Economist's View

'The Outlook Has Already Improved'

Laura D’Andrea Tyson:

... The single most important factor behind the projected growth in federal spending is the growth in health care spending, driven primarily by the growth in Medicare spending per beneficiary.

The outlook has already improved as a result of significant changes in the delivery and payment of health care services in the Affordable Care Act. As a result of these changes, growth in Medicare spending per enrollee is projected to slow to 3.1 percent a year during the next decade, about the same as the annual growth of nominal G.D.P. per capita and about two percentage points slower than the annual growth of private insurance premiums per beneficiary.

Speeding up the pace of the Affordable Care Act changes along with others, such as reducing subsidies for high-income beneficiaries and drug benefits and introducing small co-pays on home health-care services, would mean even larger Medicare savings.

A “structural reform” popular among Republican deficit hawks like Representative Paul Ryan of Wisconsin to convert Medicare to a premium-support or voucher system would be counterproductive and would drive up both spending per beneficiary and overall costs in the health care system.

The goal of a “go big” plan for deficit reduction should be to ensure the economy’s long-term growth and competitiveness. Yet the debate over spending in Washington is fixated on cutting entitlement spending. Very little is heard about the need to increase federal spending in education and training, research and development and infrastructure, three areas with proven track records in rate of return, job creation, opportunity and growth. ...

The Real Trust Fund Fiction

Kevin Drum explains that the surplus in the Social Security Trust fund allowed taxes on the wealthy to be cut, and that it's only fair that taxes on the wealthy should go back up to repay the money in the Trust Fund that was used to finance lower taxes. If it's not paid back, then it is, plainly and simply, a raid by the wealthy (through tax cuts) on the funds working class households are relying upon, and are counting on -- they held their end of the bargain and paid more into the system that it needed for decades -- for their retirements:

No, the Social Security Trust Fund Isn't a Fiction, by Kevin Drum: Charles Krauthammer is upset that Dick Durbin says Social Security is off the table in the fiscal cliff negotiations because it doesn't add to the deficit...

What Krauthammer means is that as Social Security draws down its trust fund, it sells bonds back to the Treasury. The money it gets for those bonds comes from the general fund, which means that it does indeed have an effect on the deficit. That much is true. But the idea that the trust fund is a "fiction" is absolutely wrong. ...

Starting in 1983, the payroll tax was deliberately set higher than it needed to be to cover payments to retirees. For the next 30 years, this extra money was sent to the Treasury, and this windfall allowed income tax rates to be lower than they otherwise would have been. During this period, people who paid payroll taxes suffered from this arrangement, while people who paid income taxes benefited.

Now things have turned around. As the baby boomers have started to retire, payroll taxes are less than they need to be to cover payments to retirees. To make up this shortfall, the Treasury is paying back the money it got over the past 30 years, and this means that income taxes need to be higher than they otherwise would be. For the next few decades, people who pay payroll taxes will benefit from this arrangement, while people who pay income taxes will suffer.

If payroll taxpayers and income taxpayers were the same people, none of this would matter. The trust fund really would be a fiction. But they aren't. Payroll taxpayers tend to be the poor and the middle class. Income taxpayers tend to be the upper middle class and the rich. ... When wealthy pundits like Krauthammer claim that the trust fund is a fiction, they're trying to renege on a deal halfway through because they don't want to pay back the loans they got.

As it happens, I think this was a dumb deal. But that doesn't matter. It's the deal we made, and the poor and the middle class kept up their end of it for 30 years. Now it's time for the rich to keep up their end of the deal. Unless you think that promises are just so much wastepaper, this is the farthest thing imaginable from fiction. It's as real as taxes.

Paul Krugman: Class Wars of 2012

The class war isn't over:

Class Wars of 2012, by Paul Krugman, Commentary, NY Times: On Election Day ... Logan International Airport in Boston was running short of parking spaces. Not for cars — for private jets. Big donors were flooding into the city to attend Mitt Romney’s victory party.

They were, it turned out, misinformed about political reality. But the disappointed plutocrats weren’t wrong about who was on their side. This was very much an election pitting the interests of the very rich against those of the middle class and the poor.

And the Obama campaign won largely by disregarding the warnings of squeamish “centrists” and ... stressing the class-war aspect of the confrontation. This ensured not only that President Obama won by huge margins among lower-income voters, but that those voters turned out in large numbers, sealing his victory.

The important thing to understand now is that while the election is over, the class war isn’t. The same people who bet big on Mr. Romney, and lost, are now trying to win by stealth — in the name of fiscal responsibility — the ground they failed to gain in an open election. ...

Consider, as a prime example, the push to raise the retirement age, the age of eligibility for Medicare, or both. This is only reasonable, we’re told — after all, life expectancy has risen... In reality,... it would be a hugely regressive policy change...

Or take a subtler example, the insistence that any revenue increases should come from limiting deductions rather than from higher tax rates. The key thing to realize here is that the math just doesn’t work... So any proposal to avoid a rate increase is, whatever its proponents may say, a proposal that we let the 1 percent off the hook and shift the burden, one way or another, to the middle class or the poor.

The point is that the class war is still on, this time with an added dose of deception. And this, in turn, means that you need to look very closely at any proposals coming from the usual suspects, even — or rather especially — if the proposal is being represented as a bipartisan, common-sense solution. ...

So keep your eyes open as the fiscal game of chicken continues. It’s an uncomfortable but real truth that we are not all in this together; America’s top-down class warriors lost big in the election, but now they’re trying to use the pretense of concern about the deficit to snatch victory from the jaws of defeat. Let’s not let them pull it off.

Links for 11-30-2012

• Speculation Regarding Asian-American Voting Patterns - Menzie Chinn
• Most Americans Face Lower Tax Burden Than in the 80s - NYT
• Is it a sin for the central bank to help reduce debt? - mainly macro
• Evidence for Man-Made Climate Change Stronger - Scientific American
• Dropping the Ball on Financial Regulation - Simon Johnson
• Dark Matter: A Quick Revisit - Twenty-Cent Paradigms
• Varieties of Error - Paul Krugman
• A Flood from the Past - Environmental Economics
• The BP Spill: What's the Environmental Damage? - Tim Taylor
• Keep the net beyond the autocrats’ reach - FT.com
• A new paradigm shift for the infant universe - EurekAlert
• Grover Norquist Gets Schelling 101 - Cheap Talk
• The Stunning Cost of Bad Economic Ideas - Matthew O'Brien
• Applying Evidence to Social Programs - NYTimes.com
• The unintended consequences: QE - The Economist
• The Road to Serfdom: Good Hayek or Bad Hayek? - Uneasy Money
• Veblen on universities - UnderstandingSociety
• Payday loans: statism vs libertarianism - Chris Dillow
• The U.S. economy grew 2.7% last quarter - Brad Plumer

'High-Frequency Trading and High Returns'

Have to teach classes in a bit, and running late, so just have time for a quick post -- this is from Ricardo Fernholz, a professor of economics at Claremont McKenna College:

High-Frequency Trading and High Returns, The Baseline Scenario: The rise of high-frequency trading (HFT) in the U.S. and around the world has been rapid and well-documented in the media. According to a report by the Bank of England, by 2010 HFT accounted for 70% of all trading volume in US equities and 30-40% of all trading volume in European equities. This rapid rise in volume has been accompanied by extraordinary performance among some prominent hedge funds that use these trading techniques. A 2010 report from Barron’s, for example, estimates that Renaissance Technology’s Medallion hedge fund – a quantitative HFT fund – achieved a 62.8% annual compound return in the three years prior to the report.

Despite the growing presence of HFT, little is known about how such trading strategies work and why some appear to consistently achieve high returns. The purpose of this post is to shed some light on these questions and discuss some of the possible implications of the rapid spread of HFT. ...

DeLong: America’s Political Recession

Since Brad DeLong is such a shy, wallflower type, I'll take it upon myself to highlight his latest column:

America’s Political Recession, by Brad DeLong, Commentary, Project Syndicate: The odds are now about 36% that the United States will be in a recession next year. The reason is entirely political: partisan polarization has reached levels never before seen, threatening to send the US economy tumbling over the “fiscal cliff”...

Obama broadly follows Ronald Reagan’s (second-term) security policy, George H.W. Bush’s spending policy, Bill Clinton’s tax policy, the bipartisan Squam Lake Group’s financial-regulatory policy, Perry’s immigration policy, John McCain’s climate-change policy, and Mitt Romney’s health-care policy... And yet he has gotten next to no Republicans to support their own policies. ...

There are obvious reasons for this. A large chunk of the Republican base, including many of the party’s largest donors, believes that any Democratic president is an illegitimate enemy of America, so that whatever such an incumbent proposes must be wrong and thus should be thwarted. ... Moreover, ever since Clinton’s election in 1992, those at the head of the Republican Party have believed that creating gridlock whenever a Democrat is in the White House ... is their best path to electoral success.

That was the Republicans’ calculation in 2011-2012. And November’s election did not change the balance of power anywhere in the American government...

Now, it is possible that Republican legislators may rebel against their leaders... It is possible that Republican leaders like Representatives John Boehner and Eric Cantor and Senator Mitch McConnell will conclude that their policy of obstruction has been a failure. ... But don’t count on it. ...

It seems to me that the odds are around 60% that real negotiation will not begin until tax rates go up on January 1. And it seems to me that, if gridlock continues into 2013, the odds are 60% that it will tip the US back into recession. Let us hope that it will be short and shallow.

Nah, the press will do its job, expose the fraud that underlies the Republican's budget and tactics, and they will be forced to fold their hand (are you laughing yet -- that's supposed to be a joke).

'Bring Back Real Competition to the Telecom Industry'

Are you tired of paying too much for low-quality cable, internet, and phone services?:

Bad Connections, by David Cay Johnston, Commentary, NY Times: Since 1974, when the Justice Department sued to break up the Ma Bell phone monopoly, Americans have been told that competition in telecommunications would produce innovation, better service and lower prices.

What we’ve witnessed instead is low-quality service and prices that are higher than a truly competitive market would bring.

After a brief fling with competition, ownership has reconcentrated into a stodgy duopoly of Bell Twins — AT&T and Verizon. ...

The AT&T-DirectTV and Verizon-Bright House-Cox-Comcast-TimeWarner behemoths market what are known as “quad plays”: the phone companies sell mobile services jointly with the “triple play” of Internet, telephone and television connections, which are often provided by supposedly competing cable and satellite companies. And because AT&T’s and Verizon’s own land-based services operate mostly in discrete geographic markets, each cartel rules its domain as a near monopoly.

The result of having such sweeping control of the communications terrain, naturally, is that there is little incentive for either player to lower prices, make improvements to service or significantly invest in new technologies and infrastructure. And that, in turn, leaves American consumers with a major disadvantage compared with their counterparts in the rest of the world. ...

The remedy ... is straightforward: bring back real competition to the telecom industry. The Federal Communications Commission, the Justice Department and lawmakers have long said this is their goal. But absent new rules that promote vigorous competition among telecom companies, it simply won’t happen.

Just as canals and railroads let America grow in the 19th century, and highways and airports did so in the 20th century, the information superhighway is vital for the nation’s economic growth in the 21st. The nation can’t afford to leave its future in the hands of the cartels.

Links for 11-29-2012

• The Different Paths of Greece/Spain to High Unemployment - Liberty Street
• Who killed the CRS report? - Steve Benen
• Exploiting Reciprocation - Cheap Talk
• End Federal Flood Insurance - NYTimes.com
• The Growing Burden of Payroll Taxes - NYTimes.com
• U.S. Treasury vs. Fed: You Say Long, I Say Short - RTE
• Bungee-Jumping Over the Fiscal Cliff - Robert Reich
• Putting a Spotlight on the Arbitration Industry - TripleCrisis
• The Benefits of the Safety Net - Freakonomics
• Social Security and the National Debt - Baseline Scenario
• The Right’s Post-Election Self-examination - askblog
• Monetary policy: First, assume a can-opener - The Economist
• International Capital Flows Slow Down - Tim Taylor
• CBO: Extending unemployment saves 300,000 jobs - Washington Post

'Romney is Wall Street’s Worst Bet Since the Bet on Subprime'

This is from a much longer Ezra Klein interview of Chrystia Freeland:

‘Romney is Wall Street’s worst bet since the bet on subprime’, by Ezra Klein: Ezra Klein: You’ve written about the revolt of the very rich against President Obama, and all the money they spent and time they dedicated to defeating him. So what’s the mood in those circles now that they’ve lost?

Chrystia Freeland: There’s a great joke on Wall Street which is that the bet on Romney is Wall Street’s worst bet since the bet on subprime. But I found the hostility towards Obama astonishing. ... On that Tuesday, the big Romney backers I was talking to were sure he was going to win. They were all flying into Logan Airport for the victory party. There’s this stunned feeling of how could we be so wrong, and a feeling of alienation.

The Romney comments to his donors,... I think they accurately reflected the view of a lot of these money guys. It’s the continuation of this 47 percent idea. They believe that Obama has been shoring up the entitlement society, and if you give enough entitlements to enough people, they’ll vote for you.

EK: Here’s my question about those comments. Romney was promising the very rich either a huge tax cut or, if you believe he would’ve paid for every dime and dollar of his cut, protection from any tax increases. He was promising financiers that he would roll back Dodd-Frank and Sarbanex-Oxley. He was promising current seniors that he wouldn’t touch their benefit. How are these not “gifts”?

CF: Let me be clear that I’m not defending any of them. But I think the way it works — and I think Romney’s comments were very telling in this regard — ...they’re absolutely convinced that they’re not asking for special privileges for themselves. They’re convinced that it just so happens that their self-interest coincides perfectly with the collective interest. That’s where you get this idea of the “job creators”. ... If you’ve developed an ideology that what’s good for you personally also happens to be good for everyone else, that’s quite wonderful because there’s no moral tension. ...

EK: ... From my reporting with the White House, I think the president’s view of the economy is that globalization is here and it’s not going away. The economy rewards high skills more than ever. Automatic and computerization and foreign competition are wiping out many middle class jobs, and while some new ones are created, it’s not at all clear that enough are being created. But in his view, he sees more redistribution as very necessary in this context. He thinks that if the economy is going to grow but the gains won’t be broadly shared, then it’s the government’s role to try and redistribute some, though of course not all, or even most, of those gains.

My experience is that the very rich are open to higher taxes in the context of a deficit deal. ... But they don’t like the idea that their money should be redistributed simply because they have too much of it. They don’t like the idea that, so to speak, they didn’t build all of this, and as such, they need to give back in order to make sure it continues. ... They see it as punishing their success.

CF: I completely agree. ...

Fed Watch: A Little Less Dovish...

Tim Duy:

A Little Less Dovish..., by Tim Duy: In the midst of an internal debate over policy communication, Chicago Federal Reserve President Charles Evans pulled back on his 3 percent inflation threshold in a speech yesterday. Arguably, as the only policymaker suggesting guidance well above the Fed's stated 2 percent target, Evans was the last true dove at the Fed. With Evan's falling in line with his colleagues, it looks like the last sliver of hope that the Fed would tolerate slightly higher inflation to accelerate the reduction of real burden has now been dashed.

There is a lot of interesting material in Evan's speech, but here I focus only on his basic outlook and the implications for policy. Regarding growth:

That said, monetary policymakers must formulate policy for today. In the United States, forecasts by both private analysts and FOMC participants see real GDP growth in 2012 coming in at a bit under 2 percent. Growth is expected to move moderately higher in 2013, but only to a pace that is just somewhat above potential. Such growth would likely generate only a small decline in the unemployment rate.

Of course, he added earlier that this forecast is vulnerable to the possible of an austerity bomb in 2013, but for the moment assume that issue is resolved:

Having said all that, most forecasters are predicting that the pace of growth will pick up as we move through next year and into 2014. Underlying these projections is an assumption that fiscal disaster will be avoided—and with this, that some important uncertainties restraining growth should come off the table. Also, deleveraging will run its course, and as it does, the economy’s more-typical cyclical recovery dynamics will take over. As the FOMC indicated in its policy moves last September, the current highly accommodative stance for monetary policy will be kept in place for some time to come.

He then praises recent policy actions:

Tying the length of time over which our purchases will be made to economic conditions is an important step. Because it clarifies how our policy decisions are conditional on progress made toward our dual mandate goals, markets can be more confident that we will provide the monetary accommodation necessary to close the large resource gaps that currently exist; additionally, markets can be more certain that we will not wait too long to tighten if inflation were to become an important concern.

And then tackles a big question:

The natural question at this point is to ask: What constitutes substantial improvement in labor markets? Personally, I think we would need to see several things. The first would be increases in payrolls of at least 200,000 per month for a period of around six months. We also would need to see a faster pace of GDP growth than we have now — something noticeably above the economy’s potential rate of growth.

From Evan's perspective, these conditions would be sufficient to end the expansion of the balance sheet, although interest rates will remain near zero beyond that point. When should rates rise?

Of course, we will not maintain low rates indefinitely. For some time, I have advocated the use of specific, numerical thresholds to describe the economic conditions that would have to occur before it might be appropriate to begin raising rates.

On the employment mandate:

In the past, I have said we should hold the fed funds rate near zero at least as long as the unemployment rate is above 7 percent and as long as inflation is below 3 percent. I now think the 7 percent threshold is too conservative....This logic is supported by a number of macro-model simulations I have seen, which indicate that we can keep the funds rate near zero until the unemployment rate hits at least 6-1/2 percent and still generate only minimal inflation risks.

So he shifts to a 6.5 percent threshold for unemployment, and later argues that even this might be a bit conservative as his models don't foresee much inflation pressure before 6 percent. See also Federal reserve Janet Yellen's recent speech; Evans' view is consistent with the optimal path forecasts. On one hand this is somewhat of a shift to the dovish side on the inflation forecast, suggesting that inflation will not accelerate as quickly as some might expect. What about the threshold for the rate of inflation itself?

With regard to the inflation safeguard, I have previously discussed how the 3 percent threshold is a symmetric and reasonable treatment of our 2 percent target. This is consistent with the usual fluctuations in inflation and the range of uncertainty over its forecasts. But I am aware that the 3 percent threshold makes many people anxious. The simulations I mentioned earlier suggest that setting a lower inflation safeguard is not likely to impinge too much on the policy stimulus generated by a 6-1/2 percent unemployment rate threshold. Indeed, we’re much more likely to reach the 6-1/2 percent unemployment threshold before inflation begins to approach even a modest number like 2-1/2 percent.

So, given the recent policy actions and analyses I mentioned, I have reassessed my previous 7/3 proposal. I now think a threshold of 6-1/2 percent for the unemployment rate and an inflation safeguard of 2-1/2 percent, measured in terms of the outlook for total PCE (Personal Consumption Expenditures Pride Index) inflation over the next two to three years, would be appropriate.

Notice that he really doesn't have a reason to shift his threshold; he doesn't even expect to hit the inflation threshold before hitting the employment threshold. His reason for essentially is that the 3 percent threshold makes people "anxious." Anxious about what? Anything that is perceived to be a threat to the Fed's credibility.

Does this shift on Evans' part really change anything? Probably not. He was always an outlier among Fed policymakers, with a tolerance for inflation as high as 3 percent making him a true dove. But he was never going to get any additional traction on that front from his colleagues. The 2 percent target is set in stone, and it is too much to expect the Fed will tolerate any meaningful deviations from that target. Of course, it is questionable that 3 percent is a meaningful deviation to begin with, but that is question is almost irrelevant at this point.

Bottom Line: By shifting his threshold on inflation, Evan's concedes to the political realities within the Fed. There was never much support for anything like tolerance for 3 percent inflation; for most policymakers, I suspect anything above 2.25 percent would be considered a threat to credibility. By falling in line with the rest of the FOMC, Evan abandons his role as a true dove, someone willing to tolerate substantially higher inflation. He is a dove now in the modern sense - a policymaker with a lower inflation forecast that allows for a longer period of easier policy.

Hurricane Sandy’s Lesson on Preserving Capitalism

I thought I'd note this column from several weeks ago for two reasons. First, it was widely misinterpreted as supporting laws against price-gouging, but I didn't mean to disavow the price-system. The point was that there is a lesson in the public's reaction to price-gouging: When the public believes the price-allocation mechanism results in unfairness, they won't support it. Market fundamentalists, and those who support capitalism more generally, should worry more than they do about how increasing inequality or the increasing market and political power of those at the top will affect the public's perception of the fairness of the capitalist system. If the belief that the system is unfair crosses the tipping point, who knows what type of system could be adopted in its place. Second, and more to the point, I haven't had much luck finding things to post today, and no time to write something myself (so this is filler):

Hurricane Sandy’s Lesson on Preserving Capitalism: With long gas lines and other shortages putting people on edge in the wake of Hurricane Sandy, the usual post-disaster debate over the economics and ethics of price-gouging is underway. However, while the question of whether it is okay, even desirable, for businesses to raise prices after natural disasters is certainly important, there are larger lessons that can be drawn from this debate.

Economists do not like the term “price-gouging.” They believe that price increases are the best way to allocate scarce goods and services after a natural disaster and, importantly, to encourage additional supply. When people can make a large profit by supplying goods and services to a market, they will work extraordinarily hard to meet the demand.

But if there is such an advantage to allowing the price system to work after an event like Hurricane Sandy, why did producers often choose to stick with pre-disaster prices? Why would they leave profits on the table by maintaining pre-disaster prices and allocating goods through other mechanisms such as first-come, first-serve until supplies run out? One answer is that price-gouging after a natural disaster is illegal in many places. But this just begs the question. Why do so many places choose to prohibit large price increases in response to disaster induced shortages?

Most of the explanations economists have come up with rely upon the idea of fairness. ...[continue]...

Let me add one reference to a study by Daniel Kahneman I didn't know about when I wrote this supporting the notion that perceptions of unfairness undermine support for the price-allocation system:

As far as most economists are concerned, it would be totally reasonable for a grocery store to raise prices the day be for a hurricane. In fact, that's what's supposed to happen. If prices don't go up when demand increases, you wind up with shortages. To an economist, empty shelves at grocery stores are evidence that prices were too low.

In a famous study, the Nobel laureate Daniel Kahneman and his co-authors asked ordinary people lots of questions about pricing and fairness. In one question, a hardware store raised the price of snow shovels from $15 to $20 the morning after a snowstorm.

The higher price sends a signal to the world that says: Send more snow shovels! Someone who runs a hardware store an hour away might be inspired by to put a bunch of shovels in the back of a truck and bring them to town, easing a potential shortage and, perhaps, driving prices back down.

But, not surprisingly, eighty percent of people surveyed said raising the price of snow shovels after a storm would be unfair. Presumably, those people would also say it's unfair for a store to double prices on canned food the day before a hurricane.

People feel so strongly about this that they've passed price-gouging laws in many states, banning merchants from raising prices during hurricanes or other natural disasters.

'Death of a Prediction Market'

Rajiv Sethi on the "death of a prediction market":

Death of a Prediction Market: A couple of days ago Intrade announced that it was closing its doors to US residents in response to "legal and regulatory pressures." American traders are required to close out their positions by December 23rd, and withdraw all remaining funds by the 31st. Liquidity has dried up and spreads have widened considerably since the announcement. There have even been sharp price movements in some markets with no significant news, reflecting a skewed geographic distribution of beliefs regarding the likelihood of certain events.

The company will survive, maybe even thrive, as it adds new contracts on sporting events to cater to it's customers in Europe and elsewhere. But the contracts that made it famous - the US election markets - will dwindle and perhaps even disappear. Even a cursory glance at the Intrade forum reveals the importance of its US customers to these markets. Individuals from all corners of the country with views spanning the ideological spectrum, and detailed knowledge of their own political subcultures, will no longer be able to participate. There will be a rebirth at some point, perhaps launched by a new entrant with regulatory approval, but for the moment there is a vacuum in a once vibrant corner of the political landscape.

The closure was precipitated by a CFTC suit alleging that the company "solicited and permitted" US persons to buy and sell commodity options without being a registered exchange, in violation of US law. But it appears that hostility to prediction markets among regulators runs deeper than that, since an attempt by Nadex to register and offer binary options contracts on political events was previously denied on the grounds that "the contracts involve gaming and are contrary to the public interest."

The CFTC did not specify why exactly such markets are contrary to the public interest, and it's worth asking what the basis for such a position might be.

I can think of two reasons, neither of which are particularly compelling in this context. First, all traders have to post margin equal to their worst-case loss, even though in the aggregate the payouts from all bets will net to zero. This means that cash is tied up as collateral to support speculative bets, when it could be put to more productive uses such as the financing of investment. This is a capital diversion effect. Second, even though the exchange claims to keep this margin in segregated accounts, separate from company funds, there is always the possibility that its deposits are not fully insured and could be lost if the Irish banking system were to collapse. These losses would ultimately be incurred by traders, who would then have very limited legal recourse.

These arguments are not without merit. But if one really wanted to restrain the diversion of capital to support speculative positions, Intrade is hardly the place to start. Vastly greater amounts of collateral are tied up in support of speculation using interest rate and currency swaps, credit derivatives, options, and futures contracts. It is true that such contracts can also be used to reduce risk exposures, but so can prediction markets. Furthermore, the volume of derivatives trading has far exceeded levels needed to accommodate hedging demands for at least a decade. Sheila Bair recently described synthetic CDOs and naked CDSs as "a game of fantasy football" with unbounded stakes. In comparison with the scale of betting in licensed exchanges and over-the-counter swaps, Intrade's capital diversion effect is truly negligible.

The second argument, concerning the segregation and safety of funds, is more relevant. Even if the exchange maintains a strict separation of company funds from posted margin despite the absence of regulatory oversight, there's always the possibility that it's deposits in the Irish banking system are not fully secure. Sophisticated traders are well aware of this risk, which could be substantially mitigated (though clearly not eliminated entirely) by licensing and regulation.

In judging the wisdom of the CFTC action, it's also worth considering the benefits that prediction markets provide. Attempts at manipulation notwithstanding, it's hard to imagine a major election in the US without the prognostications of pundits and pollsters being measured against the markets. They have become part of the fabric of social interaction and conversation around political events.

But from my perspective, the primary benefit of prediction markets has been pedagogical. I've used them frequently in my financial economics course to illustrate basic concepts such as expected return, risk, skewness, margin, short sales, trading algorithms, and arbitrage. Intrade has been generous with its data, allowing public access to order books, charts and spreadsheets, and this information has found its way over the years into slides, problem sets, and exams. All of this could have been done using other sources and methods, but the canonical prediction market contract - a binary option on a visible and familiar public event - is particularly well suited for these purposes.

The first time I wrote about prediction markets on this blog was back in August 2003. Intrade didn't exist at the time but its precursor, Tradesports, was up and running, and the Iowa Electronic Markets had already been active for over a decade. Over the nine years since that early post, I've used data from prediction markets to discuss arbitrage, overreaction, manipulation, self-fulfilling prophecies, algorithmic trading, and the interpretation of prices and order books. Many of these posts have been about broader issues that also arise in more economically significant markets, but can be seen with great clarity in the Intrade laboratory.

It seems to me that the energies of regulators would be better directed elsewhere, at real and significant threats to financial stability, instead of being targeted at a small scale exchange which has become culturally significant and serves an educational purpose. The CFTC action just reinforces the perception that financial sector enforcement in the United States is a random, arbitrary process and that regulators keep on missing the wood for the trees.

Links for 11-28-2012

• Bob Lucas on macro - Noah Smith
• Teaching graduate macro - mainly macro
• The Recession Probability Chart - Calculated Risk
• RIP Marvin Miller - Sports Economist
• Corporate tax is not only for little people - John Kay
• Could Higher Taxes Stimulate Academic Research? - Matthew Kahn
• Fed’s Evans Revises Thresholds for Monetary Policy Change - WSJ
• Monetary Policy in Challenging Times - Charles Evans
• What’s holding back the economy, in 10 charts - Zachary Goldfarb
• Fed: Consumer Deleveraging Continued in Q3... - Calculated Risk
• Will We Go Over The Fiscal Cliff? - Cheap Talk
• Bruce Bartlett Is A Mensch - Paul Krugman
• Inequality is not just about taxes and education - Josh Bivens
• Five Questions on Money Market Mutual Fund Reform - Treasury
• Central Bank Interactions with Financial Markets - Simon Potter
• Marketing Wittgenstein - Dan Little
• Fighting Economic Inequality - NYTimes.com
• The global economy is weakening again - OECD
• Mario on other platforms? - Digitopoly
• Volleyball Scoring - Cheap Talk
• Tax Cuts, Tax Rates and Tax Shares - Bruce Bartlett

Tim Geithner: 'Pragmatic Deal Maker'?

Robert Reich is worried:

Will Tim Geithner Lead Us Over or Around the Fiscal Cliff?, by Robert Reich: I’m trying to remain optimistic that the President and congressional Democrats will hold their ground over the next month as we approach the so-called “fiscal cliff.”

But leading those negotiations for the White House is outgoing Secretary of Treasury Tim Geithner, whom Monday’s Wall Street Journal described as a “pragmatic deal maker” because of “his long relationship with former Treasury Secretary Robert Rubin, for whom balancing the budget was a priority over other Democratic touchstones.” ...

Both Rubin and Geithner are hardworking and decent. But both see the world through the eyes of Wall Street rather than Main Street. I battled Rubin for years in the Clinton administration because of his hawkishness on the budget deficit and his narrow Wall Street view of the world.

During his tenure as Treasury Secretary, Geithner has followed in Rubin’s path — engineering a no-strings Wall Street bailout that didn’t require the Street to help stranded homeowners, didn’t demand the Street agree to a resurrection of the Glass-Steagall Act, and didn’t seek to cap the size of the biggest bank, which in the wake of the bailout have become much bigger.  In an interview with the Journal, Geithner repeats the President’s stated principle that tax rates must rise on the wealthy, but doesn’t rule out changes to Social Security or Medicare. And he notes that in the president’s budget (drawn up before the election), spending on non-defense discretionary items — mostly programs for the poor, and investments in education and infrastructure — are “very low as a share of the economy relative to Clinton.” If “pragmatic deal maker,” as the Journal describes Geithner, means someone who believes any deal with Republicans is better than no deal, and deficit reduction is more important than job creation, we could be in for a difficult December.

Not sure if this will make you feel more confident, but a recent post on the Treasury's blog from Jason Furman asserted that "Increasing Taxes on Middle-Class Families Will Hurt Consumer Spending." Unfortunately, it didn't say much about Social Security and Medicare. I am worried too.

Cyberattacks on Banks Escalating

President of the Atlanta Fed, Dennis Lockhart:

...A real financial stabiliy concern ... is the potential for malicious disruptions to the payments system in the form of broadly targeted cyberattacks. Just in the last few months, the United States has experienced an escalating incidence of distributed denial of service attacks aimed at our largest banks. The attacks came simultaneously or in rapid succession. They appear to have been executed by sophisticated, well-organized hacking groups who flood bank web servers with junk data, allowing the hackers to target certain web applications and disrupt online services. Nearly all the perpetrators are external to the targeted organizations, and they appear to be operating from all over the globe. Their motives are not always clear. Some are in it for money, while others are in it for what you might call ideological or political reasons.

Unlike other cybercrime activity, which aims to steal customer data for the purpose of unauthorized transactions, distributed denial of service attacks do not necessarily result in stolen data. Rather, the intent appears to be to disable essential systems of financial institutions and cause them financial loss and reputational damage. The intent may be mischief on a grand scale, but also retaliation for matters not directly associated with the financial sector.

Banks have been defending themselves against cyberattacks for a while, but the recent attacks involved unprecedented volumes of traffic—up to 20 times more than in previous attacks. Banks and other participants in the payments system will need to reevaluate defense strategies. The increasing incidence and heightened magnitude of attacks suggests to me the need to update our thinking. What was previously classified as an unlikely but very damaging event affecting one or a few institutions should now probably be thought of as a persistent threat with potential systemic implications.

I'm drawing your attention to this area of risk... But I feel the need to be measured about the potential for severe financial instability from this source. In my judgment, cyberattacks on payments systems are not likely to have as deep or long lasting an impact on financial system stability as fiscal crises or bank runs, for example. Nonetheless, there is real justification for a call to action. ...

Even broad adoption of preventive measures may not thwart all attacks. Collaborative efforts should be oriented to building industry resilience. Resilience measures would be similar to those put in place in the banking industry to maintain operations in a natural disaster—multiple backup sites and redundant computer systems, for example.

'By 2035, We Project Oil Imports into the US of Only 3.4 Million Barrels a Day'

Fatih Birol, chief economist of the International Energy Agency and chair of the World Economic Forum’s Energy Advisory Board, discusses his projection that "the United States will become the world’s leading oil producer within a few decades":

Q. The new report has attracted great press attention for its projection that the United States may soon become the world’s leading oil producer. Can you discuss what you see as the greatest implications of this change, in terms of energy security, geopolitics and carbon emissions?

A. The most striking implications concern U.S. oil imports and international oil-trade patterns. The upward trend in production is partly responsible for a sharp fall in U.S. oil imports. By 2035, we project oil imports into the United States of only 3.4 million barrels a day, which implies a substantial (60 percent) reduction in oil-import bills. North America as a whole actually becomes a net oil exporter. In international oil markets, this accelerates the shift in trade patterns toward Asia, raising the geostrategic importance of trade routes between Middle East producers and Asian consumers.

But what should attract equal attention … is the essential role played by energy efficiency. I believe that energy efficiency has been an epic failure by policymakers in almost all countries. Its potential is huge but much of it remains untapped. Compared with today, savings from more rigorous vehicle fuel-economy standards could prompt a 30 percent fall in U.S. oil demand by 2035.

Fed Watch: Meanwhile, in Japan...

Tim Duy:

Meanwhile, in Japan..., by Tim Duy: Back in September, I wrote:

What I expect to happen is this: The Bank of Japan will be forced into outright monetization at some point; a soft default in the form of higher inflation will occur. And dramatically higher inflation, I fear. Japan has not had inflation for two decades. I suspect they will experience all that pent-up inflation in the scope of a couple of years.

Sure enough, the battle begins. Almost lost in the holiday weekend, from Reuters last week:

Japan's main opposition Liberal Democratic Party (LDP) said on Wednesday that on its return to power it would set a 2 percent inflation target with an eye to revising the law governing the Bank of Japan so as to boost cooperation between the government and the central bank...

...In its campaign platform unveiled on Wednesday, the LDP called for bold monetary easing through cooperation between the government and the central bank on debt management, but it made no mention of Abe's calls for the BOJ to buy debt to finance infrastructure projects.

The response from the Bank of Japan was swift:

But BOJ Governor Masaaki Shirakawa dismissed many of Abe's proposals, including the possible revision of the Bank of Japan law, a step critics say is aimed at clipping the central bank's independence and forcing it to print money to finance public debt that is already double the size of Japan's economy.

"Central bank independence is a system created upon bitter lessons learned from the long economic and financial history in Japan and overseas countries," Shirakawa told a news conference....

...Shirakawa was adamant the central bank would not directly underwrite government debt because bond yields would spike and hurt the economy.

"No advanced country has adopted such a policy," he said.

Shirakawa is correct. Modern central banks may have lost some control over inflation at times, but I don't think any has engaged in outright monetization of government debt. Yet despite Shirakawa's insistence to the contrary, I still think that is exactly where Japan is headed. More central bank history in the making.

Links for 11-27-2012

• The Asset Price Meltdown and the Wealth of the Middle Class - NBER
• Household Income Stagnates, Again - NYTimes.com
• What's The Matter With Italy? - Paul Krugman
• Inside America’s Tax Battle - Laura Tyson
• Adam Smith On Exchange - Gavin Kennedy
• The Unhappy Marriage of Capitalism and Conservatism - Nancy Folbre
• Washington Post Wants Social Security Benefits Reduced - Dean Baker
• Why is the White House's CEA Helping the Republicans? - Robert Reich
• When You Come to a Fiscal Cliff, Take It - Andrew Samwick
• Bold Canadian takeover of Threadneedle Street - Gavyn Davies
• Benevolent Paternalists vs. Tough Love - Matthew Kahn
• Hayek, Friedman, And Illusions Of Conservative Economics - Robert Solow
• Republicans Propose to Raise Marginal Rate on "Job Creators" - Dean Baker
• Why Doesn't Someone Undercut Payday Lending? - Tim Taylor
• A Minimum Tax for the Wealthy - Warren Buffett

'The Multiplier is at Least Two'

For infrastructure spending, in particular spending on roads and highways, Sylvain Leduc and Daniel Wilson "find that the multiplier is at least two":

Highway Grants: Roads to Prosperity?, by Sylvain Leduc and Daniel Wilson, FRBSF Economic Letter: Increasing government spending during periods of economic weakness to offset slower private-sector spending has long been an important policy tool. In particular, during the recent recession and slow recovery, federal officials put in place fiscal measures, including increased government spending, to boost economic growth and lower unemployment. One form of government spending that has received a lot of attention is public investment in infrastructure projects. The 2009 American Recovery and Reinvestment Act (ARRA) allocated $40 billion to the Department of Transportation for spending on the nation’s roads and other public infrastructure. Such public infrastructure investment harks back to the Great Depression, when programs such as the Works Progress Administration and the Tennessee Valley Authority were inaugurated.

One criticism of public infrastructure programs is that they take a long time to put in place and therefore are unlikely to be effective quickly enough to alleviate economic downturns. The fact is, though, that surprisingly little empirical information is available about the effect of public infrastructure investment on economic activity over the short and medium term.

This Economic Letter examines new research (Leduc and Wilson, forthcoming) on the dynamic effects of public investment in roads and highways on gross state product (GSP), the total economic output of a state. This research focuses on investment in roads and highways in part because it is the largest component of public infrastructure in the United States. Moreover, the procedures by which federal highway grants are distributed to states help us identify more precisely how transportation spending affects economic activity.

We find that unanticipated increases in highway spending have positive but temporary effects on GSP, both in the short and medium run. The short-run effect is consistent with a traditional Keynesian channel in which output increases because of a rise in aggregate demand, combined with slow-to-adjust prices. In contrast, the positive response of GSP over the medium run is in line with a supply-side effect due to an increase in the economy’s productive capacity.

We also assess how much bang each additional buck of highway spending creates by calculating the multiplier, that is, the magnitude of the effect of each dollar of infrastructure spending on economic activity. We find that the multiplier is at least two. In other words, for each dollar of federal highway grants received by a state, that state’s GSP rises by at least two dollars.

The Federal-Aid Highway Program

The federal government’s involvement in financing road construction goes back to the early part of the past century. Although initially small, this involvement became much more significant in 1956 with the enactment of the Federal-Aid Highway Act, which authorized almost $34 billion in 1956 dollars over 13 years for the construction of the Interstate Highway System. At the time, The New York Times noted that “the highway program will constitute a growing and ever-more-important share of the gross national product … (affecting) every phase of economic life in this country.”

The Interstate Highway System was completed in 1992. Since then, the federal government has continued to provide funding to states mostly through a series of grant programs collectively known as the Federal-Aid Highway Program (FAHP). The FAHP helps fund construction, maintenance, and other improvements on a wide range of public roads beyond the interstate highways. Local roads are often considered federal-aid highways and are eligible for federal funding, depending on how important the federal government judges them to be.

Because road projects typically take a long time to complete, advance knowledge of future funding sources can help smooth planning. Congress designs transportation legislation to minimize uncertainty. First, it enacts legislation that typically extends five to six years. Second, it apportions funds to states according to set formulas. Thus, a typical highway bill will specify an annual national amount for each highway program over the life of the legislation and spell out the formula by which that program’s national amount will be apportioned to states. Importantly, these formulas are based on road-related metrics measured several years earlier. That means that changes to current and future highway funding are not driven by current economic conditions.

Highway bills generally include information that helps states forecast relatively accurately the amount of grants they are likely to receive while the legislation is in effect. For the past two highway bills, the Federal Highway Administration (FHWA) published forecasts of each state’s annual future grants under each program.

Estimating the effects of road spending

We conduct a statistical analysis to estimate the effects of federal highway spending on state economic activity. Specifically, we construct a variable that captures revisions to forecasts of current and future highway grants to the states, based on information from highway bills since 1991. We closely follow, but also expand on, the FHWA’s methodology for forecasting each state’s future grants.

These forecast revisions serve as proxies for changes in expectations about current and future highway spending in a given state. In economic terms, these changes can be regarded as shocks, that is, unanticipated events that affect economic activity.

We study forecast revisions rather than changes in actual highway spending for two reasons. First, actual spending may both affect and be affected by current economic conditions, making it difficult to sort out the true causal effects of the spending.

Second, changes in actual spending are most likely to be anticipated years in advance. For that reason, some of their economic effects may be felt before the spending changes actually take place. For instance, a state government and other important players, such as construction and engineering firms, may decide to spend more today if they expect the state to receive more highway grants in the future. In this way, changes in expectations regarding future grants to the states may be important for current economic activity. Failing to account for changes in expectations may lead to incorrect conclusions about how government spending affects economic activity (see Ramey 2011a).

Figure 1
Average response of state GDPs to unexpected grants

In our analysis of how changes in forecasts of highway grants to the states affect state GSP, we control for lags in state GSP, lags in receipt of highway grants, average state GSP levels, and national movements of gross domestic product (GDP) over the sample period from 1990 to 2010.

In Figure 1, the solid line shows the average percentage change in a state’s GSP following a 1% increase in forecasted future highway grants to the states. The shaded area around the line represents a 90% probability range. The horizontal axis indicates the number of years after the unanticipated change in forecasted highway grants to the states. The figure shows that changes in the forecasts have a significant short-term effect on state output in the first one to two years. This effect fades, but then increases sharply six to eight years after the forecast revisions, before declining again. This pattern holds up well with alternative estimation techniques, the inclusion of different control variables, and with different data samples.

This pattern is consistent with New Keynesian theoretical models in which public infrastructure, such as roads, are used by the private sector in the production of goods and services and take time to be built (see Leduc and Wilson, forthcoming). In this framework, the initial impact is due to a traditional Keynesian effect of an increase in aggregate demand. The medium-term effect on output arises once the public infrastructure is built, thus increasing the economy’s productive capacity.

The highway grant multiplier

One concept often used to assess the effectiveness of government spending is the multiplier. The fiscal multiplier represents the dollar change in economic output for each additional dollar of government spending. Thus, a multiplier of two implies that, when government spending increases by one dollar, output rises by two dollars.

Based on the results shown in Figure 1, we find that multipliers for federal highway spending are large. On initial impact, the multipliers range from 1.5 to 3, depending on the method for calculating the multiplier. In the medium run, the multipliers can be as high as eight. Over a 10-year horizon, our results imply an average highway grants multiplier of about two.

Our estimated multipliers are noticeably larger than those typically found in the literature on the effects of government spending. For instance, in a recent survey, Valerie Ramey reports multipliers between 0.5 and 1.5 (see Ramey 2011b). One possible reason for the wide differences is that we consider a very different form of government spending. Most of the literature concentrates on the multiplier effect of military spending. But such spending is arguably nonproductive in an economic sense. By contrast, government investment in infrastructure, such as roads, can raise the economy’s productive capacity. In that respect, it can have a higher fiscal multiplier. Another difference is that we concentrate on the multiplier effect on GSP, while the literature typically studies the effect on U.S. GDP as a whole.

The American Recovery and Reinvestment Act

The deep recession of 2007–09 led to the enactment of ARRA, which included a large one-time increase of $27.5 billion in federal highway grants to states. ARRA was designed to have strong short-term effects. In general, infrastructure projects are not viewed as effective forms of short-term stimulus because of the long lags between authorization, planning, and implementation. By the time the projects get under way, a recession may be over. The extra spending could ultimately end up feeding an already booming economy. To address this problem, ARRA stipulated that state governments had to fully use their share of federal highway grants by March 2010.

It is conceivable that highway spending during a major downturn, when productive capacity is underutilized, may affect output in a substantially different way than spending during more normal times. To test this, we examined whether unanticipated changes in highway spending in 2009 and 2010 had a different effect on GSP than in other years in our sample. We found that spending in 2009 and 2010 was roughly four times as large as the peak response shown in Figure 1. This suggests that highway spending can be effective during periods of very high economic slack, particularly when spending is structured to reduce the usual implementation lags.

Conclusion

Surprise increases in federal investment in roads and highways appear to have had positive effects on gross state product in both the short and medium run. The short-run impact is akin to the traditional Keynesian effect that stems from an increase in aggregate demand. By contrast, the positive impact on GSP in the medium run is probably due to supply-side effects that boost the economy’s productive capacity. Infrastructure investment gets a good bang for the buck in the sense that fiscal multipliers—the dollar of increased output for each dollar of spending—are large.

References

Leduc, Sylvain, and Daniel J. Wilson. Forthcoming. “Roads to Prosperity or Bridges to Nowhere? Theory and Evidence on the Impact of Public Infrastructure Investment.” NBER Macroeconomics Annual 2012.

Ramey, Valerie A. 2011a. “Identifying Government Spending Shocks: It’s all in the Timing.” Quarterly Journal of Economics 126(1), pp. 1–50.

Ramey, Valerie A. 2011b. “Can Government Purchases Stimulate the Economy?” Journal of Economic Literature 49(3), pp. 673–685.

Household Services Expenditures

Here's a graph of spending on discretionary services from Jonathan McCarthy of the NY Fed:

Household Services Expenditures: An Update, by Jonathan McCarthy, Liberty Street: This post updates and extends my July 2011 blog piece  on household discretionary services expenditures. I examine the most recent data to see what they reveal about the depth of decline in expenditures in the last recession and the extent of the recovery, and find that the expenditures appear to be further below the peak identified earlier. I then compare the pace of recovery for discretionary and nondiscretionary services in this expansion with that of previous expansions, finding that the pace in both cases is well below that of previous cycles. In summary, household spending continues to be constrained by a combination of credit conditions and weak income expectations. ...

The author also looks at the pace of the recovery of spending on both discretionary and non-discretionary services, and finds both to be subpar (see the last two graphs). The conclusion:

The pattern of a similarly sluggish pace of recovery for discretionary and nondiscretionary services expenditures suggests that the fundamentals for consumer spending remain soft. In particular, it appears that households—more than three years after the end of the recession—remain wary about their future income growth and employment prospects even though consumer confidence measures have improved in recent months. In addition, households may still see the need to repair their balance sheets from the damage incurred during the recession, especially if they expect that increases in asset prices will be subdued at best and that credit will continue to be constrained. Consequently, a positive resolution of these issues is likely necessary before a stronger services and overall consumer spending recovery can be sustained.

If households had gotten as much help with their balance sheet problems as banks got, the recovery would be a lot further along.

'Wreaking Havoc on the Environment with Little or No Accountability'

Jeff Sachs says "polluters must pay":

Polluters Must Pay: When BP and its drilling partners caused the Deepwater Horizon oil spill in the Gulf of Mexico in 2010, the United States government demanded that BP finance the cleanup, compensate those who suffered damages, and pay criminal penalties for the violations that led to the disaster. BP has already committed more than $20 billion in remediation and penalties. Based on a settlement last week, BP will now pay the largest criminal penalty in US history – $4.5 billion.

The same standards for environmental cleanup need to be applied to global companies operating in poorer countries, where their power has typically been so great relative to that of governments that many act with impunity, wreaking havoc on the environment with little or no accountability. As we enter a new era of sustainable development, impunity must turn to responsibility. Polluters must pay, whether in rich or poor countries. Major companies need to accept responsibility for their actions. ...

I can't see the companies doing this voluntarily.

Lucas Interview

Stephen Williamson notes an interview of Robert Lucas:

SED Newsletter: Lucas Interview: The November 2012 SED Newsletter has ... an interview with Robert Lucas, which is a gem. Some excerpts:

... Microfoundations:

ED: If the economy is currently in an unusual state, do micro-foundations still have a role to play?

RL: "Micro-foundations"? We know we can write down internally consistent equilibrium models where people have risk aversion parameters of 200 or where a 20% decrease in the monetary base results in a 20% decline in all prices and has no other effects. The "foundations" of these models don't guarantee empirical success or policy usefulness.

What is important---and this is straight out of Kydland and Prescott---is that if a model is formulated so that its parameters are economically-interpretable they will have implications for many different data sets. An aggregate theory of consumption and income movements over time should be consistent with cross-section and panel evidence (Friedman and Modigliani). An estimate of risk aversion should fit the wide variety of situations involving uncertainty that we can observe (Mehra and Prescott). Estimates of labor supply should be consistent aggregate employment movements over time as well as cross-section, panel, and lifecycle evidence (Rogerson). This kind of cross-validation (or invalidation!) is only possible with models that have clear underlying economics: micro-foundations, if you like.

This is bread-and-butter stuff in the hard sciences. You try to estimate a given parameter in as many ways as you can, consistent with the same theory. If you can reduce a 3 orders of magnitude discrepancy to 1 order of magnitude you are making progress. Real science is hard work and you take what you can get.

"Unusual state"? Is that what we call it when our favorite models don't deliver what we had hoped? I would call that our usual state.

Paul Krugman: Fighting Fiscal Phantoms

The deficit scolds have been wrong again and again:

Fighting Fiscal Phantoms, by Paul Krugman, Commentary, NY Times: These are difficult times for the deficit scolds who have dominated policy discussion for almost three years. One could almost feel sorry for them, if it weren’t for their role in diverting attention from the ongoing problem of inadequate recovery, and thereby helping to perpetuate catastrophically high unemployment.

What has changed? For one thing, the crisis they predicted keeps not happening. Far from fleeing U.S. debt, investors have continued to pile in, driving interest rates to historical lows. Beyond that, suddenly the clear and present danger to the American economy isn’t that we’ll fail to reduce the deficit enough; it is, instead, that we’ll reduce the deficit too much. ...

Given these realities, the deficit-scold movement has lost some of its clout. ... But the deficit scolds aren’t giving up. Now yet another organization, Fix the Debt, is campaigning for cuts to Social Security and Medicare, even while making lower tax rates a “core principle.” That last part makes no sense in terms of the group’s ostensible mission, but makes perfect sense if you look at the array of big corporations, from Goldman Sachs to the UnitedHealth Group, that are involved in the effort and would benefit from tax cuts. Hey, sacrifice is for the little people.

So should we take this latest push seriously? No... As far as I can tell, every example supposedly illustrating the dangers of debt involves either a country that, like Greece today, lacked its own currency, or a country that, like Asian economies in the 1990s, had large debts in foreign currencies. Countries with large debts in their own currency, like France after World War I, have sometimes experienced big loss-of-confidence drops in the value of their currency — but nothing like the debt-induced recession we’re being told to fear.

So let’s step back for a minute, and consider what’s going on here. For years, deficit scolds have held Washington in thrall with warnings of an imminent debt crisis, even though investors, who continue to buy U.S. bonds, clearly believe that such a crisis won’t happen; economic analysis says that such a crisis can’t happen; and the historical record shows no examples bearing any resemblance to our current situation in which such a crisis actually did happen.

If you ask me, it’s time for Washington to stop worrying about this phantom menace — and to stop listening to the people who have been peddling this scare story in an attempt to get their way.

Links for 11-26-2012

• Ignorance as an excuse - Antonio Fatas
• Disaster Economics - James Surowiecki
• America’s chance to enter the 21st century - Edward Luce
• Defining countercyclical fiscal policy: a proposal - mainly macro
• Review of Sandel's The Moral Limit of Markets - Deirdre McCloskey
• Review of Keynes Hayek, by Nicholas Wapshott - Noahpinion
• Hard to Believe There Are Still Economists Who Claim ... - Brad DeLong
• The Fox News and MSNBC of Lincoln's day - James Choi
• Republican Senators Negotiating with President Romney - EconoSpeak
• The housing cycle is the business cycle--again - Richard Green
• Is the Cochrane-Orcutt Estimator Unique? - Dave Giles
• The decade of Xi Jinping - Gavyn Davies
• Cuba: A Trip Back to 1959 - Jeff Frankel
• A Short History of Takers - Paul Krugman
• Should We Increase Dividend Taxation? 3 Views - owenzidar
• Pragmatist arguments for democracy - UnderstandingSociety
• Elasticity, slope, scale, and collusion - Nick Rowe
• What is Apple's objective function? - Richard Green
• Incredible Credibility - Paul Krugman

Banking Must not be Left in the Shadows

I agree with Gary Gorton:

Banking must not be left in the shadows, by Gary Gorton, Commentary, Financial Times: ... Addressing the details of the recent financial crisis leaves open the larger question of how it could have happened in the first place. ... One of the findings of the Financial Stability Board report is that the global shadow banking system grew to $62tn in 2007, just before the crisis. Yet we are only now measuring the shadow banking system. ...

Measurement is the root of science. Our measurement systems, national income accounting, regulatory filings and accounting systems are useful but limited. ... Now we need to build a national risk accounting system. The financial crisis occurred because the financial system has changed in very significant ways. The measurement system needs to change in equally significant ways. The efforts made to date focus mostly on “better data collection” or “better use of existing data” – phrases that, at best, suggest feeble efforts. A new measurement system is potentially forward-looking in detecting possible risks.

Another problem is conceptual. Why weren’t we looking for the possibility of bank runs before the crisis? The answer is that we did not believe a bank run could happen in a developed economy. ... Why did we think that? For no good reason. But, when an economic phenomenon occurs over and over again, it suggests something fundamental... Another law, we now know, is that privately created bank money is subject to runs in the absence of government regulation.

I'll just add the periodic reminder that we do not yet have the regulation in place that is needed to address the problem of bank runs of "privately created bank money." Gary Gorton is skeptical that we can ever solve this problem, that's one of the pointsof th ecolumn, but if that's the case then we should be doing all we can to ensure that the consequences of a shadow bank run are minimized, and there is much more we can do along these lines.

Can You Beat the Market?

This got more attention than I expected on Twitter, Facebook, etc., so thought I'd highlight it here:

Still think you can beat the market?, by Tim Harford: One of the most maligned ideas in economics is the efficient market hypothesis... The EMH has various forms, but in brief its message is very simple: an individual investor cannot reliably outperform financial markets. The reasoning is equally simple... Anything that could reasonably be anticipated already has been anticipated, and so markets instead respond only to genuinely unexpected news.

But the EMH has a problem: researchers keep discovering predictable patterns in the data... That is a minor embarrassment for the EMH; and it becomes a major one if the anomalies persist after they have been discovered. Yet this seems doubtful. ...

A new research paper by David McLean and Jeffrey Pontiff explicitly examines the idea that academic research into anomalies is a self-denying endeavor. They find some evidence of spurious patterns... But what is really striking is that after an anomaly has been published, it quickly shrinks – although it does not disappear.

The anomalies are most likely to persist when they apply to small, illiquid markets – as one might expect, because there it is harder to profit from the anomaly.

The efficient markets hypothesis is surely false. What is striking is that it is very close to being true. For the Warren Buffetts of the world, “almost true” is not true at all. For the rest of us, beating the market remains an elusive dream.

Don't Eliminate the Link between Social Security Contributions and Benefits

Because of the way the Social Security program is funded -- through a payroll tax on workers along with an employer contribution -- many people believe there is an account for them at some government agency holding those contributions, or at least giving them credit for them, and that they will be able to collect their contributions when they retire. It's their money, collected from them monthly, and no matter their income level they have a right to get that money back when they retire. Try telling them that they don't. Even those people who understand that if their income is high enough they may not receive payments equal to all they put in get something back -- it's there for them no matter what -- and this increases support for the program.

But if we change the funding so that payments for Social Security come out of the general fund -- the money the government collects through taxes for all purposes -- and impose means testing (i.e. phase out the payments once income is high enough), the link between contributions and benefits would be broken and I fear support for the program would be broken as well. It would become another welfare program, and attacked. When programs are supported through the general fund there is competition for funding, there is never enough money to go around, and it wouldn't be long before the people in power, or with lots of influence over those in power (who don't really need Social Security in most cases) would argue that the money is best used elsewhere.

I am far from the first person to make this point:

Ross Douthat Argues that Social Security Would be Easier to Cut If It Were Changed from a Social Insurance Program to a Welfare Program, by Dean Baker: Ross Douthat argues convincingly that if we eliminated the link between contributions and benefits it would be much easier politically to cut Social Security. Of course he thinks ending the link would be a good idea for that reason, but his logic is certainly on the mark, people will more strongly protect benefits that they feel they have earned. ...

The payroll tax certainly can cover the program's expenses. In fact, had it not been for the upward redistribution of income over the last three decades, which nearly doubled the share of wage income going over the cap on taxable income, the projected 75-year shortfall would be about half of its current level.

Even with the current projected shortfall, if ordinary workers shared in projected productivity growth over the next three decades, a tax increase equal to 6 percent of their wage growth over this period would be sufficient to make the program fully solvent. The problem is clearly the policies that led to the upward redistribution of income..., not Social Security.

It is worth pointing out that when Douthat proposes "means-testing for wealthier beneficiaries," his notion of wealthy means school teachers and firefighters, not Bill Gates and Mitt Romney. ...

Peggy Noonan said today that Republicans will accept tax increases if there is significant entitlement reform. Assuming she can be believed (a rather heroic assumption), and that she speaks for a significant portion of the Republican Party in saying this (which is probably true, so I'm a bit less embarrassed about quoting her), it's clear that Republicans are going to demand cuts to programs like Social Security as a condition of raising taxes.

Democrats need to remember who won the election, and that despite their act to the contrary, the Republicans are not the ones calling the shots at this point. Democrats have considerable leverage, and they need to use it to protect programs their core constituency values highly. Social Security is at the top of the list.

Links for 11-25-2012

• A Meta Modeling Meditation - Paul Krugman
• Refinery Insights and Nonsense ala Exxon - EconoSpeak
• Freud's class bias - Chris Dillow
• The real reason for almost all big business failures - Stat Views
• Tax Reform & the Effective vs Marginal Rate Debate - owenzidar
• Unbundling the incumbent: Evidence from UK broadband - vox
• Still think you can beat the market? - Tim Harford
• Science Links - Discover

Fed Watch: Stop The Holiday Shopping Media Circus

Tim Duy:

Stop The Holiday Shopping Media Circus, by Tim Duy: I feel as if every December I need to mentally prepare myself for the onslaught of inane media coverage of the holiday shopping season. This year, however, we seem to have a few more voices of reason and common sense. Barry Ritholtz, a long-time veteran of the Black Friday Media Wars, sees signs of hope:

Over the years, I have been rather annoyed (perhaps too much) at the annual foolishness over Black Friday forecasts. Each year, we hear breathless predictions of ridiculous increases in consumer spending — holiday shopping rises 16% this season! — which turn out to be wildly over-optimistic, and are never confirmed by the actual data....

....This year, the idea seems to have spread into the mainstream: Lots of coverage about it, with a few choice quotes from you know who tossed in for good measure.

Ritholtz provides a host of links on the subject, but a recent entrant is missing. Neil Irwin at the Washington Post delivers the truth about Black Friday:

Black Friday is here, and if you happen to derive pleasure from streaming around big box stores or mega malls as part of a teeming horde, well, who am I to judge another person’s sources of enjoyment.

Let’s just not pretend that it means anything...

...sales over Thanksgiving weekend tell us virtually nothing about retail sales for the full holiday season—let alone anything meaningful about the economy as a whole.

So if it is a meaningless event from an economic perspective, what explains the media obsession?

For the media, it is a ready-made story. It takes place at a time that there is little other news, and it is known in advance, so editors and TV news directors can plan in advance for coverage. And there’s no doubt that video of people stampeding through the doors of a Wal-Mart in hot pursuit of a new Wii makes for great television. That is even putting aside more cynical possibilities, such as that media depend on retail advertising and thus have a vested interest in creating a sense of hype and anticipation around an orgy of consumerism.

Nothing more than another media manufactured trend. Bookmark the Irwin piece and refer back to it each morning before you get sucked into the inevitable Bloomberg stories detailing the ups and downs of the holiday season. And remember that everyone will be looking for a quick sound bite to leverage off the holiday mania. Sarah Kliff includes one such bite in a piece on the latest Reuters/Michigan Consumer Sentiment numbers:

...the latest round of economic indicators suggest that economic gloom is finally starting to set in with the general public, and the austerity crisis may have something to do with it. The Reuters/University of Michigan Consumer Sentiment Index fell 2.2 points from the preliminary reading early in November to the final reading after the election...They’re still more optimistic about the current state of the economy, but consumers have become more pessimistic about what’s ahead—a change that IHS Global Insight chalks up to “increased awareness by many Americans of the fiscal cliff.”

“If the political rhetoric and finger pointing reaches a fever pitch similar to that of the debt ceiling crisis in the summer of 2011 then consumer confidence is likely to take a very serious hit, and this holiday season will not be very cheerful,” the IHS analysis concludes.

Aside from the pointlessness of attempting to gain deep understanding about the economy from a minor blip in the confidence numbers, before you start huddling in the corner for fear of imminent economic collapse, please refer back to last summer's dive in confidence numbers:

While the budget talks did undermine confidence last summer, the impact on spending was essentially nil. I doubt very much that US households will focus much on the fiscal cliff until the new year, choosing instead to focus on holiday parties, egg nog, and gift giving. And if they do give some thought to the cliff, they won't change their spending measurably; they have already set their budgets for the year. That will only happen if going over the fiscal cliff undermines the job market, something that would not be evident until much deeper into 2013. For now, consumer sentiment is only catching back up to where we would expect it to be given the pace of spending. Nothing more, nothing less. For economic trends more relevant to the path of spending, see Neil Irwin's reasons to be thankful this season.

Bottom Line: Black Friday hype - just say no.

Interview with Reinhart and Rogoff

Found this interview of Reinhart and Rogoff via Barry Ritholtz (I had to search the title in Google to get past the paywall):

Top Culprit in the Financial Crisis: Human Nature, by Lawrence Strauss: ... What are your thoughts about the steps taken to foster fiscal and monetary policy?

Reinhart: We can always go back and figure out a way in which the fiscal and monetary policy could have been made sharper, to do more. But the thrust in a deep financial crisis, when you throw in both monetary and fiscal stimulus, is to come up with something that helps raise the floor. That's why the decline wasn't 10% or 12%. However, one area where policy really has left a bit to be desired is that both in the U.S. and in Europe, we have embraced forbearance. Delaying debt write-downs and delaying marking to market is not particularly conducive to speeding up deleveraging and recovery. Write-downs are not easy. On the whole, write-offs have been very sluggish.

Rogoff: ... Look at Europe. A lot of policies are directed at keeping European banks afloat, and it is crippling the credit system. You could have said the same about the U.S., where a lot of policies are about recapitalizing the financial system. The policy makers were very, very cautious about breaking eggs. The thinking was, "We just have got to hold out for a year, and it is going to be fine." ...

Is there a regulatory framework that would prevent severe financial crises?

Reinhart: Of course there is. But can we get there?

Rogoff: And stay there?

Reinhart: That's the question. Getting there is one thing, staying there is a different matter. And that's where the memory, or the dissolution of memory, kicks in. This comes out very clearly in our chapter in the book about banking crises. Devastated by what happened in the 1930s, the architects of the Bretton Woods System at the end of World War II, including John Maynard Keynes, were very leery of financial markets. This was an era of financial repression. Trade boomed. Not trade in finance, but trade in goods and services. And this very tight system, with all its distortions and problems, still delivered decade after decade of no systemic crisis. Between 1945 and 1980, it was an unusually quiet period. But then, by the late-1990s, the regulations seemed passé. The financial system found ways of circumventing regulation. It was outmoded. It was discarded, and we started anew.

Rogoff: It's important to channel some financing into safer instruments. If banks were to finance themselves like normal firms by raising a significant share of their lendable capital through issuing equity or retained earnings, we would have much, much safer financial system. So that's a very simple change. ...

Reinhart: You go through history and, in good times, the tendency is to liberalize. Then a crisis happens, and you retrench. But the retrenchment lasts only as long as your memory does, and memory is not that great. Not the memory of the policy makers and not the memory of the markets. So as you start putting time in between where you are now and your last crisis, complacency sets in, and you begin to be more cavalier about what your indicators or warning signals are showing. That's the essence of the this-time-is-different syndrome. The debt ratios are X, but we really don't have to worry about that; the price-earnings ratios are Y, but that's not a concern.

And so, given that this is so grounded in human nature, I'm extremely skeptical that we will overcome financial crises in any definitive way. We may have longer stretches [without a major crisis], as we did after World War II during the era of financial repression, which grew out of the crisis of the early 1930s. Back then, you had a lot more regulation and clamps on risk-taking, both domestically and cross-border. But then we outgrew it. It was passé. Who needed Glass-Steagall? ...

I mostly agree with what they say in the interview, but they are still too hawkish on short-run fiscal policy for my taste. I believe their work and statements in interviews such as this helped to drive the harmful austerity movement in Europe and that should at least bring caution. Reinhart's argument was that yes, immediate austerity makes things worse. But the failure to invoke immediate austerity brings about even bigger problems down the road, so big that the pain now is worth it. She has backed off a bit relative to where she was a few years ago, but as the following quote shows Reinhart will only say "the idea of withdrawing stimulus in what is still a frail environment is not an easy one to tackle" -- notice that she doesn't say it is the wrong policy for a country line the U.S.:

this is not the time to be an inflation hawk. I would rather see the margin of error favor easing too much, rather than too little, for many reasons. The frailty of the recovery is still an issue. The amount of debt that is still out there for households, the financial industry, and the government is still large.

The fiscal side is more complicated, because the idea of withdrawing stimulus in what is still a frail environment is not an easy one to tackle. However, over the longer haul, a comprehensive, credible fiscal consolidation is very much needed, because as much as we allude to the level of public debt, the level of private debt, external debt, and so on are even higher. And we also have a lot of unfunded liabilities in our pension scheme, a long-term issue that needs addressing.

The last statement is annoying. It's health care costs, not unfunded pension liabilities that is the problem for the long-run federal budget. Maybe she has unfunded state and local pension liabilities in mind as well, don't know, but a bit more care when making these kinds of statements would be helpful since this will be interpreted by most as a call for big cuts in Social Security. It was enough to aid and abet the failed austerity movement, do they want to similarly aid and abet the dismantling of Social Security with careless statements such as this?

Links for 11-24-2012

• How to Govern America in 2013 - Brad DeLong
• How noisy is economics/finance peer review? - James Choi
• Poor management, not unions, killed Hostess - Michael Hiltzik
• Franc Thoughts on Bond Vigilantes - Paul Krugman
• Adam Smith on Government Intervention - Gavin Kennedy
• Inconvenient truths, probably - mainly macro
• The Fed’s Other Communications Policy Shift - WSJ
• The Fractalist - WSJ.com
• Onwards and upwards - Gillian Tett
• Should Europe Emulate the US? - Jean Pisani-Ferry
• Was Curbside Recycling the Invention of Beverage Companies? - Tim Taylor
• How fighting inequality became Obama’s driving force - Zachary Goldfarb
• Reverse Bank Run, Or When the Money Came Rollin’ In - Liberty Street

Fed Watch: Why We Can't Take Inflation Hawks Seriously

Tim Duy:

Why We Can't Take Inflation Hawks Seriously. by Tim Duy: Peter Coy at Bloomberg reports on the Shadow Open Market Committee. Not surprisingly, the SOMC fears an outbreak of inflation is just around the corner.

Conservative economists are paying attention to the man behind the curtain and not liking what they see. At a meeting in a Manhattan hotel on Nov. 20, the so-called Shadow Open Market Committee criticized Federal Reserve Chairman Ben Bernanke for an ultra-easy monetary policy that will, in their opinion, lead ultimately to dangerously higher inflation.

It is almost comical that those who profess to be experts on monetary policy appear to almost never listen to what Federal Reserve officials say. Case in point:

Marvin Goodfriend, an economist at Carnegie Mellon University, said the Federal Reserve “appears to be walking away” from a commitment it made last January to keep the inflation rate at or near 2 percent. In September, when it announced a new round of bond buying to bring down unemployment, the Fed made no mention of the 2 percent target, merely saying it would pursue its growth target “in a context of price stability.”

Made no mention of the 2 percent target? Really? Let's go to the tape:

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee is concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions. Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook. The Committee also anticipates that inflation over the medium term likely would run at or below its 2 percent objective.

I think they were pretty clear about the 2 percent target, which is the Fed's definition of price stability. If Goodfriend can't remember this, he should bookmark the appropriate page on the Board's website:

The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory mandate.

The only way this isn't clear is if you are deliberately ignoring what the Fed is saying. The SOMC also fears any policy that allows inflation to drift even temporarily above 2 percent:

Jeffrey Lacker, the hawkish president of the Federal Reserve Bank of Richmond, was the Shadow Open Market Committee’s invited keynote speaker. He shared the committee members’ concerns about letting inflation drift much above the 2 percent target in the name of growth, even for a short while.

“At the very least, the precedent set by an opportunistic attempt to raise inflation temporarily is likely to cloud our credibility for decades to come,” Lacker said.

First, actual inflation outcomes would be expected to fall in a symmetric pattern around 2 percent. When Lacker argues against allowing even a temporary drift above 2 percent, he is effectively saying that 2 percent is a ceiling, not a target, so that on average, inflation will be less than 2 percent over time (all the errors would be on the low side of the target). Thus, he is actually trying to enforce a price stability standard stricter than the current standard. Second, this whole discussion is something of a strawman to begin with. Realistically, only Chicago Federal Reserve Chairman Charles Evans supports any meaningful drift over 2 percent. Even Minneapolis Federal Reserve President Narayana Kocherlakota, much lauded for his move to the dovish side of the FOMC, sets an upward bound of just 2.25 percent before the Fed should consider a policy shift. And Federal Reserve Vice Chair Janet Yellen, also a well-noted dove, describes an optimal path for policy that foresees inflation just barely kissing 2.25 percent at best. In short, within the Fed there is very little support for any inflation drift that would "cloud our credibility for decades to come." This is simply a nonsensical fear on Lacker's part.

Next, we have the argument that we will never see inflation coming because of the Fed's large scale asset purchase program:

Mickey Levy, chief economist for Bank of America and an SOMC member, said that the Fed “has neutralized the bond vigilantes” by keeping rates low. In other words, even if bond traders are worried that inflation will heat up, they don’t dare bet that way by driving interest rates higher, because the Fed will swat them away by pushing rates back down. “The adage ‘Don’t fight the Fed’? It’s in full force,” Levy said.

Do people forget that both the BLS and the BEA publish monthly reports on prices? That the Fed would not incorporate this data into their decision making process? That the Fed can control inflation expectations as measured by the TIPS market, the very same expectations the Fed uses as a policy guide?

There will still be plenty of data and market indicators even within the context of bond purchases. Here is my expected sequence of events: If growth or inflation accelerates to the point that the Fed will be expected to change policy, bond market participants will bid down the price of Treasuries holding constant a given pace of asset purchases (that "all else equal" thing). The Fed will then have a choice - either prepare to tighten as the market expects, or accelerate the pace of asset purchases to hold rates down. If they choose the second route, the bond sell-off will accelerate as participants begin to suspect the Fed is not committed to the 2 percent target. That would be the signal the Fed is clearly moving in the wrong direction. And you should expect inflation to move higher. In other words, the Fed's bond purchase program does not by itself eliminate inflation signals should such signals emerge. The bond vigilantes have not been neutralized by the Fed; they have been neutralized by reality.

Finally, back to the 2 percent target:

The Shadow Open Market Committee meeting wrapped up just before Bernanke spoke a few blocks away at a meeting of the Economic Club of New York. Harvard University economist Martin Feldstein, who attended the SOMC symposium, was given the privilege of asking Bernanke questions at the Economic Club luncheon. He did not choose to ask the chairman whether the Fed was walking away from its 2 percent inflation target.

Right after the luncheon, though, Bloomberg TV’s Mark Crumpton asked Feldstein, who was President Ronald Reagan’s chief economic adviser, if he was concerned that the Fed hadn’t been talking about the 2 percent target lately. “Absolutely,” Feldstein said. “It’s very important for the Fed to reaffirm those goals.”

Notice that Feldstein claims the Fed is not discussing the target moments after Bernanke spoke. But what did Bernanke actually say? To the tape:

But with longer-term inflation expectations remaining stable, the ebbs and flows in commodity prices have had only transitory effects on inflation. Indeed, since the recovery began about three years ago, consumer price inflation, as measured by the personal consumption expenditures (PCE) price index, has averaged almost exactly 2 percent, which is the FOMC's longer-run objective for inflation. Because ongoing slack in labor and product markets should continue to restrain wage and price increases, and with the public's inflation expectations continuing to be well anchored, inflation over the next few years is likely to remain close to or a little below the Committee's objective.

How has the Fed not been talking about the 2 percent target? They repeatedly emphasize the target. Bernanke does so virtually every time he speaks. Cleveland Federal Reserve President Sandra Pianalto basically says the 2 percent target is so concrete that there should no longer be a distinction between hawks and doves. How can Feldstein sit through Bernanke's speech and completely miss the part that addresses Feldstein's concerns? How can he not say "the Fed talks about 2 percent every chance they get"? The only explanation: He simply does not want to recognize any information that departs from his pre-conceived view of the world.

Bottom Line: Inflation hawks continue to operate in a parallel universe.

'Imagine Economists had Warned of a Financial Crisis'

Chris Dillow:

... Imagine economists had widely and credibly warned of a financial crisis in the mid-00s. People would have responded to such warnings by lending less and borrowing less (I'm ignoring agency problems here). But this would have resulted in less gearing and so no crisis. There would now be a crisis in economics as everyone wondered why the disaster we predicted never happened. ...

His main point, however, revolves around Keynes' statement that "If economists could manage to get themselves thought of as humble, competent people on a level with dentists, that would be splendid":

I suspect there's another reason why economics is thought to be in crisis. It's because, as Coase says, (some? many?) economists lost sight of ordinary life and people, preferring to be policy advisors, theorists or - worst of all - forecasters.

In doing this, many stopped even trying to pursue Keynes' goal. What sort of reputation would dentists have if they stopped dealing with people's teeth and preferred to give the government advice on dental policy, tried to forecast the prevalence of tooth decay or called for new ways of conceptualizing mouths?

Perhaps, then, the problem with economists is that they failed to consider what function the profession can reasonably serve.

Paul Krugman: Grand Old Planet

The Republican anti-rational mind-set:

Grand Old Planet, by Paul Krugman, Commentary, NY Times: ...Senator Marco Rubio, whom many consider a contender for the 2016 Republican presidential nomination,... was asked how old the earth is. After declaring “I’m not a scientist, man,” the senator went into desperate evasive action, ending with the declaration that “it’s one of the great mysteries.”

It’s funny stuff, and conservatives ... say ... he was just pandering to likely voters in the 2016 Republican primaries — a claim that for some reason is supposed to comfort us.

But we shouldn’t let go that easily..., his inability to acknowledge scientific evidence speaks of the anti-rational mind-set that has taken over his political party. ... In one interview, he compared the teaching of evolution to Communist indoctrination tactics...

What was Mr. Rubio’s complaint about science teaching? That it might undermine children’s faith in what their parents told them to believe. And right there you have the modern G.O.P.’s attitude, not just toward biology, but toward everything: If evidence seems to contradict faith, suppress the evidence.

The most obvious example other than evolution is man-made climate change. As the evidence for a warming planet becomes ever stronger — and ever scarier — the G.O.P. has buried deeper into denial ... accompanied by frantic efforts to silence and punish anyone reporting the inconvenient facts.

But the same phenomenon is visible in many other fields. The most recent demonstration came in the matter of election polls..., the demonizing of The Times’s Nate Silver, in particular, was remarkable to behold. ...

We are, after all, living in an era when science plays a crucial economic role. How are we going to search effectively for natural resources if schools trying to teach modern geology must give equal time to claims that the world is only 6,000 years old? How are we going to stay competitive in biotechnology if biology classes avoid any material that might offend creationists?

And then there’s the matter of ... the recent study from the Congressional Research Service finding no empirical support for the dogma that cutting taxes on the wealthy leads to higher economic growth. How did Republicans respond? By suppressing the report. On economics, as in hard science, modern conservatives don’t want to hear anything challenging their preconceptions — and they don’t want anyone else to hear about it, either.

So don’t shrug off Mr. Rubio’s awkward moment. His inability to deal with geological evidence was symptomatic of a much broader problem — one that may, in the end, set America on a path of inexorable decline.

Links for 11-23-2012

• Beware the next financial blindspot - FT.com
• Workers Must Get a Bigger Slice of the Pie - NYTimes.com
• Is China Heading for Another Round of Capitalist Roading? - EconoSpeak
• Offsetting private sector financial balances with fiscal policy - mainly macro
• Why is housing such a popular investment? - Vox EU
• In which I agree with Megan McArdle - Crooked Timber
• How the Electronic Deutsche Mark Can Save Europe - Miles Kimball

Who Should Lead the SEC?

I don't know enough about this -- what more can you tell me about who should lead the S.E.C.?:

Mary Miller vs. Neil Barofsky for the S.E.C.?, by Simon johnson, Commentary, NY Times: The Obama administration is floating the idea that Mary J. Miller, under secretary for domestic finance at the Treasury Department, could become its nominee to lead the Securities and Exchange Commission. Ms. Miller, a longtime executive in the mutual funds industry, has served in the Treasury under Timothy Geithner since February 2010.

Ms. Miller represents the financial sector's preferred approach to financial reform - some talk but very little by way of serious effort. ... And there is no willingness to really face down powerful people on Wall Street.

Her potential candidacy faces ... obstacles... Mr. Barofsky is the most important obstacle... The former special inspector general for the Troubled Assets Relief Program ... he is an experienced prosecutor who understands complex financial fraud. ... Mr. Barofsky is a lifelong Democrat who has enjoyed bipartisan support in Congress. ...

A petition that Credo Action has put online urging President Obama to appoint an S.E.C. chairman who will hold Wall Street accountable, and naming Mr. Barofsky as a worthy choice, had more than 35,000 signatures by Wednesday morning.

The petition also recommends former Senator Ted Kaufman of Delaware and Dennis Kelleher of Better Markets - both of whom I endorsed here last week - and it expresses support for Sheila Bair, who would be terrific ...

Mr. Barofsky is not popular with Mr. Geithner, precisely because he has stood up to authority for all the right reasons. ... The mutual fund industry does not want reform...

Choosing a new chairman of the S.E.C. is the perfect time for President Obama to decide whether, despite everything, to go for the status quo - which brought us to our current economic predicament - and nominate Ms. Miller for the S.E.C. Or does he really want effective change? In that case, he should nominate Mr. Barofsky or someone who can match his stellar qualifications.

Let's Avoid 'Undercooked Turkey'

I'm not so thankful for this:

Ben Bernanke pessimistic on potential GDP growth, by Gavyn Davies: Ben Bernanke’s speech to the New York Economic Club on Tuesday ... seems to have accepted that the rate of growth in potential GDP has fallen sharply in recent years, which is not something he has emphasized in the past. If he persists with this more pessimistic interpretation of potential GDP growth, it would imply that there is a speed limit on the pace at which the economy can recover in the next few years, and that the Fed might need to tighten policy earlier than previously assumed.

Ever since the financial crash, Mr Bernanke has consistently emphasised that US GDP is well below its potential... The implication has been that a shortage of demand is responsible for most of the output loss... Fix the shortage of demand as quickly as possible, and you minimize the total losses of output that will be incurred during the recession. This has resulted in the assumption that the Fed would remain extremely accommodating...

What changed in this week’s speech? Importantly, the chairman did not change his view of the natural rate of unemployment. He continues to suggest that this is about 5.5 per cent to 6 per cent.. However, he now says that the potential growth of GDP is lower than the 2.5 per cent that was in place before the crisis. ...

Mr Bernanke offered three reasons why the growth in potential GDP might have declined since 2009: a decline in fixed investment, reducing the capital stock; a mismatch between the skills of unemployed workers and the needs of the industries that are expanding; and tight credit conditions, along with higher risk aversion...

The bottom line of this analysis is that the Fed may be satisfied with a much lower growth rate over the next four years...

For the time being, this will not shift the Fed away from its dovish stance. After all, actual GDP remains well below any of the potential GDP paths shown in the chart. But it does mean that, if the economy embarks on a firm recovery path, the Fed Chairman might favor an earlier tightening than some of his earlier speeches have implied. ...

It's true that the turkey will continue to cook even after it is removed from the oven (i.e. there are policy lags, so the heat should be turned off a bit before we reach our full employment goal). But I hate raw turkey, and if we are going to make a mistake on when to turn off the oven, let's make it one where labor markets are a bit overheated rather then underheated. Please.

Thanks

As I look for something to post without being, or at least appearing, too anti-social, let me say a simple thanks to all of you.

Here's  repeat from 2005:

They Held Their Noses, and Ate, by James E. McWilliams, Commentary, NY Times: No contemporary American holiday is as deeply steeped in culinary tradition as Thanksgiving. ... [It's] a feast with a narrowly proscribed list of foods - usually some combination of turkey, corn, cranberries, squash and pumpkin pie. Decorated with these dishes, the Thanksgiving table has become a secular altar upon which we worship America's pioneering character, a place to show reverence for the rugged Pilgrims who came to Plymouth in peace, sat with the Indians as equals and indulged in the New World's cornucopia with gusto. But you might call this comfort food for a comfort myth.

The native American food that the Pilgrims supposedly enjoyed would have offended the palate of any self-respecting English colonist ... Our comfort food ... was the bane of the settlers' culinary existence. Understanding this paradox requires acknowledging that there's no evidence to support the holiday's early association with food - much less foods native to North America. ... It wasn't until the mid-19th century that domestic writers began to play down Thanksgiving's religious emphasis and invest the holiday with familiar culinary values. Sarah Josepha Hale and her fellow Martha Stewarts of the day implored families to "sit down together at the feast of fat things" and raise a toast to the Thanksgiving holiday. When Abraham Lincoln declared Thanksgiving a national holiday in 1863, the cornucopia-inspired myth was, as a result of these literary efforts, in full bloom. ... [H]owever, the earthy victuals that Thanksgiving revisionists arranged on the Pilgrims' fictional table were foods that Pilgrims and their descendants would have rather avoided.

The reason is fairly simple. Hale and her fellow writers seem to have forgotten ... their Puritan forebears ... strict notions about food production and preparation. Proper notions of English husbandry generally demanded that flesh be domesticated, grain neatly planted and fruit and vegetables cultivated in gardens and orchards. Given these expectations, English migrants recoiled upon discovering that the native inhabitants hunted their game, grew their grain haphazardly and foraged for fruit and vegetables. ... [T]he English deemed the native manner of acquiring these goods nothing short of barbaric. ... They typically prepared fields by setting fire to the underbrush and girdling surrounding trees. Afterward, they planted corn, gourds and beans willy-nilly across charred ground, possibly throwing in fish as fertilizer. To the Indian women who tended the plants with clamshell hoes, the ecological brilliance of this arrangement was abundantly clear: the cornstalks stretched into sturdy poles for the beans to climb upon, the corn leaves fanned out to provide squash with shade, and the beans enriched the soil with extra nitrogen. But the English, blinded by tradition, never got it - they just looked on in horror. Where were the fences? The neat rows of cross-sectioned grain? The plows? ... The team of oxen? ... Why were perfectly good trees left to rot? ... And those fish! Why not salt them down and export them to Europe for a tidy profit? What was wrong with these people? The collective English answer - "everything" - honed the colonists' distaste for foods, especially corn and squash, that they quickly judged best for farm animals.

A similar culinary misunderstanding developed over meat. To be sure, the English frequently hunted for their meals. But hunting was preferably a sport. When the English farmer chased game to feed his family, he did so with pangs of shame. To resort to the hunt was, after all, indicative of agricultural failure... Thus the colonists reacted with extreme disapproval when they saw Indian men ... disappearing into the woods for weeks at a time to track down protein. Making the scene even more primitive was that the women who stayed behind ... toiling away at odd jobs that the English valiantly considered men's work. The elk, bear, raccoon, possum and indeed the wild turkeys that the men hauled back to the village were, for all these reasons, tainted goods reflective of multiple agricultural perversions.

They were also ... unavoidable. The methods that colonists condemned as agriculturally backwards ... became necessary to their survival. No matter how hard they tried, no matter how carefully they tended their crops and repaired their fences ... and furrowed their fields, colonial Americans failed to replicate European husbandry practices. Geography alone wouldn't allow it. The adaptation of Indian agricultural techniques ... provoked severe cultural insecurity. This insecurity turned to conspicuous dread when the colonists were mocked by their metropolitan cousins as living, in the words of one haughty Englishman, "in a state of ignorance and barbarism, not much superior to those of the native Indians." This hurt. And under the circumstances no status-minded English colonist would have possibly highlighted his adherence to native American victuals ... Indeed, it wasn't until after the Revolution, when the new nation was seeking ways to differentiate itself from the Old World, that these foods became celebrated as a reflection of emerging ideals like simplicity, manifest destiny and rugged individualism. ...

The year after Lincoln declared Thanksgiving a national holiday in 1863:

Links for 11-22-2012

• Number of Families Struggling to Afford Rent Rises Sharply - CBPP
• What an academic article of the future should look like - Digitopoly
• Brain waves encode rules for behavior - MIT News
• Maybe Nate Silver Was Wrong - Baseline Scenario
• Inequality is Killing Capitalism - Robert Skidelsky
• Response to Jeffrey Sachs - Acemoglu and Robinson
• Shadow Banking - MacroMania

Marx vs Coase

Long drive ahead of me today, and I'm late getting on the road, so just a few quick ones for now. This is from Chris Dillow:

Marx vs Coase: experimental evidence, Stumbling and Mumbling: Are firms efficient institutions for responding to uncertainty, as Coase thought? Or are they, as Marxists believe, means whereby capitalists exploit workers? A new paper by Ernst Fehr and colleagues provides experimental evidence. ...

Fehr and colleagues found that, in one-shot encounters where employment contracts were struck, 51% of principals exploited agents. "The Marxian idea that power can be used for exploitation is real" they conclude. ...

However, in repeated encounters, the prevalence of exploitation dropped to 21%. This is because employers wanted to build a reputation for fairness which they could use to encourage workers to stick to employment contracts.

Simple as it is, this gives us a framework to pose the question: under what conditions are we likely to have Coasian rather than Marxian firms?

One is where there's a strong norm of fairness. ... Another is where firms have a desire for a reputation as a "good" employer. This is more likely to be the case under conditions of near-full employment, where they have to compete for for workers.

A third is the existence of strong unions. ... This corroborates my suspicion that strong unions can be good for an economy.

There is, however, a fourth possibility - for workers to have an outside option such as welfare benefits that allow them to reject exploitative contracts.

The fact that many of capitalism's supporters reject this fourth course makes me suspect that what they are interested in is not so much efficient Coasian firms as the power of capital to exploit workers.

'What the Audience Wants'

Paul Krugman:

C Is For Class Warfare, by Paul Krugman: Ryan Chittum has a great piece about CNBC’s decision to drop even the pretense of journalistic objectivity and throw its weight behind the deficit scolds. Basically, the network has gone all in on behalf of the 0.01 percent.

One question Chittum doesn’t really get at, however, is why CNBC takes this tilt — why, in fact, it has been so dominated by the fake deficit hawk faction, the people who say that the debt is terrible, terrible, and that’s why we have to cut taxes on the rich. After all, the network’s audience does not consists mainly of the very rich; rather, it’s the 1 percent wannabees, who imagine that watching many hours of talking heads will somehow let them absorb the secrets of getting rich. ...

I ... think ... the main story ... is ... this is what the audience wants. And it’s what they want even though the Austerian stuff the network peddles has been wrong, wrong, wrong, wrong... Never mind that the Keynesians have been right about interest rates, inflation, austerity, and more; the audience wants to hear about the debt crisis and hyperinflation coming any day now unless we cut taxes on the rich, or something. ...

Only thing I'd say is that those preferences -- what viewers want to hear -- are unlikely to be independent of what they've heard from the media.

'Drug Company Money is Undermining Science'

Charles Seife:

How Drug Company Money is Undermining Science, by Charles Seife, Scientific American: ...In the past few years the pharmaceutical industry has come up with many ways to funnel large sums of money—enough sometimes to put a child through college—into the pockets of independent medical researchers who are doing work that bears, directly or indirectly, on the drugs these firms are making and marketing. The problem is not just with the drug companies and the researchers but with the whole system—the granting institutions, the research labs, the journals, the professional societies, and so forth. No one is providing the checks and balances necessary to avoid conflicts. Instead organizations seem to shift responsibility from one to the other, leaving gaps in enforcement that researchers and drug companies navigate with ease, and then shroud their deliberations in secrecy.

“There isn't a single sector of academic medicine, academic research or medical education in which industry relationships are not a ubiquitous factor,” says sociologist Eric Campbell, a professor of medicine at Harvard Medical School. Those relationships are not all bad. After all, without the help of the pharmaceutical industry, medical researchers would not be able to turn their ideas into new drugs. Yet at the same time, Campbell argues, some of these liaisons co-opt scientists into helping sell pharmaceuticals rather than generating new knowledge.

The entanglements between researchers and pharmaceutical companies take many forms. There are speakers bureaus: a drugmaker gives a researcher money to travel—often first class—to gigs around the country, where the researcher sometimes gives a company-written speech and presents company-drafted slides. There is ghostwriting: a pharmaceutical manufacturer has an article drafted and pays a scientist (the “guest author”) an honorarium to put his or her name on it and submit it to a peer-reviewed journal. And then there is consulting: a company hires a researcher to render advice. ...

It is not just an academic problem. Drugs are approved or rejected based on supposedly independent research. When a pill does not work as advertised and is withdrawn from the market or relabeled as dangerous, there is often a trail of biased research and cash to scientists. ...

The scientific community's answer to the conflict-of-interest problem is transparency. Journals, grant-making institutions and professional organizations press researchers to openly declare ... when they have any entanglements that might compromise their objectivity. ... It is an honor system. Researchers often fail to report conflicts of interest—sometimes because they do not even realize that they present a problem. ...

In theory, there is a backup system. ... When a scientist fails to report such a conflict, the university or hospital he or she works for is supposed to spot it and report it. And when a university or hospital is not doing its job catching conflicted research, then the government agency that funds most of that research—the National Institutes of Health—is supposed to step in. Unfortunately, that backup system is badly broken. ...

Links for 11-21-2012

• Banking must not be left in the shadows - Gary Gorton
• Jobless Benefits as an Antipoverty Program - NYTimes.com
• Bernanke: Cutting Interest on Reserves to Zero Would Do Little - WSJ
• The monumental folly of rent-seeking - John Kay
• China’s Transition: Three Scenarios - Econbrowser
• How We Know The Earth Is Old - Paul Krugman
• Year-End Fiscal Debate Is Chance to Address Inequality - NYTimes.com
• The Economic Recovery and Economic Policy - FRB: Speech--Bernanke
• Only One Thing That Can Save Japan Now: Inflation - Matthew O'Brien
• “I know you aren’t the plagiarism police, but . . .” - Andrew Gelman
• The New Republican Tax Policy - Bruce Bartlett
• Crises in open economies - vox
• More Affirmative Action for Deficit Hawks - Dean Baker
• U.S. Deficit Shrinking At Fastest Pace Since WWII - Jed Graham
• Choosing your own capitalism in a globalised world? - vox
• Executive pay limits narrowed scope of TARP banking rescue - EurekAlert

'The Origins of Republican Starve-the-Beast Theory'

Guess who's to blame for "starve the beast"?:

The New Republican Tax Policy, by Bruce Bartlett, Commentary, NY Times: Although it is commonly believed that the Laffer curve - the idea that tax cuts pay for themselves - is the core Republican idea about tax policy, this is wrong. The true core idea is something called starve-the-beast - the idea that tax cuts will force cuts in spending precisely because they reduce revenue. But there are slight indications that some conservatives have awakened to the reality that not only does starve-the-beast not work, but it also leads to higher spending. ...

I have traced the origins of Republican starve-the-beast theory to testimony by Alan Greenspan before the Senate Finance Committee on July 14, 1978...

'Compensation Growth and Slack in the Current Economic Environment'

This is a bit technical at times, but it makes an important point that is a bit buried in the discussion that I'd like to highlight.

The first step in the discussion is to explain what a non-linear Phillips curve is, and why a non-linear specification is needed:

Compensation Growth and Slack in the Current Economic Environment, by M. Henry Linder, Richard Peach, and Robert Rich, NY Fed: ...Our analysis is based on the estimation of a nonlinear wage-inflation Phillips curve that draws upon the modeling approach outlined in a Boston Fed paper by Fuhrer, Olivei, and Tootell. The key feature of the nonlinear Phillips curve is that the impact of a change in slack depends on the level of slack. These features are illustrated in the chart below, where the slope of the Phillips curve becomes steeper as the unemployment rate moves further below the natural rate of unemployment (higher resource utilization), while the slope becomes flatter as the unemployment rate moves further above it (lower resource utilization).

Why might the Phillips curve flatten out as the unemployment rate rises further above the natural rate of unemployment? As a reminder, what matters for labor market decisions is the real wage rate—the nominal wage adjusted for the price level (or cost of living). One explanation for the flattening of the Phillips curve is downward real wage rigidity—that is, a more sluggish response of real wages when the unemployment rate is high (see the Boston Fed paper by Holden and Wulfsberg for a more detailed discussion of theories of real wage resistance during an economic downturn). In a situation of high unemployment, wage growth becomes relatively stable around the recent level of underlying inflation, so that real wages don’t fall sufficiently to clear the labor market.

Here's how they estimate the non-linear Phillips curve and an explanation of why the sample begins in 1997:

Our Phillips curve model relates four-quarter growth in nominal compensation per hour (for the nonfarm business sector) to economic slack, controlling for movements in trend productivity growth and expected inflation. Our measure of slack is the Congressional Budget Office (CBO) estimate of the unemployment gap—the percentage point deviation between the actual unemployment rate and the CBO estimate of the natural rate of unemployment. For trend productivity growth, we use an average of the (annualized) quarterly growth rate of productivity. For expected inflation, we construct a ten-year personal consumption expenditure (PCE) survey measure by adjusting the Survey of Professional Forecasters’ ten-year expected CPI inflation series to account for the average differential between CPI and PCE inflation. As the chart below shows, expected inflation has been extremely stable during the post-1997 period. To provide additional observations for estimation and to conduct the analysis in a low-inflation environment with well-anchored expectations, we use data that cover the period from 1997 through the present.

Our model relates economic slack to an adjusted compensation measure, where we subtract the values of trend productivity growth and expected inflation from the compensation growth series. This adjustment imposes the standard restriction that increases in the real wage rate equal increases in labor productivity in the long run. The chart below provides a scatter plot of the adjusted compensation growth series and the unemployment gap. Negative (positive) values of the unemployment gap represent conditions in which unemployment is below (above) the natural rate of unemployment.

The estimated Phillips curve should have the shape predicted above, and it does:

An examination of the scatter plot shows that the general shape of the data points bears a close resemblance to the chart of the nonlinear Phillips curve, and estimation of the model provides evidence of a statistically significant nonlinear relationship between (adjusted) compensation growth and slack. ...

We also consider two additional criteria to evaluate the nonlinear Phillips curve model—within-sample fit and out-of-sample forecast performance. The within-sample fit is based on estimation of the model using data from the full sample to compare the predicted and actual values of growth in compensation per hour. The out-of-sample forecast performance is based on estimation of the model only using data through 2007:Q4 on the unemployment gap, trend productivity growth, and expected inflation. With the resulting estimated model, we input the actual values of the unemployment gap, trend productivity growth, and expected inflation during the post-2007:Q4 period to generate forecasts of compensation growth. The first forecast corresponds to compensation growth from 2008:Q1 to 2009:Q1.

The next chart plots the four-quarter change in compensation growth, the within-sample predictions, and the post-2007:Q4 out-of-sample forecasts. While the within-sample predictions fail to track some short-run movements in compensation growth, they do capture the general movements in the series. Moreover, both the within-sample predictions and out-of-sample forecasts capture the magnitude of the decline in compensation growth since 2008 as well as its subsequent stability.

Our analysis suggests that a nonlinear wage-inflation Phillips curve fits the data well during the post-1997 episode and complements the results of Fuhrer, Olivei, and Tootell, who find evidence of a nonlinear relationship between price inflation and activity gap measures.

Here's what I want to highlight:

An important conclusion from our analysis is that recent stability in the growth rate of labor compensation measures may not be informative about the extent of slack or its change. That is, stability in labor compensation measures doesn’t imply that the output gap has closed, while changes in the output gap may only have a modest impact on compensation growth.

They also note that this implies real rather than nominal wage rigidity:

In an inflation environment where actual and expected price changes are low, someone might interpret the earlier scatter plot as reflective of downward nominal wage rigidity—the idea that workers and firms have incentives to avoid reductions in nominal wages. However, the nonlinearity between wage growth and slack appears to be evident in other episodes in which large fluctuations in real activity were accompanied by high inflation and high compensation growth (this point is also discussed by Fuhrer, Olivei, and Tootell). Thus, the mild trade-off between compensation/wage growth and resource slack when slack is sizable isn’t unique to recent experience. Moreover, the source of the nonlinearity must stem from downward real wage rigidity, as downward nominal wage rigidity can generate this feature only in a low-inflation environment.

They conclude with:

We recognize that our analysis comes with important caveats... Nevertheless, if the nonlinear relationship between slack and wage/price inflation is an important feature of the data, then it will be critical for policymakers to identify other indicators that may be more responsive to slack and provide a quick and more reliable read on its movements.

It is not surprising at all that wage movements would be uninformative about labor market conditions when wages adjust sluggishly to economic conditions, but the prevalence of claims about the condition of the labor market based upon measures of compensation is a signal that people have missed this point. There can be both considerable slack in the economy (so let's do something about it), and relatively stable wages.

New Republicans? Hardly

Paul Krugman:

There has been a lot of talk since the election about the possible emergence of a new faction within the Republican party... These new Republicans, we’re told, are willing to be more open-minded on cultural issues, more understanding of immigrants, and more skeptical that trickle-down economics is enough; they’ll favor direct measures to help working families.

So what should we call these new Republicans? I have a suggestion: why not call them “Democrats”?

There are three things you need to understand here.

First, on economic issues the modern Democratic party is what we would once have considered “centrist”, or even center-right. ...

Second, today’s Republican party is an alliance between the plutocrats and the preachers, plus some opportunists along for the ride — full stop. The whole party is about low taxes at the top (and low benefits for the rest), plus conservative social values and putting religion in the schools; it has no other reason for being. Someday there may emerge another party with the same name standing for a quite different agenda... But that will take a long time, and it won’t really be the same party.

Finally, it’s true that there are some Republican intellectuals and pundits who seem to be truly open-minded about both economic and social issues. But I worded that carefully: they “seem to be” open-minded; indeed, they’re professional seemers. When it matters, they can always be counted on — after making a big show of stroking their chins and agonizing — to follow the party line, and reject anything that doesn’t go along with the preacher-plutocrat agenda. If they don’t deliver when it counts, they are excommunicated; see Frum, David.

Anyone who imagines that there is any real soul-searching going on is deluding himself or herself.

Kevin Drum:

... Practically every ambitious politician in the party is making soothing noises about being nicer to Hispanics, lightening up on social issues, and compromising on the fiscal cliff, but the thing is, it's all just talk. With only a couple of exceptions from some of the few actual moderates still left in the party, the Jindals and Walkers and Rubios are pretty transparently unwilling to change any actual policies. They're as hardnosed as ever on abortion and taxes and amnesty. They just think the party should sound a little less hardnosed. ...

We have "plutocrats and the preachers" -- what happened to the libertarians?

The Bigger They Are, the Harder They Fall on the Rest of Us

We are live:

The Bigger They Are, The Harder They Fall on the Rest of Us

The title at the link is about breaking up big banks, but one of the points is that the growing problems associated with size/interconnectedness, including those associated with too big to fail, occur in more than just the financial sector. These problems are getting worse, and the question is, what are we going to do about it?

Links for 11-20-2012

• The Year of Betting Conservatively - Nouriel Roubini
• China's Economic Growth: A Different Storyline - Tim Taylor
• Lines between macroeconomics and politics - mainly macro
• Manufacturing is coming back. Manufacturing jobs aren’t - Neil Irwin
• Gold standard bullet points - MacroMania
• A non-linear Philiips Curve - Liberty Street
• Deliberation for activists - Dan Little
• Did the Indian capital controls work? - Vox
• A Public Service Reminder: Paul Ryan is a Con Man - Paul Krugman
• The Future of Federal Reserve Policy - Stephen Williamson
• Views Differ on Age of Planet - Paul Krugman
• Interview with Hans-Werner Sinn - Spiegel
• What Are Conservatives Getting Wrong About the Economy? - Rortybomb
• The Europe-in-Rubble Excuse - Paul Krugman
• Does the app economy need institutions? - Digitopoly
• Of Parents, Puppies and Robots - Nancy Folbre

Fed Watch: Industrial Production Stalls

Tim Duy:

Industrial Production Stalls, by Tim Duy: Sober Look is questioning just how temporary will be the impact of Hurricane Sandy on the data. I tend to think about this in somewhat different terms. I am fairly confident that the impact of Sandy on the national data will be almost entirely transient. I am less confident that we are identifying underlying trends in the data as we dismiss any weaker than expected numbers as artifacts of Sandy. At the moment, however, I think this issue is largely confined to manufacturing data.

As is well known at this point, industrial production slipped 0.4% in October, but the Federal Reserve estimated that Sandy contributed to a 1 percentage point decline in production. The manufacturing side of the ledger, almost three-quarters of the index, was flat after accounting for Sandy, which is pretty much par for the course of the last year:

Obviously, the flat trend in manufacturing was in place well before Sandy, and could get much worse if the core durable goods new orders data is any indicator:

Seeing the trend in place makes me a little less comforted by the fact that the October slide can be attributed to Sandy. What if we see another slide in November? Will that too be attributed to Sandy, or is there something more than meets the eye? Should we be worried about recession? I think that answer depends on whether or not you view the manufacturing drag as largely caused by domestic or international factors. If it is largely external, I think it slows the US economy but does not tip us into recession. We experience something closer to 2007/8, with the housing rebound taking the place (albeit weakly) of the tech boom. A domestic event, would be more significant.

So which is it? The Wall Street Journal reports this morning:

U.S. companies are scaling back investment plans at the fastest pace since the recession, signaling more trouble for the economic recovery.

Half of the nation's 40 biggest publicly traded corporate spenders have announced plans to curtail capital expenditures this year or next, according to a review by The Wall Street Journal of securities filings and conference calls.

But why is capital spending weak?

At the same time, exports are slowing or falling to such critical markets as China and the euro zone as the global economy downshifts, creating another drag on firms' expansion plans...Corporate executives say they are slowing or delaying big projects to protect profits amid easing demand and rising uncertainty. Uncertainty around the U.S. elections and federal budget policies also appear among the factors driving the investment pullback since midyear....Companies fear that failure to resolve the fiscal cliff will tip the economy back into recession by sapping consumer spending, damaging investor confidence and eating into corporate profits.

Firms see the real impact of an external slowdown, and they fear the consequences of fiscal austerity. But which firms?

Snapon Inc., which makes equipment for auto technicians, reports healthy investment among the 800,000 small businesses it serves across the U.S. "Their confidence is fair and reasonable," said Snap-on CEO Nicholas Pinchuk. "As you move up to bigger companies, their foresight becomes broader and their confidence starts to erode."

This should not be surprising; large firms with significant international exposure are feeling the heat from Europe, China, etc. Already impacted by this weakness, they are especially sensitive to the potential impact from the fiscal cliff. This contrasts greatly with the evolving domestic side of the equation:

The slowdown in capital spending contrasts with a rebound in U.S. consumer spending and confidence, which has returned to a five-year high. Meanwhile, the latest survey by the Business Roundtable, which tracks expectations for sales and investment among its big-company CEOs, found the worst sentiment about the economic outlook in three years.

Consumer confidence has rebounded in recent months, and now looks consistent with the current pace of spending. Job growth continues while the unemployment rate continues to track down. The impact of Sandy on retail sales was relatively small, and note that the September number was revised up. And, importantly, it is hard to deny the upward progress in housing markets:

It would be a historical anamoly to experience a recession when housing is on the upswing, and I am challenged to believed that trade channels are by themselves sufficient to defy that history and trigger a domestic recession.

That said, I understand completely firms' lack of confidence. Particularly for larger, international firms, the impact of slowing growth overseas is real, and going over the fiscal cliff will only make their problems worse. Indeed, a rapid turn to austerity is the kind of domestic event that could turn history on its head and induce a recession despite a housing recovery.

At the moment, however, consumers seem far less concerned about the fiscal cliff than their corporate counterparts. Perhaps this is an artifact of the lack of partisan bickering since the election. Or maybe households rationally believe that since Congress has worked this out in the past, they will work it out now. But whatever the case, housesholds are not expecting Congress to disrupt their holiday spending plans. Let's hope that remains the case.

Bottom Line: The external sector is having an impact on manufacturing, and this was evident in the data well before Sandy, so we can't just ignore data weakness in that sector. The impact is greatest on just where you would expect - large multinationals. But the domestic economy still appears to be chugging along, with the housing market picking up the slack from manufacturing. On net, that suggests no great acceleration in aggregate activity in the near-term, especially when combined with more fiscal austerity. At the same time, however, the US should be able to escape the international turmoil without a recession. So what is the near term risk? Aside from the usual suspect (oil price surge from Mideast war, etc.), the fiscal cliff is still at the top of the list.

'The U.S. Does Not Have a Spending Problem, We Have a Distribution Problem'

James Kwak argues that "Forty years from now, America will be twice as rich on average as we are today. But most of that wealth will go to the very richest households. We only have a budget crisis if they refuse to pay higher taxes:

The U.S. Does Not Have a Spending Problem, We Have a Distribution Problem, by James Kwak: In this season of fiscal silliness, many people are saying that we cannot afford our current entitlement programs. They shake their heads solemnly and say that Social Security and Medicare were well-intentioned ideas, but we simply do not have the money to pay for them and there is no escaping the need for "structural changes."

Hogwash. ... The federal government exists to serve the American people, not the other way around. The real question is whether we as a society can afford our current level of entitlement spending.

The answer is obviously yes. ...