Economist's View

There Is An Inflation Problem: It's Falling Below Target

[data source]

Annualized 6 and 12 Month Trimmed Mean
PCE Inflation Rates from 1/12 - 12/12

	6-month	12-month
Jan-12	2.02	2.08
Feb-12	1.86	2.02
Mar-12	1.97	2.02
Apr-12	1.96	1.94
May-12	1.85	1.89
Jun-12	1.75	1.87
Jul-12	1.62	1.82
Aug-12	1.62	1.74
Sep-12	1.54	1.75
Oct-12	1.44	1.70
Nov-12	1.45	1.65
Dec-12	1.34	1.55

Fed Watch: Interesting Anecdote

One more from Tim Duy:

Interesting Anecdote, by Tim Duy: Looking at the Reuters report on the latest consumer confidence numbers, this caught my attention:

"The increase in the payroll tax has undoubtedly dampened consumers' spirits and it may take a while for confidence to rebound and consumers to recover from their initial paycheck shock," Lynn Franco, director of economic indicators at The Conference Board, said in a statement.

One of the more interesting anecdotes I picked up last week was from a businessman who said that after his firm issued the first paychecks of the year, virtually every employee came to the payroll office and asked why their paychecks were lower, evidently unaware that the payroll tax cut had expired.

If the expiration does come as a surprise to a large proportion of the workforce, perhaps consumer spending in the first quarter will be somewhat softer than current estimates. Something to watch for.

Fed Watch: Room For Upside in Tomorrow's ISM Report?

Tim Duy:

Room For Upside in Tomorrow's ISM Report?, by Tim Duy: Calculated Risk has the run down on tomorrow's employment report, opting to bet on the high side of the forecast. Likewise, I am inclined to bet on the high side of the ISM forecast of 50.7, up from 50.5 the previous month. A couple of things to keep in mind:

1. Industrial production firmed in recent months:

Those that thought the mid-year slowdown in production bolstered their case for an imminent recession need to head back to the drawing board.

2. Core durable goods orders are stronger:

A significant portion of the sharp slowdown this year has been reversed. Eventually, this will impact the ISM index.

3. The Chicago PMI surprised on the upside, gaining sharply to 55.6 from 50.0 in December.

4. The Markit PMI has tended to the strong side in recent months:

All in all, it looks like manufacturing is shaking off some of those mid-year doldrums. Consequently, I would expect the ISM index to come in ahead of expectations.

'Wages, Fairness, and Productivity'

Chris Dillow:

Wages, fairness & productivity: Do higher wages motivate workers to work harder? A recent experiment conducted on Swiss newspaper distributors suggests the answer's yes, but only partially so:

Workers who perceive being underpaid at the base wage increase their performance if the hourly wage increases, while those who feel adequately paid or overpaid at the base wage do not change their performance.

This suggests that people are motivated not so much by the cold cash nexus as by feelings of reciprocal fairness...

Kudlow Celebrates Negative Growth

Larry Kudlow tries to use the fact that the fall government spending in the fourth quarter of last year was associated with a big drop in GDP growth to argue that lower government spending is good for the economy. Antonio Fatas correct his misguided thinking:

Celebrating negative growth, by Antonio Fatas: GDP growth during the last quarter of 2012 turned negative in the US (-0.1%)... Looking at the different components of GDP, the biggest decline happened in government spending and in net exports (due to the weakness in other economies). This is just one quarter and the data is likely to be revised later in the year, but what is to be learned from the data? The answer is whatever justifies your priors. Here is the interpretation that Larry Kudlow does in CNBC...

He makes the claim that this is indeed a good quarter because private spending (consumption and investment) grew at about 3.4% - after removing inventories that fell significantly. From here he concludes:

"Even with the fourth-quarter contraction, the latest GDP report shows that falling government spending can coexist with rising private economic activity. This is an important point in terms of the upcoming spending sequester. Lower federal spending, limited government, and a smaller spending-to-GDP ratio will be good for growth. The military spending plunge will not likely be repeated. But by keeping resources in private hands, rather than transferring them to the inefficient government sector, the spending sequester is actually pro-growth."

So this is an interesting test that he is using to prove that decreasing government spending is good for growth. As long as we see any growth in private spending it means that the decrease in government spending is helping the private sector grow. Of course, the real test is to compare the -0.1% to what would have happened to GDP growth if government spending had not decreased. Reading Larry Kudlow's article it sounds as if GDP growth would have been even lower (although his statement is not as precise as this). Yes, consumption grew and investment (once we exclude inventories) grew as well, but how much? Not enough to compensate the decrease in government spending so the final outcome is a negative (literally negative) performance for GDP growth. ...

We see that government spending fell and this is a component of GDP. A natural reaction might be to argue that the fall in government spending had a negative effect on GDP. Given that the GDP growth number is so low (and lower than expected), this is a reason to believe that the multiplier is positive and possibly large. But, as Larry Kudlow shows, there are always other interpretations.

According to Kudlow's theory (which is contrary to the empirical evidence, but why should actual data matter when there's ideology to promote...note how he tosses inventories aside when they don't agree with his priors, doubt he does that if it is helpful to his case), a decline in government spending should cause the private sector to boom by more than enough to offset the decline in government spending (otherwise growth would fall on net). Yet he is pleased that the decline in government spending didn't cause a decline in the private sector ("shows that falling government spending can coexist with rising private economic activity"), as though that somehow supports his case. It doesn't. Government spending fell, the private sector didn't boom by anywhere near enough to offset it, and the net result was a decline in GDP growth.

[Note: As Antonio points out, "we should not be doing this, to understand fiscal multipliers we need more than one quarter of data, but I am just trying to follow his logic." For example, to qualify this is a way that could be helpful to Kudlow, there may be lags between changes in government spending and changes in private sector activity that cannot be captured in a single quarter of data. But as noted above, this actually doesn't help -- when the empirical analysis is done correctly, government spending multipliers in a depressed economy appear to be relatively large.

Let me add one more thing. I'm all for maximizing growth (with externalities internalized), but I'm also for full employment and sometimes a temporary increase in government spending in the short-run to put people back to work is the best course for long-run economic growth. This is one of those times, especially spending focused on infrastructure. Addressing our short-run problems in this way is, if anything, and contra the Kudlows, helpful for growth.

I don't have any problem asking question such as "what is the best way to raise a given amount of revenue," i.e. trying to minimize inefficiencies and inequities in the tax code with an eye toward growth. I also think it's worthwhile to think about what size of government we want to have, and figure out the best way to support it. I do have a problem with high unemployment, especially when there are steps we could take to put people to work, and even more so when theories about long-run growth that have been rejected by the data are used to institute policies that work against helping people find employment in a depressed economy (e.g. austerity). In any case, with all of our employment problems, why would anyone cheer -.1 percent growth unless "those people" don't matter?]

Fed Watch: Unsurprisingly, the Fed Stands Pat

Tim Duy:

Unsurprisingly, the Fed Stands Pat, by Tim Duy: I fell off the grid a couple of weeks ago, as seems to happen each time the teaching schedule ramps up. All those projects and papers seem like such a good idea until they show up on my desk needing to be graded. Between that and travel up and down I5 from one end of the state to the other, blogging suffered, to say the least.

There, however, is nothing like a Fed meeting to prod me back to the keyboard. Alas, the outcome of this meeting was not entirely unexpected. Policy remains unchanged, with only minimal changes to the FOMC statement. The Fed followed the path of all analysts not of the Zero Hedge variety and largely dismissed the unexpected decline in 4Q12 GDP:

Information received since the Federal Open Market Committee met in December suggests that growth in economic activity paused in recent months, in large part because of weather-related disruptions and other transitory factors.

"Transitory" = "don't panic." We can try to read something in the change of this sentence:

The Committee remains concerned that, without sufficient policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions.

to:

The Committee expects that, with appropriate policy accommodation, economic growth will proceed at a moderate pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate.

It sounds a little more optimistic, as though they are more comfortable they have policy about right. This, in turn, would suggest that no one at the FOMC is really thinking about accelerating the pace of asset purchases. Of course, I don't think anyone was expecting that anyway.

There was no indication of setting thresholds for the end of large scale asset purchases. Such discussions are likely in their infancy; for now, all we know is that the end will come before the unemployment rate hits the 6.5% threshold. 7.25%, as suggested by Boston Federal Reserve President Eric Rosengren? Or a sustained period of substantial nonfarm payroll growth, as suggested by Chicago Federal Reserve President Charles Evans? Of course, these two thresholds may be effectively equivalent.

Kansas City Fed President Esther George (was she invited to the bloggers conference?) revealed herself as a true hawk with her dissent. To be sure, not entirely surprising. Still, I had wanted a little more confirmation before I labeled her a "hawk" rather than just having "hawkish leanings." I got it. Her reason:

Voting against the action was Esther L. George, who was concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations.

The potential imbalances reason seems like the primary reason for her dissent, and falls in-line with her recent speech. Such views are not uncommon - see A. Gary Shilling in Bloomberg, for example:

In desperation, monetary policies have become highly experimental. Huge government deficits are limiting the possibility of additional fiscal stimulus so policy makers are moving toward competitive devaluations. Meanwhile, low interest rates have spawned distortions as well as zeal for yield, regardless of risks.

I can't say that I am completely immune to such fears. Indeed, it is difficult to ignore the reality that the last two expansions were correlated with what I would argue were asset price bubbles. Moreover, I am somewhat interested in learning if the Federal Reserve could in fact stoke the fires of another asset bubble. But I think all of this speculation might be just a bit premature. We have an increasingly better idea of what an asset bubble looks like, and I don't think we are quite there:

Yes, premature. Another 25% of GDP and I will likely start getting a little more nervous. Speaks to my concern that we are leaning a little too hard of monetary policy and not enough on fiscal policy. But that train has left the station.

Bottom Line: Like the Fed, I think it best to discount the GDP data. I didn't really think the economy was growing over 3 percent in the third quarter, and I don't below it was really shrinking in the fourth quarter. The underlying rate of growth is somewhere in between. More slow and steady for the time being. Slow and steady, though, has been enough to push the unemployment rate lower. As 6.5 percent comes closer - or if we see a handful of 200k+ nfp numbers - the Fed will begin easing back on the asset purchases. But I have trouble see that until mid-year at the earliest. For now, policy is on hold.

Links for 01-31-2013

• Is college education really expanding ? - Crooked Timber
• Turning Class War Into Generational War - Dean Baker
• Does Modigliani-Miller apply to countries? - Richard Green
• Protectionism During Recessions: Is This Time Different? - Monkey Cage
• China and the end of extrapolation - Vox EU
• Calvinist Monetary Economics - Paul Krugman
• The LSE ‘manifesto for growth’ - Vox EU
• The Economics of Immigration - Jared Bernstein
• Red state tax "reform" and "economic growth" - ataxingmatter
• Social embeddedness and methodological localism - Dan Little
• Krugman on U.S. Fiscal Policy, Economy - The Big Picture
• Economics of Ideas: Paul Romer and Thomas Jefferson - Tim Taylor
• Europe’s robust financial-transactions tax - Felix Salmon
• Thomas Friedman is Way Off Today - Dean Baker

'The Real, and Simple, Equation That Killed Wall Street'

I'm sympathetic to the argument that excess leverage was a problem in the financial crisis, but I don't see it the primal cause of the recession. Instead, leverage iss a magnifier that makes things much, much worse when problems occur:

The Real, and Simple, Equation That Killed Wall Street, by Chris Arnade, Scientific American: ...It ... is the overly simple narrative that many in the media have spun about the last financial crisis. Smart meddling kids armed with math hoodwinked us all.

One article, from the March 2009 Wired magazine, even pinpointed an equation and a mathematician. The article “Recipe for Disaster: The Formula That Killed Wall Street,” accused the Gaussian Copula Function.

It was not the first piece that made this type of argument, but it was the most aggressive. ...

This theme plays on the fallacy that danger always comes from complexity. ...

The reality is much simpler and less sexy. Wall Street killed itself in a time-honored fashion: Cheap money, excessive borrowing, and greed. And yes, there is an equation one can point to and blame. This equation, however, requires nothing more than middle school algebra to understand and is taught to every new Wall Street employee. It is leveraged return. ...

The Gaussian Copula Function, opaque to most, is convenient to blame. It allows us to shake off our collective sense of guilt. It obscures the real crime...

I'm willing to blame leverage for contributing to the magnitude of the crisis, and I've long-called for limits on leverage to mute the negative effects of the next financial recession, which will come no matter how hard we try to avoid it. But I don't think it's correct to blame leverage itself for our problems, i.e. that "there is an equation one can point to and blame."

[The article actually notes many other factors, e.g. bad incentives for ratings agencies, failures of regulation, easy moneary policy by the Fed, and so on, but still ends up focusing on the leverage component as the key factor. In any case, the article is directed squarely at Felix Salmon, and I'm posting this in the hope that it will help prod him into responding.]

No Change in Fed Policy Despite Negative GDP Growth

My quick reaction at MoneyWatch to today's GDP report and the Press Release from the Fed's FOMC meeting:

No Change in Fed Policy Despite Negative GDP Growth

'Falling Government Spending and Inventories Push Growth Negative'

Dean Baker on todays' news the GDP shrank in the 4th quarer of last year:

Falling Government Spending and Inventories Push Growth Negative in Quarter, by Dean Baker: A sharp drop in government spending, heavily concentrated in defense, coupled with a decline in inventories caused GDP to shrink at a 0.1 percent rate in the 4th quarter. Government spending fell at a 6.6 percent annual rate, driven by a 22.2 percent decline in defense spending, subtracting 1.33 percentage points from the growth rate in the quarter. A 40.3 drop in the rate of inventory accumulation reduced growth by another 1.27 percentage points. Without these factors, GDP would have grown at a 2.5 percent annual rate in the quarter.

Pulling out these extraordinary factors, the GDP data were largely in line with prior quarters. Consumption grew at a 2.2 percent annual rate, driven mostly by 13.9 percent growth in durable goods purchases, primarily cars. This number was inflated due to the effects of Sandy, which destroyed many cars, forcing people to buy new ones. Growth in this category will be substantially weaker and possibly negative in the next quarter. On the other side, housing and utilities subtracted 0.47 percentage points from growth in the quarter. This is likely a global warming effect with warmer than normal weather leading to less use of heating in the quarter. (There was a comparable falloff in the 4th quarter of 2011 when we also had unusually warm weather.)

One especially noteworthy item is the continuing slow pace in the growth of spending on health care services, which accounts for almost three quarters of all health care spending. Nominal spending grew at a just a 2.3 percent annual rate in the quarter. Over the last year, nominal spending is up by just 1.8 percent, far less than the rate of growth of GDP, and well below the projections from the Congressional Budget Office (CBO). It seems increasingly likely that we are on a slower health care cost trajectory. The deficit picture will look very different when CBO incorporates this slower growth trend into its projections.

Investment rebounded from a weak third quarter in which non-residential investment actually shrank. This quarter it added 0.83 percentage points to growth, with investment in equipment and software growing at a 12.4 percent rate. Housing continued to be a big positive in the quarter, adding 0.36 percentage points to growth.

Net exports were a modest drag on growth. While both exports and imports fell in the quarter, the 5.7 percent drop in exports more than offset the positive impact of a 3.2 percent decline in imports. The state and local sector government sector shrank at a 0.7 percent annual rate, knocking 0.08 percentage points off growth. Non-defense federal spending rose at a 1.4 percent annual rate.

The inflation hawks will be disappointed in this report with the overall price index rising at just a 0.6 percent annual rate. The core CPE rose at a 0.9 percent rate. Insofar as there is any trend in these data it is toward lower inflation.

One interesting item in the report was a $122.90 jump (85.2 percent at an annual rate) in dividend payouts. This was the result of companies deciding to pay out dividends to shareholders in 2012 when a lower tax rate was in effect on high-income taxpayers.

There is little evidence in this report to believe that the economy will diverge sharply from a 2.5- 3.0 percent growth path, except for the impact of the deficit reductions that Congress is considering or already put in place. Higher tax collections from the ending of the payroll tax holiday are likely to knock around 0.5 percentage points from growth. The sequester, or whatever cuts are put in place in lieu of the sequester, are likely to have an even larger impact on growth beginning in the second quarter.

One item worth noting is the GDP report provides zero evidence that "fiscal cliff" concerns had any impact on growth in the quarter. Consumer durable purchases and investment in equipment and software were the two strongest components of GDP. If worries over the fiscal cliff were supposed to cause people to put off purchases, consumers and businesses apparently did not get the memo.

Nevertheless, with the slow recovery of output and employment all is not well no matter how we spin the numbers. We need more spnding on infrastructure to help with the recovery.

Links for 01-30-2013

• The power and the terror of Irrational Expectations - Noahpinion
• Real Modelling of Expectations - Brad DeLong
• Incestuous Amplification, Economics Edition - Paul Krugman
• When formal monetary policy targets are useful - mainly macro
• Head Start is Failing Its Test - Tim Taylor
• A perilous journey to full recovery - Martin Wolf
• Mark Sanchez And The Sunk Cost Bias - Cheap Talk
• Workers Spent More of Payroll Tax Cut Than They Intended - WSJ
• Wall Street Banks Are Still Sicker Than You Think - Mohamed El-Erian
• From 'The Economic Consequences of Mr. Churchill' - Twenty-Cent Paradigms
• US Household Debt has Fallen by $833 billion since 2008 - Owen Zidar
• Completely Missing The Boat On The Budgtet (Yet Again) - EconoSpeak
• Why is There Still a Shortage Safe Assets? - David Beckworth
• Outsourcing, Insourcing and Automation - Economix
• Thinking About State Taxation - Jared Bernstein
• Joe Scarborough on the Deficit - EconoSpeak
• Contra John Taylor - Supply-Side Liberal
• Fed Risks Losses From Bonds - WSJ
• Japan’s Deflation - IGM Forum

'Trillion Dollar Deficits are Sustainable for Now – Unfortunately'

John Makin and Daniel Hanson of the conservative American Economic Institute talk sense on the deficit. Now if we could just get them over their inflation fears -- the source of the "unfortunately" part of the title -- we might be able to get somewhere in addressing our biggest problem right now, high and persistent unemployment, and enhance our long-tern growth prospects at the same time:

Trillion dollar deficits are sustainable for now – unfortunately, by John H. Makin and Daniel Hanson, Commentary, FT: An abrupt spending sequester at a rate of about $110bn per year ($1.1tn over 10 years) scheduled to begin March 1 could cause a US recession, coming as it does on top of tax increases worth about 1.5 per cent of GDP enacted in January. The April deadline for a continuing resolution to fund federal spending could lead to a fight that shuts down the government, placing a further drag on growth.

These ad hoc measures, aimed at creation of an artificial crisis, will fail to produce prompt, sustainable progress towards reduction of “unsustainable” deficits because deficits have been, and will continue to be for some time, eminently sustainable. The Chicken Little “sky is falling” approach to frightening Congress into significant deficit reduction has failed because the sky has not fallen. Interest rates have not soared as promised... Trillion-dollar federal budget deficits have continued to be sustainable because the federal government is able to finance them at interest rates of half a per cent or less. Two per cent inflation means that the real inflation-adjusted cost of deficit finance averages −1.5 per cent...

The real danger facing American policy makers is ... the current sustainability of trillion-dollar deficits, thanks to very low borrowing costs relative to GDP growth. Eventually, the Federal Reserve’s QE programme of large government debt purchases at a current rate of $800bn per year, largely aimed at sustaining the growth of outlays on entitlements that do not support economic growth, will cause inflation to rise. The Fed’s latest move to target the unemployment rate with more quantitative easing only adds to the threat of inflation because the only way monetary policy can affect growth or employment is by engineering a higher-than-expected rate of inflation.

Despite the current absence of rising inflation, Washington is flirting with a debt trap, where abrupt austerity forced by the sequester and/or a government shut down would actually boost the ratio of debt to GDP by depressing growth too rapidly. That outcome will be far more costly in terms of forgone income and unemployment than moving preemptively to reduce American primary deficits to about 3 per cent of GDP over a half decade. ...

By 2018, once the debt-to-GDP ratio has stabilised under such a programme, reducing the primary deficit to 2 percent a year (given a growth rate of 3 percent above borrowing costs) will reduce the debt-to-GDP ratio gradually by 1 per cent a year. That is the meaning of sustainable long-run reduction of government debt relative to income, which will ensure moderate deficit financing costs for decades to come.

I can't let this pass:

the Federal Reserve’s QE programme of large government debt purchases at a current rate of $800bn per year, largely aimed at sustaining the growth of outlays on entitlements that do not support economic growth...

That's NOT what Fed policy is aimed at. There is no third part of its mandate that says it needs to sustain the growth of entitlements. (And the casual, but empirically unsupported claim that entitlement spending is anti-growth is troublesome as well.)

Spending on Infrastructure Can Reduce Our Expected Debt

I couldn't resist one more plea for infrastructure construction:

How Spending on Infrastructure Can Reduce Our Long-Run Debt Burden

Spending more on infrastructure will improve our growth prospects, lower long-term unemployment, and some types of spending can actually save us money in the long-run.

Links for 01-29-2013

• Safe Assets and Financial Crises - Carola Binder
• Failures - Paul Krugman
• Currency Wars in the Era of Unconventional Monetary Policies - Econbrowser
• Economists aren't politically driven, report economists - Dylan Mathews
• No, the 90 Percent Debt Threshold Hasn't Been Proven - Rortybomb
• The Missing Transmission Mechanism (NBER) - Romer and Romer
• A Dose of Reality for Energy Policy - Tim Taylor
• Economists argue about Bayes - Andrew Gelman
• Diversifying Russia - Vox EU
• Ratings and Rates - Paul Krugman

'The Uneven Progress of Equal Opportunity'

Nancy Folbre:

The Uneven Progress of Equal Opportunity: ... Five years into the 21st century, the data reveal a surprisingly high level of job segregation in which African-American men, white women and especially African-American women only rarely worked in the same occupation in the same workplace as white men. In order to create a completely integrated private-sector workplace, more than half of all private sector workers would need to change jobs.

In most workplaces, the face of authority looks predictable. As the authors put it, “White men are often in positions in management over everyone; white women tend to supervise other women, black men to supervise black men and black women tend to supervise black women.” ...

In this world, remarkable successes like the election of an African-American president coexist with continuing failures, especially in domains where disadvantages based on race, gender and class coincide and collide. ...

Video: Chrystia Freeland Interviews Larry Summers

The Future of the American Public Sector

Gorton and Ordonez: The Supply and Demand for Safe Assets

I need to read this:

The Supply and Demand for Safe Assets, by Gary Gorton and Guillermo Ordonez, January 2013, NBER [open link]: Abstract There is a demand for safe assets, either government bonds or private substitutes, for use as collateral. Government bonds are safe assets, given the governments’ power to tax, but their supply is driven by fiscal considerations, and does not necessarily meet the private demand for safe assets. Unlike the government, the private sector cannot produce riskless collateral. When the private sector reaches its limit (the quality of private collateral), government bonds are net wealth, up to the governments own limits (taxation capacity). The economy is fragile to the extent that privately-produced safe assets are relied upon. In a crisis, government bonds can replace private assets that do not sustain borrowing anymore, raising welfare.

The Unemployment Problem is Cyclical

John Taylor argues, indirectly, that the unemployment problem is mostly cyclical, not structural:

... I like to tell the story about what Senator Hubert Humphrey said when President Ford’s Council of Economic Advisers, where I worked with Alan Greenspan, reported to the Joint Economic Committee (JEC) that it was raising the definition of the normal unemployment rate from 4.0% to 4.9%.  Humphrey, who chaired the JEC, was outraged and told us in the JEC hearing that “if the country was suffering a plague and you economists were doctors your solution would be to raise the definition of normal body temperature above 98.6 degrees”   

So I am worried when people stop talking about today’s very high unemployment rates as if they were normal. ...

He goes on to try to blame Obama for the slow recovery of labor markets ("It is not a good sign that the inaugural address was silent on the subject..."), as though the Republicans -- his party -- and its obstructionist ways has nothing to do with the fact that Obama couldn't get his jobs program passed, or any further stimulus measures put in place. But it's nice to see Taylor acknowledge that the problem is cyclical not structural, and that fiscal policy can make a difference (Obama can hardly be blamed for the Fed's actions, so when he complains that Obama isn't talking about this problem, he must have fiscal policy in mind -- probably tax cuts for the wealthy rather than, say, spending on infrastructure, but it's a start.)

Paul Krugman: Makers, Takers, Fakers

Republicans are trying to improve their image and appear less extreme, but their actual policies are moving in the opposite direction:

Makers, Takers, Fakers, by Paul Krugman, Commentary, NY Times: Republicans have a problem. ... In the 2012 election,... the picture of the G.O.P. as the party of sneering plutocrats stuck, even as Democrats became more openly populist than they have been in decades.

As a result, prominent Republicans have begun acknowledging that their party needs to improve its image. But here’s the thing: Their proposals for a makeover all involve changing the sales pitch rather than the product. When it comes to substance, the G.O.P. is more committed than ever to policies that take from most Americans and give to a wealthy handful. ...

Why is this happening ... now, just after an election in which the G.O.P. paid a price for its anti-populist stand?

Well, I don’t have a full answer, but I think it’s important to understand the extent to which leading Republicans live in an intellectual bubble. They get their news from Fox and other captive media, they get their policy analysis from billionaire-financed right-wing think tanks, and they’re often blissfully unaware both of contrary evidence and of how their positions sound to outsiders.

So when Mr. Romney made his infamous “47 percent” remarks, he wasn’t, in his own mind, saying anything outrageous or even controversial. He was just repeating a view that has become increasingly dominant inside the right-wing bubble, namely that a large and ever-growing proportion of Americans won’t take responsibility for their own lives and are mooching off the hard-working wealthy. Rising unemployment claims demonstrate laziness, not lack of jobs; rising disability claims represent malingering, not the real health problems of an aging work force.

And given that worldview, Republicans see it as entirely appropriate to cut taxes on the rich while making everyone else pay more.

Now, national politicians learned last year that this kind of talk plays badly with the public, so they’re trying to obscure their positions. Paul Ryan, for example, has lately made a transparently dishonest attempt to claim that when he spoke about “takers” living off the efforts of the “makers”...

But in deep red states like Louisiana or Kansas, Republicans are much freer to act on their beliefs — which means moving strongly to comfort the comfortable while afflicting the afflicted.

Which brings me ... to Mr. Jindal, who declared ... “we are a populist party.” No, you aren’t. You’re a party that holds a large proportion of Americans in contempt. And the public may have figured that out.

Links for 01-28-2013

• Debate at the Fed on When to Slow Its Asset Buying - NYT
• China’s brokerages turn shadow banks - FT.com
• The Austerity Delusion? - Not the Treasury view...
• Visa policies and multilateral resistance to migration - Vox EU
• Big Cities' Heat Can Change Temperatures a Continent Away - SciAm
• Bayesian vs. Frequentist: Is there any "there" there? - Noahpinion
• George Will’s Anti-Scientific Nonsense - Think Progress
• The trouble with Boeing’s 787 - James Surowiecki
• How Many Doctors Will It Take? - Brad DeLong
• Granger Causality - Dave Giles
• US faces fresh financial shock - FT.com
• Bootstrapping and Subsampling: Part II - Normal Deviate
• From Welfare Queens to Disabled Deadbeats - Paul Krugman

Climate Policy in Obama's Second Term

I think of Robert Stavins as being on the optimistic side when it comes to action on climate change, but even he seems discouraged despite Obama's mention of this issue in his inaugural address:

The Second Term of the Obama Administration, by Robert Stavins: In his inaugural address on January 21^st, President Obama surprised many people – including me – by the intensity and the length of his comments on global climate change.  Since then, there has been a great deal of discussion in the press and in the blogosphere about what climate policy initiatives will be forthcoming from the administration in its second term. ...

Although I was certainly surprised by the strength and length of what the President said in his address, I confess that it did not change my thinking about what we should expect from the second term.  Indeed, I will stand by an interview that was published by the Harvard Kennedy School on its website five days before the inauguration (plus something I wrote in a previous essay at this blog in December, 2012).  Here it is, with a bit of editing to clarify things, and some hyperlinks inserted to help readers. ...

Q: In the Obama administration’s second term, are there openings/possibilities for compromises...?

A: It is conceivable – but in my view, unlikely – that there may be an opening for implicit (not explicit) “climate policy” through a carbon tax. At a minimum, we should ask whether the defeat of cap-and-trade in the U.S. Congress, the virtual unwillingness over the past 18 months of the Obama White House to utter the phrase “cap-and-trade” in public, and the defeat of Republican Presidential candidate Mitt Romney indicate that there is a new opening for serious consideration of a carbon-tax approach to meaningful CO₂ emissions reductions in the United States.

First of all, there surely is such an opening in the policy wonk world. Economists and others in academia, including important Republican economists such as Harvard’s Greg Mankiw and Columbia’s Glenn Hubbard, remain enthusiastic supporters of a national carbon tax. And a much-publicized meeting in July, 2012, at the American Enterprise Institute in Washington, D.C. brought together a broad spectrum of Washington groups – ranging from Public Citizen to the R Street Institute – to talk about alternative paths forward for national climate policy. Reportedly, much of the discussion focused on carbon taxes.

Clearly, this “opening” is being embraced with enthusiasm in the policy wonk world. But what about in the real political world? The good news is that a carbon tax is not “cap-and-trade.” That presumably helps with the political messaging! But if conservatives were able to tarnish cap-and-trade as “cap-and-tax,” it surely will be considerably easier to label a tax – as a tax! Also, note that President Obama’s silence extends beyond disdain for cap-and-trade per se. Rather, it covers all carbon-pricing regimes.

So as a possible new front in the climate policy wars, I remain very skeptical that an explicit carbon tax proposal will gain favor in Washington. ...

A more promising possibility – though still unlikely – is that if Republicans and Democrats join to cooperate with the Obama White House to work constructively to address the short-term and long-term budgetary deficits the U.S. government faces,... then there could be a political opening for new energy taxes, even a carbon tax. ...

Those who recall the 1993 failure of the Clinton administration’s BTU-tax proposal – with a less polarized and more cooperative Congress than today’s – will not be optimistic. ... The key group to bring on board will presumably be conservative Republicans, and it is difficult to picture them being more willing to break their Grover Norquist pledges because it’s for a carbon tax.

Here's the surprising part (to me anyway), some optimism after all:

What remains most likely to happen is what I’ve been saying for several years, namely that despite the apparent inaction by the Federal government, the official U.S. international commitment — a 17 percent reduction of CO₂ emissions below 2005 levels by the year 2020 – is nevertheless likely to be achieved!  The reason is the combination of CO₂ regulations which are now in place because of the Supreme Court decision [freeing the EPA to treat CO₂ like other pollutants under the Clean Air Act], together with five other regulations or rules on SOX [sulfur compounds], NOX [nitrogen compounds], coal fly ash, particulates, and cooling water withdrawals. All of these will have profound effects on retirement of existing coal-fired electrical generation capacity, investment in new coal, and dispatch of such electricity.

Combined with that is Assembly Bill 32 (AB 32) in the state of California, which includes a CO₂ cap-and-trade system that is more ambitious in percentage terms than Waxman-Markey was in the U.S. Congress, and which became binding on January 1, 2013. ...  In other words, there will be actions having significant implications for climate, but most will not be called “climate policy,” and all will be within the regulatory and executive order domain, not new legislation. ...

'Carney rejects King'

Gavyn Davies gives an update on where monetary policy in the UK is likely headed when Mark Carney takes over as governor of the Bank of England:

Carney rejects King and supports the Fed doves, by Gavyn Davies: Mark Carney ‘s comments on monetary policy at Davos, though not specifically about the UK, opened a wide gap between his thinking and that of outgoing Governor Sir Mervyn King (see this earlier blog). The latter expressed doubts last week about the ability of monetary policy to boost the economy further, given his concerns about the UK supply-side, and his related worries about the 2% inflation target.

At Davos, Mark Carney showed very little sympathy for any of this, arguing that there is plenty of scope for monetary policy to boost the developed economies further... Mr Carney said that it might be acceptable for inflation to exceed the government’s 2% target for a fairly lengthy period, especially in the context of fiscal consolidation. ... But it is not clear how this approach can be made compatible with the Bank of England’s current mandate, which has always been interpreted by the MPC as requiring a return to a 2% inflation target over roughly a two year horizon. ...

Mr Carney seems to think that he can just about square his remarks yesterday with this “flexible inflation target” mandate, but in spirit his remarks are more in keeping with a nominal GDP target, or a twin inflation/employment mandate of the Fed variety. If policy is to shift in this direction, which means placing a greater weight on unemployment within a Taylor rule framework, then many members of the MPC might prefer the government to reduce confusion by changing the official mandate. ...

Without a change in the mandate, there is some doubt about whether the majority of the current MPC would support Mark Carney’s approach. ...

Links for 01-27-2013

• What We Have Less Of - Paul Krugman
• The Rise of the Permanent Temp Economy - NYTimes.com
• Disability Rolls and the Makers/Takers/Fakers Nonsense - Jared Bernstein
• Ask Language Log: "build out", "build-out", or "buildout"? - Language Log
• Why Government Spending Is Not Out of Control - Bruce Bartlett
• Does Inequality Stifle or Promote Growth? - Jared Bernstein
• Now even the right is focused on capitalism's flaws - Comment is free
• Monetary Alchemy, Fiscal Science - Jeff Frankel
• Populism, Republican Style - Paul Krugman

Shiller: Don't Count on a New Housing Boom

Robert Shiller says caution is in order in housing markets:

A New Housing Boom? Don’t Count on It, by Robert Shiller, Commentary, NY Times: We're beginning to hear noises that we’ve reached a major turning point in the housing market — and that, with interest rates so low, this is a rare opportunity to buy. But are such observations on target?

It would be comforting if they were. Yet the unfortunate truth is that the tea leaves don’t clearly suggest any particular path for prices, either up or down..., any short-run increase in inflation-adjusted home prices has been virtually worthless as an indicator of where home prices will be going over the next five or more years. ...

The bottom line for potential home buyers or sellers is probably this: Don’t do anything dramatic or difficult. There is too much uncertainty... If you have personal reasons for getting into or out of the housing market, go ahead. Otherwise, don’t stay up worrying about home prices any more than you do about stock prices. ...

Don't Lose Sight of Our Real Problems

Brad DeLong argues:

We have real problems. We don't need to stop ourselves from dealing with our real problems out of fear of the invisible bond market vigilantes.

Will Obama Help Unions?

John Cassidy:

... Now that Obama’s back in the White House, is the reform of labor laws back on the agenda? Almost certainly not. With the Republicans controlling the House, any effort to revive the card-check bill would be doomed. ...

With anything that requires congressional approval effectively ruled out, Obama’s options ... are limited. One thing he’s already done is speak out against the so-called right-to-work laws that Michigan and other Republican-run states are introducing... As the latest figures from the B.L.S. make clear, the Republican union-bashing is working. Last year, union membership fell... The unions badly need the President’s active involvement in the struggle against these G.O.P. initiatives...

The other venue where the unions will be looking for more favorable action is the National Labor Relations Board, which enforces labor laws and oversees elections at workplaces where unions are seeking to organize. ... At the start of 2012, Obama used recess appointments to appoint two union-friendly officials to the N.L.R.B.

By issuing some more rulings favorable to the unions over the next four years, the N.L.R.B. will help tilt the balance of power in the workplace back towards labor. But after many years in which employers were allowed to flout the law and intimidate union organizers with impunity, nobody in the labor movement is under any illusion that these administrative changes will be sufficient to reverse the unions’ historic decline. Indeed, even some economists who are sympathetic to unions believe that their decline is irreversible. ... Changing that is going to take much more than two terms of Obama in the White House. But if he is serious about pursuing a liberal agenda, he can’t avoid getting involved.

I meant to post this yesterday, but travel got in the way. Today, things have changed:

In a ruling that called into question nearly two centuries of presidential “recess” appointments that bypass the Senate confirmation process, a federal appeals court ruled on Friday that President Obama violated the Constitution when he installed three officials on the National Labor Relations Board a year ago. ...

Is anyone counting on the Supreme Court to overturn this?

Links for 01-26-2013

• How Can We Know How Much Government Debt Is too Much? - Brad DeLong
• Why some physicists shouldn't do finance - Magic, maths and money
• What Do People Have Less Of Than They Had 40 Years Ago? - Money Box
• Consumer Spending and Inequality Denial - Paul Krugman
• Not Everyone is Living Longer - Kevin Drum
• Equality of Flying Time - The American Prospect
• Five myths about Timothy Geithner - WP
• Jobs and growth are still linked - Vox EU
• Apple’s Share Price and Time Machines - Digitopoly
• Paul Ryan Resorts to Word Salad on Tax Policy - Brad DeLong
• Court Overturns E.P.A.’s Biofuels Mandate - NYT
• Why We Need More Private Safe Assets - David Beckworth
• Benghazi Myths - EconoSpeak
• The Wages of Austerity - Econbrowser
• The GOP Crackup - Robert Reich
• Look Ma, No (Human) Hands - Paul Krugman
• Mayer Zald on organizations and bureaurcracy - UnderstandingSociety
• New Home Sales at 369,000 SAAR in December - Calculated Risk
• David Brooks Is Right, but He's Also Wrong - Beat the Press
• Over 65 and Working - Tim Taylor
• How Inequality Puts a Break on U.S., U.K. Growth - WSJ.com

Paul Krugman: Deficit Hawks Down

Deficit hawks are losing their clout:

Deficit Hawks Down, by Paul Krugman, Commentary, NY Times: President Obama’s second Inaugural Address offered a lot for progressives to like. ... But arguably the most encouraging thing of all was what he didn’t say: He barely mentioned the budget deficit..., the latest sign that the self-styled deficit hawks — better described as deficit scolds — are losing their hold over political discourse. And that’s a very good thing.

Why have the deficit scolds lost their grip? I’d suggest four interrelated reasons.

First, they ... spent three years warning of imminent crisis — if we don’t slash the deficit now now now, we’ll turn into Greece... But that crisis keeps not happening ... So the credibility of the scolds has taken a ... well-deserved, hit.

Second, both deficits and public spending as a share of G.D.P. have started to decline..., and reasonable forecasts ... suggest that the federal deficit will be below 3 percent of G.D.P., a not very scary number, by 2015.

And it was, in fact, a good thing that the deficit was allowed to rise as the economy slumped. With private spending plunging..., the willingness of the government to keep spending was one of the main reasons we didn’t experience a full replay of the Great Depression. Which brings me to the third reason the deficit scolds have lost influence: the ... claim that we need to practice fiscal austerity even in a depressed economy, has failed decisively in practice. Consider ... the case of Britain. In 2010, when the new government of Prime Minister David Cameron turned to austerity policies,... the sudden, severe medicine ... threw the nation back into recession.

At this point, then, it’s clear that the deficit-scold movement was based on bad economic analysis. But ... there was also ... a lot of bad faith involved, as the scolds tried to exploit an economic (not fiscal) crisis on behalf of a political agenda that had nothing to do with deficits. And the growing transparency of that agenda is the fourth reason the deficit scolds have lost their clout. ... Prominent deficit scolds can no longer count on being treated as if their wisdom, probity and public-spiritedness were beyond question. But what difference will that make?

Sad to say, G.O.P. control of the House means that we won’t do what we should be doing: spend more, not less, until the recovery is complete. But the fading of deficit hysteria means that the president can turn his focus to real problems. And that’s a move in the right direction.

'Brave, Honest Conservatives' and Social Insurance

Brad DeLong:

... How long will it be before the likes of Veronique de Rugy stop denouncing Social Security, Medicare, Unemployment Insurance, etc. as programs that have turned us into "a nation of takers", and stop denouncing these programs beneficiaries as "moochers"?

It is in some ways very odd. It used to be that critics of the welfare state pointed to high net marginal tax rates and argued that they had high deadweight losses. Sometimes they had a point. Then, after bipartisan reforms, we got to a point where there were few high net marginal tax rates large enough to induce large deadweight losses.

And then, in the blink of an eye, the problem became not public-finance deadweight losses but, rather, the moocher class, the nation of takers, etc. ...

Paul Krugman on Paul Ryan's (ahem) defense of Social Security and Medicare:

...everyone has noted Ryan’s raw dishonesty here, let’s not let the cowardice pass unmentioned. If you’re a Randian conservative, as Ryan claims to be, then you should consider Social Security and Medicare every bit as much a part of the moocher conspiracy as Medicaid and food stamps. And don’t say that you pay for what you get: Social Security benefits aren’t proportional to payment, so that the system is somewhat redistributionist, and Medicare benefits don’t depend at all on how much you pay in, so that the system is strongly redistributionist. (You might even say that Medicare takes from each according to his ability, and gives to each according to his needs).

All of this is fine with me, but it should be anathema to Ryan. But he knows that Social Security and Medicare are popular, so he pretends that his radical philosophy has nothing bad to say about these programs, and that we can massively downsize government on the backs of the undeserving poor.

But remember, he’s a Brave, Honest Conservative. Everyone says so.

Speaking of social insurance, here's James Kwak:

...Unsurprisingly, most Americans are split between various misconceptions of what Social Security and Medicare are. Many, particularly right-wing politicians and their media mouthpieces, see them as pure tax-and-transfer programs: they gather money from one set of people and give it to another set of people. This feeds easily into the makers-vs.-takers line, with payroll taxes on workers going to fund benefits for non-workers. From this point of view, they are bad bad bad bad bad and should be cut.

Many others, particularly beneficiaries and people who hope to see beneficiaries, see them as earned benefits. The common conception is that you pay in while you’re working, so you earned the benefits you get in retirement..., you’re just getting back “your” money that you set aside during your career.

Both of these perspectives are wrong, the latter more obviously so. Most people, during their working careers, do not pay nearly enough in payroll taxes to pay for their expected benefits. This is most obvious for Medicare...

The problem with the tax-and-transfer argument is only slightly more subtle. Sure, at any given moment some people pay taxes and others collect benefits (and many do both, since Medicare is funded by general revenues). But most of us will both pay and receive at different points in our lives. So both programs are really more like income-shifting arrangements...

In the inaugural address, I think the president got it basically right. They are risk-spreading programs. You don’t get back exactly what you put in: they have a certain degree of progressivity (although less for Social Security than is commonly imagined). Their main function is to protect people against extreme outcomes by pooling a limited share of our resources.

Yes, rich people end up paying payroll taxes for insurance they end up not needing. But that’s how insurance always works: you pay the premiums hoping you won’t need it. And the key fact is that most young people, whey they start paying payroll taxes, don’t know what their own personal outcomes will be. ... Like any insurance scheme, you can make everyone better off simply by moving money around between different states of the world.

These particular insurance schemes, as the president said, have a moral element to them. They are a way of expressing out solidarity with each other as Americans, people united, however loosely, in a common endeavor. They also have an economic element to them. People protected against bad outcomes are more willing to take the risks needed for a vibrant and prosperous society. They are something to celebrate, not something to be embarrassed about whenever the Republicans come after them.

I've written quite a bit about the insurance aspect as well, e.g. see The Need for Social Insurance:

Economic systems differ in their ability to provide goods and services and in the level of economic risk faced by a typical household. Socialism is a low mean, low variance economic system. With a planned economy, cycles in unemployment do not occur unless mandated by planners. Worker income, though low, is not subject to substantial variation over time. Other economic risks, such as access to housing and risks related to healthcare are also very low since these services are provided by the state. Economic risks for workers are low in such a system, but so is average income.

Under capitalism the average level of income is much higher, but economic risk is higher as well. In a capitalist system, workers can be involuntarily displaced as new products are invented, new production techniques are implemented, production moves outside the country, or inevitable business cycle variation occurs. These are shocks that affect workers independent of their own behavior. A worker who has shown up to work every day and worked hard to support a family can be suddenly unemployed for reasons unrelated to anything connected to his or her own behavior.

As the U.S. entered the 20th century, important social changes arising from industrialization were becoming increasingly evident, and these changes exposed the high degree of economic risk under a capitalist system. Migration to cities and the resulting breakup of the extended family, reliance on wage income as a primary means of support, and increasing life expectancy resulted in increased economic risk for the typical worker relative to the more agrarian economy that existed prior to industrialization.

In an agrarian economy, economic security is provided by extended family relationships coupled with the largely self-sufficient nature of farms. On a farm, a recession is a bad harvest, but it generally does not mean a total lack of income. Times can be tough, food can be very scarce and there can be hunger, but generating a subsistence level of income from the farm is usually possible even in the worst of years. For a worker dependent solely upon wage income, the consequences of a recession are much more severe. A recession means a total lack of income, not just hard times. Without the help of others or the existence of some type of social insurance program, abject poverty is a real possibility (see Life After the Great Depression for descriptions of the misery that followed the Great Depression).

Retirement also takes on a different character. On the farm, retirement meant gradually, if often reluctantly, letting the children take over responsibility for the farm, but it did not mean a total loss of income. Children provided for parents. But an aging worker in a city, perhaps disconnected geographically from their children, faces a different circumstance upon retirement. Such a worker may face a complete loss of income, and disability from age is not always an event that occurs according to plan. Even a worker who has diligently saved for retirement can suddenly become impoverished due to events such unexpected health costs, or even a much longer life than expected.

As industrialization progressed, 1920 marks a benchmark year where, for the first time, more than half of the population lived in cities. When the Great Depression hit around a decade later, the social changes the U.S. was experiencing and the need for new ideas regarding the government’s responsibility for the economic security of its citizens became clear. The Great Depression made it evident that in a capitalist system, where the whimsies of the marketplace can wreak havoc on people’s lives, the government has an obligation to provide economic security. It was also evident that the private sector did not provide the needed level of insurance and that government intervention was required to overcome this problem (due to both moral hazard and asymmetric information problems in the private insurance market).

It is important that the economy be allowed to change with new technology and changing preferences, but the consequences for innocent workers affected by such changes is a social responsibility that needs to be addressed. In addition, as extended family relationships are hindered by geography and the social contract between parents and children breaks down, the elderly need a way to avoid poverty. Programs such as Unemployment Compensation, Medicare, and Social Security arose as a means to mitigate these economic risks under capitalism using the least amount of society’s valuable resources.

Drawing a rough analogy, socialism is like investing in T-Bills. Low risk, but low return. Capitalism is like the stock market. There is a higher average return accompanied by higher risk. Financial theory tells how to insure against such risks and there is no reason why this cannot be applied in the social insurance arena to smooth variations in income.

There is a need for social insurance under capitalism.

'Misinterpreting the History of Macroeconomic Thought'

Simon Wren-Lewis argues that the "crisis view" of change in macroeconomic theory is too simple

Misinterpreting the history of macroeconomic thought, mainly macro: An attractive way to give a broad sweep over the history of macroeconomic ideas is to talk about a series of reactions to crises (see Matthew Klein and Noah Smith). However it is too simple, and misleads as a result. The Great Depression led to Keynesian economics. So far so good. The inflation of the 1970s led to ? Monetarism - well maybe in terms of a few brief policy experiments in the early 1980s, but Monetarist-Keynesian debates were going strong before the 1970s. The New Classical revolution? Well rational expectations can be helpful in adapting the Phillips curve to explain what happened in the 1970s, but I’m not sure that was the main reason why the idea was so rapidly adopted. The New Classical revolution was much more than rational expectations.

The attempt gets really off beam if we try and suggest that the rise of RBC models was a response to the inflation of the 1970s. I guess you could argue that the policy failures of the 1970s were an example of the Lucas critique, and that to avoid similar mistakes macroeconomists needed to develop microfounded models. But if explaining the last crisis really was the prime motivation, would you develop models in which there was no Phillips curve, and which made no attempt to explain the inflation of the 1970s (or indeed, the previous crisis - the Great Depression)?

What the ‘macroeconomic ideas develop as a response to crises’ story leaves out is the rest of economics, and ideology. The Keynesian revolution (by which I mean macroeconomics after the second world war) can be seen as a methodological revolution. Models were informed by theory, but their equations were built to explain the data. Time series econometrics played an essential role. However this appeared to be different from how other areas of the discipline worked. In these other areas of economics, explaining behavior in terms of optimization by individual agents was all important. This created a tension, and a major divide within economics as a whole. Macro appeared quite different from micro.

A particular manifestation of this was the constant question: where is the source of the market failure that gives rise to the business cycle. Most macroeconomists replied sticky prices, but this prompted the follow up question: why do rational firms or workers choose not to change their prices? The way most macroeconomists at the time chose to answer this was that expectations were slow to adjust. It was a disastrous choice, but I suspect one that had very little to do with the nature of Keynesian theory, and rather more to do with the analytical convenience of adaptive expectations. Anyhow, that is another story.

The New Classical revolution was in part a response to that tension. In methodological terms it was a counter revolution, trying to take macroeconomics away from the econometricians, and bring it back to something microeconomists could understand. Of course it could point to policy in the 1970s as justification, but I doubt that was the driving force. I also think it is difficult to fully understand the New Classical revolution, and the development of RBC models, without adding in some ideology. 

Does this have anything to tell us about how macroeconomics will respond to the Great Recession? I think it does. If you bought the ‘responding to the last crisis’ narrative, you would expect to see some sea change, akin to Keynesian economics or the New Classical revolution. I suspect you would be disappointed. While I see plenty of financial frictions being added to DSGE models, I do not see any significant body of macroeconomists wanting to ply their trade in a radically different way. If this crisis is going to generate a new revolution in macroeconomics, where are the revolutionaries? However, if you read the history of macro thought the way I do, then macro crises are neither necessary nor sufficient for revolutions in macro thought. Perhaps there was only one real revolution, and we have been adjusting to the tensions that created ever since.  

Let me follow up on the ideological point with an example. Prior to the New Classical revolution in the 1970s (which, contra some recent descriptions, is different from DSGE models), the people who do not believe that government intervention is bad had a problem. It was very clear in the data that there was a positive correlation between changes in the money supply and changes in employment and real income. Further, though this is harder to establish, the relationship appeared causal. Money causes income, and this allowed government to stabilize the economy.

The (neo)classical model, with its vertical AS curve, could not explain the positive money-income correlation in the data. In the typical classical formulation, so long as prices are perfectly flexible and all markets clear at all points in time, the economy is always in long-run equilibrium. Thus, in these models the prediction is a zero correlation between money and income. But it wasn't zero.

However, a very clever idea from Robert Lucas in the 1970s allowed this correlation to be explained without admitting government can do good, i.e. without admitting that government can stabilize the economy using monetary policy. This is the ideological part -- a way to explain the data without acknowledging a role for government at the same time. I can't say that Lucas approached the problem in this way, i.e. that he started out with the ideological goal of explaining the money-income correlation without allowing a role for government. Maybe it arose in a flash of brilliance completely unconnected to ideological concerns, But I find it hard to explain why this model came about in the form it did without ideology, and the view of government the New Classical model supported surely didn't hurt its acceptance at places like the University of Chicago (as it existed then).

'Why Financial Markets are Inefficient'

Roger Farmer (I have a short comment at the end):

Why financial markets are inefficient, by Roger E. A. Farmer , Vox EU: Writing in a review of Justin Fox’s book The Myth of the Efficient Market, Richard Thaler (2009) has drawn attention to two dimensions of the efficient markets hypothesis, what he refers to as:

• ‘No free lunch’, what economists refer to as ‘informational efficiency’;
• ‘The price is right’, what economists refer to as ‘Pareto efficiency’.

My recent research with Carine Nourry and Alain Venditti argues that while there are strong reasons for believing there are no free lunches left uneaten by bonus-hungry market participants, there are really no reasons for believing that this will lead to Pareto efficiency, except, perhaps, by chance (Farmer, Nourry, Venditti 2012).

In separate work, I look at the policy implications of this, showing that the Pareto inefficiency of financial markets provides strong grounds to support central bank intervention to dampen excessive fluctuations in the financial markets (Farmer 2012b). These are strong and polarising claims. They are not made lightly.

Not irrationality, frictions, sticky prices nor credit constraints

Some economists will be sympathetic to my arguments because they believe that financial markets experience substantial frictions. For example, it is frequently argued that agents are irrational, households are borrowing constrained or prices are sticky. Although there may be some truth to all of these claims, my argument for direct central bank intervention in the financial markets does not rest on any of these alleged market imperfections.

Other readers of this piece will wish to challenge my view based on the assertion that competitive financial markets must necessarily lead to outcomes that cannot be improved upon by government intervention of any kind. That assertion has been formalised in the first welfare theorem of economics that is taught to every first-year economics graduate student.

The first welfare theorem provides conditions under which free trade in competitive markets leads to a Pareto efficient outcome, a situation where there is no way of reallocating resources that makes one person better off without making someone else worse off. In my work with Nourry and Venditti (Farmer, Nourry, Venditti 2012), we show why the conditions that are necessary for the theorem to hold do not characterise the real world.

We make some strong but standard assumptions:

• Households are rational and plan for the infinite future;
• They have rational expectations of all future prices;
• There are complete financial markets in the sense that all living agents are free to make trades contingent on any future observable event;
• No agent is big enough to influence prices.

Crucially, in our model, there are at least two types of people who discount the future at different rates; patient and impatient agents. We show that, even when both types share common beliefs, the belief itself can independently influence what occurs. This follows an important idea originating at the University of Pennsylvania in the 1980s, what David Cass and Karl Shell (1983) call ‘sunspots’, or what Costas Azariadis (1981) refers to as a ‘self-fulfilling prophecy’¹.

The first welfare theorem, birth and death

What could possibly go wrong when agents are rational, hold rational expectations, there are no frictions, and markets are complete? Well, the first welfare theorem does not account for the fact that people die and new people are born. In our world:

• Patient and impatient agents each recognise that the financial markets are fickle and that the value of the stock market could rise or fall;
• If the markets boom then the patient savers, feeling wealthier, will lend more to the impatient borrowers;
• If the markets crash, then the savers will recall their loans, made in better times.

But in our model environment, booms and crashes occur simply as a consequence of the animal spirits of market participants. Why should we care if there are big movements in the asset markets? After all, the borrowers and lenders are rational and they have made bets with each other in full knowledge that these large asset movements might occur.

• The problem is that the next generation is unable to insure against swings in wealth that have a big influence on their lives.

Steve Davis and Till von Wachter (2011) have shown that the present value of lifetime income of new entrants to the labour market can differ substantially depending on whether their first job occurs in a boom or a recession. In our model, the lifetime income of the young can differ by as much as 20% across booms and slumps.

Given the choice, the young agents in our model would prefer to avoid the risk of a 20% variation in lifetime wealth. There is a feasible way of allocating resources that would insure them against this risk, but financial markets cannot achieve this allocation, except by chance. The inability of our children to trade in prenatal financial markets is sufficient to invalidate the first welfare theorem of economics.

In short, sunspots matter. And they matter in a big way.

Conclusions

We show that financial markets cannot work well in the real world except by chance because:

• There are many equilibria;
• Only one of them is Pareto efficient;
• For all other equilibria, the whims of market participants cause the welfare of the young to vary substantially in a way that they would prefer to avoid, if given the choice.

Our paper makes some classical assumptions, but has Keynesian policy implications. Agents are rational, they have rational expectations and there are no financial frictions. Even when agents are rational, markets are not.

References

Azariadis, Costas (1981), “Self-fulfilling Prophecies”, Journal of Economic Theory, 25, 380-396.

Cass, David and Karl Shell, “Do Sunspots Matter?” (1983), Journal of Political Economy, 91(2), 193-227.

Davis, Steven and Till Von Wachter (2011), “Recessions and the Costs of Job-Losses”, Brookings Papers on Economic Activity.

Farmer, Roger E A (2012a), “The Evolution of Endogenous Business Cycles”, NBER Working Paper 18284 and CEPR Discussion Paper 9080.

Farmer, Roger E A (2012b), “Qualitative Easing: How it Works and Why it Matters”, NBER working paper 18421 and CEPR discussion paper 9153.

Farmer, Roger E A, Carine Nourry and Alain Venditti (2012), “The Inefficient Markets Hypothesis: Why Financial Markets Do Not Work Well in the Real World”, CEPR Discussion Paper No. 9283.

Fox, Justin (2009), The Myth of the Rational Market: A History of Risk, Reward and Delusion on Wall Street, New York, Harper.

Thaler, Richard (2009), “Markets can be wrong and the price is not always right”, Financial Times, 4 August.

References

1 See my survey (Farmer 2012a), which documents the evolution of the Pennsylvania School of Endogenous Business Cycles.

______________________________

My question is whether these results hold if there were Barro ("Are Bonds Net Wealth") preferences, i.e. if the utility of the parent depends upon the utility of the child?:

U = U_p(x₁, x₂, x₃, ..., x_n, U_c)

I asked Roger Farmer this question, and he replied this was a good research topic:

My guess is that Barro preferences are not enough. Why? Because the trades required to eliminate sunspot equilibria would require that some agents are born with negative net worth in some states of the world.  Since the courts would not enforce those trades, the equilibrium would unravel.  

Links for 01-25-2013

• Tim Geithner Is Wrong - Paul Krugman
• Mary Jo White’s Task - James Surowiecki
• Yes, the middle class really is falling behind - Jim Tankersley
• The Hysteresis Effects of Financial Crises Are Large - Brad DeLong
• What Can Obama Do for the Labor Movement? - Rational Irrationality
• I didn't think Phil Mickelson's Tax Rate Could be > 60% - Richard Green
• Can prices be sticky if they change all the time? - Marginal Revolution
• Alan Blinder on the Lessons of the Financial Crisis - Economix
• Missing Half the Cash - David Cay Johnston
• Valuing nature is not enough - EurekAlert
• Inequality and demand - Interfluidity
• Older, but Not Yet Retired - NYT
• The New Claims Data - Modeled Behavior
• The Curse of Richard Nixon - Brad DeLong
• How To Avoid Cutting Programs ... - Robert Reich
• Real Spending Cuts in the Real World - Jared Bernstein
• An Insurance Company With an Army - Paul Krugman
• Information asymmetry raises the cost of capital - Vox EU
• The Debt Ceiling and Playing With Fire - Simon Johnson

The Evolution of Household Income Volatility

This is part of the introduction to a new paper by Karen Dynan, Douglas Elmendorf, and Daniel Sichel on household income volatility (they find that volatility has increased in recent decades):

The Evolution of Household Income Volatility, by: Karen Dynan, Douglas Elmendorf, and Daniel Sichel: Editor's Note: The full version of this paper is available at the website for the B.E. Journal of Economic Policy and Analysis. An earlier working version of the paper can be directly downloaded [here].

1. Introduction Researchers have found it relatively straightforward to document changes in the volatility of the U.S. economy as a whole over the last several decades. The aggregate U.S. economy entered a period of relative stability known as the Great Moderation in the mid-1980s and, much more recently, has been in dramatic flux since the onset of the financial crisis and Great Recession in 2007 and 2008. However, aggregate trends do not necessarily translate into trends in the experiences of individual households. For example, the Great Moderation is generally thought to be a period over which the economy became more dynamic, with globalization, deregulation, and technological change increasing the competitive pressures and risks faced by workers. Given these developments, it is not clear that the economic environment facing individual households was in fact more stable during this period. Thus, to the extent that one is interested in household economic security, one is compelled to consider micro data. Accordingly, a large literature has developed that directly examines the volatility of earnings and income at the household level. While income volatility is not the same thing as the risk or uncertainty faced by households, changes in volatility are likely to be associated with changes in risk and uncertainty. ...

To summarize our results, we estimate that the volatility of household income—as measured by the standard deviation of two-year percent changes in income—increased about 30 percent between the early 1970s and the late 2000s. The rise in volatility did not occur in a single period but represented an upward trend throughout the past several decades; it occurred within each major education and age group as well. Yet, the run-up in volatility was concentrated in one important sense: It stemmed primarily from an increasing frequency of very large income changes rather than larger changes throughout the distribution of income changes.

Turning to the components of income, we estimate notable increases in the volatility of labor earnings and transfer income and a small increase in the volatility of capital income.  Household labor earnings (combining earnings of heads and spouses before estimating volatility at the household level) became more volatile even though the volatility of individual earnings (heads and spouses taken as individual observations) edged down. The explanation is that women’s earnings became less volatile while men’s earnings became more volatile, and the latter matters more for household earnings because men earn more than women on average. We show that rising volatility in men’s earnings owes both to rising volatility in earnings per hour and in hours worked, though our interpretation could be affected by changes in PSID methodology. And we demonstrate that earnings shifts between household members, as well as shifts in market income and transfer income, provide only small offsets to each other. ...

'Robots and All That'

Fred Moseley responds to my comments on his comments (I suggested that if he wants a theory of exploitation that is consistent, he should consider dropping Marx's Labor Theory of Value, which does not actually explain value, and instead explain exploitation in more modern terms, i.e. with reference to why workers have not received their marginal products in recent decades):

Thanks to Mark for posting my critical comment on Krugman’s explanation of stagnant real wages and declining wage share of income, and for his introductory comment, which raises fundamental issues.

A question for Mark: how do you know what the “MP benchmark” is that workers should have received. The MP benchmark is presumably the “marginal product of labor”, but how do you know what this is? I know of no time series estimates of the aggregate MPL (independent of income shares) for recent decades. If you know of such estimates, please send me the reference(s).

What you have in mind may be estimates like Mishel’s estimates of the “productivity of labor” and the “real wage of production workers”, which shows a widening gap in recent years (see Figure A in “The wedges between productivity and median compensation growth”; ). But these estimates of the “productivity of labor” are not of the MPL of marginal productivity theory, but are instead the total product divided by total labor. These estimates are more consistent with Marxian theory than with marginal productivity theory. And I agree that explaining this divergence is an important key to understanding the increasing inequality in recent decades. I think the explanation has to do with a number of factors that have put downward pressure on wages: higher unemployment, outsourcing and threat of more, declining real minimum wage, attacks on unions, etc. This is very different from Krugman’s “capital-biased technological change”.

A word on the labor theory of value: the LTV is not mainly a micro theory of prices, but is instead primarily a macro theory of profit. And I think that it is the best theory of profit by far in the history of economics (there is not much competition). It explains a wide range of important phenomena in capitalist economies: conflicts over wages, and conflicts over the length of the working day and the intensity of labor in the workplace, endogenous technological change, trends and fluctuations in the rate of profit over time, endogenous causes of economic crises, etc. (For further discussion of the explanatory power of Marx’s theory see my “Marx Economic Theory: True or False? A Marxian Response to Blaug’s Appraisal”, in Moseley (ed.) Heterodox Economic Theories: True or False?; available here:

Marginal productivity, in very unfavorable contrast, can explain none of these important phenomena.

Thanks again.

Fred

Just one comment. If the LTV cannot explain input or output prices, and it doesn't, how can it explain profit?

(Okay, two -- In defense of Krugman, his book Conscience of a Liberal was anything but a “capital-biased technological change” explanation of rising inequality, and he stated the “capital-biased technological change” explanation as something to look into rather than a conclusion he has drawn. For example, he says:

More on robots and all that ... there’s another possible resolution: monopoly power. Barry Lynn and Philip Longman have argued that we’re seeing a rapid rise in market concentration and market power. The thing about market power is that it could simultaneously raise the average rents to capital and reduce the return on investment as perceived by corporations, which would now take into account the negative effects of capacity growth on their markups. So a rising-monopoly-power story would be one way to resolve the seeming paradox of rapidly rising profits and low real interest rates. As they say, this calls for more research; but the starting point is to realize that there’s something happening here, what it is ain’t exactly clear, but it’s potentially really important.

So I don't think it's completyely fair to say that Krugman's explanation for rising inequality is "capital-biased technological change.")

'Does Income Bring Happiness?'

Tim Taylor looks at recent evidence on the relationship between income and happiness:

Does Income Bring Happiness?, by Tim Taylor: Back in 1974, Richard Easterlin published a paper called "Does Economic Growth Improve the Human Lot? Some Empirical Evidence" (available here and here, for example). Easterlin raised the possibility that what really matters to most people is not their absolute level of income, but their income level relative to others in society. If relative income is what matters, then an overall rise in incomes doesn't make me any better off relative to others, and so my happiness does not increase. ...

Since then, the question of whether income brings happiness has been much-debated by economist and other social scientists. In "The New Stylized Facts about Income and Subjective Well-Being," Daniel W. Sacks, Betsey Stevenson, and Justin Wolfers offer a compact and readable summary of the evidence (much of which they generated in earlier research) that income is not just relative--and so more income does increase happiness. The paper is available as IZA Discussion Paper No. 7105, released in December.

At a basic level, this research looks at economic data on levels of income and compares it with survey data on on life satisfaction. ... As a starting point, let's compare countries across the world... The horizontal axis of the graph is a logarithmic scale...

The general pattern is clear those in higher-income countries tend to report more life satisfaction. The best-fit straight line is drawn through the data. The much lighter dotted line is a "non-parametric" line which is a best-fit line that isn't required to be straight, and thus flattens out near the bottom and curves more steeply at the top than a straight line. Broadly speaking, it seems as if each doubling of income does lead to a distinct rise in the happiness scale, both for low-income and for high-income countries.

Of course, this result by itself doesn't prove the case either way. It could be that people in high-income countries are happier because they perceive that they are not in low-income countries, and so the happiness from their income is relative, rather than absolute. Thus, a second test is to look within individual countries at the happiness level of those with different income levels. If happiness from income is a relative concept, one might expect that, say, the rise in income from being a low-income person in the U.S to being a high-income person in the U.S. would bring more happiness, but the rise in happiness should be much less within a country than it would be across countries. However, the rise in happiness as a result of higher incomes within a country ends up looking very much like the relationship between countries.

Yet another test is to look at comparisons over time: that is, as economic growth gradually raises income levels, do people on average within a given country report a higher level of  happiness. The data here is harder to interpret, because long-run data on happiness measures isn't available for many countries, and the wording of the survey questions about life satisfaction often changes over time. While acknowledging that the existing evidence is messy and difficult to interpret firmly, the authors argue that it is at least consistent with the same finding: that is, higher income levels over time are correlated with higher reported life satisfaction.

But not for the United States! Sacks, Stevenson, and Wolfers write: "The US, however, remains a paradoxical counter-example: GDP has approximately doubled since 1972 and well-being, as measured by the General Social Survey, has decreased slightly." The authors point out that any individual country may have specific social changes that alter the reported "life satisfaction." In particular, they point out that inequality of income started rising in the U.S. economy in the 1970s, which may explain why the typical or median person in the economy isn't feeling much better off. They write: "We suggest that the US is more of an interesting outlier than a key example."

Those who want to sort through why Sacks, Stevenson, and Wolfers reach different conclusion from Easterlin can dig into the paper itself: a lot of the difference, they argue, is just that more and better data is available now.

For my own part, I confess that I find happiness surveys both intriguing and dubious. It seems to me that higher levels of income are typically correlated with more health, education, travel, consumption, and a higher quality of recreation, so it's not a surprise to me it seems to me that happiness rises with income. On the other side, it does seem to me that survey questions about life satisfaction are answered in the context of a particular place and time. If a person says that their life satisfaction was a 7 in 1960 on a scale of 0-10, and another person says that their life satisfaction is a 7 in 2013, are those two people really equally satisfied? To put it another way, if the person from 2013 was transported by a time machine back to live in 1960, with all their memories and knowledge of the technologies, medicines, foods, education, and travel available in 2013, would that time traveler really be equally happy in either time period? I suspect that when most people are asked to rank happiness on a scale of 0-10, they don't say to themselves: "Well, people living 100 years from now might have extraordinarily high levels of income and technology, so compared with them, I'm really no more than a 2." At best, survey questions on a scale of 0-10 seem like an extremely rough-and-ready way of measuring life satisfaction across very different countries or across substantial periods of time.

Links for 01-24-2013

• NGDP level targeting: Yellen it..., but nobody heard - FT Alphaville
• The growth effects of democratisation: New evidence - VoxEU
• Unions in America: 2012 Data - Jared Bernstein
• Union Membership Drops Despite Job Growth - NYT
• The Right's "47%" Theory Among the Wingnuts... - Brad DeLong
• When National Interest and Party Advantage Conflict - mainly macro
• Winding Down TARP: A Progress Report - Treasury Notes
• Frequent multitaskers are bad at it - EurekAlert
• Brave, Honest Paul Ryan - Paul Krugman
• Sir Mervyn takes a walk on the supply side - FT.com
• A Quick Reaction to Matt Yglesias’s Healthcare Chart - Owen Zidar
• Real Estate Monetary Standard: the New Wildcat Banking? - Carola Binder
• Revisions to Basel III’s Liquidity Requirements - Economics of Contempt
• China Economic Paradigm Nearing End Game - naked capitalism
• Martin Wolf, Hippie - Paul Krugman

'No US Peace Dividend after Afghanistan'

Stiglitz and Bilmes:

No US peace dividend after Afghanistan, by Joseph Stiglitz and Linda Bilmes, Commentary, FT: Nearly 12 years after the US-led invasion of Afghanistan began, a war-weary America is getting ready to leave. ... But the true cost of the war is only just beginning. ...

The number of Iraq and Afghanistan veterans receiving government medical care has grown to more than 800,000, and most have applied for permanent disability benefits. Yielding to political pressure, the White House and Congress have boosted veteran’s benefits ... and made it easier to qualify for disability... But the number of claims keeps climbing. ... To recruit volunteers to fight in highly unpopular wars, the military adopted higher pay scales and enhanced healthcare benefits... Meanwhile, there is a huge price tag for replacing ordinary equipment that has been consumed during the wars...

... The US has already borrowed $2tn to finance the Afghanistan and Iraq wars – a major component of the $9tn debt accrued since 2001... Today,... it could have been hoped that the ending of the wars would provide a large peace dividend... Instead, the legacy of poor decision-making from the expensive wars in Afghanistan and Iraq will live on in a continued drain on our economy – long after the last troop returns to American soil.

'King Stands by Inflation Targeting'

I don't get this argument from Bank of England governor Mervyn King:

The governor of the Bank of England... Sir Mervyn King ... dismissed suggestions made by his designated successor, Mark Carney, now governor of the Bank of Canada, for the Bank to ease monetary policy further by abandoning its inflation target if meaningful growth continues to elude the UK. Mr Carney succeeds him at the start of July. ...

With the UK government pursuing fiscal consolidation, monetary policy has been the mainstay of policy makers’ strategy to boost economic output... But the governor, speaking in Belfast, warned against over-reliance on monetary easing. “In many countries, including the UK, fiscal policy is constrained by the size of government indebtedness, and monetary policy has come to be seen as the only game in town,” Sir Mervyn said. “Relying on monetary policy alone, however, is not a panacea.”

That says nothing at all about whether monetary policy should be easier, tighter, or is currently just right. Actually, he does offer this:

The governor suggested the government should introduce supply-side reforms to support the UK’s shift towards higher exports and lower imports.

“It cannot be for a central bank to design a programme of such supply initiatives, but in economic terms there has never been a better time for supply-side reform,” he said.

He is suggesting that the UK's problems are entirely on the supply-side, and that further demand side measures cannot help (e.g. through further monetary easing). Bluntly, I think that's wrong. I have my doubts about nominal GDP targeting as the solution to our economic problems, but that doesn't imply that the current policy approach is optimal, or that deviating from a strict inflation target in the short-run (or the path to the target) cannot help.

America’s Fiscal Policy is Not in Crisis

Peter Orszag:

Healthcare is America’s real problem, by Peter Orszag, Commentary, FT: Healthcare costs are the core long-term fiscal challenge facing the US... This is why the recent deceleration of these costs is so encouraging...

The good news is that recent developments in health costs are better than many appreciate. Cost growth has slowed dramatically...

Last year, the Congressional Budget Office estimated that the gap between revenue and expenditure in the next 75 years would amount to 8.7 per cent of GDP. Since then, enacted revenue increases and an improved underlying budget outlook have reduced the gap to perhaps 7.5 per cent.

Achieving the lower health-cost growth would knock another 2.5 per cent of GDP off, bringing the long-term fiscal hole down to 5 per cent of GDP – a greater impact than any policy change currently being debated in Washington. ...

Martin Wolf:

America’s fiscal policy is not in crisis: ...The federal government is not on the verge of bankruptcy. If anything, the tightening has been too much and too fast. The fiscal position is also not the most urgent economic challenge. It is far more important to promote recovery. The challenges in the longer term are to raise revenue while curbing the cost of health. Meanwhile, people, just calm down.

By the way, where were the deficit hawks during the Bush years? Here's what Martin Wolf means by "If anything, the tightening has been too much and too fast":

[via Kevin Drum]

The deficit hawks don't want you to know this, but our biggest problem right now is not the deficit, it's jobs.

Higher Marginal Taxes Reduce Economic and Political Power

Richard Green:

... Higher marginal taxes reduce the ability of high income people to accumulate power, which may mean they work/play less.  I don't know that this is entirely a bad thing.

(The post is: Do higher marginal tax rates lead superstar athletes to play less often? See also Barry Ritholtz who asks Who the Hell Are Phil Mickelson’s Financial Advisers?)

Links for 01-23-2013

• The microfoundations of banking - Free exchange
• Wealth-Income Ratios in the Long Run - Tim Taylor
• The Macroeconomic Task Ahead - Econbrowser
• Outsourcing tide is not likely to turn - FT.com
• An eternity of infinities - Scientific American
• The Non-Surge in Government Spending - Paul Krugman
• A plug for optimal currency areas - Frances Woolley
• Government Expenditure Growth - Modeled Behavior
• Government Spending deflated by the GDP deflator - Robert Waldmann
• Is There a Poison Pill in the Debt Ceiling Bill? - Discourse.net
• The Most Important Graph on the Deficit - Rortybomb
• Seneca, Selma, and Stonewall - Paul Krugman
• Macro always fights the last war - Noahpinion
• Japan and the Formation of Inflation Expectations - Carola Binder
• How Has the Liberal Project Fared Under President Obama? - Rortybomb
• What Can Obama Do about Climate Change? - Scientific American
• The Vision and the Budget - Jeffrey Sachs
• 2013 Kauffman Foundation Webloggers' Conference - Brad DeLong
• Actuaries Confirm That Scare Talk on Social Security Is Off-Base - CBPP
• Central Bank Independence - Gloomy European Economist
• E.U. States Get Blessing for Financial Trading Tax - NYT
• Ben Bernanke vs. Milton Friedman - RealClearPolicy
• Contra Raghu Rajan: Economic Stimulus Has Not Failed - Brad DeLong
• Inequality's effects - Stumbling and Mumbling
• When Tax Cuts Were a Tough Sell - Economix
• Students whose parents pay for more of college - Andrew Gelman
• Is the corporate income tax progressive? - Tax Justice Network

NGDP 'Targetry' Skepticism

I guess that should be scepticism:

Monetary targetry: Might Carney make a difference?, by Charles A.E. Goodhart, Melanie Baker, Jonathan Ashworth, Vox EU: The Bank of England’s Governor-elect has argued for a switch to a nominal GDP target. This column points out problems with nominal GDP targets, especially in levels. Among other issues, nominal GDP targeting means that uncertainty surrounding future real growth rates compounds uncertainty on future inflation rates. Thus the switch is likely to raise uncertainty about future inflation and weaken the anchoring of inflation expectations. ...

Summers: End the Obsession with the Deficit

After saying:

the great likelihood is that over the next 15 years debts will rise relative to incomes in an unsustainable way if no actions are taken beyond those in the 2011 budget deal and the recent “fiscal cliff” agreement. So even without the risk of self-inflicted catastrophes — the possibility of default or a potential government shutdown this spring — it is appropriate for policy to focus on reducing prospective deficits. Those who argue against a further focus on prospective deficits on the grounds that the ratio of debt to gross domestic product may stabilize for a decade contingent on a forecast that assumes no recessions counsel irresponsibly. Given all the uncertainties and current U.S. debt levels, we should be planning to reduce debt ratios if the next decade goes well economically.

Larry Summers then says:

Reducing prospective deficits should be a key priority but should not take over economic policy.

But I don't get the very next sentence at all. How does a tax cut reduce the deficit?

Such an obsession risks the enactment of measures like pseudo-temporary tax cuts that produce cosmetic improvements in deficits at the cost of extra uncertainty and long-run fiscal burdens.

It's late, and it's been a long day -- I must be missing something. Anyway, I agree with this:

Surely even leaving aside any possible stimulus benefits, current economic conditions make this the ideal time for renewing the nation’s infrastructure. Such investments, borrowed at near-zero interest rates, need not increase debt ratios if their contribution to economic growth raises tax collections.

Infrastructure represents only the most salient of the deficits facing the United States. Nearly six years after the onset of financial crisis, we clearly are living with substantial deficits in jobs and growth. Consider that if an increase of just 0.15 percent in the economy’s growth rate were maintained over the next 10 years, the debt-to-GDP-ratio in 2023 would be reduced by about 2.5 percentage points. That’s an amount equal to the much debated year-end fiscal compromise that raised taxes. Increasing growth also creates jobs and raises incomes.

By all means, let’s address the budget deficit. But let’s not obsess over it in ways that are counterproductive, nor should we lose sight of the jobs and growth deficits that ultimately will have the greatest impact on how this generation of Americans lives and what they bequeath to the next generation

The obsession with the deficit in Washington is not going to end, and the deficit has received far too much attention relative to other issues like unemployment (which really ought to take precedence in the short-run). There is no need, at all, to remind policymakers of that the deficit needs attention.

The intent is different, but my fear is that phrases such as "the great likelihood is that over the next 15 years debts will rise relative to incomes in an unsustainable way if no actions are taken" and "it is appropriate for policy to focus on reducing prospective deficits" is the only message that Republicans and centrist Democrats will hear in this column.

Update: Paul Krugman comments.

Time Is Not On Our Side

What if we actually achieve the target of limiting global warming to a 2 degree Celsius increase? We are unlikely to meet this goal -- it's looking much worse than that -- but what if we did?:

 ... It is abundantly clear that the target of a 2-degree Celsius limit to climate change was mostly derived from what seemed convenient and doable without any reference to what it really means environmentally. Two degrees is actually too much for ecosystems. Tropical coral reefs are extremely vulnerable to even brief periods of warming. .. A 2-degree world will be one without coral reefs (on which millions of human beings depend for their well-being)..., there undoubtedly will be massive extinctions and widespread ecosystem collapse. The difficulty of trying to buffer and manage change will increase exponentially with only small increments of warming.

In addition, the last time the planet was 2 degrees warmer, the oceans were four to six (perhaps eight) meters higher. We may not know how fast that will happen (although it is already occurring more rapidly than initially estimated), but the end point in sea-level rise is not in question. A major portion of humanity lives in coastal areas and small island states that will go under water. ...

More than a 2-degree increase should be unimaginable. Yet to stop at 2 degrees, global emissions have to peak in 2016. ...

Environmental change is happening rapidly and exponentially. We are out of time.

Of course, global emissions won't be anywhere near a peak in 2016.

'Wealth Effects Revisited: 1975-2012'

Housing cycles matter:

Wealth Effects Revisited: 1975-2012, by Karl E. Case, John M. Quigley, Robert J. Shiller, NBER Working Paper No. 18667, January 2013 [open link, previous version]: We re-examine the links between changes in housing wealth, financial wealth, and consumer spending. We extend a panel of U.S. states observed quarterly during the seventeen-year period, 1982 through 1999, to the thirty-seven year period, 1975 through 2012Q2. Using techniques reported previously, we impute the aggregate value of owner-occupied housing, the value of financial assets, and measures of aggregate consumption for each of the geographic units over time. We estimate regression models in levels, first differences and in error-correction form, relating per capita consumption to per capita income and wealth. We find a statistically significant and rather large effect of housing wealth upon household consumption. This effect is consistently larger than the effect of stock market wealth upon consumption.

In our earlier version of this paper we found that households increase their spending when house prices rise, but we found no significant decrease in consumption when house prices fall. The results presented here with the extended data now show that declines in house prices stimulate large and significant decreases in household spending.

The elasticities implied by this work are large. An increase in real housing wealth comparable to the rise between 2001 and 2005 would, over the four years, push up household spending by a total of about 4.3%. A decrease in real housing wealth comparable to the crash which took place between 2005 and 2009 would lead to a drop of about 3.5%

Links for 01-22-2013

• A brief history of macro: How we got here - The Economist
• Inequality and Technology: Did the Robots Do It? - Dean Baker
• Putting time and space back into finance - Biagio Bossone
• Why financial markets are inefficient - Roger Farmer
• Optimizing Isn’t Easy Even for Belichick - Sports Economist
• End the damaging obsession with deficit - Larry Summers
• The Climate Change Endgame - NYTimes.com
• The Social Cost of Finance - Uneasy Money
• Saying the Right Stuff - Paul Krugman
• Work in the Walmartocene - Nancy Folbre
• Monetary Policy in Uncertain Times - FRBSF Economic Letter
• Who Participates In Basel Committee Rulemakings? - Conglomerate Blog
• Price Rigidity: Micro Evidence/Implications (NBER) - Nakamura and Steinsson
• The Review of Keynesian Economics: Launch of New Journal - TripleCrisis
• U.S. as a Capital Importer - Tim Taylor

More on Inequality and the Recovery:

Paul Krugman:

More On Inequality: Responses to my response to Joe Stiglitz have varied. Some are outraged that I might suggest that inequality isn’t the source of all problems — there are even some suggestions that I am acting as an apologist for the plutocrats, which will come as news to the plutocrats. But there have also been some interesting points raised. ...

How Big Should Government Be?

Travel day, so a quick one:

How Big Should Government Be?, by Justin Fox: There are a couple of fundamental questions at the bottom of Washington's ongoing battles over deficits and debt: (1) How big should the U.S. government to be? and (2) How should we pay for it? The answers to both will ultimately have to be political ones — messy calculations based on who pays, who benefits, who votes, and who makes the campaign contributions. But it would be nice to know what the economics are, wouldn't it?

It turns out economists have lots of theories of optimal government spending and optimal taxation. This isn't the same as saying they have reliable or consistent answers. As one critic wrote of Robert Lucas's American Economic Association presidential address on economic growth in 2003, in which the Nobel laureate cited several studies showing dramatic welfare gains from hypothetical tax cuts in France and the U.S.:

Such findings have two distinctive features. First, they show big numbers. Second, they are not really findings. Contrary to the words offered so traditionally and casually by economists, none of these authors actually 'found' or 'showed' their results. Rather, they chose to imagine the results they announced. In every study Lucas cited here the crucial ingredient was a theoretical model laden with assumptions.

The author of these words is University of California, Davis economic historian Peter Lindert... People on the left love Lindert's conclusion, contained in this shorter working paper, that the rise in spending (and accompanying taxation) has not carried with it the costs predicted by neoclassical economic theories such as the ones wielded by Lucas. But those on the right love his explanation that this is mostly because countries with high social spending have tax systems that appear to have been designed by a neoclassical economist: with low progressivity, low taxes on capital, and big value-added taxes on consumption. ...

Paul Krugman: The Big Deal

Progressives should cheer up:

The Big Deal, by Paul Krugman, Commentary, NY Times: On the day President Obama signed the Affordable Care Act into law, an exuberant Vice President Biden famously pronounced the reform a “big something deal” — except that he didn’t use the word “something.” And he was right..., if progressives look at where we are as the second term begins, they’ll find grounds for a lot of (qualified) satisfaction.

Consider, in particular, three areas: health care, inequality and financial reform.

Health reform is, as Mr. Biden suggested, the centerpiece of the Big Deal. Progressives have been trying to get some form of universal health insurance since the days of Harry Truman; they’ve finally succeeded. …

What about inequality? ... Like F.D.R., Mr. Obama took office in a nation marked by huge disparities in income and wealth. But where the New Deal had a revolutionary impact, empowering workers and creating a middle-class society that lasted for 40 years, the Big Deal has been limited to equalizing policies at the margin.

That said,... through new taxes ... 1-percenters will see their after-tax income fall around 6 percent... This will reverse only a fraction of the huge upward redistribution that has taken place since 1980, but it’s not trivial.

Finally, there’s financial reform. The Dodd-Frank reform bill is ... not the kind of dramatic regime change one might have hoped for… Still, if plutocratic rage is any indication, the reform isn’t as toothless as all that. …

All in all, then, the Big Deal has been, well, a pretty big deal. But will its achievements last? ... I ... think so. For one thing, the Big Deal’s main policy initiatives are already law. ... And ... the Big Deal agenda is, in fact, fairly popular — and will become more popular once Obamacare goes into effect...

Finally, progressives have the demographic and cultural wind at their backs. Right-wingers flourished for decades by exploiting racial and social divisions — but that strategy has now turned against them...

Now, none of what I’ve just said should be taken as grounds for progressive complacency. The plutocrats may have lost a round, but their wealth and the influence it gives them in a money-driven political system remain. Meanwhile, the deficit scolds (largely financed by those same plutocrats) are still trying to bully Mr. Obama into slashing social programs. ...

Still, maybe progressives — an ever-worried group — might want to take a brief break from anxiety and savor their real, if limited, victories.

Fed Watch: Is There a Big Inflation Mystery in Greece?

Tim Duy:

Is There a Big Inflation Mystery in Greece?, by Tim Duy: Tyler Cowen confuses me:

The rates of price inflation in Greece have been running in the range of 0.8% to 2%...It’s funny how many people pretend to understand what is going on here. If Greece were seeing a stronger bout of price deflation, the situation would be much clearer.

This seems to me to be a case of trying to find a problem where none exists. Greece consumer prices excluding energy:

What part of the deflation is not clear? Seems like any inflation is being driven by energy costs:

So what going on in the energy sector? Stories like this:

Greeks cutting back on household expenses are turning from oil to wood to heat their homes, but in turn are filling the night air with potentially hazardous pollutants, health care officials have warned.

The coalition government, under pressure from the EU-IMF-ECB Troika to impose more austerity measures, has pushed the price of heating oil to about 1.50 euros per litre by raising the tax on heating oil by 40 percent. Besides being a revenue-raiser, the government said the tax was meant to deter people from putting the oil in their cars instead of more expensive diesel.

And:

Greece raised electricity prices for households by up to 15 percent this year to help state-controlled power company PPC cover costs for transmission rights, the government said on Sunday...

...They come after a 9.2 percent average increase in prices last year.

PPC is the dominant player in the Greek energy market, and the country's EU and IMF lenders are pressing the government to make room for private companies. The company's tariffs are regulated by the state.

The Troika is remaking the energy sector, with the consequence of rising prices in a way that looks like a sectoral supply shock that is very obviously distinct from the demand side disturbance. What exactly is the big mystery here?