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Monday, November 20, 2006

"Bad Economic Policy, Bad Energy Policy, and Bad Foreign Policy"

James Surowiecki of The New Yorker explains why tariffs, quotas, price guarantees, and subsidies in the sugar and ethanol markets are "bad economic policy, bad energy policy, and bad foreign policy":

Deal Sweetners, by James Surowiecki, New Yorker: America ... consume[s] ... close to ten million tons of sugar every year. But American sugar producers aren’t satisfied with supplying the most sweet-hungry population in the world. They’ve relentlessly sought—and received—special favors... The government guarantees producers a fixed price for domestic sugar and sets strict quotas and tariffs for foreign sugar.

Economically..., this has many obvious bad results. It keeps sugar prices in the U.S. at least twice as high as the world average. It makes it harder for companies that use lots of sugar to do business here—in the past decade, an exodus of candy manufacturers from the U.S. has eliminated thousands of jobs. And import restrictions make Third World countries poorer than they’d otherwise be. But protecting sugar also has a surprising consequence: it’s hurting America’s efforts to become more energy-efficient. ...

In recent years, as politicians have tried to deal with high gas prices, concerns about global warming, and America’s dependence on OPEC, a new savior has been found: ethanol. Ethanol has all sorts of virtues. ... So Congress has mandated that four billion gallons of ethanol annually be blended with gasoline, and it also subsidizes ethanol production with a fifty-one-cent-per-gallon tax credit. These policies have stimulated an ethanol boom...

Unfortunately, the ethanol produced in the U.S. comes from ... corn. Corn ethanol’s “net energy balance” ... is significantly lower than that of other alternatives, and modern corn farming isn’t easy on the land. By contrast, ethanol distilled from sugarcane is much cheaper to produce and generates far more energy per unit of input—eight times more... In the nineteen-seventies, Brazil embarked on a program to substitute sugar ethanol for oil. Today, every gallon of gas in Brazil is blended with at least twenty per cent of ethanol, and many cars run on ethanol alone, at half the price of gasoline.

What’s stopping the U.S. from doing the same? In a word, politics. The favors granted to the sugar industry keep the price of domestic sugar so high that it’s not cost-effective to use it for ethanol. And the tariffs and quotas for imported sugar mean that no one can afford to import foreign sugar and turn it into ethanol, the way that oil refiners import crude from the Middle East to make gasoline. Americans now import eighty per cent less sugar than they did thirty years ago. ...

We could, of course, simply import sugar ethanol. But here, too, politics has intervened: Congress has imposed a tariff of fifty-four cents per gallon on sugar-based ethanol in order to protect corn producers from competition. ... [T]he Bush Administration proposed eliminating the ethanol tariff this past spring, but Congress quickly quashed the idea ... [T]he sugar quotas appear to be as sacrosanct as ever. ...

Our current policy is absurd even by Washington standards: Congress is paying billions in subsidies to get us to use more ethanol, while keeping in place tariffs and quotas that guarantee that we’ll use less. ... Because of the ethanol tariffs, we’re imposing taxes on fuel from countries that are friendly to the U.S., but no tax at all on fuel from countries that are among our most vehement opponents. Congressmen justify the barriers to foreign ethanol with talk of “energy security.” But how is the U.S. more secure when it has to import oil from Venezuela rather than ethanol from Brazil? These tariffs are bad economic policy, bad energy policy, and bad foreign policy. ...

    Posted by on Monday, November 20, 2006 at 12:33 AM in Economics, International Trade, Policy, Politics, Regulation | Permalink  TrackBack (1)  Comments (11) 

    Has Monetarism Been Abandoned?

    David Altig on Monetarism:

    Is Monetarism Dead?, by David Altig: Courtesy of Mark Thoma, I am sent to the Scientific American blog, where JR Minkel ruminates on the contributions of Milton Friedman, asking the question "Is economics a science?" Minkel offers up the question in the spirit of open debate, so fair enough. I did, however, find this passage somewhat puzzling:

    Well, Friedman's most famous prediction was a pretty good one: he foresaw the possibility that high unemployment could accompany high inflation, a phenomenon better known as stagflation. That foretelling earned him the Nobel Memorial Prize, although Friedman's monetary theory is currently out of favor.

    A similar sentiment is expressed by the eminent historian Niall Ferguson, in an article titled "Friedman is dead, monetarism is dead, but what about inflation?":

    [I]t will be for monetarism — the principle that inflation could be defeated only by targeting the growth of the money supply and thereby changing expectations — that Friedman will be best remembered.

    Why then has this, his most important idea, ceased to be honoured, even in the breach? Friedman outlived Keynes by half a century. But the same cannot be said for their respective theories. Keynesianism survived its inventor for at least three decades. Monetarism, by contrast, predeceased Milton Friedman by nearly two.

    The claim that "Friedman's monetary theory is currently out of favor" is, I think, wildly overstated -- at best.

    Continue reading "Has Monetarism Been Abandoned?" »

      Posted by on Monday, November 20, 2006 at 12:24 AM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (7) 

      Should Environmental and Labor Standards Be Part of Trade Negotiations?

      Should we refuse to trade with countries with low environmental and labor standards, or countries that have very low taxes or subsidize exporting industries because this gives them an unfair advantage? Here are arguments against insisting on "fair trade" standards as a condition for trade liberalization:

      What Should Trade Negotiators Negotiate About? A Review Essay, by Paul Krugman, March 1997: ...The economist's case for free trade is essentially a unilateral case - that is, it says that a country serves its own interests by pursuing free trade regardless of what other countries may do. Or as Frederic Bastiat put it, it makes no more sense to be protectionist because other countries have tariffs than it would to block up our harbors because other countries have rocky coasts. So if our theories really held sway, there would be no need for trade treaties: global free trade would emerge spontaneously from the unrestricted pursuit of national interest. ...

      Fortunately or unfortunately, however, the world is not ruled by economists. The compelling economic case for unilateral free trade carries hardly any weight among people who really matter. If we nonetheless have a fairly liberal world trading system, it is only because countries have been persuaded to open their markets in return for comparable market-opening on the part of their trading partners. Never mind that the "concessions" trade negotiators are so proud of wresting from other nations are almost always actions these nations should have taken in their own interest anyway; in practice countries seem willing to do themselves good only if others promise to do the same.

      But in that case why should ... we demand ... only of trade liberalization? ... In particular, environmental advocates and supporters of the labor movement have sought with growing intensity to expand the obligations of WTO members ..., making adherence to international environmental and labor standards part of the required package; meanwhile, business groups have sought to require a "level playing field" in terms of competition policy and domestic taxation. ...

      In 1992 Columbia's Jagdish Bhagwati ... and Robert E. Hudec ... brought together an impressive group of legal and economic experts in a three-year research project intended to address the new demands for an enlarged scope of trade negotiations. Fair Trade and Harmonization: Prerequisites for Free Trade? ... is the result of that project. ...

      In this essay I will not try to offer a comprehensive review of the papers; in particular I will give short shrift to those on competition and tax policy. ... Instead, I will try to sort through what seem to be the main issues raised by new demands for international labor and environmental standards.

      Continue reading "Should Environmental and Labor Standards Be Part of Trade Negotiations?" »

        Posted by on Monday, November 20, 2006 at 12:15 AM in Economics, International Trade, Policy, Regulation | Permalink  TrackBack (0)  Comments (10) 

        Sunday, November 19, 2006

        "Rolling Back the Bush Spending Hikes"

        Jonathan Chait has a challenge for Republicans who have been complaining that increased government spending in recent years is a betrayal of core conservative principles. Will they "recommit to smaller government" and propose "rolling back the Bush spending hikes"?:

        The Republicans' curse -- they're always right, by Jonathan Chait, Commentary, LA Times: ...No sooner had this year's election ended than nearly every conservative emerged to declare that Republicans had been defeated for betraying the One True Faith. Republicans, George Will wrote, "were punished not for pursuing but for forgetting conservatism." John McCain ... [said] they "lost their way" by supporting big government. ...

        When conservatives try to get ... specific about why voters turned against them, their explanations make ...[little] sense. Jeff Flake of Arizona, a leader among conservatives in the House, suggested that his party apologize to voters like this: "We've overspent, badly, and it was offensive to you as well as our conservative principles."

        But exactly how have Republicans overspent? The largest spending increases under Bush, by far, have come in defense and homeland security, which conservatives support. The next biggest item is the Medicare bill. Horribly designed though it was, you can't say it was unpopular. ...

        If Republicans really want to recommit to smaller government, they can run on a simple platform of rolling back the Bush spending hikes. Go ahead, Republicans, I dare you: Promise to slash the Pentagon, eliminate homeland security and take away everybody's Medicare drug coverage.

        Of course, they won't really do that. ... They'll never reduce government to the size they'd like, but they're too fanatical to admit that they can't.

        Instead of more cut taxes and spend policies supported by wishful thinking like we've seen recently, I'd settle, as a start, for a rational political conversation first about our policy objectives, and then about the alternatives and tradeoffs we face in achieving them. [I'll save you the trouble: Rational political conversation? Yeah right.]

          Posted by on Sunday, November 19, 2006 at 04:50 PM in Budget Deficit, Economics, Politics | Permalink  TrackBack (0)  Comments (6) 

          Saturday, November 18, 2006

          NBER Reporter: Firms in International Trade

          What are the characteristics of firms involved in international trade? Are these firms more productive? Do they pay higher wages? What are the effects of trade liberalization on employment, labor skill levels, and survival?

          Firms in International Trade, by Andrew B. Bernard, NBER Reporter, Fall 2006: For most of its lengthy history the field of international trade largely ignored the role of the firm... Traditional trade theory explained the flow of goods between countries in terms of comparative advantage... Even the research focusing on differentiated varieties and increasing returns to scale that followed Helpman and Krugman continued to retain the characterization of the representative firm.¹ However, the assumption of a representative firm, while greatly enhancing the tractability of general equilibrium analysis, is emphatically rejected in the data. My research ... has been an attempt to ... understand the decisions of heterogeneous firms in shaping international trade and their effects on productivity growth and welfare.

          Continue reading "NBER Reporter: Firms in International Trade" »

            Posted by on Saturday, November 18, 2006 at 08:39 PM in Academic Papers, Economics, International Trade | Permalink  TrackBack (0)  Comments (2) 

            Is the "Capitalist Domino" About to Fall?

            Robert Reich says the U.S. should normalize trade relations with Vietnam. I agree:

            The New Domino Theory, by Robert B. Reich, American Prospect: President Bush arrives in Hanoi today for discussions about regional economic issues. He would do well to discuss frankly America’s fears about the "dominoes" of Asian capitalism.

            You may remember the old domino theory of Asian communism. Four decades ago, American policy makers clung to the idea that the big domino of Soviet Communism had toppled China, and the domino of Chinese communism had then toppled North Vietnam. Unless the United States propped up South Vietnam, it was assumed, all of Indo-China would become communist.

            Tens of thousands of Americans died in that war before America got out and let the dominoes fall where they may. But then a strange thing happened. Soviet Communism disappeared. China became the fastest-growing big capitalist nation in the world. And Vietnam became one of the hottest markets in Southeast Asia.

            The real domino turned out not to be communism, but capitalism.

            Yet the capitalist domino seems almost as threatening to America today as the communist one was forty years ago. This week, Republican leaders in the House called off a vote on a measure that would have given Vietnam permanent normal trade relations with the United States. They didn’t think they could get the votes needed to pass it.

            Talk about shooting ourselves in the feet. Early next year, as part of its entry into the World Trade Organization, Vietnam will reduce tariffs on foreign goods and open its telecom and financial services sectors to foreign investment. But as things now stand, America won’t benefit from these measures because Congress won’t normalize trade relations with Vietnam.

            Why not?

            Continue reading "Is the "Capitalist Domino" About to Fall?" »

              Posted by on Saturday, November 18, 2006 at 06:57 PM in Economics, International Trade, Politics | Permalink  TrackBack (0)  Comments (13) 

              Who Needs Social Security?

              High income households are surprisingly dependent upon Social Security to maintain their living standards during their retirement years:

              Americans' Dependency on Social Security, by Laurence J. Kotlikoff, Ben Marx, and Pietro Rizza, NBER WP 12696, November 2006  [open link]: Abstract This paper determines the standard of living reductions that young, middle aged, and older households would experience were the U.S. government to cut Social Security benefits (but not taxes) to deal with its ... long-term fiscal crisis. ... The analysis considers both stylized single and married households of different ages and resource levels as well as actual households sampled from the 2004 Federal Reserve Survey of Consumer Finances (SCF). The extent of current and future living standard reductions in response to announcements of future Social Security benefit cuts depends critically on the age of the household, when the cuts are announced, the size of the cuts, the income of the household, and the degree to which the household is liquidity constrained.

              For our stylized households on the brink of retirement the complete elimination of Social Security benefits would entail retirement living standards reductions ranging from roughly one third to one hundred percent depending on the household's income. Our SCF findings also point to a strong dependency on Social Security. Indeed, 41 percent of older SCF couples and 33 percent of SCF singles would experience a living standard reduction of 90 percent or more were Social Security benefits eliminated.

              A surprising finding is the major dependency of very high-income households on Social Security.

              Continue reading "Who Needs Social Security?" »

                Posted by on Saturday, November 18, 2006 at 10:55 AM in Economics, Policy, Social Security | Permalink  TrackBack (0)  Comments (16) 

                Friday, November 17, 2006

                What You May Not Know About AIDS in Africa

                Here's the intro:

                At just twenty-six, economist Emily Oster may have the highest controversies-generated-to-years-in-academia ratio of anyone in her field. That's because, as a Ph.D. student at Harvard, she chose to hop the fence and explore a topic already claimed by doctors, social scientists, and policy wonks: the AIDS epidemic in Africa. Her studies suggest some uncomfortable possibilities—not least that the so-called experts have gotten their approach to the crisis dead wrong.

                Now a Becker Fellow at the University of Chicago, Oster continues to blur academic boundaries with further work on AIDS and a volatile new interest: the reported wave of female infanticide in Asia.

                And, the article:

                Three Things You Don't Know About Aids In Africa, by Emily Oster, Esquire: When I began studying the HIV epidemic in Africa a few years ago, there were few other economists working on the topic... [T]he questions I wanted to answer ... were being asked by anthropologists, sociologists, and public-health officials. ...

                These disciplines believe that cultural differences—differences in how entire groups of people think and act—account for broader social and regional trends. AIDS became a disaster in Africa, the thinking goes, because Africans didn't know how to deal with it.

                Economists like me don't trust that argument. We assume everyone is fundamentally alike; we believe circumstances, not culture, drive people's decisions, including decisions about sex and disease.

                I've studied the epidemic from that perspective. I'm one of the few people who have done so. And I've learned that a lot of what we've been told about it is wrong. Below are three things the world needs to know about AIDS in Africa.

                Continue reading "What You May Not Know About AIDS in Africa" »

                  Posted by on Friday, November 17, 2006 at 08:28 PM in Economics, Health Care, Policy | Permalink  TrackBack (1)  Comments (81) 

                  Accidental Externalities: Reply to Comments

                  Hal Varian responds to some of the comments on his NY Times article "Beyond Insurance: Weighing the Benefits of Driving vs. the Total Costs of Driving," posted here:

                  Some replies:

                  External costs are costs on uninvolved third parties. The costs people in a crowd impose on each other are not external, because each member of the crowd "pays" the price whether in time lost in traffic jams or standing lines, or accident insurance...

                  It is true that the members of the crowd pay the average cost of congestion, but they don't pay the marginal cost (which is higher). This is the classic problem of the commons.


                  Check out pay-as-you-drive-insurance:

                  Yes, this is the right idea.


                  Where is the detailed statistical analysis that supports this claim?

                  It obviously isn't in the 850 word Times column. But if you take the time to read the paper at http://works.bepress.com/aaron_edlin/21 you will find detailed statistical analysis.


                  And the call for a car accident tax is nonsensical. Car insurance premiums are supposed to be calculated to cover the real cost of accidents.

                  The premiums cover the average cost of accidents (obviously) but the marginal cost (i.e., the cost imposed on other drivers by an additional driver) is much higher than the average cost, at least in congested areas.


                  The number of accidents likely do increase with the number of cars but only to the point where increased congestion lowers speeds and that is far sooner than gridlock.

                  The evidence presented in the paper says otherwise.


                  The arrogance on display is simply breathtaking, though. After 100 years of auto insurance, these economists assume that they have found a flaw in the system, which mere mortals, supposedly, have never noticed.

                  The original point was first made by Nobel laureate William Vickrey in 1968. So it only took 60 years to notice the problem, not 100.  8-)


                  I sure do not see what the basis for the assertion, "drivers only face their own cost of accidents in their insurance premiums" is. The whole point of liability insurance is to pay for the costs to the other guy, of my hitting him.

                  The argument is independent of whether insurance is liability or no-fault, or whether or not there is insurance at all. Here is a more detailed example.

                  Suppose that Adam values driving at $150 and Eve at $70. Adam is currently driving and Eve is contemplating doing so. If only Adam drives there are no accident costs; if both drive the expected accident costs are $50 per car.

                  With these numbers, Eve rationally decides to drive since her value exceeds her costs: 70 > 50. Net social value from both driving is: (150 + 70) - 100 = 120. If Eve faced the full cost of her decision (the total accident costs) she would rationally decide not to drive yielding net social value of $150 (Adam's value of driving).

                  Now suppose that Adam and Eve both value driving at $150 but each has to face the $100 *marginal* cost of their decision. Net social value of both driving would be $300 - $100 = $200 which is higher than the net value of keeping one or both of them off the road. [It's true that there is an extra $100 of driving tax collected in this solution, but that can be used to reduce other taxes --- it is not a social cost.]

                  Suppose that each values driving at $70. The optimal solution here is for one to drive and the other not, yielding a net value of $70. This can be supported by charging 0 for the first driver on the road and $100 for the 2nd driver (i.e., the $50 marginal cost they face + the $50 marginal cost the would impose on the other driver.)

                  So the Vickrey tax gives the right solution when one should drive and the other not, or when both should drive. It is simply marginal cost pricing, slightly disguised.

                    Posted by on Friday, November 17, 2006 at 04:24 PM Permalink  TrackBack (0)  Comments (46) 

                    FRBSF: Interest Rates, Carry Trades, and Exchange Rate Movements

                    What is the carry trade and does it affect exchange rates? Economic theory says carry trade strategies won't be profitable, so why does the trade even exist? This Economic Letter from the San Francisco Fed examines these issues:

                    Interest Rates, Carry Trades, and Exchange Rate Movements, by Michele Cavallo,  FRBSF Economic Letter: The U.S. dollar has seen some remarkable swings against major currencies recently. ... Many observers have related these swings to what is known as the carry trade. This is a strategy widely used by investors in international financial markets that is based on exploiting the existence of interest rate differentials across countries.

                    The use of this strategy by investors is puzzling, as the theory of interest parity conditions implies that it should not generate predictable profits. This Economic Letter explores this puzzle...

                    Continue reading "FRBSF: Interest Rates, Carry Trades, and Exchange Rate Movements" »

                      Posted by on Friday, November 17, 2006 at 12:13 PM in Economics, International Finance | Permalink  TrackBack (0)  Comments (6) 

                      Hunger, By Any Other Name...


                      Eat This (or: Subjectio Ergo Sum), by cornhuskerblogger, CardCarryingMember: Set down the victory champagne. He's still in charge -- ...there's still so much compassionate conservatism to ladle out.

                      Turns out the best way to fight hunger in Bush 43's administration isn't to get food to the famished but to simply stop calling the foodless ''hungry.''

                      Every year, the Agriculture Department issues a report that measures Americans' access to food, and it has consistently used the word "hunger" to describe those who can least afford to put food on the table. But not this year.

                      Mark Nord, the lead author of the report, said "hungry" is "not a scientifically accurate term for the specific phenomenon being measured in the food security survey." Nord, a USDA sociologist, said, "We don't have a measure of that condition."

                      The USDA said that 12 percent of Americans -- 35 million people -- could not put food on the table at least part of last year. Eleven million of them reported going hungry at times. Beginning this year, the USDA has determined "very low food security" to be a more scientifically palatable description for that group. (Washington Post; 11-16)

                      Brilliant. (Aside from that whole ''more scientifically palatable" mumbo-jumbo -- which is starkly out of place with the rest of this administration's revelational M.O.) If we stop acknowledging the problem itself, it will go away. How Zen! ...

                      I wonder if this had anything to do with it. From the same article:

                      In 1999, Texas Gov. George W. Bush, then running for president, said he thought the annual USDA report -- which consistently finds his home state one of the hungriest in the nation -- was fabricated. ... Bush said he believed that the statistics were aimed at his candidacy.

                      Those who are thinking "Oh-well" might consider "Or-well" instead.

                        Posted by on Friday, November 17, 2006 at 09:54 AM in Economics, Politics | Permalink  TrackBack (0)  Comments (14) 

                        Will Globalization Cause Currency Unification?

                        Will globalization bring about a single world currency? Paul Krugman, from 1999, uses Milton Friedman's "brilliant analogy" to argue against the idea that "the fewer currencies there are, the better":

                        Monomoney Mania, by Paul Krugman, Slate: A couple of days ago my CW alarm starting buzzing furiously. For something like the sixth time in a month, a businessman I was talking to had just declared, in the tones of someone stating a profound insight, that the modern world economy no longer has room for scores of different national currencies--that the inexorable logic of globalization will soon force most countries to adopt the dollar, the euro, or the yen as their means of exchange. This particular speaker was Latin American, and was clearly influenced by the recent discussion of "dollarization" as a solution to his region's woes, but I have heard pretty much the same line from Asians and Europeans. No doubt about it: A new conventional wisdom has emerged. And you know what that means: It's time to start debunking.

                        At first sight, it might seem obvious that the fewer currencies there are, the better. After all, a proliferation of national moneys means more hassle and expense, because you keep on having to change money and to pay the associated commissions. It also means more uncertainty, because you are never quite sure what foreign goods are going to cost or what foreign customers will be willing to pay. And as globalization proceeds--as the volume of international transactions rises, both absolutely and relative to world output--the cost of having many currencies also rises. So why not have fewer--maybe only one?

                        There's also the matter of speculation. The financial crises that have shaken much of the world all started, at least in the first instance, with investors betting that the currency of the afflicted nation would fall in value against harder currencies such as the dollar. Why not spoil the speculators' game by giving them nothing to speculate about--by replacing pesos and reis with portraits of George Washington (or, if you happen to be European, with generic pictures of bridges and gates--for more on European currency design, see this 1997 Slate piece)?

                        But not so fast. There are still some very good arguments for maintaining separate national currencies. Not only that, while globalization and technological change in some ways are pushing the world toward fewer currencies, in other ways they actually reinforce the advantages of monetary pluralism.

                        The classic argument in favor of separate national currencies, with fluctuating relative values, was made by none other than Milton Friedman. (One appealing aspect of this particular debate is that it cuts across the usual ideological lines. European socialists like unified currencies, so does the Cato Institute. American liberals like floating exchange rates, so do Thatcherites.)

                        Continue reading "Will Globalization Cause Currency Unification?" »

                          Posted by on Friday, November 17, 2006 at 12:15 AM in Economics, Financial System, International Finance | Permalink  TrackBack (0)  Comments (18) 

                          The "Pummeling of Howard Dean"

                          Robert Reich has a challenge. Can you come up with a better theory?:

                          Why Are They Gunning for Howard Dean?, by Robert Reich: What can possibly account for the post-election victory party pummeling of Howard Dean by inside-the-beltway Democrats? Prominent Democratic consultants (James Carville, Stan Greenberg) go on the record (“you can quote me”) with complaints barely two weeks from a Democratic sweep. Leading congressional Democrats (Rahm Emmanuel) vent their anger vociferously (“on background”). Why? Dems now control both Houses and have twenty-eight governorships. Dean ought to be congratulated. So what’s the underlying agenda here? Three theories:

                          1. The only way a Dem gets on television after such a sweet victory isn’t by criticizing Republicans – it’s by criticizing fellow Dems. Stirring up clear waters grabs attention. Attention draws crowds. Crowds create power. Power is the name of the game in Washington, especially when formal control of Congress changes hands.

                          2. Dean’s strategy of putting money into state party infrastructure takes money out of the pockets of Washington insiders – away form Democratic consultants and key congressional party activists. That makes insiders angry.

                          3. Dean is an independent DNC chair, not under the sway of the Clintons. Unlike Ron Brown, who guided the DNC toward a Clinton victory in 1992, Dean doesn’t play the usual power games. Hence, the Clintons would like him out, and the sooner the better. Carville, Greenberg, and Emmanuel, among others, are doing their bidding.

                          Which is it? I’m not so cynical or conspiratorial as to believe any one of them. But you come up with a more credible theory.

                            Posted by on Friday, November 17, 2006 at 12:12 AM in Economics, Politics | Permalink  TrackBack (0)  Comments (60) 

                            Milton Friedman: Why Money Matters

                            The publication date, November 17, 2006, on this commentary from Milton Friedman appearing in the Wall Street Journal is correct. Here's part of the accompanying editorial:

                            Capitalism and Friedman, Editorial, WSJ: There are some public figures whose obituaries can be written years in advance. Milton Friedman was not one of them. ... He died yesterday at the age of 94, but as the op-ed running nearby attests, he was active in writing about, thinking about and explaining how economics affects our world until the end.

                            In today's feature, he updates and re-examines conclusions he reached about the Great Depression in "A Monetary History of the United States, 1867-1960," a book published with Anna Schwartz 43 years ago. ...

                            Here's Milton Friedman's commentary. He concludes that "The results strongly support Anna Schwartz's and my 1963 conjecture about the role of monetary policy in the Great Contraction":

                            Why Money Matters, by Milton Friedman, Commentary, WSJ: The third of three episodes in a major natural experiment in monetary policy that started more than 80 years ago is just now coming to an end. The experiment consists in observing the effect on the economy and the stock market of the monetary policies followed during, and after, three very similar periods of rapid economic growth in response to rapid technological change: to wit, the booms of the 1920s in the U.S., the '80s in Japan, and the '90s in the U.S.

                            The prosperous '20s in the U.S. were followed by the most severe economic contraction in its history. In our "Monetary History" (1963), Anna Schwartz and I attributed the severity of the contraction to a monetary policy that permitted the quantity of money to decline by one-third from 1929 to 1933. Since 1963, two episodes have occurred that are almost mirror images of the U.S. economy in the '20s: the '80s in Japan, and the '90s in the U.S. All three episodes were marked by a long period of rapid economic growth, sparked by rapid technological change and the emergence of new industries, and accompanied by a stock market boom that terminated in a crash. Monetary policy played a role in these booms, but only a supporting role. Technological change appears to have been the major player.

                            These three episodes provide the equivalent of a controlled experiment to test our hypothesis about what we termed the Great Contraction. In this experiment, the quantity of money is the counterpart of the experimenter's input. The performance of the economy and the level of the stock market are the counterpart of the experimenter's output... The three boom episodes all occurred in developed private enterprise market economies, involved in international finance and trade, and with similar monetary systems, including a central bank with power to control the quantity of money. This is the counterpart of the controlled conditions of the experimenter's laboratory.

                            The Money Supply: In addition, history has provided a close counterpart to the kind of variation in input that our hypothetical experimenter might have deliberately chosen. As Fig. 1 shows, monetary policy ... was very similar in the three boom periods, and very different in the three post boom periods, with settings that might be described as low, medium, high.


                            To measure the quantity of money, I use M2 in the U.S. and the conceptually equivalent M2 plus certificates of deposit in Japan. To express the data for the two countries and the widely separated periods in comparable units, I use as an index of the money stock the ratio of the quantity of money to its average value for the six years prior to the cycle peak... Finally, the data are plotted to align the dates at the cycle peak.

                            Fig. 1 shows a striking contrast between the period before the cycle peak and the period after the cycle peak. There are some differences before the peak -- money growth is slowest on the average for the earlier U.S. episode, fastest for Japan -- but the differences are small and there is reasonably steady money growth in all three episodes. The contrast with the period after the cycle peak could hardly be greater. Money supply declines sharply after the cycle peak in the first episode, goes from stable to rising mildly in the second, and rises steadily and sharply in the third. Our hypothetical experimenter planned his experiment well.

                            The GDP: The results of the third episode of this natural experiment are now all in. Fig. 2 shows how GDP in nominal terms (dollars or yen in current prices) behaved during the boom and post boom periods. I use nominal GDP rather than real GDP because M2 is also a nominal magnitude. How changes in nominal GDP are divided between prices and output is an important question but one that is not directly relevant to this experiment...

                            As in Fig. 1, there is a striking contrast between the boom and the post-boom periods: roughly similar growth during the booms, widely variable growth during the post-boom. Both before and after the cycle peak, nominal GDP growth paralleled monetary growth. During the boom, money and nominal GDP grew most rapidly in Japan, most slowly in the first U.S. episode, and at an intermediate rate in the second U.S. episode...

                            After the cycle peak, money fell sharply in the first episode and so did nominal GDP; money growth stagnated in the second episode and so did GDP; money grew at a rapid rate in the third episode and, after a brief lag (corresponding to the mild 2001 recession) so did GDP. ...

                            The Stock Market: The peak of the stock market, as measured by S&P's index, coincided with the cycle peak in the first episode, both occurring in the third quarter of 1929... However, that was not the case in the later episodes. ... Accordingly, Fig. 3 plots the data to align the series at the stock market peak.

                            The near identity of the three stock market series during the boom is truly remarkable. ... Of more interest for our purpose is what happened after the peak. For a year after, the three stock-price series fell in tandem, responding to the inner dynamics of a collapsing bubble. Then, the differences in monetary policy began to have an effect. Beginning in late 1930, the S&P index started falling away from the others under the influence of a collapsing money stock. For another year and a half, the other two indexes move in tandem. Then the much more expansive policy of the Fed in the '90s than of the Bank of Japan in the '80s takes effect and pulls the S&P 500 away from the Nikkei, which stabilizes in response to the passive monetary policy of the Bank of Japan...

                            The results of this natural experiment are clear, at least for major ups and downs: What happens to the quantity of money has a determinative effect on what happens to national income and to stock prices. The results strongly support Anna Schwartz's and my 1963 conjecture about the role of monetary policy in the Great Contraction. They also support the view that monetary policy deserves much credit for the mildness of the recession that followed the collapse of the U.S. boom in late 2000.

                              Posted by on Friday, November 17, 2006 at 12:06 AM in Economics, Macroeconomics, Monetary Policy | Permalink  TrackBack (2)  Comments (16) 

                              Thursday, November 16, 2006

                              The Role of the Fed in Financial Crises

                              William Poole on what the Fed should do when financial instability strikes: "In most cases, nothing":

                              Responding to Financial Crises: What Role for the Fed?, by William Poole, St Louis Fed President: I am delighted to return to Cato, an organization with which I feel a natural affinity, especially through Bill Niskanen with whom I served as a member of the Council of Economic Advisers a quarter century ago. ... The key issue then, as today, is time inconsistency. It seems to make sense in the middle of a financial crisis for someone to bail out a failing firm or firms. However, the inconsistency is that, however sensible a bailout seems in the heat of crisis, bailouts rarely make sense as a standard element of policy. The reason is simple: Firms, expecting aid if they end up in trouble, hold too little capital and take too many risks. As every economist understands, a policy of bailing out failing firms will increase the number of financial crises and the number of bailouts. Along the way, the policy also encourages inefficient risk-management decisions by firms. ...

                              Federal disaster relief policy is exhibit A, but every company, financial or otherwise, knows that if it gets into trouble it is at least worth a major effort to attempt to secure a bailout because there is always a significant probability of success. ...

                              Now for the topic of the panel. What should the Fed do when financial instability strikes?

                              In most cases, nothing. The important principle here is support for the market mechanism rather than support for individual firms. The Fed has, appropriately, permitted many highly visible firms to fail without any attempt to provide support, or even any particular comment except to say that it does not intend to intervene.

                              Of course, the Fed has intervened from time to time. One important case was the provision of additional liquidity and moral support to the markets when the stock market crashed in 1987. The Fed also provided support to the market at the time of the near failure of Long Term Capital Management in 1998. In both cases the Fed cut the federal funds rate, which provided evidence to the markets that the Fed was on the job and prepared to provide extra liquidity as needed. I realize that the Fed’s presence in the negotiations for additional financial support for LTCM from other firms is controversial; I would simply emphasize that the Fed itself did not provide any financial support and, in my opinion, would not have done so if the effort to encourage support from other firms had failed.

                              Some observers have viewed the large expansion of hedge funds as a rising danger to financial stability, requiring additional regulation and Fed readiness to intervene. I myself believe the dangers of systemic problems from hedge fund failures are vastly overrated. The hedge fund industry is indeed large but it is also highly diverse and competitive. Many and perhaps most of the large positions taken by individual firms have other hedge funds on the opposite side of the transactions. I trust normal market mechanisms to handle any problems that might arise. ...

                              A very interesting case arose with the terrorist attacks on 9/11. Thinking back to my academic years before coming to St. Louis, I recall no discussion or journal articles analyzing the possibility that the payments system might crash because of physical destruction. But that is what nearly happened, because the Bank of New York, a major clearing bank, was disabled when the twin towers came down. Moreover, trading closed in the U.S. Treasury and equity markets, and banks were unable to transfer funds because the Bank of New York was not functioning. With normal sources of liquidity shut down, many banks faced the prospect of being unable to meet their obligations. The Fed’s provision of funds through the discount window and in other ways prevented a cascading of defaults around the world. No private entity would have been able to provide liquidity on such a massive scale.

                              I do not know what a totally unanticipated future systemic shock might be but am sure that the Fed needs to be ready to respond, and to some extent, invent the appropriate response on the fly to a currently unimaginable shock. That is surely what a central bank is for, among other things. At the same time, a great reluctance to intervene will serve the economy well in the long run.

                              I can summarize my position very succinctly. The Fed has a responsibility above all to maintain price stability and general macroeconomic stability to reduce the likelihood of economic conditions that would be conducive to financial instability. Included in this responsibility is provision of advice to Congress on needed legislative action to deal with possible risks. The largest of these risks on my radar screen arises from the thin capital positions maintained by government-sponsored enterprises and the ambiguity of whether Congress would or would not act to bail out a troubled firm. The time to deal with potential financial instability caused by structural weaknesses of the GSEs and their regulatory regime is before instability strikes. ...

                              Although prevention is the most important of the Fed’s responsibilities, without question the Fed needs to be prepared to provide liquidity support should markets be in danger of ceasing to function. We know a lot about this subject and have in place deep contingency arrangements to assure that the Fed itself will remain operational at all times. I do not see any way that these functions could be privatized; I believe the markets do have confidence that the Fed has necessary legal authority and the internal strength to act as necessary. That said, the Fed’s reluctance to act is also an important element of strength.

                                Posted by on Thursday, November 16, 2006 at 06:03 PM in Economics, Fed Speeches, Monetary Policy | Permalink  TrackBack (0)  Comments (5) 

                                A Sad Day

                                This is very sad news:

                                Influential Economist Friedman Dies at 94, by Greg Ip, WSJ: Nobel prize winner Milton Friedman, one of the most influential economists of the last century, died today. He was 94.

                                Mr. Friedman died of heart failure after being taken to hospital near his home in San Francisco, his daughter, Janet Martell, said today. His wife Rose Friedman, who co-authored many of his books, survives him.

                                Mr. Friedman's death was also announced at a conference of the libertarian Cato Institute in Washington by the institute's vice president of academic affairs, James A. Dorn. The audience of academics and policy makers observed several moments of silence in observance.

                                Mr. Friedman was awarded the Nobel prize in 1976. He has long championed the cause of political and economic freedom and the links between the two. He has originated, or been associated with, many breakthroughs in economics since the 1950s. He is best known for explaining the role of the money supply in economic and inflation fluctuations. He also, with this year's Nobel prize winner Edmund Phelps, developed the theory in the 1960s that policy makers couldn't achieve a permanent tradeoff between lower unemployment and higher inflation, and that efforts to do so would simply result in the same unemployment rate and higher inflation, a view that holds sway at major central banks today, including the Fed.

                                Mr. Friedman also exercised extraordinary influence not just through his academic work but through his advice to politicians and his many popular books, such as Capitalism and Freedom in 1962 and Free to Choose, with Rose Friedman, in 1990, which was made into a television series.

                                Mr. Friedman had enormous impact on economic policy though he never had a formal job in a government administration after World War Two. His opposition helped lead to the end of the draft. He was an adviser to President Ronald Reagan. He has been closely associated with school vouchers and other applications of free market principles to policy issues.

                                This is my small tribute to Milton Friedman. It is based on an earlier post. This happened many years ago, a few years before I went up for tenure. I had been to a San Francisco Fed conference and, while there, I saw Friedman present his "Plucking model." A few months later, I sent him a paper I had done on the topic. Friedman, with all his fame and all the demands on his time, showed he still had time to help a young assistant professor:

                                Friedman sent me a long, detailed letter about one of my papers. He liked it and his comments were, of course, insightful and helpful. I'm still surprised that he took the time to write such a long letter, he surely had plenty of other things he could have done with his time. But receiving the letter pretty much out of the blue provided a motivational boost just when I needed it and I'm grateful to him to this day for doing that.

                                Here's a post explaining his Plucking Model.
                                Recent interview: The Romance of Economics.
                                Also, from last month: The End of the Hong Kong Experiment.

                                Update: The Financial Times looks back (free) at his major accomplishments.

                                  Posted by on Thursday, November 16, 2006 at 10:20 AM in Economics | Permalink  TrackBack (1)  Comments (30) 

                                  Accidental Externalities

                                  Hal Varian says those of you who live in high density areas don't pay nearly enough for your auto insurance:

                                  Beyond Insurance: Weighing the Benefits of Driving vs. the Total Costs of Driving, by Hal R. Varian, Economic Scene, NY Times: ...[G]enerally, the more people on the road, the more accidents will occur, at least up to the point of total gridlock. Even adding an obsessively safe driver to the road could increase total accident costs, since reckless drivers ... would now have one more car to run into. ...

                                  If the number of accidents increases as the number of cars per mile of road increases, then adding a new car to the road will increase the expected accident costs for existing drivers. The new driver has to pay for the expected accident costs she may incur (via her insurance premium) but not for the increase in accident costs that her presence creates for other drivers on the road.

                                  Economists say that the new driver imposes an “external cost” on the other drivers. Since drivers only face their own cost of accidents in their insurance premiums, they don’t face the full cost of their driving, which should include the costs they impose on others.

                                  How big is this external cost? This is the question investigated by Aaron S. Edlin ... at the University of California, Berkeley, and Pinar Karaca-Mandic ... at the RAND Corporation, in a recent paper, “The Accident Cost From Driving,” published in the Journal of Political Economy.

                                  Continue reading "Accidental Externalities" »

                                    Posted by on Thursday, November 16, 2006 at 02:34 AM in Economics, Market Failure | Permalink  TrackBack (0)  Comments (15) 

                                    Wednesday, November 15, 2006

                                    The Conservative Media

                                    Bruce Bartlett explains why so many conservatives were so surprised at the outcome of the election:

                                    Post-election autopsy, Commentary, Washington Times: ...The Republicans still seem shell-shocked by the results [of the election] and have no clue why they lost or what to do about it. One reason for this, I believe, is that many were genuinely surprised by the depth of their defeat, though it had been forecast by the polls for months.

                                    This was because there is now a fully developed alternative media where conservatives can get all their news and never hear an unfriendly voice. For months, this media -- Rush Limbaugh, Fox News, conservative Web sites -- have taken the line that Republicans not only should win, not only could win, but in fact would win. Over and over again, we heard about Karl Rove's secret polls showing a certain Republican victory, and Fred Barnes told us night after night on Fox News that the mainstream media's polls were wrong.

                                    In fact, the polls were dead-on accurate. And they told anyone who read them that blind recitation of the daily White House talking points was a one-way ticket to oblivion. Yet time and again, all I heard on conservative talk radio or read on conservative blogs was that the economy is the best it ever was, that the war in Iraq is being won, that anyone who says otherwise is a liar and so on.

                                    The one thing I know with certainty about sports and elections is that you have to be a realist to win. Living in a dream world is an absolute guarantee of defeat. I believe if Republicans had been forced to confront reality earlier, they might have been able to turn things around. Their friends in the conservative media did them no favors by feeding them a false sense of optimism.

                                    Now that Democrats actually have a chance to influence policy, if we are going to call ourselves the reality-based community, we need to avoid making the same mistake. When it's evident that the Democratic leadership "has no clothes," we should say so.

                                    On that note, here's a hope. It would be nice if the mainstream media didn't always go back to the same people every time they need a quote or an interview from a Democrat. I get tired of hearing the same voices again and again, particularity when they don't speak to my concerns as well as I would hope. There are more than two or three Democrats with something to say.

                                    Update: In comments, Bruce Bartlett adds:

                                    I think it is revealing that both Talent and Burns were even or slightly ahead in the polls BEFORE Bush came to campaign for them in the final days--uninvited, by the way.  Basically, his campaigning for them is what cost them their elections and gave the Senate to the Democrats.  Yet there are still people out there who think Rove is a genius.  I think he is the Bob Shrum of the Republican Party--a genius at turning victory into defeat.

                                      Posted by on Wednesday, November 15, 2006 at 04:32 PM in Economics, Politics, Press | Permalink  TrackBack (0)  Comments (32) 

                                      Money and Inflation

                                      Getting ready for class tomorrow and was reminded of this graph from Mishkin's text:

                                      Larger version

                                      The graph shows two things. First, it shows the long lag between changes in the money supply and changes in the inflation rate. There is a close association between inflation and the growth rate in M1 two years earlier. When the supply shocks of the 1970s are accounted for, the association is even closer.

                                      Second, the association breaks down around 1980, most likely due to the onset of rapid financial innovation around that time (e.g., see the speech by Chairman Bernanke on monetary aggregates and monetary policy). This break down in the relationship is also evident in other measures of the money supply such as M2, particularly after the early 1990s. 

                                      Whether the break down is transitory or permanent is an open question and part of the recent debate between Bernanke and Trichet. Some believe the change in the relationship between money and inflation is because rapid financial innovation has made the money supply difficult to measure. They argue the link between measurements of inflation and money growth will stabilize once again when financial innovation levels off. Others argue the measurement difficulties pose more permanent difficulties.

                                      But whether the break down persists or not, for now it is evident and, along with the corresponding theoretical support for interest rate rules, it helps to explain why the Fed has turned to interest rate targeting and why it pays little attention to (such imperfect) measures of the money supply.

                                        Posted by on Wednesday, November 15, 2006 at 04:23 PM in Economics, Inflation, Monetary Policy | Permalink  TrackBack (0)  Comments (5) 

                                        Exchange Rate Models "Not as Bad as You Think"

                                        Charles Engel says there has been progress on exchange rate models since Meese and Rogoff's famous finding that the models are no better than a random walk at predicting the out-of-sample evolution of exchange rates:

                                        Exchange-Rate Models, by Charles Engel, NBER Reporter, Fall 2006: Recent research that my co-authors and I have undertaken, as well as related research by other NBER researchers, suggests that theoretical models of foreign exchange rates are "not as bad as you think." ...

                                        Should Exchange Rate Models Out-predict the Random Walk Model? For many years, the standard criterion for judging exchange rate models has been, do they beat the random-walk model for forecasting changes in exchange rates? This criterion was popularized by the seminal work of Meese and Rogoff.[1] They found that the empirical exchange rate models of the 1970s that seemed to fit very well in-sample tended to have a very poor out-of-sample fit. ...[S]ubsequent work has evaluated exchange rate models by the criterion of whether they produce forecasts with a lower mean-squared error than the simple random walk forecast of no change. Mark's (1995) paper was important in reviving interest in empirical exchange rate models.[2] He found that the models were helpful in predicting exchange rates at long horizons. Subsequent work has cast doubt on whether exchange rates can be forecast at long horizons, so there is a weak consensus that the models are not very helpful in forecasting...

                                        West and I question the standard criterion for judging exchange rate models.[3]

                                        Continue reading "Exchange Rate Models "Not as Bad as You Think"" »

                                          Posted by on Wednesday, November 15, 2006 at 01:50 PM in Academic Papers, Economics, International Finance, International Trade | Permalink  TrackBack (0)  Comments (6) 

                                          Tuesday, November 14, 2006

                                          On the Road Again

                                          William Easterly responds to Jeff Sachs statement that:

                                          Von Hayek was wrong. In strong and vibrant democracies, a generous social-welfare state is not a road to serfdom but rather to fairness, economic equality and international competitiveness.

                                          Here's Easterly's response which makes many of the points made by Tim Duy in his defense of Hayek:

                                          Dismal Science, by William Easterly, Commentary, WSJ: Scientific American, in its November 2006 issue, reaches a "scientific judgment" that the great Nobel Prize-winning economist Friedrich Hayek "was wrong" about free markets and prosperity in his classic, "The Road to Serfdom." ... Prof. Jeffrey Sachs of Columbia University ... announces this new scientific breakthrough in a column, saying "the evidence is now in." To dispel any remaining doubts, Mr. Sachs clarifies that anyone who disagrees with him "is clouded by vested interests and by ideology." ...

                                          First, Mr. Sachs disses the great Hayek by repeating the old canard that Hayek thought any attempt at taxpayer-funded social insurance would put us all on the "Road to Serfdom." This is an especially strange charge, since Hayek ... himself calls for some form of taxpayer-funded social insurance against severe physical deprivation on pages 133-134 of "The Road to Serfdom." ...

                                          Second, if he had studied (Friedrich) Hayek, Mr. Sachs would realize what "The Road to Serfdom" is really about, and how it is of great relevance to Mr. Sachs's own current work... Hayek's great book is all about the dangers of large-scale state economic planning, courageously written in 1944 when Soviet central planning, technocratic socialism and administrative control of the wartime economy appealed as a peacetime model to many New Dealers, celebrity economists and policy wonks of all stripes.

                                          The countries that are now rich subsequently listened enough to Hayek and to common sense to avoid the road to serfdom. Yet today, Mr. Sachs (in his book "The End of Poverty") is peddling his own administrative central plan ... to end world poverty. ... Mr. Sachs is not in favor of central planning as an economic system, but he offers it as a solution, anyway, to the multifold problems of the world's poorest people. If you want the best analysis of why the approach of Mr. Sachs ... will fail to end world poverty this time (as similar efforts failed over the past six decades), you can find it in Hayek.

                                          Third, Mr. Sachs's attempt to make the case for ... the Scandinavian welfare state ... is a little shaky. If this is what passes for the scientific method in Scientific American, American science is in even worse shape than we thought. ...

                                          Mr. Sachs's empirical analysis purports to show that Nordic welfare states are outperforming those states that follow the "English-speaking" tradition of laissez-faire, like the U.K. or the U.S. Poverty rates are indeed lower in the Nordic countries, although the skeptical reader ... might wonder if the poverty outcome in, say, the U.S., with its tortured history of a black underclass and its de facto openness to impoverished but upwardly mobile immigrants, is really comparable to that of Nordic countries.

                                          Then there is the big picture, where those laissez-faire Anglophones in, first, the U.K. and, then, the U.S., just happened to have been the leaders of the ongoing global industrial revolution that abolished far more poverty over the past two centuries than a few modest Scandinavian redistribution schemes. ... Lastly, let's hear from the Nordics themselves, who have been busily moving away from the social welfare state back toward laissez-faire. ...

                                          Mr. Sachs is wrong that Hayek was wrong. In his own global antipoverty work, he is unintentionally demonstrating why more scientists, Hollywood actors and the rest of us should go back and read "The Road to Serfdom" if we want to know what will not work to achieve "The End of Poverty."...

                                          Given what has transpired on the WSJ's editorial pages with respect to global warming, another dispute Sachs was involved in, Easterly has not chosen the best platform from which to talk about what "passes for the scientific method."

                                          My view? Sachs advocates too much intervention, Easterly doesn't advocate enough. Yes, in the long-run industrial revolutions are the best solution to poverty. But, famously, "In the long-run we're all dead."

                                          One last note. Sachs is given credit in a part of the article that was cut because "he does successfully raise the profile of genuinely tragic problems." Here's his latest example from Scientific American:

                                          The Challenge of Sustainable Water, by Jeffrey D. Sachs, Scientific American: While oil shortages grab the headlines, water scarcity is creating at least as many headaches around the world. The most dramatic conditions are in Asia, where ... China and India, are grappling with deepening and unsolved water challenges.

                                          Continue reading "On the Road Again" »

                                            Posted by on Tuesday, November 14, 2006 at 11:40 PM in Economics, Policy | Permalink  TrackBack (1)  Comments (97) 

                                            Fear Itself

                                            In a comment to a Larry Summer's article on the "repudiation election" posted at his Forum, Martin Wolf urges economists to add their "mite" to foreign policy discussions:

                                            Martin Wolf: This is a forum for economists. But I think we should agree that foreign policy is too important to be left to the "experts". As citizens, if not as economists, we should be willing to add our mite, which is why I have occasionally dared to write on foreign policy questions. Larry has himself shown what is possible, by providing an excellent analysis of the mood behind what he describes as a "repudiation election".

                                            The point I would make is that the way in which the post 9/11 world was framed by this administration has been a catastrophe. There is no "war on terror". Military might cannot deliver durable security against an idea. Even in the case of the cold war, the victory was ultimately won because communism was seen as unsuccessful in delivering the good life. What we are engaged in is, in essence, a complex global policing operation, combined with a war of ideas.

                                            We should have the confidence to believe that, given time, our ideas will triumph, provided we do not betray them ourselves and do enough to give them the time they need. By rejecting core features of the rule of law, employing torture, vilifying those who disagree with them, demolishing old alliances, indulging in overweening confidence in military power and, not least, promising to remake societies at the point of a gun, the Bush administration did betray core western values. It also showed grotesque incompetence in execution. How can we win a war of ideas like that? The US and, I hope, the wider world - western and non-western - must now start all over again.

                                            I think that among FDR's greatest contributions in the dark days of the 1930s was his statement that "we have nothing to fear but fear itself". His was the politics of hope. In his very different way, Ronald Reagan also offered hope. This administration's politics have, however, been those of fear. It is this that I find unforgiveable: fear makes us small; fear makes us weak; and fear makes us detestable. We cannot win this conflict of ideas if all we have to offer is our fear.

                                            The American people have shown that fear need not paralyse. This is a triumph of the core democratic idea that a majority of ordinary people will reach the right conclusion in the end. Let us now all hope for an America that is true to its better self.

                                              Posted by on Tuesday, November 14, 2006 at 05:34 PM in Economics, Politics | Permalink  TrackBack (0)  Comments (30) 

                                              Poole: The Federal Funds Outlook is "Roughly Symmetrical"

                                              St. Louis Fed president William Poole gives his outlook for the federal funds rate:

                                              Fed's Poole Says Interest-Rate Stance 'About Right', by Scott Lanman and Craig Torres, Bloomberg: Federal Reserve Bank of St. Louis President William Poole said the central bank's interest-rate stance is ''about right,'' though higher borrowing costs will be needed should the Fed fail to bring inflation down.

                                              ''We need a policy that is disciplined enough to get the job done, but not more so,'' Poole told reporters after a speech in Wilmington, Delaware. ''If all the information taken together suggests that we are not making progress, then I will be among those who will push for a tighter policy.''

                                              Poole said inflation expectations are ''well controlled''... ''The market does believe we're serious'' about containing inflation,'' Poole said.

                                              He reiterated that he sees the outlook for the fed funds rate as ''roughly symmetrical,'' meaning the chances of an interest-rate cut and an increase are about equal. ... ''I can imagine data coming in that would make me want to tighten policy, and I could imagine data coming in that would make me want to ease policy,'' Poole said. ''I don't think we are way behind.'' ...

                                              Continue reading "Poole: The Federal Funds Outlook is "Roughly Symmetrical"" »

                                                Posted by on Tuesday, November 14, 2006 at 05:07 PM in Academic Papers, Economics, Monetary Policy | Permalink  TrackBack (1)  Comments (2) 

                                                Calling Geraldo

                                                CardCarryingMember can't resist one more poke at Senator un-elect Allen:

                                                Allen's Vault, by cornhuskerblogger: We've spent considerable time in recent days wringing all possible droplets of guilty joy from Sen. George Allen's troubled re-election campaign and comeuppance.

                                                I'd like to indulge for at least one more post. ... Turns out Allen vaulted everything he ever wrote, for posterity's sake. He so fancied himself a man of history that he thought he'd do all future scholars a favor by preserving every scrap of his writing -- from official correspondence to bar napkins featuring just a chicken scratch. According to a former Allen staffer I spoke to this weekend, Allen's habit annoyed everyone in his office.

                                                "He actually has a real vault, like they have in a bank," said the staffer, a Republican. ([cornhuskerblogger] is a redstate Democrat after all -- giving him an all-access pass to reasonable people on both sides of the aisle.) "He's ridiculous."

                                                Where is this vault? When do we get a peek at Allen's greatness...? Sounds like a job for Geraldo Rivera.

                                                  Posted by on Tuesday, November 14, 2006 at 04:51 PM in Politics | Permalink  TrackBack (0)  Comments (1) 

                                                  Pigouvian Redistribution

                                                  There has been a lot of support lately for the ideas that Arthur Cecil Pigou (1877-1959) set forth in his book The Economics of Welfare. Pigou held the chair of political economy at Cambridge (succeeding Alfred Marshall) and was the leading neoclassical economist of his day. The book is an attempt to provide a theoretical basis for government intervention to improve social conditions. His introduction of Pigouvian taxes is part of that effort.

                                                  I wonder if the Pigou fans who have been so enthusiastic about Pigouvian taxes will also endorse other ideas from his book. For example, here's part of his argument for redistributing income from the rich to the poor. It could, perhaps, serve as the Pigouvian Redistribution Club's manifesto:

                                                  [I]t is evident that any transference of income from a relatively rich man to a relatively poor man of similar temperament, since it enables more intense wants, to be satisfied at the expense of less intense wants, must increase the aggregate sum of satisfaction. The old "law of diminishing utility" thus leads securely to the proposition: Any cause which increases the absolute share of real income in the hands of the poor, provided that it does not lead to a contraction in the size of the national dividend from any point of view, will, in general, increase economic welfare.

                                                  This conclusion is further fortified by another consideration. Mill wrote: "Men do not desire to be rich, but to be richer than other men. The avaricious or covetous man would find little or no satisfaction in the possesion of any amount of wealth, if he were the poorest amongst all his neighbours or fellow-countrymen." More elaborately, Signor Rignano writes: "As for the needs which vanity creates, they can be satisfied equally well by a small as by a large expenditure of energy. ... In reality a man's desire to appear 'worth' double what another man is worth, that is to say, to possess goods (jewels, clothes, horses, parks, luxuries, houses, etc.) twice as valuable as those possessed by another man, is satisfied just as fully, if the first has ten things and the second five, as it would be if the first had a hundred and the second fifty."

                                                  Now the part played by comparative, as distinguished from absolute, income is likely to be small for incomes that only suffice to provide the necesaries and primary comforts of life, but to be large with large incomes. In other words, a larger proportion of the satisfaction yielded by the incomes of rich people comes from their relative, rather than from their absolute, amount. This part of it will not be destroyed if the incomes of all rich people are diminished together. The loss of economic welfare suffered by the rich when command over resources is transferred from them to the poor will, therefore, be substantially smaller relatively to the gain of economic welfare to the poor than a consideration of the law of diminishing utility taken by itself suggests.

                                                    Posted by on Tuesday, November 14, 2006 at 01:59 AM in Economics, Income Distribution, Taxes | Permalink  TrackBack (3)  Comments (49) 

                                                    Yesterday's Lou Dobbs

                                                    Guess where Perot "giant hypocrite sound" Systems is setting up operations?:

                                                    Company Ross Perot Built Is Now Hiring, in Mexico, by Elisabeth Malkin, NY Times: Remember Ross Perot’s “giant sucking sound”? The Texas billionaire and onetime presidential candidate railed against the North American Free Trade Agreement in the early 1990s, arguing that it would create a “giant sucking sound” of good American jobs pulled to low-wage Mexico.

                                                    But things change. Last week, Mr. Perot’s Texas company announced that it was hiring — in Mexico. The Perot Systems Corporation, which manages information technology for companies, is setting up a technology center in Guadalajara where it expects to employ 270 engineers by the middle of next year. ...

                                                    Perot Systems, based in Plano, Tex., had sales of $2 billion last year and employs 20,000 people in more than 20 countries, 6,000 of them in India alone. ...

                                                    Back in 1992 and 1993, Mr. Perot’s anti-Nafta harangues made him highly unpopular in Mexico... But a dozen years into Nafta, Mexicans are willing to let bygones be bygones. And so, it seems, is Mr. Perot...

                                                      Posted by on Tuesday, November 14, 2006 at 12:30 AM in Economics, International Trade, Politics | Permalink  TrackBack (1)  Comments (25) 

                                                      Are Prices Sticky?

                                                      One of the foundations of modern macroeconomic models is the assumption of wage and price stickiness. Is this a reasonable assumption? How sticky are prices on average?:

                                                      Sticky situations, Economics Focus, The Economist: ...How often individual prices move is an important question. Shifts in prices are like the traffic lights of an economy, signalling to people to buy more of this and less of that, to spend or to save, or to find new jobs. If the lights change readily, resources can be redirected smoothly; if they get stuck, so does the economy...

                                                      Although of great macroeconomic significance, the evidence on price stickiness lies in the microeconomic detail of thousands upon thousands of prices. Until recently, economists have known remarkably little about how often and by how much prices change, because the information needed is vast and often secret... Lately, however, several researchers have got their hands on useful data...

                                                      Most of the early work was done in America, and much of it looked at the prices of only a few things, such as magazines on news-stands or mail-order goods. It concluded that these prices changed only about once a year. However, a paper published in 2004 by Mark Bils ... and Peter Klenow ... found that most prices change more often. Messrs Bils and Klenow used data on 350 goods and services collected ... for calculating the consumer-price index. They reckoned that in 1995-97 half of these prices changed at least every four or five months.

                                                      New research by Emi Nakamura and Jon Steinsson, both graduate students at Harvard, points out the importance of sales and special promotions in the frequency of American price changes. Sales are much more common in some markets than in others, accounting for 87% of price changes for clothes (think of clearance sales), 67% in furniture (all those half-price sofas) and 58% in processed food (baked beans are on special offer again), but none in vehicle fuel or utilities and scarcely any in services (when did your lawyer last offer you a discount?). After the effects of sales and special offers were stripped out, the median duration of retail prices lay between eight and 11 months in 1998-2005. Including sales cuts the duration by half, bringing the results roughly into line with those of Messrs Bils and Klenow. It also matters, but only a bit, that Ms Nakamura and Mr Steinsson studied a later period, when inflation was slightly lower: they note that high inflation leads shops to raise prices more often.

                                                      The evidence from the euro area, fruit of a three-year project coordinated by the European Central Bank and completed this year, suggests that prices there change less often than in the United States. The European economists found that retail prices change every four or five quarters. Removing the effects of cut-price sales, where data were available, made little difference: sales, it seems, matter much less than in America. ... Price changes in Europe, when they happened, tended to be big, whether up or down: the average increase was 8% and the average cut 10%, against inflation of 2% or so. Changes in American prices, in both directions, are also much larger than the overall inflation rate.

                                                      On both sides of the Atlantic the frequency of price changes varies enormously. Generally speaking, the greater the share of raw materials in a product, the more often its price moves: petrol prices change, on average, in five months out of six...; the prices of fresh food are altered far more frequently than those of processed food. The prices of services are stickier than those of goods. This may be because services tend to be more labour-intensive than goods, and because wages are stickier ... than other prices...

                                                        Posted by on Tuesday, November 14, 2006 at 12:27 AM in Economics, Macroeconomics | Permalink  TrackBack (0)  Comments (5) 

                                                        Monday, November 13, 2006

                                                        Economists Thinking Like Economists

                                                        In this "season of non-economists opining about what economics is all about," David Altig comes to the defense, yet again, of economists thinking like economists. Having just posted a "Military Production Function" here earlier today, David's defense is timely:

                                                        More Things Economists Don't Say, by David Altig, macroblog: From The Weekly Standard (via Instapundit) comes an article by Harvard law professor William Stuntz, "explaining" how thinking like an economist is the wrong way to go about weighing the options in Iraq. I hesitate to wade into these waters... But it seems to be the season of non-economists opining about what economics is all about, and I seem to be in the mood to object.

                                                        So object I will. But before I do, let me make this ... clear: Nothing I'm about to say should construed as support, one way or another, for any particular position on whether the war was a good idea or bad idea, ... or whatever. ... I am not interested Professor Stuntz's position on the war per se, but rather his characterization of what it means to think like an economist.

                                                        With that disclaimer, we begin:

                                                        Continue reading "Economists Thinking Like Economists" »

                                                          Posted by on Monday, November 13, 2006 at 04:20 PM in Economics, Iraq and Afghanistan | Permalink  TrackBack (0)  Comments (7) 

                                                          Money and Monetary Policy

                                                          Here's a bit more on the controversy over using money in monetary policy. For those who are interested, I've included a few pages from Michael Woodford's book on this topic at the end (he's mentioned in the article). It's a section in the first chapter called "General Criticisms of Interest-Rate Rules." It doesn't directly address the Trichet-Bernanke controversy, but it does give the major objections to the use of interest-rate targeting, and it does relate to the issue:

                                                          Central bankers need money in monetary policy, by Wolfgang Munchau, Commentary, Financial Times: If there is one area where Europeans are from Mars and Americans from Venus, it is monetary policy and the role of monetary aggregates. Last week, the world’s two most prominent central bankers publicly disagreed. Jean-Claude Trichet, European Central Bank president, argued in the Financial Times why monetary analysis would remain an essential part of the ECB’s tool kit. Ben Bernanke, US Federal Reserve chairman, said a central bank would be unwise to rely too heavily on money since financial innovation had been causing disturbances to monetary statistics.

                                                          Continue reading "Money and Monetary Policy" »

                                                            Posted by on Monday, November 13, 2006 at 01:05 PM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (4) 

                                                            Paul Krugman: True Blue Populists

                                                            Paul Krugman takes a look at the populist wave evident in the recent election and wonders if the Democratic victory will translate into real reform and a new direction for economic policy:

                                                            True Blue Populists, by Paul Krugman, Commentary, NY Times: Senator George Allen of Virginia is understandably shocked and despondent. Just a year ago, a National Review cover story declared that his “down-home persona” made him “quite possibly the next president of the United States.” Instead, his political career seems over.

                                                            And it wasn’t just macaca, or even the war, that brought him down. Mr. Allen, a reliable defender of the interests of the economic elite, found himself facing an opponent who made a point of talking about ... rising inequality. And the tobacco-chewing, football-throwing, tax-cutting, Social Security-privatizing senator was only one of many faux populists defeated by real populists last Tuesday.

                                                            Ever since movement conservatives took over, the Republican Party has pushed for policies that benefit a small minority of wealthy Americans at the expense of the great majority of voters. To hide this reality, conservatives have relied on wagging the dog and wedge issues, but they’ve also relied on a brilliant marketing campaign that portrays Democrats as elitists and Republicans as representatives of the average American.

                                                            This sleight of hand depends on shifting the focus from policy to personal style: John Kerry speaks French and windsurfs, so pay no attention to his plan to roll back tax cuts for the wealthy and use the proceeds to make health care affordable.

                                                            This year, however, the American people wised up. True.., some reporters still seem to be falling for the conservative spin. “If it walks, talks like a conservative, can it be a Dem?” asked the headline on a CNN.com story featuring ... Senator-elect Jon Tester of Montana. ...

                                                            But as ... The New York Times pointed out..., what actually characterizes the new wave of Democrats is a “strong streak of economic populism.”

                                                            Look at Mr. Tester’s actual policy positions: yes to an increase in the minimum wage; no to Social Security privatization; we need to “stand up to big drug companies” and have Medicare negotiate for lower prices; we should “stand up to big insurance companies and support a health care plan that makes health care affordable for all Montanans.”

                                                            So what, aside from his flattop haircut, makes Mr. Tester a conservative? O.K., he supports gun rights. But on economic issues he’s clearly left of center, not just compared with the current Senate, but compared with current Democratic senators. The same can be said of many other victorious Democrats...

                                                            But will this wave be reflected in the actual direction of the Democratic Party?

                                                            Not necessarily. Quite a few sitting Democrats have shown themselves nearly as willing as Republicans to bow to corporate interests. Consider ... last year’s draconian bankruptcy bill. Mr. Lieberman voted for cloture, cutting off debate and ensuring the bill’s passage... Thirteen other Democratic senators also voted for cloture, including Joe Biden, who has just announced his candidacy for president.

                                                            The first big test of the new Democratic populism will come over reform of the 2003 prescription drug law. Democrats have pledged to repeal the clause ... preventing Medicare from negotiating lower drug prices. But the fine print of how they do that is crucial: Medicare reform could be a mere symbolic gesture, or it could be a real reform that eliminates the huge implicit subsidies the program currently gives drug and insurance companies.

                                                            Are the newly invigorated Democrats ready to offer a real change in this country’s direction? We’ll know in a few months.

                                                            Previous (11/10) column: Paul Krugman: The Great Revulsion
                                                            Next (11/24) column: Paul Krugman: When Votes Disappear

                                                              Posted by on Monday, November 13, 2006 at 12:15 AM in Economics, Politics | Permalink  TrackBack (0)  Comments (29) 

                                                              Sunday, November 12, 2006

                                                              The Military Production Function: V=F(L,M,T,I)

                                                              With the discussions about what went wrong in Iraq heating up, this Economic Scene by Alan Kruger from before the war might be of interest. It develops a military production function, V=F(L,M,T,I), where V=victory, L=leadership, M=morale, T=troop levels, and I=intelligence. Surprisingly, once these factors are accounted for, technological advantage makes little difference. For reference, according to the AP, "currently [we have] about 144,000 U.S. troops in Iraq, down from a peak of about 160-thousand in January."

                                                              It's evident we had the technological advantage. I will let you judge leadership, troop levels, morale, and intelligence:

                                                              Military manpower and leadership are pluses, but battles are hard to predict, by Alan Kruger, Economic Scene, NY Times, February 2003: Donald H. Rumsfeld, the defense secretary, and his top generals are vigorously debating the number of troops to deploy in the event of a second Persian Gulf war. Coalition forces numbered 795,000 in the 1991 war. Mr. Rumsfeld has argued that far fewer American troops -- no more than 100,000 -- are needed to defeat Saddam Hussein's armies this time around because of the revolution in military technology and Iraq's weakened state, while the military brass is not so sure, and prefers at least 250,000.

                                                              News reports say they have agreed to split the difference and put around 175,000 troops in the region, with 100,000 or more reinforcements available if needed.

                                                              What does it take to produce a military victory?

                                                              Continue reading "The Military Production Function: V=F(L,M,T,I)" »

                                                                Posted by on Sunday, November 12, 2006 at 03:42 PM in Economics, Iraq and Afghanistan | Permalink  TrackBack (0)  Comments (68) 

                                                                Reading List

                                                                I need to read this:

                                                                Testing Models of Low-Frequency Variability, by Ulrich Mueller and Mark W. Watson, NBER WP 12671, November 2006: Abstract We develop a framework to assess how successfully standard times series models explain low-frequency variability of a data series. The low-frequency information is extracted by computing a finite number of weighted averages of the original data, where the weights are low-frequency trigonometric series. The properties of these weighted averages are then compared to the asymptotic implications of a number of common time series models. We apply the framework to twenty U.S. macroeconomic and financial time series using frequencies lower than the business cycle. ... Conclusions ... Three main findings stand out. First, despite the narrow focus, very few of the series are compatible with the I(0) model. ... Most macroeconomic series and relationships thus exhibit pronounced non-trivial dynamics below business cycle frequencies. In contrast, the unit root model is often consistent with the observed low-frequency variability. Second, our theoretical results on the similarity of the low-frequency implications of alternative models imply that it is essentially impossible to discriminate between these models based on low-frequency information using sample sizes typically encountered in empirical work. ... Third, maybe the most important empirical conclusion is that for many series there seems to be too much low-frequency variability in the second moment to provide good fits for any of the models. From an economic perspective, this underlines the importance of understanding the sources and implications of such low-frequency volatility changes. From a statistical perspective, this finding motivates further research into methods that allow for substantial time variation in second moments. [Open link]

                                                                This too:

                                                                Linear-Quadratic Approximation of Optimal Policy Problems, by Pierpaolo Benigno and Michael Woodford , NBER WP 12672, November 2006: Abstract We consider a general class of nonlinear optimal policy problems involving forward-looking constraints (such as the Euler equations that are typically present as structural equations in DSGE models), and show that it is possible, under regularity conditions that are straightforward to check, to derive a problem with linear constraints and a quadratic objective that approximates the exact problem. The LQ approximate problem is computationally simple to solve, even in the case of moderately large state spaces and flexibly parameterized disturbance processes, and its solution represents a local linear approximation to the optimal policy for the exact model in the case that stochastic disturbances are small enough. We derive the second-order conditions that must be satisfied in order for the LQ problem to have a solution, and show that these are stronger, in general, than those required for LQ problems without forward-looking constraints. We also show how the same linear approximations to the model structural equations and quadratic approximation to the exact welfare measure can be used to correctly rank alternative simple policy rules, again in the case of small enough shocks. [Open link]

                                                                I don't expect much if any interest in these papers (though open links are included for the curious), just putting them in the archive for easy access later.

                                                                  Posted by on Sunday, November 12, 2006 at 11:12 AM in Academic Papers, Economics | Permalink  TrackBack (0)  Comments (2) 

                                                                  Do We Need Independent Fed-Like Committees to Reform Health Care and Retirement Policy?

                                                                  This is a review of the history leading up to the creation of the Federal Reserve system followed by an idea to overcome the political stalemate preventing reform of health care and pension policy. The idea is to follow the Fed model and put the reform decisions in the hands of politically independent policy experts. Here's the the Fed history and the proposal followed by extensive comments on each:

                                                                  How last century's money wars may lead to healthcare, pension reform, by H.W. Brands, Commentary, LA Times: Pity Ben Bernanke. As chairman of the Federal Reserve, his every utterance (or cough or sneeze) is analyzed for clues as to the future direction of interest rates. The weight of the American economy is laid on his shoulders...

                                                                  But matters could be worse. Trying as Bernanke's job ... might sometimes be, it is nothing like the task his more distant predecessors faced. The modern Fed was born nearly a century ago of a grand compromise that terminated one of the longest-running and most bitter struggles in American political history: the fight over the money question.

                                                                  From the 1780s until 1913, the money question roiled American public life — spawning political parties and candidates, sparking legislative fisticuffs and convention brawls, prompting boardroom conspiracies and White House scandals. It fell into two parts. What constituted money? And who controlled it? Was money gold, silver, paper currency or bank notes? Should the private sector control the money supply, the way it controlled the supply of wheat, corn and steel? Or should the public sector, which typically controlled water supplies and police services? ...

                                                                  The money question ... provided the first battleground between Alexander Hamilton's Federalists and Thomas Jefferson's Republicans, with Hamilton urging creation of a federally chartered but privately controlled bank to oversee and manage the American money supply, and Jefferson opposing Hamilton's bank as unconstitutional and elitist.

                                                                  Continue reading "Do We Need Independent Fed-Like Committees to Reform Health Care and Retirement Policy?" »

                                                                    Posted by on Sunday, November 12, 2006 at 02:43 AM in Economics, Health Care, Monetary Policy | Permalink  TrackBack (0)  Comments (15) 

                                                                    Saturday, November 11, 2006

                                                                    Restoring Faith in Government

                                                                    The last few years have done nothing that I can see to restore people's faith in government. Instead, if anything, people have become more and more doubtful about the ability of government to function at even the most basic levels.

                                                                    The election was a start - it seems to have restored people's faith that the process still works, that people eventually see through even the most carefully constructed political cover, and that they are able to speak clearly and forcefully to politicians through the ballot box. And this is despite concerted attempts to thwart such political will through gerrymandering and other such techniques.

                                                                    But it is only a start.

                                                                    Continue reading "Restoring Faith in Government" »

                                                                      Posted by on Saturday, November 11, 2006 at 06:21 PM in Economics, Politics | Permalink  TrackBack (0)  Comments (19) 

                                                                      What Happened to the Surplus?

                                                                      Greg Mankiw:

                                                                      What happened to the surplus?, by Greg Mankiw: Remember 2001, when the federal government was projecting huge surpluses, and people were worrying what we would do when the government debt was completely paid off? Well, it looks like we solved that problem!*

                                                                      How did we do it? The table above, from economist J. Edward Carter based on CBO data, shows the causes of the change from a ten-year surplus of $5.6 trillion to a ten-year deficit of $2.9 trillion -- a swing of $8.5 trillion. The biggest factor was increased spending, of which increased defense spending was the largest piece. The second biggest factor was changed economic and technical assumptions (that is, the forecasters were wrong).

                                                                      The tax cuts amounted to $1.8 trillion of the $8.5 trillion--about a fifth. And even that amount is an overestimate, because it most likely relies on static assumptions. A dynamic analysis that allows for a feedback of lower taxes to more rapid growth would reduce the share of the budget swing attributed to tax cuts.

                                                                      Reasonable people can disagree about whether the Bush tax cuts were advisable, but don't let anyone tell you that the tax cuts were the main reason the surplus of 2001 disappeared.

                                                                      * Before some commenter flames me: yes, this sentence is tongue-in-cheek.

                                                                      I'm confused what we are supposed to take away from this. If the message is that the tax cuts did not do much to contribute to deficit the problem, then I certainly disagree - 1.8 trillion, assuming that's an accurate figure, is no small bump in the budget over the 10 year period examined (2002-2011, so part of this is a forecast and thus subject to questions about the underlying assumptions - these are not actual numbers - note: see the update below).

                                                                      The claim is that the 1.8 trillion is only 20% of the total change in the budget, but the NRO article Greg refers to denies that the baseline figure used in the calculation of a 20% share is even relevant:

                                                                      Clue #1: The $5.6 trillion surplus was a mirage. It never existed. The CBO based its surplus estimate on the existing tax and spending laws and on an economic forecast that simply did not stand the test of time.

                                                                      Clue #2: Even if the CBO’s economic and technical assumptions had been accurate, and even if President Bush had not championed tax relief, and even if the country had not been dragged into a global war on terrorism, the projected surplus never would have materialized.

                                                                      Why is it being used as a baseline to calculate the impact of tax cuts if, as the article says:

                                                                      So, what do the clues reveal about the missing $5.6 trillion surplus? 1) It never existed. 2) It never would have existed. 3) Policymakers never intended for it to exist.

                                                                      So, a non-existent figure is used to make the point that 1.8 trillion is just a drop in the bucket? Why is the 20% figure relevant - shouldn't it reflect actual instead of projected numbers? What am I missing?

                                                                      Suppose you take out the part that forecasters missed, the 2.5 trillion from "technical adjustments and revised economic assumptions," from the 8.1 trillion surplus. That leaves 8.5-2.5=6.0 trillion swing in the budget given the assumptions underlying the forecasts through 2011. The tax cuts are then 1.8/6.0 = 30% of the total. That's a pretty good chunk of the swing in the budget. That spending was increased by a bit over twice that amount doesn't reduce its magnitude.

                                                                      Update: This notice appears with the article:

                                                                      BELATED FULL DISCLOSURE

                                                                      It has been pointed out elsewhere on the web that one of our pieces today was written by someone described as “an economist in Washington, D.C.” He, in fact, works for the Department of Labor. He signed the piece with a byline he’s been using for years. Not for the first time, we — wrongly — assumed the author had left government when we were approached with unsolicited pieces. We were wrong to assume. His piece now makes note of this explanation/disclosure/apology. As a practice, we don’t publish pieces from people who work in government without disclosing it. We were remiss here and apologize to our readers.

                                                                        Posted by on Saturday, November 11, 2006 at 11:52 AM in Budget Deficit, Economics, Politics, Taxes | Permalink  TrackBack (2)  Comments (22) 

                                                                        "'Tis But a Scratch"

                                                                        I keep reading variations of this type of analysis on the editorial pages:

                                                                        It reminds me of this [YouTube]:

                                                                        ARTHUR draws his sword and approaches the BLACK KNIGHT. A furious fight now starts lasting about fifteen seconds at which point ARTHUR delivers a mighty blow... ARTHUR steps back triumphantly.

                                                                        ARTHUR: Now stand aside worthy adversary.

                                                                        BLACK KNIGHT: (Glancing at his shoulder) 'Tis but a scratch.

                                                                        ARTHUR: A scratch? Your arm's off.

                                                                        BLACK KNIGHT: No, it isn't.

                                                                        ARTHUR: You are indeed brave Sir knight, but the fight is mine. ... You haven't got any arms left.

                                                                        BLACK KNIGHT: Course I have.

                                                                        ARTHUR: Look!

                                                                        BLACK KNIGHT: What! Just a flesh wound. (kicks ARTHUR)

                                                                        ARTHUR Stop that.

                                                                        BLACK KNIGHT (kicking him) Had enough ...? ... Chicken! [kick] Chickennn!

                                                                        ARTHUR: What are you going to do...?

                                                                        BLACK KNIGHT: I'm invincible!

                                                                        ARTHUR: You're a looney.

                                                                        BLACK KNIGHT: The Black Knight always triumphs. Have at you!

                                                                        ARTHUR: takes his last leg off. The BLACK KNIGHT's body lands upright.

                                                                        BLACK KNIGHT: All right, we'll call it a draw. ...

                                                                          Posted by on Saturday, November 11, 2006 at 10:13 AM in Economics, Politics | Permalink  TrackBack (0)  Comments (13) 

                                                                          FRBSF: Economic Outlook

                                                                          The view of the economy from the San Francisco Fed:

                                                                          Glenn Rudebusch, senior vice president and associate director of research at the Federal Reserve Bank of San Francisco, states his views on the current economy and the outlook:

                                                                          • The initial estimate of real GDP growth during the third quarter was 1.6 percent at an annual rate—about half the average pace during the previous two years. Strong gains in consumption and business investment were partially offset by a drop in homebuilding. Looking ahead, the economy seems likely to grow at a 2-1/2 to 2-3/4 percent pace in each of the next few quarters. This projection balances the effects of a cooling in housing markets with solid growth in the remaining 95 percent of the economy outside of residential construction.
                                                                          • Real residential investment has declined almost 10 percent over the past year, which is not as large as the declines posted during earlier periods when housing booms and busts were exacerbated, in part, by financial restrictions, such as Regulation Q. Also note that, unlike in past episodes, the current drop in housing does not coincide with a recession. Although housing permits and starts are down about 25 percent from the beginning of this year, there is no clear indication that the housing downturn is ending or that it is intensifying.
                                                                          • Despite the housing slowdown, the rest of the economy remains healthy. Real consumer spending in the third quarter increased 3.1 percent at an annual rate, and auto sales are holding up well.
                                                                          • On balance, any spillover from the housing slowdown to the rest of the economy appears to have been offset by four important factors that are supporting growth. The first of these factors is the solid growth in employment, with associated increases in labor income. The solid pace of hiring this year raises questions about whether recent flagging GDP growth reflects a transitory lull rather than a substantial slowdown. The second factor supporting growth is the recent drop in energy prices. The third factor is the recent increases in equity markets, which bolster household wealth. And, finally, as the fourth factor, borrowing costs—especially conventional fixed mortgage rates—continue to be relatively low.
                                                                          • A crucial question facing policymakers is how soon will core inflation return to a more comfortable level. One reason for cautious optimism is that inflation expectations appear to remain contained, as various indicators of these expectations are in the same range that has prevailed over the past two years. Therefore, this year's surge in price inflation has not changed the market's view about where inflation will eventually be returned to by the Fed.
                                                                          • In contrast, the upside risk to the inflation outlook from labor market pressures appears to have been growing. As the FOMC noted in its October 25 statement: "the high level of resource utilization has the potential to sustain inflation pressures." Since then, the labor market continues to tighten, and the unemployment rate fell to 4.4 percent in October, the lowest level since May 2001.
                                                                          • With labor markets fairly tight, labor costs appear to have begun to accelerate. The broadest measure of compensation in the nonfarm business sector increased 6.7 percent over the past year. In contrast, the employment cost index (ECI), which excludes stock option realizations and a few other forms of compensation that are included in the broader measure, increased only 3.3 percent over the past year. (The ECI is also based on a fixed employment structure, which would not capture any shift in the mix of jobs to higher compensation occupations.) The true underlying marginal cost pressures that firms face probably lie somewhere in between these two measures.
                                                                          • Still, core inflation will likely moderate gradually over time as labor cost pressures are absorbed by reduced markups of prices over costs and restrained by a below-trend growth. However, the upside risk to this inflation projection is an important concern for policymakers.

                                                                            Posted by on Saturday, November 11, 2006 at 01:50 AM in Economics, Monetary Policy | Permalink  TrackBack (1)  Comments (8) 

                                                                            Friday, November 10, 2006

                                                                            Monetary Aggregate Cage Match

                                                                            Central bank heads Bernanke and Trichet are battling over the use of monetary aggregates to guide monetary policy decisions. I posted Trichet's argument for the use of monetary aggregates here along with links to many previous posts on this topic (including a discussion of an academic paper by Bernanke that helped to do away with aggregates - it's first on the list at the end of the post). Here's a discussion of Bernanke's response to Trichet from the Financial Times:

                                                                            Trichet and Bernanke differ on strategy, by Ralph Atkins, Financial Times: Transatlantic differences over monetary strategy erupted into the open on Friday as the European Central Bank sought to modernise its policy of relying on money supply measures as an inflation early-warning system. Jean-Claude Trichet, ECB president, used a Frankfurt conference to stress the importance of indicators such as M3, the broad money supply measure.

                                                                            But in contrast, Ben Bernanke, US Federal Reserve chairman, said a heavy reliance on money supply measures “would seem to be unwise in the US context,” although money growth data might still offer important signals about future economic developments. ...

                                                                            Mr Bernanke pointed to larger methodological problems in the US. “The rapid pace of financial innovation in the US has been an important reason for the instability of the relationships between monetary aggregates and other macroeconomic variables.” Changes in payment technologies and individuals’ behaviour had meant usage of different kinds of accounts “have at times shifted rapidly and unpredictably”.

                                                                            The problems Bernanke discusses, rapid financial innovation and rapid movement of funds between asset classes, led to a breakdown of the relationship between monetary aggregates and macroeconomic variables in the early 1990s. Since then, researchers have not been able to find a collection of financial assets (e.g. M1, M2, and many, many variations including weighted averages of various asset collections) that exhibits the stable relationship needed to make the variable useful for predicting the future evolution of macroeconomic variables and hence useful for policy. Because of that, the Fed has embraced interest rate targeting - the federal funds rate in particular - a move also supported by theoretical work since that time (though as Trichet notes, when substantial financial frictions are present in these models, money retains a role; thus, there are theoretical bases for looking at aggregates as well as interest rates).

                                                                            Also, from the comments to the first post on this issue, this is Krzysztof Rybiński, deputy governor of the National Bank of Poland:

                                                                            The role of money in monetary policy is an open issue indeed. Benati (2006) shows that for low frequencies (8-30 years) the correlation between money and inflation is surprisingly strong. But does it offer any guidance, if central banks want assess the future inflation risks in 2-3 year horizon. Many papers show that money affects inflation over the shorter-horizons only on a global scale. I discuss these issues on my blog www.rybinski.eu (probably first ever central banker's blog)

                                                                            Update: From Cassandra in comments:

                                                                            I listened to the speeches and subsequent Q&A on taped feed and here are my two cents:

                                                                            Bernanke (TeamFRB) - He always seems rather nervous and lacking the authority, confidence (and probably arrogance) one should have if one is going to assert that money is really not so important in regards to inflation. HUH??!? So interest rates are low because there's a "savings glut," and money doesn't matter to inflation as long villagers as in Timbuktu are using it for whatever. Oh, yea, [whispering now]  and that the PBoc & BoJ continue to give us back the ones they've accumlated for us to hold temporarily. Huh??!?! He reminds me of the "Alternative School Headmaster" in my hometown when they first set up idea. You know: Kids responsible for themselves. No attendance taken. No grades. Surprise!! Guess what happen?  Hardly anyone came to school, and the kids just sat around and smoked dope all day. OK it was the 60s, but some experiments are best left unrepeated.

                                                                            Trichet (TeamECB) - Considering the high incidence of intellectual arrogance amongst the typical Grande Ecole French Technocrats (not that it isn't deserved), Mr Trichet was by comparison, profoundly thoughtful, measured, open-minded, yet disciplined, and probably the most able to "wear and consider others' positions" before asserting the superiority of the ECBs approach in theory and practice. Oh yea, in case anyone was wondering, just because Issing retired doesn't mean he's laying down early-morning towels on beach chairs in Grand Canary.

                                                                            Iwata (TeamBoJ)- Whizzbang!! Wonderful command of the material and thoughtful evaluation of quantitative easing (not that it mattered). Brought some typically nifty Japanese visual aids. Probably the best fun of the lot to go out drinking with. A real shame though that he could not (unsurprisingly) conjure a remotely sensible answer answer the question when posed [paraphrased] "Dude!!...did it ever ever ever cross your mind that ZIRP might.. like.... just have no impact on the demand for money IN Japan, but just might have every Tom Dick & Harry hedge fund manager and Foreign Bank lining OUTSIDE of Japan to up take your magnanimous offer of FREE MONEY? WHAT WERE YOU THINKING ???!??! 

                                                                            Xiaochuan (TeamPBoC) - Nice, deferential, new kid on the block. So new, that he let no opportunity pass to let everyone know that, before his experience with asset prices is limited since before 1991, there was no stock market!! And before 1995,  there was no difference between fiscal and monetary policy China. That their historical experience monitoring real estate markets is rather patchy too since real estate markets didn't exist before 1998. Everything is a learning experience. "We have a lot to learn." As for inflation, he said something like "Money growth is probably too high, but we keep watching for inflation, but, hey golly no inflation!! [smiles, scratches head like my Zen teacher used to do when quoting Suzuki about What's at the Center of An Onion]. He went on to hypothesize that probably because there was so much capex and new capacity that overcapacity in many industries has not only kept the lid on inflation, but may actually be causing certain prices to fall!! 

                                                                            One just hopes that Xiaochuan doesn't start talking to Iwata and Bernanke in private and decide that selectively falling prices for certain things (the D-word which must not be named), that in China directly resulted from over-investment that itself resulted from liquidity spillover from ZIRP in Japan + prolonged negative real US rates, now requires some effective rear-guard or preventative action like ZIRP, quantitative easing, more negative real interest rates, or heaven forbid, Ben's Helicopter. I guess what goes around comes around and keeps going and coming around.

                                                                              Posted by on Friday, November 10, 2006 at 07:29 PM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (20) 

                                                                              I'll Take a Little of That Global Warming

                                                                              After several days of rain here in Oregon, and with the certainty of many, many more cold and rainy days yet to come, words like greenhouse and warming start to sound pretty good. Forget about a Pigovian tax, it's time for a Pigovian subsidy. Joseph Stiglitz brings me back to my senses:

                                                                              Snowballing costs, by Joseph Stiglitz, Project Syndicate: The British government recently issued the most comprehensive study to date of the economic costs and risks of global warming, and of measures that might reduce greenhouse gas emissions, in the hope of averting some of the direst consequences. Written under the leadership of Sir Nicholas Stern of the London School of Economics, ... the report makes clear that the question is no longer whether we can afford to do anything about global warming, but whether we can afford not to.

                                                                              The report proposes an agenda whose cost would be equivalent to just 1% of annual consumption, but would save the world risk equivalent costs that are five times greater. The ... study may actually significantly underestimate the costs: for instance, climate change may lead to more weather variability, a possible disappearance or major shift of the Gulf Stream - of particular concern to Europe - and a flourishing of disease. ...

                                                                              Still, some suggest that because we are not certain about how bad global warming will be, we should do little or nothing. To me, uncertainty should make us act more resolutely today, not less. As one scientist friend puts it: if you are driving on a mountain road, approaching a cliff, in a car whose brakes may fail, and a fog bank rolls in, should you drive more or less cautiously? ...

                                                                              Continue reading "I'll Take a Little of That Global Warming" »

                                                                                Posted by on Friday, November 10, 2006 at 06:17 PM in Economics, Environment | Permalink  TrackBack (0)  Comments (7) 

                                                                                Summers: Finding a Way to Move Forward

                                                                                Larry Summers looks to the past for guidance about what to expect from Democrats after the "repudiation election" that returned them to power:

                                                                                After repudiation, the way forward, by Lawrence Summers, Commentary, Financial Times: Tuesday’s mid-term elections ... was a striking but not historically extraordinary event. Of the 16 mid-term elections since the second world war, Tuesday’s was the seventh that could be classified as a “repudiation election”... The varied aftermaths of past repudiation, elections show the difficulty of forecasting what will follow the Democrats’ victory...

                                                                                [H]istory does not provide an unambiguous verdict on the aftermath of a repudiation election, [but] it does suggest the political imperatives for the two parties. For the Republicans, the challenge will be to generate bipartisan accomplishments while luring Democrats into overreaching and appearing unreasonable and out of touch. For the Democrats, the challenge will be to establish credibility as a governing party. Their campaign was about the incompetence and corruption of the Republicans – it was not a referendum on a Democratic ideology. Electoral success two years from now will require the articulation of a broad vision for where the country needs to go and a comprehensive legislative programme.

                                                                                What does this suggest about likely policy outcomes?

                                                                                Continue reading "Summers: Finding a Way to Move Forward" »

                                                                                  Posted by on Friday, November 10, 2006 at 12:25 PM in Economics, Policy, Politics | Permalink  TrackBack (0)  Comments (4) 

                                                                                  Paul Krugman: The Great Revulsion

                                                                                  Paul Krugman looks at the end of the "reign of error" as he sees "a vision — maybe just a hope" realized:

                                                                                  The Great Revulsion, by Paul Krugman, Commentary, NY Times [Free Nov. 6-12]: I’m not feeling giddy as much as greatly relieved. O.K., maybe a little giddy. Give ’em hell, Harry and Nancy!

                                                                                  Here’s what I wrote more than three years ago... “I have a vision — maybe just a hope — of a great revulsion: a moment in which the American people look at what is happening, realize how their good will and patriotism have been abused, and put a stop to this drive to destroy much of what is best in our country.”

                                                                                  At the time, the right was still celebrating the illusion of victory in Iraq, and the bizarre Bush personality cult was still in full flower. But now the great revulsion has arrived. Tuesday’s election was a truly stunning victory for the Democrats...

                                                                                  The election wasn’t just the end of the road for Mr. Bush’s reign of error. It was also the end of the 12-year Republican dominance of Congress. The Democrats will now hold a majority in the House that is about as big as the Republicans ever achieved during that era of dominance.

                                                                                  Moreover, the new Democratic majority may well be much more effective than the majority the party lost in 1994. Thanks to a great regional realignment, ... Democratic control no longer depends on a bloc of Dixiecrats whose ideological sympathies were often with the other side of the aisle.

                                                                                  Now, I don’t expect or want a permanent Democratic lock on power. But I do hope and believe that this election marks the beginning of the end for the conservative movement that has taken over the Republican Party. In saying that, I’m not calling for or predicting the end of conservatism... [A] diversity of views is part of what makes democracy vital.

                                                                                  But we may be seeing the downfall of movement conservatism — the potent alliance of wealthy individuals, corporate interests and the religious right that took shape in the 1960s and 1970s. This alliance may once have had something to do with ideas, but it has become mainly a corrupt political machine, and America will be a better place if that machine breaks down.

                                                                                  Why do I want to see movement conservatism crushed? Partly because the movement is fundamentally undemocratic; its leaders don’t accept the legitimacy of opposition... And the determination ... to hold on to power at any cost has poisoned our political culture. Just think about the campaign that just ended, with its coded racism, deceptive robo-calls, personal smears, homeless men bused in to hand out deceptive fliers, and more. Not to mention the constant implication that anyone who questions the Bush administration or its policies is very nearly a traitor.

                                                                                  When movement conservatism took it over, the Republican Party ceased to be the party of Dwight Eisenhower and became the party of Karl Rove. The good news is that Karl Rove and the political tendency he represents may both have just self-destructed.

                                                                                  Two years ago, people were talking about permanent right-wing dominance of American politics. But since then the American people have gotten a clearer sense of what rule by movement conservatives means. They’ve seen the movement take us into an unnecessary war, and botch every aspect of that war. They’ve seen a great American city left to drown; they’ve seen corruption reach deep into our political process; they’ve seen the hypocrisy of those who lecture us on morality.

                                                                                  And they just said no.

                                                                                  Previous (11/6) column: Paul Krugman: Limiting the Damage
                                                                                  Next (11/13) column: Paul Krugman: True Blue Populists

                                                                                    Posted by on Friday, November 10, 2006 at 12:15 AM in Economics, Politics | Permalink  TrackBack (0)  Comments (31) 

                                                                                    Neoclassical Indoctrination

                                                                                    This story is from a reporter who enrolled in an introductory economics course at the University of Chicago to learn about "left-wing indoctrination" in college courses as practiced in economics:

                                                                                    What We Learn When We Learn About Economics, by Christopher Hayes, These Times, November 2006: There’s a case to be made that the single most intellectually and politically influential neighborhood in the United States is Chicago’s Hyde Park. Integrated, affluent and quiet, the 1.6 square mile enclave on the city’s south side is like a tiny company town, where the company happens to be the august, gothic, eminently serious University of Chicago. Students at the U. of C. sell T-shirts that read “Where Fun Goes To Die,” and the same could be said of the neighborhood, which until very recently had a bookstore-to-bar ratio of 5:2.

                                                                                    But the university is probably best known for the school of economic thought it has produced. When the Chicago School first emerged in the ’50s, its zealous support of free markets and critique of government intervention were considered reactionary and extreme. ...

                                                                                    Neoclassical economics, as the Chicago School of thought is now called, has become an international elite consensus, one that provides the foundation for the entire global political economy. In the United States, young members of the middle and upper-middle class first learn its precepts in the academy. Polls routinely show that economists and the general public have widely divergent views on the economy, but among the well-educated that gap is far narrower. A 2001 study ... showed that those with college degrees are more likely to subscribe to the views of neoclassical economists than the general public...

                                                                                    Conservatives have long critiqued academia for the ways professors use their position to indoctrinate students with left-wing ideology, but the left has largely ignored the political impact of the way people learn economics, though its influence is likely far more profound. So in order to find out just what students learn when they learn economics, I headed down to Hyde Park, where the University generously let me enroll in “Principles of Macroeconomics” for a quarter.

                                                                                    Continue reading "Neoclassical Indoctrination" »

                                                                                      Posted by on Friday, November 10, 2006 at 12:03 AM in Economics, Universities | Permalink  TrackBack (2)  Comments (179) 

                                                                                      Thursday, November 09, 2006

                                                                                      Moral Values and Market Exchange

                                                                                      Is market exchange morality in action? The author, "a fellow at the Gruter Institute and director of Claremont Graduate University's Center for Neuroeconomics Studies," says it is:

                                                                                      Moral 'bastards' have brain hormone problems, by Paul J. Zak, Project Syndicate: Recent revelations that many corporate executives have backdated their stock options ... are the latest examples of bad business behavior. ...[A] cynical public ... wonder[s] where big business has gone wrong.

                                                                                      The answer may be quite simple: Too many bosses have abandoned basic human values and embraced the credo famously uttered by Gordon Gekko in the movie "Wall Street:" "Greed is good." But a growing body of research concludes that greed is not always good, and that moral values are a necessary element in the conduct of business. ...

                                                                                      Continue reading "Moral Values and Market Exchange" »

                                                                                        Posted by on Thursday, November 9, 2006 at 02:56 PM in Economics, Science | Permalink  TrackBack (0)  Comments (30) 

                                                                                        401(not okay) Accounts?

                                                                                        Are 401(k) accounts the best way to save for retirement given the uncertainties about future government liabilities and tax rates?:

                                                                                        In Retirement Planning, There Is Nothing Certain About Death and Taxes By Austan Goolsbee, Economic Scene, NY Times: For millions of Americans, November means open enrollment time — the brief period when employees make their choices about next year’s benefits, including 401(k) savings.

                                                                                        If you are one of the millions of people trying to decide about 401(k)s, you have probably heard about the dangers of investing too much into your own company’s stock and have compared the risks of investing in stocks versus bonds. You may even have asked co-workers for hints about what to do.

                                                                                        You probably have not given much thought to political tax risk, however, or perhaps have even heard of it. Yet the purely political question of what will happen to tax rates over the next 30 years has become one of the most important factors in thinking about tax-deferred savings accounts...

                                                                                        Future increases in tax rates potentially threaten to significantly reduce the value of your retirement savings and may even mean that you should not save in 401(k) accounts at all.

                                                                                        To understand why, think about the traditional advantages of a tax-favored account like a 401(k). ... You get to put money into the account without paying income tax on it this year and you do not have to pay taxes as it builds up. You just pay income tax on the full amount at the very end when you finally pull out the money in retirement. ...

                                                                                        But the lurking catch is that the tax you will pay on your account will be at the rate in place when you retire, not the rate now. And that may be very different.

                                                                                        Budget analysts unanimously agree that the current fiscal situation of the country is unsustainable. According to the latest numbers from the Government Accountability Office, the total fiscal gap facing this country in the future is about $60 trillion, and some budget experts suggest even that is an underestimate...

                                                                                        While future budget policy seems far removed from your company’s open enrollment, you had better pay attention. How the government decides, ultimately, to balance its budget will have a tremendous impact on your retirement savings. If income tax rates double between now and when you retire, the value of your 401(k) may be cut in half. ...

                                                                                        Will it be taxes or spending? No one knows. And that is exactly the point for your 401(k). Political uncertainty is an extremely important type of risk ... If you think the government will raise income tax rates in the future but will keep capital gains and dividend tax rates low, you may not want to invest in a 401(k) at all. Paying your income tax and then investing money in the stock market may leave you better off in your retirement than investing in the supposedly tax-advantaged savings accounts.

                                                                                        To be clear, if your employer gives you a generous match for the money you put into your 401(k), that will tend to outweigh any tax risk and so you may as well take the free money and invest. Similarly, if you are the kind of person who invests only in bonds, so you have lots of interest payments, you should stick with the 401(k). If you need the restrictions of the 401(k) to keep you from spending your retirement savings, again, just go ahead and ignore the tax risks.

                                                                                        But if you are one of the millions of people who did not answer “yes” to any of those questions, you should be thinking about the reality of tax risk. One way to avoid such risk would be to put your retirement savings into a Roth I.R.A. Unlike the 401(k), you pay the income taxes on the money when you put it into the Roth rather than when you take it out... The problem is that if your family income is more than $160,000 a year, you are not eligible. And even if you are eligible, you cannot put more than about $5,000 a year into a Roth account. ...

                                                                                        So what’s a hard-working American to do? You really do not have the information you need. You will have to guess...

                                                                                        Markets should incorporate expected future tax liabilities into the price of the asset along with a risk premium to compensate for any uncertainties about future tax rates. Perhaps markets aren't pricing the risk correctly, there are some who make that argument, but so far financial markets in their collective wisdom appear surprisingly unconcerned about the impact of future government liabilities.

                                                                                          Posted by on Thursday, November 9, 2006 at 02:16 AM in Budget Deficit, Economics, Policy, Taxes | Permalink  TrackBack (0)  Comments (55) 

                                                                                          "Don't Expect Anything Bold" from Democrats

                                                                                          Robert Reich says you shouldn't expect much from Democrats, their power will be limited:

                                                                                          The Democratic Victory: Keep Your Expectations Low, by Robert Reich: Hold the champagne. Don’t expect anything bold to come out of the new Democratic House.

                                                                                          First, Dems don’t have enough votes to overcome Bush vetoes. Second, the new Dems are from marginal districts where they will have to be moderate-to-conservative in order to be reelected. Third, the Dem leadership has its eyes on the big prize – the 2008 presidency – and doesn’t want to do anything to scare off voters.

                                                                                          Barney Frank at the financial services committee will, at most, require more company disclosure of executive pay... John Dingle at energy and commerce is so concerned about the auto industry he won’t try to increase auto mileage standards (he has opposed increasing CAFÉ in the past). George Miller at education and commerce will at most seek additional money for Pell grants, but there won’t be additional money unless Dems cut defense discretionary, which they won’t do.

                                                                                          Dems will demand that Robert Gates, the new defense secretary, keep them in the loop over Iraq, but Dems won’t push him to set a timetable. Even though Iraq figured prominently in the election, ... they don’t want to be blamed for chaos and bloodshed when the 2008 election comes around. So they’ll have lots of hearings and do very little.

                                                                                          In other words, keep your expectations low.

                                                                                          On the other hand, if Dems take the Senate, there's one huge plus: Bush's next Supreme Court nominee (should he have the chance to nominate) won't get easy passage.

                                                                                            Posted by on Thursday, November 9, 2006 at 02:11 AM in Economics, Policy, Politics | Permalink  TrackBack (1)  Comments (25) 

                                                                                            Should Money Help to Guide Monetary Policy?

                                                                                            Jean-Claude Trichet, president of the European Central Bank, argues that money should play a role in monetary policy:

                                                                                            Money’s vital role in monetary policy, by Jean-Claude Trichet, Commentary, Financial Times: ...Over the next two days, the European Central Bank will host a conference to discuss the role of money in monetary policymaking. At present, the dominant academic view seems to be that monetary aggregates should have no part in monetary policy decisions. ... I do not share this view. ...

                                                                                            Do not mistake me for a monetary Luddite: I have immense appreciation for the intellectual elegance and sophistication of modern monetary policy models that leave no room for money. In many respects, I fully agree with their implications regarding the benefits of price stability, the crucial importance of central bank credibility, the advantages of pursuing a clear and predictable policy and the centrality of private inflation expectations. ... These ... considerations have ... strongly influenced the design of the ECB’s policy framework. Yet, I cannot dispel my doubts that a model of monetary policy that includes no role for money is incomplete in some important respects.

                                                                                            Academic research is starting to address some of these shortcomings. By introducing financial markets, informational asymmetries and transaction costs into the benchmark model, money and credit developments are given a role in determining macroeconomic outcomes. Moreover, empirical literature has emerged suggesting that monetary developments may be associated with asset price dynamics.

                                                                                            More fundamentally, the European experience – both before and after the introduction of the euro – suggests that assigning an important role to money in monetary policy deliberations and communication has, in practice, helped to serve precisely those principles that modern monetary policy literature holds dear. To take just two examples: I am convinced that an important role for money helps to give the policy discussion an appropriate medium- to longer-term orientation. ... Equally, in our own recent experience, when the economic analysis is complex and its conclusions uncertain, cross-checks with the monetary analysis have proved extremely useful. ...

                                                                                            Monetary policy ... research may offer some lessons for a better understanding of our own decision-making process. In monetary policy, the fact that the pooling of experience and diversity of points of view are deemed essential for reaching the right decision is illustrated by the use of collegial decision-making in all main central banks. Similarly, a pillar based on monetary analysis calls for central banks to consider the outcome of their decisions within a longer-term context; to take due account of past experience and insights accumulated over time; and not to follow too slavishly the latest analytical techniques. Monetary analysis was central to the strategies of the most successful European central banks before the euro ... This legacy cannot be disregarded lightly. Rather, we should strive to use the new and more sophisticated techniques that are being developed to enhance and complement the principles underlying our past successes. ...

                                                                                            This topic has been covered here many times. As I've noted before, my mind is open on this, but even measuring monetary aggregates accurately is problematic so I would not assign them much weight in the decision making process:

                                                                                              Posted by on Thursday, November 9, 2006 at 02:10 AM in Economics, Monetary Policy | Permalink  TrackBack (1)  Comments (6) 

                                                                                              Wednesday, November 08, 2006

                                                                                              Populism vs. Nationalism

                                                                                              I think this is a useful distinction:

                                                                                              A poll victory for economic nationalism, by Jacob Weisberg, Commentary, Financial Times: The bums, or at least many of them, have been thrown out. So the political conversation turns to the question of what the Democrats will do now... While it may be too soon to answer that question, we have seen enough to be alarmed about one tendency in particular: economic nationalism...

                                                                                              Most of those who reclaimed Republican seats campaigned against free trade, globalisation and any sort of moderate immigration policy. That these Democrats won makes it likely that others will take up their reactionary call...

                                                                                              There is an important distinction to be made between economic populism and economic nationalism. Many of Tuesday’s Democratic victors stressed familiar populist themes: corporate misbehaviour and tough times faced by working people. ... Raising the minimum wage (which Republicans foolishly failed to do before the election) is a classic populist position. Opposing Bush tax cuts for the wealthy is another. But in places where Democrats made their most impressive inroads ..., one heard a distinctly different message of economic nationalism. Nationalism begins from the same premise that working people are not doing so well. But instead of blaming the rich at home, it focuses its energy on the poor abroad. The leading economic nationalist today is probably Lou Dobbs, who natters on against free trade, outsourcing, globalisation and immigration...

                                                                                              The most prominent nationalist candidate this year was Sherrod Brown, who unseated incumbent Senator Mike DeWine in Ohio, a state that has lost 200,000 manufacturing jobs since George W. Bush became president. Mr Brown is the author of a book called Myths of Free Trade: Why American Trade Policy Has Failed. Here is a snippet from one of his television advertisements: “Sherrod Brown stood up to the president of his own party to protect American jobs, fighting against the Mexico and China trade deals that sent countless jobs oversees.” For some reason, economic nationalists never seem to complain about job-killing Dutch or Irish competition. The targets of their anger are consistently China and Mexico, with occasional whacks at Dubai, Oman, Peru and Vietnam.

                                                                                              One heard similar themes in the other pivotal Senate races. ... A much harder-edged nationalism defined many of the critical House races, where Democrats called for a moratorium on trade agreements, for cancelling existing ones, or, in some cases, for slapping protective trade tariffs on China. These candidates also lumped illegal immigrants together with terrorists and demanded a fence along the Mexican border. In Pennsylvania, Democratic challengers defeated Republican incumbents by accusing them of destroying good jobs by voting for the Central American Free Trade Agreement and being soft on illegal immigration. “Fair trade” candidates also won back formerly Republican seats in Ohio, Indiana, Iowa, North Carolina and Wisconsin.

                                                                                              Economic nationalism is not unique to Democrats – nor is it a new theme for them. The protectionist wing of the party first emerged in the 1980s when America’s manufacturing decline was linked to imports. ... But during his 1992 campaign, ... Mr Clinton espoused a free-trade position and embraced globalisation through his presidency. This set the direction for his party despite significant resistance in Congress. Mr Clinton’s argument was always that government should address the negative consequences of open trade through worker retraining programmes and by ensuring benefits not tied to employers, like healthcare and portable pensions. But the human capital part of Mr Clinton’s globalisation agenda never went anywhere, which partially explains the current backlash. ...

                                                                                              It would be going too far to say that the 2006 election ushers in a new protectionist consensus. But free trade has definitely left the building.

                                                                                              The populist, economic nationalists versus the populist, economic globalists.

                                                                                              I think Democrats should leave the globalist-nationalist debate aside and focus on areas of agreement first - implementing smart populist policies - because once that's done, the nationalist arguments will be less compelling and hopefully will then fall by the wayside. Here's a similar view:

                                                                                              Thus, ... the best road forward [is] to (a) make the Democratic coalition politically dominant through aggressive populism, and then (b) to argue for pragmatic reality-based technocratic rather than idealistic fantasy-based ideological policies within the Democratic coalition.

                                                                                                Posted by on Wednesday, November 8, 2006 at 01:27 PM in Economics, International Trade, Policy, Politics | Permalink  TrackBack (1)  Comments (49) 

                                                                                                Election Fallout: Rumsfeld Resigns

                                                                                                In case you missed this. Fox news:

                                                                                                Rumsfeld Has No Plans to Step Down, Despite Democrat Gains, Official Says, Fox News: Defense Secretary Donald H. Rumsfeld, a key target of Iraq war critics, gave no indication Wednesday that he planned to step down in the wake of Democratic midterm election gains, his chief spokesman said. He said he did not know whether Rumsfeld has talked to President Bush about his future in light of the election results....

                                                                                                Apparently that conversation didn't go so well:

                                                                                                GOP officials: Rumsfeld stepping down, CNN: Defense Secretary Donald H. Rumsfeld, architect of an unpopular war in Iraq, intends to resign after six stormy years at the Pentagon, Republican officials said Wednesday. Officials said Robert Gates, former head of the CIA, would replace Rumsfeld.

                                                                                                Bush quote from news conference: "Rumsfeld and I agreed it was a time for a change."

                                                                                                  Posted by on Wednesday, November 8, 2006 at 10:08 AM in Economics, Iraq and Afghanistan, Politics | Permalink  TrackBack (0)  Comments (32) 

                                                                                                  The Best Insurance a President Can Have

                                                                                                  Good news. The Democrats have taken the House. The Senate is still to be determined [Update: The AP has called the Senate for the Democrats]:

                                                                                                  Money Talks: Michael Radowitz, Newburgh, N.Y.: If the Democrats take over the house, Bush's misdeeds can be seriously looked into. If they somehow take over the Senate, Bush could conceivably be impeached for both abuse and neglect of authority bestowed on him as president. Also throw in failure to uphold the Constitution on more than one occasion.

                                                                                                  Paul Krugman: Bush has an insurance policy against impeachment: Dick Cheney.

                                                                                                    Posted by on Wednesday, November 8, 2006 at 12:33 AM in Economics, Politics | Permalink  TrackBack (0)  Comments (39) 

                                                                                                    Inequality and Economic Growth

                                                                                                    There has been a lot of debate about the relationship between inequality and economic growth. For example, Brad DeLong says:

                                                                                                    The correlation between economic growth--defined as ten-year growth in GDP per capita--and income inequality that Greg Mankiw asserts exists? I certainly cannot see it in the data.

                                                                                                    This paper, a study of inequality and growth in rural China, comes to a different conclusion - that higher inequality is associated with slower growth in income:

                                                                                                    Inequality and Growth in Rural China: Does Higher Inequality Impede Growth?, by Dwayne Benjamin, Loren Brandt, and John Giles, SSRN No. 2344 [alternate]: Conclusions: Is the trajectory of household income growth adversely affected by the level of inequality in the village in which it lives? ... Using a rich household-level data set stratified by village, we estimate the empirical links between the level of inequality near the beginning of reforms (1986) and the growth of household incomes in the village through 1999.

                                                                                                    Whether we use the sample of households that can be tracked all the way through the panel, or treat the villages as distinct cross-sections, we find robust evidence that initial inequality is significantly related to subsequent growth: Inequality “hurts” growth. Because we can estimate the relationship at the household level, and given a rich set of instruments that can be used to address measurement error, we are able to rule out a number of explanations. In particular, we can rule out the possibility that the relationship is an artifact of aggregation, measurement error, or other mechanical explanations based on non-linearities linking initial household income to growth. Furthermore, since we control for own resources in the household-level specification, we cast doubt on the imperfect credit-market class of explanations. In short, we find robust evidence that high village inequality exerts a negative “externality” on household economic growth. ... [V]illages with higher inequality grow significantly more slowly.

                                                                                                      Posted by on Wednesday, November 8, 2006 at 12:15 AM in Academic Papers, Economics, Income Distribution | Permalink  TrackBack (1)  Comments (11)