Cameron's failure: austerity: David Cameron’s premiership must be considered a failure. He wanted to keep the UK in the EU, but failed; he wanted to preserve the Union but Scotland might well leave as a result of Brexit; and he wanted to heal a “broken Britain” but leaves the country divided and with hate crime rising.
A big reason for these failures lies in economic policy. Unnecessary austerity contributed to Brexit in four ways:
- In contributing to stagnant incomes for many, it increased hostility to immigrants, which some Brexiteers exploited. When combined with high inequality – which Cameron did little to combat – it also contributed to increasing distrust of “elites”. ...
- In worsening public services, Cameron and Osborne allowed the false impression to grow that immigrants were responsible for pressure on the NHS. ...
- Austerity policies ran contrary to the established wisdom of most economic experts. Having shut out experts in one area, Cameron and Osborne were then less able to appeal to them on the merits of staying in the EU. They created a precedent for a rejection of mainstream economics.
- Supporting austerity at home meant that the Tories could not argue for expansionary policies in the euro zone – policies which would have both helped to reduce migration to the UK and which would have diminished the image of the EU as a failing institution. ...
In this sense, the costs of austerity have been far higher than estimated by conventional macroeconomic thinking. This perhaps reinforces an old piece of political wisdom – that if a government doesn’t get economic policy right, it’ll not get much else right either.
Posted by Mark Thoma on Wednesday, July 13, 2016 at 09:53 AM in Economics, Politics |
The Costs of Monopoly: A New View, The Region, FRB Minneapolis: Economists overwhelmingly agree that the actual costs of monopoly are small, even trivial. This consensus is based on a theory that assumes monopolies are well-run businesses that limit their output in order to drive up prices and maximize profit. And because empirical studies have found that monopolists do not restrict output or raise prices by very much, most economists have concluded that monopolies inflict relatively little harm on the economy.
In this essay, I review recent research that upends both the theoretical and empirical elements of this consensus view.2 This research shows that monopolies are not well-run businesses, but instead are deeply inefficient. Monopolies do drive up prices, as conventional theory suggests, but because they also reduce productivity, they often ultimately destroy most of an industry’s profits. These productivity losses are a dead-weight loss for the economy, and far from trivial.
The new research also shows that monopolists typically increase prices by using political machinery to limit the output of competing products—usually by blocking low-cost substitutes. By limiting supply of these competing products, the monopolist drives up demand for its own. Thus, in contrast to conventional theory, the monopolist actually produces more of its own product than it would in a competitive market, not less. But because production of the substitutes is restricted, total output falls.
The reduction in productivity exacts a toll on all of society. But the blocking of low-cost substitutes particularly harms the poor, who might not be able to afford the monopolist’s product. Thus, monopolies drive the poor out of many markets.
In this essay, I first review the standard theory of monopoly that contends it inflicts little harm, and then I introduce a new theory that refutes that view. In this new theory, groups within monopolies act as both adversaries that reduce productivity and allies that eliminate substitutes. The new theory thus demonstrates that monopolies in fact cause substantial economic harm, and that harm falls disproportionately on people with fewer financial resources.
I then provide several historical examples of monopolies from my own research and that of others. I’ll discuss monopoly subgroups in their role as adversaries in the sugar, cement and construction industries. I’ll discuss monopoly subgroups acting as allies in the dental and legal industries. But I want to emphasize that in all monopolies, subgroups engage in both roles. I’ll also take a fresh look at a familiar example of a monopoly, U.S. Steel, showing how subgroups acted as both adversaries and allies. These few examples are illustrative only and provide a narrow glimpse of a far broader economic phenomenon: Monopolies are prevalent in the U.S. (and international) economy. ...
Skipping forward to the summary and conclusion:
For decades, the theoretical understanding and empirical analysis of monopoly have themselves been monopolized by a dominant paradigm—that the costs of monopoly are trivial. This blindness to new theory and analysis has impeded economists’ understanding of the actual harm caused by monopoly. Rather than inflicting little actual damage, adversarial relationships within monopolies have significantly reduced productivity and economic welfare. And in many industries, subgroups within monopolies collaborate to eliminate competition from low-cost substitutes. This lack of competition in the marketplace has a disproportionate impact on poor citizens who might otherwise find low-cost services that would meet their needs.
I’ve described this as a “new” theory, but in truth its roots go back decades, to the ideas of Thurman Arnold. Arnold ran the Antitrust Division at the Department of Justice from 1938 to 1943, taking aim at a broad range of targets, from automakers to Hollywood movie producers to the American Medical Association.10 He argued that lack of competition reduced productivity and that monopolies crushed low-cost substitutes, hurting the poor. Arnold supported his arguments through intensive real-world research. He and his staff undertook detailed investigations of monopolies, examining the on-site operations of many industries and documenting the productivity losses and destruction of substitutes caused by monopoly.
Arnold began his work at a pivotal time—in the midst of the Great Depression, just after the United States had experimented with the cartelization of its economy. Faith in competitive markets had reached such a low that cartels and monopolies were thought to be, perhaps, better alternatives. His work and ideas played a big role in reinvigorating confidence in competitive markets. He mounted an aggressive campaign to protect society from monopoly. The campaign had two parts: forceful prosecution of monopoly through the courts, accompanied by an array of speeches and articles to educate the general public about its costs.
Economists gradually forgot Arnold and his ideas, convinced by Harberger’s empirical work and the introspection of economists, leading to, for example, the logic provided by Stigler and others. Scholars and regulators who studied monopolies focused on prices alone and found little to worry about.
But as shown by the research reviewed in this essay—and an expanding body of empirical work—the problems caused by monopoly are significant, and still pervasive. My hope is that this paper will open a new era of discussion about monopoly and its costs, and ultimately lead policymakers to encourage greater competition for the benefit of all.
Posted by Mark Thoma on Wednesday, July 13, 2016 at 12:24 AM in Economics, Market Failure |
Posted by Mark Thoma on Wednesday, July 13, 2016 at 12:06 AM in Economics, Links |
Still Confused About Brexit Macroeconomics: OK, I am still finding it hard to understand the near-consensus among my colleagues about the short- and medium-term effects of Brexit. As I’ve tried to point out, while there are clear reasons to believe that Brexit will make Britain somewhat poorer in the long run, it’s not completely obvious why this should lead to a recession in the short run. ...
When we say “uncertainty”, what do we mean? The best answer I’ve gotten is that for a while, until things have shaken out, firms won’t be sure where the good investment opportunities in Britain are, so there will be an option value to waiting.
Let’s be slightly spuriously concrete. Suppose you think Brexit might have seriously adverse effects on service exports from the City of London. This would mean that investment in, say, London office buildings would become a bad idea. On the other hand, it would also mean a weaker pound, making investment in industrial properties in the north of England more attractive. But you don’t know how big either effect might be. So both kinds of investment are put on hold, pending clarification.
OK, that’s a coherent story, and it could lead to a recession next year.
At some point, however, this situation clarifies. Either we see financial business exiting London, and it becomes clear that a weak pound is here to stay, or the charms of Paris and Frankfurt turn out to be overstated, and London goes back to what it was. Either way, the pent-up investment spending that was put on hold should come back. This doesn’t just mean that the hit to growth is temporary: there should also be a bounce-back, a period of above-normal growth as the delayed investment kicks in.
And again, since some people seem unable to read what I’m saying, this should happen even if the negative scenario holds; it’s the resolution that should produce the delayed boom, whichever way that resolution goes. But that’s not what ... almost anyone else ... seems to be saying; they’re projecting lower growth as far as the eye can see. They could be right. But I still don’t see the logic. It seems to me that “uncertainty” is being used as a catchall for “bad stuff”.
Update: See also Brad DeLong: Brexit: I Think Paul Krugman Is Confused Here...
Posted by Mark Thoma on Tuesday, July 12, 2016 at 08:03 AM in Economics |
I have a new column:
New Economic Thinking is Needed to Stop Charlatans Like Trump: After the positive employment report last week, we are hearing that faster wage growth may be “around the corner.” This is not the first time this hope has been raised, but workers have not yet realized significant gains. Will this time be different? The average hourly wage is up 2.6 percent relative to a year ago, and there are some signs of wage acceleration in recent months. However, part of the increase appears to be a shift from health care benefits to wages so the gains up to this point have not been as large as statistics on wage growth alone suggest.
If there is acceleration in wage growth that is not offset by a further decline in benefits, it would certainly be a welcome change from the wage stagnation and rising inequality that workers have experienced in recent decades. But faster wage growth won’t solve the problem of rising inequality on its own. ...
Posted by Mark Thoma on Tuesday, July 12, 2016 at 07:32 AM in Economics |
Catching Up: I snuck out of town last week and am catching up on Fed/economy news. Highlights from the past week:
1.) The labor report comes in better than expected. Nonfarm payrolls rose by 287k in June compared to the downwardly revised 11k gain in May. These results speak to the volatility typically seen in the employment data. See also Matthew Boesler on impact of end of the school year on the data. On a twelve month basis, job growth has eased only moderately. But on a three month basis, the slowdown is more pronounced:
You have to decide if this is one of those situations when the longer term trend is missing a more severe turning point in the data.
My sense is that these numbers are sufficient to convince many Fed officials that the unemployment rate will decline further in the months ahead. But many will also see reason for caution. First, as noted earlier, near term trends reveal a moderation in the pace of job growth. And the rate of improvement in the unemployment rate has slowed markedly in recent months:
This raises the prospect that job growth is actually not that much higher than that necessary to hold the unemployment rate constant. Moreover, progress toward reducing unemployment has slowed or stalled:
And while wage gains are accelerating, the pace remains tepid, roughly 100bp below the pre-recession rates:
It would be disappointing if wage growth stalled out here. Note also that the long-leading indicator of temporary help employment is tracking sideways to slightly down:
All of these indicators may be headed for upside breakouts in the months ahead, but at the moment I sense some loss of momentum in labor market improvement. This, I think, places the Fed on some precarious ground, something that the bulk of the FOMC likely recognizes. It's not that the fundamentals of the economy have necessarily broken down; it's that the Fed needs to maintain a sufficiently accommodative policy to allow those fundamentals to exert themselves.
2.) Influential policymakers urge patience. Federal Reserve Governor Dan Tarullo came out strongly against additional rate hikes at this time. Via MarketWatch:
“Inflation is not at our stated target, not near our stated target, and hasn’t been so in quite some time,” Tarullo said in a conversation at a Wall Street Journal breakfast.
“This is not an economy that is running hot,” he added.
“For some time now I thought it was the better course to wait to see more convincing evidence that inflation is moving toward and would remain around the 2% target,” Tarullo said.
“To this point, I have not seen that type of evidence,” he said.
It seems to me that Tarullo is looking for something close to the proposed Evans Rule 2.0 - no rate hikes until core-inflation hits 2 percent year-over-year. Even more interesting is this:
Tarullo said he didn’t think that the worry that low interest rates may fuel asset bubbles was an “immediate concern.”
The Fed governor, who is the quarterback of the Fed’s efforts to regulate banks, questioned whether raising rates would ease financial stability concerns in an environment where the market was pessimistic about the economic outlook.
“If markets do regard economic prospects as only modest or moderate going forward, then raising short-term rates is almost surely going to flatten the yield curve, which generally speaking is not good for financial intermediation, and in some sense could exacerbate financial stability concerns,” Tarullo said.
When rates are low, regulators should pay more attention to financial stability issues “but it doesn’t translate into ‘therefore raise rates and all will be well,’” he added.
Tarullo is obviously not pleased that the yield curve continues to flatten
and is not interested in hiking into such an environment. New York Federal Reserve President William Dudley echoes this concern:
Federal Reserve Bank of New York President William Dudley voiced concern Wednesday about very low yields on 10-year Treasury notes, which could be a sign that investor expectations for growth and inflation are waning. Mr. Dudley, who had been meeting with local leaders at Binghamton University in New York, said low yields weren’t “completely good news.”
This suggests these two policymakers would prefer to hike if long-term yield were rising, pulling the Fed along for the ride. Low yields are only feeding into the Fed's suspicion that their expectations of where rates are headed are wildly optimistic.
3.) Williams interview. Gregg Robb of MarketWatch has a long interview with San Francisco Federal Reserve President John Williams. The whole interview is worth a read. Two points. First, Williams is in the camp that the Fed need to act sooner than later to forestall the growth of imbalances:
The risk I think we face in waiting too long, or waiting maybe as long as some of these market expectations are, is that the economy is already pretty strong and if we wait too long in further removal of accommodation I do think imbalances will form more generally. It could show up as more inflation pressures down the road, we’re not seeing those yet, but I think that you do see some of this in terms of real-estate markets and other asset markets which are being priced to perfection based on an outlook of very low interest rates. You are seeing extremely high asset valuations in real estate, commercial real estate, the stock market is very strong relative to fundamentals. That is a natural result from low interest rates, that’s one of the ways monetary policy affects the economy. But if asset prices, real estate prices, continue to go further and further away from longer-term fundamentals I think that creates risk for the economy, I think it creates risks eventually for the financial system.
Note that this runs counter to Tarullo, who argued that the flattening yield curve could worsen, not improve, the financial stability situation. The need to rates rates in the name of financial stability is a growing fault line within the Fed.
Second, Williams gives his view of the disconnect between financial markets and the Fed:
In term of the private-sector forecasts, I think it’s very hard to fully understand what the Fed’s decision-making is given that we haven’t done many active policy steps in the last few years. I mean we did obviously as I mentioned the asset purchases during that period, but since we’ve ended that, we talked a lot about raising rates, we’ve given a lot of “dot plots” about raising rates, we did one rate increase in December, but then it has been over six whole months since then, and - I try to put myself in the shoes of a private sector forecaster - one of the hard things to do is kind of see what is our reaction function. What is it that is driving our decision?...
...Right now we’re just in a situation where there is just not a lot of data on actual actions because, for various reasons we’ve held off a long time on our first rate increase and then we held off so far on a second rate increase.
This I think is wrong; lack of action is a policy choice as much as action. Williams seems to think the only useful information about the Fed's reaction function comes when the Fed changes rates. This implies that holding policy steady conveys no information. I would argue that steady policy is in fact signaling the Fed's reaction function, and hence, in combination with the data flow, financial market participants are concluding that the Fed will continue at a glacial pace regardless of what the "dots" say. Indeed, I would say that financial market participants are signaling that the Fed's stated policy path would be a policy error, an error that they don't expect the Fed to make. I guess you could argue that the market doesn't think the Fed understands it's own reaction function. And given the path of policy versus the dots, the market appears to be right.
4.) Mester, seriously? Cleveland Federal Reserve President Loretta Mester dropped this line in a July 1 speech (emphasis added):
But there are also risks to forestalling rate increases for too long when we are continuing to make cumulative progress on our policy goals. Waiting too long increases risks to financial stability and raises the chance that we would have to move more aggressively in the future, which poses its own set of risks to the outlook. I believe waiting too long also jeopardizes our future ability to use the nontraditional monetary policy tools that the Fed developed to deal with the effects of the global financial crisis and deep recession. If we fail to gracefully navigate back toward a more normal policy stance at the appropriate time, then I believe there is a non-negligible chance that these tools will essentially be off the table because the public will have deemed them as ultimately ineffective. This is a risk to the outlook should we ever find ourselves in a situation of needing such tools in the future. Of course, such a risk is hard to measure and is not one we typically consider. But we live in atypical times, and we need to take the whole set of risks into account when assessing appropriate policy.
The part about low rates and financial instability is, as I noted earlier, a growing fault line within the Fed. But the next part about needing to "gracefully" return to a normal policy stance to regain policy effectiveness of nontraditional tools was unexpected. This a variation on a theme. There is a common misperception that policymakers need to raise rates not because the economy needs it, but because it needs tools to fight a future recession. Completely backwards logic, of course. Premature rate hikes only speeds up the arrival of next recession and ensures that policymakers lack room to maneuver. They don't, as Mester suggests, preserve your options. A central banker should know this.
5.) The minutes. My short takeaway from the minutes is that the divide among FOMC participants is greater than the divide among FOMC members. In other words, a larger percentage of participants are looking to hike rates sooner than members. Until the balance on the FOMC shifts, discount hawkish Fedspeak.
Bottom Line: I am keeping an eye on Tarullo; he has been more public on his monetary policy views in recent months. And those views are fairly dovish. My guess is that he and other doves regret taking one for the team last December and falling in line with a rate hike. They won't go down so easily this time around.
Posted by Mark Thoma on Tuesday, July 12, 2016 at 12:15 AM in Economics, Fed Watch, Monetary Policy |
Posted by Mark Thoma on Tuesday, July 12, 2016 at 12:06 AM in Economics, Links |
Here's a Q&A on the economics of Brexit from Christian Odendahl and John Springford of the Centre for European Reform:
Long day’s journey into economic night: There are currently more questions than answers in post-Brexit Britain. The short-term economic consequences of the vote are no exception. We have attempted to clarify our thinking about what we believe will happen, through a series of questions and (sometimes tentative) answers. ...
Posted by Mark Thoma on Monday, July 11, 2016 at 12:15 PM in Economics |
I did a podcast with David Beckworth:
Macro Musings Podcast: Mark Thoma
Posted by Mark Thoma on Monday, July 11, 2016 at 08:41 AM in Economics |
What is the "extraordinary plunge in long-term interest rates" telling us?:
Cheap Money Talks, by Paul Krugman, NY Times: What with everything else going on, from Trump to Brexit to the horror in Dallas, it’s hard to focus on developments in financial markets — especially because we’re not facing any immediate crisis. But extraordinary things have been happening lately, especially in bond markets. ...
Specifically, there has been an extraordinary plunge in long-term interest rates. ... Basically, investors are willing to offer governments money for nothing, or less than nothing. What does it mean?
Some commentators blame the Federal Reserve and the European Central Bank, accusing them of engineering “artificially low” interest rates that encourage speculation and distort the economy..., however, it’s important to understand that they’re not making sense. ...
Historically,... the way you know that money is too easy ... has been out-of-control inflation. That’s not happening... If anything, developments ... are telling us that interest rates aren’t low enough... But why?
In some past episodes of very low government borrowing costs, the story has been one of a flight to safety: investors piling into U.S. or German bonds because they’re afraid to buy riskier assets. But there’s little sign of such a fear-driven process now. ...
So what’s going on? I think of it as the Great Capitulation. ... Until recently,... investors acted as if they still expected a return to what we used to consider normal conditions. Now they’ve thrown in the towel, in effect conceding that persistent weakness is the new normal. This means low short-term interest rates for a very long time, and low long-term rates right away.
Many people don’t like what’s happening, but raising rates in the face of weak economies would be an act of folly that might well push us back into recession.
What policy makers should be doing, instead, is accepting the markets’ offer of incredibly cheap financing..., there are huge unmet demands for public investment... So why not borrow money at these low, low rates and do some much-needed repair and renovation? This would be eminently worth doing even if it wouldn’t also create jobs, but it would do that too.
I know, deficit scolds would issue dire warnings about the evils of public debt. But they have been wrong about everything for at least the past eight years, and it’s time to stop taking them seriously.
They say that money talks; well, cheap money is speaking very clearly right now, and it’s telling us to invest in our future.
Posted by Mark Thoma on Monday, July 11, 2016 at 12:51 AM in Economics |
Posted by Mark Thoma on Monday, July 11, 2016 at 12:06 AM in Economics, Links |
Posted by Mark Thoma on Sunday, July 10, 2016 at 12:06 AM
Posted by Mark Thoma on Saturday, July 9, 2016 at 12:06 AM in Economics, Links |
Employment Rebounds in June, but Unemployment Edges Higher: The Labor Department reported that the economy added 287,000 jobs in June, a sharp bounce back from the 11,000 jobs now reported for May. A big factor in the reversal was the end of the Verizon strike, which subtracted 37,000 jobs from the May growth number and added the same amount in June, but even adjusting for this effect, the June growth figure is much stronger.
The job gains were widely spread across sectors. ...
The average hourly wage is 2.6 percent above its year-ago level. In the last three months, it has risen at a 2.7 percent annual rate compared with its level for the prior three months. While there has been some acceleration in wage growth by this measure, the Employment Cost Index shows no upward trend whatsoever. Clearly compensation is being shifted in part from benefits, most importantly health care, into wages. It is important not to mistake this shift for an increase in labor costs.
The household survey showed a bleaker picture. The unemployment rate rose modestly to 4.9 percent. The employment-to-population ratio (EPOP) fell to 59.6 percent as employment measured by the household survey increased by just 67,000. Employment in the household survey is still more than 200,000 below its March level.
By demographic group, the most disturbing item is the reported rise in the unemployment rate among black teens to 31.2 percent. It had been 23.3 percent in February. These data are highly erratic, but the trend is large enough that it could reflect a substantial deterioration in the labor market.
Employment patterns by education are showing an interesting pattern in this recovery. Over the last year the unemployment rate for college grads has not changed while their EPOP is down by 0.3 percentage points. By contrast, the unemployment rate for those with a high school degree has fallen by 0.4 percentage points and by 0.6 percentage points for those with less than a high school degree. Their EPOPs have risen by 0.3 and 1.2 percentage points, respectively. The increased demand for skills is not obvious in this picture.
Other aspects of the household survey were mixed. There was a drop of 587,000 in the number of people working involuntarily part-time, which more than reversed a sharp rise reported for May. The number of discouraged workers is more than 150,000 below its year-ago level and not too far above pre-recession levels. The duration measures of unemployment were mixed. The median duration of unemployment spells fell slightly to 10.3 weeks, a new low for the recovery, but both the average duration and share of long-term unemployed rose slightly.
The percentage of unemployment due to voluntary quits remained constant at 10.7 percent. This is near the high for the recovery, but still far below pre-recession levels.
On the whole, this should be seen as a modestly positive report. The job growth in the establishment survey was impressive, but it still only brings the three-month average to 147,300. At the same time, the household survey is indicating a much weaker picture. The establishment survey is generally a better measure, but even the establishment survey is not showing strong job growth over the three-month period.
Posted by Mark Thoma on Friday, July 8, 2016 at 09:25 AM in Economics, Unemployment |
The reason "Trumpism could triumph":
All the Nominee’s Enablers, by Paul Krugman, NY Times: A couple of weeks ago Paul Ryan ... sort of laid out both a health care plan and a tax plan. ...Mr. Ryan’s latest proposals had the same general shape as every other proposal he’s released: huge tax cuts for the wealthy combined with savage but smaller cuts in aid to the poor, and the claim that all of this would somehow reduce the budget deficit thanks to unspecified additional measures. ...
Fix the Debt, a nonpartisan deficit-scold group ... issued a statement — but not, as you might have expected, condemning Mr. Ryan for proposing to make the deficit bigger. No, the statement praised him. “We are concerned that the policies in the plan may not add up,” the organization admitted, but it went on to declare that “we welcome this blueprint.”
And there, in miniature, is the story of how America ended up with someone like Donald Trump... It’s all about the enablers, and the enablers of the enablers.
At one level, all Mr. Trump has done is to channel the racism that has always been a part of our political life... But there’s a reason these tendencies are sufficiently concentrated in the G.O.P. that Trumpism could triumph...
To put it bluntly, the modern Republican Party is in essence a machine designed to deliver high after-tax incomes to the 1 percent. ... But not many voters are interested in that goal. So the party has prospered politically by harnessing its fortunes to racial hostility, which it has not-so-discreetly encouraged for decades. ...
I’m not saying that all leading Republicans are racists... It is that in pursuit of their economic — actually, class-interest — goals they were willing to act as enablers, to make their party a safe space for prejudice. And the result is a party base that is strikingly racist...
But there’s one more crucial element here: We wouldn’t have gotten to this point if so many people outside the G.O.P. — in particular, journalists and self-proclaimed centrists — hadn’t refused to acknowledge what was happening. ... Instead, the respectable, “balanced” thing was to pretend that the parties were symmetric, to turn a blind eye to the cynicism of the modern Republican project. ...
The point is that this kind of false balance does real harm. The Republican establishment directly enabled the forces that led to Trump; but many influential people outside the G.O.P. in effect enabled the enablers. And so here we are.
Posted by Mark Thoma on Friday, July 8, 2016 at 08:58 AM in Economics, Politics |
Posted by Mark Thoma on Friday, July 8, 2016 at 12:06 AM in Economics, Links |
Is the Labor Market Tossing a Fair Coin?, Macroblog: How important is tomorrow's June employment report? In isolation, the answer would surely be not much. The month-to-month swings in job gains can be quite large, and one month does not a trend make.
And yet, there seemed to be a pretty significant reaction to the May employment number...
I get it. I don't speak for the Fed, of course—above my rank—but I am in fact one of those who regularly cautions against putting excessive weight on one number. And I am also one of those taken aback by the May employment report, so much so that my view of the economy changed materially as a result of that report.
Let me check that. My view of the risks to the economy, or more specifically the risks to my assessment of the strength of the economy, changed materially.
Here's an analogy that I find useful. Flip what you assume to be a fair coin. The probability of getting a heads, as we all know, is 50 percent. And if you weren't too traumatized by the statistics courses in your past, you will recall that the probability of two heads in a row is 25 percent, dropping to just about 13 percent of the coin coming up heads three times in a row.
Now, 13 percent is not zero, but it may be getting low enough for you to begin to wonder about your assumption that the coin is actually fair. If you have some stake in whether it is or isn't, you might want to take one more toss to get a little more evidence (since the odds of getting four heads in a row is, while not impossible, pretty improbable).
The point is that it wasn't just the May statistic that was striking in last month's report, but also the fact that the March and April numbers were revised downward to the tune of nearly 60,000 jobs. And if you step back a bit, you will see that the rolling three-month average of monthly job gains has been declining through the first half of the year (as the chart shows), even adjusting the May number for the Verizon strike:
Strike-adjusted, the May job gains were the lowest since December 2013. The three-month average (again strike-adjusted) was the lowest since the middle of 2012. In other words, although the year-over-year pace of jobs gains has been holding up, momentum in the labor market is decidedly softer—at least when measured by payroll employment gains.
I have been assuming that the U.S. economy will, for a while yet, continue to create jobs at a pace greater than necessary to maintain the unemployment rate at a more or less constant level. That pace is generally believed to be about 80,000 to 140,000 jobs per month, depending on your assumptions about the labor force participation rate. Another jobs report (including revisions to past months) that counters that assumption would, I think, cause a reasonable person to reassess his or her position.
Based on today's ADP report, the odds look good for some decent news tomorrow. On the other hand, if the June employment number does tick up, some observers will no doubt note that it is a pre-Brexit statistic. It may take a few more flips of the coin to determine if that consideration matters.
Posted by Mark Thoma on Thursday, July 7, 2016 at 10:12 AM in Economics, Unemployment |
Posted by Mark Thoma on Thursday, July 7, 2016 at 12:06 AM in Economics, Links |
''Confidence in Federal Reserve Economic Management is, Right Now, Lacking'': Correct, IMHO, from the very sharp Narayana Kocherlakota [Three Antidotes to the Brexit Crisis]. Now perhaps his successor Neel Kashkari and the other Reserve Bank presidents not named Charlie Evans might give him some back up?
The one thing I do not like is Narayana's "Granted, there is a risk that such steps will spook markets by signaling that the Fed is concerned about the state of the U.S. financial system." That sentence seems to me to misread market psychology completely. As I see it--and as the people in markets I talk to say--right now markets are fairly completely spooked by their belief that the Federal Reserve is unconcerned, and takes that lack of concern as a sign of Federal Reserve detachment from reality. Narayana's following sentences seems to me to be highly likely to be the right take: "I'd say the markets are already pretty spooked" and "By demonstrating that it is paying attention to these obvious signals, the Fed can help to bolster confidence in its economic management".
Let me stress that, at least from where I sit, that confidence in Federal Reserve economic management is, right now, lacking. ...
For eight straight years now the Federal Reserve has been more optimistic than the markets. And for eight straight years now the markets have been closer to being correct. And yet the Federal Reserve still believes that it "can't be led by what the market thinks" and has "got to make our own analysis"? Why? ...
Posted by Mark Thoma on Wednesday, July 6, 2016 at 11:10 AM
A Remarkable Financial Moment: The US 10 and 30 year interest rates today reached all time low levels of 1.32 percent and 2.10 percent. Record low 10 year interest rate were also registered in Germany, France, Switzerland and Australia. Notably Swiss 50 year interest rates are now for the first time negative. Rates out 15 years are negative in Germany and 9 years in France. ...
Remarkably the market does not now expect a full Fed tightening until early 2019. This is despite all the Fed speeches expressing optimism about the economy and a desire to normalize interest rates.
I believe that these developments all reflect a growing awareness of the importance of the secular stagnation risks that I have highlighted over the last several years. ...
Unfortunately markets have been much more aggressive in responding to events than policymakers. ... Having the right world view is essential if there is to be a chance of making the right decisions. Here are the necessary adjustments.
First..., neutral real interest rates are likely close to zero going forward. ...
Second, as counterintuitive as it is to central bankers who came of age when the inflation of the 1970s defined the central banking challenge, our problem today is insufficient inflation. ...
Third, in a world where interest rates over horizons of more than a generation are far lower than even pessimistic projections of growth, traditional thinking about debt sustainability needs to be discarded. ...Brad Delong and I set out in 2012 for expansionary fiscal policy to pay for itself are much more easily satisfied today than they were at that time.
Fourth, the traditional suite of structural policies to promote flexibility are not especially likely to be successful in the current environment... Indeed in the presence of chronic excess supply structural reform has the risk of spurring disinflation rather than the contributing to a necessary increase in inflation. There is in fact a case for strengthening entitlement benefits so as to promote current demand. ...
Posted by Mark Thoma on Wednesday, July 6, 2016 at 10:16 AM in Economics, Fiscal Policy, Monetary Policy |
Posted by Mark Thoma on Wednesday, July 6, 2016 at 12:06 AM in Economics, Links |
How Martin Feldstein Learned to Stop Worrying and Love Inflation: Martin Feldstein and I go back a ways. Not that I have ever met him, which I haven’t, or that he has ever heard of me, which he probably hasn’t, but I have been following his mostly deplorable commentary on Fed policy since at least 2010 when he published an op-ed piece in the Financial Times, “QE2 is risky and should be limited,” which was sufficiently obtuse to provoke me to write a letter to the editor in response. A year and a half later, after I had started this blog – five years ago to the day on July 5, 2011 – Feldstein wrote an op-ed (“The Federal Reserve’s Policy Dead End”) in the Wall Street Journal, to which he is a regular contributor, in which he offered another misguided critique of quantitative easing, eliciting a blog post from me in response.
Well, now, almost six years after our first encounter, Feldstein has written another op-ed (“Where the Fed Will Be When the Next Downturn Comes“) for the Wall Street Journal which actually shows some glimmers of enlightenment on Feldstein’s part. Always eager to offer encouragement to slow learners, I am glad to be able to report that Feldstein seems to making some headway in understanding how monetary policy operates. He is still far from having mastered the material, but he does seem to be on the right track. If he keeps progressing, the Wall Street Journal will probably stop publishing his op-eds, which would be powerful evidence that he had progressed in understanding of the basics of monetary policy. ...
Posted by Mark Thoma on Tuesday, July 5, 2016 at 07:44 PM in Economics, Inflation, Monetary Policy |
Republicans Talk a Better Game on the Economy Than Democrats: Over the weekend Brad DeLong wrote a post about Kansas Gov. Sam Brownback and how his disastrous tax cuts have decimated the state's economy. It prompted several of the usual comments, and DeLong highlights this one in particular:
The process Brownback has put the state on isn't something he regrets. And obviously over the next several years, Kansas will recover in that it won't get worse and will have growth that more or less tracks national growth. And at that point the state will declare Brownback's policies to be a "success."
This reminds me of something I've meant to point out for a while: economies always recover eventually.1 Conservatives take advantage of this fact by loudly and clearly insisting that their proposed tax cuts will supercharge economic growth. They know that eventually there will be growth, and when it happens they can then loudly and clearly insist that their tax cuts were responsible. Since they've been loudly and clearly saying this all along, ordinary citizens conclude that they're right.
Democrats don't really do this. When Barack Obama put together his various economic initiatives in 2009, for example, he was pretty circumspect about what they'd accomplish. Ditto for Bill Clinton in 1993. ...
Why is this? ...
...Republicans ... [ha]ve been focused like a laser beam on tax cuts as economic miracle workers for more than 30 years now. The fact that virtually no evidence supports this claim doesn't matter. Democrats, conversely, can't quite bring themselves to make the same unequivocal claim. Are they too embarrassed to just flatly lie about it? Too disorganized to agree on any one thing? Too muddled to make their points loudly and clearly? It is a mystery. ...
Posted by Mark Thoma on Tuesday, July 5, 2016 at 06:04 PM in Economics, Politics |
Kavya Vaghul at Equitable Growth:
U.S. democracy stuck in an “inequality trap”: Economic inequality in the United States appears to be trapped in a vicious cycle, as shown by several new working papers published today by the Washington Center for Equitable Growth alongside other recent research. Non-white, lower-income Americans are far less likely to vote than wealthier white citizens, and much of this participation gap is due to discriminatory practices at the ballot box. As a result, the political interests of lower-income minorities are not well-represented, and these interests are vastly different than those of their voting counterparts. This in turn means that policy decisions are made that exacerbate economic inequality and the inequalities that limit citizens’ voices in the first place.
To figure out how to break this cycle, social scientists need to understand what is happening at various points along the political continuum. So, let’s first examine new and existing research on the vote. ...
Posted by Mark Thoma on Tuesday, July 5, 2016 at 02:11 PM in Economics, Politics |
Posted by Mark Thoma on Tuesday, July 5, 2016 at 12:06 AM
Don't "mistake tough talk on trade for a pro-worker agenda":
Trump, Trade and Workers, by Paul Krugman, NY Times: Donald Trump gave a speech on economic policy last week. Just about every factual assertion he made was wrong, but I’m not going to do a line-by-line critique. What I want to do, instead, is talk about ... the candidate’s claim to be on the side of American workers. ...
About globalization: There’s no question that rising imports, especially from China, have reduced the number of manufacturing jobs..., completely eliminating the U.S. trade deficit in manufactured goods would add about two million manufacturing jobs.
But ... total employment exceeds 140 million. Shifting two million workers back into manufacturing would raise ... employment back from around 10 percent to around 11.5 percent. To get some perspective: in ... the 1960s it was more than 25 percent. ... Trumponomics wouldn’t come close to bringing the old days back.
In any case, falling manufacturing employment is only one factor in the decline of the middle class...
Mr. Trump..., even as he tried to pose as a populist ... repeated the same falsehoods usually used to justify anti-worker policies. We are, he declared, “one of the highest taxed nations in the world.” Actually, among 34 advanced countries, we’re No. 31. And, regulations are “an even greater impediment” to our competitiveness than taxes: Actually, we’re far less regulated than, say, Germany, which runs a gigantic trade surplus. ...
What’s important is that voters not mistake tough talk on trade for a pro-worker agenda.
No matter what we do on trade..., we need policies that give ... workers the essentials of a middle-class life. This means guaranteed health insurance — Obamacare brought insurance to 20 million Americans, but Republicans want to repeal it and also take Medicare away from millions. It means the right of workers to organize and bargain for better wages — which all Republicans oppose. It means adequate support in retirement from Social Security — which Democrats want to expand, but Republicans want to cut and privatize.
Is Mr. Trump for any of these things? Not as far as anyone can tell. And it should go without saying that a populist agenda won’t be possible if we’re also pushing through a Trump-style tax plan, which would offer the top 1 percent huge tax cuts and add trillions to the national debt.
Sorry, but adding a bit of China-bashing to a fundamentally anti-labor agenda does no more to make you a friend of workers than eating a taco bowl does to make you a friend of Latinos.
Posted by Mark Thoma on Monday, July 4, 2016 at 11:01 AM in Economics, Politics |
Posted by Mark Thoma on Monday, July 4, 2016 at 12:06 AM in Economics, Links |
Chris Waller, research director at the St. Louis Fed (and a classmate in graduate school) argues that "TBTF status leads to a wealth transfer from new buyers to existing holders of the debt":
Who Exactly Benefits from Too Big To Fail?: Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, has revived discussion of the Too Big To Fail (TBTF) issue for large U.S. financial institutions. TBTF arises when the government and regulators fear that a bank’s failure would cause widespread damage to the financial system. Consequently, when a large bank or highly interconnected bank is on the verge of failure, the government steps in and prevents its collapse. When this happens, howls are heard that the government is “bailing out” equity and bond holders at taxpayer expense and that the proper action is to wipe them out.
Why is having a bank labeled TBTF a problem? First, by being viewed as TBTF, a bank receives an insurance policy against default from taxpayers but does not pay a premium for this insurance. Second, being provided with this insurance creates moral hazard since bank management can undertake riskier activities and reap the higher returns while shifting the risk of default to the taxpayer. Note that the first benefit occurs even if the bank does not change the risk structure of its balance sheet—e.g., even if it does not engage in moral hazard. Thus, it is important to keep in mind that having TBTF status is not just about moral hazard. It is also about the provision of free insurance to the bank by the taxpayer. This latter point is often overlooked in discussions of TBTF.
But, as heretical as it may sound, are the current equity holders and bank creditors the true beneficiaries of the bailout? The answer depends on whether or not the TBTF designation for a bank was accounted for in its equity and debt prices at an earlier date. If a bank is declared TBTF unexpectedly at the moment it is about to default, then equity and bond holders are bailed out since their asset positions did not price-in this status at the time of purchase.
However, what if the TBTF designation was given prior to default? Looking back at the financial crisis, this seems to be the more-relevant case. Ron Feldman and Gary Stern warned about banks having this designation in their 2004 book, Too Big to Fail: The Hazards of Bank Bailouts, and the risks it created for the U.S. taxpayer. They point out that the failure of Continental Illinois in 1984, the seventh largest bank in the U.S. at the time, and the government’s generous treatment of unsecured creditors brought TBTF front and center into the public policy arena. Feldman and Stern succinctly summarize the TBTF problem: “The roots of the TBTF problem lie in creditors’ expectations...and the source of the problem is a lack of credibility” that the government will let them fail. Thus, the problem with TBTF is that a bank is viewed this way long before it actually gets into trouble.
It is exactly this timing that makes it difficult to determine who benefits from TBTF. To make this scenario as stark as possible, suppose the government knows that its promises to let bank A fail are not credible. So the government simply announces at date t that bank A is too big to fail and will be bailed out if it is on the verge of default.
What will happen at the time of this announcement? Bank A’s equity price will increase to reflect the absence of default risk associated with this new designation. Furthermore, the price of the bank’s outstanding debt and its newly issued debt will increase to reflect the elimination of default risk.
So who benefits from this? Well, obviously those holding equity claims on bank A when the TBTF status is announced. They get a capital gain on their shares from the price appreciation. The same is true for those holding bank A debt—the higher price of bank A debt would generate a capital gain to the debt holders at the time of the announcement. This all happens even if the bank does not change the riskiness of its portfolio.1
But what about those who buy bank A stocks and bonds after the announcement? If financial markets are efficient, then the TBTF status should be fully capitalized into the value of the bank. As a result, a risk-neutral investor would be indifferent between (i) buying the stock at a low price without TBTF protection and (ii) buying the stock at a higher price but with TBTF status. In short, new buyers are paying for the TBTF insurance via higher equity and bond prices. They do not receive a windfall from the TBTF status assigned to bank A.
To illustrate with a simple example, suppose bank A has an outstanding simple discount bond at time t that matures in period t +1with face value of $1. Assume the probability of default is zero in period t but occurs with an exogenous probability π > 0 in t + 1. If default occurs, the bond holder gets zero. Since default is purely exogenous, moral hazard does not come into play. In the absence of TBTF status, the time t price of the bond that a risk-neutral investor would pay to acquire the bond is
where i is the discount rate used by all investors. Note that the bond price reflects the probability of default.
Now suppose that, at the beginning of period t, the government announces that bank A is too big to fail. Then the bond price will instantly jump to
So the initial holder of the debt reaps a capital gain of
from selling his bond after the announcement. However, the new buyer has to pay a higher bond price to get this “insurance” from the government. Thus, the TBTF status leads to a wealth transfer from new buyers to existing holders of the debt. Note that the difference p̂t – pt is the fair market price for the insurance (the “premium”) that the existing bond holder would be willing to pay to avoid default. So, in short, the government provides the insurance but existing bondholders collect the premium from new buyers of the debt.2
A similar exercise can be done with equity pricing as well. Suppose the firm faces a constant and exogenous probability π of failing each period and pays a dividend d if it doesn’t fail and 0 otherwise. Using a simple present discounted value formula applied to the dividend stream yields the equity share price
Once the bank is declared TBTF, default goes to zero and the equity price jumps to3
which yields a capital gain of
But what about the buyers of bank A equity after the announcement? As we can see, they paid a much higher equity price in response. Again, they are paying for the default protection.4 The equity holders at the time of the announcement are the ones who reap the rewards of the TBTF status.
Now suppose the government chose to let bank A fail after this announcement and wiped out the equity holders and creditors. Well, the initial bondholders would not care. They received the insurance premium and sold the bond. They do not suffer. However, those who bought the bond at price p̂t “paid” for insurance but did not get the promised payoff. They actually lose.5 Hence, it is not surprising that they would be upset by the government’s action. Who wouldn’t be upset after paying for insurance that didn’t pay off when it should have?6
A similar argument applies to equity holders. The initial stock holders wouldn’t care. They reaped their capital gains by selling their shares to new buyers. But a shareholder who bought shares at êt would again argue that they paid for the default protection. They would not be happy if they are told it’s “fair” that they should be wiped out ex post. If someone held a share of bank A stock prior to the time of the announcement until the government allowed them to fail, then they would receive no capital gain and would be wiped out appropriately since they paid et not êt. This seems to be the view of those opposed to bailing out equity holders: that those holding equity at the time of bank A’s failure were the same ones holding equity when the TBTF status was announced.
Moral hazard is a separate issue and an important one. But a similar logic applies. Bond holders care only about the default insurance. They do not reap the additional earnings from the riskier portfolio. Suppose the government sold a credit default swap (CDS) to potential buyers of bank A’s debt. They would be willing to pay p̂t > 0 for the CDS and nothing more. Is this enough to compensate the government for taking on this risk? Most likely not, since under moral hazard the risk of default increases, say, to π̄ > π. But this is not the new bondholders’ problem. It’s a problem between the government and the equity owners.
For equity holders, moral hazard would imply bank management undertakes actions such that π̄ > π and d̄ > d. If markets could properly assess this behavior in pricing bank A’s changed risk structure, then the equity price would be
which reflects the fact that the shareholders reap the higher dividend stream but the government absorbs the downside risk since π̂does not appear. As before, a new buyer of equity is paying for (i) the default protection and (ii) the higher dividend stream arising from moral hazard. So, yes, they receive the benefits of moral hazard in the form of higher dividend payments but they paid for it via the price they paid to acquire the stock. The problem once again is that the government absorbs the downside risk but isn’t compensated for it by the equity holders at the time of the announcement. How severe the moral hazard problem is depends on its quantitative importance. And research is only now beginning to explore this.7
To summarize, the value of being designated TBTF is capitalized into the price of a firm’s equities and its bonds. TBTF provides a windfall capital gain to shareholders and creditors at the time of the designation. But after that, new buyers of equities and debt are paying for that status. Consequently, determining who gets “bailed out” when an institution is TBTF is a more complicated task than it appears.
If the government is unable to commit to letting banks fail or breaking them up is not a serious option, then the best that can be done is compensate taxpayers for the default insurance it provides to large financial institutions. Minneapolis Fed President Kashkari has advocated turning the banks into financial public utilities and regulating them accordingly. An alternative may be to have the government sell CDSs against the debt of large financial institutions. Debt holders would then pay the government directly for this insurance. Having the U.S. government sell insurance is already a common policy: The U.S. government currently sells crop insurance, flood insurance, disability insurance, etc. So it is not unprecedented. While this may not solve the moral hazard problem, it at least compensates taxpayers for providing default insurance.
1 The same logic applies to stock options of senior management. If the announcement of TBTF causes the equity price to jump high enough, then the strike price is below the market price of the stock, meaning senior executives are “in the money” and get a capital gain from their stock options.
2 Another way to think about this is to assume the government issues a credit default swap. If it sold the CDS on the market it would receive the premium p̂t – pt from the buyer of the CDS. If default does not occur, the taxpayer makes a profit from the CDS; if default does occur, the taxpayer is on the hook for the loss. Now suppose the government gives the CDS to the existing bondholders and lets them sell it. The current bondholders get the premium as a windfall profit without absorbing any risk. Meanwhile, the taxpayer gets zero if no default occurs and is on the hook for $1 if default occurs. The buyer of the CDS is not bailed out—he paid the fair market price for the insurance.
3 Since bond financing costs are lower, this would allow for a higher dividend payment after TBTF status is announced. Nevertheless, this is priced-in for new buyers of the equity.
4 Again, senior managers who join bank A after the TBTF designation now face a higher strike price for their stock options, which effectively lowers their executive compensation.
5 This applies even if the government could credibly remove the TBTF status of bank A.
6 This line of reasoning also applies to many situations. For example, consider the mortgage interest rate deduction. Many argue that it is a subsidy to homeowners and should be eliminated. However, the deduction has now been capitalized into the price of the house so a new owner would actually take a capital loss if the deduction was removed. Again, new homeowners have paid for the subsidy and get very angry when elimination of the mortgage interest deduction is discussed.
7 See Javier Bianchi’s “Efficient Bailouts” (forthcoming in American Economic Review; https://www.minneapolisfed.org/research/wp/wp730.pdf) for an excellent attempt at quantifying the moral hazard problem in banking. Bianchi’s main finding is that moral hazard is not quantitatively important if bailouts are systematic as opposed to being focused on a particular bank.
Posted by Mark Thoma on Sunday, July 3, 2016 at 11:46 AM in Economics, Financial System, Regulation |
Posted by Mark Thoma on Sunday, July 3, 2016 at 12:06 AM in Economics, Links |
Posted by Mark Thoma on Saturday, July 2, 2016 at 12:06 AM in Economics, Links |
Markets and states are complements: The main point of my 1999 book with Jeff Williamson was that globalisation produces both winners and losers, and that this can lead to an anti-globalisation backlash. ...
What was missing from all this was an analysis of what, if anything, governments can do about this. Which is where Dani Rodrik’s finding that more open states had bigger governments in the late 20th century comes in. Dani’s interpretation is that markets expose workers to risk, and that government expenditure of various sorts can help protect them from those risks. In a series of articles, and an important book, Michael Huberman showed that this correlation between states and markets was present before 1914 as well: countries with more liberal trade policies tended to have more advanced social protections of various sorts, and this helped maintain political support for openness.
Anti-immigration sentiment was clearly crucial in delivering an anti-EU vote in England. And if you talk to ordinary people, it seems clear that competition for scarce public housing and other public services was one important factor behind this. If the Tories had really wanted to maintain support for the EU, investment in public services and public housing would have been the way to do it: if these had been elastically supplied, that would have muted the impression that there was a zero-sum competition between natives and immigrants. It wouldn’t have satisfied the xenophobes, but not all anti-immigrant voters are xenophobes. But of course the Tories were never going to do that, at least not with Osborne at the helm.
If the English want continued Single Market access, they will have to swallow continued labor mobility. There are complementary domestic policies that could help in making that politically feasible. ...
Too much market and too little state invites a backlash. Take the politics into account, and it becomes clear (as Dani has often argued) that markets and states are complements, not substitutes.
Posted by Mark Thoma on Friday, July 1, 2016 at 08:41 AM in Economics, Immigration, International Trade, Social Insurance |
U.S. top one percent of income earners hit new high in 2015 amid strong economic growth: The top 1 percent income earners in the United States hit a new high last year, according to the latest data from the U.S. Internal Revenue Service. ... The latest IRS data show that incomes for the bottom 99 percent of families grew by 3.9 percent over 2014 levels, the best annual growth rate since 1998, but incomes for those families in the top 1 percent of earners grew even faster, by 7.7 percent, over the same period. ...
After a large decline of 11.6 percent from 2007 to 2009, real incomes of the bottom 99 percent of families registered a negligible 1.1 percent gain from 2009 to 2013, and then grew by 6.0 percent from 2013 to 2015. Hence, a full recovery in income growth for the bottom 99 percent remains elusive. Six years after the end of the Great Recession, those families have recovered only about sixty percent of their income losses due to that severe economic downturn.
In contrast, families at or near the top of the income ladder continued to power ahead. ... The share of income going to the top 10 percent of income earners—those making on average about $300,000 a year—increased to 50.5 percent in 2015 from 50.0 percent in 2014, the highest ever except for 2012. The share of income going to the top 1 percent of families—those earning on average about $1.4 million a year—increased to 22.0 percent in 2015 from 21.4 percent in 2014.
Income inequality in the United States persists at extremely high levels, particularly at the very top of the income ladder. ... This ... is unfortunately on par with a long-term widening of inequality since 1980, when the top 1 percent of families began to capture a disproportionate share of economic growth. ...
Policymakers ... need to grasp whether past efforts to raise taxes on the wealthy—in particular the higher tax rates for top U.S. income earners enacted in 2013 as part of the 2013 federal budget deal struck by Congress and the Obama Administration—are effective at slowing income inequality.
The latest data from the IRS suggests the 2013 reforms proved to be fleeting in terms of reducing income inequality. There was a dip in pre-tax income earned by the top one percent in 2013, yet by 2015 top incomes are once again on the rise—following a pattern of growing income inequality stretching back to the 1970s.
Posted by Mark Thoma on Friday, July 1, 2016 at 08:07 AM in Economics, Income Distribution |
Posted by Mark Thoma on Friday, July 1, 2016 at 12:06 AM in Economics, Links |
Ben Bernanke at Brookings:
How do people really feel about the economy?: Political outsiders have had quite a good year in the United States (and elsewhere), and many pundits have attributed their success to voters’ profound dissatisfaction with the economy. Certainly there is plenty to be dissatisfied about, including growing inequality of income and wealth and stagnation in real wages. But there are positives as well, including an improving labor market, low inflation, and low gasoline prices. How do people really feel about the U.S. economy?
This post will not tackle the substance of Americans’ worries about the economy but instead highlights a puzzle... I’ll show that, when Americans are asked specifically about the economy, in an apolitical context, they are for the most part not nearly as pessimistic as the conventional wisdom would have it. ... But, at the same time, when asked more generally about the way things are going in the United States, or about whether the country is going in the right direction, a strong majority gives downbeat answers... I end the post with a few thoughts on possible reasons. ...
There are of course multiple possibilities, not mutually exclusive. For example, traumatic national events, including the 9/11 attacks and the 2007-2009 financial crisis, may have had lasting effects on public confidence that are not captured in their near-term assessments of economic performance. (Satisfaction with the way things are going did begin a sustained decline around 2001, at about the time of 9/11, the end of the tech bubble, and the 2001 recession.) It may also be that, in responding to broad questions about the direction of the country, people are taking into account non-economic concerns, such as social problems and cultural fears. Such factors must certainly be part of the story, but it should be noted that many social indicators (such as teenage births and crime rates) have been moving in generally favorable directions.
I suspect that greater social and political polarization itself has a role to play in explaining reported levels of dissatisfaction. To an increasing extent, Americans are self-selecting into non-overlapping communities (real and virtual) of differing demographics and ideologies, served by a fragmented and partisan media. ...
In a highly polarized environment, with echo-chamber media, political debates often become shrill, and commentators and advocates have strong incentives to argue that the country’s future is bleak unless their party gains control. In this environment, it seems plausible that people will respond more intensely and negatively to open-ended questions about the general state of the country, while questions in a survey focused narrowly on economic conditions elicit more moderate responses. Without doubt, the economic problems facing the country are real, and require serious and sustained responses. But while perceptions of economic stress are certainly roiling our national politics, it may also be that our roiled politics are worsening how we collectively perceive the economy.
Posted by Mark Thoma on Thursday, June 30, 2016 at 09:31 AM in Economics, Politics |
The continued rigidity of wages in the United States: “Wage rigidity” is an important feature of many models of the macroeconomy...
Some research on wage rigidity challenges this assumption. Pointing to data on individual wage growth, some economists argue that the wages of new hires is more important. If wages are really rigid, then the inflation-adjusted wages of new hires won’t vary as recessions come and go. Yet these researchers can point to data showing the wages of new hires moving up during economic expansions and down during recessions. So perhaps wages are more flexible than some think.
Now comes a new paper that shows how the cyclical nature of the wages of new hires isn’t really evidence against wage rigidity. The working paper, by economists Mark Gertler of New York University, Christopher Huckfeldt of Cornell University, and Antonella Trigari of Bocconi University, was released earlier this month. The three economists’ major point is to show that looking at the wages of all new hires in the United States is lumping together two groups of workers with different experiences. There are new hires who were previously unemployed and then there are new hires who were previously employed. ...
What they find is that the trends in wages for these two different groups of new hires are clearly different. The wages for new hires from the unemployment line don’t vary much more over time than the wages of already employed workers. But the wages of new hires from the ranks of the already employed do vary. This phenomenon, however, is less about flexible wages and more about workers moving up the job ladder, which mostly only happens during economic expansions, and is the reason why wages for these new hires move with economic cycles.
Outside of the implications for macroeconomic models of the labor market during recessions, the results from Gertler, Huckfeldt, and Trigari are also a reminder of the effects an economic downturn can have on workers’ career earnings. Recessions hinder the hiring of already employed workers, which hurts their chances of climbing the job ladder and future wage gains. Downturns don’t just harm the workers who lose jobs, but also the ones who keep their jobs.
Posted by Mark Thoma on Thursday, June 30, 2016 at 08:24 AM in Economics, Macroeconomics, Unemployment |
Posted by Mark Thoma on Thursday, June 30, 2016 at 12:06 AM in Economics, Links |
Luigi Zingales at ProMarket:
The Real Lesson From Brexit: ...What we have observed in Britain and ... in the U.S. with Trump is a growing mistrust of voters toward experts. In the Brexit debate it was hard to find any economist justifying a departure from the European Union. In fact, many were willing to make forecasts so pessimistic as to be accused of scaremongering. Not only did these forecasts fail to rally the vote for Remain, they probably contributed to the victory of Leave.
In the Financial Times Chris Giles lamented this phenomenon as an example of voters’ irrationality. I fear this has nothing to do with irrationality, but has everything to do with mistrust; a mistrust that, while exaggerated, has a very rational basis: the disconnect between the intellectual elite and the population at large–the very disconnect that caused pollsters, betters, and journalists to miss the mounting Brexit wave. ...
Today wealth concentration allows a few rich individuals to singlehandedly fund think tanks, which have increasingly become loudspeakers of vested interests, rather than centers of elaboration of public policy. Campaign financing and future lobbying jobs are increasingly transforming elected officers from representatives of the people to “butlers of industrial interests,” to use a famous muckraking expression.
The effects are there for all to see. Doctors are perceived to promote the medicines of the companies that sponsor their lunches...; scientists to minimize the effect of pollutants produced by companies that fund their labs; economists to defend the interests of banks that pay them hefty consulting fees. Even journalists, when they are not perceived to promote the interest of their advertisers and owners, are accused of turning a blind eye to their problems. ...
Even when there is no financial incentive distorting experts’ views, there is a cultural affinity between the experts and the economic and political elites. A combination of legacy admissions and selection based on the quality of the high school (and thus the census) the students come from has created an increasingly homogenous academic population at top colleges, detached from the vast majority of the country. Scientists, journalists, and intellectuals all belong to the same world and so inevitably look at the world from the same perspective.
All these factors together lead to a mistrust toward experts. They lead to a presidential candidate who is proud not to rely on them and receives support for this reason. They lead to political decisions, like Brexit, that might have negative consequences for the very people who voted for it. ...
Fault does not lie with the people mistrusting us. We need to rebuild that trust. It is not sufficient that most doctors, intellectuals, and journalists do a very fine job. We should have transparency rules in place to ensure that they all free from conflict of interest. We should have admission rules that favor not just ethnic diversity, but also economic and social diversity. We should have campaign financing rules that free our representatives from the yoke of vested interests.
In sum, we need to create the conditions to undermine this mistrust of experts. This is the most important lesson from Brexit.
Posted by Mark Thoma on Wednesday, June 29, 2016 at 11:57 AM in Economics |
Powell First Out Of The Gate, by Tim Duy: The first Fed speaker of the post-Brexit era delivered a decidedly dovish message. Confirming the expectations of market participants, Federal Reserve Governor Jerome Powell made clear that the Fed was in a holding pattern until the dust settles. Much of the material is similar in content to his May speech, but the shift in emphasis and nuance indicate a substantially policy path.
Powell summarizes the economic situation as:
How should we evaluate our current performance against the dual mandate? I would say that we have made substantial progress toward maximum employment, although there is still some room for improvement. We have more work to do to assure that inflation moves back up to our 2 percent goal.
Both points are important. On the first point, Powell sees evidence of labor market slack in low participation rates, high numbers of part-time workers, and low wage growth. Recent labor reports concern him:
While I would not want to make too much of two monthly observations, the strength of the labor market has been a key feature of the recovery, allowing us to look through quarterly fluctuations in GDP growth. So the possible loss of momentum in job growth is worrisome.
My guess is that they will want to see a string of 2 or 3 solid labor reports before they breathe easier. Still, by acknowledging that the economy is operating near full employment, does he open the door to concerns about inflation? No:
When I was first exposed to macroeconomics in college, more than four decades ago, the view was that inflation was strongly influenced by the amount of slack in the economy. But the relationship between slack and inflation has weakened substantially over the years.
Or, in other words, the Phillips Curve is flat. Not quite flat as a pancake, but pretty darn flat. More important:
In addition, inflation depends importantly on the inflation expectations of workers and firms. A widely shared view among economists today is that, unlike during the 1970s, expectations are no longer heavily influenced by fluctuations in inflation, but are fairly constant, or anchored. For both these reasons, inflation has become less responsive to cyclical changes in the economy.
And what is happening to inflation expectations:
We measure inflation expectations through surveys of forecasters and the general public, and also through market readings on inflation swaps and "breakevens," which represent inflation compensation as measured by the difference between the return offered by nominal Treasury securities and that offered by TIPS. Since mid-2014, these market-based measures have declined significantly to historically low levels. Some of this decline probably represents lower risk of high inflation, or an elevated liquidity preference for much more heavily traded nominal Treasury securities, rather than expectations of lower inflation. Some survey measures of inflation expectations have also trended down.
The signs are worrisome:
Given the importance of expectations for determining inflation, these developments deserve, and receive, careful attention. While inflation expectations seem to me to remain reasonably well anchored, it is essential that they remain so. The only way to assure that anchoring is to achieve actual inflation of 2 percent, and I am strongly committed to that objective.
By downplaying the importance of slack while emphasizing the importance of inflation expectations, he is neutering the primary argument of Fed hawks who insist that approaching full employment necessitates higher interest rates to stay ahead of inflationary pressures. The line about achieving actual inflation of 2 percent could be a nod toward Evans Rule 2.0. Something to keep an eye on.
The impact of Brexit and the subsequent market turmoil is straightforward:
These global risks have now shifted even further to the downside, with last week's referendum on the United Kingdom's status in the European Union. The Brexit vote has the potential to create new headwinds for economies around the world, including our own. The risks to the global outlook were somewhat elevated even prior to the referendum, and the vote has introduced new uncertainties.
And the implication for monetary policy:
It is far too early to judge the effects of the Brexit vote. As the global outlook evolves, it will be important to assess the implications for the U.S. economy, and for the stance of policy appropriate to foster continued progress toward our objectives of maximum employment and price stability.
Notice that he does not warn that rate hikes are coming! Compare to his May speech:
If incoming data continue to support those expectations, I would see it as appropriate to continue to gradually raise the federal funds rate. Depending on the incoming data and the evolving risks, another rate increase may be appropriate fairly soon.
He is wisely now mum on the timing of the next rate hike. More Fed speakers will follow him than not.
But Brexit alone is not the only factor depressing the rate outlook:
I am often asked why rates remain so low now that we are near full employment. A big part of the answer is that, at least for the time being, the appropriate level of rates is simply lower than it was before the crisis. As a result, policy is not as stimulative as it might appear to be. Estimates of the real interest rate needed to keep the economy on an even keel if it were operating at 2 percent inflation and full employment--the "neutral rate" of interest--are currently around zero. Today, the real short term interest rate is about negative 1-1/4 percent, so policy is actually only moderately stimulative. I anticipate that the neutral rate will move up over time, as some of the headwinds that have weighed on economic growth ease.
The Fed increasingly recognizes that policy is not highly accommodative simply because rates are zero. The stance of policy is relative to the real interest rate, and a lower real rate means that policy is actually only "moderately" stimulative. Translation: There is no need to hike rates soon because policy is not particularly accommodative.
Missing now is this warning from May:
There are potential concerns with such a gradual approach. It is possible that monetary policy could push resource utilization too high, and that inflation would move temporarily above target. In an era of anchored inflation expectations, undershooting the natural rate of unemployment should result in only a small and temporary increase in the inflation rate. But running the economy above its potential growth rate for an extended period could involve significant risks even if inflation does not move meaningfully above target. A long period of very low interest rates could lead to excessive risk-taking and, over time, to unsustainably high asset prices and credit growth. Macroprudential and other supervisory policies are designed to reduce both the likelihood of such an outcome and the severity of the consequences if it does occur. But it is not certain that these tools would prove adequate in a financial system in which much intermediation takes place outside the regulated banking sector. Thus, developments along these lines could ultimately present a difficult set of tradeoffs for monetary policy.
By not reiterating this risk, Powell removes an argument to raise rates even inflation remains below target, the financial stability risk. But how much of a risk is it? If the natural rate of interest is lower, than the potential for financial market instability is also lower for a given interest rate. Or, in other words, since monetary policy is not as accommodative as previously believed, the risk of financial instability is lower.
Bottom Line: Powell embraces the lower real interest rate story as a reason that monetary policy is only moderately accommodative, warns that downside risks are rising, replaces expectations of a rate hike in the imminent future with only guidance that rates will be appropriate to foster economic growth, and drops concerns about the risks of a sustained low rate environment. The key takeaway - no expectation that an imminent rate hike will be needed. Gradual to glacial to just nothing.
Posted by Mark Thoma on Wednesday, June 29, 2016 at 12:15 AM in Economics, Fed Watch, Monetary Policy |
Posted by Mark Thoma on Wednesday, June 29, 2016 at 12:06 AM in Economics, Links |
I have a new column:
Why the Public Has Stopped Paying Attention to Economist: The predictions from economists about the consequences of Brexit were widely ignored. That shouldn’t be surprising. In recent years the public has lost faith the in the economics profession.
One reason for the lack of faith is the failure to predict the Great Recession, but the public’s dismissal of macroeconomists is based upon more than the failure to foresee the dangers the housing bubble posed for the economy. It is also due to false promises about the benefits to the working class from globalization, tax cuts for the wealthy, and trade agreements – promises that were often used to support ideological and political goals or to serve special interests. ...
Posted by Mark Thoma on Tuesday, June 28, 2016 at 06:13 AM in Economics, Macroeconomics |
Jason Furman at ProMarket:
Productivity, Inequality, and Economic Rents: Productivity growth—a necessary (though not sufficient) condition for rising incomes in the long run—has slowed since 1973... At the same time, inequality in the United States is higher and, in recent decades, has risen faster than in other major advanced economies. ...
These dual trends ... have many distinct sources, but insofar as they have some causes in common, there is the potential to address these causes in ways that simultaneously improve efficiency and equity. To this end, the evidence that a rise in rents is contributing to both phenomena is important. ...
The good news is that to the degree that the “rents” interpretation is correct, it suggests that it is possible to reduce inequality and promote productivity growth without hurting efficiency by changing how rents are divided—or even that it is possible to do both while increasing efficiency by acting to reduce rents in the economy. Policies that raise the minimum wage and provide greater support for collective bargaining can help level the playing field for workers in negotiations with employers, in turn changing the way that rents are divided. Measures that would rationalize licensing requirements for employment, reduce zoning and other land-use restrictions, appropriately balance intellectual property regimes, and change the incentives that have led to the expansion of the financial sector as a share of the economy would all help curb excessive rents.
Additional measures that would reduce the scope and unequal distribution of economic rents include the promotion of competition through rulemaking and regulations, as well as the elimination of regulatory barriers to competition. ...
The bad news, however, is that rents have beneficiaries and these beneficiaries fight hard to keep and expand their rents. As a result, political reforms and other steps aimed at curbing the influence of regulatory lobbying are important for reducing the ability of people and corporations to seek rents successfully. Such actions would help ensure that economic growth in the decades ahead is robust, sustainable, and widely shared.
Posted by Mark Thoma on Tuesday, June 28, 2016 at 12:15 AM in Economics, Income Distribution, Market Failure, Productivity |
Posted by Mark Thoma on Tuesday, June 28, 2016 at 12:06 AM in Economics, Links |
Fed Once Again Overtaken By Events, by Tim Duy: With global financial markets reeling in the wake of Brexit - Britain's unforced error as a political gamble went too far - the Fed is back on the sidelines. A July hike was already out of the question before Brexit, while September was never more than tenuous, depending on the data falling in place just right. Now September has moved from tenuous to "what are you thinking?" Indeed, the debate has shifted in the opposite direction as market participants weigh the possibility of a rate cut. The Fed is probably not there yet, but internally they are probably increasingly regretting the unforced error of their own - last December's rate hike.
The primary economic challenge now is the uncertainty created by the British decision. No one knows what the ultimate end game will be, and how long it will take to get there. Indeed, given the political vacuum in the UK, it appears that pro-Leave politicians really had no plan because they never thought it would actually happen. At lest partially in consequence, any exit promises to be a long process that if recent European history is any guide will prove to be repeated games of chicken between the UK and the EU.
So uncertainty looks to dominate in the near term. And market participants hate uncertainty. The subsequent rush to safe assets - and with it a tightening of financial conditions - is evident in plunging government bond yields and a resurgent dollar. The Fed's initial response was a fairly boilerplate statement:
The Federal Reserve is carefully monitoring developments in global financial markets, in cooperation with other central banks, following the results of the U.K. referendum on membership in the European Union. The Federal Reserve is prepared to provide dollar liquidity through its existing swap lines with central banks, as necessary, to address pressures in global funding markets, which could have adverse implications for the U.S. economy.
More direct action depends on the length and depth of the financial turmoil currently underway. I think the Fed is far more primed to deliver such action than they were a year ago. And that ultimately is good news for the economy as it will minimize the domestic damage from Brexit.
The Fed began 2015 under the direction of a fairly hawkish contingent that viewed rate hikes as necessary to be ahead of the curve on inflation. Better to raise preemptively than risk a sharper pace of rate hikes in the future. In other words, it was important to remove financial accommodation as the headwinds facing the economy receded and labor markets approached full employment. As the year progressed, however, the need for less financial accommodation never became evident. Indeed, I would argue that asset markets were telling exactly the opposite, that there was far less accommodation than the Fed believed. Fed hawks were slow to realize this, and, despite the financial turmoil of last summer, forced through a rate hike in December. I think this rate hike had more to do with a perceived need to be seen as "credible" rather than based in economic necessity. I suspect doves followed through in a show of unity for Chair Janet Yellen. They should have dissented.
Markets stumbled again in the early months of 2016, and, surprisingly, Fed hawks remained undeterred. Federal Reserve Vice Governor Stanley Fischer scolded financial market participants for what he thought was an overly dovish expected rate path. And even as recently as prior to the June meeting, Fed speakers were highlighting the possibility of a June rate hike, evidently with the only goal being to force the market odds of a rate hike higher.
But I think that as of the June FOMC meeting, the hawkish contingent has been rendered effectively impotent. Simply put, had they been correct, the US economy should have been surging ahead by now, with more evident inflationary pressures. The hawks were far too early with such a prediction. It became increasingly apparent that maybe the yield curve was telling an important story they should heed. Low long-term yields were never consistent with the Fed's outlook, and, when combined with tepid activity, suggested that the Fed's long-term guide, the natural rate of interest, was much lower than anticipated.
Consequently, I suspect the Fed will be much more responsive to the signal told by the substantial drop in long-term yields that began last Friday (as I write the 10 year is hovering about 1.46%) then they may have been a year ago. The drop in yields will feed into their current anxiety about the level of the natural rate of interest, and as a consequence they will more quickly realize the need to accommodate financial markets to limit any undesirable tightening of financial conditions. I expect some or all of the following options depending on the degree of financial market and real economic distress:
1.) Forward guidance I. Fed speakers will concur with financial market participants that policy is on hold until the dust begins to settle. Optimally, they will dispense with all talk of rate hikes as it is unnecessary and unhelpful at this juncture.
2.) Forward guidance II. They will reinforce point I in the next FOMC statement. Watch for the balance of risks to reappear - it seems reasonable to believe they have shifted decidedly to the downside.
3.) Forward guidance III. This would be an opportune time for Chicago Federal Reserve President Charles Evans to push through Evans Rule 2.0. No rate hike until core inflation hits 2% year-over-year. The Fed could justify such a move as a response to the uncertainty surrounding the natural rate. Essentially, rather than using an unknown variable as a guide, use a know variable.
4.) Forward guidance IV. A lower path of dots in the next Summary of Economic projections to validate market expectations.
5.) Rate cut. Former Minneapolis Federal Reserve President Narayana Kocherlakota argues that the Fed should just move forward with a rate cut in July. I concur; I continue to believe that the Fed has the best chance of exiting the zero bound at some point in the future by utilizing more aggressive policy now. That said, I don't expect this to be the Fed's first option. Moving beyond forward guidance will require evidence that the US economy is set to slow sufficiently to push the employment and inflation mandates further out of reach.
6.) If all else fails. If some combination of 1 through 5 were to fail, the Fed will turn to more QE and/or negative rates. I think the former before the latter because it is more comfortable for them.
Bottom Line. The Fed will stand down for the moment; where they go down the road depends upon the depth and length of current disruption. I think at this point it goes without saying that if you hear a Fed speaker talking about July being on the table or confidently warning about two or three rate hikes this year, you should ignore them. Perhaps we can have that conversation later with regards to the December meeting, but certainly not now. Most Fed officials will stick to the script and downplay the possibility of a rate hike and instead focus on the Fed moves to the sidelines angle. I still think an interesting scenario is one in which the Fed needs to accept above target inflation because global financial stability will depend on a very accommodative Federal Reserve, but that hypothesis will only be tested once inflation actually hits target.
Posted by Mark Thoma on Monday, June 27, 2016 at 11:50 AM in Economics, Fed Watch, Monetary Policy |
Cecchetti & Schoenholtz:
A Primer on Helicopter Money: ... We are wary of joining the cacophony of commentators on helicopter money, but our sense is that the discussion could use a bit of structure. So, as textbook authors, we aim to provide some pedagogy. (For the record, here are links to Ben Bernanke’s excellent blog post, to a summary of Vox posts, and to Willem Buiter’s technical paper.)
To understand why helicopter money is not just another version of unconventional monetary policy, we need to describe both a bit of economic theory and some relevant operational practice. We use simple balance sheets of the central bank and the government to explain.
First, some background. In the 1960s, Milton Friedman described what he believed to be a surefire mechanism that central banks could use to generate inflation (were that desired): drop currency straight from helicopters on to the population, while promising never to remove it from circulation. The result would be higher prices (and, if you keep doing this, inflation). ...
Now, there are three problems with this thought experiment. First, transferring funds to households is what fiscal policymakers do, not central bankers. The latter issue central bank money to acquire assets. Second, except when interest rates are at the effective lower bound (ELB), monetary policymakers today control interest rates, not the monetary base (or another monetary aggregate). The monetary base is determined by the demand of individuals to hold currency and of banks to hold reserves at the central bank’s interest rate target. In practical terms, this means that the central bank cannot credibly promise to permanently increase the monetary base. Third, 21st century central banks pay interest on reserves. And they do so precisely to control the level of interest rates in the economy.
What this means is that the notion of helicopter money today is necessarily different from what Friedman had in mind. ...
Does this make any difference? Is helicopter money in this setting any different from standard QE when the Fed purchased long-term bonds in exchange for reserves in an effort to flatten the yield curve? Since the alternative is for the fiscal authorities to sell long-term bonds, the answer is no. ...
We are left with a simple conclusion. Helicopter money today is different from what Milton Friedman imagined; it is expansionary fiscal policy financed by central bank money. And, if interest rates have fallen to the ELB, it is neither more nor less powerful than any bond-financed cut in taxes or increase in government spending in combination with QE.
[There is quite a bit more detail and explanation in the full post.]
Posted by Mark Thoma on Monday, June 27, 2016 at 11:01 AM in Economics, Monetary Policy |
Roberto Astolfi of the OECD Statistics Directorate:
Did the OECD Composite Leading Indicators see it coming?: ...Professor Luis Garicano of the London School of Economics is ... the man Queen Elizabeth asked “Why did no one see it coming?”; “it” being the crisis. In retelling the story, Pr. Garicano pointed out that he welcomed the question as it provided an opportunity to cite many that did see it coming, including Messrs, Krugman and Volcker. Was the OECD among them?
At the OECD, we use a number of techniques to determine what the data are telling us is happening now and what might happen in the future. ... One ... technique used by the OECD Statistics Directorate is the system of Composite Leading Indicators (CLIs). Simply put, the CLIs combine individual indicators for a given country to anticipate when economic expansion starts entering a downturn, or when growth starts to return. A relevant question in this context therefore is:
How useful were the OECD CLIs just before the crisis? ...
Using the most recent statistical information, (in other words, including any revisions that may have been made in the interim) Gyomai and Guidetti in 2011 concluded that the “CLI was able to anticipate the downturn in the real economy at least 5 months ahead...
A more stringent approach is to review the performance of the CLI at the time of the crisis using only the statistical information that was then available... Nevertheless,... the latest results confirm ... that the statistical and methodological revisions that have occurred since the crisis have not shifted CLI turning points to earlier dates, nor have they artificially improved the CLI performance.
Overall then, the OECD CLIs proved to be a robust tool in anticipating the crisis some months before GDP reached its pre-crisis high watermark, and so, perhaps they can be added to the list of illustrious names that can be quoted the next time somebody asks ‘why did no-one see it coming’. Moreover, although, by their very nature and design, CLIs are not able to quantify the magnitude of slowdowns or upturns, and, so, could not quantify the severity of the crisis, the increasing downbeat tone of assessments that followed the first warning in September 2007 provided strong pointers.
Posted by Mark Thoma on Monday, June 27, 2016 at 11:01 AM in Economics |
Posted by Mark Thoma on Monday, June 27, 2016 at 12:06 AM in Economics, Links |
Property Rights, the Income Distribution and China: ...why has the distribution of income, in the United States and Europe, tilted towards capital and away from labor over the past few decades? There is growing evidence that this redistribution is connected with the opening of trade with China. Globalization has lifted a billion Chinese workers out of poverty and it has led to huge income gains for Americans and Europeans at the top of the income and wealth distributions. These gains have not been shared with middle class and working class people in the US and Europe. ...
It is ... possible to conceive of alternative forms of democracy that would provide greater rights to workers. Workers councils, for example, have proved to be relatively successful in Germany.
The concept of private property is contingent on rights that are defined and enforced by national governments. Those rights are constantly evolving. When the US founding fathers signed the Declaration of Independence, it was still possible to buy and sell human beings. The idea that a national government would enforce the property rights of a slave owner is, to today's sensibilities, abhorrent. It is entirely possible that a system of property rights that allows a factory owner to close down a large manufacturing plant without consulting the workers whose livelihoods depend on its continued operation, will, in another two hundred years, appear to be equally abhorrent.
[This is part of a discussion of whether intervention in financial markets necessarily leads to an upward redistribution of income.]
Posted by Mark Thoma on Sunday, June 26, 2016 at 01:38 PM in Economics, Income Distribution |
Posted by Mark Thoma on Sunday, June 26, 2016 at 12:06 AM in Economics, Links |
Brad Delong (The VoxEU column is in the post below this one):
In Which I Call for Academic Scribblers and Funct Economists to Enter into Utopian Frenzy with Respect to the Institutional Design of the Eurozone: From my perspective, this piece at Vox.eu makes many too many bows to conventional-wisdom idols with not just feet but bodies and heads of clay. Thus I cannot sign on to it.
The situation is dire. The Eurozone as currently constituted has been a macroeconomic disaster.
The forecast that the authors make is that on the current policy path "economic health will eventually be restored, unemployment will decrease, and the periphery countries will regain competitiveness" is not a real forecast. I think that this is not a real forecast: if it were a real forecast, it would have a date attached, no?
Thus the framing of needed policy changes as things needed to improve "resiliency" just in case things do not "go as forecast" substantially underplays the seriousness of the problem. Fewer readers will pick up on the "things rarely go as forecast" to understand that the forecast is not a forecast.
The first and most obvious feature of the Eurozone is that its interest rates are at the zero lower bound and its economy lacks aggregate demand. A depressed economy at the zero lower bound needs fiscal expansion. If for some reason normal fiscal expansion is feared to be unwise by some holding veto points, the economy needs helicopter drops--backed up by strong commitments by central banks to raise reserve requirements to curb the velocity of outside money should it suddenly become higher rather than lower than desirable.
The bank regulatory system needs responsibility for banks’ rescue to be transferred from national governments to the ESM now. Without that transfer, nation-level governments will continue to make the political calculation that letting supervisory and regulatory standards slide is the more attractive course. It may be true "this is the kind of political step that seems unlikely to be feasible in the near term". But that does not keep it from being needed now. The purpose of a document like this is to set out what is needed--not to reassure people by claiming that whatever is not politically possible now is not needed now.
Public debt is too high if and only if market interest rates now and forecast for the foreseeable future are about to undergo a rapid and massive jump upward. Right now g > r--which means that public debt is not too high but too low.
How governments should hedge against interest rate increases in a world where g > r is an interesting research question. The obvious route is simply to sell consols. Then, when the real consol rate is higher than the societal return on additional government expenditures, we can talk about what the target debt-to-GDP ratio should be and how to get there. But those who are unwilling to advocate the sale of consols as the obvious way to manage public debt risk have, as long as g > r, no standing to complain that public debts are too high--let alone to set out the proposition that public debt is too high as a self-evident truth.
A massively-underfunded ESM is not "the right institution to deal with [government debt] default". It is the wrong institution. It is worse than no institution at all, because it allows people to claim that there is a backstop when there is, in fact, no backstop.
The "structural reform" agenda is more-or-less orthogonal to the macroeconomic institution redesign agenda. To even hint that energy that would otherwise be devoted to macroeconomic institution design should be diverted to lobby for structural reform is in its essence a call to do less on macroeconomic institution redesign. And that strikes me as unhealthy.
Now I think that I do understand why the economists below--who are, by and large, among the best economists in the world in their wisdom and in their understanding of the European situation--have made the rhetorical choices that they have. They want to appeal to practical men, who believe they are exempt from any trace of utopian frenzy.
But if the Eurozone is to be a good thing for Europe rather than a millstone around the neck of the continent, I think that utopian frenzy is needed.
Posted by Mark Thoma on Saturday, June 25, 2016 at 10:22 AM in Economics, Politics |
Authors: Richard Baldwin, Charlie Bean, Thorsten Beck, Agnès Bénassy-Quéré, Olivier Blanchard, Peter Bofinger, Paul De Grauwe, Wouter den Haan, Barry Eichengreen, Lars Feld, Marcel Fratzscher, Francesco Giavazzi, Pierre-Olivier Gourinchas, Daniel Gros, Patrick Honohan, Sebnem Kalemli-Ozcan, Tommaso Monacelli, Elias Papaioannou, Paolo Pesenti, Christopher Pissarides, Guido Tabellini, Beatrice Weder di Mauro, Guntram Wolf, and Charles Wyplosz.
Making the Eurozone more resilient: What is needed now and what can wait?, VoxEU: The UK’s choice to leave the EU was, we believe, a historic mistake. But the choice was made; we must now turn to damage control – especially when it comes to the euro.
The Eurozone is growing, albeit slowly. If all goes as forecast, economic health will eventually be restored, unemployment will decrease, and the periphery countries will regain competitiveness.
But things rarely go as forecast – as we were so forcefully reminded last week. Brexit was the latest – but certainly not the last – shock that will challenge the monetary union.
The question is: Is the Eurozone resilient enough to withstand the bad shocks that it is likely to face in the months and years to come?
For many observers, the answer is “no”. To survive the next bad shock, they argue, Europe’s monetary union needs major reform and deeper political integration. As such deeper integration is extremely difficult in today’s political climate, pessimism is the order of the day.
We do not share this pessimism. The Eurozone’s construction has surely followed a convoluted process, but the fundamental architecture is now in place. Yes, some measures are needed to strengthen this architecture. And yes, more ambitious steps would improve resilience further, but these will have to wait for a political breakthrough.
The purpose of this essay is to identify what needs to be done soon, and what would be good to do but can probably wait. To avoid the mind-numbing details that often cloud discussions of Eurozone reform, we paint our arguments with a broad brush. (We will follow up with further documents with much greater detail on specific reform proposals.)
On banks and the financial system
Think of a good financial architecture for the Eurozone as achieving two main objectives in coping with another bad shock: 1) reducing the risk of bank defaults; and 2) containing the broader economic effects when defaults do occur.
This architecture is largely built. Both supervision and regulation are now largely centralised. Supervision is improving and stress tests are becoming more credible with each iteration. The Single Resolution Mechanism is in place and private-sector bail-in rules have been defined. The Single Resolution Fund can provide some recapitalisation funds if and when needed. If they turn out not to be enough, the European Stability Mechanism (ESM) can, within the context of a macroeconomic adjustment programme, add more. In the longer term, a euro-wide deposit insurance scheme could improve resiliency, but this will take time.
So what more needs to be done soon? Mostly to make sure that the rules in place can be enforced. Italy provides two cases in point. First, non-performing loans have steadily increased and are carried on the books at prices substantially above market prices. Second, the Italian government has proven very reluctant to apply the bail-in rules. The credibility of the rules is at stake. Either they have to be applied, or credibly modified.
What are the measures that would be good to take, but can probably wait?
Diversifying the portfolios of banks so that there are more resilient to domestic shocks would clearly be desirable. The focus has been on decreasing the proportion of domestic sovereign bonds in banks’ portfolios. This would be good, but domestic sovereign bonds represent a relatively small proportion of banks’ portfolios. Decreasing banks’ overexposure to domestic loans would also be an important step towards boosting resiliency. A different approach would be to transfer the responsibility for banks’ rescue from national governments to the ESM. But this is the kind of political step that seems unlikely to be feasible in the near term.
On public finances
Public debt is high, even if, for the time being, low interest rates imply a manageable debt service. Just as for the financial system, a resilient public finance architecture needs to: 1) reduce the risk of default; and 2) contain the adverse effects of default, if it were to occur nevertheless.
On both counts, much remains to be done.
Reducing the risk of default is best achieved through a combination of good rules and market discipline. Neither is really in place. The accumulation of rules has made them unwieldy, unenforceable, and open to too many exceptions. They can and should be simplified. In most countries, the level of expenditure – rather than the deficit – is the main problem. High expenditure makes it difficult to raise taxes and balance the budget, leading to dangerous debt dynamics. Thus, a focus on expenditure rules, linking expenditure reduction to debt levels, appears to be one of the most promising routes. Market discipline, on the other hand, will not work if the holders of the debt do not know what will happen if and when default takes place. This takes us to the second objective.
The Eurozone has put in place the right institution to deal with default, namely the ESM. Like the IMF, the ESM can, under a programme, help a country adjust. In its current form however, the ESM falls short of what is needed. First, the ESM’s ‘firepower’ is too small compared to the sort of shock-absorbing operations it may be called on to undertake in the case of a large Eurozone nation getting into debt trouble. Second, given its current decision-making procedures, markets cannot be sure that action will be taken promptly. Higher funding or higher leverage, and changes in governance such as replacing the requirement of unanimity by a more flexible one, are needed to make the ESM able to respond quickly and fully to a country in trouble. Third, the current structure is silent on who should negotiate a public debt restructuring in the extreme case where one was needed. Putting an explicit process in place should be a priority; the ESM is the natural place for it.
What other measures which would be good to have, but can probably wait?
Initiatives to address the legacy of high public debt would bolster Eurozone resiliency and thus would be very useful. However, as low interest rates are likely for some time to come, debt service is manageable, and debt forecasts show that debt-to-GDP ratios will slowly decline (absent a bad shock). Since proposals for dealing with legacy national debts would require the sort of political willpower that seems in short supply for now, such plans cannot be realistically put on the ‘do now’ menu, even if they are may be necessary in the future.
Another set of measures would implement stronger risk sharing, and transfer schemes to further reduce the impact of domestic shocks on their own economy. Proposals run from euro bonds to fiscal transfer schemes for countries subject to bad shocks. These measures would make the Eurozone more resilient and thus may be desirable. But, equally clearly, they would require more fiscal and political integration than is realistic to assume at this point. We believe that the Eurozone can probably function without tighter fiscal integration at least for some time.
We end with two sets of remarks.
Solvency and liquidity
Whether it is with respect to banks or states, the two issues facing policymakers are how to deal with solvency and liquidity problems. We have argued that, when solvency is an issue, the ESM is the right structure to address it (assuming a public debt restructuring procedure is in place). With respect to liquidity, we believe that, in addition to the liquidity facilities of the ECB, which can address sudden stops on banks, the Outright Monetary Transactions (OMT) is the right structure to address sudden stops facing states. One step that could be taken soon is a clearer articulation of how to combine the two. This would clarify the role of the ECB, and eliminate a source of criticism about the allocation of roles between the ECB and other Eurozone structures such as the ESM. The resulting clarity would make it easier for markets and investors to be assured that Europe’s monetary union could deal effectively with any future shocks.
In any country, at any point, some pro-growth structural and institutional reforms are desirable. Is there a particularly strong argument for them in the case of the Eurozone? To some extent, yes. The institutional problems of the euro are made worse by low growth, and demographic change. If the structural and institutional reforms delivered higher growth, this would be good by itself – ignoring distribution effects – and it would allow for faster improvement in bank and state balance sheets.
Those specific structural reforms which allow for faster adjustment of competitiveness, be it through faster cost adjustment or faster reallocation, would also improve the functioning of the monetary union. Implementing such reform is a slow and difficult process, but necessary nonetheless. The Eurozone will never be a well-functioning monetary union until it is much more of an economic union as well.
We have stressed that actions need to be taken soon, while others are more long term, but the long-term questions do need to be discussed without delay.
Do you support this view?
Starting next week, we will open this column to endorsement by economists. Details to be posted on Monday.
Posted by Mark Thoma on Saturday, June 25, 2016 at 10:01 AM in Economics, Politics |