George Hall and Thomas Sargent advise Republicans who support the idea of debt prioritization to "ponder the actions" of Hamilton, Madison, and Grant:
Fiscal prioritisation: Lessons from three wars, by George Hall, Thomas J. Sargent, Vox EU: With the temporary suspension on the US Treasury’s statutory debt limit set to expire in late May, Republicans in the US House of Representatives have advanced the idea of debt prioritization. This proposal, put forward in the Full Faith and Credit Act (HR 807), would "require that the government prioritize all obligations on the debt held by the public in the event that the debt limit is reached”. Specifically, as an alternative to increasing the debt limit, the Secretary of the Treasury would be instructed to pay the principal and interest on Treasury securities held by public and the Social Security trust fund before paying the government’s other obligations. Hence the government would honor some of its promises (e.g. those to its bond holders) while threatening to break some of its promises to others (e.g. those to veterans and Medicare recipients expecting payments).
This is hardly the first time that the US government has faced the question of whether it should discriminate among its different promises (see Hall and Sargent 2013). In 1868, immediately following the Civil War, the US faced what seemed a crushing debt burden with outstanding Treasury obligations exceeding 35% of GDP. While this may seem low by today’s standards, tax receipts as a share of GDP at the height of the war barely exceed 5% and fell to 3% immediately after war. Hence, debt was roughly ten times tax receipts. Today, the quantity of debt held by the public is between four and five times tax receipts.
In order to create sufficient fiscal space to allow the government to rebuild the war-torn South and to honor the long-term pension obligations to Union soldiers and their families, many advocated discriminating across different classes of government creditors. None other than the president at the time, Andrew Johnson, stated in his 1868 Annual Message to Congress:
“Various plans have been proposed for the payment of the public debt. However they may have varied as to the time and mode in which it should be redeemed, there seems to be a general concurrence as to the propriety and justness of a reduction in the present rate of interest. … The lessons of the past admonish the lender that it is not well to be over-anxious in exacting from the borrower rigid compliance to the letter of the bond”.
‘Lessons of the past’
What were these ’lessons of the past’ that might suggest less than rigid compliance to previous promises? Prior to the Civil War, the US had fought three major wars. Two of these wars, the Revolutionary War and The War of 1812, had also led to fiscal crises.
In 1790, during the US’ first fiscal crisis, then Secretary of the Treasury Alexander Hamilton crafted a plan to restructure the Continental and state debts incurred in the course of the Revolutionary War. Under this plan, Hamilton gave first priority to foreign creditors, paying off Dutch creditors in full (see Table 9 of Garber 1991). Hamilton then reduced the promised interest payments to domestic bondholders while preserving their promised principal payments. This reduction in the interest rate was a form of repudiation, though perhaps Hamilton repudiated less than had been expected during the 1780s, earning him substantial gratitude from 1780s speculators. But not all government creditors fared so well. Holders of Continental Dollars received only 1% of their face value.
Clearly Hamilton’s plan enhanced the credit of the new nation, but it was not until the resolution of the second US fiscal crisis that government debt would consistently trade at par. And it would not be for another 70 years that the Treasury could credibly issue paper money.
Fast forward 25 years and the Federal government faced a second fiscal crisis during the War of 1812. During this conflict, the value of US Treasury bonds fell to 75 cents on the dollar as many creditors were unwilling to support an unpopular war and saw the nation’s capital burned to the ground. Despite this difficultly in borrowing, President James Madison resisted resorting to the mainstay of the American Revolution – an inflation tax – in financing the war and, in years following the war, awarded outsized positive returns to all holders of US debt.
Late 1860s advocates of `lowering ex post interest rates' to be paid to Union creditors might legitimately appeal to Alexander Hamilton as an example; but they could not appeal to the precedent set by the Madison administration and its successors.
While President Johnson advocated prioritizing government obligations so that bond holders would receive less then was promised, the 1868 Republican presidential candidate and former Union general Ulysses S Grant argued that to protect the nation’s honor, every dollar of government indebtedness should be paid in full. After winning the presidency, Grant stated: “no repudiator of one farthing of our public debt will be trusted in public place”. And as its very first act following the inauguration, the Congress passed ‘An Act to Strengthen the Public Credit’ committing the Treasury not to discriminate among different classes of creditors.
The fact that the US government honored in full all of its obligations after the War of 1812 – including those to British creditors – established precedents that led President Grant and the Congress to preside over a period of post-Civil War deflation. This deflation had the effect of rewarding people who held Union obligations throughout the war, and by 1879, people trusted US government nominal promises to be ‘as good as gold’ for the first time in the country’s history.
Alexander Hamilton discriminated among different classes of federal obligations – paying some in full while partially repudiating others. After Hamilton’s restructuring, Treasury debt traded at a discount relative to its par value for nearly 30 years.
Contemporary advocates of engaging in fiscal discrimination might ponder the actions of Presidents Madison and Grant, who honored all existing federal obligations despite challenging fiscal conditions.
References
Garber, Peter (1991), “Alexander Hamilton’s Market Based Debt Reduction Plan”, Carnegie-Rochester Conference Series on Public Policy 35, 79–104.
Hall, George J and Thomas J Sargent (2013), "Fiscal Discriminations in Three Wars", NBER Working Papers 19008, National Bureau of Economic Research, Inc.
This is from Matt Clements, Associate Professor and Chair of the Economics Department at St. Edward’s University:
Dear Professor Thoma,
Allow me to add to the flood of responses you have no doubt received to your offer to help publicize your readers’ research. The paper is called "Self-interest vs. Greed and the Limitations of the Invisible Hand," forthcoming in the American Journal of Economics and Sociology (pdf of the final version). The point of the paper is that greed, as opposed to enlightened self-interest, can be destructive. Markets always operate within some framework of laws and enforcement, and the claim that greed is good implicitly assumes that the legal framework is essentially perfect. To the extent that laws are suboptimal and enforcement is imperfect, greed can easily enrich some market participants at the expense of total surplus. All of this seemed sufficiently obvious to me that at first I wondered if the paper was even worth writing, but the referees were surprisingly difficult to convince.
Chairman Ben S. Bernanke is an optimist when it comes to our long-run economic prospects (i.e. he does not endorse the notion that productivity is slowing). I'm with him. (This is a graduation speech Bernanke gave at Bard College at Simon's Rock, Great Barrington, Massachusetts):
Economic Prospects for the Long Run: Let me start by congratulating the graduates and their parents. The word "graduate" comes from the Latin word for "step." Graduation from college is only one step on a journey, but it is an important one and well worth celebrating.
I think everyone here appreciates what a special privilege each of you has enjoyed in attending a unique institution like Simon's Rock. It is, to my knowledge, the only "early college" in the United States; many of you came here after the 10th or 11th grade in search of a different educational experience. And with only about 400 students on campus, I am sure each of you has felt yourself to be part of a close-knit community. Most important, though, you have completed a curriculum that emphasizes creativity and independent critical thinking, habits of mind that I am sure will stay with you.
What's so important about creativity and critical thinking? There are many answers. I am an economist, so I will answer by talking first about our economic future--or your economic future, I should say, because each of you will have many years, I hope, to contribute to and benefit from an increasingly sophisticated, complex, and globalized economy. My emphasis today will be on prospects for the long run. In particular, I will be looking beyond the very real challenges of economic recovery that we face today--challenges that I have every confidence we will overcome--to speak, for a change, about economic growth as measured in decades, not months or quarters.
Many factors affect the development of the economy, notably among them a nation's economic and political institutions, but over long periods probably the most important factor is the pace of scientific and technological progress. Between the days of the Roman Empire and when the Industrial Revolution took hold in Europe, the standard of living of the average person throughout most of the world changed little from generation to generation. For centuries, many, if not most, people produced much of what they and their families consumed and never traveled far from where they were born. By the mid-1700s, however, growing scientific and technical knowledge was beginning to find commercial uses. Since then, according to standard accounts, the world has experienced at least three major waves of technological innovation and its application. The first wave drove the growth of the early industrial era, which lasted from the mid-1700s to the mid-1800s. This period saw the invention of steam engines, cotton-spinning machines, and railroads. These innovations, by introducing mechanization, specialization, and mass production, fundamentally changed how and where goods were produced and, in the process, greatly increased the productivity of workers and reduced the cost of basic consumer goods. The second extended wave of invention coincided with the modern industrial era, which lasted from the mid-1800s well into the years after World War II. This era featured multiple innovations that radically changed everyday life, such as indoor plumbing, the harnessing of electricity for use in homes and factories, the internal combustion engine, antibiotics, powered flight, telephones, radio, television, and many more. The third era, whose roots go back at least to the 1940s but which began to enter the popular consciousness in the 1970s and 1980s, is defined by the information technology (IT) revolution, as well as fields like biotechnology that improvements in computing helped make possible. Of course, the IT revolution is still going on and shaping our world today.
Now here's a question--in fact, a key question, I imagine, from your perspective. What does the future hold for the working lives of today's graduates? The economic implications of the first two waves of innovation, from the steam engine to the Boeing 747, were enormous. These waves vastly expanded the range of available products and the efficiency with which they could be produced. Indeed, according to the best available data, output per person in the United States increased by approximately 30 times between 1700 and 1970 or so, growth that has resulted in multiple transformations of our economy and society.1 History suggests that economic prospects during the coming decades depend on whether the most recent revolution, the IT revolution, has economic effects of similar scale and scope as the previous two. But will it?
Continue reading "Bernanke: Economic Prospects for the Long Run" »
Two from Tim Duy:
First, "Dollar Up":
Dollar Up, by Tim Duy: The Dollar continues to gain despite the supposed "Great Debaser" Federal Reserve Chairman Ben Bernanke bringing us multiple rounds of quantitative easing:
Just sayin....
And second, "Confidence Boom?":
Confidence Boom?, by Tim Duy: The early read on the Thomson Reuters/University of Michigan Consumer Sentiment index jumped to 83.7 in May, up from 76.4 in April. Just a quick reminder before we get too excited - sentiment has tended to be low relative to actual spending. May's sentiment bounce just returns us to trend:
Better than collapsing confidence, but by itself not pointing to an imminent acceleration in consumer spending.
Narayana Kocherlakota on how he sees the balance between keeping interest rates low for an extended time period to help with the unemployment problem (the benefit) and potential financial instability that low rates bring (the cost). He doesn't give a precise statement about how he sees the tradeoff, but does seem to indicate that he sees the benefits as being much larger than the cost. He also explains how the increased demand for safe assets and the fall in supply translates into lowered aggregate demand and the need for stimulative policy from the Fed, and concludes that "Despite its actions, the FOMC has still not lowered the real interest rate sufficiently in light of the changes in asset demand and asset supply that I’ve described." I certainly agree. (This is from a Q&A at the 61st Annual Management Conference of the University of Chicago Booth School of Business.):
The Key Challenges Facing Central Bankers, by Narayana Kocherlakota, President Federal Reserve Bank of Minneapolis: Question: What are the key challenges facing central bankers around the world today?
Narayana Kocherlakota: Thanks for the question. Before answering, I should point out that my remarks today will reflect only my own views and not necessarily those of anyone else in the Federal Reserve System.
In my view, the biggest challenge for central banks—especially here in the United States—is changes in the nature of asset demand and asset supply since 2007. Those changes are shaping current monetary policy—and are likely to shape policy for some time to come.
Let me elaborate. The demand for safe financial assets has grown greatly since 2007. This increased demand stems from many sources, but I’ll mention what I see as the most obvious one. As of 2007, the United States had just gone through nearly 25 years of macroeconomic tranquility. As a consequence, relatively few people in the United States saw a severe macroeconomic shock as possible. However, in the wake of the Great Recession and the Not-So-Great Recovery, the story is different. Workers and businesses want to hold more safe assets as a way to self-insure against this enhanced macroeconomic risk.
At the same time, the supply of the assets perceived to be safe has shrunk over the past six years. Americans—and many others around the world—thought in 2007 that it was highly unlikely that American residential land, and assets backed by land, could ever fall in value by 30 percent. They no longer think that. Similarly, investors around the world viewed all forms of European sovereign debt as a safe investment. They no longer think that either.
The increase in asset demand, combined with the fall in asset supply, implies that households and firms spend less at any level of the real interest rate—that is, the interest rate net of anticipated inflation. It follows that the Federal Open Market Committee (FOMC) can only meet its congressionally mandated objectives for employment and prices by taking actions that lower the real interest rate relative to its 2007 level. The FOMC has responded to this challenge by providing a historically unprecedented amount of monetary accommodation. But the outlook for prices and employment is that they will remain too low over the next two to three years relative to the FOMC’s objectives. Despite its actions, the FOMC has still not lowered the real interest rate sufficiently in light of the changes in asset demand and asset supply that I’ve described.
The passage of time will ameliorate these changes in the asset market, but only gradually. Indeed, the low real yields on long-term TIPS bonds suggest to me that these changes are likely to persist over a considerable period of time—possibly the next five to 10 years. If this forecast proves true, the FOMC will only meet its congressionally mandated objectives over that long time frame by taking policy actions that ensure that the real interest rate remains unusually low.
One challenge with this kind of policy environment—and this is closely linked to the overarching theme of this panel—is that low real interest rates are often associated with financial market phenomena that signify instability. There are many examples of such phenomena, but let me focus on a particularly important one: increased asset price volatility. When the real interest rate is unusually low, investors don’t discount the future by as much. Hence, an asset’s price becomes sensitive to information about dividends or risk premiums in what might usually have seemed like the distant future. These new sources of relevant information can lead to increased volatility, in the form of unusually large upward or downward movements in asset prices.
These kinds of financial market phenomena could pose macroeconomic risks. These potentialities are best addressed, I believe, by using effective supervision and regulation of the financial sector. It is possible, though, that these tools may fail to mitigate the relevant macroeconomic risks. The FOMC could respond to any residual risk by tightening monetary policy. However, it should only do so if the certain loss in terms of the associated fall in employment and prices is outweighed by the possible benefit of reducing the risk of an even larger fall in employment and prices caused by a financial crisis. Hence, the FOMC’s decision about how to react to signs of financial instability—now and in the years to come—will necessarily depend on a delicate probabilistic cost-benefit calculation.
Here’s an example of the kind of calculation that I have in mind. Last week, the Survey of Professional Forecasters reported that it saw less than one chance in 200 of the unemployment rate being higher than 9.5 percent in 2014, and an even smaller chance of the unemployment rate being that high in 2015.1 One possible cause of this kind of a large upward movement in the unemployment rate is an untoward financial shock ultimately attributable to low real interest rates. Thus, the gain to tightening monetary policy is that the FOMC may—and I emphasize the word may—be able to reduce the already low probabilities of adverse unemployment outcomes.
Endnote
1 See the Survey of Professional Forecasters, page 14.
Dan Little:
What about Marx?, by Dan Little: At various points since the death of Karl Marx in 1883 his work has been regarded as a dead issue -- no longer relevant, too ideological, methodologically flawed, too rooted in the nineteenth century. And yet each of these periods of extinction has been followed by a resurgence of interest in Marx's ideas, as new generations try to make sense of the tough and often cruel social conditions in which they find themselves. What are the important dimensions of theory that Marx presented through his writings? And how can any of these be considered valuable in trying to come to grips with the global, capitalist, turbulent, unequal, violent world that we now inhabit?
We might say that there are a small handful of key theoretical frameworks that Marx advocated.
Materialism as a methodology for social science. Social change is driven by material circumstances, the forces and relations of production. This encompasses the property system and the ensemble of technologies present in a given level of society. Materialism denies that ideas and thought drive social change; so religion, patriotism, nationalism, and ideologies of patriarchy are epiphenomena rather than originating causes.
Emphasis on the primacy of property and class. Sociologists and historians want to explain processes of social change. Marx puts it forward that the economic interests created by the property system in a given society create powerful foundations for collective social action. Those who occupy positions of advantage within a given set of property relations want to do what they can to preserve those relations; and those who are disadvantaged by the property relations have a latent interest in mobilizing to change those relations. Persons who share a location in the property system constitute a class, and their interests are systematically different from those in other such positions.
A sketch of a theory of consciousness and culture. Institutions of consciousness and culture play a role in stabilizing and attacking the most important relations of domination in a society. Educational institutions, it is argued, prepare young people for their specific roles in society -- workers, managers, elites, sub-proletarians. So struggles over the content and form of the institutions of enculturation can be expected to be polarized along class lines. Less directly, Marxists like Gramsci have postulated that worldviews reflect life experiences; so elites create cultural worlds that are quite distinct from those imagined by subordinate groups.
A diagnosis of social ills including exploitation, alienation, and dehumanization of social relations. Exploitation has to do with the flow of wealth and material goods through the property system from producers to property-owners. Alienation has to do with the loss of autonomy and self-control that individuals have within a capitalist structure. Marx's distinctive addition to this idea is that this loss of autonomy has psychic consequences -- disaffection, lack of self-respect, depression. The dehumanization of social relations follows from the structure of the capitalist workplace -- workers and bosses, each related to the other through the workings of a command system. Wittgentstein got it right when he described the "slab" language game: the boss says "slab", and the worker produces a slab. There is nothing "I-thou" about this relation (Buber, I and Thou).
A theory of several distinct modes of production. Marx believes that history takes the form of a succession of separable and structurally distinct modes of production: ancient slavery, feudalism, and capitalism differ by the structure of the production system, the property system, and the technologies that each embodied. Marx's most extensive analysis of social formations is his treatment of the capitalist mode of production in Capital: Volume 1: A Critique of Political Economy and the writings that were posthumously edited and published as volumes 2 and 3 of Capital.
A common thread through these framing ideas is the perspective of critique: a critical intelligence trying to understand why modern society produces such human misery. But even from the perspective of critique -- the perspective that tries to diagnose and understand the systemic flaws of contemporary society -- Marxism leaves quite a bit of terrain untouched: gender relations, racism, nationalism, and religious hatred, for example. Marxism doesn't do a good job of explaining a regime of sexual violence (rape in India); it doesn't have much to contribute to the rise of fascism; it doesn't have resources for understanding Islamo-phobia and hatred. So Marxism is not a comprehensive theory of modern social failings; and we might say that its emphasis on economic conflict eclipses other forms of domination in ways that are actually harmful to our ability to improve our social relations.
Geoff Boucher takes up the issue of the continuing relevance of Marx in the contemporary world in Understanding Marxism. Here is how he opens the book:
But Boucher rejects this neoliberal consensus.Today, radical thinking about social alternatives stands under prohibition. According to defenders of the neoliberal transformation of every facet of human existence into a market, Marxism has failed…. Marx is dead; Marxism is finished -- and it must stay that way. (1)
Here are the core reasons that Boucher offers for thinking that Marxism is still relevant in the twenty-first century:Marxism as an intellectual movement has been one of the most important and fertile contributions to twentieth-century thought. The influence of Marxism has been felt in every discipline, in the social sciences and interpretive humanities, from philosophy, through sociology and history, to literature. (2)
And later:
Marxism is the most serious normative social-theoretical challenge to liberal forms of freedom that does not at the same time reject the modern world.
Marxism is the most sustained effort so far to think the present historically and to reflexively grasp thought itself within its socio-historical context. (2)
Marxism is a distinctively historical theory that normatively challenges liberalism in a way no other modern theory does. (3)
Much of Boucher's book contributes to one of two intellectual aims: to give a clear exposition of the most important of Marx's theoretical ideas; and to explicate the several "Marxisms" that followed in the twentieth century. The successive Marxisms take up the bulk of the book, with chapters on Classical Marxism, Hegelian Marxism, The Frankfurt School, Structural Marxism, Analytical Marxism, Critical Theory, and Post-Marxism. So the book provides very extensive explication of the theoretical ideas and developments that have grown out of the Marxist tradition.
What Boucher doesn't really provide is a clear rationale, based on contemporary sociology and history, for the conclusions he wants us to share about the continuing utility of Marxism as a framework for understanding the present and future. We don't get the reasoning that would support the affirmative ideas expressed above. The best rebuttal to the neoliberal triumphalism mentioned above is a compelling collection of sociological studies grounded in the perspectives mentioned above. Michael Burawoy's sociology of factories is a good example (e.g. Manufacturing Consent: Changes in the Labor Process Under Monopoly Capitalism). But this isn't an approach that Boucher chooses to pursue.
So what about it? Is Marxism relevant today? Yes, if we can avoid the dogmatism and rigidity that were often associated with the tradition. Power, exploitation, class, structures of production and distribution, property relations, workplace hierarchy -- these features certainly continue to be an important part of our social world. We need to think of Marx's corpus as a multiple source of hypotheses and interpretations about how capitalism works. And we need to recognize fully that no theoretical framework captures the whole of history or society. Marxism is not a comprehensive theory of social organization and change. But it does provide a useful set of hypotheses about how some of the key social mechanisms work in a class-divided society. Seen from that perspective, Marxist thought serves as a sort of proto-paradigm or mental framework in terms of which to pursue more specific social and historical investigations.
Another from Tim Duy:
Lumping Everything into the Wealth Effect, by Tim Duy: After posting my review of Martin Feldstein's WSJ op-ed, I waded through Dallas Federal Reserve President Richard Fisher's latest speech and found this:
The former outcome is that envisioned by the theoreticians that lead the Fed: According to this plot, by driving rates to historical lows along the entire length of the yield curve, investors will rebalance their portfolios and reach out to riskier assets, providing the financial wherewithal for businesses to increase capital expenditures and reengage workers, expand payrolls and regenerate consumption. Rising prices of bonds, stocks and other financial instruments will bolster consumer confidence. The CliffsNotes account of this play has the widely heralded “wealth effect” paving the way for economic expansion, thus saving the day.
The latter outcome posits that the wealth effect is limited, for two possible reasons. One is that our continued purchases of Treasuries are having decreasing effects on private borrowing costs, given how low long-term Treasury rates already are. Another is that the uncertainty resulting from fiscal tomfoolery is a serious obstacle to restoring full employment. Until job creators are properly incentivized by fiscal and regulatory policy to harness the cheap and abundant money we at the Fed have engineered, these funds will predominantly benefit those with the means to speculate, tilling the fields of finance for returns that are enabled by historically low rates but do not readily result in job expansion. Cheap capital inures to the benefit of the Warren Buffetts, who can discount lower hurdle rates to achieve their investors’ expectations, accumulating holdings without necessarily expanding employment or the wealth of the overall economy.
Is it just me, or is Fisher being explicitly derisive about the wealth effect? And when did we start lumping all the channels of monetary policy into the "wealth effect"? The wealth effect is but one channel of monetary policy. See something like this graphic from Frederick Mishkin's money and banking textbook:
While equity prices do operate through a number of channels, only one of those is the "wealth effect." To his credit, Fisher has a more sophisticated view of those channels than Feldstein, who appears to limit the impact of QE to the strict definition of the wealth effect:
That drives up the price of equities, leading to more consumer spending.
But even if Fisher does see the bigger picture, should he really be lumping together all the channels of monetary policy into the "wealth effect?" Doing so only feeds the bias against monetary easing by perpetuating the view it is about nothing more than creating an artificial boost of equity prices and benefiting speculators rather than stimulating the economy via a number of channels that subsequently enhance the profitability of firms and thus raises equity prices.
Of course, Fisher and Feldstein are deliberately trying to perpetuate a bias against quantitative easing. And even after all these years, I still find it odd that Fisher appears to believe his job is to undermine the institution that provides his employment.
This is from Sultan Mehmood. The article appears in the May edition of Defense and Peace Economics, which the author describes as "a highly specialized journal on conflict":
Terrorism and the Macroeconomy: Evidence from Pakistan, by Sultan Mehmood, Journal of Defense and Peace Economics, May 2013: Summary: The study evaluates the macroeconomic impact of terrorism in Pakistan by utilizing terrorism data for around 40 years. Standard time-series methodology allows us to distinguish between short and long run effects, and it also avoids the aggregation problems in cross-country studies. The study is also one of the few that focuses on evaluating impact of terrorism on a developing country. The results show that cumulatively terrorism has cost Pakistan around 33.02% of its real national income over the sample period.
Motivation: Studies on the impact of terrorism on the economy have exclusively focused on developed countries (see e.g. Eckstein and Tsiddon, 2004). This is surprising because developing countries are not only hardest hit by terrorism, but are more responsive to external shocks. Terrorism in Pakistan, with magnitude greater than Israel, Greece, Turkey, Spain and USA combined in terms of incidents and death count, has consistently hit news headlines across the world. Yet, terrorism in Pakistan has received relatively little academic attention.
The case of Pakistan is unique for studying the impact of terrorism on the economy for a number of reasons. Firstly, Pakistan has a long and intense history of terrorism which allows one to capture the effect on the economy in the long run. Secondly, growth retarding effects of terrorism are hypothesized to be more pronounced in developing rather than developed countries (Frey et al., 2007). Thirdly, the Pakistani economy is exceptionally vulnerable to external shocks with 12 IMF programmes during 1990-2007 (IMF, 2010, 2011). Lastly, the case study of terrorism for a developing or least developing country is yet to be done. Scholars of the Copenhagen Consensus studying terrorism note the ‘need for additional case studies, especially of developing countries’ (Enders and Sandler, 2006, p. 31). This research attempts to fill this void.
Main Results: The results of the econometric investigation suggest that terrorism has cost Pakistan around 33.02% of its real national income over the sample time period of 1973–2008, with the adverse impact mainly stemming from a fall in domestic investment and lost workers’ remittances from abroad. This averages to a per annum loss of around 1% of real GDP per capita growth. Moreover, estimates from a Vector Error Correction Model (VECM) show that terrorism impacts the economy primarily through medium- and long-run channels. The article also finds that the negative effect of terrorism lasts for at least two years for most of the macroeconomic variables studied, with the adverse effect on worker remittances, a hitherto ignored factor, lasting for five years. The results are robust to different lag length structures, policy variables, structural breaks and stability tests. Furthermore, it is shown that they are unlikely to be driven by omitted variables, or [Granger type] reverse causality.
Hence, the article finds evidence that terrorism, particularly in emerging economies, might pose significant macroeconomic costs to the economy.
I have had several responses to my offer to post write-ups of new research that I'll be posting over the next few days (thanks!), but I thought I'd start with a forthcoming paper from a former graduate student here at the University of Oregon, Eric Guass:
Robust Stability of Monetary Policy Rules under Adaptive Learning, by Eric Gaus, forthcoming, Southern Economics Journal: Adaptive learning has been used to assess the viability a variety of monetary policy rules. If agents using simple econometric forecasts "learn" the rational expectations solution of a theoretical model, then researchers conclude the monetary policy rule is a viable alternative. For example, Duffy and Xiao (2007) find that if monetary policy makers minimize a loss function of inflation, interest rates, and the output gap, then agents in a simple three equation model of the macroeconomy learn the rational expectations solution. On the other hand, Evans and Honkapohja (2009) demonstrates that this may not always be the case. The key difference between the two papers is an assumption over what information the agents of the model have access to. Duffy and Xiao (2007) assume that monetary policy makers have access to contemporaneous variables, that is, they adjust interest rates to current inflation and output. Evans and Honkapohja (2009) instead assume that agents only can form expectations of contemporaneous variables. Another difference between these two papers is that in Duffy and Xiao (2007) agents use all the past data they have access to, whereas in Evans and Honkapohja (2009) agents use a fixed window of data.
This paper examines several different monetary policy rules under a learning mechanism that changes how much data agents are using. It turns out that as long as the monetary policy makers are able to see contemporaneous endogenous variables (output and inflation) then the Duffy and Xiao (2007) results hold. However, if agents and policy makers use expectations of current variables then many of the policy rules are not "robustly stable" in the terminology of Evans and Honkapohja (2009).
A final result in the paper is that the switching learning mechanism can create unpredictable temporary deviations from rational expectations. This is a rather starting result since the source of the deviations is completely endogenous. The deviations appear in a model where there are no structural breaks or multiple equilibria or even an intention of generating such deviations. This result suggests that policymakers should be concerned with the potential that expectations, and expectations alone, can create exotic behavior that temporarily strays from the REE.
Michael Kinsley tries to take on Paul Krugman, but ends up showing he really doesn't know what he is talking about. For details, see:
I suppose Kinsley is just trying to do his cute contrarian thing, and show his flair as a writer, but this kind of crap does real harm. If we are going to mock people, it ought to be the people who embraced the false ideas Krugman is addressing all the while ignoring the plight of the unemployed. To me, the way so many turned their backs on the unemployed is unforgiveable and it's puzzling why Kinsley would contribute to it through this sort of false equivalency. The unemployment problem isn't even mentioned in his article, though he does say:
I don’t think suffering is good, but I do believe that we have to pay a price for past sins, and the longer we put it off, the higher the price will be.
Actually, solving problems today, e.g. increasing employment so that fewer people exit the labor force permanently, lowers the long-run price. In any case, who's this "we" he's talking about? Has he or any of his VSP buddies suffered as much as the long-term unemployed, some of whom may never find a job again? If we were to say you and your VSP friends need to "suffer" higher taxes in the future so we can help the unemployed today (suffer is, of course, hardly the right word to use for increasing taxes on high income households), would he be on board, or we he confound it with nonsense like he wrote in his latest article?
Tim Duy:
Dodged That Bullet, by Tim Duy: I was reading Robin Harding's take on the possible nomination of Federal Reserve Vice Chair Janet Yellen for the top job at the Fed, and a chill went down my spine when he reminded me of this:
Mr Bernanke’s own appointment in 2005 was a case in point. There were several candidates that year. According to people involved, then-President George W. Bush leaned towards Martin Feldstein, a former economic adviser to Ronald Reagan.
But fate intervened:
But Mr Feldstein was a director of the insurance company AIG, which restated five years of financial results that May after an accounting scandal. Then in October, Mr Bush ran into a huge backlash after nominating his lawyer Harriet Miers, who later withdrew, to the Supreme Court.
I think we dodged a bullet there. Indeed, it might be proof of a higher power. Martin Feldstein could have been Fed chair during the worst financial crisis since the Great Depression. Consider that in light of May 9, 2013 Wall Street Journal op-ed in which he professes that raising equity prices is the ONLY mechanism by which quantitative easing impacts the economy:
Quantitative easing, or what the Fed prefers to call long-term asset purchases, is supposed to stimulate the economy by increasing share prices, leading to higher household wealth and therefore to increased consumer spending. Fed Chairman Ben Bernanke has described this as the "portfolio-balance" effect of the Fed's purchase of long-term government securities instead of the traditional open-market operations that were restricted to buying and selling short-term government obligations.
Here's how it is supposed to work. When the Fed buys long-term government bonds and mortgage-backed securities, private investors are no longer able to buy those long-term assets. Investors who want long-term securities therefore have to buy equities. That drives up the price of equities, leading to more consumer spending.As might be expected, Feldstein finds this channel lacking:
...Although it is impossible to know what would happen without the central bank's asset purchases, the data imply that very little increase in GDP can be attributed to the so-called portfolio-balance effect of the Fed's actions.
Even if all of the rise in the value of household equities since quantitative easing began could be attributed to the Fed policy, the implied increase in consumer spending would be quite small. According to the Federal Reserve's Flow of Funds data, the total value of household stocks and mutual funds rose by $3.6 trillion between the end of 2009 and the end of 2012. Since past experience implies that each dollar of increased wealth raises consumer spending by about four cents, the $3.6 trillion rise in the value of equities would raise the level of consumer spending by about $144 billion over three years, equivalent to an annual increase of $48 billion or 0.3% of nominal GDP.
This 0.3% overstates the potential contribution of quantitative easing to the annual growth of GDP, since some of the increase in the value of household equities resulted from new saving and the resulting portfolio investment rather than from the rise in share prices. More important, the rise in equity prices also reflected a general increase in earnings per share and an increase in investor confidence after 2009 that the economy would not slide back into recession.
Oh my. Can Feldstein really believe that only the wealth effect channel is in operation? What about other channels that could boost activity and drive the improvements in earnings and confidence? And does Bernanke believe quantitative easing has an impact only throughthe wealth effect? I don't think that is the conclusion you reach if you read his speeches. Bernanke's description of the portfolio-balance impact is a bit more sophisticated than Feldstein's interpretation. From last year's Jackson Hole speech:
One mechanism through which such purchases are believed to affect the economy is the so-called portfolio balance channel, which is based on the ideas of a number of well-known monetary economists, including James Tobin, Milton Friedman, Franco Modigliani, Karl Brunner, and Allan Meltzer. The key premise underlying this channel is that, for a variety of reasons, different classes of financial assets are not perfect substitutes in investors' portfolios....Thus, Federal Reserve purchases of mortgage-backed securities (MBS), for example, should raise the prices and lower the yields of those securities; moreover, as investors rebalance their portfolios by replacing the MBS sold to the Federal Reserve with other assets, the prices of the assets they buy should rise and their yields decline as well. Declining yields and rising asset prices ease overall financial conditions and stimulate economic activity through channels similar to those for conventional monetary policy.
Quantitative easing acts through a variety of channels - interest rate, credit, exchange rate, etc. - just like traditional interest rate policy. And other channels as well:
Large-scale asset purchases can influence financial conditions and the broader economy through other channels as well. For instance, they can signal that the central bank intends to pursue a persistently more accommodative policy stance than previously thought, thereby lowering investors' expectations for the future path of the federal funds rate and putting additional downward pressure on long-term interest rates, particularly in real terms. Such signaling can also increase household and business confidence by helping to diminish concerns about "tail" risks such as deflation. During stressful periods, asset purchases may also improve the functioning of financial markets, thereby easing credit conditions in some sectors.
So, no, Bernanke does not view quantitative easing as acting only through equity price and related wealth effects, and no, Feldstein shouldn't either. But somehow he does, or wants to trick you into believing that Bernanke's only objective is boosting equity prices. Either way, I don't think this is the intellectual approach we should be looking for in a Fed chair.
With regards to Feldstein's claim that it is impossible to know what would have happened in the absence of quantitative easing, I think Bernanke would have something like this to say:
If we are willing to take as a working assumption that the effects of easier financial conditions on the economy are similar to those observed historically, then econometric models can be used to estimate the effects of LSAPs on the economy. Model simulations conducted at the Federal Reserve generally find that the securities purchase programs have provided significant help for the economy. For example, a study using the Board's FRB/US model of the economy found that, as of 2012, the first two rounds of LSAPs may have raised the level of output by almost 3 percent and increased private payroll employment by more than 2 million jobs, relative to what otherwise would have occurred....Overall, however, a balanced reading of the evidence supports the conclusion that central bank securities purchases have provided meaningful support to the economic recovery while mitigating deflationary risks.
Yes, like it or not, quantitative easing has been a successful policy.
I understand that in the midst of the crisis there was a significant confusion about what monetary policymakers were doing and why. But we are well past that stage. We would hope that any potential Fed chair would by now have come to an understanding about what quantitative easing is and how it works. And we should be relieved that any candidate that has not made that leap did not get the pick for the top job at the Federal Reserve.
Paul Krugman on the recent news that the deficit is falling:
About That Debt Crisis? Never Mind, by Paul Krugman: OK, another toe dipped in reality. The new CBO numbers are out, and they scream “debt crisis? What debt crisis?” ...
Yes, debt rose substantially in the face of economic crisis — which is what is supposed to happen. But runaway deficits? Not a hint.
Yes, there are longer-term issues of health costs and demographics. As always, however, these have no relevance to what we should be doing now...
Meanwhile, our policy discourse has been dominated for years by what turns out to be a false alarm. To the millions of Americans who are out of work and may never get another job thanks to premature fiscal austerity, the VSPs would like to say, “oopsies!”
Or maybe not even that. ...
It's a good scam if your goal is to reduce the size and influence of government: implement spending cuts that slow the economy, never mind the unemployed, then call loudly for tax cuts and deregulation to spur economic growth. Repeat as needed.
The previous post reminds me of an offer I've been meaning to make to try to help to publicize academic research:
If you have a paper that is about to be published in an economics journal (or was recently published), send me a summary of the research explaining the findings, the significance of the work, etc. and I'd be happy to post the write-up here. It can be micro, macro, econometrics, any topic at all, but hoping for something that goes beyond a mere echo of the abstract and I want to avoid research not yet accepted for publication (so I don't have to make a judgment on the quality of the research -- I don't always have the time to read papers carefully, and they may not be in my area of expertise).
New and contrary results on the wealth effect for housing:
Homeowners do not increase consumption despite their property rising in value, EurekAlert: Although the value of our property might rise, we do not increase our consumption. This is the conclusion by economists from University of Copenhagen and University of Oxford in new research which is contrary to the widely believed assumption amongst economists that if there occurs a rise in house prices then a natural rise in consumption will follow. The results of the study is published in The Economic Journal.
"We argue that leading economists should not wholly be focused on monitoring the housing market. Economists are closely watching the developments on the housing market with the expectation that house prices and household consumption tend to move in tandem, but this is not necessarily the case," says Professor of Economics at University of Copenhagen, Søren Leth-Petersen.
Søren Leth-Petersen has, alongside Professor Martin Browning from University of Oxford and Associate Professor Mette Gørtz from University of Copenhagen, tested this widespread assumption of 'wealth effect' and concluded that the theory has no significant effect.
Søren Leth-Petersen explains that when economists use the theory of 'wealth effect' the presumption is that older homeowners will adjust their consumption the most when house prices change whilst younger homeowners will adjust their consumption the least. However, according to this research, most homeowners do not feel richer in line with the rise of housing wealth.
"Our research shows that homeowners aged 45 and over, do not increase their consumption significantly when the value of their property goes up, and this goes against the theory of 'wealth effect'. Thus, we are able to reject the theory as the connecting link between rising house prices and increased consumption," explains Søren Leth-Petersen. ...
The research shows that homeowners aged 45 and over did not react significantly to the rise in house prices. However, the younger homeowners, who are typically short of finances, took the opportunity to take out additional consumption loans when given the chance. ...
Basit Zafar, Max Livingston, and Wilbert van der Klaauw examine the impact of the payroll tax cut in 2011 and 2012, and its subsequent reversal:
My Two (Per)cents: How Are American Workers Dealing with the Payroll Tax Hike?, by Basit Zafar, Max Livingston, and Wilbert van der Klaauw, Liberty Street Economics, NY Fed: The payroll tax cut, which was in place during all of 2011 and 2012, reduced Social Security and Medicare taxes withheld from workers’ paychecks by 2 percent. This tax cut affected nearly 155 million workers in the United States, and put an additional $1,000 a year in the pocket of an average household earning $50,000. As part of the “fiscal cliff” negotiations, Congress allowed the 2011-12 payroll tax cut to expire at the end of 2012, and the higher income that workers had grown accustomed to was gone. In this post, we explore the implications of the payroll tax increase for U.S. workers.
The impact of such a tax hike depends on two factors. One, how did U.S. workers use the extra funds in their paychecks over the last two years? And two, how do workers plan to respond to shrinking paychecks? With regard to the first factor, in a recent working paper and an earlier blog post, we present survey evidence showing that the tax cut significantly boosted consumer spending, with workers reporting that they spent an average of 36 percent of the additional funds from the tax cut. This spending rate is at the higher end of the estimates of how much people have spent out of other tax cuts over the last decade, and is arguably a consequence of how the tax cut was designed—with disaggregated additions to workers’ paychecks instead of a one-time lump-sum transfer. We also found that workers used nearly 40 percent of the tax cut funds to pay down debt.
To understand how the tax increase is affecting U.S. consumers, we conducted an online survey in February 2013. We surveyed 370 individuals through the RAND Corporation’s American Life Panel, 305 of whom were working at the time and had also worked at least part of 2012. ...
After a presentation of the survey results, and a discussion of what they mean, the authors conclude:
Overall, our analysis suggests that the payroll tax cut during 2011-12 led to a substantial increase in consumer spending and facilitated the consumer deleveraging process. Based on consumers’ responses to our recent survey, expiration of the tax cuts is likely to lead to a substantial reduction in spending as well as contribute to a slowdown or possibly a reversal in the paydown of consumer debt. These effects are also likely to be heterogeneous, with groups that are more credit and liquidity constrained more likely to be adversely affected. Such nuances may be lost in the aggregate macroeconomic statistics, but they’re important for policymakers to consider as they debate fiscal policy.
In response to arguments that tax cuts wouldn't help because they would be mostly saved, I have argued that there are two ways that tax cuts can help (see Why I Changed My Mind about Tax Cuts). One is to increase spending, and the other is to help households restore household balance sheets that were demolished in the downturn (i.e. the cure for a "balance sheet recession"). The sooner this "deleveraging process" is complete, the sooner the return to normal levels of consumption and the faster the exit from the recession (rebuilding household balance sheets takes a long time and this is one of the reasons the recovery from this type of recession is so slow, tax cuts that are used to reduce debt can help this prcess along). It looks like both effects are present for payroll tax changes (and work in the wrong way with a payroll tax increase).
Jon Chait notes some bad news for deficit hawks and opponents of Obamacare:
Give Back that Pulitzer, Wall Street Journal Editorial Page: The recent slowdown in health-care costs is one of those facts, like climate change or the rapid growth after Bill Clinton raised taxes, that flummoxes American conservatism. The slowdown of health-care costs is one of the most important developments in American politics. The long-term deficit crisis — those scary charts Paul Ryan likes to hold up, with federal spending soaring to absurd levels in a grim socialist dystopian future — all assume the cost of health care will continue to rise faster than the cost of other things. If that changes, the entire premise of the American debate changes. And there’s a lot of evidence to suggest it is changing — health-care costs have slowed dramatically, and experts believe it’s happening for non-temporary reasons.
The general conservative response to date has involved ignoring the trend, or perhaps dismissing it as a temporary, recession-induced dip... Yesterday, the Wall Street Journal editorial page offered up what may be the new conservative fallback position: Okay, health-care costs are slowing down, but it has absolutely nothing to do with the huge new health-care reform law. “It increasingly looks as if ObamaCare passed amid a national correction in the health markets,” the Journal now asserts, “that no one in Congress or the White House understood.” It’s another one of those huge, crazy coincidences!
Of course, it’s not just that the Journal didn’t predict the health-care cost slowdown. The Journal insisted ... that Obamacare would ... necessarily lead to a massive increase in health-care inflation. In a series of hysterical, freedom-at-dusk editorials which were, unbelievably, awarded a Pulitzer Prize for commentary, the Journal expounded extensively on this belief. ...
The ... fact that the right is being forced to fall back from predicting a staggering rise in health-care costs to explaining away the staggering decline in health-care costs represents real progress...
More bad news for deficit hawks from the CBO. Ezra Klein explains:
CBO says deficit problem is solved for the next 10 years: ...according to the Congressional Budget Office, the debt disaster that has obsessed the political class for the last three years is pretty much solved, at least for the next 10 years or so.
The last time the CBO estimated our future deficits was February– just four short months ago. Back then, the CBO thought deficits were falling and health-care costs were slowing. Today, the CBO thinks deficits are falling even faster and health-care costs are slowing by even more.
Here’s the short version: Washington’s most powerful budget nerds have cut their prediction for 2013 deficits by more than $200 billion. They’ve cut their projections for our deficits over the next decade by more than $600 billion. Add it all up and our 10-year deficits are looking downright manageable. ...
Tim Duy:
Plosser on the Exit, by Tim Duy: As is well known, policymakers have been coalescing around a QE exit strategy for some time, since at least the March FOMC meeting. Two central issues with the exit are the timing and the communications. Officials do not want to undermine the recovery, knowing full-well that previous flirtations with exits have gone awry. At the same time, however, they fear the cost-benefit analysis may be turning against them. For some doves it is not the potential inflation cost, but the potential financial instability cost. Some policymakers want to begin tapering asset purchases at the next meeting, some are looking to the summer, and others looking to the fall.
Regarding the communications issue, policymakers seem to be taking pains to make clear that the financial markets should not overreact to any one policy move. The tapering process may be smooth, it may be choppy, it may be long, it may be short. It is contingent on the state of the economy, something inherently unknown. Mostly, they want to avoid a 1994-type of miscommunication.
Today's speech by Philadelphia Federal Reserve President Charles Plosser covers nearly all of these elements. In general, although I do not agree with his conclusions regarding timing, I think he makes a what would be viewed by some as a credible argument for tapering to begin sooner than later.
Begin with his base forecast:
My forecast of 3 percent growth should allow for continued improvements in labor market conditions, including a gradual decline in the unemployment rate, similar to the trend we have seen over the past three years, which was a 0.7- to 0.8-percentage point decline per year. Continuing at such a pace would lead to an unemployment rate close to 7 percent at the end of 2013 and a rate below 6.5 percent by the end of 2014.
Indeed, this year we have already seen the unemployment rate fall from 7.9 percent in January to 7.5 percent in April. Employers added 165,000 jobs in April, but the more positive news came in the revisions for February and March. The revised data indicate that firms added 332,000 jobs in February and 138,000 in March. The upward revisions for these two months added 114,000 jobs.
The forecast of a 6.5% unemployment rate by the end of 2014 is important. My thought is that the Fed will want to conclude asset purchases before hitting that target. Moreover, optimally they would like time so that, if necessary, the tapering can be a slow process. That argues for tapering to begin sooner than later. Indeed, Plosser would like asset purchases to end this year:
Based on the stated views of the Committee regarding the flexibility in pace of purchases, I believe that labor market conditions warrant scaling back the pace of purchases as soon as our next meeting. Moreover, unless we see a significant reversal in current trends that jeopardizes my forecast of near 7 percent unemployment rate by the end of this year, then I anticipate that we could end the program before year-end. Let's look at some of the data.
The end of the year is actually fast approaching; if you want to taper off over the course of a hand full of meetings, the calendar is driving you to begin now. Now, back to that data:
In the six months through September 2012, when the decision to initiate the latest open-ended asset purchase program was made, nonfarm payrolls had increased an average of 130,000 per month, and the unemployment rate had averaged 8.1 percent. In the most recent six months, from November 2012 through April 2013, nonfarm payrolls have increased on average 208,000 per month — a 60 percent increase — and the unemployment rate has averaged 7.7 percent. As I noted earlier, April's unemployment rate has now reached 7.5 percent.
Moreover, the average duration of unemployment has fallen, the share of long-term unemployment has dropped, and hours worked and earnings have risen. While further progress would certainly be desirable, I believe the evidence is consistent with a significantly improving labor market. Thus, it is appropriate to begin scaling back the pace of asset purchases.
At this point, I raise my hand and say "But isn't underemployment still too high and being driven by cyclical factors? Aren't you erring on the side of removing stimulus too early?" But that arguement is neither here nor there for Plosser. He has obviously decided these are second-order issues. He does deliver what (I think) is a novel argument for tapering sooner than later:
Indeed, in my view, were the FOMC to refrain from reducing the pace of its purchases in the face of this evidence of improving labor market conditions, it would undermine the credibility of the Committee's statement that the pace of purchases will respond to economic conditions. Similarly, if there were sufficient evidence that conditions in labor markets had deteriorated, I would expect the FOMC to consider increasing the pace of purchases. After all, this is the meaning of state-contingent monetary policymaking. But if we reach the point that markets only expect us to move in one direction — that is, toward more easing — and we become reluctant to dial back on purchases over concerns of disappointing or surprising markets, then we will find ourselves in a very difficult position going forward.
In short, the Fed communicated a particular strategy - one in which the pace of asset purchases would be determined by recovery in the labor market. And, by Plosser's reckoning, the 60% increase in the pace of job growth is evidence of exactly the kind of improvement the Fed was looking to achieve.
Notice that Plosser is not appealing to a fear that the Fed's credibility on inflation is at risk. Instead, not acting to slow asset purchases undermines the credibility of the Fed's communications strategy. This is an argument that might resonate with other policymakers who are already worried that financial markets will misinterpret future policy actions. I suspect Plosser knows inflation concerns are likely to fall on deaf ears. Indeed, he addresses the inflation topic earlier in the speech:
Should inflation expectations begin to fall, we might need to take action to defend our inflation goal, but at this point, I do not see inflation or deflation as a serious threat in the near term. However, I do believe that our extraordinary level of monetary accommodation will have to be scaled back, perhaps more aggressively than some think, to ensure that inflation over the medium term remains consistent with our target.
Convincing others to pull back on easing due to inflation concerns is something of a challenge when your preferred inflation measure is below target and trending down. But where that argument fails, perhaps a credibility/communications argument can succeed?
Plosser is careful to add the now required "not tightening" clause:
I want to emphasize that in this state-contingent framework, reducing the pace or even ending asset purchases need not be the start of an exit strategy or more aggressive tightening. Nor would it indicate that an increase in the policy rate was imminent. Instead, these actions would slow and then halt efforts to continuously expand the level of accommodation by increasing the size of the balance sheet. Given the improving economy, dialing back asset purchases is an appropriate response.
I imagine we will see something like this in every speech going forward. Policymakers do not want market participants to jump to conclusions on the basis of any one policy move.
Bottom Line: While the Fed is moving closer to tapering asset purchases, timing remains an issue. I think that most policymakers will not be swayed to an early end by the "Fed's inflation credibility is at risk" argument. But a subset is likely swayed by the "financial stability is at risk" argument. And another subset may be swayed by the "communications credibility is at risk argument" that is an element of Plosser's speech. In short, the majority favoring continuing asset purchases at the current pace is obviously shrinking. Hopefully this week's upcoming speech by Federal Reserve Chairman Ben Bernanke and the release of the minutes from the last FOMC meeting will help clarify how quickly that majority is loosing ground.
Jared Bernstein:
Why Should Any Of These Groups Have Tax-Exempt Status?: Nope, I’m not going to defend the IRS, which appears to have acted in ways wholly inconsistent with their mandate for unbiased investigations into, in this case, whether certain political groups should receive tax-exempt status. It is unclear how high up the chain of command these untoward actions went, but this morning’s news suggests it wasn’t just a few rogue auditors in Cincinnati. ...
Republicans will of course try to pin this on the President, despite the fact that since Nixon used the IRS to target his enemies, the president’s been barred from even discussing this kind of thing with the agency.
No, the problem here isn’t the president. It’s the Supreme Court’s Citizen United decision and subsequent tax law written by Congress that gives these groups tax exempt status (under rule 501(c)(4)) as long as most of their activities are primarily on educating the public about policy issues, not direct campaigning.
Of course, the ambiguities therein are insurmountable. Many of these groups, especially the big ones, spend millions on campaign ads mildly disguised as “issue ads,” and under current law they can do so limitlessly and with impunity. ...
Weirdly, the IRS hasn’t seemed particularly interested in going after the big fish here, like Rove’s Crossroads GPS on the right or Priorities USA on the left. Instead, they appear to have systematically targeted small fry on the far right. If so, not only is that clearly biased and unacceptable—it’s also ridiculous given the magnitude of the violations of tax exempt status by these small groups relative to the big ones.
At the end of the day, we should really ask ourselves what societal purpose is being served here by carving out special tax status for any of these groups. If anyone can show me any evidence that the revenue forgone is well spent, that these groups are making our political system and our country better off, please do so. If not, then no one’s saying shut them down—they’ve got a right to speak their minds. But not tax free.
Steven Pearlstein argues that The case for austerity isn’t dead yet, and that:
austerity by itself won’t solve the problem of high employment and low growth in developed economies. But neither will fiscal stimulus by itself. Neither will work unless incorporated into a program of serious and credible structural reform.
But this is incorrect, and it confuses long-run growth policy with short-run stabilization. Monetary and fiscal policy can be used to stabilize fluctuations in the economy even without reforms that could raise long-run growth (the short-run stabilization policies may help with long-run growth, e.g. by improving labor market conditions and preventing people from permanently leaving the labor force, so the policies are not fully independent, but it's important to keep them conceptually separate). As Antonio Fatás points out in a post that anticipates and counters this argument (this was written before Pearlstein's piece), the idea that monetary and fiscal policy cannot work to stabilize the economy without structural reform is wrong (especially in countries like the US):
Time travel in Euroland: Unfortunately, this is not news by now, but the president of the Euro group, Jeroen Dijsselbloem in an interview with CNBC yesterday dismissed the role that fiscal policy and monetary policy can have to address the economic crisis (emphasis is mine):
"Monetary policy can really not help us out of the crisis. It can take away the pressure, it can accommodate new growth, but what we really need in all countries is structural reforms in the first place. I'd just like to stress the point that in the policy mix of fiscal policy, monetary policy and structural reforms — I'd like the order to be exactly the other way around. Structural reforms in the first place, fiscal policy and viable targets in the mid-term for all regions in second place — and monetary policy can only accommodate domestic economic problems in the short-term."
It is not exactly clear what to make out of his statement but it seems that long-term solutions should come first before we implement those that will help us in the short term. It is surprising that even today there is such a great confusion about long-term versus cyclical problems.
This confusion comes from a basic belief that some hold that there is nothing inherently different in the dynamics of an economy when one looks at the short run and the long run. This is part of a never-ending academic debate but when it comes to policy makers and politicians it seems to be more a matter of beliefs.
What it is not always understood is that we are dealing with two separate problems and therefore we need two different set of tools or solutions to deal with them.
It is possible that irresponsible behavior, excessive spending and accumulation of debt (private or public) are the cause of the Great Recession. And if this is true, it will require future adjustments to spending plans, deleveraging, and fiscal discipline to avoid a repetition of this event in the future.
But once the crisis started we are dealing with a second problem: a recession that moves us away from full employment. This is a cyclical phenomenon that is well described in macroeconomic textbooks and to deal with it we use monetary and fiscal policy. The fact that potentially debt and excessive spending were the cause of this cyclical event does not mean that we need to deal with these imbalances now to get out of the crisis. We are dealing with two separate phenomena that are only related because one possibly led to the second one, but the dynamics associated with each of them are very different and the recipe to get out of them can be, in some cases, the opposite.
This is what we write in all macroeconomics textbooks: what works in the short run might not work in the long run. As an example, we emphasize the importance of saving in the long run to drive investment and growth. But when we talk about the short run we emphasize the importance of spending to understand fluctuations in economic activity. Excessive spending hurts growth in the long run but it is spending and demand what drives growth in the short run.
There will be a day when we will have to debate about whether the cyclical phenomenon has already been addressed because we are back to full employment and therefore all our focus should be on the long term, but it is very hard to argue that this is where Europe is today. My point is not to deny that there are many deep structural issues to be addressed among Euro countries, but to recognize that we are dealing with two set of dynamics that require different solutions and until we invent time traveling the short term still comes before the long term.
Tim Duy once again:
What Does Japan Mean For The Rest of the World?, by Tim Duy: Is Abenomics about boosting exports or domestic demand? I tend to agree with Lars Christensen on this issue:
There has been a lot of focus on the fact that USD/JPY has now broken above 100 and that the slide in the yen is going to have a positive impact on Japanese exports. In fact it seems like most commentators and economists think that the easing of monetary policy we have seen in Japan is about the exchange rate and the impact on Japanese “competitiveness”. I think this focus is completely wrong.
While I strongly believe that the policies being undertaken by the Bank of Japan at the moment is likely to significantly boost Japanese nominal GDP growth – and likely also real GDP in the near-term – I doubt that the main contribution to growth will come from exports. Instead I believe that we are likely to see is a boost to domestic demand and that will be the main driver of growth. Yes, we are likely to see an improvement in Japanese export growth, but it is not really the most important channel for how monetary easing works.
In my view, Abenomics has been remarkably centered on the domestic economy. The impact on the Yen is almost an afterthought, whereas in the past policymakers would have turned to intervention to directly support the economy. This looks like policymakers finally realized that such a policy approach wasn't working and they need to change gears to a frontal-assault on domestic policy levers.
That said, a side-effect of Abenomics is currency depreciation, and this will have an impact on global trade. Investment Week has an interview with hedge fund manager Hugh Hendry:
"Japan's monetary pivot towards QE will not create economic growth out of nothing. Instead it seeks to redistribute global GDP in a manner that favours Japan versus the rest of the world. This is the last thing the global economy needs right now," he said.
So what's right and what's wrong with that quote? What's right is that there will be a trade impact. A story floating around right now is that Japanese exporters are not changing prices, but instead just allowing the impact of the weaker Yen to fall straight through to the bottom line. But they will soon turn their attention to leveraging the weaker Yen to cut prices and take market share. And they have Europe in their sights. They might not be able to compete with Chinese exporters, but they can with German ones.
What's wrong, however, is that this is exactly what the global economy needs right now. If Germany and by extension Europe experiences weaker growth, European policymakers will need to respond. And they are not likely to respond by buying Yen to hold its value up. They are likely to respond by stimulating their domestic economy directly via easier monetary policy and, hopefully, easier fiscal policy.
In other words, successful domestically-orientated policy in Japan will have second-round effects that will induce further policy easing Europe. And a good kick in the pants in Europe is exactly what we need right now. Rather than thinking about Japan's policy as triggering "competitive devaluations," think of it as triggering "coordinated global easing."
What's also wrong is Hendry's usual hedge-fund bias again monetary policy. By altering expectations to lower real interest rates, Japan's monetary policy is in a sense creating economic growth out of nothing. We frequently heard that "uncertainty" was holding back the recovery, but isn't this the same thing as creating a recession out of nothing? If you can create a recession out of nothing, then why not an expansion?
This is related to the recent post from Gavyn Davies. Recall that he is worried about the unemployment rate giving misleading signals about the labor market. Many workers have dropped out of the labor force, and if those workers return to the labor force as the economy improves, then the measured unemployment rate will make conditions in the labor market look better than they actually are.
In this Economic Letter from the SF Fed, Leila Bengali, Mary Daly, and Rob Valletta argue that this is, in fact, something to worry about. They "find evidence, reinforcing other research, that the recent decline in participation likely has a substantial cyclical component" (i.e. their analysis concludes that exit from the labor market is temporary for a substantial number of people, and they will begin seeking work again when the economy improves):
Will Labor Force Participation Bounce Back?, by Leila Bengali, Mary Daly, and Rob Valletta, Economic Letter, FRBSF: The most recent U.S. recession and recovery have been accompanied by a sharp decline in the labor force participation rate. The largest declines have occurred in states with the largest job losses. This suggests that some of the recent drop in the national labor force participation rate could be cyclical. Past recoveries show evidence of a similar cyclical relationship between changes in employment and participation, which could portend a moderation or reversal of the participation decline as the current recovery continues.
Since the beginning of the recession in 2007, the U.S. labor force participation rate has dropped sharply. Some of this decline reflects long-term demographic trends and other factors that helped push down the participation rate before 2007. But the recent withdrawal of prime-age workers from the labor market is unprecedented and may reflect a cyclical component that could reverse as the labor market recovery solidifies. The return of these workers to the labor force would partially offset the longer-term demographic influences and potentially cause the participation rate to bounce back (Daly et al. 2012, Van Zandweghe 2012). Moreover, the increase in the number of active jobseekers in the labor force associated with higher participation could slow the decline in the unemployment rate.
Assessing the contribution of cyclical factors and the likelihood of a reversal or slower decline in labor force participation is difficult based on aggregate labor market data alone. Such data cannot perfectly distinguish between long-term trends and shorter-term cyclical factors, particularly given the severity of the labor market dislocation during the past recession. To assess the role of cyclical factors in the current recovery, we examine state-level variation in the relationship between changes in the labor force participation rate and changes in employment over several business cycles. ...
After a detailed analysis, they conclude that:
The U.S. labor force participation rate has declined sharply since 2007, intensifying a downward trend that has been evident since about 2000. Distinguishing between long-term influences on the participation rate, such as demographics, and short-term cyclical effects is important because it helps us understand and predict the future path of macroeconomic variables such as the unemployment rate. Using state-level evidence on the relationship between changes in employment and labor force participation across recessions and recoveries, we find evidence, reinforcing other research, that the recent decline in participation likely has a substantial cyclical component. States that saw larger declines in employment generally saw larger declines in participation. A similar positive relationship was evident in past recessions and recoveries. In the current recovery, it will probably take a few years before cyclical components put significant upward pressure on the participation rate because payroll employment is still well below its pre-recession peak.
Let me add, once again, that the costs of being wrong are not symmetric. If we are going to make a policy mistake, the bias ought to be toward keeping policy in place too long (and perhaps enduring a temporary bout of inflation) rather than putting the brakes on too quick (and ending up with an elevated unemployment rate and all of the short-run and long-run consequences that come with it).
One more from Tim Duy:
Implications of Fed Tightening for Equities, by Tim Duy: Thinking further about this from Friday's Jon Hilsenrath Wall Street Journal article:
Stocks and bond markets have taken off since the Fed announced in September that it would ramp up the bond-buying program, and major indexes closed at another record Friday. An abrupt or surprising end to it could send stocks and bonds in the other direction, but a delayed end could allow markets to overheat. And some officials feel they've ended other programs too soon and don't want to repeat the mistake.
Although past performance is no guarantee of future performance, it strikes me that previous instances of tighter monetary policy did not trigger immediate widespread declines in equities:
Just an eyeball look at past behavior suggests that equities are mostly flat in the initial stages of monetary tightening, and rise in later stages. Generally at least two years before the Fed inverts the yield curve and triggers recession. In addition, we are not expecting the Fed to begin raising rates until late 2014 or 2015. So policy is likely to remain supportive for what, at least three or four more years?
Fears of an imminent policy-driven collapse in equity prices are likely greatly over-exaggerated. See also Mark Dow here.
Tim Duy:
Fed Notes, by Tim Duy: Gavyn Davies at the Financial Times questions the Federal Reserve's employment target:
On the wider issue of general monetary policy, the behaviour of inflation and unemployment remain the key drivers, and here the Fed has a headache. Its forward guidance on unemployment is in danger of giving misleading signals about the need for tightening, and it probably needs to be changed.
I agree. Davies cites research indicating that recession-driven underemployment makes the unemployment rate a poor measure of resource utilization. The policy implications:
What does this imply for policy? It implies that the Fed will have a bias to keep policy aggressively easy long after the unemployment rate has fallen below 6.5 per cent, and even after it has fallen below the estimated natural rate of 5.25 to 6 per cent, provided that the inflation threshold is still intact. This is because the reserve army of disguised unemployed people will exert a downward force on inflation which will not be correctly picked up by the official unemployment statistics.
See my related piece on structural (or lack thereof) unemployment here. Davies raises a often-forgotten point: Even though the Federal Reserve is turning its attention to ending quantitative easing, the timing of the first rate hike is most likely much farther off in the future.
A challenge for the Fed is that asset purchases are at least in part a communications device that signals commitment to a given policy path. Thus, the Federal Reserve will need to take care to avoid the impression of imminent rate hikes as they scale back asset purchases. Indeed, I thought this was the most important takeaway from Friday's Jon Hilsenrath article in the Wall Street Journal:
Officials are focusing on clarifying the strategy so markets don't overreact about their next moves.
Overreaction can come in many forms:
For example, officials want to avoid creating expectations that their retreat will be a steady, uniform process like their approach from 2003 to 2006, when they raised short-term interest rates in a series of quarter-percentage-point increments over 17 straight policy meetings...An abrupt or surprising end to it could send stocks and bonds in the other direction, but a delayed end could allow markets to overheat. And some officials feel they've ended other programs too soon and don't want to repeat the mistake.
This sounds as if Fed officials are cognizant of this from Davies:
The more precise the forward guidance given, the more the Fed exaggerates the degree of knowledge which the central bank can possibly have about its own future actions, since these actions will depend on many factors which cannot be exactly predicted in advance.
Which also speaks to the inclusion of "increase or decrease" phrase in the last FOMC minutes. Back to Hilsenrath:
The Fed said in its postmeeting statement that it was "prepared to increase or reduce the pace of its purchases" as the economic outlook evolved.
The suggestion that the Fed might boost its bond buying was a change in the policy statement that seemed to some an acknowledgment that more aid for the economy might be needed...
...But many officials believe the recovery is on track and aren't yet concerned about the inflation slowdown. Instead, the most recent statement seems more aimed at signaling the Fed's broader flexibility in managing the programs.
Bottom Line: We need to be very careful in extrapolating the implications of the next policy move to future policy moves. The Fed has only a general strategy for exit, but policymakers lack enough certainty about the future to determine the exact nature of that exit. Still, even given that uncertainty, the current state of labor force utilization and inflation suggest that while the end of QE may occur this year, the first rate hike is not likely until some point well into the future.
Some of the RSS feeds in the sidebar stopped working for mysterious reasons (DeLong, Krugman, Econbrowser, Calculated Risk, Free Exchange, Environmental Economics, and a few more) -- I didn't change a thing -- and several of you have emailed/left comments wondering what happened.
United decided to delay yet another flight (grrr!!!), and it gave me some unexpected time so I fixed them. For now anyway. Let me know if the feedes stop working again.
(TypePad has a limit on how many RSS feeds you can have in the sidebar, but I found a way around it -- that may be the problem, don't know.)
Gavyn Davies argues the Fed is targeting the wrong thing (unemployment instead of employment):
...the Fed has a headache. Its forward guidance on unemployment is in danger of giving misleading signals about the need for tightening, and it probably needs to be changed. ...
The difficulty is that unemployment is declining towards the announced threshold in part because large numbers of people have left the labour force altogether as the recession has dragged on, and this probably means that the official unemployment rate is no longer acting as a consistent measuring rod for the amount of slack in the labour market.
The upshot is that the Fed will probably want to keep short rates at zero until unemployment has dropped a long way below 6.5 per cent...
[I]t is a distortion which the Fed cannot afford to ignore. Its mandate requires that it should aim for “maximum employment”, not “minimum unemployment on the official statistics”, which is what it risks doing under its current forward guidance. ...
If the Fed is going to make a mistake -- ease too long or tighten too soon -- you can probably guess which mistake I think is worse.
Dean Baker:
Corporate Boards Are Still Failing: The median pay for a member of the board of a Fortune 500 company is almost $240,000 a year. This typically involves 4-8 meetings a year. One of the top priorities of the board is supposed to be ensuring that top management doesn't rip off the company. They have not been doing a very good job as Gretchen Morgenson points out in her column today. That raises the question of what exactly the get all this money for? ...
Gretchen Morgenson:
Directors Disappoint by What They Don’t Do: Directors of some high-profile public companies are coming under scrutiny this proxy season. Shareholder advocates say it’s about time.
The coming meeting of JPMorgan Chase shareholders, to be held in Tampa, Fla., on May 21, is a case in point. Directors on that board are under fire for not monitoring the bank’s risk management, a failure highlighted by last year’s $6 billion trading loss... Shareholder advisory firms have recommended voting against some of the directors on the risk policy committee and audit committee, so it will be interesting to see what kind of support those board members receive at the election.
The risk-management fiasco at JPMorgan was an obvious failing, but directors of public companies often let down their outside shareholders in ways that are more subtle, but equally important... Directors commonly neglect chief executive succession planning and inadequately analyze company performance as it relates to managers’ pay. ...
See also Lucian Bebchuk here (academic papers) and here (op-eds).
Learn why hedge fund traders are so angry with Ben Bernanke, and why
There is a reason that the trade of shorting the bonds of a sovereign issuer of a global reserve currency in a depressed economy is called "the widowmaker".
See: Moby Ben, or, The Washington Super-Whale: Hedge Fundies, the Federal Reserve, and Bernanke-Hatred by Brad DeLong.
Paul Krugman:
In Praise of Econowonkery: ... I would say that in general the quality of economic discussion we’ve been having in recent years is the best I’ve ever seen. ...
Part of what he covers is
that we’re having a conversation in which issues get hashed over with a cycle time of months or even weeks, not the years characteristic of conventional academic discourse. ... events are moving fast, and the long lead times of conventional publication essentially guarantee that it will be irrelevant to current policy issues.
I've called this "real-time analysis" (this is from a much longer essay):
... Real-Time Analysis and Policy Prescriptions
Economic research is largely backward looking. After the fact – when all of the data has been collected and the revisions to the data are complete – economists examine data on, say, a financial crisis, and then figure out what caused the economy to become so sick. Once the cause has been determined, which may involve the construction of new theoretical frameworks, they tell us how to avoid it happening again, i.e. the particular set of policies that would have prevented or attenuated the damage.
But the internet and blogs are changing what we do, and to some extent we now act like emergency room physicians rather than pathologists who have the time to carefully examine data from tests, etc., determine what went wrong, and then recommend how to avoid problems in the future. When the financial crisis hit so unexpectedly, it was like a patient showed up at the emergency room very sick and in need of immediate diagnosis and care. We had to reach into our bag of macroeconomic models, choose the one that was correct for this question, and then use it to both diagnose the problems and prescribe policies to fix them. There was no time for a careful retrospective analysis that patiently determined the cause and then went to work on the potential policy responses.
That turned out to be much harder than expected. Our models and cures are not designed for that type of use. What data should we look at to make an immediate diagnosis? What tests should we conduct to give us data on what is wrong with the economy? If we aren’t sure what the cause is but immediate action is needed to save the economy from getting very sick, what is the equivalent of using broad spectrum antibiotics and other drugs to attack unknown problems? The development of blogs puts economists in real-time contact with the public, press, and policymakers, and when a crisis hits, traffic spikes as people come looking for answers.
Blogs are a start to solving the problem of real-time analysis, but we need to do a much better job than we are doing now at providing immediate answers when they are needed. If Lehman is failing and the financial sector is going down with it, or if Europe is in trouble, we need to know what to do right now, it won’t help to figure that out months from now and then publish the findings in a journal article. That means the discipline has to adjust from being backward looking pathologists with plenty of time to determine causes and cures to an emergency room mode where we can offer immediate advice. Blogs are an integral part of that process. ...
Trying to figure out what to make of this:
Markets erode moral values, EurekAlert: Researchers from the Universities of Bamberg and Bonn present causal evidence on how markets affect moral values
Many people express objections against child labor, exploitation of the workforce or meat production involving cruelty against animals. At the same time, however, people ignore their own moral standards when acting as market participants, searching for the cheapest electronics, fashion or food. Thus, markets reduce moral concerns. This is the main result of an experiment conducted by economists from the Universities of Bonn and Bamberg. The results are presented in the latest issue of the renowned journal "Science".
Prof. Dr. Armin Falk from the University of Bonn and Prof. Dr. Nora Szech from the University of Bamberg, both economists, have shown in an experiment that markets erode moral concerns. In comparison to non-market decisions, moral standards are significantly lower if people participate in markets. ...
Details here.
Tim Duy:
When Will The Divergence Between PCE and CPI Matter?, by Tim Duy: The divergence between PCE and CPI measures of inflation remains in the headlines. Pedro da Costa at Reuters sees a test of the Fed's credibility at hand:
With the inflation rate about half of the Federal Reserve's 2.0 percent target, the central bank is facing a major test and some experts wonder whether it will eventually need to ramp up its already aggressive bond buying program.
The challenge for policymakers is that they are clearly falling short of their dual mandate and that should open the door for additional asset purchases. But, but, but...I think that additional asset purchases is just about the last thing they want to do right now. We will see if their thinking evolved much at the last FOMC meeting, but the minutes of the March meeting clearly indicate that a large contingent of FOMC members are looking to end the asset purchase program by the end of this year. Take ongoing improvements in labor markets, add in concerns about financial stability, mix in some cost-benefit analysis about the efficacy of additional QE, and top-off with a dash of improving housing markets, bake at 350 for 40 minutes, and you get monetary policymakers hesitant to push the QE lever any further.
My sense is that policymakers will thus try to find reasons to dismiss falling PCE inflation as a non-issue. From an email exchange last week, today da Costa quotes me as saying:
"The Fed may view the divergence between the two measures as indicating that worries about deflation are premature," said Tim Duy, a professor of economics at the University of Oregon. "If core CPI was trending down as well, the Fed would be more likely to conclude that their inflation forecasts should be guided lower."
And also last week, Greg Ip at the Economist had this observation:
If CPI inflation were to converge to PCE inflation, that would be a concern. Goldman expects CPI inflation to drop to 1.8% in coming years and PCE inflation to rise to 1.5%. It would be preferable for both to converge to 2%; but so long as inflation expectations remain where they are, it is of little consequence for monetary policy – and a tangible plus for incomes and spending.
Yesterday, Philadelphia Federal Reserve President Charles Plosser had this to add, via the Wall Street Journal:
As of right now, “I’m not concerned” about inflation drifting too far under the central bank’s price target of 2%, Federal Reserve Bank of Philadelphia President Charles Plosser said in response to reporter’s questions at a conference here.
Inflation expectations “look pretty well anchored,” and it’s likely that price pressures as measured by the personal consumption expenditures price index will drift back up to 2% over time and reconverge with the consumer price index, he said.
Today, Chicago Federal Reserve President Charles Evans seemed resigned to low inflation. Again, from the Wall Street Journal:
“Inflation is low, and it’s lower than our long-run objective,” Mr. Evens said in an interview on Bloomberg Television, adding that he would like to see inflation closer to 2% but expects it to stay below 2% for several more years. Inflation, he said, “can be too low” when the central bank’s objective is 2%.
Asked if low inflation should prompt a policy response from the Fed, Mr. Evans said “I think it’s way too early to think like that.” In the debate over how the Fed might exit from the asset purchase program, Mr. Evans, a voting member of the policy-setting Federal Open Market Committee, said he remains “open minded [and] I’m listening to my colleagues.”
The general story seems to be that as long as inflation expectations remain anchored, and CPI inflation does not drift much below 2%, then the Fed will resist accelerating the pace of asset purchases.
Also note that the downward inflation drift is an underlying trend, or so concludes the Federal Reserve Bank of Atlanta's macroblog. The authors use a principle component model to estimate a common trend in the price data, and get these results:
The author's note that by this measure, the decline in PCE is not as ominous as it first seems, but it is clear that inflation by either measure is missing the Fed's target and currently trending away from that target. They conclude:Does that mean we should ignore the recent disinflation being exhibited in the core PCE inflation measure? Well, let’s put it this way: If you’re a glass-half-full sort, we’d say that the recent disinflation trend exhibited by the PCE price index doesn’t seem to be “woven” into the detailed price data, and it certainly doesn’t look like what we saw in 2010. But to you glass-half-empty types, we’d also point out that getting the inflation trend up to 2 percent is proving to be a curiously difficult task.
Indeed, very curious given that we tend to think that at a minimum the monetary authority should be able to raise inflation rates. You are left with thinking that either the Federal Reserve still had more work to do or that monetary policy can do little more at this point than put a floor under the economy. If the latter, and if you want something more, you need to turn to fiscal policy.
Bottom Line: I suspect that at this point the Fed tends to think the costs of additional action still outweigh the benefits, and thus below-target inflation only induces pressure to maintain the current pace of QE longer than they currently anticipate rather than increase the pace of purchases.
I am here today (I discuss inequality, poverty, and social policy quite a bit and thought this conference would be a good opportunity to hear some of the latest academic research on these issues):
NBER Universities' Research Conference
Poverty, Inequality, and Social Policy
Phillip B. Levine and Melissa Schettini Kearney, Organizers
May 10-11, 2013
Royal Sonesta Hotel
PROGRAM
Friday, May 10
1:30 pm Welcome and Introduction
1:40 pm
Hilary W. Hoynes, University of California at Davis and NBER
Marianne Bitler, University of California at Irvine and NBER
Elira Kuka, University of California at Davis
Do In-Work Tax Credits Serve as a Safety Net?
Discussant: Bruce Meyer, University of Chicago and NBER
2:30 pm
Bhashkar Mazumder, Federal Reserve Bank of Chicago
Sarah Miller, University of Michigan RWJ Scholar
The Effects of the Massachusetts Health Reform on Financial Well Being
Discussant: Robin McKnight, Wellesley College and NBER
3:20 pm Break
3:40 pm
Joanne Hsu, Federal Reserve Board
David Matsa, Northwestern University
Brian T. Melzer, Northwestern University
Unemployment Insurance and Consumer Credit
Discussant: Tal Gross, Columbia University and NBER Food Insecurity Roundtable
4:30 pm
Neeraj Kaushal, Columbia University and NBER
Jane Waldfogel, Columbia University
Vanessa Wight, Columbia University
Public Policy and Food Insecurity among Children
Patricia M. Anderson, Dartmouth College and NBER
Kristin Butcher, Wellesley College and NBER
Hilary W. Hoynes, University of California at Davis and NBER
Diane Whitmore Schanzenbach, Northwestern University and NBER
Understanding Food Insecurity During the Great Recession
Lucie Schmidt, Williams College
Lara Shore-Sheppard, Williams College and NBER
Tara Watson, Williams College and NBER
The Effect of Safety Net Programs on Food Insecurity
5:30 pm Adjourn
6:00 pm Reception and Group Dinner
Saturday, May 11
8:00 am Continental Breakfast
8:30 am
Hannes Schwandt, Princeton University
Unlucky Cohorts: Income, Health Insurance and AIDS Mortality of Recession Graduates
Discussant: Ann Huff Stevens, University of California at Davis and NBER
9:20 am
Ariel Kalil, University of Chicago
Magne Mogstad, University College London
Mari Rege, Case Western Reserve University
Mark Votruba, Case Western Reserve University
Father Presence and the Intergenerational Transmission of Educational Attainment
Discussant: Elizabeth Ananat, Duke University and NBER
10:10 am Break
10:30 am
Phillip B. Levine, Wellesley College and NBER
Melissa Schettini Kearney, University of Maryland and NBER
Income Inequality and the Decision to Drop Out of High School
Discussant: David Deming, Harvard University and NBER
11:20 am
Anna Aizer, Brown University and NBER
Florencia Borrescio Higa, Brown University
Hernan Winkler, University of California at Los Angeles
Impact of Rising Inequality on Health at Birth
Discussant: Doug Almond, Columbia University and NBER
12:10 pm Lunch
1:10 pm
Adriana Lleras-Muney, University of California at Los Angeles and NBER
Anna Aizer, Brown University and NBER
Joseph P. Ferrie, Northwestern University and NBER
Shari Eli, University of Toronto
The Long Term Impact of Means-Tested Transfers: Evidence from the Mother's Pension Program
Discussant: Hoyt Bleakely, University of Chicago and NBER
2:00 pm
Sendhil Mullainathan, Harvard University and NBER
Eldar Shafir, Princeton University
The Psychology of Poverty (additional paper)
2:45 pm
David Ellwood, Harvard University and NBER
What Can We Possibly Do Now? Reflections on Future Directions for Research and Policy in an Era of Rising Inequality
3:15 pm Adjourn
Should we worry about bond and/or stock bubbles?
Bernanke, Blower of Bubbles?, by Paul Krugman, Commentary, NY Times: Bubbles can be bad for your financial health — and bad for the health of the economy, too. .... So when people talk about bubbles, you should ... evaluate their claims — not scornfully dismiss them, which was the way many self-proclaimed experts reacted to warnings about housing.
And there’s a lot of bubble talk out there right now. Much of it is about an alleged bond bubble.... But the rising Dow has raised fears of a stock bubble, too.
So do we have a major bond and/or stock bubble? On bonds, I’d say definitely not. On stocks, probably not, although I’m not as certain. ....
Why, then, all the talk of a bond bubble? Partly it reflects the correct observation that interest rates are very low by historical standards. What you need to bear in mind, however, is that the economy is also in especially terrible shape... The usual rules about what constitutes a reasonable level of interest rates don’t apply.
There’s also, one has to say, an element of wishful thinking here. For whatever reason, many people in the financial industry have developed a deep hatred for Ben Bernanke... As it turns out, however, dislike for bearded Princeton professors is not a good basis for investment strategy. ...
O.K., what about stocks? Major stock indexes are now higher than they were at the end of the 1990s, which can sound ominous. It sounds a lot less ominous, however, when you learn that corporate profits ... are more than two-and-a-half times higher than they were when the 1990s bubble burst. Also, with bond yields so low, you would expect investors to move into stocks, driving their prices higher.
All in all, the case for significant bubbles in stocks or, especially, bonds is weak. And that conclusion matters for policy as well as investment.
For one important subtext of all the recent bubble rhetoric is the demand that Mr. Bernanke and his colleagues stop trying to fight mass unemployment, that they must cease and desist their efforts to boost the economy or dire consequences will follow. In fact, however, there isn’t any case for believing that we face any broad bubble problem, let alone that worrying about hypothetical bubbles should take precedence over the task of getting Americans back to work. Mr. Bernanke should brush aside the babbling barons of bubbleism, and get on with doing his job.
Another travel day quickie:
Economists See Deficit Emphasis as Impeding Recovery, by Jackie Calmes and Jonathan Weisman: The nation’s unemployment rate would probably be nearly a point lower, roughly 6.5 percent, and economic growth almost two points higher this year if Washington had not cut spending and raised taxes as it has since 2011, according to private-sector and government
After two years in which President Obama and Republicans in Congress have fought to a draw over their clashing approaches to job creation and budget deficits, the consensus about the result is clear: Immediate deficit reduction is a drag on full economic recovery.
Hardly a day goes by when either government analysts or the macroeconomists and financial forecasters who advise investors and businesses do not report on the latest signs of economic growth — in housing, consumer spending, business investment. And then they add that things would be better but for the fiscal policy out of Washington. Tax increases and especially spending cuts, these critics say, take money from an economy that still needs some stimulus now, and is getting it only through the expansionary monetary policy of the Federal Reserve. ...
In all this time, the president has fought unsuccessfully to combine deficit reduction, including spending cuts and tax increases, with spending increases and targeted tax cuts for job-creation initiatives in areas like infrastructure, manufacturing, research and education. That is a formula closer to what the economists propose. But Republicans have insisted on spending cuts alone and smaller government as the key to economic growth. ...
And they keep insisting this is true despite the evidence to the contrary because it supports their ideological goals, and there is little political price for taking this position.
Travel day, so some quick ones before heading out:
Big Data Needs a Big Theory to Go with It, by Geoffrey West: As the world becomes increasingly complex and interconnected, some of our biggest challenges have begun to seem intractable. What should we do about uncertainty in the financial markets? How can we predict energy supply and demand? How will climate change play out? ... To bring scientific rigor to the challenges of our time, we need to develop a deeper understanding of complexity itself.
What does this mean? Complexity comes into play when there are many parts that can interact in many different ways so that the whole takes on a life of its own: it adapts and evolves in response to changing conditions. It can be prone to sudden and seemingly unpredictable changes—a market crash is the classic example. One or more trends can reinforce other trends in a “positive feedback loop” until things swiftly spiral out of control and cross a tipping point...
The digital revolution is driving much of the increasing complexity..., but this technology also presents an opportunity..., enormous amounts of data. ... The trouble is, we don't have a unified, conceptual framework for addressing questions of complexity. ... “Big data” without a “big theory” to go with it loses much of its potency and usefulness... We now need to ask if our age can produce universal laws of complexity...
We won't predict when the next financial crash will occur, but we ought to be able to assign a probability of one occurring in the next few years. The field is in the midst of a broad synthesis of scientific disciplines, helping reverse the trend toward fragmentation and specialization, and is groping toward a more unified, holistic framework for tackling society's big questions. The future of the human enterprise may well depend on it.
One thing I learned from the recent crisis is that despite my indifference to the day to day gyrations in asset markets, I need to pay more attention to them. For example, is there presently a bubble in stock market prices?
Antonio Fatás argues that it's a difficult to find evidence for this:
Let's get real about the stock market: As reported by the financial press, the stock market continues to hit fresh record-high levels in many advanced economies. The Dow Jones passed the 15,000 mark, the Nikkei just went over 14,000, and the DAX just went above its previous record. It seems to be the time to talk about bubbles in asset prices - an important issue given how these bubbles have dominated the last business cycles in these economies.
Except that we are looking at the wrong numbers. It is remarkable that the discussion on the value that these indices are reaching ignores two fundamental issues:
- These are nominal values and as we were told in the first economics lesson, we need to look at real variables and not nominal ones.
- Asset prices are not supposed to stay constant (in real terms). In many cases its appreciation will reflect real growth in the economy, earnings and/or the expected return that these assets should provide in equilibrium.
No need to look for data that provides a better benchmark than just nominal indices. Robert Shiller provides all the necessary data in his web site. Adjusting for inflation is easy and below is a chart with the real price of the S&P500 index where the CPI has been used to convert nominal into real variables.
After adjusting for inflation we can see that the index is far from its peak in 2000 and it is even below the peak in 2007. No sign of a record level yet.
Adjusting for inflation is not enough as the fundamentals (earnings) also grow because of real growth. The price-to-earnings ratio takes care of this adjustment (it also takes care of inflation because earnings are measures in nominal terms). Making this adjustment is more difficult but I will reply on Shiller's numbers again (his book and writings provide a lot of detailed analysis on his data).
Once we adjust for nominal as well as real growth, the current levels look even less impressive. Very low compared to the bubble built in the 90s and significantly lower than the ratio observed in most of the years during the 2002-2007 expansion. We are very far from record-high levels if we use this indicator.
Of course, to do a proper analysis we need to bring a lot of other factors: expected earnings growth, interest rates, risk appetite,.... And there will be room there to debate whether the current valuation of the stock market is reasonable, too high or too low. But starting the analysis with a statement of record-high levels when measured in nominal terms and ignoring real growth in earnings is clearly the wrong place to start the debate.
For more on stock prices, see Fernando Duarte and Carlo Rosa of the NY Fed: Are Stocks Cheap? A Review of the Evidence:
We surveyed banks, we combed the academic literature, we asked economists at central banks. It turns out that most of their models predict that we will enjoy historically high excess returns for the S&P 500 for the next five years. But how do they reach this conclusion? Why is it that the equity premium is so high? And more importantly: Can we trust their models? ...
Why is the equity premium so high right now? And why is it high at all horizons? There are two possible reasons: low discount rates (that is, low Treasury yields) and/or high current or future expected dividends. ... We find that the equity risk premium is high mainly due to exceptionally low Treasury yields at all foreseeable horizons. In contrast, the current level of dividends is roughly at its historical average and future dividends are expected to grow only modestly above average in the coming years. ...
Via Cardiff Garcia at FT Alphaville, Inflation is falling everywhere:
(Charts via Capital Economics.)
... It’s probably worth noting that the wild fluctuations in the headline rate have had only a muted impact on core inflation in the past decade. Just something to keep in mind when you start hearing calls for policy action at the first hint of commodity price gyrations.
Capital Economics writes that there is divergence among some of the bigger emerging economies, with India and Brazil headed in opposite directions, but across the developed world the story is similar (though Japanese inflation expectations are heading higher, and are now above the eurozone’s, by one popular market measure):
Dani Rodrik:
What is wrong (and right) in economics?, by Dani Rodrik: The World Economics Association recently interviewed me on the state of economics, inquiring about my views on pluralism in the profession. You can find the result on the WEA's newsletter here (the interview starts on page 9). I reproduce it below. ...
Two from Tim Duy. Here's the first:
Really? One Basis Point?, by Tim Duy: Bloomberg has a story with an ominous opening paragraph:
Bank of Japan Governor Haruhiko Kuroda’s stimulus policies are backfiring in the housing market, where mortgage rates are rising even as the central bank floods the financial system with cash.
Lions, tigers, and bears, oh my! The next paragraph:
Fixed 35-year home-loan costs rose to 1.81 percent this month, the first increase since February and up from an all-time low of 1.8 percent in April, according to data compiled by the Japan Housing Finance Agency. Federal Reserve Chairman Ben S. Bernanke’s monetary easing almost halved 30-year U.S. mortgage rates since 2008 to 3.35 percent on May 2.
Seriously? The case against Kuroda is that after declining since February, mortgage rates climbed a whole basis point? And Kuroda is expected to accomplish in a few months what took Bernanke five years? And I thought I could be a harsh critic of central bankers!
Hopefully this is just a typo; I can't seem to locate a time series of the 35-year mortgage rate in Japan. Otherwise, one might be tempted to conclude that the reporters were biased against Abenomics.
And here's the second:
Rising Structural Unemployment?, by Tim Duy: This tweet from Andy Harless caught my eye:
HIres-to-openings ratio looking uglier & uglier bls.gov/news.release/j… Looks like rising structural unemployment
— Andy Harless (@AndyHarless) May 7, 2013The chart:
The ratio of hires to openings fell to the low of the last cycle. Now compare the ratio to the unemployment rate:
Unemployment appears to be too high relative to the hires/openings ratio (caution is warranted, however, as the JOLTS data only extends back to 2001). One would normally associate such a low ratio with low unemployment as the number of hires would be relatively low because of the lack of available workers. In this case, however, the number of hires appears to be low despite a large pool of potential employees, consistent with the concern that available workers lack the skills firms seek. Structural unemployment, as Harless suggests.
That said, recall that Matthew O'Brien pointed us at research here and here suggesting that high unemployment is attributable not to structural factors, but instead to a bias against the long-term unemployed. O'Brien recognizes the insidious nature of this problem:
Circles don't get more vicious than this. The people who need work the most can't even get an interview, let alone a job. It's a cycle that could end with the long-term unemployed becoming unemployable. It's what economists call hysteresis, the idea being that a slump, left untreated, can make us permanently poorer by reducing our future ability to do and make things.Bias against the long-term unemployed might explain why wage growth remains muted:
One would think that a low hires/openings ratio suggests that wage growth would be accelerating (as employers appear to face a relative shortage of workers), but that is not the case. Indeed, low wage growth is one reason to believe that excessive unemployment is cyclical in nature. How does this fit with the long-term unemployed story above? Perhaps that although firms have a bias against the long-term unemployed, those potential workers still place downward pressure on wages. The newly unemployed don't require higher wages despite demand for their skills because they know there is a large pool of people available with similar skills. If the newly unemployed demand too high wages, they may induce employers to take another look at the pool of long-term unemployed. Consequently, they do not seek higher wages.
Incidentally, this also explains the low quits rate. The consequences of becoming long-term unemployed are particularly severe, raising the expected cost of voluntarily leaving a job.
So I guess the "good" news would be this: If bias against the long-term is simply creating the illusion of structural unemployment, then we are not yet faced with the problem of hysteresis. If the pool of long-term unemployed can place downward pressure on wages, then they must have a valuable skill set. Otherwise, they would not represent a threat to the newly unemployed. Keep the demand up for employees long-enough, and firms will eventually give up their bias against the long-term unemployed (I assume this would be preferable to the alternative of prematurely escalating wages). Eventually, the pool of unemployed would decrease and then wage pressures increase.
Still, the longer we wait for this bias to diminish, the more likely it is that the unemployment does indeed become structural. Then we would expect rapidly rising wages despite elevated unemployment. Another argument for pulling on all the stimulus levers. Alas, that is not the case.Update: And after I wrote all this, I saw this Harless tweet:
Likely part of the reason 4 low hires/opening is that most applicants r now long-term unemployed, who face a more rigorous screening process
— Andy Harless (@AndyHarless) May 8, 2013Apparently on the same path.
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