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Sometimes, looking at raw statistics, e.g. rates of bankruptcy across variaous groups, is not enough to tell the full story:
Blacks Face Bias in Bankruptcy, Study Suggests, by Tara Siegel Bernard, NY Times: Blacks are about twice as likely as whites to wind up in the more onerous and costly form of consumer bankruptcy as they try to dig out from their debts, a new study has found.
The disparity persisted even when the researchers adjusted for income, homeownership, assets and education. The evidence suggested that lawyers were disproportionately steering blacks into a process that was not as good for them financially...
The vast majority of debtors file under Chapter 7 of the bankruptcy code, which typically allows them to erase most debts in a matter of months. It tends to have a higher success rate and is less expensive than the alternative, Chapter 13, which requires debtors to dedicate their disposable income to paying back their debts for several years.
The study of racial differences in bankruptcy filings ... found that bankruptcy lawyers were much more likely to steer black debtors into a Chapter 13 than white filers even when they had identical financial situations. ...
“Unfortunately I’m not surprised with these results,” said Neil Ellington, executive vice president of Consumer Education Services, a credit counseling agency in Raleigh, N.C. “The same underlying issues that created the problem in mortgage lending, with minorities paying higher interest rates than their white counterparts having the same loan qualifications, are present in all financial fields.” ...
Chapter 13 is not always an inferior choice. Many distressed borrowers go that route because they may be able to save their homes from foreclosure. But even that does not explain away the difference: among blacks who did not own their homes, the rate of filing for Chapter 13 was still twice as high...
If a debtor chooses an inappropriate chapter, there can be serious implications. ...
Republicans want you to beleive that the government's support of programs to promote home ownership among low-income households caused the crisis. The claim doesn't withstand an examination of the actual evidence, but it goes along with the ideology that the government is too large due to spending on social programs for the undeserving "others." It also resonates politically in certain circles, so it has been pushed pretty hard by those supporting conservative ideology. However, it's becoming more and more clear -- crystal clear -- that these groups were the victims of the crisis rather than its cause. Addressing the true causes of the crisis, e.g. an unregulated shadow banking sector, will cause traditional Republican constituencies to lose the freedom to exploit whomever they want/can to make a few more bucks, and that's the truth Republican operatives are trying to hide with this relatively successful attempt to blame the crisis on government help for the poor.
Posted by Mark Thoma on Saturday, January 21, 2012 at 10:17 AM
Posted by Mark Thoma on Saturday, January 21, 2012 at 12:06 AM in Economics, Links |
Another reason to be suspicious of fracking:
Fracking Would Emit Large Quantities of Greenhouse Gases, by Mark Fischetti, Scientific American: Add methane emissions to the growing list of environmental risks posed by fracking.
Opposition to the hydraulic fracturing of deep shales to release natural gas rose sharply last year over worries that the large volumes of chemical-laden water used in the operations could contaminate drinking water. Then, in early January, earthquakes in Ohio were blamed on the disposal of that water in deep underground structures. Yesterday, two Cornell University professors said at a press conference that fracking releases large amounts of natural gas, which consists mostly of methane, directly into the atmosphere—much more than previously thought. ...
Molecule for molecule, methane traps 20 to 25 times more heat in the atmosphere than does carbon dioxide. The effect dissipates faster, however: airborne methane remains in the atmosphere for about 12 years before being scrubbed out by ongoing chemical reactions, whereas CO2 lasts 30 to 95 years. Nevertheless, recent data from the two Cornell scientists and others indicate that within the next 20 years, methane will contribute 44 percent of the greenhouse gas load produced by the U.S. Of that portion, 17 percent will come from all natural gas operations. ...
Posted by Mark Thoma on Friday, January 20, 2012 at 01:26 PM in Economics, Environment, Science |
The arguments for taxing capital gains at a lower rate than other types of income are easily dismissed:
Taxes at the Top, by Paul Krugman:, Commentary, NY Times: Call me peculiar, but I’m actually enjoying the spectacle of Mitt Romney doing the Dance of the Seven Veils —... it’s about time that we had this discussion.
The theme of his dance ... is taxes — his own taxes. Although disclosure of tax returns is standard practice for political candidates, Mr. Romney has never done so, and, at first, he tried to stonewall the issue... Then he said that he probably pays only about 15 percent..., and he hinted that he might release his 2011 return. ...
If Mr. Romney is telling the truth about his taxes, he’s actually more or less typical of the very wealthy. ... The main reason the rich pay so little is that most of their income takes the form of capital gains, which are taxed at a maximum rate of 15 percent, far below the maximum on wages and salaries. So the question is whether capital gains — three-quarters of which go to the top 1 percent of the income distribution — warrant such special treatment.
Defenders of low taxes on the rich mainly make two arguments: that low taxes on capital gains are a time-honored principle, and that they are needed to promote economic growth and job creation. Both claims are false.
When you hear about the low, low taxes of people like Mr. Romney, what you need to know is that it wasn’t always thus... Low capital gains taxes date only from 1997... Correspondingly, the low-tax status of the very rich is also a recent development. ...
So is it essential that the rich receive such a big tax break? There is a theoretical case for according special treatment to capital gains, but there are also theoretical and practical arguments against such special treatment. In particular, the huge gap between taxes on earned income and taxes on unearned income creates a perverse incentive to arrange one’s affairs so as to make income appear in the “right” category.
And the economic record certainly doesn’t support the notion that superlow taxes on the superrich are the key to prosperity. During that first Clinton term, when the very rich paid much higher taxes than they do now, the economy added 11.5 million jobs, dwarfing anything achieved even during the good years of the Bush administration.
So Mr. Romney’s tax dance is doing us all a service by highlighting the unwise, unjust and expensive favors being showered on the upper-upper class. At a time when all the self-proclaimed serious people are telling us that the poor and the middle class must suffer in the name of fiscal probity, such low taxes on the very rich are indefensible.
Posted by Mark Thoma on Friday, January 20, 2012 at 12:48 AM in Economics, Income Distribution, Taxes |
Posted by Mark Thoma on Friday, January 20, 2012 at 12:06 AM in Economics, Links |
Japan Revisited, by Tim Duy: I haven't had a chance to comment on the recent debate regarding Japan's lost decades, so I am coming to the party a bit late. A view is forming that the situation is not as dire as many believe. Paul Krugman notes:
This picture suggests that the Japanese economy was indeed depressed for about 16 years, and deeply so after the slump of the late 1990s. But it may have returned to more or less potential output on the eve of the current crisis.
Just to be clear, this is not a picture of policy success; it is, in fact, a picture of enormous waste. But the condition wasn’t permanent.
Yes, the lost years surely indicate a policy failure. But arguably there is some success. On one hand, we can see this as vindication of massive deficit spending. But is this really success? Because on the other hand, there is no end in sight of such deficit spending. On Japan's 2012 budget, via the FT:
Even by current grim international fiscal standards, Japan’s budget for the year from April 1 makes scary reading.
For the fourth year in a row, government revenue from bond issuance is set to exceed that from all taxes. Outstanding government debt is expected to hit an extraordinary Y937tn.
I don't intend to go down the "Japan's bond market is about to collapse" path. But what I am wondering about is Krugman's description of the condition as not permanent. Do we need to see a reversal of debt to GDP ratios to declare victory? Well, even on that metric it looks like there was some hope heading into the recent downturn:
But such hopes have since been dashed.
Where does this leave me? Yes, fiscal policy can work - it can back fill missing demand. But we haven't seen enough activity in Japan to really jump start the economy to a point that fiscal policy is no longer an economic necessity. And I am not sure we can expect such a jump start without more explicit help from the central bank. In which case, Japan has not truly "recovered." Thus, we cannot yet conclude their condition is not permanent.
In short, before we can declare recovery in Japan, we need to define what a successful recovery should look like. Is it just about returning to potential output (adjusted, in this case, for demographics), or should it be recovery to the point that deficit spending is no longer necessary to support that output?
Posted by Mark Thoma on Thursday, January 19, 2012 at 03:59 PM in Economics, Fed Watch, Financial System, Monetary Policy |
Department of “Duh”, by James Kwak: The Times has a story out today: Surprise, all the Republican candidates’ tax plans increase the national deficit! The numbers (reduction in 2015 tax revenues, from the Tax Policy Center):
- Romney: $600 billion
- Gingrich: $1.3 trillion
- (Late lamented) Perry: $1.0 trillion
- Santorum: $1.3 trillion
I guess that makes Romney the “fiscally responsible” choice, at least among the Republicans. But President Obama’s tax proposals would only reduce 2015 tax revenues by $222 billion. (That’s $385 billion in Table S-4 less $163 billion in Table S-3.)
Second surprise: The big winners in all of these tax plans are the rich! (That’s not just in dollars, but in percentage increase in after-tax income.)
I don’t mean to be hard on the Times reporters. This is exactly the kind of story they should be writing. Someone has to point out that the same people who are complaining about deficits are proposing to vastly increase those deficits. Especially when their fantastic claims are essentially going unchallenged on the campaign trail.
The call for deficit reduction is really a cover for the ideological goal of smaller government. That's why "starve the beast" tax cuts that increase the deficit do not create an uproar among the so-called deficit hawks.
Posted by Mark Thoma on Thursday, January 19, 2012 at 10:30 AM in Budget Deficit, Economics, Politics |
Via Calculated Risk, some decent news on the jobs front:
Weekly Initial Unemployment Claims decline to 352,000, by Calculated Risk: The DOL reports:
In the week ending January 14, the advance figure for seasonally adjusted initial claims was 352,000, a decrease of 50,000 from the previous week's revised figure of 402,000. The 4-week moving average was 379,000, a decrease of 3,500 from the previous week's revised average of 382,500.
The previous week was revised up to 402,000 from 399,000.
The following graph shows the 4-week moving average of weekly claims since January 2000.
Click on graph for larger image.
The dashed line on the graph is the current 4-week average. The four-week average of weekly unemployment claims decreased this week to 379,000.
The 4-week moving average is well below 400,000. ... This is the lowest level for weekly claims since April 2008.
Things are looking better, but I am not ready to conclude we are in the clear just yet -- there are still risks ahead and, in any case, we need an acceleration of activity in order to recover in a decent period of time. Unfortunately, it's not clear where that acceleration will come from. I hope the good news continues, and that it gets even better, but policymakers need to remain wary and, importantly, they should not conclude that the economy is healthy enough to begin raising interest rates or pursuing aggressive deficit reduction -- it's still far too early in the recovery process for that.
Posted by Mark Thoma on Thursday, January 19, 2012 at 10:30 AM in Economics, Unemployment |
Posted by Mark Thoma on Thursday, January 19, 2012 at 12:06 AM in Economics, Links |
Robert Shiller is more generous toward the idea of expansionary austerity than I would have been, but in the end he doesn't believe that contractionary policy is expansionary:
Does Austerity Promote Economic Growth?, by Robert J. Shiller, Project Syndicate: In his classic Fable of the Bees: or, Private Vices, Publick Benefits (1724), Bernard Mandeville, the Dutch-born British philosopher and satirist, described – in verse – a prosperous society (of bees) that suddenly chose to make a virtue of austerity, dropping all excess expenditure and extravagant consumption. What then happened?
The Price of Land and Houses falls;
Mirac’lous Palaces, whose Walls,
Like those of Thebes, were rais’d by Play
Are to be let; . . . .
The building Trade is quite destroy’d
Artificers are not employ’d; . . .
Those, that remain’d, grown temp’rate strive
Not how to spend, but how to live . . .
That sounds a lot like what many advanced countries have been going through, after financial-crisis-induced austerity plans were launched, doesn’t it? ...
But how do we know if Mandeville is right about austerity? His research method – a long poem about his theory – is hardly convincing to modern ears. ...
There is no abstract theory that can predict how people will react to an austerity program. We have no alternative but to look at the historical evidence. And the evidence ... does show that deliberate government decisions to adopt austerity programs have tended to be followed by hard times.
Policymakers cannot afford to wait decades for economists to figure out a definitive answer, which may never be found at all. But, judging by the evidence that we have, austerity programs in Europe and elsewhere appear likely to yield disappointing results.
Posted by Mark Thoma on Wednesday, January 18, 2012 at 01:27 PM in Budget Deficit, Economics |
The editors at CBS asked me to respond to Ari Fleischer's tweets about how tax burdens have changed in recent years:
Are the wealthy paying to much in taxes?: Ari Fleischer, the former White House Press Secretary for U.S. President George W. Bush , has been trying to make the case on Twitter that the wealthy are taking on more of the tax burden than ever. Here's a sample of his tweets:
@AriFleischer The share of total federal tax paid by bottom 60% dropped from 22.5% in '79 to 14.4% today. Source: CBO
@AriFleischer The share of total federal tax paid by middle income dropped from 21% in '79 to 16.5% in '07.
@AriFleischer The share of total federal taxes paid by top 10% rose from 40.7% in '79 to 55% in '07.
The share of total federal taxes paid by top 1% rose from 15.4% in '79 to 28.1% in '07
Of course, the argument is incomplete without knowing how the share of income changed over these years. He uses the CBO as a source, so I'll use the same same data to respond to his claims:
CBO finds that, between 1979 and 2007, income grew by:
- 275 percent for the top 1 percent of households,
- 65 percent for the next 19 percent,
- Just under 40 percent for the next 60 percent, and
- 18 percent for the bottom 20 percent.
The share of income going to higher-income households rose, while the share going to lower-income households fell.
- The top fifth of the population saw a 10-percentage-point increase in their share of after-tax income.
- Most of that growth went to the top 1 percent of the population.
- All other groups saw their shares decline by 2 to 3 percentage points.
Let's take the top 1% first. Between 1979 and 2007 income for this group grew by 275 percent, and the share of income doubled from around 10 percent to around 20 percent of total income. However, the share of taxes for this group less than doubled. Thus, a doubling of income resulted in less than a doubling of taxes. Given that income growth outpaced tax growth, it's hard to see how we can describe this as an increase in the tax burden for the top 1%.
What about the middle of the distribution? As noted above, the share of total federal tax paid by middle income taxpayers dropped from 21 percent in 1979 to 16.5 percent in 2007. However, over the same time period the share of income for this group went from 51.1 percent to 43.5 percent. When the fact that the share of income for the middle income group has fallen is accounted for, it's no surprise that the share of taxes has fallen as well. On net, the two roughly cancel -- the fall in income and the fall in taxes are roughly proportional. Thus, the notion that the rich are paying more, and middle income families are paying less -- that income is being redistributed from the rich to the middle -- does not hold up to further scrutiny. The rich are doing better than ever, tax rates are at historic lows for this group, and their share of taxes has not risen by as much as their share of income.
What about the bottom of the income distribution? First, it's highly misleading to just look at federal taxes for this group. The federal tax burden is relatively low for this group, but when state taxes, sales taxes, and the like are factored in the burden is relatively high. For example:
Data from the Institute on Taxation and Economic Policy show that the poorest fifth of households paid a stunning 12.3 percent of their incomes in state and local taxes in 2010
When all federal, state, and local taxes are taken into account, the bottom fifth of households paid 16.3 percent of their incomes in taxes, on average, in 2010.
Mitt Romney pays 15 percent, or thereabouts (probably a bit more when state and local taxes are accounted for), while this group pays more than 15 percent in taxes even though their incomes are very low. Enough said about who faces a larger tax burden.
Ari Fleischer is trying to make you believe that taxes on the wealthy have risen, and that the increase in taxes is being used to fund tax reductions for lower income classes. However, when income gains are factored in the numbers tell a different story. This graph shows what has actually happened to the tax rates for the wealthy:
The next time Ari Fleischer or any other political operative tries to make the case that the wealthy have experienced an increase in their tax burden, keep this graph in mind.
Posted by Mark Thoma on Wednesday, January 18, 2012 at 11:21 AM in Economics, Income Distribution, Politics, Taxes |
I am now a fellow of the Century Foundation:
The Century Foundation to announce new fellows, by Allen McDuffee, Washington Post: The Century Foundation will announce today the addition of five fellows to the New York based, progressive think tank’s roster. ...
The list of fellows from the release:
•Daniel Alpert, the founding managing partner of Westwood Capital, LLC, who writes perceptively about the causes of the economic woes facing America and the rest of the world while recommending ambitious policy responses.
•Michael Cohen, a foreign policy analyst and author who writes about U.S. foreign policy, national security and foreign assistance, and whose critiques of U.S. military policy, and particularly America’s approach to the Afghanistan war, have proven to be prescient.
•Amy B. Dean, whose Century Foundation book, A New, New Deal: How Regional Activism Will Reshape the American Labor Movement, and other work highlights innovative alternatives to traditional unions that have arisen throughout the country and how these local institutions realize economic change.
•Suzanne Mettler, a Cornell University political scientist who analyzes the problems of policymaking through tax expenditures, sources of the public’s alienation from government through examination of health care reform, and the implications for democracy of higher education policy and stagnating access to college.
•Mark Thoma, a University of Oregon economist whose widely read blog, Economist’s View, synthesizes current economic research for non-experts and highlights ideas for strengthening American social insurance and employment opportunities.
From the "about" page linked above:
The Century Foundation has a strong legacy of work, including key roles in crafting the Securities Exchange Act of 1934 and the critical 1937 amendments to the Social Security Act, as well as Gunnar Myrdal’s writing on Vietnam. At the beginning of our current century, TCF cosponsored the National Commission on Federal Election Reform, led by former Presidents Jimmy Carter and Gerald Ford. The Commission’s final report greatly influenced what became the Help America Vote Act. More recently, in the spring of 2011, a high-level international task force assembled by TCF called for a prompt start to talks to explore the possibilities for negotiations to end the Afghanistan conflict.
Posted by Mark Thoma on Wednesday, January 18, 2012 at 10:37 AM in Economics |
Posted by Mark Thoma on Wednesday, January 18, 2012 at 12:06 AM in Economics, Links |
Miles Corak defends the "Great Gatsby Curve's" illustration of a link between inequality and mobility:
The Economics of the Great Gatsby Curve, by Miles Corak: In an article on the Brookings Institution website that was originally posted by the National Review, Scott Winship questions the idea that greater inequality at a point in time is associated with less generational mobility over time — what the Chairman of the Council of Economic Advisors, Alan Krueger, called the “Great Gatsby Curve” in a speech given on January 12th.
Winship’s article does a disservice to a well-established literature on generational mobility by suggesting that the basic information Krueger used is in some sense invalid. Krueger’s Great Gatsby Curve is in fact well-rooted in the labour economics literature, and debate would be better placed addressing the policy implications he draws than to suggest that President Obama’s top economist feels compelled to create his own facts.
So in the spirit of moving evidence-based public policy forward here is a quick review of the underpinning of the Great Gatsby Curve in both theory and practice. ...[continue reading point by point defense]...
The bottom line?:
Alan Krueger is entitled to his own views on public policy, but not to his own facts. But this also holds for public policy entrepreneurs in the blogosphere. In this case Krueger got his facts right. ...
Posted by Mark Thoma on Tuesday, January 17, 2012 at 07:23 PM in Economics, Income Distribution |
We are, as they say, live:
How Did the Fed Get Things So Wrong?
It's about the Fed's mistakes before and during the crisis, and how it might improve going forward.
Posted by Mark Thoma on Tuesday, January 17, 2012 at 12:42 AM in Economics, Financial System, Fiscal Times, Monetary Policy, Regulation |
Is Europe About to Unravel?, by Tim Duy: Even the illusion of political unity in Europe appears to be dissolving before our eyes. This, of course, should come as no surprise to anyone watching the European crisis unfold. The key problem always was the internal imbalances, a problem for which European policymakers have never offered a credible solution. They simply don't have such a solution in the context of a system of fixed exchange rates. I believe that currency devaluation is the only option that will change relative competitiveness in any reasonable timeframe and restore internal balance. But that option is unavailable for Euro members.
Lacking currency devaluation as a tool to resolve imbalances, European policymakers turned to fiscal austerity. That plan has failed, pushing nation after nation into ever deepening recession. With Greece going on its fifth year of recession, I imagine by now that Portugal, Spain, and even Italy now see the writing on the wall for themselves. Sadly, however, the alternative is exiting the Euro, which almost certainly means financial chaos for the Continent as a whole.
The Eurozone is like a roach motel. You can get in, but you can't get out.
Still, peripheral nations can only accept so much pain before the costs of being in the Euro outweigh the costs of leaving. And Italy is now sending Berlin a clear warning that such an endgame is approaching. Via the Financial Times:
Italy’s prime minister has pleaded for Germany and other creditor countries to do more to help lower his country’s borrowing costs, warning there would be a “powerful backlash” among voters in the eurozone’s struggling periphery if they did not...
..Rome would push the German government to realise it was in “its own enlightened self-interest” to lend more of its fiscal weight to lowering borrowing costs of Italy and other highly indebted governments. The single currency had brought “huge benefits …and maybe [to] Germany even more than others,” he said....
...The stance could put Mr Monti, whose appointment to replace Silvio Berlusconi was cheered by German chancellor Angela Merkel, on a collision course with Berlin.
What can Germany do? Germany could do lots of things to help - running a massive budget deficit to drive consumption and inflation higher comes to mind. Monti, however, is looking for something a little more reasonable, real help on interest rates via Eurobonds and a German commitment to a larger rescue fund. Arguably small concessions given the magnitude of the problem, but Germany resists. He also holds out hope for additional ECB aid:
But he said he believed the ECB should feel more secure to move once a new fiscal discipline treaty is agreed at an Brussels summit at the end of the month.
Perhaps he hopes for too much: A deep rift between politicians and the ECB looks to be growing. A stunning development, again via the Financial Times:
The European Central Bank has harshly criticised negotiators working on a new treaty to enshrine fiscal discipline in the eurozone, saying that recent revisions to the draft amounted to “a substantial watering down” of the pact’s strictures intended to force down debt levels within the single currency.
Jörg Asmussen, a member of the ECB’s executive board, wrote to negotiators that new provisions in the treaty that would allow highly indebted eurozone countries to breach budget deficit limits “in periods of severe economic downturn” amounted to an “escape clause” that could lead to “easy circumvention of the rule”.
“These revisions in my view clearly run against the spirit of the initial general agreement on an ambitious fiscal compact,” Mr Asmussen wrote in a letter on the ECB’s behalf, dated Thursday.
The original compact would of course be watered down - it was never credible to begin with, as it called for a level of fiscal austerity across the Eurozone compatible only with Depression. The ECB is looking for just such an outcome:
In proposed treaty language accompanying the letter, Mr Asmussen suggested that eurozone countries should only be allowed to breach the deficit limit – which is defined in the text as 0.5 per cent of economic output – in times of “natural catastrophes and serious emergency situations outside the control” of eurozone governments.
How far with the ECB push the issue? Will they back away from further bond purchases? Edward Harrison and Martin Feldstein have more here and here. I would add that it pays to remember the ECB plays for keeps, and is not above outright extortion to get what it wants.
Meanwhile, via Naked Capitalism, Wolf Richter informs us of another rift growing in the Eurozone rescue efforts, this time in the disaster that is Greece:
But now the Troika itself is in disarray. It surfaced today at an IMF press briefing in Washington: the IMF no longer supports austerity as a guiding principle. Athens News quoted a senior IMF source, who was speaking on condition of anonymity. Frustration was practically palpable:
Horizontal austerity measures are constantly being adopted that are leading nowhere, whilst further wage and pension cuts are unjustified because the only way to improve competitiveness is through growth-creating market liberalization, the opening of closed professions, and productive investments.
The three Troika inspectors—Poul Thomsen from the IMF, Mathias Morse from the EU, and Klaus Mazouch from the ECB—are supposed to head to Greece next week to inspect its books; the budget deficit is once again higher than the revised limit that Greece had vowed to abide by. And they’re supposed to negotiate additional “structural reforms.” But there probably won’t be three inspectors, according to senior IMF sources. Missing: Poul Thomsen. The IMF has had enough.
Finally, note that last week's S&P downgrade came down especially hard on Portugal. That bailout is headed toward another round of private sector involvement. Only a matter of time.
Bottom Line: In Europe, the unstoppable force of austerity is colliding with the immovable object that is reality. Expect fireworks.
Posted by Mark Thoma on Tuesday, January 17, 2012 at 12:33 AM in Economics, Fed Watch, Financial System |
Posted by Mark Thoma on Tuesday, January 17, 2012 at 12:06 AM in Economics, Links |
Martin Feldstein has a warning about European plans for further austerity:
European political leaders may be about to agree to a fiscal plan which, if implemented, could push Europe into a major depression. ...
The European Union’s summit in Brussels ... agreed to cap annual “structural” budget deficits at 0.5% of GDP, with penalties imposed on countries whose total fiscal deficits exceeded 3% of GDP – a limit that would include both structural and cyclical deficits, thus effectively limiting cyclical deficits to 3% of GDP. ...
The most frightening recent development is a formal complaint by the European Central Bank that the proposed rules are not tough enough. Jorg Asmussen, a key member of the ECB’s executive board, wrote to the negotiators that countries should be allowed to exceed the 0.5%-of-GDP limit for deficits only in times of “natural catastrophes and serious emergency situations” outside the control of governments.
If this language were adopted, it would eliminate automatic cyclical fiscal adjustments, which could easily lead to a downward spiral of demand and a serious depression.
Posted by Mark Thoma on Monday, January 16, 2012 at 12:57 PM in Budget Deficit, Economics, Fiscal Policy |
Rising inequality "threatens to make America a different and worse place":
How Fares the Dream?, by Paul Krugman, Commentary, NY Times: “I have a dream,” declared Martin Luther King, in a speech that has lost none of its power to inspire. And some of that dream has come true. ... When we observe Martin Luther King’s Birthday, we have something very real to celebrate: the civil rights movement was one of America’s finest hours...
King ... dreamed of a nation in which his children “will not be judged by the color of their skin but by the content of their character.” But what we actually became is a nation that judges people ... by the size of their paychecks. And in America, more than in most other wealthy nations, the size of your paycheck is strongly correlated with the size of your father’s paycheck.
Goodbye Jim Crow, hello class system.
Economic inequality isn’t inherently a racial issue... But ... there are racial implications to the way our incomes have been pulling apart. ... In the 1960s it was widely assumed that ending overt discrimination would improve the economic as well as legal status of minority groups. And at first this seemed to be happening. ...
But around 1980 the relative economic position of blacks in America stopped improving. Why? An important part of the answer, surely, is that circa 1980 income disparities in the United States began to widen dramatically...
The Times recently reported on a well-established finding..., we actually have less intergenerational economic mobility than other advanced nations. ... And there’s every reason to believe that our low economic mobility has a lot to do with our high level of income inequality.
Last week Alan Krueger, chairman of the president’s Council of Economic Advisers, gave an important speech about income inequality... Highly unequal countries, he showed, have low mobility... And ... this relationship suggests that America in the year 2035 will have even less mobility than it has now,... a place in which the economic prospects of children largely reflect the class into which they were born.
That is not a development we should meekly accept.
Mitt Romney says that we should discuss income inequality, if at all, only in “quiet rooms.” There was a time when people said the same thing about racial inequality. Luckily, however, there were people like Martin Luther King who refused to stay quiet. And we should follow their example today. For the fact is that rising inequality threatens to make America a different and worse place — and we need to reverse that trend to preserve both our values and our dreams.
Posted by Mark Thoma on Monday, January 16, 2012 at 01:11 AM in Economics, Income Distribution |
How's That Austerity Working?, by Tim Duy: From a Wall Street Journal article on the collapse of the Greek debt talks:
The negotiations have been tortuous. After first insisting no default by any euro-zone country would be possible, leaders agreed in July to seek a deal to cut about 10% from the face value of Greece's bonds in private hands. By October, Greece's prospects had deteriorated, and euro-zone governments and the IIF agreed to pursue a deal to cut the face value in half. Since October, Greece's economy, which is entering its fifth year of recession, has weakened further, worsening the state of its government finances. That means a bigger gap in Greece's budget that must be filled either by more debt relief or more new lending from official creditors.
How can this downward spiral end with anything other than a technical default? It can't, which is why the debt talks collapsed. The cuts necessary to bring Greek debt down to anything even remotely sustainable is much greater than the supposed 50% haircut agreed to last October. And that 50% headline number is now a source of heartburn for European politicians. Via the FT:
Charles Dallara, the IIF’s managing director, told the Financial Times on Sunday that he believed an agreement in principle needed to be completed by the end of this week if the restructuring deal was to be finalised in time for a €14.4bn Greek bond redemption due on March 20.
Though he said Greek officials were negotiating in good faith, he was critical of other eurozone negotiators, saying they were not living up to the outlines of the haircut deal reached at a tense October EU summit. “[Ms Merkel and Mr Sarkozy] and all the European heads of state said they wanted a deal with a 50 per cent [haircut] and a voluntary agreement,” Mr Dallara said. “Some of their own collaborators are not following that decision.”...
...Greek debt managers had agreed with bondholders on a coupon just below 5 per cent but creditors last week proposed a much lower interest rate.
Germany has proposed a 2-3 per cent coupon that would increase bondholders’ losses from 60 per cent to more than 80 per cent in net present value terms.
It looks like Merkel and Sarkozy are trying to pull the old bait and switch on creditors. The difference between a 60% and an 80% cut is meaningful, and sufficient to drive some debtholders, such as hedge funds that picked the stuff up on the cheap, to think they are better off to take the chance on their CDS counterparties rather than submit to a "voluntary" restructuring of the magnitude necessary to bring real relief to Greece's fiscal situation.
One has to say this about European policymakers - they sure keep it interesting.
Meanwhile, German Chancellor Angela Merkel appears to have learned nothing from the ongoing debt-deflation dynamics throughout much of Europe. Responding to the S&P downgrades, via the FT:
Ms Merkel said the downgrade made implementation of steps towards fiscal union – to be codified in an inter-governmental treaty which could be signed by the end of January – urgent. She called on leaders to resist softening up the so-called fiscal compact “here, there and everywhere” as details were hammered out.
Even after German GDP turned negative in the final quarter of last year, Merkel can find no other option than fiscal austerity. Perhaps some hope from France:
François Fillon, prime minister, at the weekend ruled out more austerity measures, saying the government’s efforts were aimed at boosting growth.
Then perhaps, maybe not:
But he also said in an interview with Journal du Dimanche, a Sunday newspaper: “We will do everything to get it [the triple A] back.”
Does France have any choice but additional austerity? What would happen politically if the core refused to embrace what it pushed upon the periphery? Spain appears ready to double-down on the austerity path, even as a slowing economy pushes the budget deficit over 8% of GDP:
Mariano Rajoy, the centre-right prime minister who took power in Spain last month, has responded to Friday’s credit downgrade from Standard & Poor’s by saying that his government will persevere with austerity and economic reforms, cutting the budget deficit, modernising labour laws and restructuring the banking sector.
Good luck with that - it has worked so well in Greece.
Bottom Line: The actions of the European Central Bank greatly eased the immediate financial pressures in the Eurozone. But the underlying problem of internal imbalances remain, and the European response is still not addressing those imbalances. Instead, the commitment to the fixed exchange rate combined with Germany's failure to recognize that their current account surplus must turn to deficit if they ever hope to be repaid promises to lock the Eurozone on the path of ongoing recession.
Posted by Mark Thoma on Monday, January 16, 2012 at 12:29 AM
Posted by Mark Thoma on Monday, January 16, 2012 at 12:06 AM in Economics, Links |
John Kay says that the term "capitalism" is misleading in modern economies:
Let’s talk about the market economy, by John Kay, Commentary, Financial Times: ...Karl Marx never used the word capitalism. But after the publication of Das Kapital, the term came to describe the system of business organization which had made the industrial revolution possible. By the mid-19th century ... individuals or ... a small group of active partners ... built and owned both the factories and plants in which the new working class was employed... The economic and political power of business leaders derived from their ownership of capital and the control that ownership gave them over the means of production and exchange.
The political and economic environment in which Marx wrote was a brief interlude in economic history. ... Legislation passed in Marx’s time permitted the establishment of the limited liability company, which made it possible to build businesses with widely dispersed share ownership. ...
So the business leaders of today are not capitalists in the sense in which Arkwright and Rockefeller were capitalists. Modern titans derive their authority and influence from their position in a hierarchy, not their ownership of capital. They have obtained these positions through their skills in organizational politics, in the traditional ways bishops and generals acquired positions in an ecclesiastical or military hierarchy. ...
People do not know who owns their work tools because the answer does not matter. If your boss pushes you around, exploits you or appropriates your surplus value, the reasons have nothing to do with the ownership of capital..., ownership of the means of production and exchange matters very little.
Sloppy language leads to sloppy thinking. By continuing to use the 19th-century term capitalism for an economic system that has evolved into something altogether different, we are liable to misunderstand the sources of strength of the market economy and the role capital plays within it.
This is an important point, and it relates directly to the claim by many that inequality is needed in capitalist economies as an engine of growth. I think small businesses still operate in something resembling old fashioned capitalism -- owners putting their own resources at risk to open a new business -- but big business is another story (and in some cases, such as the finncial industry, too big too fail considerations reduce risk considerably for high level executives making arguments that this type of risks motivates innovation, etc. hard to swallow).
Posted by Mark Thoma on Sunday, January 15, 2012 at 11:15 AM in Economics |
Posted by Mark Thoma on Sunday, January 15, 2012 at 12:06 AM in Economics, Links |
Once again, Jeff Sachs takes on the editorial page of the WSJ and tries to expose the "big lie of our time" (or one of them anyway):
How the Wall Street Journal Misleads About Federal Jobs, by Jeff Sachs: The editorial board of Rupert Murdoch's Wall Street Journal has a simple game. They want to cut taxes for the rich and government services for the rest, and end regulations of banks and the environment. They support taxpayer-financed bailouts of Wall Street when needed. They will twist any facts in the service of these goals.
Today's lead editorial, with its graph of "Obama's Growing Payroll," is a perfect example... The gist of the editorial is that Obama is presiding over a massive increase of government, exemplified by the surge of civilian employees. The graph shows a striking rise of federal employment from around 1.875 million in 2008 to 2.1 million in 2011. (I reproduce this as Figure 1 below).
The Journal neglects the fact that today's 2.1 million workers is actually identical to the number of Federal employees in 1981 at the start of the Reagan Administration, 1989 at the end of the Reagan Administration, and 1993 at the end of the Bush Sr. Administration. The numbers went down slightly after that ... with a decline in Defense Department civilian employees, a decline that was probably offset by the rise of private defense contractors (not included in the OMB tables). There is no long-term trend at all. (I show this as Figure 2 below).
The Journal endlessly tries to portray the "growth of government" as a social welfare system run amok. The editorial implies that President Obama is repeating LBJ's Great Society by building up giant welfare and regulatory programs reflected in the "boom" of federal employment. But where did this so-called "boom" (actually a tiny boomlet) actually appear? In Great Society programs? In entitlements?
No, the increase in employment is mainly in national-security-related employment: the military, homeland security, and justice (including prisons, FBI, drug enforcement, and the like). Welfare and entitlements programs little to do with it. If we parse the increase of 225,000 federal jobs between 2008 and 2011, three-fourths came in the Defense Department (+84,000), Homeland Security (+28,000), Justice (+13,000), and Veteran's Affairs (+45,000).
Of course the Journal's entire argument is ... a red herring, since the increase of 225,000 jobs represents all of 0.0017 of U.S. non-farm employment of 131 million workers. The entire federal civilian workforce is a mere 1.6 percent of the total non-farm employment. The Journal is taking tiny fluctuations and making them into a federal case, so to speak, for its propagandistic purposes.
The actual fact of relevance is that the federal government has been declining as a share of national non-farm employment, from 2.3 percent in 1981 to 1.6 percent in 2011. ...
The big lie of our time is that the federal government is expanding out of control. ... For government services that count for the 99 percent, the federal government is shrinking, alas, no matter which phony figures the Wall Street Journal throws our way.
Posted by Mark Thoma on Saturday, January 14, 2012 at 12:38 PM in Economics, Politics, Press, Social Insurance |
Economics is not value free in practice, but should economics be value free, at least in principle? I used to think the answer was a clear yes -- we should do our best to promote positive analysis and avoid normative -- but in recent years I've become much more open to other possibilities.
I'm still not fully convinced that we should abandon the principle of promoting positive analysis over normative, I want to believe it's possible, but as it stands many people disguise normative conclusions behind positive analysis -- and these are some of the top people in the profession. (One of the reasons my views have evolved is the surprising and rather blatant political posturing hidden as economic analysis from some top economists on the other side of the political fence -- I refuse to sit by idly while those games are being played. It's also amazing how often economists get theoretical and empirical results that support their political leanings. I'd like to believe that their economics is pure and that it drives their politics, and not the other way around, but given how often prior political beliefs are confirmed through what is supposed to a scientific process, you have to wonder if we aren't more like lawyers arguing an ideological position than scientists in search of the truth. I'd also like to believe these behaviors can be eliminated over time through devotion to truth-seeking as a profession, but that may not be possible. If not, then pretending that we are pursuing purely positive questions and adhering to these principles simply plays into the hands of those with an agenda who know better. In my heart of hearts, I want economics to be a positive science, but that may be a hope that cannot be realized.)
Posted by Mark Thoma on Saturday, January 14, 2012 at 10:13 AM in Economics, Methodology |
Posted by Mark Thoma on Saturday, January 14, 2012 at 12:06 AM in Economics, Links |
Simon Wren-Lewis on ideology and demand denial (I agree with his comments on the "asymmetry" in the views of Keynesian and non-Keynesian economists, and that in many cases ideology is the likely explanation for the differnece):
Ideology and Demand Denial, mainly macro: ...What the debate over fiscal policy has revealed is an underlying generic antagonism towards Keynesian analysis.
There is an asymmetry here. Keynesian economists do not deny that productivity or other supply side shocks can often be important. On the other side there appears to be, among many at least, a belief that Keynesian economics is never relevant. What this amounts to is what Krugman and others call demand denial. Yet the basis in economic theory for demand denial appears very unclear. Say’s Law, or maybe some kind of quantity theory with fixed velocity, would do it – but these were really bad ideas that the profession dismissed many decades ago. ...
Keynes had a number of thoughts on this, as the following from the General Theory shows (‘it’ in the first sentence is a theory that involves demand denial).
That it reached conclusions quite different from what the ordinary uninstructed person would expect, added, I suppose, to its intellectual prestige. That its teaching, translated into practice, was austere and often unpalatable, lent it virtue. That it was adapted to carry a vast and consistent logical superstructure, gave it beauty. That it could explain much social injustice and apparent cruelty as an inevitable incident in the scheme of progress, and the attempt to change such things as likely on the whole to do more harm than good, commanded it to authority. That it afforded a measure of justification to the free activities of the individual capitalist, attracted to it the support of the dominant social force behind authority.
Now beautiful though this passage is, a good deal has changed since 1936. New Keynesian theory is a ‘consistent logical superstructure’, so there is no intellectual prestige involved in denying its relevance (except, perhaps, to fellow believers). Yet two sentences still ring true. The first is the idea that austerity is virtuous. Some of the popular discourse around fiscal policy has moral overtones, perhaps stemming from the idea that governments, like individuals, have to practice self control. Now while I think seeing economics as a morality play is generally unhelpful, in the case of fiscal policy there is a problem of deficit bias: governments over the last few decades have tended, on average, to spend too much or tax too little. (Some particular evidence, and a fairly comprehensive discussion of reasons for deficit bias, can be found here. ...) However deficit bias is a long term problem and a recession is not the time to start dealing with it.
The final sentence from Keynes also still rings true. One explanation for demand denial is that it has ideological roots. In the real world we have the problem of ensuring aggregate demand matches supply, and this requires state intervention – normally monetary policy. For those who want to argue that state intervention in the economy is generally a bad thing, it is embarrassing to acknowledge that there is one area where it is essential. But I get no joy in seeing ideology mess with economics, and so I would be more than happy to be convinced that there was another explanation for demand denial.
Posted by Mark Thoma on Friday, January 13, 2012 at 03:15 PM in Economics, Macroeconomics, Methodology |
Michael Spence surprises me by making many of the points about markets I've been trying to emphasize lately (and help making these points is more than welcome), in particular that markets are not very good at addressing stability, distributional equity, and sustainability issues:
Mind over Market, by Michael Spence, Commentary, Project Syndicate: In the 66 years since World War II ended, virtually all centrally planned economies have disappeared, largely as a result of inefficiency and low growth. Nowadays, markets, price signals, decentralization, incentives, and return-driven investment characterize resource allocation almost everywhere.
This is not because markets are morally superior... Markets are tools that, relative to the alternatives, happen to have great strengths with respect to incentives, efficiency, and innovation. But they are not perfect; they underperform in the presence of externalities (the un-priced consequences – for example, air pollution – of individual actions), informational gaps and asymmetries, and coordination problems when there are multiple equilibria, some superior to others.
But markets have more fundamental weaknesses. Or, rather, most societies have important economic and social objectives that markets and competition are not designed to achieve. In today’s rapidly globalizing world, the most important of these objectives – expressed in various ways through the political and policymaking process in a wide range of countries – are stability, distributional equity, and sustainability. ... Stability, equity, and sustainability challenges have become crucially important, and the role of the state in relation to markets may need re-thinking as a result. ...[continue reading]...
Posted by Mark Thoma on Friday, January 13, 2012 at 10:57 AM in Economics, Income Distribution, Market Failure, Policy |
There's a big difference between "running a business and managing an economy":
America Isn’t a Corporation, by Paul Krugman, Commentary, NY Times: ...the main plank of Mitt Romney’s case that he should be president ... is ... that what we need to fix our ailing economy is someone who has been successful in business. ...
But there’s a ... problem...: America is not, in fact, a corporation. Making good economic policy isn’t at all like maximizing corporate profits. And businessmen — even great businessmen — do not, in general, have any special insights into what it takes to achieve economic recovery.
Why isn’t a national economy like a corporation? ... Most ... giant corporations sell the great bulk of what they produce to other people, not to their own employees — whereas even small countries sell most of what they produce to themselves, and big countries like America are overwhelmingly their own main customers. ...
And the fact that we mostly sell to ourselves makes an enormous difference when you think about policy.
Consider what happens when a business engages in ruthless cost-cutting. From the point of view of the firm’s owners (though not its workers), the more costs that are cut, the better. ...
But the story is very different when a government slashes spending in the face of a depressed economy. Look at Greece, Spain, and Ireland, all of which have adopted harsh austerity policies. In each case, unemployment soared, because cuts in government spending mainly hit domestic producers. And, in each case, the reduction in budget deficits was much less than expected, because tax receipts fell as output and employment collapsed. ...
Did I mention that the last businessman to live in the White House was a guy named Herbert Hoover? (Unless you count former President George W. Bush.)
And there’s also the question of whether Mr. Romney understands the difference between running a business and managing an economy.
Like many observers, I was somewhat startled by his latest defense of his record at Bain — namely, that he did the same thing the Obama administration did when it bailed out the auto industry, laying off workers in the process. ...
But what really struck me was how Mr. Romney characterized President Obama’s actions: “He did it to try to save the business.” No, he didn’t; he did it to save the industry, and thereby to save jobs that would otherwise have been lost, deepening America’s slump. Does Mr. Romney understand the distinction?
America certainly needs better economic policies than it has right now — and while most of the blame for poor policies belongs to Republicans and their scorched-earth opposition to anything constructive, the president has made some important mistakes. But we’re not going to get better policies if the man sitting in the Oval Office next year sees his job as being that of engineering a leveraged buyout of America Inc.
Posted by Mark Thoma on Friday, January 13, 2012 at 12:32 AM in Economics, Politics |
Posted by Mark Thoma on Friday, January 13, 2012 at 12:06 AM
The big story today seems to be the Fed's comments about the housing bubble in transcripts from their meetings in 2006. The transcripts show what we already knew, that the Fed was never fully convinced there was a housing bubble, and asserted that even if there was the dmage could be contained -- they could easily clean up after it pops without the economy suffering too much damage:
Greenspan image tarnished by newly released documents, by Zachary A. Goldfarb, Washington Post: The leaders of the Federal Reserve went around the room saluting Alan Greenspan during his last major meeting as chairman of the central bank Jan. 31, 2006. ...
Some six years later, Greenspan’s record — sterling when he left the central bank after 18 years — looks much more mixed. Many economists and analysts say a range of Fed policies contributed to the financial crisis and resulting recession. These included keeping interest rates low for an extended period, failing to take action to stem the bubble in housing prices and inadequate oversight of financial firms.
The Thursday release of transcripts of Fed meetings in 2006 shows that top leaders of the Fed — several of whom continue to hold key positions today — had a limited awareness of the gravity of the threat that the weakness in the housing market posed to the rest of the economy. And they had what turned out to be an excessive optimism about how well things would turn out. ...
A Fed economist reported in a 2006 meeting that “we have not seen — and don’t expect — a broad deterioration in mortgage credit quality.” That turned out to be incorrect. ...
Posted by Mark Thoma on Thursday, January 12, 2012 at 10:48 AM in Economics, Monetary Policy |
I think it would be fair to say that Joe Stiglitz isn't predicting a return to general prosperity anytime soon:
The Perils of 2012, by Joseph E. Stiglitz, Commentary, Project Syndicate: The year 2011 will be remembered as the time when many ever-optimistic Americans began to give up hope. President John F. Kennedy once said that a rising tide lifts all boats. But now, in the receding tide, Americans are beginning to see not only that those with taller masts had been lifted far higher, but also that many of the smaller boats had been dashed to pieces in their wake.
In that brief moment when the rising tide was indeed rising, millions of people believed that they might have a fair chance of realizing the “American Dream.” Now those dreams, too, are receding. ...
This year is set to be even worse. It is possible, of course, that the United States will solve its political problems and finally adopt the stimulus measures that it needs to bring down unemployment to 6% or 7% (the pre-crisis level of 4% or 5% is too much to hope for). But this is as unlikely as it is that Europe will figure out that austerity alone will not solve its problems. ...
Meanwhile, long-term problems – including climate change and other environmental threats, and increasing inequality in most countries around the world – have not gone away. Some have grown more severe. ...
I'm not sure it was intended as a joke, but this part made me laugh: "It is possible, of course, that the United States will solve its political problems and finally adopt the stimulus measures that it needs..."
Posted by Mark Thoma on Thursday, January 12, 2012 at 10:32 AM in Economics |
While I frantically look for something else to post before I have to go teach today, here's something I did a few day sago on Obama's plans to cut military spending:
Will Obama's military cuts hurt the economy?, by Mark Thoma, CBS News: President Obama and Pentagon leaders late last week unveiled a new defense strategy for a smaller, more flexible military force, which the president says will prepare the nation for the threats of the future while restoring balance between the defense budget and domestic spending.
The plan would cut defense spending by 10 percent over the next decade, and there are worries that this could harm our ability to recover from the recession and potentially lower long-run economic growth.
How valid are these concerns? Beginning with the worry about the effect of the cuts on the recovery from the recession, anything that reduces spending on domestic goods and services will slow the economy and hurt our ability to recover. Thus, if cuts to defense spending cause the demand for goods and services to fall substantially, there would be a corresponding decline in gross domestic product (GDP), and a slower recovery.
Will the cuts cause significant declines in spending on domestic goods and services? To answer this, there are several things to consider: the timing of the cuts, the degree to which the cuts come from domestic rather than foreign spending, the size of the cuts, and their composition.
The first thing to note, in a point made by Ezra Klein, is that although the growth of defense spending will be reduced, that growth will still be positive. Thus, relative to the old, higher spending trajectory for defense spending, this is certainly a reduction -- but there will still be growth over time. Therefore, while it's likely that economic growth will be lower than otherwise as a result of the cuts, the net impact of defense spending will still be positive.
The other factors are more difficult to evaluate. As noted in The Washington Post, "The strategy review will not spell out potential $480 billion to $1 trillion in spending cuts that the Pentagon is facing over the next decade. Details of those reductions will begin to trickle out next month." So we don't know the composition of the cuts, their timing, whether they will come from spending in the U.S. or spending in foreign countries, and so on.
But we do know the size of the cuts -- an average of to $48 billion to $100 billion per year -- and that is enough to matter, especially to a recovering economy. And although the exact cuts are unknown, it's probably a safe bet that several weapons system will be cut. (For example, there is already talk that Boeing (BA) is canceling plans for a new factory). Again, those types of cuts would matter.
However, I expect many of the cuts will be delayed. That's good news for the recovery, but it also means the cuts will need to be even larger in the latter years of the 10-year window for spending reductions. But even if the cuts are larger than average in the later years, so long as the economy is relatively healthy when the cuts are made, they shouldn't have large negative effects. However, if the recovery is very slow -- if there are still many years to go, as many analysts expect -- then the chances that these cuts will hit too soon increases quite a bit.
Turning next to the concerns about long-run growth reported by Binyamin Appelbaum of The New York Times, the worry is that cutting military spending on research and development (which represents 12 percent of total military spending) will reduce technological spillovers to the private sector and harm long-run economic growth.
There is less than full agreement among economists about the degree to which these types of spillovers are important to economic growth. However, even if there are important spillovers, as Ezra Klein notes, there are more effective ways to produce the type of R&D that enhances future growth than relying upon spillovers from military technology. Thus, to the extent this is a problem, the answer is to redirect the spending to non-military research efforts.
There are concerns about the economic impact of the cuts to defense spending in both the short-run and long-run. However, those concerns are likely overblown. In short short-run, so long as the cuts to overall government spending are delayed until the economy is on better footing -- as they are likely to be -- they should not have a large impact on the economy. And in the longer run, there should not be any substantial harm to economic growth so long as research outside of the military receives adequate support.
Note: As I said in comments the other day, I wish I hadn't cut this paragraph -- or something like it -- in editing:
The other thing we know, if we can believe the talk in Washington, is that the spending will represent a reduction in the deficit, the money saved from the cuts will not be redirected to non-military government uses, e.g. on infrastructure. If it were redirected then the effects would almost certainly be very small no matter the timing (and they could even be positive if inefficient and wasteful military spending is redirected to more efficient, and more stimulative private sector uses -- as noted here, "military spending ... tends to bring fewer spillover benefits than many other forms of government spending"). Thus, to the extent that the cuts do reduce demand, and won't be offset elsewhere, that will increase their impact on the economy.
That is, I wish I would have talked more about using the savings from reductions in military spending to stave off cuts to important social insurance programs, infrastructure, etc.
Posted by Mark Thoma on Thursday, January 12, 2012 at 09:23 AM in Budget Deficit, Economics |
Posted by Mark Thoma on Thursday, January 12, 2012 at 12:06 AM in Economics, Links |
A recent column (on the claim that Democrat are anti-market, socialists, see here too):
Democrats are Not Anti-Market, by Mark Thoma: Republican hopefuls are attempting to portray the coming presidential election as a battle between people who believe in free markets and those who want to turn the U.S. into a socialist state. Michele Bachmann has been quite explicit with this charge, and Mitt Romney, Newt Gingrich, and the other leading Republican candidates have made similar claims.
There are certainly those on the left who call for radical change, including the elimination of the market system, just as there are those on the right who have extreme views on a variety of topics. But the Democratic Party is not calling for the overthrow of capitalism, and the claim that Democrats prefer a socialist state is false. Democrats support markets too. The disagreement is about the best way to bring about a well-functioning market system, and whether that system produces an equitable distribution of income and opportunity.
Conservatives believe that markets work best when government involvement is minimal or absent altogether. They don’t deny that individual markets can fail for a variety of reasons, and they acknowledge that the aggregate economy is subject to cyclical swings that bring periods of high unemployment. However, with patience markets and the macroeconomy will fix themselves. If the government steps in and tries to help, on net it will make things worse, not better. Thus it’s almost always best to wait for the economy to heal itself, even if the wait is a long one.
Democrats have different ideas about what it takes for markets to fully realize their potential. They believe that individual markets work best when government takes an active role to prevent market failures. They also believe that monetary and fiscal policies are useful tools to offset cyclical swings in the aggregate economy.
Democrats also differ from Republicans on the need for government to redistribute income. Republicans believe that redistributing income reduces the incentive to pursue economic gains, and this lowers long- run economic growth. Democrats believe that a more equitable distribution of income is desirable in some instances, and that worries about the impact redistribution will have on economic growth are overstated. Democrats also believe there are significant concentrations of political power and market failures that distort the distribution of income, and these distortions should be corrected through government action.
Which of these two visions is correct? Republicans have tried to blame the financial crisis on the government, in particular government programs to support housing for low-income households, but the evidence overwhelmingly refutes this claim. The problem wasn’t too much government, it was that government did not do enough.
We would be much better off today if government had ignored Alan Greenspan and other advocates of deregulation who argued that financial markets are self-policing, and had instead provided strong regulatory oversight of both the traditional and shadow banking sectors. We would also be better off if the Fed had intervened and popped the housing bubble as it was inflating rather than denying there was a bubble and arguing it could always clean up the mess quickly and neatly in any case.
And in assessing the two views, it’s important to note that the things the government did do were helpful. Though the design of the Bush administration’s bailout of the financial sector left much to be desired, it prevented a much worse outcome. There’s also little doubt that the fiscal stimulus put in place during the Obama administration helped the economy. Things would be better today if we had resisted the austerity minded and done even more to stimulate output and job creation.
In the coming year, we will have to choose between these competing views of the government’s proper role in the economy. The Republican view is that the economy can take care of itself. There’s no need for government to intervene, and the distribution of income – no matter how skewed – should also be left alone.
We’ve already tried Republican policies in recent decades and the promised economic growth, stability, and widely shared prosperity did not materialize. Instead we had a Great Recession, inequality widened substantially, and market and political power became more and more concentrated.
In addition, the recent recession challenges the GOP’s “markets are magic” point of view. During the time when the housing bubble was inflating, markets misdirected resources and too much of our intellectual talent, labor, and raw materials were drawn into housing and finance. Markets also failed to optimally hedge against risks, they have been very slow to self-correct – labor markets in particular – and the fact that the extraordinarily high profits in the financial sector have not been eroded away through new entry is a sign of excessive and persistent market imperfections.
The other view, that of Democrats, speaks directly to these problems. It embraces active oversight of markets to ensure they are operating to maximize social good, it encourages the use of countercyclical monetary and fiscal policies to stabilize output and employment, and it advocates correcting the inevitable inequities in income and opportunity that arise in imperfect, real world market systems.
Thus, contrary to the charge from Republicans that Democrats are anti-market, there’s a strong argument to be made that it’s the policies of Democrats rather than Republicans that do the best job of allowing markets to reach their full potential.
Posted by Mark Thoma on Wednesday, January 11, 2012 at 10:55 AM in Economics, Fiscal Policy, Fiscal Times, Market Failure, Monetary Policy |
Output Gaps and Inflation, by Tim Duy: Regarding, again, the size of the output gap, this remark is found in the most recent Fed minutes:
However, a couple of participants noted that the rate of inflation over the past year had not fallen as much as would be expected if the gap in resource utilization were large, suggesting that the level of potential output was lower than some current estimates.
I think this has less to do with the size of the output gap and more to do with downward nominal wage rigidities. Note that wages are still rising, although the pace of wage growth for production and nonsupervisory workers is still falling:
Perhaps a better example is the relatively new series, wages for all workers:
Overall private wage growth bottomed out in 2009 and held around 1.75%, perhaps just beginning to rise in recent months.
Despite very high unemployment and underemployment, wage growth is still positive. It tends to be very difficult to induce workers to take wages cuts (think also how the newly unemployed will resist taking new jobs with a substantially lower pay), which in-turn helps put a downside to inflation. In other words, one would expect the relationship between the output gap (or, similarly, high unemployment) and inflation to flatten as inflation rates fall toward zero.
This is also covered by Paul Krugman here and here.
Also note that rising wages doesn't necessarily imply higher inflation. Between the two is productivity growth. To account for the latter, we can look at unit labor costs:
Not exactly a lot of inflationary pressures stemming from unit labor cost growth. Presumably, high real wages could come by redistributing productivity gains to workers in the context of low inflation. For that to happen, however, I think we will need a lot more upward pressure on the labor market than we are seeing right now.
Posted by Mark Thoma on Wednesday, January 11, 2012 at 12:17 AM in Economics, Fed Watch, Inflation, Monetary Policy, Unemployment |
Posted by Mark Thoma on Wednesday, January 11, 2012 at 12:06 AM in Economics, Links |
Via Chris Dillow, this is Simon Wren-Lewis of Oxford University:
Mistakes and Ideology in Macroeconomics, by Simon Wren-Lewis: Imagine a Nobel Prize winner in physics, who in public debate makes elementary errors that would embarrass a good undergraduate. Now imagine other academic colleagues, from one of the best faculties in the world, making the same errors. It could not happen. However that is exactly what has happened in macro over the last few years.
Where is my evidence for such an outlandish claim? Well here is Nobel prize winner Robert Lucas
But, if we do build the bridge by taking tax money away from somebody else, and using that to pay the bridge builder -- the guys who work on the bridge -- then it's just a wash. It has no first-starter effect. There's no reason to expect any stimulation. And, in some sense, there's nothing to apply a multiplier to. (Laughs.) You apply a multiplier to the bridge builders, then you've got to apply the same multiplier with a minus sign to the people you taxed to build the bridge.
And here is John Cochrane, also a professor at Chicago, and someone who has made important academic contributions to macroeconomic thinking.
Before we spend a trillion dollars or so, it’s important to understand how it’s supposed to work. Spending supported by taxes pretty obviously won’t work: If the government taxes A by $1 and gives the money to B, B can spend $1 more. But A spends $1 less and we are not collectively any better off.
Both make the same simple error. If you spend X at time t to build a bridge, aggregate demand increases by X at time t. If you raise taxes by X at time t, consumers will smooth this effect over time, so their spending at time t will fall by much less than X. Put the two together and aggregate demand rises.
But surely very clever people cannot make simple errors of this kind? Perhaps there is some way to re-interpret such statements so that they make sense. ,,. Brad deLong tries very hard along these lines (see here for example), but just throws up inconsistencies.
I prefer to just note that if any undergraduate or graduate student in the UK wrote this in an exam, they would lose marks. The more interesting question for me is why the errors were made. ...
I want to suggest two answers. The first is familiarity with models. I cannot imagine anyone who teaches New Keynesian economics, or who talked to people who teach New Keynesian economics, making this mistake. This is because, in these models, we do have to worry about aggregate demand. We focus on consumption smoothing, and Ricardian Equivalence... I often tell my first year undergraduate students that if they write anything like ‘Ricardian Equivalence says fiscal stimulus will never work’, they are in danger of failing. ...
Lack of familiarity with New Keynesian economics may be partly explained by the history of macroeconomic thought that I briefly noted in an earlier post. As New Keynesian theory is an ‘add-on’ to the basic Ramsey/RBC model, it is possible to teach macro without getting round to teaching New Keynesian theory. However, what many people find difficult to understand is how monetary policy (or at least monetary policy as seen by pretty much every central bank) could be regarded as an optional add-on in macroeconomics.
The second difference between physics and macro that could lead to more mistakes in the latter is ideology. When you are arguing out of ideological conviction, there is a danger that rhetoric will trump rigour. In the next paragraph Cochrane writes
These ideas changed because Keynesian economics was a failure in practice, and not just in theory. Keynes left Britain 30 years of miserable growth. Richard Nixon said, “We are all Keynesians now,” just as Keynesian policy led to the inflation and economic dislocation of the 1970s--unexpected by Keynesians but dramatically foretold by Milton Friedman’s 1968 AEA address. Keynes disdained investment, where we now all realize that saving and investment are vital to long-run growth. Keynes did not think at all about the incentives effects of taxes. He favored planning, and wrote before Hayek reminded us how modern economies cannot function without price signals. Fiscal stimulus advocates are hanging on to a last little timber from a sunken boat of ideas, ideas that everyone including they abandoned, and from hard experience. ...
Let’s not worry about where the idea that Keynes disdained investment comes from, or any of the other questionable statements here. This is just polemic: Keynes=fiscal expansion=planning=macroeconomic failure. It is guilt by association. What on earth does fiscal expansion have to do with planning? Well, they are both undertaken by the state.
I have argued elsewhere that the problem too many macroeconomists have with fiscal stimulus lies not in opposing schools of thought, or the validity of particular theories, or the size of particular parameters, but instead with the fact that it represents intervention by the state designed to improve the working of the market economy. They have an ideological problem with countercyclical fiscal policy. But the central bank is part of the state, and it intervenes to improve how the economy works, so this ideological view would also mean that you played down the role of monetary policy in macroeconomics. So ideology may also help explain a lack of familiarity with the models central banks use to think about monetary policy. In short, an ideological view that distorts economic thinking can lead to mistakes.
Posted by Mark Thoma on Tuesday, January 10, 2012 at 10:03 AM in Economics, Macroeconomics, Methodology |
I need to think about this more before signing onto or rejecting this argument, but here is Chris Dillow's response to the post above this one (and it provides a nice complement to the post that follows by Dan Little):
Mechanisms vs models, by Chris Dillow: Simon Wren-Lewis asks a good question about Robert Lucas‘s and John Cochrane‘s apparent misunderstanding of the balanced budget multiplier: how can very clever people make silly errors?
He suggests two good answers. I’d like to suggest a third. There are two different ways of thinking about economics - the model paradigm and the mechanism paradigm, and the former has crowded out the latter.
If you spend X at time t to build a bridge, aggregate demand increases by X at time t. If you raise taxes by X at time t, consumers will smooth this effect over time, so their spending at time t will fall by much less than X. Put the two together and aggregate demand rises.
This is clear and true. And it would be obvious to anyone using the mechanism paradigm. If you ask “What is the mechanism whereby higher taxes reduce consumer spending?” you pretty much walk into the notion of consumption smoothing. ...
But lots of brilliant economists don’t think merely in terms of mechanisms but rather build impressive models. And like photographers, they tend to fall in love with their models which distracts them both from others’ models and from mechanisms.
This matters, because the importance of particular mechanisms varies from time to time. The social sciences, wrote Jon Elster:
can isolate tendencies, propensities and mechanisms and show that they have implications for behaviour that are often surprising and counter-intuitive. What they are more rarely able to do is state necessary and sufficient conditions under which the various mechanisms are switched on. This is [a] reason for emphasizing mechanisms rather than laws. Laws by their nature are general…Mechanisms by contrast make no claim to generality. (Nuts and bolts for the social sciences, p 9-10)
A good example of this lies in the idea of expansionary fiscal contraction. The virtue of this idea is that it draws our attention to mechanisms (a falling exchange rate, better corporate animal spirits, whatever) whereby fiscal contraction might boost the economy. The drawback is that these mechanisms are just unlikely to operate here and now. Yes, there’s a model that tells us that expansionary fiscal contraction can work. And there are models that say it can’t. But arguing about competing models misses the practical point.
Now, there is an obvious reply to all this. Models have the virtue of ensuring internal consistency, and thus avoiding potentially misleading partial analysis. However, I’m not sure whether this is an argument against mechanisms so much as against poor thinking about them.
When I was a student (back in the 80s!) I learned lots of models (OK, a few), but when I became a practising economist, I found them to be less useful in thinking about the economy than Elsterian thinking about mechanisms.
This is not to dismiss models entirely. I’m just saying that, insofar as they have uses other than as mental gymnastics for torturing students, it is because of the mechanisms contained within them. The parts might be more useful than the sum.
Posted by Mark Thoma on Tuesday, January 10, 2012 at 10:02 AM in Economics, Macroeconomics, Methodology |
Dan Little discusses how the definition of a scientific explanation has changed over time:
Recent thinking about scientific explanation, by Dan Little: What do we want from a scientific explanation? Is there a single answer to this question, or is the field of explanation fundamentally heterogeneous, perhaps by discipline or by research community? Do biologists explain outcomes differently from physicists or sociologists? Is a good explanation within the Anglo-American traditions of science also a good explanation in the German or Chinese research communities? Is the idea of a scientific explanation paradigm-dependent?
For several decades in the twentieth century there was a dominant answer to this question, that was an outgrowth of the tradition of logical positivism and examples from the natural sciences. This theory of explanation focused on the idea of subsumption of an event or regularity under a higher-level set of laws. The deductive-nomological theory of explanation specified that an outcome is explained when we have produced a deductively valid argument with premises that include at least one general law and that lead to a description of the event as conclusion. Carl Hempel was the most prominent advocate for this theory (Aspects of Scientific Explanation), but it was widely accepted throughout the philosophy of science in the 1950s and 1960s. The "covering law" model was a core dogma for the philosophy of science for several decades.
The D-N theory was subject to many kinds of criticisms, including the obvious point that much explanation involves phenomena that are probabilistic rather than deterministic. Hempel introduced the inductive version of the D-N model to cover probabilistic-statistical explanation, along these lines. An argument provides a scientific explanation of E if it provides at least one probabilistic law and a set of background conditions such that, given the law and conditions, E is highly probable. This model was described as the "Inductive-Statistical" model (I-S model). Wesley Salmon's Scientific Explanation and the Causal Structure of the World falls within this tradition but offers important refinements, including his formal definition of causal relevance.
In each case the motivation for the theory of explanation is a plausible one: we explain an event when we show how it was necessary [or highly probable] in the circumstances, given existing conditions and relevant laws of nature. On the logical positivist approach, an explanation is an answer to a "why necessary" question: why did this event occur? In this conception of explanation the idea of necessity or probability is replaced with the idea of deductive or inductive derivability -- a syntactic relationship among sets of sentences.
A different approach to explanation turns to the idea of causation. We provide an explanation of an event or pattern when we succeed in identifying the causal conditions and events that brought it about. This approach can be tied to the D-N approach, if we believe that all causal relations are the manifestation of strict or probabilistic causal regularities. But not all D-N explanations are causal, and not all causal explanations invoke regularities. Derivability is no longer the criterion of explanatory success, and explanation is no longer primarily a syntactic relation between sets of sentences. Instead, substantive theories of causal powers and properties are the foundation of scientific explanation. A leading exponent of this view is Rom Harré in Harré and Madden, Causal Powers: Theory of Natural Necessity. Nancy Cartwright's Nature's Capacities and Their Measurements is also an important contribution to this view. And J. L. Mackie's The Cement of the Universe: A Study of Causation is an important contribution as well. The causal approach retains the idea that explanation involves showing why an event is necessary or probable, but it turns from derivability from statements of laws of nature, to theories of causal powers and properties.
The causal mechanisms approach to explanation continues the insight that explanations involve demonstrating why an event occurred; but this approach moves even farther away from the idea of a causal law, replacing it with the idea of a discrete causal mechanism. On this approach, we explain an event when we identify a series of causal interactions that lead from some antecedent condition to the outcome of interest. Hedstrom and Swedborg's Social Mechanisms: An Analytical Approach to Social Theory presents aspects of this theory of explanation in application to the social sciences. One benefit of the social mechanisms approach is that it also provides a basis for answering "how possible" questions: if our puzzlement is that an outcome has occurred that seems inherently unlikely, we can provide an account of a set of causal mechanisms that transpired to bring it about.
The chief line of dispute in the traditions mentioned so far is between the "general laws" camp and the "causal powers" camp. Both are committed to the idea that explanation involves showing how an outcome fits into the ways the world works; but the general laws approach presumes that law-like regularities are fundamental, whereas the causal approach presumes that causal powers and mechanisms are fundamental.
So what has developed in the theory of explanation in the past twenty years? Quite a bit. A recent collection of essays coming largely from the Scandinavian tradition of the philosophy of science is quite helpful in orienting readers to recent developments. This is Johannes Persson and Petri Ylikoski's 2007 Rethinking Explanation. Quite a number of the contributions are worth reading carefully. But Jan Faye's "Pragmatic-Rhetorical Theory of Explanation" is a good place to start. Faye distinguishes among three basic approaches to the theory of explanation: formal-logical, ontological, and pragmatic. The formal-logical approach is essentially the H-D and I-S approaches described above. The ontological approach is the causal-powers approach described above. The pragmatic approach is in a sense the most important recent contribution to the theory of explanation, and represents a significant re-focusing of the debates in post-empiricist philosophy of science. Here is how Faye describes the pragmatic approach to explanation-theory:
The pragmatic view sees scientific explanations to be basically similar to explanations in everyday life. It regards every explanation as an appropriate answer to an explanation-seeking question, emphasising that the context of the discourse, including the explainer’s interest and background knowledge, determines the appropriate answer.
And why should we consider a pragmatic approach? Faye offers eight reasons:
First, we have to recognise that even within the natural sciences there exist many different types of accounts, which scientists regard as explanatory.
Second, if one is looking for a prescriptive treatment of explanation, I see no reason why the social sciences and the humanities should be excluded from such a prescription. If they are included, the prescriptive account must include intentional and interpretive explanations, i.e., accounts providing information about either motives or meanings.
Third, the meaning of a why-question alone does not determine whether the answer is relevant or not.
Fourth, John Searle has correctly argued that the meaning of every indicative sentence is context-dependent. He does not deny that many sentences have literal meaning, which is traditionally seen as the semantic content a sentence has independently of any context.
Fifth, many explanations take the form of stories. Arthur Danto has argued that what we want to explain is always a change of some sort. When a change occurs, we have one situation before and another situation after, and the explanation is what connects these two situations. This is the story.
Sixth, a change always takes place in a complex causal field of circumstances each of which is necessary for its occurrence. Writers like P.W. Bridgman, Norwood Russell Hanson, John Mackie, and Bas van Fraassen have all correctly argued that events are enmeshed in a causal network and that it is the salient factors mentioned in an explanation that constitute the causes of that events.
Seventh, the level of explanation depends also on our interest of communication. In science an appropriate nomic or causal account can be given on the basis of different explanatory levels, and which of these levels one selects as informative depends very much on the rhetorical purposes.
Eight, scientific theories are empirically underdetermined by data. It is always possible to develop competing theories that explain things differently and, therefore, it is impossible to set up a crucial experiment that shows which of these theories that yields the correct account of the data available.
Faye then goes on to analyze scientific explanation as a speech act. We need to understand the presuppositions and purposes that the explainer and the listener have, before we can say much about how the explanation works.
Petri Ylikoski's contribution to the volume, "The Idea of Contrastive Explanandum," picks up on one particular but pervasively important feature of the rhetorical situation of explanation, the idea of contrast. When we ask for an explanation of an outcome, often we are not asking simply why it occurred, but rather why it occurred instead of something else. And the contrastive condition is crucial. If we ask "why did the Prussian army win the Franco-Prussian War?", the answer we give will be very different depending on whether we understand the question as:
"Why did the Prussian army [rather than the French army] win the Franco-Prussian War?"
"Why did the Prussian army win [rather than fighting to stalemate] the Franco-Prussian War?"
So scientific explanation is context-dependent in at least this important respect: we need to understand what the question-asker has in mind before we can provide an adequate explanation from his/her point of view. As Henrik Hallsten puts it in his contribution, "What to Ask of an Explanation-Theory",
To summarize: Any explanation-theory must [do] justice to the distinction between objective explanatory relevance and context dependent explanatory relevance or provide good arguments as to why this distinction should not be upheld. (16)
So perhaps the most important recent developments in the theory of scientific explanation fall in a few categories. First, there has been substantial work on refining the idea of causal explanation (link). Second, philosophers have reinforced the idea that explanation has pragmatic and rhetorical aspects that cannot be put aside in favor of syntactic and substantive features of explanation. And third, there is more recognition and acceptance of the idea that explanatory models and standards may reasonably differ across disciplines and research areas. In particular, the social and historical sciences are entitled to offer explanatory frameworks that are well adapted to the particular kinds of why and how questions that are posed in these fields. In each case the philosophy of science has made a very great deal of progress since the state of the debates about explanation that transpired in the 1960s.
Posted by Mark Thoma on Tuesday, January 10, 2012 at 08:45 AM in Economics, Methodology |
Posted by Mark Thoma on Tuesday, January 10, 2012 at 12:06 AM in Economics, Links |
More on the Output Gap, by Tim Duy: Only time for a quick post between classes today...
Hoisted from the comments from my last piece, Steve notes:
In an interview with Bloomberg last week, Bullard explicitly said he expected the economy to follow a new output trend out of the base of the recession rather than a recovery to a trend from the previous peak. The written media didn't pick up on these quotes; rather they focused his comments that explicit inflation targeting is near.
I missed that interview, but found it here. And yes, St. Louis Federal Reserve President James Bullard does say that estimates of the output gap are too high and will be revised downward. He says the outcomes of the last expansion were not related to economic fundamentals and thus we should not expect to be able to return to those levels of output and, presumably, employment. He does not aim to return to the pre-recession trend of output growth and is instead ready to manage the economy along the new path. Bullard does admit, however, that he has gotten little traction for his view.
On the other end of the spectrum, San Francisco Federal Reserve President John Williams offers an interview to the Wall Street Journal, and sounds dovish even after the most recent employment report:
In a follow-up email exchange, Mr. Williams wrote that the report didn't fundamentally alter his views on the economy.
"My view of it is inflation is going to be for a sustained period below target," he said. "Unemployment is going to be sustained above a reasonable estimate of the natural rate of unemployment, which is closer to 6.5% than the 8.5% that we have now. That does make an argument that we should have more stimulus."
There is a caveat, however:
Mr. Williams also hedges, though, adding that it "really depends in how much confidence you have in that forecast. And also there are costs to taking greater policy action. There are always trade-offs that have to be weighed."
This is frustrating, because if there is indeed an argument further stimulus, what is holding the Fed back? Why hedge by questioning the forecast? And what are the costs? Presumably the cost is higher inflation, but Williams already says he expects inflation to be below target. So why pull your punches?
I am starting to wonder if the whole "we can do more" meme from the dovish side of the FOMC has more to do with just offering a counterweight to the hawks who seem to see an imminent need for tightening rather than a push for an actual policy change.
Posted by Mark Thoma on Monday, January 9, 2012 at 07:01 PM in Economics, Fed Watch, Monetary Policy |
A Note on Determinants of Aggregate Demand..., by Brad DeLong: Paul Krugman wrote:
A Note On The Ricardian Equivalence Argument Against Stimulus: I’ve tried to explain why Lucas and those with similar views are all wrong several times…. But it just occurred to me that there may be an even more intuitive way to see just how wrong this is: think about what happens when a family buys a house with a 30-year mortgage. Suppose that the family takes out a $100,000 home loan…. If the house is newly built, that’s $100,000 of spending that takes place in the economy. But the family has also taken on debt, and will presumably spend less because it knows that it has to pay off that debt.
But the debt won’t be paid off all at once — and there’s no reason to expect the family to cut its spending right now by $100,000. Its annual mortgage payment will be something like $6,000, so maybe you would expect a fall in spending by $6000; that offsets only a small fraction of the debt-financed purchase.
Now notice that this family is very much like the representative household in a Ricardian equivalence economy, reacting to a deficit financed infrastructure project like Lucas’s bridge; in this case the household really does know that today’s spending will reduce its future disposable income. And even so, its reaction involves very little offset to the initial spending.
How could anyone who thought about this for even a minute — let alone someone with an economics training — get this wrong? And yet as far as I can tell almost everyone on the freshwater side of this divide did get it wrong, and has yet to acknowledge the error.
Let me make two points:
First, in their defense, I would note that if the government buys the same goods as the private sector would have bought anyway and hands them out, then the family would cut its spending right now by $100,000, because then it is both the case that (a) you are poorer because of the future tax liability, and (b) your marginal utility of consumption right now is low because the government is giving you all of this stuff. But since what the government buys (roads, bridges, weather stations, human capital for twelve year olds, etc.) tends to be quite different from what the private sector buys, this defense is extremely shaky and limited.
Second, I remember--long ago--Bob Barro telling a bunch of us that "RE is just a Modigliani-Miller result for the government's balance sheet". And he was right. However, there is nobody who says: "corporate capital structure is irrelevant". Instead, people say: "corporate capital structure is relevant because it can help the corporation (a) create assets that those with preferred habitats are willing to pay healthy premiums to hold, and (b) minimize the appropriate combination of future monitoring, agency, and reorganization costs." Nobody takes MM to be the end of analysis: it is the start.
Yet a lot of people--for reasons I have never understood--take RE to be the end of the analysis...
Posted by Mark Thoma on Monday, January 9, 2012 at 02:07 PM in Economics, Macroeconomics |
I was asked to comment on the economic impact of cuts to defense spending:
Will Obama's military cuts hurt the economy?
Posted by Mark Thoma on Monday, January 9, 2012 at 08:26 AM in Budget Deficit, Economics, Unemployment |
Do Republicans really believe in a level playing field?:
America’s Unlevel Field, by Paul Krugman, Commentary, NY Times: Last month President Obama gave a speech invoking the spirit of Teddy Roosevelt on behalf of progressive ideals — and Republicans were not happy. Mitt Romney, in particular, insisted that where Roosevelt believed that “government should level the playing field to create equal opportunities,” Mr. Obama believes that “government should create equal outcomes,”... a society where “everyone receives the same or similar rewards, regardless of education, effort and willingness to take risk.”
As many people were quick to point out, this portrait of the president as radical redistributionist was pure fiction. What hasn’t been as widely noted, however, is that Mr. Romney’s picture of himself as a believer in a level playing field is just as fictional. ...
Americans are much more likely than citizens of other nations to believe that they live in a meritocracy. But ... America actually stands out as the advanced country in which it matters most who your parents were, the country in which those born on one of society’s lower rungs have the least chance of climbing to the top or even to the middle. And if you ask why..., a large part of the reason is that our government falls down on the job of creating equal opportunity. ...
Which brings me back to those, like Mr. Romney, who claim to believe in equality of opportunity. Where is the evidence for that claim?
Think about it: someone who really wanted equal opportunity would be very concerned about ... inequality... He would support more nutritional aid for low-income mothers-to-be and young children. He would try to improve the quality of public schools. He would support aid to low-income college students. And he would support ... a universal health care system...
If Mr. Romney has come out for any of these things, I’ve missed it. And the Congressional wing of his party seems determined to make upward mobility even harder. For example, Republicans have tried to slash funds for the Women, Infants and Children program, which helps provide adequate nutrition to low-income mothers and their children; they have demanded cuts in Pell grants, which are designed to help lower-income students afford college. And they have, of course, pledged to repeal a health reform...
So where is the evidence that Mr. Romney or his party actually believes in equal opportunity? Judging by their actions, they seem to prefer a society in which your station in life is largely determined by that of your parents — and in which the children of the very rich get to inherit their estates tax-free. Teddy Roosevelt would not have approved.
Posted by Mark Thoma on Monday, January 9, 2012 at 12:51 AM in Economics, Income Distribution, Politics |
Tim Duy, by Tim Duy: Last week - before the most recent employment report - the Wall Street Journal offered up the odds of another round of quantitative easing:
“Primary dealers,” those 21 lucky banks that answered the Old Bridge Troll’s questions correctly and were granted the right to do business directly with the Fed, see QE3 coming and don’t see the Fed raising rates for at least two years.
That’s according to the results of a new survey of primary dealers by the New York Fed.
Primary dealers, on average, assign a 45% chance of a Fed interest-rate increase in the second quarter of 2014. Before that, the chances of a rate increase are never higher than 15%.
High expectations are not a surprise given the propensity of some officials to make remarks like these from New York Federal Reserve President William Dudley:
However, because the outlook for unemployment is unacceptably high relative to our dual mandate and the outlook for inflation is moderate, I believe it is also appropriate to continue to evaluate whether we could provide additional accommodation in a manner that produces more benefits than costs, regardless of whether action in housing is undertaken or not.
It's no secret some Fed officials have been looking into additional purchases of mortgage-backed assets to support the economy via the housing market. And once they started talking about it, market participants began to assume it was imminent. Moreover, the idea of additional easing popped up in the most recent minutes:
A number of members indicated that current and prospective economic conditions could well warrant additional policy accommodation, but they believed that any additional actions would be more effective if accompanied by enhanced communication about the Committee's longer-run economic goals and policy framework.
So now we have a timeline - first, enhanced communication. Second, additional easing. Seems straight forward, especially now that inflation looks to be trending downward, alleviating the panic that appeared to seize FOMC members in the first part of 2011.
But after the first part of 2011 comes a string of relatively solid data, at least as solid as one gets in this recovery. That data culminates with the decidedly not-terrible employment report. How long could it be before monetary policymakers started to question the need for additional easing?
Just a single day. On Saturday, St. Louis Federal Reserve President started to toss cold water on the idea of additional easing. Via MarketWatch:
“I don’t think it [QE] is very likely right now because the tone of the data has been very strong right now,” Bullard told reporters after a speech at the American Economic Association meeting....
...Bullard said he was encouraged by the December employment report that showed a drop in the unemployment rate to near a three-year low of 8.5%.
“I thought the jobs report was encouraging. Hopefully it is harbinger of more robust activity,” he said.
Bullard said he thinks Wall Street is too gloomy about the outlook.
“I think forecasters are a bit too pessimistic about the U.S. economy,” he said. “The recession has been over for fair amount of time. It is a logical point in the recovery where you would expect somewhat more rapid growth and somewhat better jobs market, so we’ll see if that is what happens.”
The logical point to see more rapid growth is in the quarters immediately following a significant contraction, not two years later. But putting that aside for the moment, I think it is easy for the Federal Reserve to read the recent data as signs the Great Depressing is beginning to unwind. Consider recent behavior of monthly private nonfarm payrolls:
Just eyeballing the chart, it looks like payroll growth is settling into a trend consistent with something around what we would think of as potential growth, except that growth may be a little slower than in the pre-recession period and is occurring along an equilibrium path below the pre-recession path. And that growth is translating into a falling unemployment rate:
Now, in my mind, this would guarantee that the Fed would not be really unwinding the Great Depression as much as managing a the economy along a new trend. Unwinding the Great Depression, I think, means fully reversing the drop in the employment to population ratio:
At this rate, we could be approaching 7% by next year, which would then put unemployment below the Fed's forecast for 2014. By my standards still an unacceptably slow pace given that decelerating inflation provides room for additional easing, but I can easily see where FOMC members decided the risk of additional easing outweigh the benefits.
Note that in the previous recession, the employment to population ratio edged up, but fell short of regaining the previous peak. Imagine the same occurring this time. Complicating a complete unwind is the economy's dependence on asset bubbles to support high levels of employment:
It seems that the loss of net wealth equal to 100% of GDP must be a depressing effect on spending. My sense is that we are unlikely to craft another widespread asset bubble and thus we will be missing a piece of demand that was critical to supporting the economy. How I think you might compensate for this lost demand is for the Fed to explicitly raise the inflation target and stimulate growth such that nominal wages rise sufficiently to quickly erode the real value of debt. If the Fed doesn't allow that to happen, instead sticking with the 2% target, then I suspect they will reduce accommodation long before the economy would regain the pre-recession equilibrium path. In other words, the Fed manages the economy along the new equilibrium path, and makes no pretense of trying to achieve pre-recession employment targets.
Could the Fed credibly commit to a higher inflation target and make actionable such a commitment? I think they can, but would need to announce they are making some permanent additions to the money stock and ease the expectation that the balance sheet expansion will be fully unwound at the first possible moment. In other words, to convince the public that you intend to raise the level of the price path relative to the existing path, you need to be willing to allow for the permanent increase in the money supply that would allow that to happen. Barring that, they can target the dollar directly and do what they won't do - buy foreign currency or foreign debt. But this is now a more academic than practical discussion. The Fed has a target. Period. End of story.
Bottom Line: Bullard reminds us that QE3 is not a certainty. True, inflation is easing and in aggregate the labor market remains weak, even if recent numbers are coming in a bit stronger. Arguably plenty of room for additional easing, which is why I have tended to think the Fed would eventually take additional action (that and the never-ending European mess). But the Fed hasn't shown an eagerness to ease further despite what they saw as a very slow reduction in unemployment - and it is reasonable to assume that forecast is getting a little bit brighter. Under such conditions, one or two months of "positive" employment news could fully derail the QE3 train. I increasingly think it depends on what the Fed's ultimate objective is - to unwind the Great Recession and attempt to restore pre-recession employment to population ratios, or just manage along a new output path. I used to think the former was the Fed's objective, but now am questioning that belief.
Posted by Mark Thoma on Monday, January 9, 2012 at 12:48 AM in Economics, Fed Watch, Monetary Policy |
Posted by Mark Thoma on Monday, January 9, 2012 at 12:06 AM in Economics, Links |
Ultimately, It's About the Inflation Target, by Tom Duy: Ryan Avent reports from Chicago on the willingness to believe the Fed is powerless to produce additional inflation:
Why is Mr Hall—why are so many economists—willing to conclude that the Fed is helpless rather than just excessively cautious? I don't get it; it seems to me that very smart economists have all but concluded that the Fed's unwillingness to allow inflation to rise is the primary cause of sustained, high unemployment. And yet...this is not the message resounding through macro sessions. Instead, there are interesting but perhaps irrelevant attempts to model the funny dynamics of a macro challenge that actually boils down to the political economy constraints (or intellectual constraints) facing the central bank. Let's focus our attention on that, for heaven's sake.
Avent is correct. It does seem that most economists believe that at the zero bound, allowing inflation expectations to rise is an effective - perhaps the only effective - mechanism for the central bank to accelerate activity. Moreover, if, as Avent says, we believe the Fed can prevent deflationary expectations, then they can certainly create inflationary expectations. The fact that they don't would then be something of a mystery, as certainly we don't see Federal Reserve Chairman Ben Bernanke as intellectually deficient on this issue. He can clearly do the math as well as anyone.
An answer to this conundrum is evident in the Fed's forecasts (dark blue is the central tendency):
The disconnect between the unemployment and inflation forecasts is clear. The Fed has a dual mandate, and, according to its forecasts, it cannot meet both of the mandates in the near to medium terms under the expected policy path. So a choice needs to be made. And the Fed has chosen to focus on meeting the inflation side of the mandate (note, headline PCE inflation in the long-run, which is why I focused on that measure in a piece last week). No mystery. No reason for vast intellectual expenditures. Price stability means 2% inflation, and if we can't meet the unemployment target within that mandate, so be it.
In other words, they are certainly capable of inducing higher inflation. They just don't because, in their view, 2% is a firm target, and the costs of exceeding that target, or, more importantly, changing that target, are effectively assumed to be infinite and thus by definition exceed any expected benefits.
Now, you could argue, that it really isn't this simple, since the "price stability" objective is not legally defined at 2% (Notice also that 2% is really the upper limit. On average, it appears that monetary policymakers would actually like something closer to 1.8%). There is a real question here that I don't believe the Fed has adequately answered - why should the definition of price stability be 2% rather than 3%?
So what is the constraint - political, intellectual, or irrational - that forces the Fed to adopt a 2% inflation target, and then choose to act as if that target was written in stone? I imagine policymakers would respond to the first point by claiming that price stability really means zero percent inflation, and that they choose 2% because we overestimate inflation and need some cushion from the lower bound problem. Fine, but what if you are already in the liquidity trap? For the second part, they would argue that the economy would be less stable in the absence of a firm target. My reply is that this might be correct for the eight decades a century that you are not in a liquidity trap, but what about the other two decades you are in a liquidity trap? Is a target calibrated during normal economic conditions then supporting suboptimal outcomes in a liquidity trap?
I expect to get some relief in at least the near term inflation forecasts at the conclusion of the next FOMC meeting, a decrease of the lower boundary of the central tendency which then helps clear the way for additional Fed easing. Core inflation has clearly been rapidly decelerating in recent months:
If you believe, as the Fed appears to, that core-inflation provides useful information on the direction of headline inflation, then the message is clear - headline inflation is likely to drift lower, and the economy needs more stimulus. What the Fed will deliver, however, will still be within the bounds of the 2% inflation target, and thus still falls short of the increase in expected inflation that the Fed should really be delivering.
Posted by Mark Thoma on Sunday, January 8, 2012 at 01:08 AM in Economics, Fed Watch, Monetary Policy |
I talked to Jamie Galbraith briefly today at a session he was participating in here at the AEA meetings in Chicago -- he was a discussant on a panel talking, in part, about the problems in the financial sector that caused the crisis. More than anyone I know, Jamie has been asking why the F-word -- fraud -- is so absent from these discussion. I wasn't able to stay for his full remarks due to another commitment, but I thought about tweeting a bet that the word fraud would be used as some point during his presentation. I'm guessing he'd like this news:
Raskin Urges Penalties on Mortgage Servicers, Reuters: Federal Reserve Governor Sarah Bloom Raskin on Saturday said the Fed must impose monetary penalties on banks who entered into an April agreement with regulators over how to fix problems in their mortgage servicing businesses.
"The Federal Reserve and other federal regulators must impose penalties for deficiencies that resulted in unsafe and unsound practices or violations of federal law," Raskin said... "The Federal Reserve believes monetary sanctions in these cases are appropriate and plans to announce monetary penalties."
Raskin did not say when the penalties will be announced.
She said that "appropriately sized" penalties would "incentivize mortgage servicers to incorporate strong programs to comply with laws when they build their business models."...
Posted by Mark Thoma on Sunday, January 8, 2012 at 12:42 AM in Economics, Financial System, Regulation |