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| September 2007 »
I'm worried that other countries are going to stop trading with us because
our lax environmental enforcement - allowing, for example, hundreds of miles of
streams to be destroyed to lower the price of energy - gives us an unfair
advantage. Here's part of the house that Jack built:
Rule to Expand Mountaintop Coal Mining, by John M. Broder, NY Times: The
Bush administration is set to issue a regulation on Friday that would enshrine
the coal mining practice of mountaintop removal. The technique involves blasting
off the tops of mountains and dumping the rubble into valleys and streams. ...
The new rule would allow the practice to continue and expand...
The regulation is the culmination of six and a half years of work by the
administration to make it easier for mining companies to dig more coal to meet
growing energy demands and reduce dependence on foreign oil. ...
A spokesman for the National Mining Association, Luke Popovich, said that
unless mine owners were allowed to dump mine waste in streams and valleys it
would be impossible to operate in mountainous regions like West Virginia that
hold some of the richest low-sulfur coal seams...
Environmental activists say the rule change will lead to accelerated pillage
of vast tracts and the obliteration of hundreds of miles of streams in central
“This is a parting gift to the coal industry from this administration,” said
Joe Lovett, executive director of the Appalachian Center for the Economy and the
Environment in Lewisburg, W.Va...
Mountaintop mining is the most common strip mining in central Appalachia, and
the most destructive. Ridge tops are flattened with bulldozers and dynamite,
clearing all vegetation and, at times, forcing residents to move. ...
Roughly half the coal in West Virginia is from mountaintop mining, which is
generally cheaper, safer and more efficient than extraction from underground
The rule ... is known as the stream buffer zone rule. First adopted in 1983,
it forbids virtually all mining within 100 feet of a river or stream. ...
The Army Corps of Engineers, state mining authorities and local courts have
read the rule liberally, allowing extensive mountaintop mining and dumping of
debris in coal-rich regions of West Virginia, Kentucky, Tennessee and Virginia.
From 1985 to 2001, 724 miles of streams were buried under mining waste,
according to the environmental impact statement accompanying the new rule.
If current practices continue, another 724 river miles will be buried by
2018, the report says. ...
The early stages of the revision process were supported by J. Stephen Griles,
a former industry lobbyist who was the deputy interior secretary from 2001 to
2004. Mr. Griles had been deputy director of the Office of Surface Mining in the
Reagan administration and is knowledgeable about the issues and generally
supports the industry.
In June, Mr. Griles was sentenced to 10 months in prison and three years’
probation for lying to a Senate committee about his ties to Jack Abramoff, the
lobbyist at the heart of a corruption scandal who is now in prison. ...
Posted by Mark Thoma on Thursday, August 23, 2007 at 12:24 AM in Economics, Environment, Policy, Regulation |
knzn continues, but not quite from where he left off:
Did this in Housing seem an obvious bubble?, by knzn: I don’t think I’m
going to be continuing yesterday’s post from just where I left off, but
hopefully over the course of the next few posts it should become clear why I
hold such bizarre beliefs. In this post I’m updating one from last year, in
which I argued two points:
- It is still reasonable to believe that the housing boom was not a bubble;
- Even if one believes that, one can still be ultra-bearish on housing today.
Posted by Mark Thoma on Thursday, August 23, 2007 at 12:15 AM in Economics, Housing |
Posted by Mark Thoma on Thursday, August 23, 2007 at 12:06 AM in Links |
Michael Woodford, who knows more than a little bit about this topic,
use of monetary aggregates as a basis for setting monetary policy.
His bottom line is that monetary aggregates should not be used as targets of
monetary policy, or even play a prominent role in policy discussions, but they do have their uses. Many macroeconomic variables are
unobservable and, to the extent that monetary aggregates are correlated with
these unobservables, monetary aggregates can be used to extract information about them and thus help to determine the potential evolution of the macroeconomy. Thus, Woodford
believes that monetary aggregates may contain useful information about the economy, but
there is currently no good reason to assign target values to monetary
aggregates in the conduct of policy.
This is the abstract, introduction, and conclusion - the paper itself is a bit
How Important is Money in the
Conduct of Monetary Policy?, by Michael Woodford, NBER WP 13325, August 2007
link]: Abstract: I consider some of the leading arguments for assigning an
important role to tracking the growth of monetary aggregates when making
decisions about monetary policy. First, I consider whether ignoring money means
returning to the conceptual framework that allowed the high inflation of the
1970s. Second, I consider whether models of inflation determination with no role
for money are incomplete, or inconsistent with elementary economic principles.
Third, I consider the implications for monetary policy strategy of the empirical
evidence for a long-run relationship between money growth and inflation. And
fourth, I consider reasons why a monetary policy strategy based solely on
short-run inflation forecasts derived from a Phillips curve may not be a
reliable way of controlling inflation. I argue that none of these considerations
provides a compelling reason to assign a prominent role to monetary aggregates
in the conduct of monetary policy.
It might be thought obvious that a policy aimed at controlling
inflation should concern itself with ensuring a modest rate of growth of the
money supply. After all, every beginning student of economics is familiar with
Milton Friedman's dictum that "inflation is always and everywhere a monetary
phenomenon" (e.g., Friedman, 1992), and with the quantity theory of money as a
standard account of what determines the inflation rate. Yet nowadays monetary
aggregates play little role in monetary policy deliberations at most central
banks. King (2002, p. 162) quotes then-Fed Governor Larry Meyer as stating that
"money plays no explicit role in today's consensus macro model, and it plays
virtually no role in the conduct of monetary policy."
Continue reading "Michael Woodford: How Important is Money in the Conduct of Monetary Policy?" »
Posted by Mark Thoma on Wednesday, August 22, 2007 at 06:39 PM in Academic Papers, Economics, Monetary Policy |
Dean Baker says ignore the whining from mortgage market participants, what do
you expect when people stand to lose millions?:
Wall Street Welfare Whimps Keep Whining, by Dean Baker: That should have
been the headline of the NYT
piece reporting that the Wall Street crew are complaining that the Fed has
not done enough to help them out. These supposedly informed investors sunk
trillions of dollars in mortgage debt that is going bad at a very rapid rate and
they desperately want the government to bail them out.
The reporting should make clear what is going on here. People who earn tens
and hundreds of millions of dollars a year because of their alleged skills are
now facing a financial disaster. Rather than be willing to live with market
outcomes, they are trying to use their political power to force the Fed and
Congress to rescue them.
We shouldn't help people just because they whine, but just as importantly, we
shouldn't refuse help just because it looks like we are giving in to the
whiners. Thus, it will be important to make it clear that a rate cut or other interventions, if they were
to occur, are to address general macroeconomic conditions and protect people who
had nothing to do with bringing about the mortgage mess, not to bail out the
mortgage industry in particular.
The Fed cannot do countercyclical policy without easing conditions, that's
the only way to stimulate the economy, and when they ease conditions some
businesses or investments that would have failed otherwise will be bailed out.
But that doesn't mean we shouldn't help. If failure to act will cause an
economic downturn that will harm the innocent, then I think the Fed should
intervene to protect those who had no hand in causing the problems rather than
harming the innocent as a by-product of ensuring that market participants are fully
Posted by Mark Thoma on Wednesday, August 22, 2007 at 03:24 AM in Economics, Housing, Policy |
When Caveat Emptor Doesn't Work in China -- or in America, by Robert Reich:
...China’s problem isn't too much government intrusion into its economy; it's
too little ... of the right kind. Some Chinese toy makers have used lead paint,
some Chinese pet-food producers have used toxic chemicals, and makers of
counterfeit toothpaste in China have used other toxins.
A basic free market principle is that when consumers cannot differentiate
between risky products and good products, they’ll withdraw from the market,
which is what’s happening to China’s consumer exports. China’s responsible
exporters are suffering because irresponsible ones have cut corners to make
fatter profits, and global consumers can't tell the difference. So the challenge
for China is to rein in its rip-roaring free-market capitalists with regulations
that better ensure safe products.
The American financial market is facing much the same challenge. When it
became apparent that many sub-prime mortgage loans were far riskier than
assumed, and were packaged with other loans, investors began withdrawing from
financial instruments altogether. That's because they couldn’t figure out how
much risk they had taken on. So the challenge for the United States is to rein
in our rip-roaring financial capitalists with regulations that clarify risk...
The lesson on both sides of the Pacific is that free-market capitalism and
government intervention are not on opposite sides of a great ideological divide.
Free markets need governments to police them so buyers can be confident about
what they're buying. ...
The practical question, then – in both China and America – is not whether
you’re in favor of free markets or government regulation. It’s what kind of
regulation is necessary to make markets work.
And a good guiding principle on market regulation is to ensure that the
conditions for competitive markets are met as much as possible. In these two
cases, for example, the problem is lack of information. Competitive markets
assume full information is present, but as these examples show, that is not
always the case.
When there is uncertainly about the quality of a product, buyers will be more
cautious than they would be under the full information outcome. By helping to ensure
that information is made available to both buyers and sellers, government
regulation allows markets to function more competitively. Thus, these are cases
where, contrary to the usual complaint, government intervention improves efficiency. Another example of this is
housing. Regulations that force sellers to disclose known problems prior to sale
make the market function more, not less efficiently.
Some people argue that markets will regulate themselves - that over time the
cheaters will be forced from the marketplace - but the fact that these
regulations were needed in the first place tells you that wasn't working out so
well. In the case of housing, for example, people sell very few houses during
their lifetime so reputation is not all that important. If you sell a house
without disclosing problems thus getting too much money for it, and don't sell
again for another ten or twenty years, it's unlikely that the buyers in the
second transaction will even know about the sale of the first house so there is
little chance of facing a penalty for failing to disclose, i.e. little chance of
facing market discipline. Thus, there is little incentive to disclose problems
on the second sale and the market failure due to lack of information will
I suppose a private sector business devoted to collecting and selling such information about buyers could develop, but it didn't and such a firm is caught in a catch-22: if its business is successful so that everyone is afraid to cheat, nobody will need its services (the mere threat that these firms might come into existence does not appear to provide sufficient market discipline either). And it does not completely eliminate the problem in any case. For example, if you are elderly and you are cashing out and you know it's the last sale, why do you care what the rating agency will say on the next sale? There won't be one. Anytime there is a single sale for whatever reason and reputation is unimportant, the threat of market discipline from misrepresenting the product vanishes. Government regulation does not have these problems since it allows you to collect from the seller if problems turn up post sale that the buyer was clearly aware of. And the same outcome - full disclosure - is achieved without the fee that would need to be paid to the private sector firm.
Posted by Mark Thoma on Wednesday, August 22, 2007 at 12:24 AM in Economics, Policy, Regulation |
Posted by Mark Thoma on Wednesday, August 22, 2007 at 12:21 AM in Links |
Markets seem to be calmer today after Senator Dodd spoke about his meeting
with Fed chair Ben Bernanke and Treasury Secretary Henry Paulson:
Fixing the Credit Crunch, by John Godfrey, WSJ Washington Wire: Senate
Banking Committee Chairman Christopher Dodd said Federal Reserve Chairman Ben
Bernanke promised to use “all the tools available” to respond to volatility in
the nation’s financial markets.
Dodd, a ... Democrat ... met with Bernanke and Treasury Secretary Henry
Paulson ... to discuss the recent volatility in the financial markets and the
broader implications for the U.S. economy. Dodd said he also spoke with Paulson
and Bernanke about possible additional steps that can be taken to help stabilize
mortgage and financial markets and help homeowners nationwide. “I expressed the
need for both the Fed and Treasury to use all the tools at their disposal to
keep our markets working and so that the business and consumers can have the
funds to prosper,” Dodd said.
“Chairman Bernanke agreed,” Dodd added. He, however, was frustrated with
Paulson’s unwillingness to consider increasing the portfolio caps at Fannie Mae
and Freddie Mac. “The power exists today with the regulator to lift those caps,”
Dodd said. ...
But there's something odd here. Normally, it is the Treasury Secretary's job
to issue statements to calm the market, not the chair of the Senate Banking
Committee, but for some reason Paulson has been ineffective. If anything, it
seems like markets panic further when he talks which may say something about the
credibility of loyal Bushies, even those who have been at Goldman Sachs. It's
also a bad sign that Paulson’s free market ideology is getting in the way of the
Treasury Secretary taking Bernanke's advice to lift the caps at Fannie Mae and
Freddie Mac, so perhaps the markets indifference or negative reaction to his
statements is justified.
To see the difference between how past Treasury Secretaries reacted in the
face of a financial crisis and what we have now, recall "The Committee to Change
the World" comprised of "The Three Marketeers," Robert Rubin, Larry Summers, and
Alan Greenspan that came into being after the LTCM crisis in the late 1990s:
The Three Marketeers, by Joshua Cooper Ramo, Time Asia, 2/15/99:
...Although the U.S. economy has been nothing but sunshine, it has been a
terrifying year in world markets: famed financier George Soros lost $2 billion
in Russia last year; a hedge fund blessed with two Nobel prizewinners blew up in
an afternoon, nearly taking Wall Street with it; and Brazil's currency, the
real, sambaed and swayed and then swooned. In the past 18 months 40% of the
world's economies have been tugged from robust growth into recession or
So far, the U.S. has dodged these bullets, but the danger to its economy is
far from over. ... In late-night phone calls, in marathon meetings and over
bagels, orange juice and quiche, ... three men--Robert Rubin, Alan Greenspan and
Larry Summers--are working to stop what has become a plague of economic panic.
Continue reading "Treasury Secretaries Then and Now" »
Posted by Mark Thoma on Tuesday, August 21, 2007 at 05:40 PM in Economics, Financial System, Regulation |
knzn says that, all told, the housing boom was a good thing:
I come to bury the Housing Boom, not to praise it, by knzn: OK, I
lied: I come to praise it. Basic macroeconomics is leading me to some unpopular
- The housing boom was a good thing; therefore
- Far from worrying about moral hazard, the Fed should be deliberately
rewarding those who participated; and
- (At least according to my reading of the macroeconomy) The Fed should
encourage the continuation of a housing boom (or something of that nature).
My basic argument is quite simple: without the housing boom, there would have
been no economic recovery, and…recovery is good.
It’s not very controversial that the housing boom was the main reason for the
economic recovery, so let’s do a thought experiment in which we re-run the years
since 2001 without a housing boom. Would something else have happened instead to
produce a recovery? Let’s line up the candidates.
First, fiscal policy. We did have a war, two large tax cuts, and a large new
entitlement benefiting the age group with the highest marginal propensity to
spend. The consensus is that all these were not enough. Perhaps they would have
prevented the recession from getting worse, but without the direct and indirect
effects of the housing boom, any recovery would have been meager at best. OK,
how about a big public works program? Not a bad idea, if you ask me, but this is
where we have to begin distinguishing between thought experiment and fantasy. If
your conception has a public works program that dwarfs the New Deal being passed
by a Republican Congress and signed by George W. Bush, I recommend you get in
touch with George Lucas about the special effects.
What about an export boom (and/or substitution of domestic products for
imports) supported by a weak dollar? That is, after all, the traditional
mechanism by which monetary policy is supposed to operate in an open economy
with a flexible exchange rate. The first problem that arises is that the US
exchange rate against many countries isn’t (and, most emphatically, wasn’t)
flexible, and even when it is nominally flexible, the competing products are
often effectively priced in dollars. One could imagine a mildly successful
beggar-thy-neighbor policy against Europe (supposing that, in the absence of a
housing boom, the dollar would have crashed against the Euro in 2002 instead of
falling gradually over 5 years). At best, that gives us a mild (and somewhat
stagflationary) recovery in the US and a severe recession in Europe (which, as
you may recall, had its own problems in the early years of this decade). All in
all, the possibilities created by a falling dollar (in place of the housing
boom) are not impressive.
So what’s left? An investment boom supported by low interest rates? If it
didn’t happen when the federal funds rate was at 1%, would it have happened if
the rate had fallen to 0%? I tend to doubt it. An investment boom supported by
“quantitative easing”? Possibly, but it took Japan years even to hit on that
possibility, and the jury is still out on whether quantitative easing was the
real reason for Japan’s recovery. The premise that such a policy would have been
tried successfully in the US during this decade is speculative at best. Other
ideas? Money dropping from the sky? Maybe, but remember, “Helicopter Ben” didn’t
take over the Fed until 2006. And so on… Rather than going from the bizarre to
the more bizarre, I’m just going to reassert my premise and suggest that the
burden of proof is now on anyone who disagrees: Without the housing boom, there
would have been no economic recovery.
The implication of having no economic recovery is that we would have slack
resources the whole time – the sort of event that used to be called a depression
before the term fell victim to political correctness. Thus, comparing my
counterfactual world to the actual world, all the extra production that we got
out of the US economy was done with resources that would otherwise have been
wasted. From a macroeconomic point of view, all those extra houses and such were
free – a free lunch, if you will. (... in
Keynesian economics there has always been a free lunch; that was the main point
of the General Theory.) So those who say that the housing boom was a bad thing
are saying that we should have turned down that free lunch when it was offered.
And what of those who participated in the boom? To my mind, they are in the
same category as the Iraqi Shiite rebels in 1991. They helped US policymakers
accomplish their laudable goals. ... Sir Alan even flew a
mission over their region to drop leaflets touting the virtues of ARMs. And now
should we leave them to be massacred? I’m not saying we should invade the
mortgage derivatives market and set up a democratic regime by force. But at the
very least, don’t we have a humanitarian moral duty to declare a no fly zone?
This post is already too long, and I have to get back to my real job. I
haven’t even finished arguing my second point, and the third point is clearly
going to be the hardest to defend. For now I’m going to have to abort, hoping to
continue tomorrow. Have patience, gentle friends...
Posted by Mark Thoma on Tuesday, August 21, 2007 at 03:33 PM in Economics, Housing, Policy |
Perhaps Michael Moore Should Run a Taxi Service, Vox Baby
I don't know which of the following statements is more surprising. From the
A 35-year-old Canadian woman has given birth to rare identical quadruplets,
officials at a Great Falls hospital said Thursday. Karen Jepp of Calgary,
Alberta, delivered Autumn, Brooke, Calissa and Dahlia by Caesarian section
Sunday afternoon at Benefis Healthcare, said Amy Astin, the hospital's director
of community and government relations.
The four girls were breathing without ventilators and listed in good condition
Thursday, she said.
Wonderful. And this part:
The Jepps drove 325 miles to Great Falls for the births because hospitals in
Calgary were at capacity, Key said.
"The difficulty is that Calgary continues to grow at such a rapid rate. ... The
population has increased a lot faster than the number of hospital beds," he
For those of you unclear on the geography, their trip looked something
this and would take about five hours at the posted speed
limits. About halfway through the trip, they would pass through Lethbridge,
which is home to
Chinook Regional Hospital, which claims to offer a "high level
neonatal intensive care unit." Not good enough? No beds there either? When they
were in Lethbridge, they were about an hour away from Medicine Hat, home to this
institution and its
NICU, or two and a half hours plus a border crossing away from
Great Falls. They chose the latter.
UPDATE (8/20): At the prompting of a commenter, I found that the doctor's
statement about them driving the 325 miles is incorrect, and so too is my
travelogue in the last paragraph of the original post (now italicized). Here is
report from the BBC that explains:
A medical team and space for the babies had been organised for the Jepp
family at the Foothills Medical Centre in Calgary but several other babies were
born unexpectedly early, filling the neonatal intensive care unit.
Health officials said they checked every other neonatal intensive care unit in
Canada but none had space.
The Jepps, a nurse and a respiratory technician were flown 500km (310 miles) to
the Montana hospital, the closest in the US, where the quadruplets were born on
My apologies for the hasty and incorrect post, though this notion that "every
other neonatal intensive care unit in Canada" had no space is more of an
indictment of the system than my original remarks.
I'm not sure why going to extraordinary lengths to solve a peak load problem
shows the inferiority of the system rather than a commitment to serve patients.
This wasn't one infant, this was quadruplets, so it's hardly typical -- space for four babies all at once can be hard to find. According to
it's true that the U.S. has more beds per live birth than Canada, "The
United States has 3.3 neonatal intensive care beds per 10000 live
births, while Australia and Canada have 2.6." But that doesn't seem
like a huge difference (by the way, the data were collected in an attempt to
explain why health outcomes for infants are worse in the U.S. even though
resource usage is higher, so maybe that taxi service Andrew calls for ought to run in the other direction).
This is somewhat dated (1991), perhaps things have improved since then, but
since we're telling anecdotes and extrapolating to whole systems, maybe that doesn't matter (though this does present actual evidence as well). It
indicates that our system also has its problems:
As More Tiny Infants Live, Choices and Burden Grow, NY Times: ...[A]s
advances allow medicine to save more and more babies, the demand for neonatal
intensive care has risen and existing units are bursting at the seams. ... As a result, most neonatal intensive care units have removed walls to squeeze
in a few more beds, and hired nurses to work overtime. Most operate at more than
100 percent of their licensed capacity.
Dr. Dweck, whose intensive care unit serves five counties north of New York
City, said he had to turn away 250 babies each year. ...
"Last week there was a 900-gram baby at a community hospital who we knew we
could help, but we were horribly overcrowded," Dr. Kleinman said...
Would Canada turn away 250 babies each year in their equivalent of five
counties, or would they find a place for them to get the care they need, even if it's in the U.S.?
Posted by Mark Thoma on Tuesday, August 21, 2007 at 07:11 AM in Economics, Health Care, Policy |
Tim Duy continues with his analysis of the likelihood that the Fed will cut its target interest rate:
Waiting for the Inevitable, by Tim Duy: As
I noted yesterday, the Fed let the genie out of the bottle last week; rather
than dissipating expectations for a rate cut, the statement had the exact
Analyst after analyst is lining up to predict not just a cut, but the
beginning of a rate cutting cycle. It is tough to see how they can avoid
delivering at this point:
The Fed does not want to cut rates;
they are searching for a middle ground between maintaining their inflation
concerns while promoting stability in the financial markets. Consequently, I do
not believe the Fed’s discount rate cut was intended by policymakers to be
simply a symbolic move. I think the
Street Journal summarizes the Fed’s intentions quite succinctly with:
In essence, the Fed is following advice that British journalist Walter
Bagehot offered in his 1873 book, "Lombard Street," a copy of which Mr. Bernanke
kept on a shelf when he was Princeton professor. In times of "internal
discredit" -- when uncertainty leads private players to pull back -- the
prescription to the central bank is: Lend freely.
Unfortunately, an effort to avoid cutting the fed funds rate at this point is
hampered by at least four factors:
1. The credibility on the “subprime is contained” story is simply shot. That
calls into question their judgment on the ultimate economic impact of the
subprime turmoil. Now we need the data to confirm the Fed’s view, rather
than giving the Fed the benefit of the doubt until that data arrives. The
confirming data is weeks if not months away; market participants will read
positive data as old news, while focusing on the weak data.
2. The failure of the emergency statement to mention anything about inflation
leaves little room to suddenly turn around and scream “inflation” even if
inflation holds above their comfort level. That credibility thing again.
3. The market has fully and completely embraced the rate cut story –
Monday’s amazing surge in short dated T-bills. If the Fed thought they were
having a crisis of confidence last week, just see what happens if they attempt
to verbally reverse the new expectations.
4. Cutting the discount rate may have very little impact, regardless of the
Fed’s intentions. Not only is it widely viewed as just symbolic
(regardless of the Fed’s intentions), it does not get to the heart of the
matter, the question of the fundamental value of subprime-based assets. Moreover, commentators have noted that given funding alternatives, banks have
little incentive to pay the penalty rate, and some believe that the banks that
do go to the discount window are simply doing it as a show of support. In
essence, the Fed may have nullified the effectiveness of the discount rate when
it was changed to a penalty rate – the jury is still out.
As far as what all this means for the economy, I already thought the next few
months would look weak, and am much more interested in next year. Quick
thoughts on the outlook: Note first the steepness of the yield curve given
expectations of easing. About as steep as one can expect given the starting
point of low 10 year rates to begin with, and a pretty good signal that the
economy will be chugging along quite nicely next year (see
also Jim Hamilton on the corporate-Treasury spread). Second, notice that a
policy shift now means the Fed would initiate a rate cut cycle on the backside
of an inventory correction:
The closest example of such a move was the emergency cuts in the fall of
1998, when, arguably, the Fed did not have the data in hand to show the economy
was convincingly on the backside of the inventory correction. You know the story
after that. This time, the Fed will be cutting well in advance of any new
correction that might be forming.
Finally, thinking into 2008, three more points strike me:
1. The Chinese government will pull out all of the stops to keep the economy
running at full steam through the Olympics. Too much national pride is at
stake. Don’t underestimate the power of central planners to dictate short
2. Assuming the Fed does ease, they will be slow to reverse the easing. We have been through this before in 1999.And next year is an election,
with the incumbent party looking, shall we say, weakened…not to question Fed
independence, but after seven years of this administration, my innocence is
3. There is a real chance that productivity is pulling back from the
accelerated rates of the late 1990s.At the same time, labor force
participation is pretty much topped out for secular reasons.
If you buy this story (it is not the only story), then you can do the math on
the inflation implications for 2009. You can see why the Fed just might want to
keep policy steady – there is a distribution of possible outcomes for the US
economy, and the bearish story is not the only one.
Tough times for a Fed watcher – knowing the Fed wants to hold steady, but
seeing the box they made closing in around them. It is difficult to see what
combination of data and events will allow the Fed to hold steady in the months
ahead at this point. The best chance for the Fed to avoid a rate cut (a
cut they don’t want) is that both the financial markets remain calm and the
August jobs report is very strong.
[Update: See also
Fed Rate Cuts Are a Possibility, Not a Certainty, by John M. Berry]
Posted by Mark Thoma on Tuesday, August 21, 2007 at 04:05 AM in Economics, Fed Watch, Monetary Policy |
Just a brief follow-up to
Tim's post. It appears that the Fed's first response to the financial market
problems may not be enough. Recall that as the crisis has been developing, firms
holding high-quality mortgage-backed securities in need of liquidity have been
unable to find buyers for these securities unless they are heavily discounted.
The result has been a "new-fashioned
bank run" (see also "A
New Type of Bank Run"). To try to alleviate this liquidity problem, the Fed
has done two things, it has accepted high-quality mortgage-backed securities as
collateral on discount loans, and it has also accepted these securities as
collateral in repo agreements. The discount loan change, for example, allows firms to essentially borrow from the discount window using banks as go-betweens. (The firm gives the securities to the bank as collateral on a loan, the bank then gives the securities to the Fed to hold against a discount loan. Thus, the bank passes the securities from the firm to the Fed, and then passes the cash in the other direction making a profit on the exchange.)
But a correspondent points to this news
"Analysts said the rally in short-term T-bills indicated nervousness remained
in credit markets, leading investors to seek the safe-haven of government bonds.
Expectations that the central bank will cut its key Fed funds rate was also
boosting short-term Treasury bonds.
"But money failed to convincingly return to the commercial bond market on
Monday, where liquidity has been drying up in recent weeks.
"Low T-bill yields indicate that liquidity is not yet flowing to those areas
of the credit markets that need liquidity most, such as toward the mortgage
market and the commercial paper markets, for example, where investors have been
on a buying strike," said Tony Crescenzi, fixed-income analyst at Miller Tabak.
And, from Reuters, "Two
U.S. Companies Involved in Mortgages Move to Raise Cash":
The struggling mortgage investment firm Luminent Mortgage Capital and the
lender Thornburg Mortgage took steps to bolster their liquidity yesterday, but
the companies signaled their troubles were not completely over.
Thornburg said it sold $20.5 billion of mortgage assets and reduced its
short-term borrowings by an equivalent amount in a bid to reduce its risk of
losing access to short-term credit markets. The sale amounted to more than 35
percent of its assets as of June 30.
Luminent said it would sell a majority of itself at a deep discount to shore
up its financial condition. Arco Capital, a holding company..., will have the
right to buy up to 51 percent of the company at 18 cents a share — a price 76
percent below Friday’s closing price.
So the liquidity crisis, and corresponding new fashioned bank run, do not appear to be
Posted by Mark Thoma on Tuesday, August 21, 2007 at 02:43 AM in Economics, Financial System, Monetary Policy |
Via email, four opinions about what the Fed should do in response to the
On What the Fed Hath Wrought (So Far), by Yves Smith:
A gut-wrenching two weeks in the credit markets have been capped by
unprecedented moves by central bankers. The ECB's
offer of an unlimited infusion to member banks the week before last was
followed last Friday' by the Fed's discount rate cut, which included
stern warnings that those who needed it better use it and a volte-face on
its interest rate posture (a bias towards tightening suddenly became a promise
that the Fed would provide more liquidity if conditions warranted). The Fed, ECB,
and Bank of Japan are
continuing to inject funds, albeit at a lower rate.
Opinion about the wisdom of the central bankers' actions is coalescing into what
we will characterize, broadly, as four views. Note that while some commentators
may engage in nuanced fence-straddling, for the most part, the positions are
For the purpose of simplicity, we'll focus on the Fed, although these comments
apply to some degree to other central bankers.
Continue reading "Four Views on What the Fed Should Do" »
Posted by Mark Thoma on Tuesday, August 21, 2007 at 02:34 AM in Economics, Monetary Policy |
Posted by Mark Thoma on Tuesday, August 21, 2007 at 12:21 AM in Links |
Paul Krugman on "new-fashioned bank runs":
a Miserable Life, by Paul Krugman, Commentary, NY Times: Last week the scene
at branches of Countrywide Bank, with crowds of agitated depositors trying to
withdraw their money, looked a bit like the bank run in the classic holiday
movie “It’s a Wonderful Life.” ...
But bank deposits up to $100,000
are protected by the Federal Deposit Insurance Corporation. Old-fashioned bank
runs just don’t make sense these days.
New-fashioned bank runs, on the other hand, do make sense — and they’re at
the heart of the current financial crisis. ...
Traditional banks ... lend out most of the money depositors place in their
care, keeping only a fraction in cash. ... Banks get in trouble ... when some event, like a rumor that major loans
have gone bad, leads many depositors to demand their money at the same time.
The scary thing about bank runs is that doubts about a bank’s soundness can
be a self-fulfilling prophecy: a bank that should be safely in the black can
nonetheless fail if it’s forced to sell assets in a hurry. And bank failures can
have devastating economic effects. ...
That’s why bank deposits are now protected by a combination of guarantees and
regulation. ... But these ... apply only to traditional banks.
Meanwhile, a growing number of unregulated bank-like institutions have become
vulnerable to the 21st-century version of bank runs.
Consider the case of KKR Financial Holdings..., a powerhouse Wall Street operator. KKR Financial raises money by
issuing asset-backed commercial paper ... used by large investors to temporarily
park funds — and invests most of this money in longer-term assets. So the
company is acting as a kind of bank, one that offers a higher interest rate than
It sounds like a great deal — except that last week KKR Financial announced
that it was seeking to delay $5 billion in repayments. That’s the equivalent of
a bank closing its doors because it’s running out of cash.
The problems ... are part of a broader picture in which many
investors, spooked by the problems in the mortgage market, have been pulling
their money out of institutions that use short-term borrowing to finance
long-term investments. These institutions aren’t called banks, but in economic
terms what’s been happening amounts to a burgeoning banking panic.
On Friday, the Federal Reserve tried to quell this panic by announcing a
surprise cut in the discount rate, the rate at which it lends money to banks. It
remains to be seen whether the move will do the trick.
The problem, as many observers have noticed, is that the Fed’s move is
largely symbolic. It makes more funds available to ... old-fashioned banks — but old-fashioned banks aren’t where the crisis is
centered. And the Fed doesn’t have any clear way to deal with bank runs on
institutions that aren’t called banks.
Now, sometimes symbolic gestures are enough. The Fed’s surprise quarter-point
interest rate cut ... at the height of the crisis caused by the
implosion of the hedge fund Long-Term Capital Management, was similarly a case
of providing money where it wasn’t needed. Yet it helped restore calm to the
markets, by conveying the sense that policy makers were on top of the situation.
Friday’s cut might do the same thing. But if it doesn’t, it’s not clear what
Whatever happens now, it’s hard to avoid the sense that the growing
complexity of our financial system is making it increasingly prone to crises —
crises that are beyond the ability of traditional policies to handle. Maybe
we’ll make it through this crisis unscathed. But what about the next one, or the
one after that?
Previous (8/17) column:
Paul Krugman: Workouts, Not Bailout
Next (8/24) column: Paul Krugman: Seeking Willie Horton
Posted by Mark Thoma on Monday, August 20, 2007 at 12:33 AM in Economics, Housing, Regulation |
There's been a lot of talk about the significance of the Fed's cut in the
discount rate and whether it was more than a symbolic gesture.
The WSJ notes one way in which it may have been more than symbolic.
A big problem for those who held mortgage-backed securities was that in many cases they were
unable to find buyers, hence these assets could be used in trade for needed liquidity. But if the Fed is
willing to accept these securities as collateral on discount loans, then, with
banks acting as intermediaries between those holding the assets and the discount
window, the liquidity problem is eased:
How a panicky day led the Fed to act, WSJ: Over the past few weeks, Wall
Street executives peppered Fed officials in New York and Washington with
suggestions for easing the logjam in credit markets. One idea was for the Fed to
widen the type of assets it accepts in its "open-market operations," when it
pumps cash into the economy by buying U.S. government bonds... Some thought the
Fed should buy lower-quality mortgages. ...
For several days, Mr. Bernanke pondered options with his confidants. ... The
officials were looking for a maneuver dramatic enough to shore up confidence,
while avoiding a cut in the Fed's main interest rate, the federal-funds rate.
Mr. Bernanke was still not convinced the economy needed a cut, and some Fed
officials feared it might encourage more of the sloppy lending that led to the
They began to look more closely at the discount window. Banks remain
well-capitalized and profitable. But they appeared reluctant to provide credit
to companies, issuers of commercial paper and even each other, perhaps out of
uncertainty over the safety of their customers or their collateral.
Eventually, Fed officials agreed to reduce the rate charged on loans from the
discount window (to 5.75% from 6.25%) and try to reduce the usual stigma
associated with such loans. By making these direct loans to banks more
attractive, the Fed hoped to reassure banks that they could borrow if they
needed to -- without the usual penalty to their bottom line or to their
Particularly at times of stress, what the Fed says can be almost as powerful
a weapon as what the Fed does. So Mr. Geithner, whose job makes him the
traditional liaison to Wall Street, turned to a convenient forum, the Clearing
House Payments Co., which is owned by a group of banks and operates much of the
plumbing of the nation's financial system. ...Mr. Geithner sought a 15-minute
telephone conference call.
On the call were commercial bankers who work with Clearing House as well as
several top investment bankers...
Joined by Mr. Kohn, but not Mr. Bernanke, Mr. Geithner told banks about the
discount-rate cut and said they could wait up to 30 days, instead of just a day,
to pay back their discount-window loans. "We will consider appropriate use of
the discount window...a sign of strength," said Mr. Geithner, according to a
Another banker participating in the call said of the Fed, "What they came up
with is pretty ingenious." Investment banks or hedge funds that hold
mortgage-backed securities can't borrow from the Fed directly, but they can
bring those securities to banks. In turn, the banks can offer the paper as
collateral to the Fed for a 30-day loan.
The Fed "really wanted to drive home the point that if [bankers] were
complaining about not being able to borrow money against liquid, high-quality
securities -- mortgages -- we have no more basis for complaint. We were all
given a clear message," says this banker. ...
Should the Fed should be intervening in mortgage markets at all? One
justification for intervening is that there is a threat to the macroeconomy
generally. When the cost of intervening (e.g. encouraging bad economic behavior
in the future) is less than the cost of doing nothing (and potentially allowing
catastrophic macroeconomic problems and costs to individuals who had nothing to
do with the decisions that caused the problems), then intervention is justified.
I am still undecided as to how much of a threat problems in these particular
markets pose for the macroeconomy generally, but since that uncertainty includes
a significant chance that there would be big problems if there had been no
intervention, it was prudent of the Fed to react. In any case, it may be time for the Fed to rethink what the term "bank" encompasses in today's financial markets, and to put institutions and regulations in place that can respond appropriately to problems that threaten the overall economy.
Update: I see
James Surowiecki is thinking along the similar lines,:
When the health of the U.S. economy is under serious threat, the Fed should
act. But in this case it’s far from clear that the turmoil was an actual menace
to the underlying economy... Bailing out hedge-fund managers was great
for Wall Street, but it may not have been such a good deal for Main Street.
Wall Street so dominates our image of the U.S. economy these days that it’s
easy to assume that what’s bad for the Street must be bad for everyone else.
But, while it’s true that a complete market meltdown would have disastrous
effects on the economy as a whole, market downturns like those of the past few
weeks often have only a small effect on businesses and consumers. In part,
that’s because much of what happens on Wall Street consists of the shuffling of
assets among various well-heeled players, rather than anything that’s
fundamental to the smooth functioning of the U.S. economy. ... Similarly, ...
stock-market tumbles ... have no concrete impact on most American consumers...
And, in the short run, they’re irrelevant to most corporations, too, since few
companies actually use the stock market to raise capital. ...
That’s not to say that the economy has suffered no fallout from the subprime
collapse. The fall in housing prices, the drying up of new construction, and the
sharp rise in foreclosures in many areas are having a serious impact on
employment and economic growth. But... Cutting the discount rate is not going to
help subprime borrowers get new loans, nor will it get the housing market moving
again. What it will do is reassure investors and save some money managers from
well-deserved oblivion. It may be that the risk of a full-fledged credit crunch
was high enough to make this worth doing. But there is something unseemly about
watching the avatars of free-market capitalism rely on the government to pay for
their bad bets. And there is something scary about contemplating the even bigger
bets they’ll make in the future if they know that the Fed is there to bail them
Posted by Mark Thoma on Monday, August 20, 2007 at 12:24 AM in Economics, Financial System, Monetary Policy |
Will the Fed cut the federal funds rate? Here's Tim Duy with his latest Fed Watch:
The Genie is Out of the Bottle, by Tim Duy: The Fed clearly does not want to cut the Federal Funds rate, especially in an
intermeeting move. They are aggressively looking for alternatives, and pulled a
rabbit out of the hat with Friday’s cut in the discount rate. And, as is widely
known, this was not simply a symbolic move, made absolutely clear by the Fed’s
urging of banks to use the discount window.
But did markets bounce on the discount rate cut, or the Fed’s statement that
opened the door for a rate cut? I suspect the latter. The Fed effectively
confirmed market participants’ expectations that a rate cut was coming sooner or
later, and probably sooner at that. The genie is out of the bottle, and I
suspect the Fed will have a hard time getting it back in.
Expectations are important. My expectation
was that the economy was going to look weak going into the fall, and that
there would be mounting pressure on the Fed to ease. But given the Fed’s
resolve, and willingness to look through slowdowns, it was reasonable to believe
they would hold steady through the year – and market participants pretty much
With the Fed statement, however, expectations are now turned upside down,
with market participants looking for at least 75bp (intermeeting, September, and
October, and maybe again in December) by the end of the year. Can the Fed turn
those expectations around in a period of lackluster data, with the nadir of the
housing market still ahead, even if the financial turmoil eases? Note that even
as late as last Thursday, the
Street Journal was still writing:
A stubborn inflation rate along with stronger factory output could keep
Federal Reserve officials wary of cutting interest rates despite the latest
turmoil hitting markets.
As I noted Friday, the
read on data is now decidedly negative. The Fed will not look at the dark
side of each piece of data, they never do. I think that the Fed does not want to
continue the crisis/ease/bubble cycle of the last decade. I believe they think
this is becoming an increasingly dangerous game with inflation at the high end
of tolerance. I think some are nervous that the productivity cycle is about to
cut against them this time.
And I think that Bernanke & Co. have lost boatloads of credibility with the
“subprime is contained” story. And that will make it difficult for them to sell
the “housing is contained” story in the coming months.
As an interesting side note, I also believe that global central bankers in
general are nervous that the liquidity creation of the last decade will soon
come home to roost in the form of higher inflation. But if the Fed cuts,
will be pressure on other central banks to halt, if not follow suit with
rate cuts of their own. Think of the pressure on the ECB to cut if the dollar
slide against the euro as the result of a Fed rate cut…
Bottom line: The Fed does not want to cut the Federal Funds rate; they want
to look through the slowdown. But they have now opened the door to a rate cut,
feeding into market expectations for such a policy shift. Closing that door will
not be easy.
Posted by Mark Thoma on Monday, August 20, 2007 at 12:15 AM in Economics, Fed Watch, Monetary Policy |
Posted by Mark Thoma on Monday, August 20, 2007 at 12:06 AM in Links |
The Economist's blog Free Exchange
argues that increases in income inequality have not caused a corresponding
increases in unhappiness and asks that egalitarians defend the proposition that
inequality is harmful. Chris Dillow answers the challenge:
The tangible harm of inequality, by Chris Dillow:
The Economist's blog
asks egalitarians to point to some "tangible harm" from income inequality.
In some senses, the question is silly. To see why, imagine a slave society in
which the slaves are reasonably content. It would be hard to point to a tangible
harm, but something would be wrong.
This just shows that the "tangible harm" criterion is psychologically,
economically and philosophically naive. Psychologically so, beecause people
adapt to their circumstances, so "losers" don't feel too bad. Economically,
because a gain foregone should count as much as a tangible cost; in a slave
society no-one can see that freedom creates prosperity better than slavery, but
this fact should surely count in our judgment. And philosophically, because
inequality matters for more than consequentialist reasons. Justice matters too.
Anyhow, let's address the question. Aside from the ill-health which the
Economist mentions - as if death were not tangible enough - I'd cite five other
1. Crime. Basic
economics says the relatively poor commit more crime than the relatively
rich. This is because their opportunities to make money honestly are more
limited, and the cost of being imprisonment - foregone earnings - is lower.
work corroborates this. Is it really a coincidence that unequal countries
(south America) have more crime than egalitarian ones (Japan, Korea,
2. Lower social mobility. Societies with higher income inequality have
social mobility. Politics in the US and the national media in the UK are now
largely hereditary occupations. Many of you might think this unhealthy.
3. Slower growth. There are
some reasons to think inequality can retard growth, say, by reducing social
capital and therefore investment, or by creating credit constraints that prevent
4. Bad customer service and job dissatisfaction. The inequalities that matter
are not merely of income, but of power. Some people have it, some don't. And in
companies, these inequalities breed slovenliness and inefficiency. Cloke and
Goldsmith put it
Through years of experience, employees learn that it is safer to suppress
their innate capacity to solve problems and wait instead for commands from
above. They lose their initiative and ability to see how things can be improved.
They learn not to care and to accept things as they are. They justify making
mistakes and are allowed to be irresponsible and pass the blame to others for
their mistakes. They become mindlessly obedient, fatalistic, intransigent and
5. Inner-city blight. Another consequence of inequalities in power is that
poor areas become bad areas, with urban decay, poor schools and crime, because
the poor lack the power to get the state to provide proper policing and schools.
So, there are almost certainly tangible harms from inequality. The more awkward
question for egalitarians is: would there be more harm done by reducing
There is also
Robert Frank's argument about positional goods:
The conventional wisdom has long been that a growing gap between the rich and
the middle class is a bad thing. But that view is now under challenge. Some
revisionists, respected economists among them, argue that inequality doesn't
really matter so long as no one ends up with less in absolute terms. Using
income levels to measure the well-being of individual families, these inequality
optimists argue that since the rich now have much more money than before and the
middle class doesn't have less, society as a whole must be better off.
Yet "having more income" and "being better off" do not have exactly the same
meaning. I will argue that changes in spending patterns prompted by recent
changes in the distributions of income and wealth have imposed not only
important psychological costs on middle-income families but also a variety of
more tangible economic costs. . . .
I'll also note that since the survey data measuring happiness is potentially
problematic, the initial premise about happiness and income inequality cn be
challenged. One source on this is the paper "Some
Uses of Happiness Data in Economicsw" (open link)," by Rafael Di Tella and
Robert MacCulloch appearing in the
Winter 2006 volume of The Journal of Economic Perspectives. Though they don't competely rule out happiness data as useful, they are cautious:
Happiness data are being used to tackle important questions in economics.
Part of this approach is quite natural, as many questions in economics are
fundamentally about happiness. But the approach departs from a long tradition in
economics that shies away from using what people say about their feelings.
Instead, economists have built their trade by analyzing what people do and, from
these observations and some theoretical assumptions about the structure of
welfare, deducing the implied changes in happiness. Economists who believe that
welfare can be measured to some extent by happiness surveys have an easier time.
They simply compare measures of welfare, and what causes changes in welfare,
under different scenarios. Of course, results based on happiness surveys should
be treated critically and cautiously. ...
Posted by Mark Thoma on Sunday, August 19, 2007 at 11:34 AM in Economics, Income Distribution |
The view of Iraq from soldiers serving there:
The War as We Saw It By Buddhika Jayamaha, Wesley D. Smith, Jeremy Roebuck, Omar
Mora, Edward Sandmeier, Yance T. Gray and Jeremy A. Murphy: (Baghdad) Viewed
from Iraq at the tail end of a 15-month deployment, the political debate in
Washington is indeed surreal. ... To believe that Americans, with an occupying
force that long ago outlived its reluctant welcome, can win over a recalcitrant
local population and win this counterinsurgency is far-fetched. As responsible
infantrymen and noncommissioned officers with the 82nd Airborne Division soon
heading back home, we are skeptical of recent press coverage portraying the
conflict as increasingly manageable and feel it has neglected the mounting
civil, political and social unrest we see every day. ...
The claim that we are increasingly in control of the battlefields in Iraq is
an assessment arrived at through a flawed, American-centered framework. ... What
soldiers call the “battle space” remains the same, with changes only at the
margins. It is crowded with actors who do not fit neatly into boxes: Sunni
extremists, Al Qaeda terrorists, Shiite militiamen, criminals and armed tribes.
This situation is made more complex by the questionable loyalties and
Janus-faced role of the Iraqi police and Iraqi Army, which have been trained and
armed at United States taxpayers’ expense. ...
In short, we operate in a bewildering context of determined enemies and
questionable allies, one where the balance of forces on the ground remains
entirely unclear. (In the course of writing this article, this fact became all
too clear: one of us, Staff Sergeant Murphy, an Army Ranger and reconnaissance
team leader, was shot in the head ... on Aug. 12; he is expected to survive...)
While we have the will and the resources to fight in this context, we are
effectively hamstrung because realities on the ground require measures we will
always refuse — namely, the widespread use of lethal and brutal force.
Given the situation, it is important not to assess security from an
American-centered perspective. The ability of, say, American observers to safely
walk down the streets of formerly violent towns is not a resounding indicator of
security. What matters is the experience of the local citizenry and the future
of our counterinsurgency. When we take this view, we see that a vast majority of
Iraqis feel increasingly insecure and view us as an occupation force that has
failed to produce normalcy after four years and is increasingly unlikely to do
so as we continue to arm each warring side.
Continue reading ""We are Skeptical of Recent Press Coverage Portraying the Conflict as Increasingly Manageable"" »
Posted by Mark Thoma on Sunday, August 19, 2007 at 12:42 AM in Iraq and Afghanistan |
Jim Hamilton can't find much evidence that recent financial turmoil signifies
fear of an economic downturn:
Where's the risk?, by Jim Hamilton: Usually an economic downturn is
associated in a big increase in the spread between corporate and Treasury
yields. This spiked pretty dramatically last week, but still has a long way to
Difference in yield between Moody's Baa-rated corporate debt and
constant-maturity 10-year Treasuries based on monthly averages, with
indicated as shaded regions. Data sources: FRED
The above graph plots monthly averages of the corporate-Treasury yield spread
through July. Going back to 1953, this spread averaged 170 basis points, and
typically rose over a hundred basis points during an economic downturn. Insofar
as there is a higher probability of default during an economic recession, even
risk-neutral investors would require a higher yield on corporate debt when more
businesses are failing.
This spread spiked substantially last week, as long-term Treasuries fell 20
basis points while the Baa yield showed little movement. Even so, the current
spread of 206 basis points is not much above the long-term average or the
short-term range we've seen over the last two years.
Daily values for difference in yield between Moody's Baa-rated corporate debt
and constant-maturity 10-year Treasuries. Data sources: FRED
If the financial turmoil over the last few weeks reflects fears of a
significant economic downturn and financial distress, I would have expected to
see an even bigger spread at this point.
Posted by Mark Thoma on Sunday, August 19, 2007 at 12:33 AM in Economics, Financial System |
Robert Shiller takes a look at the stock market's "unusually negative skew":
Something's up as 'buy' confidence slips, by Robert Shiller: The sharp drop
in the world's stock markets on Aug. 9 — after BNP Paribas announced that it
would freeze three of its funds — is just one more example of the markets'
recent downward instability or asymmetry. The markets have been more vulnerable
to sudden large drops than they have been to sudden large increases.
Daily stock price changes for the 100-business-day period ended Aug. 3 were
unusually negatively skewed in Argentina, Australia, Brazil, Canada, China,
France, Germany, India, Japan, Korea, Mexico, the United States and Britain. ...
In the U.S., the skew has been this negative only three other times since
Stock markets' unusually negative skew is not inconsistent with booming price
growth in recent years. The markets have broken all-time records, come close to
doing so or, at least, done very well since 2003 ... by making up for the big
drops incrementally, in a succession of smaller increases.
Nor is the negative skew inconsistent with the fact that world stock markets
have been relatively quiet for most of this year. With the conspicuous exception
of China and the less conspicuous exception of Australia, all have had low
standard deviations of daily returns for the 100-business-day period ended Aug.
3 when compared with the norm for the country. ...
Indeed, one of the big puzzles of the U.S. stock market recently has been low
price volatility since around 2004 amid the most volatile earnings growth ever
seen. ... One would expect volatile market prices as investors try to absorb
what this earnings volatility means. But we have learned time and again that
stock markets are driven more by psychology than by reasoning about
Does psychology explain the pervasive negative skew in recent months? Maybe
we should ask why the skew is so negative. Should we regard it as just chance
or, when combined with record-high prices, as a symptom of some instability?
The adage in the bull market of the 1920s was "one step down, two steps up,
again and again." The updated adage for the recent bull market is "one big step
down, then three little steps up, again and again," so far at least. No one is
looking for a sudden surge, and volatility is reduced by the absence of sharp
But big negative returns have an unfortunate psychological impact on markets.
People still talk about Oct. 28, 1929, or Oct. 19, 1987. Big drops get their
attention, and this primes some people to be ... ready to sell if another one
In fact, willingness to support the market after a sudden drop may be
declining. The "buy-on-dips stock market confidence index" that we compile at
the Yale School of Management has been falling gradually since 2001, and has
fallen especially far lately. The index is the share of people who answered
"increase" to the question "If the Dow dropped 3 percent tomorrow, I would guess
that the day after tomorrow the Dow would: Increase? Decrease? Stay the Same?"
In 2001, 72 percent of institutional investors and 74 percent of individual
investors chose "increase." By May 2007, only 48 percent of institutional
investors and 59 percent of individual investors chose "increase."
Perhaps the buy-on-dips confidence index has slipped lately because of
negative news concerning credit markets, notably the U.S. subprime mortgage
market, which has increased anxiety about the fundamental soundness of the
But something more may be at work. Everyone knows that markets have been
booming, and everyone knows that other people know that a correction is always a
possibility. So there may be an underlying sensitivity to price drops, which
could fuel a succession of downward price changes, amplifying public concerns
about problems in the economy and heralding a profound change in investor
Posted by Mark Thoma on Sunday, August 19, 2007 at 12:24 AM in Economics, Financial System |
Posted by Mark Thoma on Sunday, August 19, 2007 at 12:06 AM in Links |
Apologies If I've been less attentive lately, and posts the last few days have been mostly just one or two sentences of introduction. Here's why. The pictures are a day behind since this part of Flagstaff is not on the Edge network, though hopefully they will post sometime today (yesterday was Arches National Park in Moab, Utah and I have to say it was pretty cool). So far, as national parks go, I've been to Yellowstone, The Grand Tetons, Rocky Mountain, Arches, and I'm heading off to the Grand Canyon in about half an hour. I wish the iPhone camera was better, but it's all I have so it will have to do. After today, who knows? I'm deciding where to go next somewhat spontaneously.
Posted by Mark Thoma on Saturday, August 18, 2007 at 09:09 AM in Miscellaneous |
Hamid Varzi, "an economist and banker based in Tehran," discusses how the
U.S. is viewed by the rest of the world:
culture gone awry, by Hamid Varzi, Commentary, IHT: (Tehran) The U.S.
economy, once the envy of the world, is now viewed across the globe with
suspicion. America has become shackled by an immovable mountain of debt that
endangers its prosperity and threatens to bring the rest of the world economy
crashing down with it.
The ongoing sub-prime mortgage crisis, a result of irresponsible lending
policies designed to generate commissions for unscrupulous brokers, presages far
deeper problems in a U.S. economy that is beginning to resemble a giant
smoke-and-mirrors Ponzi scheme. And this has not been lost on the rest of the
This new reality has had unfortunate side effects that go beyond economics.
As a banker working in the heart of the Muslim world, I have been amazed by the
depth and breadth of anti-Americanism, even among U.S. allies, manifested in
reactions ranging from fierce anger to stoic fatalism. Muslims outside the
United States interpret America's policies in the Middle East not as an effort
to spread democracy but as a blatant neocolonialist attempt to solve its
economic problems by force. Arabs and Persians alike argue that America's fiscal
irresponsibility has forced the nation to seek solutions through military
Many believe that America's misguided adventure in Iraq was a desperate
attempt to capture both a reliable source of cheap oil and a major export market
for the United States. ...
What have Americans gained from their nation's mountain of debt? A crumbling
infrastructure, a manufacturing base that has declined 60 percent since World
War II, a rise in the wealth gap, the lowest consumer-savings rate since the
depths of the Great Depression, 50 million Americans without health insurance,
an educational system in decline and a shrinking dollar that makes foreign
travel a luxury.
The best cars, the best bridges and highways, the fastest trains and the
tallest buildings are all to be found outside America's borders. ...
The bottom line is that America is awash in red ink and seeks the wrong
solutions to its debt problems. A return to fiscal responsibility would make
America far stronger, both domestically and internationally, than would a
continuation of current policies that falsely project strength through idle
protectionist threats and failed military aggression.
Current tensions between the United States and the rest of the world will
continue as long as America's military bark is louder than its economic bite.
A solution to the U.S. debt problem requires radical measures, including: the
elimination of corporate tax loopholes, a reversal of tax breaks for the
ultra-rich, a bipartisan campaign to eliminate budget "pork," imposition of
stringent limits on corporate debt and speculative lending, a vast reduction in
military expenditure and, finally, an additional 50 cent per gallon gasoline tax
that would slash the federal deficit, curtail energy waste and spur
Let us hope America heeds the warnings, dispenses with junk-food economics
and embraces a crucial diet of fiscal discipline. It remains to be seen,
however, whether America's political leaders have the courage to instigate such
reforms, and whether Congress is finally willing to do something for the future
of ordinary, hard-working Americans.
Posted by Mark Thoma on Saturday, August 18, 2007 at 02:43 AM in Economics, Politics |
Dani Rodrik on exchange rate policy for developing countries:
Value of Being Undervalued, by Dani Rodrik, Project Syndicate: The paramount
policy dilemma that emerging markets face nowadays is this: on the one hand,
sustained economic growth requires a competitive (read “undervalued”) currency.
On the other hand, any good news is immediately followed by currency
appreciation, making the task of remaining competitive that much harder. ...
Your fiscally responsible political party just won the election? Or your
commodity exports hit the jackpot? Good for you! But the currency appreciation
that follows will likely set off an unsustainable consumption boom, wreak havoc
with your export sector, create unemployment, and sap your growth potential. ...
In response, central banks may intervene in currency markets to prevent
appreciation, at the cost of accumulating low-yield foreign reserves and
diverting themselves from their primary goal of price stability. This is the
strategy followed by countries such as China and Argentina.
Or the central bank lets the markets go where they will, at the cost of
drawing the ire of business, labor, the rest of the government, and, in fact,
practically everyone except financial types. This is the strategy pursued by
countries such as Turkey and South Africa, which have adopted more conventional
“inflation targeting” regimes.
The first strategy is problematic because it is unsustainable. The second is
undesirable because it buys stability at the cost of growth.
The importance of a competitive currency for economic growth is undeniable.
Virtually every instance of sustained high growth has been accompanied by a
significantly depreciated real exchange rate. ...
So what should policymakers do?
Continue reading ""The Value of Being Undervalued"" »
Posted by Mark Thoma on Saturday, August 18, 2007 at 12:24 AM in Budget Deficit, Economics, International Finance, Monetary Policy |
An interview with Edmund Phelps:
Lunch with the FT: Edmund Phelps, by Ralph Atkins, Commentary, Financial Times
(free): ...Traditionally, the Nobel prize for economics recognises work that
was carried out many decades ago but still has relevance today. [Edmund] Phelps
won his for work in the late 1960s that overturned then-conventional wisdom that
a stable relationship existed between inflation and unemployment... But he is
also renowned for his criticism of continental European “corporatism”, which he
believes hampers interaction between entrepreneurs and financiers, and results
in Europe relying on the import of ideas and techniques from the US. It is his
explanation for continental Europe’s dismal growth in the past decade. ...
Phelps feels that he is at the stage in his career “where I can afford to be
as radical as I want to be. And so I am having a lot of fun thinking about
capitalism and trying to imagine how economics would have to be re-written to
capture the heart of that kind of system.” Traditional economics, he explains,
sees the world as if it were a plumbing system. “It’s basically rooted in
equilibrium – things work out as people expect them to do.” Capitalist reality,
however, “is a system of disorder. Entrepreneurs have only the murkiest picture
of the future in which they are making their bets, and also there is ambiguity,
they don’t know when they push this lever or that lever that the outcome is
going to be what they think it is going to be – there is the law of
unanticipated consequences. This is not in the economic text books, and my
mission, late in my career, is to get it into the text books.” ...
I switch the conversation to Europe, which, Phelps believes, is doomed always
to trail behind the US... “I don’t begrudge Europe waiting to see what works in
America before expending the resources to adopt this or that new good or
technique,” he says. “I just think that the Europeans are depriving themselves
of a high-employment economy and they are depriving themselves of intellectual
stimulation in the workplace – and personal growth – by sticking to the
stultifying, rigid system that I call corporatism.”
Phelps says Italian friends tell him that things have changed, that “we’re
virtually like America now”. But notwithstanding Europe’s impressive growth
rebound lately, he sees too much backsliding. ...
Continue reading "Phelps: I Can Afford To Be As Radical As I Want To Be" »
Posted by Mark Thoma on Saturday, August 18, 2007 at 12:15 AM in Economics |
Posted by Mark Thoma on Saturday, August 18, 2007 at 12:06 AM in Links |
The Fed issued a statement today changing its assessments of downside risks to output:
For immediate release
Financial market conditions have deteriorated, and tighter credit conditions
and increased uncertainty have the potential to restrain economic growth going
forward. In these circumstances, although recent data suggest that the economy
has continued to expand at a moderate pace, the Federal Open Market Committee
judges that the downside risks to growth have increased appreciably. The
Committee is monitoring the situation and is prepared to act as needed to
mitigate the adverse effects on the economy arising from the disruptions in
Voting in favor of the policy announcement were: Ben S. Bernanke, Chairman;
Timothy F. Geithner, Vice Chairman; Richard W. Fisher; Thomas M. Hoenig; Donald
L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Michael H. Moskow; Eric
Rosengren; and Kevin M. Warsh.
Brad DeLong also notes that the Fed has cut the discount rate (symbolically) from 6.25% to 5.75% [see also
Text of Fed Statement on Discount Rate,
Explaining the Discount Window].
Posted by Mark Thoma on Friday, August 17, 2007 at 08:46 AM in Economics, Monetary Policy |
Paul Krugman has a proposal to deal with the consequences of the mortgage
Workouts, Not Bailouts, by Paul Krugman, Commentary, NY Times: ...According to data released yesterday, both housing starts and applications
for building permits have fallen to their lowest levels in a decade, showing
that home construction is still in free fall. And if historical relationships
are any guide, home prices are still way too high. The housing slump will
probably be with us for years, not months.
Meanwhile, it’s becoming clear that the mortgage problem is anything but
contained. ... Many on Wall Street are clamoring for a bailout — for Fannie Mae or the
Federal Reserve or someone to step in and buy mortgage-backed securities from
troubled hedge funds. But that would be like having the taxpayers bail out Enron
or WorldCom when they went bust — it would be saving bad actors from the
consequences of their misdeeds.
For it is becoming increasingly clear that the real-estate bubble of recent
years, like the stock bubble of the late 1990s, both caused and was fed by
widespread malfeasance. Rating agencies like Moody’s Investors Service ... seem to have
played a similar role to that played by complaisant accountants in the corporate
scandals of a few years ago. In the ’90s, accountants certified dubious earning
statements; in this decade, rating agencies declared dubious mortgage-backed
securities to be highest-quality, AAA assets.
Yet our desire to avoid letting bad actors off the hook shouldn’t prevent us
from doing the right thing, both morally and in economic terms, for borrowers
who were victims of the bubble.
Most of the proposals I’ve seen ... are of the locking-the-barn-door-after-the-horse-is-gone variety: they
would ... have been very useful three
years ago — but they wouldn’t help much now. What we need at this point is a
policy to deal with the consequences of the housing bust.
Consider a borrower who can’t meet his or her mortgage payments and is facing
foreclosure. In the past, ... the bank that made the loan would often have been willing to offer a
workout, modifying the loan’s terms to make it affordable, because what the
borrower was able to pay would be worth more to the bank than its incurring the
costs of foreclosure and trying to resell the home. That would have been
especially likely in the face of a depressed housing market.
Today, however, the ... mortgage was
bundled with others and sold to investment banks, who in turn sliced and diced
the claims to produce artificial assets that Moody’s or Standard & Poor’s were
willing to classify as AAA. And the result is that there’s nobody to deal with.
This looks to me like a clear case for government intervention: there’s a
serious market failure, and fixing that failure could greatly help thousands,
maybe hundreds of thousands, of Americans. The federal government shouldn’t be
providing bailouts, but it should be helping to arrange workouts. ...
The mechanics ... would need a lot of work, from lawyers as
well as financial experts. My guess is that it would involve federal agencies
buying mortgages — not the securities conjured up from these mortgages, but the
original loans — at a steep discount, then renegotiating the terms. But I’m
happy to listen to better ideas.
The point, however, is that doing nothing isn’t the only alternative to
letting the parties who got us into this mess off the hook. Say no to bailouts —
but let’s help borrowers work things out.
Previous (8/13) column:
Paul Krugman: It’s All About Them
Next (8/20) column: Paul Krugman: It's a Miserable Life
Posted by Mark Thoma on Friday, August 17, 2007 at 12:33 AM in Economics, Housing, Market Failure, Policy |
Tim Duy with more on how the Fed is likely to react to current economic
Collision Coming, by Tim Duy: Someone is going to get hurt bad, as financial market participants and Fed
policymakers are barreling toward each other. Who will be the first to swerve?
Whether the Greenspan put is real or not, markets are convinced that the Fed
will flinch in the face of the ongoing panic. Is panic too strong? I think not,
at least given the tenor of the financial press. From
''People are losing faith in credit, so the economy is seizing up,'' said
Biggs, 74, who runs the Traxis Partners LLC hedge fund in New York and was
formerly a strategist at Morgan Stanley.
Looking out the window, I sense “the economy is seizing up” is something of
an exaggeration. There appears to be considerable activity at the local shops,
my internet connection is solid, the electricity is on, etc. Some students
appear unsteady on their feet, but I suspect this has more to do with
post-summer finals revelry than impending economic collapse.
All joking aside, there is a real concern, and I can not say that I do not
share it, that the situation is quickly getting away from the Fed. In my
opinion, we are at a point where people no longer have the time to rationally
analyze the incoming news, reacting to speculation and rumor rather than fact.
Sounds like a good definition of “panic” to me.
The daily activities of the New York Fed, which have gone unnoticed for
years, suddenly becomes an object of intense speculation about the intentions of
the Fed. It is as if we have reverted to the days when the Fed did not announce
policy decisions. Indeed, speculation is rising that the
secretly cut rates already. Likewise, data analysis has become subject to
exaggeration as well. I particularly enjoyed David Gaffen’s remarks from the
Wall Street Journal’s MarketBeat:
Continue reading "Tim Duy: Collision Coming" »
Posted by Mark Thoma on Friday, August 17, 2007 at 12:15 AM in Economics, Fed Watch, Housing, Policy |
The importance of the steamboat for economic development in America:
Steaming into the future, by Kirkpatrick Sale, Commentary, LA Times: Monday,
Aug. 17, 1807, was another hot summer day in New York City, and most of the
women of fashion on the Hudson River pier, arms linked to laced and ruffled
gentlemen, had their pastel parasols up against the sun. It was unusual for such
a crowd to gather midday on a Monday.... But a good deal of excitement had been
stirred up in the city by the prospect of Robert Fulton's strange and improbable
steamboat making its maiden voyage to Albany.
This was not the first steamboat... But Fulton's was superior in design and
engineering. If he made the voyage without mishap that day, it would prove that
his craft could go faster than any boat on the river, in any kind of weather,
and thus lead to the first commercially viable steamboat operation in the world.
Interest was particularly high because ... it was widely held that the whole
outlandish contraption was likely to explode. ... In his later account, Fulton
noted that "in the moments before the word was to be given for the boat to
move," the people on deck showed "anxiety mixed with fear" and were "silent, sad
and weary." Indeed, "I read in their looks nothing but disaster, and almost
repented of my efforts."
But he had not spent much of the previous five years learning about steam
propulsion, and the previous six months and nearly $10,000 of his own money
(plus an equal amount from Livingston) actually building the boat, just to give
in to a few skeptics. At 1 p.m., he gave the signal for the engine to be powered
and the boat to be cast off.
The boat glided a few yards into the Hudson, then stopped. ... He started
examining the machinery and wheels, and in less than half an hour, "the boat was
again put in motion" and "continued to move on."... [T]here it was, moving at a
steady 4 miles an hour northward, and Fulton proudly noted, "I overtook many
sloops and schooners . . . and parted with them as if they had been at anchor."
Continue reading ""The Globe's Modern Commerce"" »
Posted by Mark Thoma on Friday, August 17, 2007 at 12:12 AM in Economics |
Posted by Mark Thoma on Friday, August 17, 2007 at 12:06 AM in Links |
The article "The
Man Who Killed Compassionate Conservatism"
As for Thompson, the original compassionate conservative, there would be no
small-government incarnation of the great society on his watch. Rather than
reinventing Medicaid, Thompson was called on to twist Republican arms in favor
of Bush's prescription drug benefit... It's hard to imagine Thompson the
reformist governor being enamored of the open-ended, fuzzy-numbered, nakedly
political bill that Thompson the Bush administration factotum helped pass.
Reading this reminded me of confusion -- perhaps intentional by those who
popularized the phrase -- about the term "compassionate conservatism." It isn't a
kindler, gentler brand of conservatism, though that's certainly the impression
the phrase is intended to convey. It doesn't mean, for example, government
stepping in and helping after an event like hurricane Katrina. It refers to the
work of Marvin Olasky, who
wrote in his book Renewing American Compassion that reforming the
present welfare system often means nothing more than "scraping off a bit of
mold." Thus, he advocates scrapping the present welfare system entirely and replacing it with
private and religious charity, a system he says was "effective in the nineteenth
century." This is compassionate conservatism. It is a rebranding of an old
approach, not a fundamentally new idea.
Posted by Mark Thoma on Thursday, August 16, 2007 at 01:44 AM in Economics, Politics, Social Insurance |
I don't know what to make of this report from Robert Novak that the Fed was
secretly planning a new FOMC statement indicating a bias toward a rate cut, but
was derailed by the fallout from the "international credit scares," but I'm skeptical. The report
is attributed to "Capitol Hill sources," and the vagueness of the sources along
with a general wariness about anything Novak reports makes it hard to evaluate. In addition, the report is very much at odds with what the first Fed official to
comment since the financial crisis, William Poole, has said:
William Poole, president of the St. Louis Federal Reserve Bank, said the
subprime mortgage rout doesn't threaten U.S. economic growth, and only a
''calamity'' would justify an interest-rate cut now. Poole, who confers
regularly with regional business contacts, said ... the ... best course is for
officials to assess economic figures, including the August jobs report, when
they next convene on Sept. 18...
A Rate Cut on Hold, by Robert D. Novak, Commentary, Washington Post: Before
the recent global financial crisis began, the Federal Reserve Board under
Chairman Ben S. Bernanke was ready to take a subtle step toward easier money in
order to stave off U.S. recession fears. Ready for approval was a new Federal
Open Market Committee (FOMC) statement ending the central bank's neutrality and
putting it on a bias for an interest rate cut. But international credit scares
changed all that.
The Fed and other central banks moved quickly and in unison last Friday to
pump more cash into financial systems, successfully stabilizing markets made
jittery by collapsing hedge funds around the world. It was central banking at
its best... But Bernanke's broader plans for easier money have to be placed on
hold because he cannot be seen as bailing out greedy hedge fund operators. ...
While the FOMC's decisions now are disclosed promptly, the central bankers do
not disclose and try not to leak their plans. However, according to Capitol Hill
sources, they had secretly decided to issue a statement soon changing the Fed's
bias toward easing -- which no longer would be in neutral.
While such a change in itself can boost the economy, it normally is followed
immediately by an actual drop in interest rates. In this case, however, sources
indicated that the second step would not come for several months, to coincide,
if possible, with good anti-inflation numbers. ...
But any kind of easing now -- either abandoning neutrality or a full-scale
cut in interest rates -- could make it appear as though Bernanke was less
interested in the broader economy than in protecting millionaire hedge fund
operators and traders. ...
As Bernanke considers his course, the "R" word (recession) is in the air in
Washington. That's why the Fed secretly decided to move away from neutrality
toward easing, which is now on hold thanks to the global crisis.
Update: Tim Duy, who comments further on the Poole statement in his latest Fed Watch, says:
ABSOLUTE BS! … When I
was in DC, Novak was called "Nofacts".
Update: Since the topic is columnists is Washington Post columnists trying to
write about the Fed, let me add this.
George Will is confused about the Fed's mandate. He says:
The Federal Reserve's proper mission is not to produce a particular rate of
economic growth or unemployment... It is to preserve the currency as a store of
value -- to contain inflation.
That would be news to the Fed. For example, Federal Reserve Governor
Mishkin thinks there is dual mandate:
In the United States, as in virtually every other country, the central bank
has a ... specific set of objectives that have been established by the
government. This mandate was originally specified by the Federal Reserve Act of
1913 and was most recently clarified by an amendment to the Federal Reserve Act
According to this legislation, the Federal Reserve's mandate is "to promote
effectively the goals of maximum employment, stable prices, and moderate
long-term interest rates." Because long-term interest rates can remain low only
in a stable macroeconomic environment, these goals are often referred to as the
dual mandate; that is, the Federal Reserve seeks to promote the two coequal
objectives of maximum employment and price stability.
But unlike George Will, you already knew that. Be wary when reading Will.
One more update: Barry Ritholtz has more in "Attention Robert Novak: The Fed isn't at Neutral."
Posted by Mark Thoma on Thursday, August 16, 2007 at 12:24 AM in Economics, Monetary Policy |
Tim Duy evaluates the chances of a Fed rate cut in light of recent price data
and comments from St. Louis Fed president William Poole:
First Fed Speaker Comes Out Against Rate Cut, by Tim Duy: St. Louis Fed President William Poole became the first Fed official to speak
in the wake of recent financial disruption. For those looking for a rate cut
before the September meeting,
his interview with Bloomberg
was not particularly supportive:
''I don't see any impact as yet on the real economy or on the inflation
rate,'' he said in an interview in the bank's boardroom. ''Obviously, there
could be an impact, but we have to rely on some real evidence.''
Barring a ''calamity,'' there is no need to consider an emergency rate cut,
''No one has called up and said the sky is falling,'' Poole said today. ''As
I talk to companies, their capital spending plans are intact.''
Moreover, those looking for a cut in September should note Poole’s warning:
Poole said he didn't regret that the Aug. 7 statement retained a bias against
inflation. He also said that while consumer price gains are ''moving in the
right direction,'' the ''job is not done.''
Important comments as they came after the release of today’s CPI report for
July. While the trend appears to be in the right direction, the Fed simply lacks
conviction inflation will continue to head in their desired direction. Not
really that surprising – although core CPI was up just 0.2%, after a downward
rounding, note that the 3-month annualized rate stands at 2.5%, well above an
As I noted earlier this week, the Fed is considerably more deliberate than
market participants when it comes to changing policy. The flow of data so far is
not supportive of a rate in September. To be sure, retail sales data were
not spectacular, but consumer weakness is expected by the Fed – they anticipate
a rising savings rate. Industrial production was ahead of expectations, and,
most importantly, the June trade figures are likely to push 2Q07 above 4%. Don’t
ignore the potential for the external sector to support growth in the quarters
ahead. Exports growth looks set to continue, while sagging consumption is likely
to come at the expense of import growth – those flat screen TV’s are not made on
Felix Salmon has posted what I believe to be
a misleading chart
suggesting that the Fed changed policy in the past week. Thankfully
William Polley provides some context,
noting that the downward pull on the effective Fed Funds rate is being driven by
few trades at extremely low rates. Importantly, he notes that the high end
of the trading range remains right where is should be. My interpretation of the
low trades is that the New York Fed is erring on side of caution, not
unreasonable given the current frenzied state of market participants.
I will quibble with this from Polley:
Remember also that this infusion of liquidity represents reserves, or base
money. It doesn't get multiplied through the deposit process unless banks lend
those reserves to create new deposits. Something tells me that's not going to be
an enormous risk in this case. Intermediaries are more likely to be carrying
some excess reserves at this point.
The reason this is not a risk is the seemingly forgotten fact that these are
temporary operations – all with the exception of one 14-day operation last
Thursday are overnight repos. The money goes in, the next morning it goes out
and new money, if necessary, is put in. Financial reporters insist on ignoring
the second part of a repo operation. And clearly banks will not lend out money
they know they will only hold for 24 hours or less.
Of course, the Fed does also change the size of its portfolio with permanent
open market purchases. This would permanently change the amount of base money
available for loans and the money creation process.
The last such operation
was on May 3 for $1.4 billion. I hope the NY Fed is not planning another
permanent purchase anytime soon – who knows how it will be interpreted.
Bottom Line: The path to a rate cut will not be as direct as appears to
be priced into markets; the Fed will resist until they see hard data to justify
a policy shift.
Posted by Mark Thoma on Thursday, August 16, 2007 at 12:15 AM in Economics, Fed Watch, Monetary Policy |
Alan Auerbach explains how to tax capital gains:
How to Tax
Capital Gains, by Alan Auerbach, Commentary, WSJ: The recent controversy
over the taxation of "carried interest" ... demonstrates the problems that can
arise from taxing capital gains differently from other types of income. While
it's relatively simple to change the way we treat carried interest, it would be
far better to undertake an overall reconsideration of the way we tax capital
As President Reagan and others who crafted the Tax Reform Act of 1986
understood, different tax rates on different types of income-producing
activities often distort economic decisions and increase the tax system's
complexity. Their solution was a broad-based tax with low and uniform marginal
tax rates. The identical rate was applied to capital gains and to wage and
salary income. But the reform survived only a few years, and we now confront the
old problems magnified by two decades of financial innovation.
We can do better, and here are some guidelines:
• Increase the capital gains tax rate, but not the "lock-in" effect.
...[T]axing capital gains has a big impact on investors' decisions about when to
sell capital assets. Higher tax rates delay sales, causing investors to be
"locked in" to their current holdings...
By itself, an increase in the capital gains tax rate worsens the lock-in
effect. But this impact can be offset by other desirable changes, such as
indexing capital gains for inflation ... and taxing capital gains at death.
(Currently, we do not collect capital gains taxes when someone dies; this makes
people want to hold onto appreciated assets throughout their lifetimes.)
So-called "constructive realization" (i.e., taxation of capital gains at death)
could help solve our current estate tax impasse by substituting capital gains
revenues for some of the lost estate taxes. ...
• Reconsider how best to encourage innovation and risk-taking. Some
argue that low capital gains tax rates can spur the formation and development of
new enterprises, for the payoffs from successful start-ups flow to their owners
largely in the form of capital gains. But ... only a miniscule fraction of the
economy's capital gains are associated with new ventures. A low capital gains
tax rate is a very poor way to encourage entrepreneurial activity. It would be
far better to carefully tailor tax provisions to spur innovation...
• Don't raise the cost of capital. ...Lowering capital income taxes
reduces the cost of capital and spurs investment; raising these taxes increases
the cost of capital and discourages investment.
But not all capital income taxes equally influence the cost of capital.
Capital gains taxes have a relatively weak impact on the cost of capital because
a large share of the tax revenues is associated with income not generated by new
investment. Thus only a small portion of the capital gains realized over the
next several years will result from today's investment, so changing the tax rate
on the gains won't influence today's investment much. By contrast, tax
provisions targeted toward new investment, such as the bonus depreciation scheme
introduced in 2002, tie tax reductions to new investment and thereby produce a
bigger bang for each buck of tax reduction. Offsetting an increase in the
capital gains tax rate with a revenue-neutral tax reduction that targets new
investment is likely to reduce the cost of capital. ...
There are, of course, more sweeping tax reform alternatives available. Some
proposals would move us from taxing income toward taxing consumption, or toward
taxing capital gains as they accrue, rather than only when assets are sold.
There are coherent and attractive proposals available to implement either of
these approaches. But we need not wait for the next grand tax reform to improve
on our current method of taxing capital gains.
Posted by Mark Thoma on Thursday, August 16, 2007 at 12:12 AM in Economics, Taxes |
Posted by Mark Thoma on Thursday, August 16, 2007 at 12:06 AM in Links |
David Leonhardt says the "stock run-up of the 1990s was so big ... that the
market may still not have fully worked it off"
Remembering a Classic Investing Theory, by David Leonhardt, New York Times:
More than 70 years ago, two Columbia professors named Benjamin Graham and David
L. Dodd came up with a simple investing idea that remains ... influential... In
the wake of the stock market crash in 1929, they urged investors to focus on
hard facts — like a company’s past earnings and the value of its assets...
Their classic 1934 textbook, “Security Analysis,” became the bible for what
is now known as value investing. Warren E. Buffett took Mr. Graham’s course at
Columbia Business School in the 1950s and, after working briefly for Mr.
Graham’s investment firm, set out on his own to put the theories into practice.
Mr. Buffett’s billions are just one part of the professors’ giant legacy.
Yet somehow, one of their big ideas about how to analyze stock prices has
been almost entirely forgotten. The idea essentially reminds investors to focus
on long-term trends and not to get caught up in the moment. Unfortunately, when
you apply it to today’s stock market, you get even more nervous about what’s
Most Wall Street analysts, of course, say there is nothing to be worried
about, at least not beyond the mortgage market. In an effort to calm investors
after the recent volatility, analysts have been arguing that stocks are not very
expensive right now. The basis for this argument is the standard measure of the
market: the price-to-earnings ratio. ...
In its most common form, the ratio is equal to a company’s stock price
divided by its earnings per share over the last 12 months. ... The higher the
ratio, the more expensive the stock is — and the stronger the argument that it
won’t do very well going forward.
Right now, the stocks in the Standard & Poor’s 500-stock index have an
average P/E ratio of about 16.5, which by historical standards is quite normal.
... The core of Wall Street’s reassuring message, then, is that even if the
mortgage mess leads to a full-blown credit squeeze, the damage will not last
long because stocks don’t have far to fall. ...
Mr. Graham and Mr. Dodd ... would have had a problem with the way that the number is calculated today.
... They realized that a few months, or even a year, of financial information
could be deeply misleading. ...
So they argued that P/E ratios should not be based on only one year’s worth
of earnings. It is much better, they wrote in “Security Analysis,” to look at
profits for “not less than five years, preferably seven or ten years.” This
advice has been largely lost to history. ...
Today, the Graham-Dodd approach produces a very different picture from the
one that Wall Street has been offering. Based on average profits over the last
10 years, the P/E ratio has been hovering around 27 recently. That’s higher than
it has been at any other point over the last 130 years, save the great bubbles
of the 1920s and the 1990s. The stock run-up of the 1990s was so big, in other
words, that the market may still not have fully worked it off.
Now, this one statistic does not mean that a bear market is inevitable. But
it does offer a good framework for thinking about stocks. Over the last few years, corporate profits have soared. ... In just three
years, from 2003 to 2006, inflation-adjusted corporate profits jumped more than
30 percent... This profit boom has allowed standard, one-year P/E ratios to
remain fairly low.
Going forward, one possibility is that the boom will continue. In this case,
the Graham-Dodd P/E ratio doesn’t really matter. It is capturing a reality that
no longer exists... The other possibility is that the boom will prove fleeting. Perhaps the
recent productivity gains will peter out (as some measures suggest is already
happening). Or perhaps the world’s major economies will slump in the next few
years. If something along these lines happens, stocks may suddenly start to look
In the long term, the stock market will almost certainly continue to be a
good investment. But the next few years do seem to depend on a more rickety
foundation than Wall Street’s soothing words suggest. Many investors are banking
on the idea that the economy has entered a new era of rapid profit growth, and
investments that depend on the words “new era” don’t usually do so well. ...
Dean Baker says he gets it "almost" right:
Leonhardt Gets It Right on Stock Market Valuations (Almost), by Dean Baker:
NYT columnist David Leonhardt does a good job of spreading some basic
commonsense on stock prices. The stock price should reflect earnings. Leonhardt
notes that current PEs are about 27 against trend earnings, far higher than the
The reason for including the "almost" is that Leonhardt felt the need to say
that maybe stocks aren't over-valued if profits keep growing rapidly (sounds
like Alan Greenspan in the 90s). Well don't hold your breath on that one.
Profits peaked in the 3rd quarter of 2006 and were down sharply in the 4th
quarter of 2006 and the first quarter of 2007. It's always possible that they
will bounce back, just like it's possible that President Bush will sign the
Kyoto agreement, but I don't know anyone who will bet on either event.
Posted by Mark Thoma on Wednesday, August 15, 2007 at 12:33 AM in Environment, Financial System |
Robert Samuelson on global warming. There's plenty to talk about here, but my
internet connection is less than perfect at the moment, so I am going to leave
this one (and the others today) to comments:
Global Warming Simplicities, by Robert J. Samuelson, Commentary, Washington Post:
We in the news business often enlist in moral crusades. Global warming is among
the latest. Unfortunately, self-righteous indignation can undermine good
journalism. A recent Newsweek cover story on global warming is a sobering
reminder. It's an object lesson on how viewing the world as "good guys vs. bad
guys" can lead to a vast oversimplification of a messy story. Global warming has
clearly occurred; the hard question is what to do about it.
If you missed Newsweek's story, here's the gist. A "well-coordinated,
well-funded campaign by contrarian scientists, free-market think tanks and
industry has created a paralyzing fog of doubt around climate change." This
"denial machine" has obstructed action against global warming and is still
"running at full throttle." The story's thrust: Discredit the "denial machine,"
and the country can start the serious business of fighting global warming. ...
The global-warming debate's great unmentionable is this: We lack the
technology to get from here to there. Just because Arnold Schwarzenegger wants
to cut emissions 80 percent below 1990 levels by 2050 doesn't mean it can
happen. At best, we might curb the growth of emissions.
Consider a 2006 study from the International Energy Agency. Using present
policies, it projected that emissions of carbon dioxide ... would more than
double by 2050; developing countries would account for almost 70 percent of the
increase. The IEA then simulated an aggressive, global program to cut emissions
that is based on the best available technologies: more solar, wind and biomass
energy; more-efficient cars, appliances and buildings; more nuclear energy.
Under this admitted fantasy, global emissions in 2050 would still slightly
exceed 2003 levels.
Even the fantasy would be a stretch. In the United States, it would take
massive regulations, higher energy taxes or both. Democracies don't easily adopt
painful measures in the present to avert possible future problems. ...
One way or another, our assaults against global warming are likely to be
symbolic, ineffective or both. But if we succeed in cutting emissions
substantially, savings would probably be offset by gains in China and elsewhere. ...
Against these real-world pressures, Newsweek's "denial machine" is a
peripheral and highly contrived story. ... The alleged cabal's influence does not seem impressive. The mainstream media
have generally been unsympathetic; they've treated global warming ominously. ... Nor does public opinion seem much swayed. ...
What to do about global warming is a quandary. Certainly, more research and
development. Advances in underground storage of carbon dioxide, battery
technology (for plug-in hybrid cars), biomass or nuclear power could alter
energy economics. To cut oil imports, I support a higher gasoline tax -- $1 to
$2 a gallon, introduced gradually -- and higher fuel-economy standards for
vehicles. These steps would also temper greenhouse gas emissions. Drilling for
more domestic natural gas (a low-emission fuel) would make sense. ...
But the overriding reality seems almost un-American: We simply don't have a
solution for this problem. As we debate it, journalists should resist the
temptation to portray global warming as a morality tale -- as Newsweek did -- in
which anyone who questions its gravity or proposed solutions may be ridiculed as
a fool, a crank or an industry stooge. Dissent is, or should be, the lifeblood
of a free society.
Posted by Mark Thoma on Wednesday, August 15, 2007 at 12:24 AM in Economics, Environment, Regulation |
Martin Wolf says that without fear, financial markets "go crazy":
Fear makes a welcome return, by Martin Wolf, Commentary, Financial Times:
...Panic follows mania as night follows day. ... Ours has been a world of ...
confidence, cleverness and too much cheap credit. This is not new. It is as old
as financial capitalism itself. The late Hyman Minsky, who taught at the
University of California, Berkeley, laid down the canonical model. The process
starts with “displacement”, some event that changes people’s perceptions of the
future. Then come rising prices in the affected sector. The third stage is easy
credit and its handmaiden, financial innovation.
The fourth stage is over-trading, when markets depend on a fresh supply of
“greater fools”. The fifth stage is euphoria, when the ignorant hope to enjoy
the wealth gained by those who came before them. The warnings of those who cry
“bubble” are ridiculed, because these Cassandras have been wrong for so long. In
the sixth stage comes insider profit-taking. Finally, comes revulsion.
In the latest cycle, displacement began with the huge cuts in interest rates
in the early 2000s, which drove up prices in housing. The easy credit was
stimulated by innovations that allowed those making the loans to regard their
service as somebody else’s problem. Then people started to buy dwellings to
resell them, not live in them. Subprime lending was a symptom of euphoria. So,
in a different way, was the rush of bankers into hedge funds and of the wealthy
and big institutions into financing them. Then came profit-taking, falling
prices and, last week, true revulsion.
This was what George Magnus of UBS bank calls a “Minsky moment” . It was the
moment when credit dried up even to sound borrowers. Panic had arrived.
The correct policy response is also well known. ... The central bank must
save not specific institutions, but the market itself. It must advance money
freely, at a penal rate, on good security.
In providing money to the markets last week and this, the ... central banks
have been doing their jobs. Whether the terms on which they have done this were
sufficiently penal is another matter.
Financial markets, and particularly the big players within them, need fear.
Without it, they go crazy. Moreover, it is impossible for outsiders to regulate
a global financial system riddled with conflicts of interest and dominated by
huge derivatives markets, massive trading by highly leveraged hedge funds and
reliance on abstruse mathematics and questionable statistical models. These
markets must regulate themselves. The only thing likely to persuade them to do
so is the certainty that the players will be allowed to go bust. ...
The world has witnessed four great bubbles over the past two decades – in
Japanese stocks in the late 1980s, in east Asia’s stocks and property in the
mid-1990s, in the US (and European) stock markets in the late 1990s and,
finally, in the housing markets of much of the advanced world in the 2000s.
There has been too much imprudent finance worldwide, with central bankers and
ministries of finance providing rescue at virtually every stage.
Unfortunately, there is every chance of repeating mistakes. A bail-out has
already occurred in Germany... More are likely. US
legislators want Fannie Mae and Freddie Mac to bail out the mortgage markets.
The pressure on the Federal Reserve to cut interest rates will also grow. ...
The consequences [of this implosion] cannot be “ring-fenced”, as those of LTCM
were. Trust in counterparties and financial instruments has fled. The likelihood
is a period of recognising losses, tightening credit conditions and deleveraging.
Such a period, desirable in itself, will lead to strong pressure for swift
declines in interest rates, at least in the US, and so for another partial
bail-out of a crisis-prone system. This pressure should be resisted as long as
Posted by Mark Thoma on Wednesday, August 15, 2007 at 12:15 AM in Economics, Financial System, Monetary Policy |
Posted by Mark Thoma on Wednesday, August 15, 2007 at 12:06 AM in Links |
Joshua Green says there is a "contradiction at the heart of 'compassionate
A ‘Great Society’ Conservative, by Joshua Green, Commentary, NY Times: There
is a paradox at the heart of Karl Rove’s tenure in the White House, and it is a
key to understanding why he failed to remake American politics, despite
ambitious plans to do so. ... Conservatives believe the Great Society programs
that liberals pushed in the 1960s demonstrated that government engineering
doesn’t work. Lyndon Johnson’s War on Poverty failed, this critique goes,
because liberals simply didn’t understand the limits of government’s power to
transform culture. ...
[T]here can be little dispute that Mr. Rove pursued his vision of a new
political order with the activist zeal of a 1960s Great Society liberal. From
the outset of the Bush administration, Mr. Rove aimed to create a “permanent
majority” for Republicans, just as Franklin Roosevelt did for Democrats in the
1930s, and as William McKinley and his campaign manager Mark Hanna — Mr. Rove’s
hero — did for Republicans in the 1890s.
As Mr. Rove sought a political realignment that would create a durable
Republican majority, he seized on government as his chief mechanism. He tried to
realign American politics principally through the pursuit of major initiatives
that he believed would reorient a majority of Americans to the Republican Party:
establishing education standards; rewriting immigration laws; partially
privatizing Social Security and Medicare; and allowing religious organizations
to receive government financing.
The only thing that united these government actions was the likelihood that
they would weaken political support for Democrats. Social Security privatization
would create a generation of market-minded stockholders. Pork-barrel spending on
religious organizations would keep evangelical Christians engaged in the
political process — and pry loose some African-American voters by funneling
money to black churches. No Child Left Behind would appeal to voters who
traditionally looked to Democrats as the party of education. And generous
immigration policies would persuade Hispanics to vote Republican.
Mr. Rove’s entire vision for Republican realignment was premised on the
notion that he could command government to produce the specific effects that he
desired. But as a conservative could have predicted, his proposed policies
unleashed a series of failures and unintended consequences.
Mr. Rove had extraordinary power within the administration to shape domestic
policy. But pushing through many of his programs proved difficult. On Social
Security and immigration reform, Congress and the country weren’t prepared to
embrace his vision. Like a 1960s liberal in love with the abstract merits of a
guaranteed income, Mr. Rove misread the mood of the country and tried to do too
Mr. Rove married a liberal’s faith in the potential of government to a
conservative’s contempt for its actual functioning. This was the contradiction
at the heart of “compassionate conservatism,” and it helps explain the tension
between the president’s fine words about, say, helping those hurt by Hurricane
Katrina, and his actions.
Conservatives don’t have a lot to celebrate these days. Mr. Rove’s attempt at
a Great Republican Society has left his party in tatters...
Of course, there is a bright side. If nothing else, Mr. Rove has strengthened
the conservative critique of what happens when you try to engineer great
societal changes through government policy. Perhaps conservatives can find some
solace by telling themselves they were right all along.
The language is careful to talk about changing culture and society rather
than the effectiveness of particular government programs, but it leaves the impression that this example helps to prove the general case about government effectiveness. While it's true that
Rove and company were unable to push society where it did not want to go, I
don't think it says much about the effectiveness of government programs
Take the two main examples above, Social Security and
immigration reform. On Social Security, try as they might, conservatives were unable to end or substantially alter the existing program. If the program was a failure, reform plans would not have faced such stiff opposition. On immigration reform, it's not as though a
program was put into place and then failed, it never got past the proposed
legislation stage. So it's hard to generalize too much about the effectiveness
of government programs from that example.
But I think there is a lesson about
government programs to be learned from this administration. As events like
hurricane Katrina showed, who's running the programs matters, and it matters more than I thought. However, those instances don't prove government failure either, no more than the existence of an incompetent manager at a firm proves private sector failure. All it shows is that if you put incompetent people in charge of things, then bad things can happen.
Posted by Mark Thoma on Tuesday, August 14, 2007 at 12:33 AM in Economics, Politics, Social Insurance |
John Campbell on "Households, Institutions, and Financial Markets":
Institutions, and Financial Markets, by John Y. Campbell, NBER Reporter:
Economists studying asset pricing have begun to grapple seriously with the
extraordinary diversity of financial market participants. Investors, including
both households and financial institutions, differ in their overall resources,
current and future labor income, housing and other assets that are expensive to
trade, tax treatment, access to credit, attitudes towards risk, time horizons,
and sophistication about financial markets. My recent research measures and
models this heterogeneity, with a particular focus on time horizons and
Behavioral finance emphasizes that some investors are likely to be more
sophisticated about financial markets than others. Early behavioral models
emphasized a distinction between "noise traders" and sophisticated arbitrageurs,
the former trading randomly and creating profits for the latter.1 This of course
raises the question of who can be described as a noise trader. Discussions at
conferences are sometimes reminiscent of the old verse "It isn't you, it isn't
me, it must be that fellow behind the tree". Recent literature has argued that
institutional investors act as arbitrageurs, while the household sector as a
whole may play the role of noise traders.
Continue reading "John Campbell: Who are the Noise Traders?" »
Posted by Mark Thoma on Tuesday, August 14, 2007 at 12:24 AM in Academic Papers, Economics, Financial System |
Can "the fickle American consumer" bring about change in China?:
China's new revolutionaries: U.S. consumers, by Nathan Gardels, Commentary, LA
Times: Who would have thought that tainted pet food and toys would threaten
to unravel the authoritarian export model of Chinese growth that the brutal
Tiananmen Square crackdown in 1989 was partly meant to secure? China's then
"paramount leader" Deng Xiaoping, who had been purged during the Cultural
Revolution, could well imagine how political upheaval would derail China's
stable path to prosperity. But it surely never entered his mind, nor that of his
descendant comrades, that the fickle American consumer would one day become, as
the students in the square wanted to be, the agent of revolutionary change in
In the name of sovereignty, China's leaders for a long time have gotten away
with suppressing their own citizens while ignoring the get-gloriously-rich-quick
corruption that has thrived in the absence of the rule of law. But, thanks to
globalization, China's export reliance on the U.S. market has imported the
political demands of the U.S. consumer into the equation. Americans won't
hesitate to cut the import lifeline and shift away from Chinese products that
might poison their children or kill their pets.
Unlike organized labor or human rights groups, consumers don't have to
mobilize to effect change; they only have to stop spending. And their bargaining
agents -- Wal-Mart, Target, Toys R Us -- have immensely more clout than the
AFL-CIO and Amnesty International in fostering change in China.
Ironically, the United States' "most favored nation" trade treatment for
China (and its later entry into the World Trade Organization), which labor and
human rights groups so virulently opposed in the past, has become a Trojan
horse. China's future is now so linked to the American consumer that Beijing
will be forced to curb corruption and strengthen regulation through the rule of
law or face the certain doom of its export-led growth. ...
For consumers to trust Chinese products, they must trust regulation of those
products. And regulation cannot be trusted without the rule of law, which
doesn't bend to bribery, fraud and quanxi (connections). ...
[T]he ultimate paradox of Deng's soft totalitarianism is that privatizing
people's lives will ultimately deprive the authorities of their power. As more
people come to enjoy private freedom, fewer will abide it being taken away.
Globalization, it seems, has accelerated this process by forging a kind of
objective coalition of the growing Chinese middle class and the American
consumer in favor of the rule of law. ...
Savvy consumers are not likely to buy China's response of prosecuting or
executing high-level officials -- "killing the chicken to scare the monkey."
They simply want the lead removed from their children's toys or they will take
their purchases elsewhere.
Of course, a move toward the reliable rule of law is not democracy, but it is
a big step on the long march in that direction.
Some years ago, the once-famous but now forgotten dissident, Wei Jingsheng,
lamented how the attention of global public opinion and that of most Chinese had
shifted "from Democracy Wall [where Wei was arrested for putting up posters
calling for democratic political reforms] to the shopping mall."
Now, especially as the spotlight of next summer's Olympics approaches, it
seems the tables may be turning again.
Posted by Mark Thoma on Tuesday, August 14, 2007 at 12:15 AM in China, Economics, Regulation |
Posted by Mark Thoma on Tuesday, August 14, 2007 at 12:06 AM in Links |
Paul Krugman on the similarity between President Bush and leading contenders
for the Republican nomination for president:
All About Them, by Paul Krugman, Commentary, NY Times: Ask not what your
country can do for you — ask what you can do for your father’s political
Last week, ... a woman ... asked Mr. Romney whether any of his five sons are
serving in the military and, if not, when they plan to enlist.
The candidate replied ... “It’s remarkable how we can show our support for
our nation, ... and one of the ways my sons are showing support for our nation
is helping to get me elected, because they think I’d be a great president.”
Wow. ... Mr. Romney apparently considers helping him get elected an act of
service comparable to putting your life on the line in Iraq.
Yet the week’s prize for most self-centered remark by a serious presidential
contender goes ... to ... Rudy Giuliani [who] has lately been getting some
long-overdue criticism for his missteps both before and after 9/11. For example,
... Mr. Giuliani is being attacked for his failure to take adequate precautions
to protect those who worked on the cleanup at ground zero from the hazards at
the site. Many workers have since been sickened by the dust and toxic materials.
For a politician whose entire campaign is based on the myth of his leadership
that fateful day ... anything that challenges his personal legend is a big
problem. So here’s what Mr. Giuliani said last week...: “I was at ground zero as
often, if not more, than most of the workers. ... I was exposed to exactly the
same things they were exposed to. So in that sense, I’m one of them.”
Real ground zero workers, who were digging through the toxic rubble while Mr.
Giuliani held photo ops, were understandably outraged. ...
What’s striking about these unintentional moments of self-revelation is how
much Mr. Romney and Mr. Giuliani sound like the current occupant of the White
It has long been clear that President Bush doesn’t feel other people’s pain.
His self-centeredness shines through whenever he makes off-the-cuff, unscripted
remarks, from his jocular obliviousness in the aftermath of Hurricane Katrina to
the joke he made ... when visiting the Brooke Army Medical Center, which treats
the severely wounded: “As you can possibly see, I have an injury myself — not
here at the hospital, but in combat with a cedar. I eventually won. The cedar
gave me a little scratch.”
What’s now clear is that the two men most likely to end up as the G.O.P.
presidential nominee are cut from the same cloth.
This probably isn’t a coincidence. ... To be a serious presidential
contender, after all, you have to be a fairly smart guy — and nobody has accused
either Mr. Romney or Mr. Giuliani of being stupid. To appeal to the G.O.P. base,
however, you have to say very stupid things, like Mr. Romney’s declaration that
we should “double Guantánamo,” or Mr. Giuliani’s dismissal of the idea that
raising taxes is sometimes necessary to pay for things like repairing bridges as
a “Democratic, liberal assumption.”
So the G.O.P. field is dominated by smart men willing to play dumb to further
their personal ambitions. We shouldn’t be surprised, then, to learn that these
men are monstrously self-centered.
All of which leaves us with a political question. Most voters are thoroughly
fed up with the current narcissist in chief. Are they really ready to elect
Previous (8/10) column:
Paul Krugman: Very Scary Things
Next (8/17) column: Paul Krugman: Workouts, Not Bailout
Posted by Mark Thoma on Monday, August 13, 2007 at 12:33 AM in Economics, Politics |
Mark Gertler says that monetary policy from 2003 to 2005 helped to stabilize
the economy and hence is not to blame for current problems in financial markets:
Bernanke Co-Author Says Fed Was NOT ‘Too Easy for Too Long’, WSJ Economics Blog:
Mark Gertler, a prominent economist and close associate of Ben Bernanke,
says the Fed didn’t create the current turmoil by keeping interest rates too low
earlier this decade, as some have argued. Rather, Mr. Gertler, ... says
investors and lenders became more comfortable with risk thanks to the greater
stability of economic growth and inflation in recent decades. That “Great
Moderation,” says Mr. Gertler, reflects better monetary policy. ...
For the second time in recent days The Wall Street Journal’s
suggests that the recent turmoil in credit markets is due to “the Federal
Reserve’s willingness to keep money too easy for too long” during 2003-2005.
This kind of reasoning leaves me scratching my head: There is simply no hard
evidence to support it. The only telltale sign of when a central bank has been
too easy is rising inflation. While it is true that the ... personal consumption
expenditures price index excluding food and energy, crept a bit above 2% for a
period of time, this is hardly an indication of profligate monetary policy.
Understanding the recent financial market turbulence requires a more nuanced
view: Since the early 1980s there has been a significant drop in the volatility
of the macroeconomy. .... This phenomenon, known as the Great Moderation, is
true not only for the U.S. economy but also for industrialized economies across
the globe, with the notable exception of Japan. Most serious observers attribute
the Great Moderation to three main factors: (i) good luck (smaller shocks); (ii)
structural change (e.g. financial market innovations that have improved
borrowing capacity); and (iii) improved monetary policy. While there is debate
over the relevant importance of each factor, my own view is that each deserves
about equal credit.
The decline in the aggregate volatility of the macroeconomy has naturally
lead to a decline in both risk premia and credit spreads. This in itself should
not be a problem. However, it is also possible that the relatively long period
of tranquility ... has lead to a sense of complacency in financial markets,
which in turn has lead investors to fail to appropriately discount risk and
lenders to not apply standards that are sufficiently tight. It is also possible
that there has been abuse of the existing regulatory system, particularly
involving mortgage lending. These kinds of factors play out once the markets are
put under stress and only serve to magnify the turmoil, as has been the case
Now, about monetary policy during 2003-2005: By keeping interest rates low in
the absence of inflationary pressures, the Fed prudently insured against a
Japan-style stagnation. It is not unreasonable to suggest, further, that this
period provides an illustration of how the Fed has contributed to the Great
Moderation. So, oddly enough, Fed policy may be relevant to current financial
market volatility not because it was bad, but rather because it was good!
Posted by Mark Thoma on Monday, August 13, 2007 at 12:24 AM in Economics, Monetary Policy |
Tim Duy on the likelihood that the Fed will cut rates in coming months:
Playing Chicken, by Tim Duy: Wow – what a week! One could almost
forget that there was an FOMC meeting less than seven days ago. Ancient history
as far as financial market participants are concerned, as the surge of Fed
lending in the overnight market seemingly made the Fed’s stated inflation
concerns seem almost naïve, moving up expectations, once again, for that
inevitable rate cut. My caution is to remember that the Fed tends to act more
deliberately than markets.
A sizeable portion of the rise in expectations for an imminent rate cut is
clearly attributable to remarkably bad, sensationalistic financial journalism
that fed into the turmoil. For criticisms, see
Dean Baker and
Calculated Risk, for example. The Fed’s actions last week did not constitute
a change in policy. Note also that the use of mortgage backed securities as
collateral is not new (although the size is impressive). Instead, the Fed was
carrying out its stated policy objective – to keep the federal funds rate at its
Hamilton provides a great summary of relevant analysis on this point,
The bottom line is that the Fed was doing exactly what it needed to do. But
the fact that this was needed is a very troubling development.
A troubling development, indeed. Interestingly,
I warned a couple of weeks back that the economy was likely to run into a
period of turbulence that would cause a reevaluation of the Fed’s policy stance,
albeit it happened a bit sooner than I anticipated. And so far, all the actors
are playing their roles to perfection; with market participants clamoring for a
rate cut while the Fed holds steady while making sufficient liquidity available
to hold the fed funds rate at its target. Assuming the Fed sticks to its policy
statement of just last week, policymakers will be hesitant to cut rates in an
inter-meeting move, or even in the September meeting.
Continue reading "Fed Watch: Playing Chicken" »
Posted by Mark Thoma on Monday, August 13, 2007 at 12:15 AM in Economics, Fed Watch, Monetary Policy |
Posted by Mark Thoma on Monday, August 13, 2007 at 12:06 AM in Links |