance. Such regulation is the very opposite of freedom; it is instead the sheer imposition of outside force, intruding on willing transactors, and thereby discouraging them to some extent, if not entirely, with consequent loss of the wealth that such transactions would have created, in addition to the loss of liberty...
Glaeser quotes Milton Friedman to good effect in his article... Friedman’s arguments were good as far as they went, but they did not go nearly far enough. Like Glaser, Friedman was prepared to make many concessions to state power, and his focus on utilitarian arguments, as opposed to moral principles, diminished the intellectual force of his laudable efforts to enlarge the scope of liberty in economic affairs.
Taxation is robbery, regulation is a threat of violence -- it's not hard to understand why so many people who hold these beliefs do not accept the legitimacy or the authority of the democratic process as a means to resolve disputes about the proper role of government.
The Moral Heart of Economics, by Edward Glaeser, NY Times: ...Today, I focus on ... the complaint that economics is a discipline without a moral core. ...
Because our teaching is so mathematical and formal, it’s easy to miss that we start by making a huge leap, that is basically moral, not mathematical.
Teachers of first-year graduate courses in economic theory ... often begin by discussing the assumption that individuals can rank their preferred outcomes. We then propose a ... ranking mechanism called a utility function ... This “utility function” has nothing to do with happiness or self-satisfaction; it’s just a mathematical convenience for ranking people’s choices.
But then we turn to welfare, and that’s where we make our great leap.
Improvements in welfare occur when there are improvements in utility, and those occur only when an individual gets an option that wasn’t previously available. We typically prove that someone’s welfare has increased when the person has an increased set of choices.
When we make that assumption (which is hotly contested by some people, especially psychologists), we essentially assume that the fundamental objective of public policy is to increase freedom of choice.
Our opponents have every right to contend that economists are unwisely idolizing liberty, but they err by saying we sail without a moral North Star. ...
Tuesday, January 25, 2011
- Globalization Marches On - Jagdish Bhagwati
- The Moral Heart of Economics - Edward L. Glaeser
- Why China missed the industrial revolution - voxeu.org
- Robert Shiller on Human Traits Essential to Capitalism - The Browser
- The Global Inflation Debate - Modeled Behavior
- Why China hates loving the dollar - Martin Wolf
- Lesson From Europe: Fiscal Austerity Kills Economies - New Deal 2.0
PBS Newshour asked for reactions to the State of the Union speech. Like last year (click on "analysis" in the sidebar and people such as Brad DeLong will pop up), they will link some of these comments to parts of the speech (after editing, I basically live-blogged these comments so they are a bit raw, I'll add the link once it's up-- here it is).
Here's what I just emailed.
Jobs: Most of the programs the President mentioned to create jobs and improve the prospects for workers in the future will take quite some time to have an effect. Educational improvements, for example, will not happen immediately. We've been trying to do this for decades already with little to show for it, so we shouldn't expect things to improve overnight. And if reform does eventually happen, it will be many years after that before better educated students begin to enter the workforce. Another initiative from the President, investment in infrastructure, is a little better in terms of how long it takes to create jobs. There will be additional jobs as the infrastructure is under construction, and more jobs in the long-run when it enhances our productivity. But we must first get these programs through Congress and that will take time -- if it can be done at all given the opposition from the GOP. And if and when a program does eventually get through Congress, it will take even more time before the first shovel hits the dirt. I like the ideas I heard from the president, but what about our more immediate job problem? How do we help those who need a job right now? Solving the more immediate job problem needs to be first and foremost on our national agenda, but this was not addressed in the speech.
Eliminating regulation: The idea is that removing unnecessary regulation will improve our ability to innovate, and this will help the economy create new, good jobs. However, it wasn't lack of innovation or lack of competitiveness that got us into this mess, it was an out of control financial sector. The President talked about eliminating unnecessary regulation, but far too little was said about the need to implement new regulations where they are needed. In addition, by focusing so much on helping business, the president risks sending the message that what is good for business is necessarily good for the nation. Businesses need the right environment to thrive, but we must not lose sight of the fact that it's the skills of the people that work at businesses that matters most. Our ultimate goal is the best possible life for as many people as possible, and that requires a broader focus than businesses alone.
[The next one on deficits could go -- I'm so-so on this one.]
Deficits: We need to get our deficit under control, but not before the economy is ready for it. If we move too soon to balance the budget, we could slow the recovery or even cause a return to recessionary conditions. We can learn something about this from the UK. The UK has embraced austerity and taken steps to balance the budget. The idea was that this would create confidence and spur recovery. However, the dismal GDP growth figures released today for the UK tell us we should be very cautious about cutting spending or raising taxes before the economy is on firmer footing that it's on presently. Fortunately for us, Congress moves slowly. That works in our favor here. But with the president signaling such an openness to work with the GOP on this issue, a more immediate and harmful move toward deficit reduction is not out of the question. I would have liked to have heard the president make clear that while deficit reduction must be addressed, we need to be careful not to hit our still fragile economy with austerity before it is ready for it.
Tax increases for the wealthy: I was pleased to hear the president say that "we simply cannot afford a permanent extension of the tax cuts for the wealthiest 2% of Americans." But there needed to be more emphasis on the fact that eliminating tax cuts for the wealthy and spending cuts will not solve our budget problem by themselves. Taxes are going to go up, and the president could have started paving the way for this to happen.
Commitment to freeze spending: The details weren't given, but the President likely has an across the board freeze in mind -- i.e. the discretionary spending freeze means that no program can grow beyond current levels. However, a spending freeze while population is growing amounts to a cut in per capita spending. While this sounds courageous, it's actually the easy way out since it avoids tough choices on which programs to cut and which programs to preserve. It is also not optimal for the economy because per capita cuts in some programs will be much more painful than in others. A better way to do this, and hopefully what will actually happen, is to cut back (or eliminate) the programs that provide the least value, and maintain or perhaps even expand those that provide critical services to citizens. Thus, if the freeze is across the board, it could be quite disruptive to some programs and to the economy. If it is done wisely, the pain from the cuts could be much less.
[I like that reaction best, but here are two more just in case:]
Commitment to freeze spending: As the CBO has made very clear, our long-run budget problem is mainly a problem with rising health care costs. If we fix the health care cost problem, we'll fix the budget problem. If the health care cost problem is not fixed, the deficit will grow uncontrollably no matter what we do with the rest of the budget. Thus, one danger here is that the spending freeze will lead to a false sense that we are solving the budget problem, and this in turn will cause us to lose focus on the critical health care cost problem.
Commitment to freeze spending: One worry here is that if the economy goes into a double dip -- an unlikely but not an impossible event by any means -- our commitment to hold the line on spending and cut the deficit will tie our hands in a way that prevents Congress from doing what is needed to get the economy going again.
With more time and thought, I would have refined what I said, and there are quite a few things I didn't address at all. But too late now. So let me ask: What would you have said?
This is very, very sad:
To all Maxine Udall Girl Economist Readers: It is with great sadness that we bring you the news that Dr. Alison Snow Jones, aka Maxine Udall, Girl Economist, passed away suddenly on Monday, January 17, 2011. "What Price Microfinance" was her last post.
Dr. Jones received her Ph.D. in Health Economics from Johns Hopkins School of Hygiene and Public Health (now Bloomberg School of Public Health). She served on the faculty of Johns Hopkins and later Wake Forest School of Medicine. Her last position was at Drexel University where she headed a joint program between the Schools of Business and Public Health. Those of you familiar with this blog know that she was strong believer in capitalism, but espoused an infusion of morality in business behavior and education.
In order to honor her writing, her courage in tackling difficult issues with clarity and grace, her varied and passionate interests, her love for people in all walks in life, and her many fans, we will keep this blog online. You can still comment on any post. We will share information here on where you can contribute to her memorial fund as it becomes available.
Please read, link to, and mine Dr. Jones's writing for information, insight and inspiration. Her deepest hope was to challenge people to think in new ways about our society and how we live, and to bring her unique viewpoint to as many people as possible. I think she has succeeded.
Dr. Jones loved writing and was brimming with new ideas and enthusiasm. She was happiest when crafting another blog post as Maxine Udall.
She will be sorely missed.
David Pinney, Meredith Frost
"She will be sorely missed." Very much so.
The “Recalculating” Debate, by Tim Duy: The fundamental nature of the recession continues to be debated – a debate with important policy consequences. Is the recession the consequence of a general aggregate demand deficiency, or is it a structural consequence of the housing bubble? If the former, the policy approach should be to support aggregate demand via a combination of fiscal and monetary policy. If the latter, only time will resolve the challenge, and aggressive policy will only lead to inflation.
Now, however, we’re seeing a much more widespread attack on demand-side economics. More than that, it’s becoming clear that many people don’t so much disagree with the idea that demand matters as find it abhorrent, incomprehensible, or both.
Nick Rowe offers an alternative explanation:
For decades my job has been to teach students that, despite the evidence of their senses, and contrary to their hearsay of the heretical teachings of the Keynesian Cross, aggregate output is basically supply-determined. Which it is. Basically. Though short-run fluctuations in demand can and will cause short run fluctuations in aggregate output around an average level that is determined by the supply-side.
And, for once, the memories of their parents are actually supporting me in my job. Look what happened in the 1970's, when demand increased. Printing too much money and increasing demand really did cause inflation. It really didn't make us all richer. It didn't reduce unemployment.
Now, just for once, we have to switch gears. These times are not normal. Just for once, the demand side really is the problem. Just for once, the overly obvious truth your senses are telling you really is the truth. Just for once, your parents' experience of the 1970's doesn't apply. Just for once, it really is OK to have a drink, even though you are a recovering alcoholic.
In some sense, economists diluted the reasoning of demand side macroeconomics with a focus on supply side factors. The Great Moderation only served to entrench the supply side view – after all, by the late-90’s I recall articles suggesting that we had conquered the business cycle. Demand side fluctuations had become a thing of the past.
I would offer another observation. I agree that the issue is a shortfall in demand. And not just for this recession, but arguably the entire last decade. That said, I think it is easy to lose sight of this demand shortfall in light of another feature of the past two business cycles. Both appear to have been inexorably connected to asset price bubbles, first in information technology and then in housing:
Supporting sufficient aggregate demand to maintain full employment looks to have required supporting relative levels of net worth well above a decades-long baseline. And pushing net worth to those levels was a consequence of asset price bubbles. Hence, it appears that the demand generated by that wealth was “fake.” Moreover, that “fake” demand arguably induced a supply side effect by pushing capital first into information technology and then into housing. To be sure, ultimately the impacts of such capital misallocations will fade away. Information technology depreciated rapidly, and the excess housing stock will eventually be absorbed by a growing population. It is not quite obvious, however, why this adjustment needs to extend to such a large portion of the workforce. The answer, I think, is not the housing adjustment itself, but the loss of general demand precipitated by the housing decline and subsequent balance sheet malaise.
The wealth-supported demand surely was not “fake,” as real goods and services were indeed purchased. But it was ephemeral, evaporating with the popping of bubbles. So it should be of little surprise the Federal Reserve is viewed by some as doing nothing more than supporting another round of “fake” demand. Fed officials probably compound this problem by citing the stock market increase as evidence that QE2 is working. Via the Wall Street Journal:
In recent weeks, the Federal Reserve has been turning to an unusual metric to prove the potency of its bond-buying program: the stock market.
Comments from Fed Chairman Ben Bernanke and other officials, as well as research by the central bank, cite rising stock prices as a sign that the central bank’s $600 billion bond-buying program is working to bolster the economy.
Of course, it is perfectly reasonable for officials to note that high equity prices signal improving economic prospects, the latter a consequence of their policy stance. Some, however, may interpret this as further evidence that the Fed is simply trying to create another asset price bubble, which will, if history is any guide, will also prove to be fleeting. The resulting aggregate demand will then be viewed as “fake.” In this light, the Federal Reserve is not really fixing anything, just papering over the underlying problem.
In short, I appreciate hesitation to embrace “more money” as a solution when it appears that “more money” was part of the problem. Indeed, I used to be more sympathetic to that notion than I am now.
But what exactly is the underlying problem? Or is there an underlying problem? I don’t know that we have agreement on that. Why was the US economy dependent on asset bubbles to spur demand over the past decade, and will the same be true for the next decade? Is the Fed’s current policy stance destined to fuel another bubble? I don’t think that is a excuse to forego monetary and fiscal support – the alternative of ongoing high unemployment is not particularly enticing – but I think we would all feel a bit more comfortable if the next decade sees robust growth without an asset price bubble.
Paul Krugman responds to (and disagrees with) Axel Leijonhufvud:
Are Low Rates A Subsidy to Banks?, by Paul Krugman: Mark Thoma sends us to Axel Leijonhfvud, who declares that
The Fed is supplying the banks with reserves at a near-zero rate. Not much results in bank lending to business, but banks can buy Treasuries that pay 3% to 4%.
This hefty subsidy to the banking system is ultimately borne by taxpayers. Neither the subsidy, nor the tax liability has been voted for by Congress.
This is a common view. But it misses the key point, which is maturity: short-term rates are near zero, while those 3-4 percent Treasuries are long-term.
Here’s a stylized picture:
Short rates will (and should) remain low until the economy recovers substantially; thereafter, they’ll rise as we get closer to full employment. Long-term rates are, to a first approximation, the average future expected short-term rate — because investors choose whether to park their funds short-term or buy long bonds based on which they think will yield more over the next 10 years.
So what can we say about a bank that gets short-term deposits or loans and puts the money into long-term Treasuries? Yes, it’s earning more interest now than it’s paying. But it’s also tying up funds in long-term assets; if and when short rates rise, it will either find itself paying more interest than it receives, or have to sell those long-term bonds at a capital loss. There’s no subsidy here.
Now, there is a question about reported earnings: do rosy numbers on bank earnings take into account the likely future losses on those long-term bonds? I suspect not, or at least not sufficiently — which means that reports of the revival of the financial sector are exaggerated, as are bonuses. But that misreporting is the issue — not the alleged subsidy to the banks.
Axel Leijonhufvud argues that political independence of central banks is "impossible to defend in a democratic society":
Shell game: Zero-interest policies as hidden subsidies to banks, by Axel Leijonhufvud, Vox EU: The two pioneers of modern monetary economics – Irving Fisher and Knut Wicksell – were passionately concerned to find monetary arrangements that would insure against arbitrary redistributions of income and wealth. They saw such distributive effects as offenses against social justice and consequently as a threat to social and political stability.
Fisher and Wicksell thought that price level stability was a sufficient condition for avoiding distributive effects. In this they were in error. A hundred years later, the motivating concern for their work has long since disappeared from monetary economics.
But the error survives. For example:
- The Fed is supplying the banks with reserves at a near-zero rate. Not much results in bank lending to business, but banks can buy Treasuries that pay 3% to 4%.
- This hefty subsidy to the banking system is ultimately borne by taxpayers. Neither the subsidy, nor the tax liability has been voted for by Congress.
The Fed policy drives down the interest rates paid to savers to some small fraction of 1%. At the same time, banks leverage their capital by a factor of 15 or so, thus earning a truly outstanding return from buying Treasuries with costless Fed money or very nearly costless deposits.
Wall Street bankers are then able once again to claim the bonuses they became used to in the good old days and to which they feel entitled because of the genius required to perform this operation. These bonuses are in effect transfers from tax-payers as well as from the mostly aged savers who cannot find alternative safe placements for their funds in retirement.
The shell game: “Now you see it, now you don’t.”
The Fed’s low-interest-rate policy has turned into a shell game for the general public who are unable to follow how the money flows from losers to gainers.
- The bailouts of the banks during the crisis were clear for all to see and caused widespread outrage; now the public is being told that they are being repaid at no cost to the taxpayer.
- What the public is not told is that the repayments come to a substantial extent out of revenues paid by taxpayers for the banks to hold Treasuries.
- Both parties supported the bailouts so neither party seems ready to protest the claim that they are being repaid at no cost to taxpayers.
The goals of monetary policy
Present monetary policy achieves two aims.
- One is to recapitalize the banks and to do so without the government taking an equity stake.
The authorities do not want to be charged with “nationalization” or “socialism.” So the banks have to be given the funds outright. Economists have agonized a lot lately about the zero lower bound to the interest rate as an obstacle to effective policy in the present circumstances. The agony seems misplaced. As long as the big banks are to be subsidized, why not just pay them to accept reserves from the friendly central bank?
- The second aim, of course, is to prevent the housing bubble from deflating all the way.
In this respect, the policy has had some effect. Homeowners whose houses are not “under water” can often refinance at long-term rates around 5% and sometimes even lower.
Miscalculation of economic values: Who pays?
Any financial crash reveals a large, collective miscalculation of economic values. The incidence of the losses resulting from such miscalculations has to be worked out before the economy can begin to function normally again. Because the process of a crash is unstable, it cannot be left for the markets and bankruptcy courts to work out the eventual incidence. In the present case, doing so would simply have led into another Great Depression.
This means political choices have to be made to determine who bears the losses from this collective miscalculation. Obviously such choices are terribly difficult. Yet, temporizing can prolong the period of subnormal economic performance indefinitely – as the history of Japan over the last 20 years illustrates. The shell game, as presently played, is in effect an attempt to settle a large part of the incidence problem “under the radar” of public opinion.
The risks of this quiet bank subsidy
Quite apart from its distributional effects, the policy is not without risk.
- To the extent that it succeeds in inducing the banks to load up on long-term, low-yield assets, a return to more normal rates will spell another round of banking troubles.
If the US were to suffer years of slow deflation, a return to higher rates will be long postponed. At present, strong deflationary pressures are kept at bay by equally strong inflationary policies. If the US escapes the Japanese syndrome, the Fed will sooner or later have to raise rates to stem inflation or to defend the dollar.
Central Bank independence?
For the last 20 or 30 years, political independence of central banks has been a popular idea among academic economists and, of course, heartily endorsed by central bankers. Such independence has not been much in evidence in the recent crisis. But central banks would very much like to restore their independence.
The independence doctrine, however, is predicated on the distributional neutrality of their policies. Once it is realized that monetary policy can have all sorts of distributional effects, the independence doctrine becomes impossible to defend in a democratic society.
Lane Kenworthy contests the idea that the social safety net has been completed with the passage of health care reform:
Is America finished with major expansions of the safety net?, by Lane Kenworthy: That’s the message from Jim Kessler, endorsed here, here, and here. Kessler urges President Obama to say, in his State of the Union address, that “with the passage of health care reform, America’s 85-year quest to weave a strong safety net is now complete.”
We have a safety net, but I wouldn’t call it “strong” by 21st-century standards. Some elements that are inadequate or altogether absent:
The 2010 health care reform, even if fully implemented, likely will leave millions of Americans uninsured.
Early education (preschool, child care), beginning at age one, is a very good idea. Not all states have full-day kindergarten; few have preschool for four-year-olds; none have much in the way of public funding of education for kids age one to three.
Paid parental leave is available in only a few states and covers a relatively short period.
Sickness insurance: ditto.
Unemployment insurance covers too few of us.
Unemployment insurance should be supplemented by or folded into a new wage insurance program.
Social assistance benefits have been decreasing steadily over the past generation.
If markets are now structured in such a way as to severely limit real earnings growth for those in the bottom half of the distribution, we may need to massively expand the EITC.
We ought to do more for children, working-age adults, and elderly persons with assorted physical, cognitive, emotional, and social disabilities.
The aim is not, let me emphasize, to expand government for its own sake. Government should play an integral role in providing these supports and protections because they are underprovided by private markets, and because in some instances government can do so more efficiently than private actors.
Monday, January 24, 2011
Some news on the State of the Union address:
Obama won't endorse raising retirement age or reducing Social Security benefits, by Lori Montgomery, Washington Post: President Obama has decided not to endorse his deficit commission's recommendation to raise the retirement age, and otherwise reduce Social Security benefits, in Tuesday's State of the Union address, cheering liberals and drawing a stark line between the White House and key Republicans in Congress. ...
Administration officials said Obama is unlikely to specifically endorse any of the deficit commission's recommendations in the speech, but cautioned that he is unlikely to rule them off the table, either. On Social Security, for example, he is likely to urge lawmakers to work together to make the program solvent, without going into details, according to congressional sources. ...
That Obama won't be endorsing these suggestions from the deficit commission is good news, but now the question is whether he'll steadfastly oppose these changes if they are part of the deal that arises when "lawmakers to work together to make the program solvent." The caution that nothing is off the table is not very reassuring. It sounds like he has no desire to lead the charge, but may jump aboard if he can say the other side gave him no other choice. I hope I'm wrong about that.
The Economist asks:
What's the correct way to think about the rise of the global super-rich? Is there any reason to be concerned about recent changes in the income distribution, in America, across rich countries, or globally? Is there reason to believe that inequality contributes to financial or economic instability?
- Reducing inequality can be growth-enhancing - Mark Thoma
- Focus on consumption, rather than income, disparities - Scott Sumner
- Economic power begets political power - Daron Acemoglu
- The "haves" have a strong incentive to protect their status - Konstantin Sonin
- Absent growth, inequality means falling living standards for some - Michael Heise
Here's what I said:
Why Does Inequality Matter?: Inequality has attained levels rivaling those of the Gilded Age, and if it continues to grow—and there's nothing to indicate that it won't—it could reach the point where it becomes morally intolerable. In addition, there is evidence that social ills grow as inequality widens. And high levels of inequality can also have negative effects on the economy.
We know that a society with perfect equality does not grow at the fastest possible rate. When everyone gets an equal share of income, people lose the incentive to try and get ahead of others. We also know that a society where one person has almost everything while everyone else struggles to survive—the most unequal distribution of income imaginable—will not grow at the fastest possible rate either. Thus, the growth-maximising level of inequality must lie somewhere between these two extremes (one reason for declining economic growth beyond some critical level of inequality may be due, at least in part, to the political problems and loss of opportunity that come with high levels of inequality that Daron Acemoglu discusses in his guest contribution).
We may be near or even past the level of inequality where growth begins falling. The evidence on this is highly uncertain, so it’s difficult to say. But a few more decades like the last few could make the difference, so why take a chance?
But how do we help those who are falling farther and farther behind?
As Lane Kenworthy notes, when we look at how inequality has changed in various rich nations over the last several decades, "it turns out that there is no relationship between changes in income inequality and changes in the absolute incomes of low-end households. The reason is that income growth for poor households has come almost entirely via increases in net government transfers." Thus, nations where lower income households have fared better are also the nations where income transfers have been the highest.
One hope for turning this around in the future is education, but even if we can fix the problems in our educational system—something we've devoted considerable effort to already without much to show for it—it may only slow rather than reverse the growth in inequality. Unfortunately, we won't know the answer until we actually improve education, then wait to see how our better educated young fare when they graduate, a process that will take decades. It will do little to alleviate existing levels of inequality.
For these reasons, I am increasingly of the view that redistribution of income is the only answer to our inequality problem.
But won't such policies lower economic growth? No. Given the present, elevated level of inequality, a reduction is unlikely to have much of an impact on incentives that are important for economic growth.
If we want to preserve a growing and socially healthy economy, and avoid moving to points on the inequality curve curve associated with lower growth, then we will need to do much more redistribution of income than we have done over the last several decades. That means the wealthy will no longer get it all, or at least almost all; they will be asked to share economic growth with the workers who helped to bring it about, workers who ought to be rewarded for their growing productivity.
We can expect considerable protest when the wealthy are asked to give up a portion of the growth that has been flowing exclusively to them for so long, and we’ll hear every reason you can think of and a few more as to why redistributive polices are bad for jobs and bad for America more generally. But sharing economic gains among all those who had a hand in creating them is the right thing to do. For the foreseeable future, redistributive polices appear to be the only way to ensure that workers receive their share of the growing economic pie.
What does Obama's embrace of competitiveness as a theme of the State of the Union Address signal about economic policy in the future?:
The Competition Myth, by Paul Krugman, Commentary, NY Times: Meet the new buzzword, same as the old buzzword. In advance of the State of the Union, President Obama has telegraphed his main theme: competitiveness. ...
This may be smart politics. Arguably, Mr. Obama has enlisted an old cliché on behalf of a good cause, as a way to sell a much-needed increase in public investment...
But ... talking about “competitiveness” as a goal is fundamentally misleading. At best, it’s a misdiagnosis of our problems. At worst, it could lead to policies based on the false idea that what’s good for corporations is good for America.
About that misdiagnosis: What sense does it make to view our current woes as stemming from lack of competitiveness?
It’s true that we’d have more jobs if we exported more and imported less. But ... ultimately, we’re in a mess because we had a financial crisis, not because American companies have lost their ability to compete...
But isn’t it at least somewhat useful to think of our nation as if it were America Inc., competing in the global marketplace? No.
Consider: A corporate leader who increases profits by slashing his work force is considered successful. Well, that’s more or less what has happened in America recently: employment is way down, but profits are hitting new records. Who, exactly, considers this economic success?
Still, you might say that talk of competitiveness helps Mr. Obama quiet claims that he’s anti-business. That’s fine, as long as he realizes that the interests of nominally “American” corporations and the interests of the nation, which were never the same, are now less aligned than ever before. ...
So what does the administration’s embrace of the rhetoric of competitiveness mean for economic policy?
The favorable interpretation, as I said, is that it’s just packaging for an economic strategy centered on public investment, investment that’s actually about creating jobs now while promoting longer-term growth. The unfavorable interpretation is that Mr. Obama and his advisers really believe that the economy is ailing because they’ve been too tough on business, and that what America needs now is corporate tax cuts and across-the-board deregulation.
My guess is that we’re mainly talking about packaging here. ... But even if he proposes good policies, the fact that Mr. Obama feels the need to wrap these policies in bad metaphors is a sad commentary on the state of our discourse.
The financial crisis of 2008 was a teachable moment, an object lesson in what can go wrong if you trust a market economy to regulate itself. ... For whatever reason, however, the teachable moment came and went with nothing learned.
Mr. Obama himself may do all right: his approval rating is up, the economy is showing signs of life, and his chances of re-election look pretty good. But the ideology that brought economic disaster in 2008 is back on top — and seems likely to stay there until it brings disaster again.
Tim Duy notes rising concern about inflation from hawkish central bankers in Europe and elsewhere, and the tension that is building "as emerging markets fight the Fed":
Inflation fears—fueled by spiraling food, oil and raw material prices—are mounting around the globe, prompting the head of the European Central Bank to signal that it could raise interest rates in the future even though some countries have been weakened by the Continent's debt crisis.
In an interview with The Wall Street Journal ahead of this week's annual meeting of the World Economic Forum in Davos, Switzerland, Jean-Claude Trichet warned that inflation pressures in the euro zone must be watched closely, and urged central bankers everywhere to ensure that higher energy and food prices don't gain a foothold in the global economy…
An interesting development in light of the ongoing (or is it never ending?) European Debt Crisis. Rate hikes will just be adding insult to injury for the peripheral nations already struggling with a debt-deflation spiral. The price for being part of the Euro just keeps getting higher.
Inflation fears have yet to grip the Federal Reserve, for good reason. Back to the Wall Street Journal:
While high unemployment and spare capacity are restraining underlying inflation pressures in the U.S. and elsewhere in the developed world, annual inflation in China is almost 5%—and a sizzling 9.8% economic growth rate in the fourth quarter triggered fears of more price pressures ahead. Inflation in Brazil is even higher.
The next inflation crisis is not occurring in the US, as opponents of QE2 thought likely, but in the developing markets instead. To be sure, my sympathy for developing nations wore thin long ago. They will identify the Federal Reserve as the proximate cause of their problems, whereas they have only themselves to blame. Higher inflation abroad was the only outcome if the protocols of Bretton Woods II did not submit to the onslaught of QE2. And the Federal Reserve has very good reason to keep the pedal to the medal. A review of recent inflation behavior:
If inflation abroad is a problem, it is not because the Federal Reserve has set rates too low, but because emerging markets been unwilling to allow their currencies to appreciate sufficiently against the Dollar. See, for example, recent Dollar buying on the part of Brazil. See also Paul Krugman, who illustrates the clear difference in emerging and developed nation industrial production trends. Again, if inflation abroad is a problem, it is one that emerging markets need to tackle themselves.
Expect global tensions to continue building as emerging markets fight the Fed. While the Fed may identify higher commodity prices as a potential concern, policymakers are not likely to reverse course and tighten policy unless higher commodity prices push through to core inflation. Such an outcome appears unlikely given persistently high unemployment. Consider too that the likely outcome of rising commodity prices is to slow US growth, thereby decreasing the odds of pass-through to core.
I have said this before – I do not see how this ends well. Given that the Fed is not likely to back down from this fight, emerging markets need to put the brakes on their internal inflation issues, the sooner the better. Otherwise they will be facing pain of a real inflation crisis, one that requires stepping on the brakes even harder. How this story unfolds this year will determine of the global economy can transition to a sustainable, balanced growth trajectory, or plunges into yet another of the seemingly all-too-frequent crises.
From David Warsh:
The last two volumes of Paul Samuelson’s collected papers appeared this month, edited by Janice Murray, his assistant for twenty years. As far as I can tell, the only mention of Commodities Corp. to be found anywhere in the seven volumes appears in the final one, in the last serious piece he ever wrote... Samuelson left his share of loose ends. Reflections on his role in Commodities Corp. may be among them.
It turns out that the great MIT economist was influential in the creation of one of the earliest and most influential hedge funds. Launched in 1970, Commodities Corp. blazed a trail of extremely high returns throughout the 1970s and early ’80s, before disappearing in various pieces into Bermuda mailboxes and Goldman Sachs. Many of its star traders – Bruce Kovner of Caxton and Paul Tudor Jones, chief among them—formed successful hedge funds of their own. Samuelson thus had a ringside seat at the birth of an influential industry that is still only poorly understood.
About the same time, he invested a substantial amount in shares of Warren Buffet’s Berkshire Hathaway Inc. It was in 1970, too, that he won the Nobel prize in economics, the second to be awarded. Long famous for the fortune that his pioneering textbook earned him after 1948, it turns out that Samuelson may have made more money as an investor than as an author. He was both smarter and richer than is generally understood: as an investor, a bigger winner, perhaps, than the more volatile John Maynard Keynes. ...[read more]...
Sunday, January 23, 2011
This is a year too late, more than that actually, but President Obama's intent to focus on jobs in the State of the Union address is welcome. The abandonment of the recommendations of the bipartisan majority on the debt-reduction commission -- for now anyway -- is also good news. This committee appeared to have Social Security in its sights mostly for ideological reasons rather than as something that would make a meaningful dent in the budget problem. However, some of the things emphasized in the speech do bring some concerns. In particular, Obama's new found friendliness toward business and the seeming embrace of a principle of what's good for business is good for America could lead him astray:
Obama to Press Centrist Agenda in His Address, NY Times: President Obama will outline an agenda for “winning the future” in his State of the Union address on Tuesday night, striking a theme of national unity and renewal as he stresses the need for government spending in key areas and an attack on the budget deficit.
Mr. Obama previewed ... that his speech would be geared more broadly toward the political center, to independent voters and business owners and executives alienated by the expansion of government and the partisan legislative fights of the past two years. ...
Mr. Obama has signaled that after two years in which his response to the economic crisis and his push for passage of the health care bill defined him to many voters as a big-government liberal, he is seeking to recast himself as a more business-friendly, pragmatic progressive.
That means emphasizing job creation, deficit reduction and a willingness to compromise in a new period of divided government. But it also means a willingness to make the case for spending — or investment, as many in his party would prefer to call it — in areas like education, transportation and technological innovation ... essential to the nation’s long-term prosperity. ...
Without going into detail, he will touch on issues like overhauling the corporate tax code and encouraging exports, and he will defend his health care law. ...
Mr. Obama is unlikely, they said, to embrace the recommendations of a bipartisan majority on the debt-reduction commission he created, which proposed slashing projected annual deficits through 2020 with deep cuts in domestic and military spending, changes to Social Security and Medicare, and an overhaul of the individual and corporate tax codes...
In general, the theme of deficit reduction will be less prominent in the speech as Mr. Obama emphasizes spending “investments” and “responsible” budget cutting...
Advisers said the president would describe five “pillars” for ensuring America’s competitiveness and economic growth: innovation, education, infrastructure, deficit reduction and reforming government. ...
“He’s making the transition from an economic security president to an economic growth president,” said Jim Kessler, co-founder of the centrist organization Third Way, “and he’s moving from the left to the center.” ...
While I'm happy about the focus on jobs, we shouldn't get our hopes up too much. There are job programs that are intended to carry people through the down side of a business cycle -- short run initiatives to put people to work that have been largely missing in the response to the crisis -- and there are initiatives that are designed to increase economic growth and create jobs over the longer run. I expect the focus will be much more on creating jobs through long-run growth than on the more immediate unemployment problem (which means a likely embrace of the GOP's claim that tax cuts lead to jobs -- though see here for a rebuttal to the claim that tax cuts spur economic growth). And to the extent that the president does focus on more immediate needs, it's unlikely to find support in Congress even with a strong move to (and even past) the center. These initiatives will be about long-run growth and a more hopeful future (and mostly confined to tax cuts, or to use the terms above "tax overhaul," if the GOP gets its way). That is surely needed, hope for the future has eroded substantially with the crisis, but we also have millions of people out of work right now and they need attention too.
Uwe E. Reinhardt:
Provide Cash, or Benefits in Kind?, by Uwe E. Reinhardt, Economix: ...Is it better to give people for whom one has compassion goods or services they ought to have (what we call benefits in kind), or is it better simply to give them the equivalent in cash...? Economists believe ... cash is superior. ...
The economists’ reasoning is simple. Suppose one were prepared to purchase $10,000 worth of in-kind benefits for a poor family... Now if one gave the family $10,000 cash instead, it could ... procure for itself the bundle of services the donor originally had in mind... On the other hand, the head of that family might buy ... a quite different bundle of services that he or she or the family would like even better...
Ergo, conclude economists,... one should give the recipient cash rather than benefits in kind. ... How can anyone argue with that? ... Whether in democracies or other systems of government, politicians the world over have through the ages preferred to redistribute economic privilege mainly through benefits in kind, rather than through cash. What must they be thinking? ...
Could it be that politicians have a much better understanding of the typical taxpayer’s preferences on the use of their tax dollars than economists have dreamed of? ...
A plausible ... hypothesis might be that taxpayers merely wish to see the poor have access to certain kinds of goods and services that taxpayers deem essential and meritorious, but do not trust the poor to purchase those goods and services were they to be given just cash. It is a paternal posture, to be sure, but what if it actually describes the median voter?
Can we even imagine, for example, Congress dumping $400 billion a year in cash into the pockets of Medicaid beneficiaries and a similar amount into the pockets of Medicare beneficiaries, without opprobrium from American voters?
A compromise position between pure cash and pure benefits in kind is to give the poor cash-like vouchers – such as food stamps — that can be spent only on a limited range of specified goods and services. It allows the recipients some more sovereignty than would pure benefits in kind, but not total sovereignty. ...
Roman Frydman emails that he'd like a chance to respond to Chris Sims' defense of DSGE models. This is from the session "Life After Rational Expectations":
Update: More from Roman Frydman on this topic:
“The Imperfect Knowledge Imperative in Modern Macroeconomics and Finance Theory,” prepared for the conference on Microfoundations for Modern Macroeconomics, co-authored with Michael D. Goldberg, Center on Capitalism and Society, Columbia University, New York, November 2010, revised version forthcoming in Roman Frydman and Edmund S. Phelps (eds.), Micro-Macro: Back to the Foundations, Princeton University Press.
“Opening Models of Asset Prices and Risk to Non-Routine Change,” prepared for the conference on Microfoundations for Modern Macroeconomics, Center on Capitalism and Society, Columbia University, New York, November 2010, revised version forthcoming in Roman Frydman and Edmund S. Phelps (eds.), Foundations for a Micro-Macro: Back to the Foundations, Princeton University Press.
And while I'm here again, turning in another direction, here's George Akerlof on whether the efficient markets hypothesis caused the crisis:
Saturday, January 22, 2011
A recent column of mine:
It covers familiar territory for many of you, but as budget discussions begin to get more serious, it doesn't hurt to remind people of the important role that social insurance plays.
Richard Thaler on the health insurance mandate:
Adding Clarity to Health Care Reform, by Richard Thaler, Commentary, NY Times: ...Perhaps the most unpopular feature of the health care legislation now in place is a provision that requires nearly everyone to buy insurance. It is known as the mandate, and it is the aspect of the bill that could end up before the Supreme Court. In contrast, nearly everyone seems to approve of the provision ensuring that pre-existing medical conditions won’t prevent you from finding affordable insurance, as well as the rule that prevents insurers from dropping you if you get sick.
Unfortunately, it is hard to have the popular features without some version of the mandate. A health insurance system cannot work unless most healthy people participate. ...
The Supreme Court may make the ultimate decision in the next year or two. If it rules the mandate unconstitutional, the viability of the rest of the plan is not clear. Until the legal issues are settled, the status of health care reform will be uncertain.
In this light, here are three thoughts about constructive steps we might take now:
... My "Reagan plan." ... In 1984, President Ronald Reagan signed a bill encouraging all states to adopt a minimum drinking age of 21. To nudge states into going along, the plan said that any state that didn’t join would have its highway funds cut by a certain percentage. Although Mr. Reagan initially had misgivings about the plan, he would later come to embrace it, saying that the harm caused by teenage drunken drivers was “bigger than the individual states.”
All of the states ended up complying, although some were reluctant — and South Dakota, in fact, sued. But ... the Supreme Court ruled 7 to 2 that the law was constitutional.
Here is how the Reagan plan could apply to health care: Adopt a new bill that says that if a state doesn’t want to accept a mandate ... it may opt out of health care reform. But a state that chooses this course would lose ... federal funds...
I've discussed the mandate in the past. Why We Need an Individual Mandate for Health Insurance uses a standard market failure (adverse selection) argument to explain why we need broad based coverage. But I should have emphasized the need to provide households with help in purchasing the insurance. The current health care legislation does not do enough to help people with the additional, mandated expense for health insurance, an expense that comes at a time when wages and income are stagnating for the majority of people and jobs are hard to come by. In this regard, a system where the government provides health care for everyone and pays for it out of taxes is preferred.
this is hackneyed stuff, and involves a fundamental misconception about the nature of our economic problems.
It’s OK to talk about competitiveness when you’re specifically asking whether a country’s exports and import-competing industries have low enough costs to sell stuff in competition with rivals in other countries; measures of relative costs and prices are, in fact, commonly — and unobjectionably — referred to as competitiveness indicators.
But the idea that broader economic performance is about being better than other countries at something or other — that a
country is like a corporation –is just wrong. I wrote about this at length a long time ago, and everything I said then still holds true. ...
Robert Reich notes several different definitions of competitiveness:
But what’s American “competitiveness” and how do you measure it? Here are some different definitions:
— It’s American exports. Okay, but the easiest way for American companies to increase their exports from the US is for their American-made products to become cheaper internationally. ... Their biggest cost is their payrolls. So it follows that the simplest way for them to become more “competitive” is to cut their payrolls...
— It’s net exports. Another way to think about American “competitiveness” is the balance of trade — how much we import from abroad versus how much they import from us. The easiest and most direct way to improve the trade balance is to coax the value of the dollar down relative to foreign currencies (the Fed’s current strategy for flooding the economy with money could have this effect). ...
— It’s the profits of American-based companies. In case you haven’t noticed, the profits of American corporations are soaring. That’s largely because sales from their foreign-based operations are booming... — so their profitability has little or nothing to do with the number and quality of jobs here in the US. In fact, it may be inversely related.
— It’s the number and quality of American jobs. This is my preferred definition, but on this measure we’re doing terribly badly. Most Americans are imprisoned in a terrible tradeoff — they can get a job, but only one that pays considerably less than the one they used to have, or they can face unemployment or insecure contract work. The only sure way to improve the quality of jobs over the long term is to build the productivity of American workers and the US overall, which means major investments in education, infrastructure, and basic R&D. But it’s far from clear American corporations and their executives will pay the taxes needed to make these investments. ...
It’s politically important for President Obama, as for any president, to be available to American business, and to avoid the moniker of being “anti-business.” But the President must not be seduced into believing — and must not allow the public to be similarly seduced into thinking — that the well-being of American business is synonymous with the well-being of Americans.
The last point, that "the President must not be seduced into believing — and must not allow the public to be similarly seduced into thinking — that the well-being of American business is synonymous with the well-being of Americans." is important, and one Krugman notes as well.
Krugman and Reich have covered most of the ground, but let me add one more note. The notion of competitiveness -- and the idea that since businesses create jobs, anything good for business is good for workers (see Reich's first point above) -- will undoubtedly turn into a call to cut business taxes to enhance competitiveness and spur economic growth. Jobs will be featured in that argument, as they always are. But as I've noted before, there's little evidence that this will be successful:
"...One of the most frequent arguments for extending the tax cuts and for making them permanent is that failing to do so would hurt economic growth. Is this true? One way to answer the question is to ask whether the Bush tax cuts had a large impact on growth after they were enacted.
The evidence is not favorable. For example, according to this Census report (see table A1), median household income in 2007, adjusted for inflation, was lower than it was in 2000. And as the non-partisan Center on Budget and Policy Priorities reports, based upon data from the Bureau of Labor Statistics, employment growth was particularly weak, 'with employment and wage and salary growth ... lower than in any previous post-World War II expansion. Employment grew at an average annual rate of only 0.9 percent from November 2001 to September 2007, as compared with an average of 2.5 percent for the comparable periods of other post-World War II expansions. In addition, real wages and salaries grew at a 1.8 percent average annual rate in the 2001-2007 expansion, as compared with a 3.8 percent average annual rate for the comparable periods of other post-World War II expansions.'
Thus, there is little evidence to support that the Bush tax cuts had a significant effect on growth. In addition, contrary to the argument that the tax cuts would pay for themselves being made at the time the tax cuts were enacted, the deficit ballooned as a result of the tax cuts. ..."
What will we need is "major investments in education, infrastructure, and basic R&D." That means that if we want productivity to grow, and to provide decent jobs for our citizens, it is vital that we make the necessary investments in our future that will allow that to happen (and that includes investments in economic security for workers and their families). We'll hear again and again how tax and spending cuts to reduce the size of the public sector are needed to restore competitiveness (after all, a small, hands off government is the key to success in China and in the European countries that we are worried will outcompete us). But the relatively mindless tax and spending cuts the GOP is pushing won't restore competitveness as properly defined, they'll undermine the foundation we need to build upon to provide decent opportunities for our citizens.
Friday, January 21, 2011
I haven't posted enough of the videos from the inaugural INET conference at King's College, especially some of the slightly more technical presentations. As a start to rectifying this, here's Chris Sims defending the use of DSGE models in the session "How Empirical Evidence Does or Does Not Influence Economic Thinking and Theory: Calibration, Statistical Inference, and Structural Change":
Here are two more I've posted before, one from Richard Koo on balance sheet recessions, and another from Joseph Stiglitz on what's wrong with macroeconomics (from a session I moderated -- though I won't be posting the video of my nervous introduction):
The topic of balance sheet recessions and what to do about them has been discussed quite a bit recently. This is something I wrote on this topic about a month ago:
Balance Sheet Recessions, by Mark Thoma: As this year comes to a close, and as we finally begin the recovery stage of the recession, it’s a good time to look back and ask how policymakers could have improved their response to the downturn. What can we learn from this recession? How can we do better the next time a large financial shock hits the economy?
There are many ways policy could have been improved; providing more help for state and local governments is high on the list, but I’ll focus on another way: using fiscal policy to help households make up for losses from the recession. This is an important, but too often ignored aspect of recovering from what are known as “balance sheet recessions.”
Recessions can occur for a variety of reasons. For example, oil price shocks, stock market crashes, housing bubbles, monetary shocks, and productivity shocks can all lead to economic downturns. However, curiously, while the effects of a recession differ depending upon the cause, the response of policy – fiscal policy in particular – tends to be the same. This is undesirable, since a policy tailored to the specific type of recession would result in a speedier recovery. Monetary policy is better on this score, particularly nontraditional policy, but even this could be improved along these lines.
One way to distinguish recessions is through differences in their effects on balance sheets, in particular those of households and banks. For households, the collapse of a housing bubble, which also tends to cause a stock market crash, results in a decline in home equity as well as the loss of retirement and education savings. When combined with the loss of jobs due to the recession, and the fact the debts do not decline with the fall in asset values, the effect on balance sheets can be devastating – much larger than, say, the balance sheet impact of an oil price shock. Households have no choice but to set aside part of their income to both rebuild the asset side of the balance sheet and to pay down their debts.
This is one of the main reasons why recovery from these “balance sheet recessions” is notoriously slow. As households rebuild their balance sheets, resources are directed away from consumption, and the reduction in aggregate demand is a drag on the economy. It takes a long time for households to recover what is lost, and the recovery will be slow so long as this rebuilding process continues. Fiscal policy attempts to restore the lost aggregate demand, and that is important, but it does very little to directly address the household balance sheet issue.
The same cannot be said about bank balance sheets. The effect on bank balance sheets also varies with the type of recession, and a financial collapse brought about by bad loans is particularly severe. The present recession is an example of this, and policy has done a good job of preventing even worse problems from developing by rebuilding financial sector balance sheets through the bank bailout and other means.
But household balance sheets have not received as much attention. We could have helped households rebuild their balance sheets, and this would have helped banks by lowering the default rate on loans. Instead, we left households to mostly solve their problems on their own, and then helped banks when households could not repay what they owed.
When a balance sheet recession hits, one of the keys to a quick recovery is to use the federal government’s balance sheet as a means of offsetting the deterioration in the private sector’s financial position. But we shouldn’t just focus on banks. Household balance sheet problems are every bit as severe, and in total every bit as systemically important as the balance sheet problems of banks. We’ll recover faster from balance sheet recessions if we pay attention to all private sector balance sheets instead of focusing mainly on the problems of banks.
The perception that the government bailed out undeserving wealthy bankers while leaving households to fend for themselves is a big part of the backlash against the policies put into place to help with the recession. That perception is correct, for the most part, and it will stand in the way of repeating this policy the next time there is a financial collapse. When the next balance sheet recession hits, and another one will hit no matter how hard we try to avoid it, we need to do a better job of helping households. Not only is this good economics – we will recover faster with this policy – the politics of helping households are far superior to those associated with bailing out banks.
Balance sheet recessions take a large toll on the finances of banks, households, and state and local governments, and policymakers – fiscal policymakers in particular – must do a better job of taking such factors into account as they respond to downturns in the economy.