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Thursday, October 20, 2011

links for 2011-10-20

    Posted by on Thursday, October 20, 2011 at 12:06 AM in Economics, Links | Permalink  Comments (40)


    Wednesday, October 19, 2011

    What's Needed to Successfully Target the Level of Nominal GDP?

    Brad DeLong:

    What Needs to Happen for the Fed to Successfully Target the Level of Nominal GDP?, by Brad DeLong: Paul Krugman writes:

    Getting Nominal: “Market monetarists” like Scott Sumner and David Beckworth are crowing about the new respectability of nominal GDP targeting. And they have a right to be happy. My beef with market monetarism early on was that its proponents seemed to be saying that the Fed could always hit whatever nominal GDP level it wanted; this seemed to me to vastly underrate the problems caused by a liquidity trap. My view was always that the only way the Fed could be assured of getting traction was via expectations, especially expectations of higher inflation –a view that went all the way back to my early stuff on Japan. And I didn’t think the climate was ripe for that kind of inflation-creating exercise.

    At this point, however, we seem to have a broad convergence. As I read them, the market monetarists have largely moved to an expectations view. And now that we’re almost four years into the Lesser Depression, I’m willing, out of a combination of a sense that support is building for a Fed regime shift and sheer desperation, to support the use of expectations-based monetary policy as our best hope.

    And one thing the market monetarists may have been right about is the usefulness of focusing on nominal GDP. As far as I can see,the underlying economics is about expected inflation; but stating the goal in terms of nominal GDP may nonetheless be a good idea, largely as a selling point, since it (a) is easier to make the case that we’ve fallen far below where we should be and (b) doesn’t sound so scary and anti-social.

    I still believe that the chances of success will be a lot larger if we have expansionary fiscal policy too; but by all means let’s try whatever we can…

    Let's try to answer this question by using… the IS-LM model!

    If you are--as we are right now--in a liquidity trap, with extremely interest-elastic money demand, then expansionary monetary policy that involved the Federal Reserve buying financial assets for cash:

    1. will have next to no effect on the short-term safe nominal interest rate--it's already zero.
    2. will decrease the long-term safe nominal interest rate to the extent that your open-market operations today change people's expectations of what your target for the short-term safe nominal interest rate in the future.
    3. will decrease the long-term safe real interest rate to the extent that it decreases the short-term nominal interest rate and changes expectations today of what inflation will be in the future.
    4. will decrease the long-term risky real interest rate to the extent that it decreases the long-term safe real interest rate and to the extent that the assets purchased for cash by the Federal Reserve free up the risk-bearing capacity of private investors and lead to a reduction in risk spreads.
    5. will increase spending to the extent that it decreases the long-term risky real interest rate and to the extent that private spending responds positively to decreases in the long-term risky real interest rate.

    Lots of steps here, some of which may well be weak.

    By contrast, the alternative expansionary policy is for the government to print money and spend it buying useful things. Then:

    1. The buying of useful things raises spending.
    2. Financing it by printing money rather than issuing bonds means no increase in interest rates to crowd out private spending.
    3. Financing it by printing money rather than promising to levy future taxes means no increase in the present value of future tax liability to crowd out private spending.
    4. Financing it by printing money means no worries about any increase in fears of some future government default.

    By contrast, if we tried to target nominal GDP through fiscal policy alone--through borrowing and spending buying useful things:

    1. The buying of useful things raises spending.
    2. Financing it by issuing bonds might mean an increase in interest rates that would crowd out private spending.
    3. Financing it by promising to levy future taxes means an increase in the present value of future tax liability that might crowd out private spending.
    4. Financing it by issuing bonds means a possible increase in fears of some future government default.

    To try to target nominal GDP using either only monetary policy or only fiscal policy seems hazardous. To coordinate--monetary and fiscal expansion, money printing-financed purchase of useful things--seems to be the winner.

    Yep, as I've been arguing since this started, we need attack the unemployment problem aggressively with both barrels of the policy gun.

      Posted by on Wednesday, October 19, 2011 at 02:07 PM in Economics, Fiscal Policy, Monetary Policy | Permalink  Comments (13)


      A Convenient Excuse

      If you don't have a job, many in the GOP think it's your own fault. Never mind that there are fewer jobs than people looking by a wide margin, somehow if the unemployed would try harder, the jobs will magically appear:

      GOP debate crowd cheers idea that jobless are to blame for their plight, by Greg Sargent: ...This moment from last night’s debate, in which the audience cheered the idea that the unemployed are solely to blame for not having a job, strikes me as one of the most iconic moments we’ve seen at the debates yet...
      Anderson Cooper says: “Herman Cain, I’ve got to ask you — two weeks ago, you said, `Don’t blame Wall Street, don’t blame the big banks. If you don’t have a job, and you’re not rich, blame yourself.’ That was two weeks ago. Do you still say that?” At this point applause starts, and after Cain stands by the claim, the applause crescendos and hoots of approval can be heard.
      Lovely,... the crowd is applauding the idea that the unemployed are solely to blame for their plight. The basic suggestion here is that ... it’s morally correct to place all the blame for unemployment on the jobless themselves. ...

      Convenient, isn't it? It gives people who don't think they have any obligation to contribute to social insurance a reason to turn their backs on the unemployed.

        Posted by on Wednesday, October 19, 2011 at 11:07 AM in Economics, Unemployment | Permalink  Comments (83)


        The "Embarrassment of Riches"

        Jared Bernstein:

        9-9-9: The Most Massively Regressive Redistribution of Taxes Ever Seriously Considered, by Jared Bernstein: The Tax Policy Center’s analysis of candidate Herman Cain’s 9-9-9 plan is out and man, it provides us with an embarrassment of riches in terms of which data to feature.

        So let’s stick with the “embarrassment of riches” theme and look at dollars of federal tax change by income class.

        The first figure shows that average tax payments go up, on average, for the bottom 80% of households, including the bottom fifth (average income, $10,100) by about $1,700, and for the middle fifth (avg inc: about $50,700) by about $3,200.  The average tax payment for the top fifth (avg inc: $273,000) falls by about $23,500.


        Source: TPC, see link above.

        But aggregating things up that way obscures just how extremely regressive 9-9-9 really is.  If you break out the top 1% (avg inc: $1.8 million) and the tippy-top 0.1% (avg inc: $7.9 million), that’s where you really see the plan go to work.  It reduces the tax burden of the top 1% by $300,000 and that of the top 0.1% by…get ready for it…$1.7 freakin’ million.


        Souce: TPC, see link above.

        Conclusions:

        –to implement the 9-9-9 plan would truly be the most dramatic and regressive shifting of the tax burden in the history of our nation...

          Posted by on Wednesday, October 19, 2011 at 12:42 AM in Economics, Income Distribution, Taxes | Permalink  Comments (88)


          "A Call for Economic Justice"

          The local scene:

          Editorial: A call for economic justice, Register Guard, Eugene, Oegon: Nearly 2,000 people made a statement in Eugene on Saturday — a statement of economic and political discontent that made up in intensity for what it lacked in specificity.
          It was fascinating — and revealing — to see the wide range of people who participated in the march. They were young, old and all ages in between. They were employed, unemployed, underemployed and still in school. They were frustrated voters on the political left, center and yes, some on the right. ...
          What they shared in common was a profound dissatisfaction and anger with an economic inequality that has become the grinding norm... What they shared was a desire, a demand for an “economic justice” that meant different things to those who marched but that bound them together in a common cause. ...
          Protesters marched in Eugene — and across the nation — to voice their frustration not only with Wall Street but also with federal lawmakers, both Republicans and Democrats, who for decades have laid the legal groundwork for a tectonic shift of wealth and opportunity from the middle class to the wealthiest Americans.
          There was an impressive sense of order and cooperation among not only the protesters, but also the police who accompanied the protesters as they marched from the Wayne Morse Free Speech Plaza across the Ferry Street Bridge to Alton Baker Park and back. The event’s organizers wisely chose to work closely with city officials and police to avoid conflicts and misunderstandings, but it also was clear that the police officers were sympathetic to marchers’ call for economic justice and governmental accountability. ...

            Posted by on Wednesday, October 19, 2011 at 12:24 AM in Economics, Income Distribution, Oregon, Politics | Permalink  Comments (5)


            links for 2011-10-19

              Posted by on Wednesday, October 19, 2011 at 12:06 AM in Economics, Links | Permalink  Comments (17)


              Tuesday, October 18, 2011

              The GOP's (Lack of a) Jobs Plan

              The GOP wants to take us backwards:

              GOP: ‘Deregulate Wall Street!’, by Ezra Klein: In recent days, more than 900 cities have hosted protests under the Occupy Wall Street banner. But the enthusiasm ... hasn’t trickled up to the GOP presidential campaign. There, the candidates want to leave Wall Street alone. ... They want to deregulate -- actively and aggressively.

              “I introduced the bill to repeal Dodd-Frank,” bragged Rep. Rep. Michele Bachmann... But Herman Cain was not to be outdone. “Repeal Dodd-Frank, and get rid of the capital gains tax,” he countered. Repealing the capital gains tax would make it vastly more profitable to earn a living through investment income rather than wage income. A hedge-fund manager, for instance, might escape income taxation entirely. It would give smart, young college students even more reason than they have now to go into the hedge fund game than, say, medicine.
              “Dodd-Frank obviously is a disaster,” agreed Rep. Ron Paul. “But Sarbanes-Oxley costs a trillion dollars, too. Let’s repeal that, too!” Sarbanes-Oxley ... is the law passed in the wake on the Enron scandals. It sought to make balance sheets more transparent and financial statements more trustworthy. It is not well liked by the financial sector.
              Mitt Romney, while not quite as carefree in his denunciations of the financial-regulation reforms, largely agrees with his co-candidates. His jobs plan promises that a Romney presidency would “seek to repeal Dodd-Frank and replace it with a streamlined regulatory framework,” though it doesn’t give much detail on what that streamlined framework would be. He also says that “the Sarbanes-Oxley law passed in the wake of the accounting scandals of the early 2000s should also be modified as part of any financial reform.”
              So three years after the worst financial crisis since the Great Depression, the consensus in the Republican Primary is that we should deregulate Wall Street not just to where it was before the bubble burst, but to somewhere nearer to where it was before Enron crashed. ...

              Romney's jobs plan is to repeal Dodd-Frank? Speaking of jobs, how about the GOP jobs plan?:

              Republicans Getting a Pass on Their Jobs Plans, by Kevin Drum: Greg Sargent wants to know why the media is giving Republicans a huge pass on their various "jobs plans":

              Obama and the Senate GOP have both introduced jobs plans. In reporting on the Senate plan, many news organizations described it as a “GOP jobs plan.” And that’s fine — Rand Paul said it would create five million of them. But few if any of the same news orgs that amplified the GOP offering of a jobs plan are making any serious effort to determine whether independent experts think there’s anything to it. And independent experts don’t think there’s anything to it — they think the GOP jobs plan would not create any jobs in the near term, and could even hurt the economy. By contrast, they do think the Obama plan would create jobs and lead to growth.
              Why aren’t these facts in every single news story about the ongoing jobs debate? Why aren’t they being broadcast far and wide? ...

              I ... suspect that reporters are simply so used to Republicans embracing nonsense that they evaluate it on a whole different plane than they do "serious" proposals. GOP campaign plans are treated more as optics than as actual policy, as ways to signal a candidate's conservative bona fides more than as blueprints for actual legislation.

              But Greg is right: this should stop. There's no reason to give these guys a pass on their laughable jobs plans that virtually no one thinks will create any actual jobs. ...

              Perry's jobs program -- have people drill holes in the ground and then, for the most part, fill them up again -- sounds quite Keynesian. But it's mostly a way to argue for deregulation of his bread and butter, the energy industry, rather than a serious job creation proposal (the claim that it is a favor to the energy industry rather than a serious jobs proposal is bolstered by the other leg of his jobs plan, to dismantle the Environmental Protection Agency). This is characteristic of all the GOP jobs proposals -- pick something that you don't like, the EPA, Dodd-Frank, health care legislation, Sarbanes-Oxley, etc. -- and then argue that eliminating it will create jobs. Then wait for the press to report it as a serious job creation proposal (or at least fail to point out that the claims can't withstand scrutiny).

                Posted by on Tuesday, October 18, 2011 at 10:35 AM in Economics, Financial System, Regulation, Unemployment | Permalink  Comments (24)


                "The Seven Biggest Economic Lies"

                Robert Reich:

                The Seven Biggest Economic Lies, by Robert Reich: ...Here’s a short ... effort to rebut the seven biggest whoppers now being told by those who want to take America backwards...:
                1. Tax cuts for the rich trickle down to everyone else. Baloney. Ronald Reagan and George W. Bush both sliced taxes on the rich and what happened? Most Americans’ wages (measured by the real median wage) began flattening under Reagan and have dropped since George W. Bush. Trickle-down economics is a cruel joke.
                2. Higher taxes on the rich would hurt the economy and slow job growth. False. From the end of World War II until 1981,... the top taxes on the very rich were far higher than they’ve been since. Yet the economy grew faster during those years than it has since. ...
                3. Shrinking government generates more jobs. Wrong again. It means fewer government workers – everyone from teachers, fire fighters, police officers, and social workers at the state and local levels to safety inspectors and military personnel at the federal. ...
                4. Cutting the budget deficit now is more important than boosting the economy. Untrue. With so many Americans out of work, budget cuts now will shrink the economy. They’ll increase unemployment and reduce tax revenues. That will worsen the ratio of the debt to the total economy. The first priority must be getting jobs and growth back by boosting the economy. Only then, when jobs and growth are returning vigorously, should we turn to cutting the deficit.
                5. Medicare and Medicaid are the major drivers of budget deficits. Wrong. Medicare and Medicaid spending is rising quickly, to be sure. But that’s because the nation’s health-care costs are rising so fast. ...
                6. Social Security is a Ponzi scheme. Don’t believe it. Social Security is solvent for the next 26 years. It could be solvent for the next century if we raised the ceiling on income subject to the Social Security payroll tax. That ceiling is now $106,800.
                7. It’s unfair that lower-income Americans don’t pay income tax. Wrong. There’s nothing unfair about it. Lower-income Americans pay out a larger share of their paychecks in payroll taxes, sales taxes, user fees, and tolls than everyone else. ...

                Seven more: tax cuts pay for themselves, regulation and uncertainty are holding back the economy, there are plenty of jobs but people don't want to work, Fannie, Freddie, and the CRA caused the crisis, CEOs deserve their high incomes, most unemployment is structural, and regulating the financial sector will harm economic growth. (And, for good measure, global warming doesn't exist and if does exits it wasn't caused by people. Even if it was caused by people, carbon taxes are still bad.)

                  Posted by on Tuesday, October 18, 2011 at 12:24 AM in Economics, Politics | Permalink  Comments (109)


                  links for 2011-10-18

                    Posted by on Tuesday, October 18, 2011 at 12:06 AM in Economics, Links | Permalink  Comments (16)


                    Monday, October 17, 2011

                    Yglesias: Glass-Steagall Is Mostly A Red Herring

                    Mathew Yglesias argues that "Glass-Steagall is mostly a red herring":

                    Glass-Steagall Is Mostly A Red Herring, by Mathew Yglesias: Something I’ve heard from participants in the 99 Percent Movement is a revival of interest in rescinding the repeal of the 1932 Glass-Steagall Act. I think this is largely a misunderstanding...
                    First off, what did Glass-Steagall do? Well it did a number of things (like establish the FDIC) that were never repealed. But the rule that was repealed in the 1999 Gramm–Leach–Bliley Act were restrictions on the same holding company owning a bank and owning other kinds of financial companies. The thing about this is just that there’s really nothing in particular about co-ownership that you can point to as having been a problem in the financial crisis. And if anything that fact seems to indicate that the repealers were right to think there’s no special problem here — even in a huge financial crisis combined financial firms worked no worse than other kinds. ...

                    I am sympathetic to this point of view, i.e. that the elimination of Glass-Steagall wasn't an important causative factor in the crash. However, as I said a few days ago:

                    There is a debate over the extent to which removing Glass-Steagall -- the old version of the Volcker rule -- contributed to the crisis. However, whether the elimination of the Glass-Steagall act caused the present crisis is the wrong question to ask. To determine the value of reinstating a similar rule, the question is whether the elimination of the Glass-Steagall act made the system more vulnerable to crashes. When the question is phrased in this way, it's clear that it has for the reasons outlined above.

                    So there's still a reason to reinstate some version of the rule even if it wasn't the main problem in the banking sector this time around. 

                      Posted by on Monday, October 17, 2011 at 05:04 PM in Economics, Financial System, Regulation | Permalink  Comments (45)


                      Spence: The Global Jobs Challenge

                      Michael Spence:

                      The Global Jobs Challenge, by Michael Spence, Commentary, Project Syndicate: ...The third challenge is distributional. As the tradable part of the global economy (goods and services that can be produced in one country and consumed in another) expands, competition for economic activity and jobs broadens. That affects the price of labor and the range of employment opportunities within all globally integrated economies. Subsets of the population gain, and others lose, certainly relative to expectations – and often absolutely.
                      Many advanced countries – in fact, most of them – have experienced limited middle-income growth. ... In the United States, income inequality has risen as the upper end of the income and education spectrum benefits from globalization, while the rest experience declining employment opportunities in the tradable sector. ...
                      What does it mean – for individuals, businesses, and governments – that structural adjustment is falling further and further behind the global forces that are causing pressure for structural change?
                      Above all, it means that expectations are broadly inconsistent with reality, and need to adjust, in some cases downward. But distributional effects need to be taken seriously and addressed. The burden of weak or non-existent recoveries should not be borne by the unemployed, including the young. In the interest of social cohesion, market outcomes need to be modified to create a more even distribution of incomes and benefits, both now and in inter-temporal terms. ...
                      None of this will be easy. ... Nevertheless, the unemployed and underemployed, especially younger people, expect their leaders and institutions to try.

                      I don't like the call to accept that things will be worse in the future, and to get used to it. It is generally based upon the idea that much of our growth was due to the bubble - it was false growth -- and hence led to the perception that we can grow faster than is actually possible.

                      But if the resources hadn't have been invested in the financial industry, they wouldn't have been wasted, they would have gone elsewhere. If we had taken all the resources (and talent) that went into the financial sector and directed it elsewhere, it would have promoted growth and employment -- and likely of a far more stable and broad-based variety. In my view the challenge is to redirect these resources into productive uses, and to fix the mal-distribution of income gains. But simply accepting that expectations need to adjust downward -- that the fate of the middle and lower classes is a diminished future -- is not acceptable. We can do better than that.

                        Posted by on Monday, October 17, 2011 at 10:35 AM in Economics, Unemployment | Permalink  Comments (19)


                        Chow: Usefulness of Adaptive and Rational Expectations in Economics

                        Gregory Chow of Princeton on rational versus adaptive expectations:

                        Usefulness of Adaptive and Rational Expectations in Economics, by Gregory C. Chow: ...1. Evidence and statistical reason for supporting the adaptive expectations hypothesis ... Adaptive expectations and rational expectations are hypotheses concerning the formation of expectations which economists can adopt in the study of economic behavior. Since a substantial portion of the economic profession seems to have rejected the adaptive expectations hypothesis without sufficient reason I will provide strong econometric evidence and a statistical reason for its usefulness...
                        2. Insufficient evidence supporting the rational expectations hypothesis when it prevailed The popularity of the rational expectations hypothesis began with the critique of Lucas (1976) which claimed that existing macro econometric models of the time could not be used to evaluate effects of economic policy because the parameters of these econometric models would change when the government decision rule changed. A government decision rule is a part of the environment facing economic agents. When the rule changes, the environment changes and the behavior of economic agents who respond to the environment changes. Economists may disagree on the empirical relevance of this claim, e.g., by how much the parameters will change and to what extent government policies can be assumed to be decision rules rather than exogenous changes of a policy variable. The latter is illustrated by studies of the effects of monetary shocks on aggregate output and the price level using a VAR. Such qualifications aside, I accept the Lucas proposition for the purpose of the present discussion.
                        Then came the resolution of the Lucas critique. Assuming the Lucas critique to be valid, economists can build structural econometric models with structural parameters unchanged when a policy rule changes. Such a solution can be achieved by assuming rational expectations, together with some other modeling assumptions. I also accept this solution of the Lucas critique.
                        In the history of economic thought during the late 1970s, the economics profession (1) accepted the Lucas critique, (2) accepted the solution to the Lucas critique in which rational expectations is used and (3) rejected the adaptive expectations hypothesis possibly because the solution in (2) required the acceptance of the rational expectations hypothesis. Accepting (1) the Lucas critique and (2) a possible response to the Lucas critique by using rational expectations does not imply (3) that rational expectations is a good empirical economic hypothesis. There was insufficient evidence supporting the hypothesis of rational expectations when it was embraced by the economic profession in the late 1970s. This is not to say that the rational expectations hypothesis is empirically incorrect, as it has been shown to be a good hypothesis in many applications. The point is that the economic profession accepted this hypothesis for general application in the late 1970s without sufficient evidence.
                        3. Conclusions This paper has presented a statistical reason for the economic behavior as stated in the adaptive expectations hypothesis and strong econometric evidence supporting the adaptive expectations hypothesis. ... Secondly, this paper has pointed out that there was insufficient empirical evidence supporting the rational expectations hypothesis when the economics profession embraced it in the late 1970s. The profession accepted the Lucas (1976) critique and its possible resolution by estimating structural models under the assumption of rational expectations. But this does not justify the acceptance of rational expectations in place of adaptive expectations as better proxies for the psychological expectations that one wishes to model in the study of economic behavior. ...

                          Posted by on Monday, October 17, 2011 at 09:54 AM in Academic Papers, Economics, Macroeconomics, Methodology | Permalink  Comments (3)


                          Paul Krugman: Losing Their Immunity

                          The wizards of whine street:

                          Losing Their Immunity, by Paul Krugman, Commentary, NY Times: As the Occupy Wall Street movement continues to grow, the response from the movement’s targets has gradually changed: contemptuous dismissal has been replaced by whining. ... The modern lords of finance look at the protesters and ask, Don’t they understand what we’ve done for the U.S. economy? The answer is: yes, many of the protesters do understand..., that’s why they’re protesting. ...

                          My favorite quote came from an unnamed money manager who declared, “Financial services are one of the last things we do in this country and do it well. Let’s embrace it.” ... But ... the financialization of America wasn’t dictated by the invisible hand of the market. What caused the financial industry to grow much faster than the rest of the economy starting around 1980 was ... deregulation...

                          Not coincidentally, the era of an ever-growing financial industry was also an era of ever-growing inequality of income and wealth. ... All of this was supposed to be justified by results: the paychecks of the wizards of Wall Street were appropriate, we were told, because of the wonderful things they did. Somehow, however, that wonderfulness failed to trickle down to the rest of the nation — and that was true even before the crisis. ...

                          Then came the crisis, which proved that all those claims about how modern finance had reduced risk ... were utter nonsense. Government bailouts were all that saved us from a financial meltdown as bad as or worse than the one that caused the Great Depression. ...

                          Wall Street pay has rebounded even as ordinary workers continue to suffer from high unemployment and falling real wages. Yet it’s harder than ever to see what, if anything, financiers are doing to earn that money. Why, then, does Wall Street expect anyone to take its whining seriously? ...

                          Wall Street still has plenty of [one thing] thanks to those bailouts...: money. Money talks in American politics, and what the financial industry’s money has been saying lately is that it will punish any politician who dares to criticize that industry’s behavior, no matter how gently — as evidenced by the way Wall Street money has now abandoned President Obama in favor of Mitt Romney. And this explains the industry’s shock over recent events.

                          You see, until a few weeks ago it seemed as if Wall Street had effectively bribed and bullied our political system into forgetting about that whole drawing lavish paychecks while destroying the world economy thing. Then, all of a sudden, some people insisted on bringing the subject up again.

                          And their outrage has found resonance with millions of Americans. No wonder Wall Street is whining.

                            Posted by on Monday, October 17, 2011 at 12:24 AM in Economics, Financial System, Income Distribution, Politics, Regulation | Permalink  Comments (53)


                            links for 2011-10-17

                              Posted by on Monday, October 17, 2011 at 12:06 AM in Economics, Links | Permalink  Comments (24)


                              Sunday, October 16, 2011

                              "Stop Dehumanizing the Protestors"

                              Andrew Samwick:

                              A note to Nelson D. Schwartz and Eric Dash of The New York Times.  If you are going to put this in your article, put it in quotes and attribute it properly or keep it out of the news section of the paper:

                              Without a coherent message, the crowds will ultimately thin out, Wall Street types insist — especially when the weather turns colder. They see the protesters as an entertaining sideshow, little more than flash mobs of slackers, seeking to lock arms with Kanye West or get a whiff of the antiestablishment politics that defined their parents’ generation.

                              I don't think it is incumbent on #OWS to have a coherent message.  They are people who feel that their freedoms are being constricted due to the corruptness of others.  They are joining together to push back against that feeling.  They win just by showing up and eschewing violence.  If the NYPD and branch managers at Citibank can't figure that out and stop dehumanizing the protestors, then #OWS will win even more. ...

                              The use of the term "slackers" is telling. You see, there's plenty of work for the industrious, our unemployment problem is due to laziness. There are plenty of jobs -- pay no attention to the fact that the number of unemployed is far, far greater than the number of jobs -- people don't really want to work. It has nothing to do with the crash of Wall Street destroying the economy, and the bounce back and present good fortune on Wall Street has nothing to do with the government bailing them out -- it was their hard work that fixed the problems. For the little people to expect the government to treat them similarly -- to bail them out during tough times -- is just plain anti-capitalist. If you are wealthy, a government handout that preserves your wealth is necessary, but to expect the government to provide jobs -- not Wall Street type handouts but the opportunity to work -- is "antiestablishment" and a threat to our way of life.

                                Posted by on Sunday, October 16, 2011 at 10:17 AM in Economics | Permalink  Comments (90)


                                links for 2011-10-16

                                  Posted by on Sunday, October 16, 2011 at 12:06 AM in Economics, Links | Permalink  Comments (40)


                                  Saturday, October 15, 2011

                                  Shiller: Making the Most of Our Financial Winter

                                  A little less than a year ago, I wrote:

                                  ...Farmers face a yearly crop cycle that has a lot in common with business cycles. There is a boom period in the spring, summer, and fall when there never seem to be enough people or hours in the day to do everything that needs to be done. And there is also a down period – call it a recession – in winter.
                                  The very best farmers are not idle during the winter. They use this time to repair equipment, expand capacity, and do other things to get ready for the next year’s planting and harvesting. In the spring, summer, and fall it is too costly to do these things because there is so much else to do, but in the winter there is lots of labor and equipment available for such tasks. This often requires farmers to take on new debt and pay it off after harvest, but farmers who take advantage of downtime to get ready for whatever the coming growing and harvest season might throw at them have an advantage over those who mostly remain idle during this time.
                                  Boom times and recessions for entire economies are much the same. During boom times it is very costly to divert resources to construction and repair of the infrastructure necessary to promote economic growth. But during the economic winter, i.e. in recessions, when large quantities of labor, equipment, and raw materials are idle, the cost of such activities is relatively low. Governments that take advantage of this will be in a better position to compete in the global economy than governments that allow labor and other resources to sit idle waiting for things to improve. It does require an increase in the deficit, but if we follow the farmers’ lead and pay off the debt during boom times– something we’ve had trouble doing – we will be better off. ...

                                  So I suppose I agree with Robert Shiller:

                                  Making the Most of Our Financial Winter, by Robert Shiller, Commentary, NY Times: On a traditional farm, when winter comes and there’s no need for planting, fertilizing or harvesting, it’s time for infrastructure projects. Farmers fix their barns, build fences or dig wells — important tasks that could be done in any season if there weren’t more pressing jobs to do.
                                  If the winter is unusually long and cold, planting time is delayed and additional projects are undertaken. It’s all very simple and sensible: the idea is not to let people sit around idle, and to use down time to get important things done.

                                  The farm needn’t go into debt to do this. All able-bodied people on the farm are expected to contribute their labor, an imposition we can view as an informal tax. Later, everyone on the farm enjoys the benefits of all that work, by participating in the various benefits — the economic growth — it helps to create.

                                  In many respects, the American Jobs Act, proposed by President Obama but blocked in its full form by the Senate last week — would do much the same thing for the nation during the current economic winter. Parts of the plan would provide for projects like school modernization, airport and highway improvements, high-speed rail systems and redevelopment of abandoned and foreclosed-upon properties to stabilize neighborhoods. Those are the modern national equivalents of fixing the barn and building a fence. And these projects would be made possible by taxes. ...[continue reading]...

                                  [He is arguing for a balanced budget multiplier where taxes and spending increase at the same time. In my example short-run spending increases are financed by borrowing and there is a promise to balance the budget when times are better. That explains the difference in the two examples with respect to whether or not farmers take on debt during the down times. Borrowing allows more to be done in the short-run to help the economy (just as borrowing gives farmers more options in terms of how to spend the downtime productively) so there is a benefit, but it also adds risks and hence may not be politically viable. But the balanced budget approach also has political problems. Conservatives will worry that once the spending and taxes are in place they will never be reversed, and many will oppose these policies for this reason.]

                                    Posted by on Saturday, October 15, 2011 at 01:08 PM in Economics, Fiscal Policy | Permalink  Comments (20)


                                    Did Speculation Drive Oil Prices?

                                    Reviving an old debate (see here too):

                                    Did Speculation Drive Oil Prices? Market Fundamentals Suggest Otherwise, by Michael D. Plante and Mine K. Yücel, Economic Letter, FRB Dallas: Oil market speculation became an especially popular topic when the price of crude tripled over 18 months to a record high $145 per barrel in July 2008. Of particular interest to many is whether speculators drove oil prices beyond what fundamentals would have otherwise justified. We explore this issue over two Economic Letters. In this article, we look at evidence from the physical market for oil and conclude that fundamentals, and not speculation, were behind the dramatic rise and fall in oil prices. In our companion Economic Letter, we examine the futures market.
                                    Oil prices began their climb in 2002, reaching a record high in mid-2008, and then collapsed at the end of ’08 amid the global recession. As world economic growth picked up, so did oil prices. Overall, the year-over-year change in oil prices has fairly closely tracked world gross domestic product (GDP) growth (Chart 1).

                                    Chart 1: World GDP Mirrors Oil Price Growth

                                    Energy consumption increases as GDP rises; but energy consumption in developing countries increases almost twice as fast as in developed countries. GDP expansion in emerging economies was particularly strong between 2005 and 2007, averaging 8 percent per year. Real GDP in China, for example, grew by an average 12.7 percent annually between 2005 and 2007, while the nation’s oil consumption increased 5.1 percent annually during the period.
                                    From the beginning of 2007 to mid-2008, weekly prices for West Texas Intermediate (WTI) crude oil jumped 152 percent, from $57 to $143 per barrel. It’s possible that growing demand for crude oil might not be the reason for the rise. However, if the increase was due to other factors, oil consumption should have begun falling in response to the higher prices. Instead, there was almost no consumption decline during the period, implying that oil prices were driven by growing world income and demand.

                                    Continue reading "Did Speculation Drive Oil Prices?" »

                                      Posted by on Saturday, October 15, 2011 at 09:18 AM in Economics, Oil | Permalink  Comments (36)


                                      links for 2011-10-15

                                        Posted by on Saturday, October 15, 2011 at 12:06 AM in Economics, Links | Permalink  Comments (51)


                                        Friday, October 14, 2011

                                        Wanted: Job Creation

                                        I wish I could find a way to adequately express the frustration I feel over the way Congress has all but turned its back on the unemployed. Even now, the only reason we're hearing anything from Democrats about job creation is because there's an election ahead. The legislation is timed for the politicians -- it needs to maximize reelection chances -- minimizing the struggles of the unemployed is a secondary consideration (if that). If the election were further away it's unlikely we'd be hearing about this much at all. And Republicans are worse, they have no plans at all except to use unemployment as an excuse to further ideological goals (balanced budget amendments, tax cuts for the wealthy, etc.). How can politicians be so indifferent to the struggles that the unemployed face daily? Are they really so disconnected from the lives of ordinary people that they don't understand how devastating this is to those who lost jobs due to the recession, people who can't find a way to get hired again no matter how hard they try?

                                        Anyway, I can't seem to find a way to say this with the shrillness it deserves, and I apologize for that, but I just don't understand why the unemployment crisis isn't a national emergency.

                                          Posted by on Friday, October 14, 2011 at 09:54 AM in Economics, Politics, Unemployment | Permalink  Comments (158)


                                          Fulfilling Free Trade's Promise

                                          Richard Green:

                                          For free trade to fulfill its promise, the national government must redistribute income: As a card-carrying economist, I like trade--overall, it potentially enriches countries that engage in it. The problem is the meaning of enrichment.
                                          Trade theory says that trade enlarges the pie that people share.  But among the most important contributions to trade theory is the Samuelson-Stolper Theorem, which says that relatively scarce factors of production see their returns fall when trade is introduced. In the context of an economy like the US, this means that low skilled workers see their wages fall in the presence of trade. The trajectory of wages in the US over the past 20 years or so are consistent with the predictions of Samuelson and Stolper.
                                          NAFTA was sold to the US public as something that would make everyone better off. And it principle, it could have done so, had some of the gains to those who benefited from NAFTA been redistributed to those who lost as a result of it. Instead we got the NAFTA but not redistribution. This likely explains the widening disparity of incomes.

                                            Posted by on Friday, October 14, 2011 at 08:46 AM in Economics, Income Distribution, International Trade, Social Insurance, Unemployment | Permalink  Comments (36)


                                            Paul Krugman: Rabbit-Hole Economics

                                            The GOP is "becoming a caricature of itself":

                                            Rabbit-Hole Economics, by Paul Krugman, Commentary, NY Times: Reading the transcript of Tuesday’s Republican debate on the economy is, for anyone who has actually been following economic events these past few years, like falling down a rabbit hole. Suddenly, you find yourself in a fantasy world where nothing looks or behaves the way it does in real life.
                                            And since economic policy has to deal with the world we live in, not the fantasy world of the G.O.P.’s imagination, the prospect that one of these people may well be our next president is, frankly, terrifying.
                                            In the real world, recent events were a devastating refutation of the free-market orthodoxy that has ruled American politics these past three decades. Above all, the long crusade against financial regulation...
                                            But down the rabbit hole, none of that happened. We didn’t find ourselves in a crisis because of runaway private lenders like Countrywide Financial. We didn’t find ourselves in a crisis because Wall Street pretended that slicing, dicing and rearranging bad loans could somehow create AAA assets — and private rating agencies played along. We didn’t find ourselves in a crisis because “shadow banks” like Lehman Brothers exploited gaps in financial regulation to create bank-type threats to the financial system without being subject to bank-type limits on risk-taking.
                                            No, in the universe of the Republican Party we found ourselves in a crisis because Representative Barney Frank forced helpless bankers to lend money to the undeserving poor. ..., government caused the whole problem. So what you need to know is that this orthodoxy has hardened even as the supposed evidence for government as a major villain in the crisis has been discredited. ...
                                            The Great Recession should have been a huge wake-up call. Nothing like this was supposed to be possible in the modern world. Everyone, and I mean everyone, should be engaged in serious soul-searching, asking how much of what he or she thought was true actually isn’t.
                                            But the G.O.P. has responded to the crisis not by rethinking its dogma but by adopting an even cruder version of that dogma, becoming a caricature of itself. During the debate, the hosts played a clip of Ronald Reagan calling for increased revenue; today, no politician hoping to get anywhere in Reagan’s party would dare say such a thing.
                                            It’s a terrible thing when an individual loses his or her grip on reality. But it’s much worse when the same thing happens to a whole political party, one that already has the power to block anything the president proposes — and which may soon control the whole government.

                                              Posted by on Friday, October 14, 2011 at 12:24 AM in Economics, Politics | Permalink  Comments (51)


                                              links for 2011-10-14

                                                Posted by on Friday, October 14, 2011 at 12:06 AM in Economics, Links | Permalink  Comments (41)


                                                Thursday, October 13, 2011

                                                Roubini: The Instability of Inequality

                                                Nouriel Roubini says inequality is a destructive force:

                                                The Instability of Inequality, by Nouriel Roubini, Commentary, Project Syndicate: This year has witnessed a global wave of social and political turmoil and instability, with masses of people pouring into the real and virtual streets... While these protests have no unified theme, they express in different ways the serious concerns of the world’s working and middle classes about their prospects in the face of the growing concentration of power among economic, financial, and political elites. ...
                                                The problem is not new. Karl Marx oversold socialism, but he was right in claiming that globalization, unfettered financial capitalism, and redistribution of income and wealth from labor to capital could lead capitalism to self-destruct. ...
                                                Even before the Great Depression, Europe’s enlightened “bourgeois” classes recognized that, to avoid revolution, workers’ rights needed to be protected, wage and labor conditions improved, and a welfare state created to redistribute wealth and finance public goods – education, health care, and a social safety net. The push towards a modern welfare state accelerated after the Great Depression... by widening the provision of public goods through progressive taxation of incomes and wealth and fostering economic opportunity for all.
                                                Thus, the rise of the social-welfare state was a response ... to the threat of popular revolutions, socialism, and communism as the frequency and severity of economic and financial crises increased. Three decades of relative social and economic stability then ensued, from the late 1940’s until the mid-1970’s, a period when inequality fell sharply and median incomes grew rapidly.
                                                Some of the lessons ... were lost in the Reagan-Thatcher era, when the appetite for massive deregulation was created in part by the flaws in Europe’s social-welfare model. Those flaws were reflected in yawning fiscal deficits, regulatory overkill, and a lack of economic dynamism that led to sclerotic growth then and the eurozone’s sovereign-debt crisis now.
                                                But the laissez-faire Anglo-Saxon model has also now failed miserably. To stabilize market-oriented economies requires a return to the right balance between markets and provision of public goods. That means moving away from both the Anglo-Saxon model of unregulated markets and the continental European model of deficit-driven welfare states. Even an alternative “Asian” growth model – if there really is one – has not prevented a rise in inequality in China, India, and elsewhere.
                                                Any economic model that does not properly address inequality will eventually face a crisis of legitimacy. Unless the relative economic roles of the market and the state are rebalanced, the protests of 2011 will become more severe, with social and political instability eventually harming long-term economic growth and welfare.

                                                I made similar points here: Why a Working-Class Revolt Might Not Be Unthinkable (and to some extent, more recently here: Why America Should Spread the Wealth, and a bit further back here: Redistribute Income to Grow Economy). And Jeff Sachs weighs in with Occupy Wall Street and the Demand for Economic Justice.

                                                  Posted by on Thursday, October 13, 2011 at 10:44 AM in Economics, Income Distribution | Permalink  Comments (38)


                                                  "Innuendo, Half Truths, Misdirection, and Utter Non-Sequiturs"

                                                  I think it would be fair to say that Jeff Sachs is unhappy with Rupert Murdoch, and for good reason:

                                                  The Murdoch Legacy, by Jeffrey Sachs: At age 80, Rupert Murdoch will be long gone in coming decades when the planet is grappling with greatly intensified climate change. ...
                                                  I mention this because Murdoch's paper, the Wall Street Journal, again last week performed its usual disservice by publishing an extremely misleading opinion piece on climate change in the banner location of the paper (Robert Bryce, "Five Truths About Climate Change," October 6). That column is not merely an opinion piece among a range of various opinions. It is part of that paper's steady drumbeat of opposition to action on climate change. And the Journal teams up in this with Murdoch's other propaganda outlet, Fox News.
                                                  The real problem with the Journal is this. The Journal's business coverage outside of the opinion pages is important and difficult to replicate (and this is still true even as the professional reporters apparently are facing more intrusions from the Murdoch minions). Excellent reporting draws eyes to the Murdoch propaganda and misinformation on the opinion pages.
                                                  In this particular column, the writer, Robert Bryce, purports to tell us five truths about climate change to reach the conclusion that we shouldn't care about carbon emissions. The column is a study in innuendo, half truths,... misdirection..., and utter non-sequiturs. Its purpose is to dissuade us from action on carbon dioxide. ...
                                                  Murdoch's News Corporation, the owner of the Wall Street Journal and Fox News, is the opposite of a true news corporation. It is news as in Orwell's newspeak. Its major role is to peddle corporate propaganda, frighten politicians, and make lots of money. In those roles it has been successful. ...

                                                    Posted by on Thursday, October 13, 2011 at 12:42 AM in Economics, Environment | Permalink  Comments (33)


                                                    "A Breathtaking Act of Economic Vandalism"

                                                    As this says, everyone expected Republicans to block President Obama’s jobs bill, but it's still disappointing to see the "you're on your ownership socety" in action:

                                                    No Jobs Bill, and No Ideas, Editorial, NY Times: It was all predicted, but the unanimous decision by Senate Republicans on Tuesday to filibuster and thus kill President Obama’s jobs bill was still a breathtaking act of economic vandalism. There are 14 million people out of work, wages are falling, poverty is rising, and a second recession may be blowing in, but not a single Republican would even allow debate on a sound plan to cut middle-class taxes and increase public-works spending.
                                                    The bill the Republicans shot down is not a panacea, but independent economists say it would have a significant and swift effect on the current stagnation. Macroeconomic Advisers ... said it could raise economic growth by 1.25 percentage points and create 1.3 million jobs in 2012. Moody’s Analytics estimated new growth at 2 percentage points and 1.9 million jobs. ...
                                                    The Republicans offer no actual economic plans, only tired slogans about cutting regulations and spending, and ending health care reform. The party seems content to run out the clock on Mr. Obama’s term while doing very little. On Tuesday, Mr. Obama’s campaign manager, Jim Messina, accused Republicans of trying to “suffocate the economy” in hopes that the pain would work to their political advantage. They are doing little to refute that charge. ...

                                                      Posted by on Thursday, October 13, 2011 at 12:33 AM in Economics, Fiscal Policy, Politics, Unemployment | Permalink  Comments (28)


                                                      "Tim Duy Asks; CG&G Answers"

                                                      Stan Collender responds to Tim Duy:

                                                      Tim Duy Asks; CG&G Answers, by Stan Collender: Over at his own blog, Tim Duy provided an interesting post about what we should expect fiscal policy-wise in 2013.
                                                      Tim said he saw two possibilities -- fiscal austerity or abandon fiscal austerity -- and he that he'd "like to hear the views of the gang at Capital Games and Gains." Since he quoted one of my posts from several weeks ago and mentioned me by name earlier in the piece, I will take up the challenge...
                                                      Tim is using "fiscal austerity" as a surrogate for spending cuts, and I strongly suspect that, if the GOP wins the White House as he asks us to assume, that at least a symbolic spending cut will be on the agenda.  If the Senate goes and the House stays Republican, the cut may be more than symbolic.
                                                      But...I also expect that a tax cut will be a priority for the GOP at the same time.  In fact, it's likely to be a higher, and perhaps a much higher, priority than anything they will propose on the spending side.  I also expect that the GOP-proposed tax cut will increase the deficit by more than the GOP-proposed spending cut will reduce it, especially in the first two years.
                                                      Short-term pain and an increase in federal borrowing to get a long-term gain will be the battle cry.  The fact that the GOP wouldn't let Obama say or so that won't matter a bit.
                                                      Is that "austerity"?  I doubt it, but it will be sold as if it is.  
                                                      The higher short-term deficits will also be sold as something that was required because of the budget mess Obama left us.  That will be nonsense, of course, but that won't matter in the afterglow of a GOP president taking the oath of office.

                                                        Posted by on Thursday, October 13, 2011 at 12:24 AM in Budget Deficit, Economics, Politics, Taxes | Permalink  Comments (1)


                                                        links for 2011-10-13

                                                          Posted by on Thursday, October 13, 2011 at 12:06 AM in Economics, Links | Permalink  Comments (41)


                                                          Wednesday, October 12, 2011

                                                          Fed Watch: Widespread Lack of Conviction

                                                          Tim Duy:

                                                          Widespread Lack of Conviction, by Tim Duy: Menzie Chinn at Econbrowser looks at the OECD data and concludes the world is close to stall speed. Alcoa is an early victim, as the impact of the European financial crisis becomes evident. Via Reuters:

                                                          [Alcoa] CEO Klaus Kleinfeld warned of weak economic conditions through the year, particularly in Europe, "as confidence in the global recovery faded."

                                                          That sapped aluminum demand from the automotive, industrial products, construction and packaging sectors since the second quarter, with only the aerospace and transport sectors growing.

                                                          Can the global economy recovery? Will the damage be limited to Europe? With growth teetering on an edge, it would be nice to have one old US recession indicator back in the tool kit - the yield curve. With short-term interest rates at zero, it is impossible for the yield curve to invert, a traditional indication of recession. Bloomberg reports on an effort to overcome this challenge and regain that tool:

                                                          The bond market indicator that has predicted every U.S. recession since 1970 shows that the economy has about a 60 percent chance of contracting within 12 months.

                                                          The so-called Treasury yield curve, adjusted for distortions caused by the Federal Reserve’s record low zero to 0.25 percent target interest rate for overnight loans between banks, shows that two-year notes yield 20 basis points, or 0.20 percentage point, less than five-year notes, according to Bank of America Corp. research. The unadjusted gap of 79 basis points at the end of last week indicates the chance of recession at about 15 percent...

                                                          ...“The adjusted curve is giving a powerful signal for an upcoming U.S. recession,” said Ruslan Bikbov, a fixed-income strategist in New York at Bank of America, one of the 22 primary dealers of U.S. government securities that trade with the Fed. “If that happens, the Fed’s target rate could remain near zero beyond 2014,” more than a year longer than the central bank has indicated, he said in an interview on Oct. 3.

                                                          More on the topic can be found at the FT Alphaville blog, including this chart:

                                                          Yieldchart

                                                          Alas, still not the defining indicator we could hope for. While 60% is better than even, it is still a call that lacks conviction. As are the other outlooks reported by Bloomberg. First:

                                                          Goldman Sachs Group Inc., another primary dealer, puts the odds of another recession at 40 percent, the firm’s economists wrote in an Oct. 3 report.

                                                          Next:

                                                          JPMorgan Chase & Co. economists said in an Oct. 7 report that they see “a soft growth picture, but one that is not falling into recession at the moment.” The firm, also a primary dealer, forecasts the 10-year note yield will end the year at 2.25 percent.

                                                          Then:

                                                          “Markets these days give mild signs of a collapse,” Gross said in an Oct. 4 Bloomberg Television interview with Lisa Murphy. The odds of recession in developed economies is about 50 percent, with the U.S. on the “brink,” he said. “This is one of those times where you are worried about the return of your money.”

                                                          60%, 40%, 50%. Still seems to be only one firm with a strong conviction:

                                                          A “contagion” of economic indicators have come together to signal the economy is tipping into a contraction, according to Lakshman Achuthan, co-founder of ECRI, a research firm that predicts changes in the economic cycle.

                                                          “You have wildfire among the leading indicators across the board,” Achuthan said in a radio interview on Sept. 30 on “Bloomberg Surveillance” with Tom Keene and Ken Prewitt. “It’s a vicious cycle that is going to get quite a bit worse.”

                                                          Truth be told, I can't admit to being much better. I am seduced by the logic that room for recession is limited given the failure of many sectors, notably autos and housing, to fully or even begin to recover from the last recession. That said, the near-term policy picture in the US looks dismal and I am extremely wary to dismiss the European financial crisis as something easily resolved. Moreover, while some attributed Monday's rally on Wall Street to a positive reaction to the news that China was moving to support their banks, I saw only an indication the Chinese economy is on a very weak footing. Combining these thoughts with the memory that the safe bet over the past three years has been on the weak side of the coin, I too am pushed over the edge with better than even odds of recession. And while I will be searching for clues about the Fed's intentions in the release of the FOMC meeting minutes, I suspect that if the seeds of recession are already planted, policymakers are already too far behind the curve to engineer a timely rebound.

                                                            Posted by on Wednesday, October 12, 2011 at 09:27 AM in Economics, Fed Watch | Permalink  Comments (13)


                                                            "Benford's Law and the Decreasing Reliability of Accounting Data"

                                                            This is from Jialan Wang:

                                                            Benford's Law and the Decreasing Reliability of Accounting Data for US Firms, by Jialan Wang: ...[T]here are more numbers in the universe that begin with the digit 1 than 2, or 3, or 4, or 5, or 6, or 7, or 8, or 9. And more numbers that begin with 2 than 3, or 4, and so on. This relationship holds for the lengths of rivers, the populations of cities, molecular weights of chemicals, and any number of other categories. ...
                                                            This numerical regularity is known as Benford's Law, and specifically, it says that the probability of the first digit from a set of numbers is d is given by

                                                            In fact, Benford's law has been used in legal cases to detect corporate fraud, because deviations from the law can indicate that a company's books have been manipulated. Naturally, I was keen to see whether it applies to the large public firms that we commonly study in finance.
                                                            I downloaded quarterly accounting data for all firms in Compustat,... over 20,000 firms from SEC filings... (revenues, expenses, assets, liabilities, etc.).
                                                            And lo, it works! Here are the distribution of first digits vs. Benford's law's prediction for total assets...

                                                            Next, I looked at how adherence to Benford's law changed over time, using a measure of the sum of squared deviations of the empirical density from the Benford's prediction...
                                                            Deviations from Benford's law have increased substantially over time, such that today the empirical distribution of each digit is about 3 percentage points off from what Benford's law would predict. The deviation increased sharply between 1982-1986 before leveling off, then zoomed up again from 1998 to 2002.  Notably, the deviation from Benford dropped off very slightly in 2003-2004 after the enactment of Sarbanes-Oxley accounting reform act in 2002, but this was very tiny and the deviation resumed its increase up to an all-time peak in 2009.

                                                            So according to Benford's law, accounting statements are getting less and less representative of what's really going on inside of companies.The major reform that was passed after Enron and other major accounting standards barely made a dent.
                                                            Next, I looked at Benford's law for three industries: finance, information technology, and manufacturing. ... [shows graphs] ... While these time series don't prove anything decisively, deviations from Benford's law are compellingly correlated with known financial crises, bubbles, and fraud waves. And overall, the picture looks grim. Accounting data seem to be less and less related to the natural data-generating process that governs everything from rivers to molecules to cities. Since these data form the basis of most of our research in finance, Benford's law casts serious doubt on the reliability of our results. And it's just one more reason for investors to beware....

                                                              Posted by on Wednesday, October 12, 2011 at 12:33 AM in Economics | Permalink  Comments (50)


                                                              Rodrik: Milton Friedman’s Magical Thinking

                                                              Dani Rodrik argues that Milton Friedman leaves "an ambiguous and puzzling legacy":

                                                              Milton Friedman’s Magical Thinking, by Dani Rodik, Commentary, Project Syndicate: Next year will mark the 100th anniversary of Milton Friedman’s birth. Friedman ... will be remembered primarily as the visionary who provided the intellectual firepower for free-market enthusiasts..., and as the éminence grise behind the dramatic shift in the economic policies that took place after 1980.
                                                              At a time when skepticism about markets ran rampant, Friedman explained in clear, accessible language that private enterprise is the foundation of economic prosperity. ... He railed against government regulations that encumber entrepreneurship and restrict markets. ...
                                                              Inspired by Friedman’s ideas, Ronald Reagan, Margaret Thatcher, and many other government leaders began to dismantle the government restrictions and regulations that had been built up over the preceding decades. China moved away from central planning and allowed markets to flourish... Latin America sharply reduced its trade barriers and privatized its state-owned firms. When the Berlin Wall fell in 1990, there was no doubt as to which direction the former command economies would take: towards free markets.
                                                              But Friedman also produced a less felicitous legacy. ... In effect, he presented government as the enemy of the market. He therefore blinded us to the evident reality that all successful economies are, in fact, mixed...
                                                              The Friedmanite perspective greatly underestimates the institutional prerequisites of markets. Let the government simply enforce property rights and contracts, and – presto! – markets can work their magic. In fact,... markets ... are not self-creating, self-regulating, self-stabilizing, or self-legitimizing. Governments must invest in transport and communication networks; counteract asymmetric information, externalities, and unequal bargaining power; moderate financial panics and recessions; and respond to popular demands for safety nets and social insurance. ... [And] Given China’s economic success, it is hard to deny the contribution made by the government’s industrialization policies.
                                                              Free-market enthusiasts’ place in the history of economic thought will remain secure. But thinkers like Friedman leave an ambiguous and puzzling legacy, because it is the interventionists who have succeeded in economic history, where it really matters.

                                                                Posted by on Wednesday, October 12, 2011 at 12:24 AM in Economics, Market Failure | Permalink  Comments (45)


                                                                links for 2011-10-12

                                                                  Posted by on Wednesday, October 12, 2011 at 12:06 AM in Economics, Links | Permalink  Comments (31)


                                                                  Tuesday, October 11, 2011

                                                                  Christopher Sims and Tests for Causality

                                                                  To tell the full story of Christopher Sims' contributions to causality, we need to go back to the state of the art in policy evaluation in the 1960s, in particular, to something known as the St. Louis equation:

                                                                  Yt = c + a0Mt + a1Mt-1 + a3Mt-2 + b0Gt + b1Gt-1 + b2 Gt-2 + et

                                                                  In this equation, output (Y) is regressed on current and lagged values of money (M) and government spending (G). The idea was to see how output responded historically to changes in money and government spending, and then use these estimates to guide policy. If we know how Y responds to M, then we can use that knowledge to set monetary policy optimally.

                                                                  Now, there is a fundamental problem with this approach highlighted by the Lucas critique (the negative reaction to the other common approach, using large-scale structural models to evaluate policy, was discussed yesterday). If you change monetary policy you also change the values of the a and b coefficients so that the estimates are no longer reliable, and hence no longer a guide, but that criticism came later. At the time there was another worry.

                                                                  The worry was something known as simultaneity bias. Consider the Mt term in the equation above. If Mt is "econometrically exogenous," i.e. if it doesn't depend upon Yt, then the estimated value of a0 will be unbiased. But if Mt depends upon Yt , perhaps through and equation such as Mt = h0 + h1Yt + ut, then the estimate of  will be biased and hence a poor guide to policy decisions.

                                                                  The first use of causality tests was to test to see if h1 in the "policy equation" was equal to zero, and Sims was a key player in the development of these tests. Thus, Sims starts his 1972 AER paper with:

                                                                  This study has two purposes. One is to examine the substantive question: Is there statistical evidence that money is "exogenous" in some sense in the money-income relationship? The other is to display in a simple example some time-series methodology not now in wide use. The main methodological novelty is the use of a direct test for the existence of unidirectional causality.

                                                                  If there was unidirectional causality from M to Y, then the estimate would be unbiased. But if there was two-way causality, i.e. if Y causes M (h1 is not zero), then the estimate would be problematic.

                                                                  Sims contributed greatly to this literature, and once this work was largely complete, it quickly became clear that these tests could be used to assess causality more generally, the method was not limited to checking for econometric exogeneity.

                                                                  But there was also a problem. The basic technique (an F-test on a set of coefficients) to test for causality worked well on 2-variable systems, but it didn't work reliably for systems with three or more equations (the problem was that X can cause Y, and Y can then cause Z so that there is a causal path from X to Z, but the F-test approach will miss this).

                                                                  Sims Second major paper on causality addresses this problem by providing two new tools to assess causality, impulse response functions and variance decompositions (along the way it was also shown that Sims and Granger causality are equivalent). Impulse response functions, which have since become a key analytical device in macroeconomics, trace out the response of the variables in the model to a shock to another variable in the system (identification restrictions are needed to ensure that the shock is actually a policy shock, see here). If the variable, say output, responds robustly to a shock to, say, the federal funds rate, then we say that the federal funds rate causes output. But if we shock the federal funds rate and output essentially flat-lines in response, then causality is absent.

                                                                  However, even when there is causality according to the impulse responses, impulse response functions do not tell us how important one variable is in explaining the variation in another variable (the impulse response function could look impressive, but it may be that we are only explaining 1% of the total variation in the other variable so that the response we are seeing is not very important in explaining why the other variable fluctuates over time). Variance decompositions solve this problem. They don't tell you the sign/pattern of the response like impulse response functions do, but the do give an indication of how important one variable is in explaining the variation in another variable (e.g. if M explains 75% of the variance in output, that's impressive and notable, but if it's only 1% then money isn't very important in explaining why output changes over time).

                                                                  Sims second paper also made another important point. In his first paper, he found that money causes output (so it could not be treated as econometrically exogenous as in the St. Louis equation). But that was in a two-variable system including only M and Y. In his second paper he adds interest rates (i) and prices (P) to get a four variable system, and he finds that this overturns the results in his first paper. Once i is added to the model, M no longer causes Y. Thus, the lesson is that if you leave important variables out of a VAR system, it can produce misleading results.

                                                                  But Sims' main contributions were, initially, the F-tests for testing causality in bivariate systems, and the addition of IRFs and VDCs to assess causality in higher order systems. In addition, he also provided many of the common "pitfalls of causality testing," -- causality testing can be misleading in a number of ways. One is above, leaving a variable out of a system. If A causes B to change tomorrow, and C to change the next day, a system containing only B and C will look as though B causes C when in fact there is no causality at all, a third variable causes both. Other pitfalls can occur, for example, when there is optimal control or when expectations of future variables are in the model. Identifying the pitfalls of the methods he (and others) developed was also an important contribution to the literature.

                                                                  Sims' work on causality was highlighted in the Nobel announcement, and I hope this provided some background on this topic. But there's a lot more to be said about Sims' work over and above his work on causality testing discussed above and his work on structural VARs I discussed yesterday, e.g. his recent papers on rational inattention, and I hope to write more about both Sims and Sargent when I can find the time.

                                                                    Posted by on Tuesday, October 11, 2011 at 01:08 PM in Economics, Methodology | Permalink  Comments (13)


                                                                    Raise Taxes on the Wealthy: It’s the Fair Thing to Do

                                                                    New column:

                                                                    Why America Should Spread the Wealth

                                                                      Posted by on Tuesday, October 11, 2011 at 09:09 AM in Economics, Equity, Fiscal Times, Income Distribution, Taxes | Permalink  Comments (28)


                                                                      The Rise of the Renminbi as International Currency: Historical Precedents

                                                                      Jeff Frankel:

                                                                      The Rise of the Renminbi as International Currency: Historical Precedents, by Jeff Frankel: All of a sudden, the renminbi is being touted as the next big international currency. Just in the last year or two, the Chinese currency has begun to internationalize along a number of dimensions. A RMB bond market has grown rapidly in Hong Kong, and one in RMB bank deposits. Some of China’s international trade is now invoiced in the currency. Foreign central banks have been able to hold RMB since August 2010, with Malaysia going first.
                                                                      Some are now claiming that the renminbi could overtake the dollar for the number one slot in the international currency rankings within a decade (especially Subramanian 2011a, p.19; 2011b). ...
                                                                      The dollar is one of three national currencies to have attained international status during the 20th century. The other two were the yen and the mark, which became major international currencies after the breakup of the Bretton Woods system in 1971-73. (The euro, of course, did so after 1999.) In the early 1990s, both were spoken of as potential rivals of the dollar for the number one slot. It is easy to forget it now, because Japan’s relative role has diminished since then and the mark has been superseded. ...
                                                                      The current RMB phenomenon differs in an interesting way from the historical circumstances of the rise of the three earlier currencies. The Chinese government is actively promoting the international use of its currency. Neither Germany nor Japan, nor even the US, did that, at least not at first. In all three cases, export interests, who stood to lose competitiveness if international demand for the currency were to rise, were much stronger than the financial sector, which might have supported internationalization. One would expect the same fears of a stronger currency and its effects on manufacturing exports to dominate the calculations in China.
                                                                      In the case of the mark and yen after 1973, internationalization came despite the reluctance of the German and Japanese governments. In the case of the United States after 1914, a tiny elite promoted internationalization of the dollar despite the indifference or hostility to such a project in the nation at large. These individuals, led by Benjamin Strong, the first president of the New York Fed, were the same ones who had conspired in 1910 to establish the Federal Reserve in the first place.
                                                                      It is not yet clear that China’s new enthusiasm for internationalizing its currency includes a willingness to end financial repression in the domestic financial system, remove cross-border capital controls, and allow the RMB to appreciate, thus helping to shift the economy away from its export-dependence. Perhaps a small elite will be able to accomplish these things, in the way that Strong did a century earlier. But so far the government is only promoting international use of the RMB offshore, walled off from the domestic financial system. That will not be enough to do it.
                                                                      [This perspective note summarizes the argument in "Historical Precedents for the Internationalization of the RMB"...] ...

                                                                        Posted by on Tuesday, October 11, 2011 at 12:51 AM in China, Economics, Financial System, International Finance | Permalink  Comments (5)


                                                                        "A Boom in 2013?"

                                                                        One more from Tim Duy:

                                                                        A Boom in 2013?, by Tim Duy: While searching through market commentary, I came across these remarks, via Bloomberg:

                                                                        “We are focusing on major U.S. equities now, looking past the European stock markets because there’s too much volatility there,” Tim Hartzell, who oversees about $350 million as chief investment officer for Houston-based Sequent Asset Management, said in a telephone interview. “The Fed is still accommodative and we’re entering into an election year, when politicians are usually pulling various levers to make the economy grow.”

                                                                        Put aside the issue of the Fed's level of accommodation for the moment. Instead, will politicians be in a position to stoke growth during the upcoming election year? As it stands, policy will turn increasingly contractionary in the months ahead. Moreover, conventional wisdom is that a weak economy favors Republicans, who can run on the "are you better off than four years ago?" platform. And looking at the latest news of declining median incomes in the post-recession period, combined with an economy that has dramatically underperformed relative to the Administration's expectations when the stimulus was proposed in 2009, that argument has some legs.

                                                                        Sure, we can argue that Republican intransigence is the core policy problem. But at the same time, the Administration had no back-up plan for an L-shaped recovery, joined the fiscal austerity parade, and continued to place faith in reaching a "Grand Bargain" on the debt rather than focusing on the issue at hand - the unemployment crisis. When all is said and done, I suspect that from the view of the average voter, this Administration owns the economy lock, stock, and barrel.

                                                                        Politically, it makes sense for the Republicans to thwart Democratic attempts to reduce unemployment, and instead keep the focus on the "failure" of such policies to date. And they would like the Federal Reserve kept in line as well. Stan Collender on the recent attempt by Republican leadership to prevent additional easing:

                                                                        In other words, now that the GOP has made it all but impossible for fiscal policy to be used to improve they economy, they want to make sure that the only other tool the government has at its disposal -- monetary policy -- isn't used either.

                                                                        Why take on the Fed? The Republicans have some direct control over fiscal policy because they can either refuse to consider a proposal in the House where they are in the majority or can filibuster legislation in the Senate where they are in the minority. Because the Fed is an independent agency, the GOP can only do what they did today in the letter by threatening to bring down the wrath of god if it dares take any action to get the economy moving.

                                                                        Maybe we will see an extension of payroll tax break and business-tax credits, but that only limits the contractionary turn in fiscal policy. Better than nothing, but far short of what is necessary.

                                                                        So assume fiscal policy is locked up in Washington through 2012, and the Republicans win the White House. What will policy look like in 2013? I would like to hear the views of the gang at Capital Gains and Games. I see two possible outcomes. One is to embrace fiscal austerity with both arms. The other is to abandon fiscal austerity, as it was only a useful weapon to win back the White House. Instead, do exactly the opposite and embrace the mantra that "Reagan proved deficits don't matter." That seems like a strategy designed to win in 2016. But it pushes meaningful policy action out until 2013 rather than 2012 - bad news for the unemployed and financial markets.

                                                                          Posted by on Tuesday, October 11, 2011 at 12:42 AM in Economics, Fed Watch, Fiscal Policy | Permalink  Comments (11)


                                                                          The New Keynesian IS-LM and IS-MP Models

                                                                          David Romer's name has come up several times in recent discussions of the IS-LM and IS-MP models. This is how Romer's new edition of his graduate level macroeconomics book derives the IS-LM and IS-MP curves:

                                                                          Assume that firms produce labor using labor as the only input, i.e. Y = F(L), F'>0, F''≤0, and that government, international trade, and capital are left out of the model for convenience (so that Y=C+I+G+NX becomes Y=C).

                                                                          Also assume that "There is a fixed number of infinitely lived households that obtain utility from consumption and from holding real money balances, and disutility from working. For simplicity, we ignore population growth and normalize the number of households to 1. The representative household's objective function is":

                                                                          Eq1

                                                                          There is diminishing marginal utility (or increasing marginal disutility), as usual. (Note that assuming money is in the utility function is a standard short-cut. See Walsh for a more extensive discussion of this.)

                                                                          Next, let the utility functions for consumption and real money balances take their usual constant relative risk aversion forms:

                                                                          Eq2

                                                                          There are two assets in the model, money and bonds. Money pays no interest, while bonds receive an interest rate of it. Wealth evolves according to:

                                                                          Eq3

                                                                          where At is household wealth at the start of period t, WtLt is nominal income, PtCt is nominal consumption, and Mt is nominal money holdings. This equation says that wealth in period t+1 is equal to the amount of money held at the end of time t plus (1+it) times the bonds help from t to t+1 (the term in parentheses is bonds).

                                                                          Households take the paths of P, W, and i as given, and they choose the paths of C and M to maximize the present discounted value of utility subject to the flow budget
                                                                          constraint and a no-Ponzi-game condition (for simplicity, the choice of L is set aside for the moment). Finally, the path of M is chosen by the monetary authority (later, when the MP curve is derived, this assumption will be changed).

                                                                          The optimization condition (Euler equation) for the intertemporal consumption tradeoff is:

                                                                          Eq4

                                                                          We now, in essence, have the New Keynesian IS curve. To see this, take logs of both sides:

                                                                          Eq5

                                                                          And using the fact that Y=C, approximating ln(1+r) as r (which holds fairly well when r is small), and dropping the constant for convenience gives:

                                                                          Eq6

                                                                          This is the New Keynesian IS curve.  It's just like the ordinary IS curve, except for the lnYt+1 term on the right-hand side (in models with stochastic shocks, this becomes EtlnYt+1, where  EtlnYt+1 is the expected value of Yt+1 given the information available at time t -- often the information set contains only lagged values of variables in the model).

                                                                          Thus, the big difference between the old IS and the microfounded New Keynesian IS curve is the EtlnYt+1 term on the right-hand side. (Thus, it's relatively easy to amend the traditional model of the IS curve to incorporate the expectation term.)

                                                                          It can also be shown (e.g. through a variations argument) that the first order condition for money holding is:

                                                                          Eq7

                                                                          This implies that:

                                                                          Eq8

                                                                          Money demand is increasing in output and decreasing in the nominal
                                                                          interest rate. If this is set equal to (exogenous) money supply, then we have an LM curve. And if we graph the LM curve along with the New Keynesian IS curve, it looks just like the traditional formulation of the model (with the main difference being the expectation of future output term discussed above).

                                                                          Lm Finally, as Romer notes:

                                                                          The ideas captured by the new Keynesian IS curve are appealing and useful... The LM curve, in contrast, is quite problematic in practical applications. One difficulty is that the model becomes much more complicated once we relax Section 6.1's assumption that prices are permanently fixed... A second difficulty is that modern central banks do not focus on the money supply.

                                                                          The first problem is that the LM curve shifts when P changes, so if there is inflation it will be in constant motion making it hard to use as an anlytical tool. That can be overcome, but the second objection is harder to dismiss. However, it is easy to address. Simply assume that the central bank follows a rule for the interest rate such as:

                                                                          Eq9

                                                                          If the central bank adjusts M to ensure this holds, then the money supply is now essentially endogenous (and the interest rate is set externally through the rule). This is an upward sloping curve in r-lnY space, and it is called the MP curve (for monetary policy). It replaces the LM curve in the IS-LM diagram giving us the IS-MP model.

                                                                          Mp However, it would still be possible to do the analysis with the IS-LM diagram, just put a horizontal line at the fixed interest rate and find the money supply that makes this an equilibrium, but as noted above in the presence of inflation the LM curve shifts out continuously making the model hard to use. Thus, in the presence of inflation and an interst rate rule, the IS-MP formulation is much simpler to use. But for other questions, e.g. quantitative easing at the lower bound or pedagogically examining a money rule, the IS-LM model is often more intuitive.

                                                                          But the main point is that if you start from (very simple) microfoundations, the resulting model looks a lot like the old IS-LM model. It still needs to be able to handle price-changes, so it's necessary to add a model of supply to the model of demand provided by the IS-MP or the IS-LM diagrams, and the expectation term on the right-hand side of the IS curve is an important difference from the older modeling scheme, but the two models have a lot in common.

                                                                            Posted by on Tuesday, October 11, 2011 at 12:33 AM in Economics, Macroeconomics, Methodology | Permalink  Comments (9)


                                                                            links for 2011-10-11

                                                                              Posted by on Tuesday, October 11, 2011 at 12:06 AM in Economics, Links | Permalink  Comments (13)


                                                                              Monday, October 10, 2011

                                                                              Fed Watch: Too Early to Sound the All Clear?

                                                                              Tim Duy:

                                                                              Too Early to Sound the All Clear?, by Tim Duy: Last week I wrote:

                                                                              The economy was not in recession in the third quarter, which means the backward looking data flow through this month will not be particularly dire.

                                                                              Consistent with this prediction, the September employment report painted a picture of an economy still wading through knee-deep mud, but not in economic collapse. That said, prior to the report, Barry Ritholtz offered some wisdom regarding individual data points versus trends:

                                                                              What does matter is the overall vector of a given economic sector. Vectors include the rate of acceleration or deceleration, persistency, direction etc. Think overall “trend” and changes thereto. For employment, this means: Are we seeing an increase in the factors that lead to hiring? What is the ratio between hires at big firms vs small firms? Are Wages increasing, staying flat, or decreasing; Temp workers getting hired, total hours worked etc. What are the likely data and modeling errors? Collectively, those factors all add up to an issue of the employment situation roughly improving, maintaining a stability, or getting worse.

                                                                              Hence, each data point should be looked at in terms of whether it is continuing the overall trend, or suggesting a reversal in trend. Everything else is noise.

                                                                              With trends in mind, the data did little to dispel my concern that private sector hiring rolled-over earlier this year, especially when combined with last week's read on employment via the ISM nonmanufacturing report:

                                                                              FRED Graph

                                                                              Trends notwithstanding, Bloomberg offers up some optimisim on the outlook:

                                                                              A string of stronger-than-projected statistics -- capped by the news on Oct. 7 of a 103,000 rise in payrolls last month --has prompted economists at Goldman Sachs Group Inc. and Macroeconomic Advisers LLC to raise their growth forecasts for third quarter growth to 2.5 percent from about 2 percent. That’s nearly double the second quarter’s 1.3 percent rate and would be the fastest growth in a year.

                                                                              “The U.S. economy doesn’t look like it’s double-dipping at all,” said Allen Sinai, president of Decision Economics Inc. in New York. “But it is a crummy recovery.”

                                                                              The article offers up the usual caution on Europe and increasingly tight fiscal policy when the New Year begins. But the bottom line is correct - on the basis of existing data, the recession call looks like a long-shot.

                                                                              Getting to the recession call requires generally ignoring the incoming data on the real economy and instead focusing on financial markets. Then recognize that in recent experience, financial distress leads to broader economic distress. Moreover, at the moment, the slowdown in US economic growth coupled with the possibility of sovereign default in Europe are combining in such a way as to expose the inherent vulnerabilities in a still-under-capitalised global financial system. See Edward Harrison here.

                                                                              And although there is optimism the European situation can be resolved in three weeks, they seem to be walking a very fine line between attempting to recapitalize the banking system without undermining sovereign debt ratings while maintaining what effectively amounts to a pegged exchange rate system that is fundamentally inconsistent with the economic needs of more than one nation. In addition, they have an odd situation where every nation needs to issue Euro-denominated debt, but no nation can actually print Euros as a backstop. It's as if each nation issues only foreign-denominated debt, with ultimately no lender of last resort on a national level. Of course, the European Central Bank could fill this role, but will they?

                                                                              My experience is that when a financial landscape is as ugly as we see here, there is no rescue plan. Things tend to get much worse before they get better. That seems to be what financial market are telling us.

                                                                              With that cheery thought in mind, I offer another distressing correlation. While I generally find monetary aggregates difficult indicators in the best of time, this caught my attention:

                                                                              FRED Graph

                                                                              Since the end of the 1990's, there has been a negative correlation between M2 growth and industrial production growth. It appears that financial market disruptions of the current magnitude are sufficient to drive substantial changes in spending. If this correlation continues to hold, then I need to rethink my belief that any recession in the near term will be relatively mild considering the lack of rebound from the last recession. Perhaps underneath today's seemingly comforting data something very ugly is brewing. Which means enjoy these big rallies on Wall Street while you can.

                                                                                Posted by on Monday, October 10, 2011 at 03:24 PM Permalink  Comments (7)


                                                                                The Nobel Prize in Economics: A Note on Chris Sims' Contributions

                                                                                Let me talk a bit about Sims contributions to economics, and if I have time I'll try to cover Sargent later.

                                                                                Prior to Sims work, in particular his paper "Macroeconomics and Reality," the state of the art in macroeconometrics was to use large-scale structural models. These models often involved scores or even hundreds of equations, essentially a S=D equation for every important market, identities to make sure things add up correctly, etc. But in order to estimate the parameters of these models, the structural parameters as they are known, you had to overcome the identification problem.

                                                                                Without getting into the details, the identification problem essentially asks if its possible to estimate the structural parameters at all. The answer, in general, is no. For example, if every variable in the model appears in every equation, then it won't be possible to estimate the structural model. Let me give an example to illustrate. Suppose that X and and Y are the endogenous variables, e.g. price and quantity for some market, and that the structural model is:

                                                                                Yt = a0 + a1Xt + a2Yt-1 + a3Xt-1 + ut

                                                                                Xt = b0 + b1Yt + b2Yt-1 + b3Xt-1 + vt

                                                                                The a's and the b's are the parameters that economists are generally interested in, but in this form it is not possible to estimate them. There must be what are known as exclusion restrictions before estimation is possible. In this case, for example, identification can be achieved by making either a1 or b1 equal to zero (more on this below), i.e. excluding one of the variables from one of the equations. If there is a reason for this, then excluding the variable is okay, but a variable can't be left out simply to achieve identification -- there must be good reason for excluding Xt from the first equation, or Yt from the second (or both). Omitting a variable that ought to be in a model in order to satisfy the identification restrictions results in a misspecified model and biased estimates.

                                                                                In large models, these exclusions are numerous, and many researchers simply assumed whatever exclusion restrictions were needed to achieve identification, and then went on to estimate the model. In Macroeconomics and Reality, Sims pointed out the problem with this approach. The assumptions that researchers were imposing to achieve identification had no theoretical basis. They were ad hoc and difficult to defend (especially when expectations are in the model -- expectations tend to depend upon all the variables in a model making it difficult to exclude anything from an equation involving expectations).

                                                                                What Sims suggested as an alternative was to drop structural modeling altogether, and to use generalized reduced forms as the basis for estimation. There would be no hope of recovering structural parameters in most cases, but there was still much that could be learned by using reduced forms instead of structural models.

                                                                                For example, the reduced form for the model above is (you can find the reduced form by expressing the endogenous variables Xt  and Yt in terms of exogenous and predetermined variables):

                                                                                Xt = [1/(1-a1b1)]{(a0 + a1b0) + (a1b2 + a2)Yt-1 + (a1b3 + a3)Xt-1 + a1vt + ut}

                                                                                Yt = [1/(1-a1b1)]{(b0 + b1a0) + (b1a2 + b2)Yt-1 + (b1a3 + b3)Xt-1 + vt + b1ut}

                                                                                To estimate this, write it as:

                                                                                Xt = c0 + c1Yt-1 + c2Xt-1 + a1vt + ut

                                                                                Yt = d0 + d1Yt-1 + d2Xt-1 + vt + b1ut

                                                                                This is a VAR model. At first, Sims thought we could draw important conclusions from this model, e.g. suppose that X is money and Y is output. Then this model could tell us how a shock to money would change output over time (these are called impulse response functions -- you hit the system with a shock, and then use the estimated model to trace out the path of the endogenous variables over time). We could use this model to answer important questions such as whether money causes output (Sims' technique for testing causality was essentially the same as Granger causality, but Sims' made an important contribution in extending the causality techniques to systems with three or more variables when he introduced impulse response functions and variance decompositions).

                                                                                But, as Cooley and LeRoy pointed out in an important paper, these models don't avoid structural assumptions after all, at least not if you want to say anything about how variables in the model respond to structural shocks. To see this, note first that the shock we are interested in is the shock to money, vt. Now look at the errors in the two reduced form equations. We can estimate each equation by OLS, and when we do the error terms will be estimates of a1vt + ut for the first equation and vt + b1ut for the second. Thus, we get estimates of linear combinations of the vt and  ut  shocks we are interested in, but we don't get the shocks in isolation like we need. And there's no way to isolate the shocks, i.e. to determine their individual values. That's a problem because we need to find the money shock alone if we want to estimate its effect on output.

                                                                                How can we do this? One way is to make either a1 or b1 equal to zero. Let's set b1=0 because that's the easiest to discuss. In this case, when we estimate the second equation by OLS (the equation with the d parameters), the error will now be an estimate of vt, which is just what we need. However, notice that this is nothing more than an exclusion restriction -- by assuming that b1=0, we are excluding Yt from the second equation (see the structural model). Thus, we have come full circle.

                                                                                This is where Sims Structural VARS come into play. The reduced form above is known as a VAR model (in its estimable form, i.e. the second set of reduced for equations above involving the c and d parameters). It turns out that if we can often defend particular restrictions theoretically, e.g. if money can only respond to output with a lag, perhaps due to information problems, then there is no reason to have the contemporaneous value of output on the right-hand side of the structural equation for money, i.e. this implies that b1=0.

                                                                                Thus, while this still amounts to an exclusion restriction, the restriction is no longer ad hoc -- simply imposed as necessary to achieve identification as back in the old, large-scale structural model days -- it is grounded in theory. And the fact that we insist these restrictions be grounded in theory marks an important difference from the work that came before Sims.

                                                                                And even better, this technique also allows the model to be identified without using exclusion restrictions at all. For example, if we think that some variables in the model have short-run but not long-run effects, e.g. that money can affect output in the short-run, but only produces price effects in the long-run -- a standard assumption in most macro models -- then the zero impact in the long-run can be imposed as an identifying restriction. Exclusion restrictions won't be needed (this is the Blanchard-Quah and Shapiro-Watson techniques).

                                                                                This just scratches the surface of Sims' work -- I wish I had time to do more -- but *hopefully* this provides a window into one part of Sims' contributions.

                                                                                  Posted by on Monday, October 10, 2011 at 11:43 AM in Economics, Methodology | Permalink  Comments (18)


                                                                                  The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel

                                                                                  I'm late getting to this, but congratulations to this year's recipients of the Nobel Prize in Economics, Chris Sims and Tom Sargent. Here are more details:

                                                                                  Empirical Macroeconomics: One of the main tasks for macroeconomists is to explain how macroeconomic aggregates -- such as GDP, investment, unemployment, and inflation -- behave over time. How are these variables affected by economic policy and by changes in the economic environment? A primary aspect in this analysis is the role of the central bank and its ability to influence the economy. How effective can monetary policy be in stabilizing unwanted fluctuations in macroeconomic aggregates? How effective has it been historically? Similar questions can be raised about fiscal policy. Thomas J. Sargent and Christopher A. Sims have developed empirical methods that can answer these kinds of questions. This year's prize recognizes these methods and their successful application to the interplay between monetary and …fiscal policy and economic activity.
                                                                                  In any empirical economic analysis based on observational data, it is difficult to disentangle cause and effect. This becomes especially cumbersome in macroeconomic policy analysis due to an important stumbling block: the key role of expectations. Economic decision-makers form expectations about policy, thereby linking economic activity to future policy. Was an observed change in policy an independent event? Were the subsequent changes in economic activity a causal reaction to this policy change? Or did causality run in the opposite direction, such that expectations of changes in economic activity triggered the observed change in policy? Alternative interpretations of the interplay between expectations and economic activity might lead to
                                                                                  very different policy conclusions. The methods developed by Sargent and Sims tackle these difficulties in different, and complementary, ways. They have become standard tools in the research community and are commonly used to inform policymaking. ...[continue reading]...

                                                                                    Posted by on Monday, October 10, 2011 at 10:26 AM in Economics | Permalink  Comments (4)


                                                                                    Paul Krugman: Panic of the Plutocrats

                                                                                    Are "Wall Street’s Masters of the Universe" feeling some heat?:

                                                                                    Panic of the Plutocrats, by Paul Krugman, Commentary, NY Times: It remains to be seen whether the Occupy Wall Street protests will change America’s direction. Yet the protests have already elicited a remarkably hysterical reaction from Wall Street, the super-rich in general, and politicians and pundits who reliably serve the interests of the wealthiest hundredth of a percent. ...
                                                                                    Consider first how Republican politicians have portrayed the modest-sized if growing demonstrations... Eric Cantor, the House majority leader, has denounced “mobs” and “the pitting of Americans against Americans.” The G.O.P. presidential candidates have weighed in, with Mitt Romney accusing the protesters of waging “class warfare,” while Herman Cain calls them “anti-American.” ... And if you were listening to talking heads on CNBC, you learned that the protesters “let their freak flags fly,” and are “aligned with Lenin.”
                                                                                    The way to understand all of this is to realize that it’s part of a broader syndrome, in which wealthy Americans who benefit hugely from a system rigged in their favor react with hysteria to anyone who points out just how rigged the system is.
                                                                                    Last year, you may recall, a number of financial-industry barons went wild over very mild criticism from President Obama. ... And then there’s the campaign of character assassination against Elizabeth Warren, the financial reformer now running for the Senate in Massachusetts. ...
                                                                                    What’s going on here? The answer, surely, is that Wall Street’s Masters of the Universe realize, deep down, how morally indefensible their position is. They’re not John Galt; they’re not even Steve Jobs. They’re people who got rich by peddling complex financial schemes that, far from delivering clear benefits to the American people, helped push us into a crisis whose aftereffects continue to blight the lives of tens of millions of their fellow citizens.
                                                                                    Yet they have paid no price. Their institutions were bailed out by taxpayers, with few strings attached. They continue to benefit from explicit and implicit federal guarantees — basically, they’re still in a game of heads they win, tails taxpayers lose. And they benefit from tax loopholes that in many cases have people with multimillion-dollar incomes paying lower rates than middle-class families.
                                                                                    This special treatment can’t bear close scrutiny — and therefore, as they see it, there must be no close scrutiny. Anyone who points out the obvious, no matter how calmly and moderately, must be demonized and driven from the stage. ...
                                                                                    So who’s really being un-American here? Not the protesters, who are simply trying to get their voices heard. No, the real extremists here are America’s oligarchs, who want to suppress any criticism of the sources of their wealth.

                                                                                      Posted by on Monday, October 10, 2011 at 12:24 AM in Economics, Financial System | Permalink  Comments (134)


                                                                                      Why Wait?

                                                                                      Richard Thaler:

                                                                                      The country has a long list of roads and bridges that are either dangerous or obsolete. We can begin the inevitable process of rebuilding this infrastructure now, when construction costs are low and borrowing costs are essentially zero, or we can wait.
                                                                                      But why wait? Postponing will only make the projects cost more when we finally get around to starting them, and, in the meantime, we risk disaster if one of those bridges fails. Do we think we will no longer need bridges? If Greece defaults, American cars will not suddenly become amphibious.

                                                                                        Posted by on Monday, October 10, 2011 at 12:15 AM in Economics, Fiscal Policy | Permalink  Comments (13)


                                                                                        links for 2011-10-10

                                                                                          Posted by on Monday, October 10, 2011 at 12:06 AM in Economics, Links | Permalink  Comments (30)


                                                                                          Sunday, October 09, 2011

                                                                                          How Long Will It Take for the Labor Market to Recover?

                                                                                          To state the obvious, we need to create a lot more jobs per month than we have so far. If we continue at present rates, the unemployment rate will stay constant or increase even further. Even if we duplicate the performance of the economy prior to the recession, it will take four years to reach an unemployment rate of 7%. Thus, to get out of this in a reasonable amount of time we need job creation to accelerate considerably, and it's hard to see that happening without help from Congress. Unfortunately, Congress pretends to "feel your pain," but they don't seem to really understand how hard it is for those who are struggling with unemployment -- that this is a crisis requiring immediate, agressive action -- and it's hard to imagine that Congress will give labor markets the amount of help they need. So no need to hold on to your hats, it looks like we're headed for a very slow ride:

                                                                                          Two more job market charts, macroblog: ...Payroll employment growth has averaged about 110,000 jobs a month since February 2010, the jobs low point associated with the crisis and recession. This growth level compares, unfavorably, with the 158,000 jobs added per month during the last jobs recovery period from August 2003 (the low point following the 2001 recession) through November 2007 (the month before the recent recession began). One hundred and ten thousand jobs a month compares favorably, however, to the 96,000 job creation pace so far this year.
                                                                                          Are these sorts of differences material? ...[W]ith a few assumptions, such as the presumptions that the labor force will grow at the same rate as census population projections (for the aficionados, my calculations also assume that the ratio of household employment to establishment employment is equal to its average value since January of this year), the unemployment rates associated with job growth of 158,000, 110,000, and 96,000 per month would look something like this:
                                                                                          These paths are just suggestive, of course, but I think they tell the story. The same jobs recovery rate of the prerecession period would get the unemployment rate down below 7 percent in four years or so. But at the pace we have been going this year, things get worse, not better.

                                                                                            Posted by on Sunday, October 9, 2011 at 09:27 AM in Economics, MoneyWatch, Unemployment | Permalink  Comments (72)


                                                                                            links for 2011-10-09

                                                                                              Posted by on Sunday, October 9, 2011 at 12:06 AM in Economics, Links | Permalink  Comments (23)


                                                                                              Saturday, October 08, 2011

                                                                                              "Financial Crisis and Stimulus"

                                                                                              Ezra Klein:

                                                                                              Financial crisis and stimulus: Could this time be different?, by Ezra Klein, Commentary, Washington Post: Christina Romer had been asked to scare her new boss. It was six weeks after the 2008 election, and the incoming administration had gathered in Chicago. David Axelrod, Barack Obama’s top political adviser, couldn’t have been more clear in his instructions to Romer: The president-elect needed to know how bad the economy was going to get. No pulling punches, no softening the news.
                                                                                              So Romer, the preternaturally cheerful economist whose expertise on the Great Depression made her a natural choice to head the incoming president’s Council of Economic Advisers, worked up some numbers to show how quickly the economy was deteriorating and what would happen if the federal government wasn’t able to mount an effective response.
                                                                                              It was not a pleasant presentation to sit through. The situation was grim. Afterward, Austan Goolsbee, Obama’s friend from Chicago and Romer’s successor, remarked that “that must be the worst briefing any president-elect has ever had.”
                                                                                              But Romer wasn’t trying to be alarmist. Her numbers were based, at least in part, on everybody else’s numbers: There were models from forecasting firms such as Macroeconomic Advisers and Moody’s Analytics. There were preliminary data pouring in from the Bureau of Labor Statistics, the Bureau of Economic Analysis and the Federal Reserve. Romer’s predictions were more pessimistic than the consensus, but not by much.
                                                                                              By that point, the shape of the crisis was clear: The housing bubble had burst, and it was taking the banks that held the loans, and the households that did the borrowing, down with it. Romer estimated that the damage would be about $2 trillion over the next two years and recommended a $1.2 trillion stimulus plan. The political team balked at that price tag, but with the support of Larry Summers, the former Treasury secretary who would soon lead the National Economic Council, she persuaded the administration to support an $800 billion plan.
                                                                                              The next challenge was to persuade Congress. There had never been a stimulus that big, and there hadn’t been many financial crises this severe. So how to estimate precisely what a dollar of infrastructure spending or small-business relief would do when let loose into the economy under these unusual conditions? Romer was asked to calculate how many jobs a stimulus might create. Jared Bernstein, a labor economist who would be working out of Vice President Biden’s office, was assigned to join the effort.
                                                                                              Romer and Bernstein gathered data from the Federal Reserve, from Mark Zandi at Moody’s, from anywhere they could think of. The incoming administration loved their report and wanted to release it publicly. Romer took it home over Christmas to double-check, rewrite and pick over. At 6 a.m. Jan. 10, just days before Obama would be sworn in as president, his transition team lifted the embargo on “The Job Impact of the American Recovery and Reinvestment Act.” It was a smash hit.
                                                                                              “It will be a joy to argue policy with an administration that provides comprehensible, honest reports,” enthused columnist Paul Krugman in the New York Times.
                                                                                              There was only one problem: It was wrong. ...[continue reading]...

                                                                                                Posted by on Saturday, October 8, 2011 at 03:24 PM in Economics, Financial System, Politics | Permalink  Comments (20)


                                                                                                Reich: The Wall Street Occupiers and the Democratic Party

                                                                                                Robert Reich  argues that Democrats will have trouble embracing the populist goals of Occupy Wall Street. Why? Just "follow the money, and remember history":

                                                                                                The Wall Street Occupiers and the Democratic Party, by Robert Reich: Will the Wall Street Occupiers morph into a movement that has as much impact on the Democratic Party as the Tea Party has had on the GOP? Maybe. But there are reasons for doubting it. ...
                                                                                                So far the Wall Street Occupiers have helped the Democratic Party. Their inchoate demand that the rich pay their fair share is tailor-made for the Democrats... But if Occupy Wall Street coalesces into something like a real movement, the Democratic Party may have more difficulty digesting it than the GOP has had with the Tea Party.
                                                                                                After all, a big share of both parties’ campaign funds comes from the Street and corporate board rooms. The Street and corporate America also have hordes of public-relations flacks and armies of lobbyists to do their bidding – not to mention the unfathomably deep pockets of the Koch Brothers and Dick Armey’s and Karl Rove’s SuperPACs. Even if the Occupiers have access to some union money, it’s hardly a match.
                                                                                                Yet the real difficulty lies deeper. A little history is helpful here.
                                                                                                In the early decades of the twentieth century, the Democratic Party had no trouble embracing economic populism. It charged the large industrial concentrations of the era – the trusts – with stifling the economy and poisoning democracy. In the 1912 campaign Woodrow Wilson promised to wage “a crusade against powers that have governed us … that have limited our development … that have determined our lives … that have set us in a straightjacket to so as they please.” The struggle to break up the trusts would be, in Wilson’s words, nothing less than a “second struggle for emancipation.”
                                                                                                Wilson lived up to his words – signing into law the Clayton Antitrust Act..., establishing the Federal Trade Commission (to root out “unfair acts and practices in commerce”), and creating the first national income tax.
                                                                                                Years later Franklin D. Roosevelt attacked corporate and financial power by giving workers the right to unionize, the 40-hour workweek, unemployment insurance, and Social Security. FDR also instituted a high marginal income tax on the wealthy. ...
                                                                                                By the 1960s, though, the Democratic Party had given up on populism. Gone from presidential campaigns were tales of greedy businessmen and unscrupulous financiers. This was partly because the economy had changed profoundly. Postwar prosperity grew the middle class and reduced the gap between rich and poor. By the mid-1950s, a third of all private-sector employees were unionized, and blue-collar workers got generous wage and benefit increases.
                                                                                                By then Keynesianism had become a widely-accepted antidote to economic downturns – substituting the management of aggregate demand for class antagonism. ... Who needed economic populism when fiscal and monetary policy could even out the business cycle, and the rewards of growth were so widely distributed?
                                                                                                But there was another reason for the Democrats’ increasing unease with populism. The Vietnam War spawned an anti-establishment and anti-authoritarian New Left that distrusted government as much if not more than it distrusted Wall Street and big business. Richard Nixon’s electoral victory in 1968 was accompanied by a deep rift between liberal Democrats and the New Left, which continued for decades.
                                                                                                Enter Ronald Reagan, master storyteller, who jumped into the populist breach. If Reagan didn’t invent right-wing populism in America he at least gave it full-throttled voice. “Government is the problem, not the solution,” he intoned, over and over again. In Reagan’s view, Washington insiders and arrogant bureaucrats stifled the economy and hobbled individual achievement.
                                                                                                The Democratic Party never regained its populist footing. ...
                                                                                                Which brings us to the present day. Barack Obama is many things but he is as far from left-wing populism as any Democratic president in modern history. True, he once had the temerity to berate “fat cats” on Wall Street, but that remark was the exception – and subsequently caused him endless problems on the Street.
                                                                                                To the contrary, Obama has been extraordinarily solicitous of Wall Street and big business – making Timothy Geithner Treasury Secretary and de facto ambassador from the Street; seeing to it that Bush’s Fed appointee, Ben Bernanke, got another term; and appointing GE Chair Jeffrey Immelt to head his jobs council.
                                                                                                Most tellingly, it was President Obama’s unwillingness to place conditions on the bailout of Wall Street – not demanding, for example, that the banks reorganize the mortgages of distressed homeowners ... as conditions for getting hundreds of billions of taxpayer dollars – that contributed to the new populist insurrection. ...
                                                                                                This is not to say that the Occupiers can have no impact on the Democrats. ... Pressure from the left is critically important. But the modern Democratic Party is not likely to embrace left-wing populism the way the GOP has embraced – or, more accurately, been forced to embrace – right-wing populism. Just follow the money, and remember history.

                                                                                                Nothing will change until the interests of the powerful are threatened -- they won't give in until populist demands are the lesser of two evils. In the aftermath of the Great Depression, the fear that capitalism would be replaced by something much worse for business contributed to the acquiescence of the powerful to reform that stripped away some of their power and benefited the working class. But what threats do the powerful face now that would cause them to embrace reform as better than the alternative? Is there anything that makes reversing growing inequality, reducing the political power of the wealthy, and changing the view that the system is rigged in favor of the few the best political choice for those who have the most political influence? So far, I don't think there is -- we see pictures on the news of people on Wall Street sipping champagne and enjoying the show with no signs they feel threatened rather than amused -- and there is little sign so far that Democrats believe their reelection chances hinge on embracing this movement (and if this starts to happen, the powerful will do their best to undermine the movement with hippie bashing -- which has already started -- and other attempts to strip the movement of its ability to bring about change).

                                                                                                The powerful aren't going to worry about you, they, of course got where they are with hard work, brains, skill, etc., not a rigged system, family connections, inheritance, the Harvard buddy system, etc. If you weren't as talented as they are, that's your problem. But they will worry about themselves, and if their interests are threatened they'll demand change. Thus, the key will be to make the change the working class needs the only acceptable choice for the powerful, and as I see it we are still (unfortunately) quite a ways from that goal.

                                                                                                  Posted by on Saturday, October 8, 2011 at 11:07 AM in Economics, Income Distribution, Politics | Permalink  Comments (55)


                                                                                                  links for 2011-10-08

                                                                                                    Posted by on Saturday, October 8, 2011 at 12:06 AM in Economics, Links | Permalink  Comments (32)


                                                                                                    Friday, October 07, 2011

                                                                                                    Mankiw: The IS-LM model

                                                                                                    I haven't bothered with the LM versus MP curve debate because it's all been done before, and because there's really nothing to debate. But I forget that many of you weren't around in 2006 (when the post below was written). For me the bottom line is easy, some questions are easier to answer using the IS-LM model (e.g. see here), some with the IS-MP model (in both cases, coupled with a model of AS), but in general, as noted below, "There is no truly substantive debate here. These two models are alternative presentations of the same set of ideas":

                                                                                                    The IS-LM Model, by Greg Mankiw: A reader emails me the following question:

                                                                                                    Dear professor Mankiw:

                                                                                                    I like your blog a lot. I daily go to it in order to read good economics. Keep up the excellent work!

                                                                                                    May I ask you why economists authors of textbooks on intermediate macroeconomics like you keep using the IS-LM model even though we already know that the Central Bank does not set the monetary supply. Instead, it does set the interest rate. Shouldn´t you do like Wendy Carlin and David Soskice in their recent and fantastic book "Macroeconomics: Imperfections, Institutions and Policies" where they replace the LM curve by a monetary rule (for example, a Taylor rule). Wouldn´t that be more representative of what occurs in reality rather than supposing that the institution gets the control of the quantity of money?

                                                                                                    Thanks for your attention in advance.

                                                                                                    Best,
                                                                                                    [name withheld]

                                                                                                    ... My email correspondent wonders whether it would be better just to jettison the traditional IS-LM model in favor of an alternative framework that ignores the money supply altogether and simply takes an interest-rate rule as given. This approach has been advocated by my old friend David Romer. (Economics trivia fact: I was the best man at David Romer's wedding, and he at mine.) You can find David's approach here (figures here). David calls his alternative presentation the IS-MP model, because it combines an IS curve with a monetary policy reaction function.

                                                                                                    The first thing to understand about the choice between IS-LM and IS-MP is that it is not about determining which is the better model of short-run fluctuations. There is no truly substantive debate here. These two models are alternative presentations of the same set of ideas. The key issue in deciding which approach to prefer is not theoretical or empirical but pedagogical.

                                                                                                    The IS-LM approach has a long history behind it. That is one reason to stick with it, but it is not dispositive. If I were convinced that the IS-MP model was a clear and substantial step forward, I would switch. So far, however, I am not convinced that the new approach is easier to teach or more intuitive for students.

                                                                                                    The key difference between the two approaches is what you hold constant when considering various hypothetical policy experiments. The IS-LM model takes the money supply as the exogenous variable, while the IS-MP model takes the monetary policy reaction function as exogenous. In practice, both the money supply and the monetary policy reaction function can and do change in response to events. Exogeneity here is meant to be more of a thought experiment than it is a claim about the world. The two approaches focus the student's attention on different sets of thought experiments.

                                                                                                    I like the IS-LM model because it keeps the student focused on the important connections between the money supply, interest rates, and economic activity, whereas the IS-MP model leaves some of that in the background. The IS-MP model also has some quirky features: In this model, for instance, an increase in government purchases causes a permanent increase in the inflation rate. No one really believes that result as an empirical prediction, for the simple reason that the monetary policy reaction function would change if the natural interest rate (that is, the real interest rate consistent with full employment) changed. This observation highlights that neither model's exogeneity assumption should be taken too seriously.

                                                                                                    In the end, I remain open-minded, but at this point I prefer the IS-LM model when teaching (at the intermediate level) about the short-run effects of monetary and fiscal policy. If one were to teach IS-MP to undergrads, I would prefer to do it as an supplement, rather than a substitute, for IS-LM.

                                                                                                    Related link: Here (and here in published form) is Paul Krugman's cogent defense of teaching the IS-LM model. The article was written quite a while ago, before IS-MP hit the scene, so I don't know what he would say about this alternative framework. But the Krugman piece is interesting, if only vaguely on point, so I wanted to give it some free advertising.

                                                                                                      Posted by on Friday, October 7, 2011 at 02:43 PM in Economics, Macroeconomics, Methodology | Permalink  Comments (22)