Friday, September 21, 2007
Thursday, September 20, 2007
Are we emotionally predisposed to the creation of bubbles?:
In the mood for instability, by By Richard Taffler and David Tuckett, Commentary, Financial Times: What caused the credit bubble? The current debate lacks analysis of the role emotions play in financial activity. The new discipline of emotional finance aims to show how emotion drives investors’ behaviour. ...
We tend to deal with anxiety in one of two states of mind: “depressive” (D) or “paranoid-schizoid” (PS). Applied to investors, in a D state they recognise the inherent unpredictability of markets, in which investments have both attractive and unattractive characteristics, and judgments are imperfect. A realistic view, in other words.
In a PS state of mind investors seek to avoid the pain of reality by separating good and bad feelings. Ideas that feel good excite, while those that feel bad are repressed. This allows investors to ignore the consequences of decisions, or to blame others for them. ...
In a D state, the risk of loss is evaluated against potential gain, so an opportunity is taken with awareness of potential losses. In a PS state, investors separate risk and reward and so do not think properly; there appears to be no downside to speculation. ...
All financial crises follow the same emotional trajectory: excitement at some new idea, domination of the market by the excitement, then jitters, panic and blame. The new idea ... creates a belief that something revolutionary is happening. This turns to euphoria and boom; emotions determine “reality”, as when internet stocks rose by 500 per cent in 18 months. A paranoid-schizoid state dominates and anxiety that might spell caution is denied. Doubters are dismissed. When the bubble bursts, we see panic and revulsion, then anger and blame, but surprisingly little guilt or learning. Typically, investors blame others for allowing them to be caught up. The sense of reality is still PS – because responsibility is disowned.
The credit bubble follows this pattern. Lending to subprime borrowers was overdone with the true risk apparently invisible. The “safe” assembly of high-risk loans into complex investment vehicles could only appear to eliminate risk if a PS state of mind was predominating. By “spreading” (avoiding) ownership of risk, such methods may even encourage irresponsibility. ... Calls for the authorities to take responsibility for the crisis again demonstrate how investors place responsibility and blame with others.
The solution to financial crises will not easily be found in increased regulation, more transparent information or cuts in interest rates. Rather, it lies in understanding how a market in which a paranoid-schizoid state of mind is encouraged is inherently unstable. ... Understanding the part emotions play in all investment activity should concern central banks, market regulators – and us all.
Olivier Blanchard outlines steps he believes are necessary to reform the labor market in France. The idea is to reduce the protection given to existing jobs, and put into place a system that reduces the economic harm from becoming unemployed and smooths the transition between jobs:
How to reform the job market successfully, by Olivier Blanchard, Vox EU: Why must the French job market undergo major reform?
- The unemployment rate is too high and has been for too long to attribute it to bad macroeconomic policies.
- Unemployment periods last too long – more than a year on average. When someone is out of work for that long, it often affects them for life.
- Lastly, there’s an increasingly polarised job market – with the young too often starting their professional lives alternating between small jobs and unemployment, and older workers too often in pre-retirement, or unemployed long-term.
Can we do better? Evidence from other countries clearly says ‘yes’. There are, on the whole, two ways to protect employees.
National Review editor Ramesh Ponnuru wonders why Republicans are pushing tax cuts that don't benefit the Party's lower income supporters:
Taxing the Hand That Feeds Us, by Ramesh Ponnuru: Republican presidential candidates can’t get elected without owning the tax issue. So far, the current crop is giving it away. ...
Republican contenders for 2008 are promising to keep all of Mr. Bush’s tax cuts. But the Democrats are not threatening the child tax credit or Mr. Bush’s reductions in the lower-level income-tax rates. Those issues are off the table.
What Mitt Romney and Rudy Giuliani ... are really saying is that they will make sure that taxes on capital gains, dividends, estates and high earners will stay low. Not many middle-class taxpayers will benefit directly from any of those policies.
Mr. Romney adds that he will try to cut the corporate tax rate, which his adviser Glenn Hubbard calls “a drain on competitiveness.” ... Cutting corporate tax rates may or may not be a good idea, but we don’t need to make it a priority to preserve our competitiveness.
Both Mr. Romney and Mr. Giuliani speak vaguely about making sure the alternative minimum tax doesn’t affect any more middle-class families. That is a step in the right direction. But it isn’t a tax cut.
Mr. Romney has also proposed an initiative to make the return on middle-class savings tax-free. It may also be a step in the right direction, but it’s small change. The primary focus of the Romney and Giuliani tax plans remains high earners.
What would be a serious middle-class tax cut? One answer is to expand the tax credit for children. But none of the candidates is proposing to do so, or any other big tax relief for regular folks. You might think that Mr. Giuliani would want to do everything he can to appeal to social conservatives short of actually becoming one himself. But why should he offer a pro-family tax cut when even the hard-core social conservatives in the race aren’t interested? Mike Huckabee wants a national sales tax and Sam Brownback wants a flat tax. Either proposal would increase taxes on a lot of middle-class families.
The Republicans in Congress are no better. For much of the right, the great passion of the moment is to make sure that the carried interest at hedge funds is taxed at what look an awful lot like preferential rates. For years, liberals have said that Republicans talk about “family values” but won’t do anything to meet the economic needs of families. Right now, on taxes, that charge hits home. ...
Paul Krugman gives us a taste of what is blog will be like:
What I Hate About Political Coverage, by Paul Krugman: Warning: this is a bit (actually, more than a bit) of a rant.
One of my pet peeves about political reporting is the fact that some of my journalistic colleagues seem to want to be in another business – namely, theater criticism. Instead of telling us what candidates are actually saying – and whether it’s true or false, sensible or silly – they tell us how it went over, and how they think it affects the horse race...
There are two big problems with this kind of reporting. The important problem is that it fails to inform the public about what matters. ... The other problem, which has become very apparent lately, is that this sort of coverage often fails even on its own terms, because the way things look to inside-the-Beltway pundits can be very different from the way they look to real people.
Which brings me to the Petraeus hearing.
To a remarkable extent, punditry has taken a pass on whether Gen. Petraeus’s picture of the situation in Iraq is accurate. Instead, it was all about the theatrics – about how impressive he looked, how well or poorly his Congressional inquisitors performed. And the judgment you got if you were watching most of the talking heads was that it was a big win for the administration – especially because the famous MoveOn ad was supposed to have created a scandal, and a problem for the Democrats.
Even if all this had been true, it wouldn’t have mattered much: if the truth is that Iraq is a mess, the public would find out soon enough, and the backlash would be all the greater because of the sense that we had been deceived yet again.
But here’s the thing: new polls by CBS and Gallup show that the Petraeus testimony had basically no effect on public opinion: Americans continue to hate the war, and want out. The whole story about how the hearing had changed everything was a pure figment of the inside-the-Beltway imagination.
What I found striking about the whole thing was the contempt the pundit consensus showed for the public – it was, more or less, “Oh, people just can’t resist a man in uniform.” But it turns out that they can; it’s the punditocracy that can’t.
"To a remarkable extent, punditry has taken a pass on whether Gen. Petraeus’s picture of the situation in Iraq is accurate." We'll hear a lot more about whether the evidence in the OJ trial is accurate than we'll ever hear about the accuracy of the evidence that Petraeus presented in his testimony. That's pretty sad.
On Fed independence:
Perspectives on Federal Reserve Independence—A Changing Structure for Changing Times, by Bruce K. Mac Laury, FRB Minneapolis: ...The Semantics of Fed Independence Quite probably the term “independence” has been over-used. It was a key concept in the design of our central banking system—but in a relative sense, not as an absolute.
What does “independence” mean? Is the Federal Reserve accountable? Is it responsive to changing national priorities?
First, let's be clear on what independence does not mean.
Wednesday, September 19, 2007
Robert Shiller says the housing boom and subsequent crash isn't the Fed's fault. He says the Fed didn't start the bubble, couldn't have done much to prevent it (though they could have leaned harder against it), and can't do much now to stop it from popping:
Worldwide bubble trouble,by Robert Shiller, Project Syndicate: The future of the housing boom, and the possible financial repercussions of a substantial price decline in coming years, are a matter of mounting concern among governments around the world. ... [Many] countries have had dramatic housing booms since 2000, most of which appear to be continuing, at least for the time being. But there [is] no consensus on the longer-run outlook for home prices.
Of all these countries, the United States appears to be the most likely to have reached the end of the cycle. ... There seems to be a general recognition of substantial downside risk, as the current credit crisis seems to be related to the decline in U.S. home prices that we have already seen.
The boom, and the widespread conviction that home prices could only go higher, led to a weakening of lending standards. Mortgage lenders seem to have believed that home buyers would not default, because rising prices would make keeping up with their payments very attractive.
Moreover, the boom resulted in a number of financial innovations, which may have been good ideas intrinsically, but which were sometimes applied too aggressively, given the risk of falling prices...
Paul McCulley of PIMCO ... argued that in the past month or two we have been witnessing a run on what he calls the "shadow banking system," which consists of all the levered investment conduits, vehicles and structures that have sprung up along with the housing boom. The shadow banking system, which is beyond the reach of bank regulators and deposit insurance, fed the boom in home prices by helping provide more credit to buyers. ...
The U.S. Federal Reserve is sometimes blamed for the current mortgage crisis, because excessively loose monetary policy allegedly fueled the price boom that preceded it. Indeed, the real (inflation-corrected) federal funds rate was negative for 31 months, from October 2002 to April 2005. ...
But loose monetary policy is not the whole story. The unusually low real funds rate came after the U.S. housing boom was already well under way. ... The rapid increase thus appears to be mostly the result of speculative momentum that occurred before the interest-rate cuts.
Alan Greenspan, the former Fed chairman, recently said that he now believes that speculative bubbles are important driving forces in our economy, but that, at the same time, the world's monetary authorities cannot control bubbles. He is mostly right: the best thing that monetary authorities could have done, given their other priorities and concerns, is to lean against the real estate bubble, not stop it from inflating.
The current decline in home prices is associated just as clearly with waning speculative enthusiasm among investors, which is likewise largely unrelated to monetary policy. The world's monetary authorities will have trouble stopping this decline, and much of the attendant problems, just as they would have had trouble stopping the ascent that preceded it.
Robert Lucas says to relax, everything will be just fine if we maintain a commitment to low unwavering taxes and strict inflation targeting:
Mortgages and Monetary Policy, by Robert E. Lucas, Jr., Commentary, WSJ: In the past 50 years, there have been two macroeconomic policy changes ... that have really mattered. One of these was the supply-side reduction in marginal tax rates... The other was the advent of "inflation targeting," ... monetary policy focused on inflation-control to the exclusion of other objectives. As a result of these changes, steady GDP growth, low unemployment rates and low inflation rates ... have been a reality in the U.S. for more than 20 years.
Both of these reforms work, in part, because they stabilize people's expectations about aspects of the future. The supply side tax cuts, in contrast to Keynesian on-again-off-again temporary tax cuts, are designed to be in place over the long run... Inflation targeting is a commitment that no matter what unpredictable shocks the economy is subjected to, the Fed will do what is needed to restore a fixed, target inflation rate and so maintain a "nominal anchor" to expectations.
This summer's subprime mortgage crisis puts the long-run emphasis of inflation targeting to a severe test. Something has to be done right now. What should it be? There are two distinct aspects to this test, which deserve separate analysis.
There is an immediate risk of a payments crisis, a modern analogue to an old-fashioned bank run ... that ... can force otherwise solid enterprises into failure. ... There is no way to rule this possibility out based on market forces alone: If everyone else wants to cash out, then I want to be first in line. So we need a second commitment by the Fed, unrelated to inflation control, to ... serve as lender of last resort.
By reducing the discount rate and encouraging use of the discount window -- instead of reducing the funds rate until yesterday -- I think Mr. Bernanke was trying to separate the short-term problem of lender of last resort and the long-term problem of inflation targeting, and to show that we can and will deal forcefully with the liquidity crisis, if one should emerge, without weakening the commitment to price stability.
The need for a lender-of-last-resort function is one qualification to the discipline of inflation targeting, but it is a necessary one. There is a second line of argument that seems to me much less compelling.
It ... is all too easy for easy money advocates to see a recession coming and rationalize low interest rates. ... [But] I am skeptical about the argument that the subprime mortgage problem will contaminate the whole mortgage market, that housing construction will come to a halt, and that the economy will slip into a recession. Every step in this chain is questionable and none has been quantified. If we have learned anything from the past 20 years it is that there is a lot of stability built into the real economy.
To me, inflation targeting at its best is an application of Milton Friedman's maxim that "inflation is always and everywhere a monetary phenomenon," and its corollary that monetary policy should concentrate on the one thing it can do well -- control inflation. It can be hard to keep this in mind in financially chaotic times, but I think it is worth a try.
Update: See Brad Delong.
Tim reviews today's rate cut decision, and wonders what the Fed might do next:
The Fed Yields, by Tim Duy: Well, it is all over but the shouting. Like many, I was caught by surprise. I was comfortable with my 25bp call going into the meeting. Data and Fedspeak were not reliable indicators this time around, in my opinion. Kudos to those who were looking for 50bp, and even to those few brave souls still believing that the Fed would hold pat. This was not an obvious call by any measure.
Now the attention turns to the October meeting…one and done? The statement gives us little guidance; Bernanke & Co. considered the future too hazy to venture a guess on the path for economic growth. Can’t really blame them; too much risk of being wrong. Moreover, the Fed did not want to commit to a particular path given the uncertainty. I think the Fed is hoping that a large move now will prevent the need for additional cuts later – the one and done theory.
Still, barring further Fedspeak, the safe bet for the moment is to expect that more cuts are coming, albeit not necessary in October. Given that the housing market is not likely to stabilize near the near term, we can expect a steady drumbeat of bad news from that sector alone. But more generally, economic activity is likely to look soft in the near term, giving the Fed basis for additional easing; this will especially be the case if core inflation continues to trend downward.
The Fed statement did claim that “some inflation risks remain,” but the concern rings hollow in the wake of a 50bp cut. Oil and gold gained on the news, while the Greenback sunk to a record low against the Euro before recovering. Were these, like the equity surge on Wall Street, just knee-jerk reactions? To some extent yes, but traders tend to get the direction right even if the magnitude is initially wrong. As I said last time, the Fed is ahead of the curve in many respects – cutting when manufacturing is expanding, cutting when inventory levels have corrected, cutting before significant upward movements in unemployment, etc. Also note that the yield curve is pointing to rebounding growth by next Spring.
In short, I remain concerned about the potential for inflation to gain significantly next year (but I am not expecting an upward surprise in this morning’s CPI report). The international response will play into this as well. Will global central banks respond with rate cuts of there own, in order to keep the dollar from sinking? Are we poised not just for a US easing, but a global easing? But these concerns aside, the bottom line is that the Fed has decided that inflation, if it were to be a problem, is one they can fight another day.
Paul Krugman has a new blog, The Conscience of a Liberal (Note: the chart he references is missing, so I've added one from a Piketty and Saez article [data] that I believe matches his description of changes in share of income going to the top 10% over time, and I also included the graph for the top 1% for comparison - Update: The graph is there now and I've added it below):
Introducing This Blog, by Paul Krugman: “I was born in 1953. Like the rest of my generation, I took the America I grew up in for granted – in fact, like many in my generation I railed against the very real injustices of our society, marched against the bombing of Cambodia, went door to door for liberal candidates. It’s only in retrospect that the political and economic environment of my youth stands revealed as a paradise lost, an exceptional episode in our nation’s history.”
That’s the opening paragraph of my new book, The Conscience of a Liberal. It’s a book about what has happened to the America I grew up in and why, a story that I argue revolves around the politics and economics of inequality.
I’ve given this New York Times blog the same name, because the politics and economics of inequality will, I expect, be central to many of the blog posts – although I also expect to be posting on a lot of other issues, from health care to high-speed Internet access, from productivity to poll analysis. Many of the posts will be supplements to my regular columns; I’ll be using this space to present the kind of information I can’t provide on the printed page – especially charts and tables, which are crucial to the way I think about most of the issues I write about.
In fact, let me start this blog off with a chart that’s central to how I think about the big picture, the underlying story of what’s really going on in this country. The chart shows the share of the richest 10 percent of the American population in total income – an indicator that closely tracks many other measures of economic inequality – over the past 90 years, as estimated by the economists Thomas Piketty and Emmanuel Saez. I’ve added labels indicating four key periods. These are:
Income Share of Top 10% Excluding Capital Gains
The Long Gilded Age: Historians generally say that the Gilded Age gave way to the Progressive Era around 1900. In many important ways, though, the Gilded Age continued right through to the New Deal. As far as we can tell, income remained about as unequally distributed as it had been the late 19th century – or as it is today. Public policy did little to limit extremes of wealth and poverty, mainly because the political dominance of the elite remained intact; the politics of the era, in which working Americans were divided by racial, religious, and cultural issues, have recognizable parallels with modern politics.
The Great Compression: The middle-class society I grew up in didn’t evolve gradually or automatically. It was created, in a remarkably short period of time, by FDR and the New Deal. As the chart shows, income inequality declined drastically from the late 1930s to the mid 1940s, with the rich losing ground while working Americans saw unprecedented gains. Economic historians call what happened the Great Compression, and it’s a seminal episode in American history.
I would also argue that cutting taxes ... made a significant difference in dealing with the deficit because the growing economy yielded more tax revenues, which allowed us to shrink the deficit.
The tax cuts paid for themselves? I wish the President and others would quit misleading people about this because it's not true. His own economists don't even believe that. I know some of you are tired of hearing this over and over, but somebody has to try to call them on this or they'll just keep saying it, and the press seems unwilling to do so so. For example, the Wall Street Journal article the quote above is taken from doesn't even bother to mention that there's no evidence to support this claim, instead it's treated as a "he said-she said" story between Bush and Greenspan.
The tax cuts made the deficit worse. End of story.
Tuesday, September 18, 2007
This is an article that first appeared fifty years ago in Scientific American (the actual article is quite a bit longer):
Metropolitan Segregation, by Morton GrodzinsScientific American, October, 1957: As Negroes move in from the South and whites move out to the suburbs, a new pattern of segregation emerges in the big cities of the U.S., bringing with it significant economic, social and political problems ... In each of the major urban centers the story is the same: the better-off white families are moving out of the central cities into the suburbs; the ranks of the poor who remain are being swelled by Negroes from the South. This trend threatens to transform the cities into slums, largely inhabited by Negroes, ringed about with predominantly white suburbs. The racial problem of the U.S., still festering in the rural South, will become equally, perhaps most acutely, a problem of the urban North. ...
The sheer cost of suburban housing excludes Negroes from many suburban areas. Furthermore, the social satisfactions of slum or near-slum existence for a homogeneous population have been insufficiently studied, and it may very well be true that many Negro urban dwellers would not easily exchange current big-city life for even reasonably priced suburban homes. The crucial fact, however, is that Negroes presently do not have any free choice in the matter. They are excluded from suburbia by a wide variety of devices.
Social antagonism alone has been highly effective. In addition, the suburban towns have employed restrictive zoning, subdivision and building regulations to keep Negroes out. Some, for example, have set a minimum of two or more acres for a house site, or required expensive street improvements, and have enforced these regulations against undesirable developments but waived them for desirable ones. A builder in a Philadelphia suburb recently told an interviewer that he would like to sell houses to Negroes, but the town officials would ruin him. He explained: "The building inspectors would have me moving pipes three eighths of an inch every afternoon in every one of the places I was building, and moving a pipe three eighths of an inch is mighty expensive if you have to do it in concrete!"
When barriers of this sort fail, suburban whites have been known to resort to violence against Negro property and persons. As this is written, 350 residents of Levittown, Pa., are demonstrating in the street before a home acquired by a Negro family. Within the central cities, to which Negroes are thus consigned, they are further confined to virtual ghettos. Every city has its black belt or series of black areas. ...
I am surprised. The Fed cut the federal funds rate more than I expected, from 5.25% to 4.75%. Here's the Press Release:
The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 4 3/4 percent.
Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.
Readings on core inflation have improved modestly this year. However, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.
Developments in financial markets since the Committee's last regular meeting have increased the uncertainty surrounding the economic outlook. The Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Charles L. Evans; William Poole; Eric S. Rosengren; and Kevin M. Warsh.
In a related action, the Board of Governors unanimously approved a 50 basis point decrease in the discount rate to 5 1/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve banks of Boston, New York, Cleveland, St. Louis, Minneapolis, Kansas City and San Francisco.
Jim Hamilton discusses a recent evidence on the prospects for Iraq gleaned from financial markets:
Economic indicators of success in Iraq, By James Hamilton: Some economists have been interpreting economic developments as shedding light on the success of the military surge in Iraq. I think one needs to use a bit of caution in drawing conclusions from such evidence.
To understand what's really happening in Iraq, follow the oil money, which already knows that the surge has failed....
.... Last month, the provincial government in Kurdistan, defying the central government, passed its own oil law; last week, a Kurdish Web site announced that the provincial government had signed a production-sharing deal with Hunt Oil of Dallas, and that seems to have been the last straw.
Now here's the thing: Ray L. Hunt, the chief executive and president of Hunt Oil, is a close political ally of Bush. More than that, Hunt is a member of the President's Foreign Intelligence Advisory Board, a key oversight body.
....what's interesting about this deal is the fact that Hunt, thanks to his policy position, is presumably as well-informed about the actual state of affairs in Iraq as anyone in the business world can be. By putting his money into a deal with the Kurds, despite Baghdad's disapproval, he's essentially betting that the Iraqi government-- which hasn't met a single one of the major benchmarks Bush laid out in January-- won't get its act together. Indeed, he's effectively betting against the survival of Iraq as a nation in any meaningful sense of the term.
The smart money, then, knows that the surge has failed, that the war is lost, and that Iraq is going the way of Yugoslavia. And I suspect that most people in the Bush administration-- maybe even Bush himself-- know this, too.
Mr. Hunt's plan is apparently not a distant potential, but something for implementation here and now. Dallas Morning News reports:
Hunt said it would begin its geological survey and seismic work by the end of this year and planned to begin drilling in 2008.
Here's the question for Professor Krugman-- would you invest many millions of your own dollars in a region that you were convinced is slipping irrevocably into chaos and instability? I found the Kurds' spin on this story (as reported again by Dallas Morning News) a much more natural interpretation than Krugman's:
"Kurdistan is looking more and more like an island of stability" in Iraq, said Qubad Talabani, the son of Iraq's president and the representative of the Kurdistan Regional Government to the United States. "This should get the attention of other companies."
Now, I'll grant Krugman that the deal does suggest that the future of Iraq may develop along different lines than embodied by the current central government and its oil plan. But that does not mean that the future is necessarily a bleak one for the Iraqi people or U.S. interests.
I have a similar concern about the thoughtful new research paper by MIT Professor Michael Greenstone, which has been favorably described by Freakonomics, Marginal Revolution, and Economist's View, among others. Greenstone looks at a number of indicators, one of which is the price of the Iraqi government debt. Here's Greenstone's description of the background:
Prior to Iraq's invasion of Kuwait in 1990, Iraq issued about $130 billion in debt. After the Gulf war, they defaulted on this debt. When the US led coalition invaded Iraq in 2003, the holders of this debt were spread around the world.... After the end of combat operations in May 2003, the US government brokered a deal to exchange $1000 in the existing bonds for $200 worth of new bonds for those creditors who held at least $35 million in Iraqi bond so that the new Iraqi government would not be hamstrung by this debt. As a result of this debt relief agreement, the Iraqi government issued roughly $2.66 billion in US dollar denominated notes in January 2006.
Greenstone then notes that the interest rate on this debt has increased in recent months. One of his most interesting graphs was the following, which calculates that the implicit probability of default on these bonds has risen from less than a 6% annual risk to more than an 8% annual risk:
The Implied annual default Rate of Iraqi state bonds. Source: Greenstone (2007).
Greenstone described this as a 40% increase in the expected default rate. I suspect that fewer people would be misled if we had instead reported these same numbers as a 2% increase in the probability of default. And while I agree that it is most natural to interpret this as market concern over increased instability, that is far from the only possible explanation. I would think, for example, that exactly the same kind of conditions under which Hunt Oil would profit from its deal with the Kurds would also mean a reduced likelihood of the central government repaying the debt. I could also well imagine that further debt forgiveness could be an integral part of negotiations for what comes next. So while I agree with Krugman and Greenstone that the oil deal and interest rate changes may signal less confidence in the continuation of the current regime in its present form, I do not see the basis for assuming that any changes in that regime necessarily equate with less stability.
Notwithstanding, I can certainly recommend Greenstone's paper for its careful and thorough analysis, which has a number of interesting results besides the observation on interest rates. For example, Greenstone concludes that the surge has successfully reversed the trend in civilian fatalities:
Daily fatalities of Iraqi civilians from 1 year before the surge began through 153 days after the surge began, with regression lines allowing for a break in trend. Source: Greenstone (2007).
If one were asking the question, as I wish more people were, of which course among the currently feasible options would be in the best interests of the Iraqi people, I think exploration for new oil and a decrease in the number of Iraqis who are being killed would be viewed as unambiguously hopeful developments.
I appreciate the point that we should think about what's best for the Iraqi people. Sometimes, that seems to be given little weight or forgotten in these discussions. A few points in response:
First, I thought one of the points of the paper is that the standard indicators give mixed messages about the success of the surge. The unreliability of the data combined with the ability for those in charge to manipulate the data make it difficult to reach firm conclusions. As the author says, "Evaluating such conflicting indicators is challenging," and hence the use of financial market data instead which, though not perfect, may give a better indication of the chance of success. And what the financial market data say is not encouraging.
Second, of all the data used in the paper, the author took special note of the data on civilian deaths, saying that "even among the available data, there are legitimate questions about quality and reliability. This is especially the case with the civilian casualty data." For that reason, the confidence intervals are large and the break shown in the graph is unlikely to be statistically significant when all sources on uncertainty are accounted for.
Third, beyond the measurement problems with civilian deaths, and there are serious questions about how these data are gathered, much like the fall in interest rates can be a sign of god or bad developments in the economy depending upon the source of the change, a drop in civilian deaths must be interpreted in terms of the underlying cause. There is evidence that the fall in civilian deaths is due to ethnic cleansing in many neighborhoods. Once a neighborhood is "cleansed," violence drops, but it's hard to interpret that as a success for the Iraqi people.
Fourth, is Balkanization good or bad for the Iraqi people overall? It probably depends upon which group you belong to and how it plays out. I can't disagree that Balkanization "does not mean that the future is necessarily a bleak one for the Iraqi people or U.S. interests," but there's certainly no guarantee that will be the case and it's hard to imagine getting to that outcome without a substantial amount of violence. Since the Hunt deal relies upon the dissolution of the current government and involves who gets the property rights to Iraqi oil, the potential for instability and negative consequences for the Iraqi people seems quite real.
Another jab at Microsoft:
I.B.M. to Offer Office Software Free in Challenge to Microsoft’s Line, by Steve Lohr, NY Times: I.B.M. plans to mount its most ambitious challenge in years to Microsoft’s dominance ... by offering ... desktop software, called I.B.M. Lotus Symphony... The programs will be available as free downloads from the I.B.M ... Symphony software is a free alternative to Microsoft’s mainstay Office programs — Word, Excel and PowerPoint. ...
Its offerings are versions of open-source software developed in a consortium called OpenOffice.org. ... I.B.M.’s engineers have been working with OpenOffice technology for some time. But last week, I.B.M. declared that it was formally joining the open-source group, had dedicated 35 full-time programmers to the project and would contribute code to the initiative.
Free office productivity software has long been available from OpenOffice.org, and the open-source alternative has not yet made much progress against Microsoft’s Office. But I.B.M. ... has such reach and stature with corporate customers that its endorsement could be significant. ...
I.B.M. executives compare this move with the push it gave Linux... In 2000, I.B.M. declared that it would forcefully back Linux with its engineers, its marketing and its dollars. The support from I.B.M. helped make Linux a mainstream technology in corporations, where it competes with Microsoft’s Windows server software.
I.B.M. is also joining forces with Google... Google supports the same document formats in its online word processor and spreadsheet service.
I.B.M. views its Symphony desktop offerings as part of a broader technology trend that will open the door to faster, more automated movement of information within and between organizations.
A crucial technical ingredient, they say, is the ... OpenDocument Format. It makes digital information independent of the program, like a word processor or spreadsheet, that is used to create and edit a document. OpenDocument Format is based on an Internet-era protocol called XML, short for Extensible Markup Language, which enables automated machine-to-machine communication.
For example, an individual investor might create a spreadsheet with automated links to market information, and prices at which he or she wants to buy or sell shares in particular stocks. The person would get an alert by e-mail or cellphone message of price swings, and could create the document for a buy or sell order with a keystroke.
Or, in a doctor’s office, patient records could be linked to hospital, clinic and other databases and updated automatically.
Microsoft has the same vision of software automation, but it champions its own document format, called Office Open XML. Earlier this month, Microsoft failed in its initial effort to have Office Open XML ratified as a global technical standard by the International Organization for Standardization... The OpenDocument Format, backed by I.B.M., Google, Sun and others, was approved by the standards organization last year.
I.B.M. clearly regards its open-source desktop offerings as a strategic move in the document format battle. ... Any inroads I.B.M. and its allies make against Microsoft, analysts say, will not come easily. “Three major players — I.B.M., Google and Sun — are now solidly behind a potential competing standard to Office,” said Rob Koplowitz, an analyst at Forrester Research. “But it’s a tough road. Office is very entrenched.”
Monday, September 17, 2007
Though it surprises me that it is not weighted more heavily toward a cut of .25%, it would be safe to say the market is split over whether the Fed will cut rates by .25% or .50%:
CME Group Fed Watch – September 17, 2007: ...Based upon the September 17 market close, the 30-Day Federal Funds futures contract for the October 2007 expiration is currently pricing in a 100 percent probability that the FOMC will decrease the target rate by at least 25 basis points from 5-1/4 percent to 5 percent at tomorrow’s FOMC meeting.
In addition, the 30-Day Federal Funds futures contract is pricing in a 50 percent probability of a further 25-basis point decrease in the target rate to 4-3/4 percent (versus a 50 percent probability of just a 25-basis point rate decrease).
September 11: 28% for -25 bps versus 72% for -50 bps.
September 12: 26% for -25 bps versus 74% for -50 bps.
September 13: 42% for -25 bps versus 58% for -50 bps.
September 14: 42% for -25 bps versus 58% for -50 bps.
September 17: 50% for -25 bps versus 50% for -50 bps.
September 18: FOMC decision on federal funds target rate.
From the Cleveland Fed:
Here's an idea for additional transparency into Fed thinking. Suppose we require that each of the twelve members of the Federal Open Market Committee (the committee that sets the federal funds rate) post their stance on monetary policy once per day on a central web site.
On the Fed's main web site there would be a page listing each Committee member's answer to the question "If I had to set the federal funds rate today, I would set it at ____" and a table would list all twelve answers along with the last time the answer was updated, Committee members would be required to update their answer at least once per day, even if there is no change, and they could update it more often if desired, e.g. in response to news about the economy (the basic unit of time could be weekly as well). It would probably be best if the votes were anonymous, but that isn't essential.
I haven't thought this through, just one of those things that pops into your head, but it does seem to take away some of the uncertainty about the course of policy. What are the problems with this? Would this be viable? It wouldn't resolve all uncertainty about the outcome of FOMC meetings, but most of the time market participants would have a pretty good idea what to expect.
Greg Ip reminds us that the Fed also has to decide on what to do with both the federal funds rate and the discount rate at its rate setting meeting tomorrow:
Discount Rate Is Also on the Fed's Table, by Greg Ip, WSJ: When the Federal Reserve meets today, a cut in its main short-term interest-rate target, the federal-funds rate, won't be the only thing on the table. Officials will also have to decide what action to take on the lesser-known discount rate, at which banks borrow directly from the Fed.
Normally, banks pay a "penalty" to borrow from the Fed's discount window of one percentage point over the target for the federal-funds rate, at which banks lend to one another... Banks seldom borrow at the discount window because they can borrow federal funds more cheaply. The direct loans also have carried a stigma because they were often a last resort for troubled banks.
On Aug. 17, in a bid to improve the flow of cash to clogged credit markets, the Fed cut the discount rate to 5.75%, a penalty of half a percentage point above the 5.25% federal-funds target. It also extended the term of such loans to as long as 30 days from one day...
Many on Wall Street feel the Fed has yet to make the discount window attractive. The actual penalty, they note, is larger than the normal half point because the Fed has allowed the federal-funds rate to fall to 5%... Many market participants recommend that the Fed cut the discount rate so it sits just a quarter point above the fed-funds rate or even matches it.
David Greenlaw ... at Morgan Stanley, said that while he doubts the Fed is about to make such a move, it could take the place of a deeper cut in the fed-funds rate that the Fed fears could look like a bailout of investors.
Peter Hooper, chief economist at Deutsche Bank Securities, said the Fed could compromise by cutting the fed-funds rate a quarter point and the discount rate a half point. ...
Wall Street officials say they are still reluctant to borrow at the discount window because, if their identity became known, it could make counterparties skittish or hurt share prices. If the penalty were cut or eliminated, they say, banks could argue they were using the window because it was profitable. ...
Fed officials ... also worry that cutting the discount rate too much would prompt many banks to fund all of their needs from the window instead of the money market. That could make it harder for the Fed to manage the fed-funds rate with open-market operations.
It's not written in stone anywhere that there shall be a 1% spread between the discount rate and the federal funds rate. Suppose the Fed were to go back to a 1% spread, like before, and there is another financial crises. Then people will expect the Fed to lower the discount rate by .5% like it did this time and nobody will want to take out a loan until the rate is lowered (if they can possible wait). So even if the Fed does raise the discount rate to .75% or 1% above the federal funds rate, in light of recent events you have to wonder how credible a commitment to maintain the spread at .75% or 1% would be if another financial crises were to hit. For that reason, for now at least, I'd prefer to see them keep the spread as it is. If the spread is raised and things do get worse, we don't want financial institutions hesitating while they wait to see if the Fed will cut the discount rate or improve the terms on the loans in some other way. This is also a reason not to cut the spread any further. The Fed could try to argue that the circumstances are unusual enough to warrant a further cut in the spread between the federal funds rate and the discount rate, and that the action is only temporary, but from then on any trouble in financial markets would bring about speculation that the spread will be adjusted downward adding additional uncertainty at a time when that's the last thing financial markets need.
Paul Krugman takes issue with Alan Greenspan's contention that he didn't mean to endorse the Bush tax cuts:
Sad Alan’s Lament, by Paul Krugman, Commentary, NY Times: When President Bush first took office, it seemed unlikely that he would succeed in getting his proposed tax cuts enacted. The questionable nature of his installation in the White House seemed to leave him in a weak political position, while the Senate was evenly balanced between the parties. It was hard to see how a huge, controversial tax cut, which delivered most of its benefits to a wealthy elite, could get through Congress.
Then Alan Greenspan, the chairman of the Federal Reserve, testified before the Senate Budget Committee.
Until then Mr. Greenspan had presented himself as the voice of fiscal responsibility, warning the Clinton administration not to endanger its hard-won budget surpluses. But now Republicans held the White House, and ... Greenspan ... was a very different man.
Suddenly, his greatest concern ... was to avert the threat that the federal government might actually pay off all its debt. To avoid this awful outcome, he advocated tax cuts. And the floodgates were opened. ...
Mr. Greenspan now says that he didn’t mean to give the Bush tax cuts a green light, and that he was surprised at the political reaction to his remarks. ... But ... if Mr. Greenspan wasn’t intending to lend crucial support to the Bush tax cuts, he had ample opportunity to set the record straight...
His first big chance to clarify himself came a few weeks after that initial testimony, when he appeared before the Senate Committee on Banking, Housing and Urban Affairs.
Here’s what I wrote following that appearance: “Mr. Greenspan’s performance yesterday ... was a profile in cowardice. Again and again he was offered the opportunity to say something that would help rein in runaway tax-cutting; each time he evaded the question... He declared ... that he was speaking only for himself, thus granting himself leeway to pronounce on subjects far afield of his role as Federal Reserve chairman. But when pressed on the crucial question of whether the huge tax cuts that now seem inevitable are too large, he said it was inappropriate for him to comment on particular proposals.
“In short, Mr. Greenspan defined the rules of the game in a way that allows him to intervene as he likes in the political debate, but to retreat behind the veil of his office whenever anyone tries to hold him accountable for the results of those interventions.”...
I received an irate phone call from Mr. Greenspan ... in which he demanded to know what he had said that was wrong. In his book, he claims that Robert Rubin ... was stumped by that question. ... I certainly wasn’t: Mr. Greenspan’s argument for tax cuts was contorted and in places self-contradictory, not to mention based on budget projections that everyone knew, even then, were wildly overoptimistic.
[T]wo years later, when the administration proposed another round of tax cuts, even though the budget was now deep in deficit..., guess what? The former high priest of fiscal responsibility did not object.
And in 2004 he expressed support for making the Bush tax cuts permanent —... tax cuts he now says he didn’t endorse — and argued that the budget should be balanced with cuts in entitlement spending, including Social Security benefits, instead. ...
In retrospect, Mr. Greenspan’s moral collapse in 2001 was a portent. It foreshadowed the way many people in the foreign policy community would put their critical faculties on hold and support the invasion of Iraq, despite ample evidence that it was a really bad idea.
And like enthusiastic war supporters who have started describing themselves as war critics now that the Iraq venture has gone wrong, Mr. Greenspan has started portraying himself as a critic of administration fiscal irresponsibility now that President Bush has become deeply unpopular and Democrats control Congress.
Previous (9/14) column: Paul Krugman: A Surge, and Then a Stab
Alan Greenspan explains his comment about oil and the Iraq war:
Greenspan Says Hussein's Removal Was 'Essential', by Bob Woodward, Washington Post: Alan Greenspan, the former Federal Reserve chairman, said in an interview that the removal of Saddam Hussein had been "essential" to secure world oil supplies, a point he emphasized to the White House in private conversations before the 2003 invasion of Iraq.
Greenspan ... made the striking comment in a new memoir out today that "the Iraq War is largely about oil." In the interview, he clarified..., saying that while securing global oil supplies was "not the administration's motive," he had presented the White House with the case for why removing Hussein was important for the global economy.
"I was not saying that that's the administration's motive," Greenspan said in an interview Saturday, "I'm just saying that if somebody asked me, 'Are we fortunate in taking out Saddam?' I would say it was essential."
He said that in his discussions with President Bush and Vice President Cheney, "I have never heard them basically say, 'We've got to protect the oil supplies of the world,' but that would have been my motive." Greenspan said that he made his economic argument to White House officials and that one lower-level official, whom he declined to identify, told him, "Well, unfortunately, we can't talk about oil." Asked if he had made his point to Cheney specifically, Greenspan said yes, then added, "I talked to everybody about that." ...
Greenspan ... added that he was not implying that the war was an oil grab. "No, no, no," he said. Getting rid of Hussein achieved the purpose of "making certain that the existing system [of oil markets] continues to work, frankly, until we find other [energy supplies], which ultimately we will."
One more person telling the administration what they wanted to hear prior to the war.
If I had questions about monetary policy, Ben Bernanke is one of the first people I would want to consult. Few, if any people are more knowledgeable about both the theory and evidence, and his recent experience enhances his understanding of how the Fed interacts with financial markets.
But if I want to know about oil markets, how removing a dictator in the Middle East will impact the region's stability, and so on, Ben Bernanke is not the first person I would think of to talk to. He might not even be in the top ten or twenty.
Greenspan was telling members of the administration what they wanted to hear, and I'm sure they used his worries about oil markets to buttress their case for going to war. But I hope Greenspan also encouraged the administration to consult with others who have more expertise on these issues than he has. I'm not sure exactly what or who Greenspan relied upon to draw his conclusions, so perhaps he consulted the experts himself, and given the cherry picking of "facts" that went on perhaps it wouldn't have mattered much in any case, but when war is involved you hope that the best and the brightest are part of the discussion.
Sunday, September 16, 2007
Why do Americans work more than Europeans?:
Americans do work more than Europeans, but please don’t think that Europeans are lazy, by Claudio Michelacci and Josep Pijoan-Mas, Vox EU: The aggregate amount of hours worked in the US and in Continental Europe has evolved quite differently over the last 35 years. In the 1970s the average number of working hours per capita was slightly larger in European countries such as France, Italy, and Germany than in the US. Today Americans work around 30% more than Europeans. These differences are important and they explain almost all existing US-Europe differences in GDP per capita: GDP per capita is today 30% higher in the US than in France or Germany, while productivity, measured by GDP per hour worked, is roughly equal. This means that Americans are today richer than Europeans not because they are more productive but simply because they work more.
The emerging gap in working time is partly due to the evolution of the participation rate (that has increased more in the US) and the unemployment rate (that has increased just in Europe). But another substantial part has to do with the number of hours worked per worker, the dynamics of which explain between one third and one half of the differences.
The decision on how many hours to work once employed is for many workers voluntary. Of course there are exceptions - in some countries and for some jobs, existing legislations restrict the maximum amount of hours worked, but rules are not always binding or not always enforced. Differences between actual and desired working time are indeed small for European workers and they have even decreased over the last decades. So it has been argued that we should not worry too much about the diverging evolution of hours per worker in the US and Europe. Today Europeans simply devote less time to working time activities because they have started to enjoy leisure more.
But is it really the case that Americans and Europeans have become intrinsically different? It may be. Yet, it is also true that aggregate labour market conditions have evolved quite differently in the US and Europe. During the last thirty years, wage inequality has increased substantially in the US and little in Europe, while the unemployment rate has risen in Europe but not in the US. Today, unemployment risk is smaller in the US than in Europe, obtaining better jobs is easier, there are greater chances to move up the career ladder, and to get employed in highly paid jobs. This implies quite different incentives during the working life of American and European workers.
Our recent research shows that these differences in incentives can account for the observed differences in working time across the two sides of the Atlantic. Getting promoted in the current job, and obtaining better jobs requires hard work, and workers are ready to do it only if the endeavour is worth it. When this return falls, hours worked fall. This is the case of Europe over the last three decades. While the pursuit of the American dream makes Americans work hard, the sluggish economic performance of Europe discourages European workers from working longer hours. So rather than blaming Europeans for devoting too much time to leisure activities, it may be worth liberalising European markets further. Giving more powerful incentives to European workers over their working life would be the most effective way to close the output gap between the US and Europe.
Is social mobility higher in the U.S.? Not according to Paul De Grauwe. This is also from Vox EU:
Developments of the last decades have shattered this American Dream. It now appears that many EU countries have created an environment in which it is significantly easier for the poor to climb the social ladder than it is in the US. Structural reforms will be necessary in the US if it wants to emulate the success of European countries in organising social mobility.
[Originally posted April 26, 2005] Yesterday, in this post, I discussed a Washington Times editorial attempting to absolve Alan Greenspan of responsibility for playing a role in promoting tax cuts that led to the current budget deficit. Quoting from the editorial:
Mr. Greenspan told Mr. Sarbanes that the charge was "frankly unfair" because it neglected the Fed chairman's unambiguous endorsement of "trigger" mechanisms during the same testimony. "I advocated tax cuts" in 2001, Mr. Greenspan acknowledged Thursday, "but I also advocated triggers in the same testimony."
Did he advocate triggers? While that term is not used directly in his testimony, it is used in a CBS report noted below, the only report I could find explicitly discussing spending restraint mechanisms, and Greenspan does say:
… In recognition of the uncertainties in the economic and budget outlook, it is important that any long-term tax plan, or spending initiative for that matter, be phased in. Conceivably, it could include provisions that, in some way, would limit surplus-reducing actions if specified targets for the budget surplus and federal debt were not satisfied. Only iaf the probability was very low that prospective tax cuts or new outlay initiatives would send the on-budget accounts into deficit, would unconditional initiatives appear prudent. … Indeed, the current economic weakness may reveal a less favorable relationship between tax receipts, income, and asset prices than has been assumed in recent projections. … But the risk of adverse movements in receipts is still real, and the probability of dropping back into deficit as a consequence of imprudent fiscal policies is not negligible.
But let me end on a cautionary note. With today's euphoria surrounding the surpluses, it is not difficult to imagine the hard-earned fiscal restraint developed in recent years rapidly dissipating. We need to resist those policies that could readily resurrect the deficits of the past and the fiscal imbalances that followed in their wake.
In my view, he does add quite a bit of caution regarding slipping back into large deficits, cautions that, as noted below, were not reported widely in the press. So, as far as it goes, the Washington Times editorial is correct. He did talk about mechanisms to restrain spending and warned about the return of deficits.
However, it is also my view that this does not absolve him of responsibility. ... He knew that a zero budget target ... would create deficit problems in the future, but he did not protest. ... From the time of Greenspan’s testimony on January 25, 2001 until now, the press has missed what Greenspan was really talking about. He was afraid of a large surplus building up and the effect that would have on the private market when the government invested the large surplus in the private sector. To avoid this problem, his solution was to accumulate the Trust Fund surplus in private accounts so that individuals rather than the government would participate in the private market, and to cut taxes. At the time, Krugman stated in a column in the NY Times:
Some people — including, alas, Alan Greenspan — have made it seem as if any purchase of private-sector assets by the trust funds would instantly politicize the financial markets and undermine the foundations of the free-enterprise system. But that's ideology, not analysis; people who have looked seriously at the issue think that these concerns are vastly overblown. There are well-established techniques for protecting government investment accounts from political meddling, such as legal requirements that the funds buy a broad index. Are these techniques imperfect? Maybe — but who would argue that rather than running some slight risks of politicizing the markets, we should squander the money that was supposed to pay for our retirement?
Only a politician with an irresponsible tax cut to sell.
However, when the economy began slipping into deficit and the Trust Fund assets were evaporating, Greenspan did not protest, and importantly, neither did the press.
David Leonhardt reviews "Super Crunchers: Why Thinking-by-Numbers Is the New Way to Be Smart," by Ian Ayres:.
Let’s Go to the Stats, by David Leonhardt, NY Times: ...In the late 1980s, ... Orley Ashenfelter began publishing a newsletter called Liquid Assets that predicted how good each Bordeaux vintage would turn out to be. Instead of basing his judgments on the taste or smell of the wine in its early stages, Ashenfelter, an economist at Princeton, preferred data. He had come to believe that the weather during a growing season in Bordeaux was a remarkably accurate predictor of the eventual price of the wine. A hot, dry year seemed to make for great Bordeaux.
As you might expect, wine critics didn’t take very kindly to the professor’s ideas. A British wine magazine denounced their “self-evident silliness.” Robert Parker called Ashenfelter “an absolute total sham.” ...
In field after field, there have been versions of the Ashenfelter story. Michael Lewis wrote a best-selling book, “Moneyball,” about how Billy Beane, the general manager of the Oakland Athletics, had succeeded despite a relatively meager payroll, largely by giving more weight to statistical analysis than to intuitive judgments about players’ abilities. Ever since its publication, old-time baseball commentators have been slipping anti-Beane cracks into broadcasts and newspaper columns. More tragically, the 19th-century Austrian doctor Ignaz Semmelweis was ridiculed and ignored by his fellow physicians after collecting evidence that the lives of many mothers could be saved if only doctors and nurses washed their hands before a baby’s delivery.
Today, Semmelweis is a hero. To Ian Ayres, ... the author of “Super Crunchers,” he is also a forefather of a modern movement of statistical detectives who are changing the world. “We are in a historic moment of horse-versus-locomotive competition,” Ayres writes, “where intuitive and experiential expertise is losing out time and time again to number crunching.” ...
For all its successes, though, statistical analysis continues to face tremendous skepticism and even animosity. For one thing, Ayres notes, statistics threaten the “informational monopoly” of experts in various fields. But even to many people without a vested interest, relying on cold, hard numbers rather than human instinct seems soulless. ...
Ayres’s point is that human beings put far too much faith in their intuition and would often be better off listening to the numbers. Ashenfelter, using data, predicted that the 1986 Bordeaux vintage would be ordinary, while Parker, relying on expertise, said it would be exceptional. Ashenfelter was right.
The best stories in the book are about Ayres and other economists he knows, whether they are studying wine, the Supreme Court or jobless benefits. He’s less convincing when he writes about doctors advocating “evidence-based medicine,” Hollywood executives who use “neural networks” to predict box-office receipts, or almost anyone else outside a university. ...
Ayres is simply too optimistic about the impact data analysis is having. “Super Crunching approaches are winning the day and driving out intuition and experience-based expertise,” he writes. But that’s not quite right. Evidence-based medical treatment, to take one of his favorite examples, is still far from the norm in this country. The Super Crunchers, aided by the explosion of inexpensive computing power, do their job remarkably well. The next step is finding some Super Persuaders.
A lot of you don't believe in a Phillips curve, but I've argued that there is a short-run inflation-output tradeoff and I've cited New Keynesian models along with supporting empirical evidence to reinforce that position. But when I make that argument, you should cite this paper by Golosov and Lucas to argue against the existence of a significant inflation-output tradeoff. The paper argues that if there is a Phillips curve, the inflation-output tradeoff is pretty steep, steep enough so that nominal shocks are "nearly neutral":
Menu Costs and Phillips Curves, by Mikhail Golosov and Robert E. Lucas Jr., Journal of Political Economy, 2007, vol. 115, no. 2
[open link]: I. Introduction This paper develops a model of a monetary economy in which firms must pay a fixed cost—a "menu cost"—in order to change nominal prices. Menu costs are interesting to macroeconomists because they are often cited as a microeconomic foundation for a form of "price stickiness" assumed in many New Keynesian models. Without sticky prices these models would not exhibit the real effects of monetary shocks—Phillips curves—that they are designed to analyze.
Saturday, September 15, 2007
Greg Mankiw proposes (surprise, surprise) a Pigouvian tax to solve the global warming problem. The focus here is on its political viability:
One Answer to Global Warming: A New Tax, by N. Gregory Mankiw, Economic View, NY Times: In the debate over global climate change, there is a yawning gap that needs to be bridged. The gap is not between environmentalists and industrialists, or between Democrats and Republicans. It is between policy wonks and political consultants.
Among policy wonks like me, there is a broad consensus. The scientists tell us that world temperatures are rising because humans are emitting carbon into the atmosphere. Basic economics tells us that when you tax something, you normally get less of it. So if we want to reduce global emissions of carbon, we need a global carbon tax. Q.E.D. ...
Those vying for elected office, however, are reluctant to sign on to this agenda. Their political consultants are no fans of taxes, Pigovian or otherwise. ... Yet this natural aversion to carbon taxes can be overcome if the revenue from the tax is used to reduce other taxes. By itself, a carbon tax would raise the tax burden on anyone who drives a car or uses electricity produced with fossil fuels, which means just about everybody. Some might fear this would be particularly hard on the poor and middle class.
But Gilbert Metcalf, a professor of economics at Tufts, has shown how revenue from a carbon tax could be used to reduce payroll taxes in a way that would leave the distribution of total tax burden approximately unchanged. He proposes a tax of $15 per metric ton of carbon dioxide, together with a rebate of the federal payroll tax on the first $3,660 of earnings for each worker.
The case for a carbon tax looks even stronger after an examination of the other options on the table. Lawmakers in both political parties want to require carmakers to increase the fuel efficiency of the cars they sell. Passing the buck to auto companies has a lot of popular appeal.
Increased fuel efficiency, however, is not free. Like a tax, the cost of complying with more stringent regulation will be passed on to consumers in the form of higher car prices. But the government will not raise any revenue that it can use to cut other taxes to compensate for these higher prices. ...
More important, enhancing fuel efficiency by itself is not the best way to reduce energy consumption. ...
A carbon tax would provide incentives for people to use less fuel in a multitude of ways. By contrast, merely having more efficient cars encourages more driving. Increased driving not only produces more carbon, but also exacerbates other problems, like accidents and road congestion.
Another popular proposal to limit carbon emissions is a cap-and-trade system, under which carbon emissions are limited and allowances are bought and sold in the marketplace. The effect of such a system depends on how the carbon allowances are allocated. If the government auctions them off, then the price of a carbon allowance is effectively a carbon tax.
But the history of cap-and-trade systems suggests that the allowances would probably be handed out to power companies and other carbon emitters, which would then be free to use them or sell them at market prices. In this case, the prices of energy products would rise as they would under a carbon tax, but the government would collect no revenue to reduce other taxes and compensate consumers.
The international dimension of the problem also suggests the superiority of a carbon tax over cap-and-trade. Any long-term approach to global climate change will have to deal with the emerging economies of China and India. ...
Agreement on a truly global cap-and-trade system, however, is hard to imagine. ... A global carbon tax would be easier to negotiate. All governments require revenue for public purposes. The world’s nations could agree to use a carbon tax as one instrument to raise some of that revenue. No money needs to change hands across national borders. Each government could keep the revenue from its tax and use it to finance spending or whatever form of tax relief it considered best.
Convincing China of the virtues of a carbon tax, however, may prove to be the easy part. The first and more difficult step is to convince American voters, and therefore political consultants, that “tax” is not a four-letter word.
There's a lot of talk about the need to regulate product and financial markets, and how to avoid overreaction or favoring special interest groups in the process. First, Jim Hamilton:
Well-functioning financial markets depend on transparency and confidence that institutions are playing by clearly defined rules. Both were in short supply in the months leading up to the August meltdown and remain so today. Large pools of unregulated capital, often highly leveraged, especially in hedge and private equity funds remain opaque and have been joined by massive sovereign investment funds to transform the financial landscape in ways that are out of reach of regulators here at home and in other wealthy countries. We lack the information that we need to ensure safety and soundness as well as the confidence that comes from the requirements mandating governance and reporting standards that apply to publicly traded companies.
To an important extent these new pools of capital are structured in a fashion that allows them to avoid the scrutiny that is required of firms and financial institutions in the regulated sectors. We should not be surprised. It is a fact of life that investors and firms will seek to innovate their way around whatever regulatory strictures apply, whether they deal with health and safety, labor protections, or reporting obligations. This tendency has been exacerbated by a 30-year attack on the very notion of a regulatory role for governments and loud professions that the market not only knows best, but knows everything.
Our job is to understand the changes in the financial marketplace and consider what we must do to ensure that our regulatory system is able to keep up with those changes. Innovation is as important in financial markets as it is in product markets, but it would be foolish to act as if regulatory structures, designed for a different world, do not have to be as nimble and innovative as those they regulate.
On the other side of this argument we seem to have Fed Chair Ben Bernanke, who argues that lenders have learned their lesson and these problems are being corrected on their own. Now, I happen to believe there is also a lot of truth to what Bernanke is saying here as well. But I would invite those in the Federal Reserve to look a few months down the road and ask how this discussion is going to play out if, as I fear likely, the financial consequences of previous reckless real estate lending continue to grow. Each new report of another failed institution, another family losing their home, another pension fund without the money to pay the retirees, and another decline in real estate prices is going to mean more pressure for the kinds of changes that Representative Frank has called for, and burn more of the political capital of anyone who tries to argue against them.
While I agree with what Representative Frank had to say, the devil is in the details. I would vastly prefer to have the staff at the Federal Reserve craft these reforms. But doing so requires the Fed to get on board now to try to set the direction for this debate, before they get swept aside by a political tsunami. ...
Can't say I'm in agreement with this one. This is Robert Reich:
CEOs Deserve Their Pay, by Robert Reich, Commentary, WSJ: ...The typical CEO of a Fortune 500 company ...[makes] more than 364 times the pay of an average employee. Forty years ago, top CEOs earned 20 to 30 times what average workers earned. The trend has ignited a flurry of attention in Washington. ...[But]... Hold on.
There's an economic case for the stratospheric level of CEO pay which suggests shareholders -- even if they had full say -- would not reduce it. In fact, they're likely to let CEO pay continue to soar. That's because of a fundamental shift in the structure of the economy over the last four decades, from oligopolistic capitalism to super-competitive capitalism. CEO pay has risen astronomically over the interval, but so have investor returns.
The CEO of a big corporation 40 years ago was mostly a bureaucrat in charge of a large, high-volume production system whose rules were standardized and whose competitors were docile. It was the era of stable oligopolies, big unions, predictable markets and lackluster share performance. The CEO of a modern company is in a different situation. Oligopolies are mostly gone and entry barriers are low. Rivals are impinging all the time -- threatening to lure away consumers all too willing to be lured away, and threatening to hijack investors eager to jump ship at the slightest hint of an upturn in a rival's share price. ...
So how does the modern corporation attract and keep consumers and investors...? How does it distinguish itself? More and more, that depends on its CEO -- who has to be sufficiently clever, ruthless and driven to find and pull the levers that will deliver competitive advantage.
There are no standard textbook moves, no well-established strategies to draw upon. If there were, rivals would already be using them. The pool of proven talent is small because so few executives have been tested and succeeded. And the boards of major companies do not want to risk error. The cost of recruiting the wrong person can be very large -- and readily apparent in the deteriorating value of a company's shares. ...
The proof is in the numbers. Between 1980 and 2003, the average CEO in America's 500 largest companies rose sixfold, adjusted for inflation. Outrageous? Not to investors. The average value of those 500 companies also rose by a factor of six, adjusted for inflation. ...
As the economy has shifted toward supercapitalism, CEOs have become less like top bureaucrats and more like Hollywood celebrities who get a share of the house. ...
If you assume shareholders would rein in CEO pay, take a look at the United Kingdom. Since 2003, changes in British securities law have given investors more say over what British CEOs are paid. Nonetheless, executive pay there has continued to skyrocket, on the way to matching the pay of American CEOs. ...
This economic explanation for sky-high CEO pay does not justify it socially or morally. It only means that investors think CEOs are worth it. ... But if America wants to rein in executive pay, the answer isn't more shareholder rights..., the answer ... is a higher marginal tax rate on the super pay of those in super demand.
There are lots of reasons to believe CEO pay does not reflect underlying fundamentals and hence is inconsistent with the best interests of shareholders (e.g. agency issues). In addition, I am not as convinced as he is that market structure - the degree of competitiveness - faced by a typical firm has changed as much as claimed over the last 40 years. Firms have certainly gained leverage on the input side as the decline of unions and Wal-Mart's ability to pressure suppliers will attest, so market power in input markets may be more not less unbalanced, and oligopolistic and monopolistically competitive output markets are still common features of the marketplace. In addition, the fact that the top firms are now six times bigger can perhaps be explained by changes in the efficient scale of operation due to changes in technology, but in and of itself the presence of bigger firms does not imply more competitive markets (and as to the "proof is in the numbers," there is evidence that the relationship between CEO pay and firm size is not stable over time).
While a higher marginal tax rate is one answer to reining in CEO pay, doing what we can to ensure that CEO compensation contracts are consistent with shareholder interests, that firms operate in competitive input and output markets, and that business interests do not have undue influence over legislation and other political decisions might also make a difference. The issue extends beyond CEOs, when power is unbalanced of course people are going to take advantage of that, and we need to do more than we have in recent years to ensure that no individual or firm has the opportunity or ability to influence market and political outcomes.
Friday, September 14, 2007
Alan Greenspan isn't happy with Republicans. He also says the housing boom during his tenure as Chair of the Fed was caused by the end of communism, not Fed policy to keep interest rates low:
Greenspan Book Criticizes Bush And Republicans, by Greg Ip and Emily Steel, WSJ (free): In a withering critique of his fellow Republicans, former Federal Reserve Chairman Alan Greenspan says in his memoir that the party ... deserved to lose power last year for forsaking its small-government principles.
In [his new book] "The Age of Turbulence: Adventures in a New World," ..., Mr. Greenspan criticizes both congressional Republicans and President George W. Bush for abandoning fiscal discipline. ...
Mr. Greenspan, who calls himself a "lifelong libertarian Republican," writes that he advised the White House to veto some bills to curb "out-of-control" spending while the Republicans controlled Congress. He says President Bush's failure to do so "was a major mistake." Republicans in Congress, he writes, "swapped principle for power. They ended up with neither. They deserved to lose."
Many economists say the Fed, by cutting short-term interest rates to 1% in mid-2003 and keeping them there for a year, helped foster a housing bubble that is now bursting. In his book, which was largely written before much of the recent turmoil in credit markets, Mr. Greenspan defends the policy. "We wanted to shut down the possibility of corrosive deflation," he writes. "We were willing to chance that by cutting rates we might foster a bubble, an inflationary boom of some sort, which we would subsequently have to address....It was a decision done right."
He attributes the housing boom to the end of communism, which he says unleashed hundreds of millions of workers on global markets, putting downward pressure on wages and prices, and thus on long-term interest rates. ...
Mr. Greenspan writes that when President Bush chose Dick Cheney as vice president and Paul O'Neill as treasury secretary -- both colleagues from the Gerald Ford administration, during which Mr. Greenspan was chairman of the Council of Economic Advisers -- he "indulged in a bit of fantasy" that this would be the government that would have resulted if Mr. Ford hadn't lost to Jimmy Carter in 1976. But Mr. Greenspan discovered that in the Bush White House, the "political operation was far more dominant" than in Mr. Ford's. "Little value was placed on rigorous economic policy debate or the weighing of long-term consequences," he writes. ...
He devotes chapters to each of the major economic challenges facing the U.S. and the world. On energy, he recommends more use of nuclear power, and he predicts efforts to reduce global warming with carbon caps or taxes will fail. Rising income inequality could undo "the cultural ties that bind our society" and even lead to "large-scale violence." The remedy, he says, is not higher taxes on the rich but improved education, which can be helped by paying math teachers more.
Mr. Greenspan returns repeatedly to the far-reaching importance of communism's collapse. He says it discredited central planning throughout the world and inspired China and later India to throw off socialist policies. ...
In coming years, as the globalization process winds down, he predicts inflation will become harder to contain. Recent increases in the price of imports from China and a rise in long-term interest rates suggest "the turn may be upon us sooner rather than later."
Left alone, he said, the Fed's policy-making body, the Federal Open Market Committee, can keep inflation between 1% and 2%, but that could require forcing interest rates to double-digits, a level "not seen since the days of Paul Volcker," his predecessor as Fed chairman. "I fear that my successors on the FOMC, as they strive to maintain price stability in the coming quarter century, will run into populist resistance from Congress, if not from the White House," he writes.
If the Fed succumbs to that pressure, inflation could rise from a little over 2% at present to an average of 4% to 5% by the year 2030, he writes. Ten-year Treasury yields, now below 5%, will rise to "at least 8%" with the potential to go "significantly higher for brief periods." This, he says, will lead to stagnant returns on stocks and bonds and much smaller gains in housing prices.
Mr. Greenspan won plaudits for achieving low inflation and unemployment with just two mild recessions during his tenure at the Fed. But more recently his record has taken some knocks. Some critics fault him for not doing more to restrain the stock bubble of the 1990s, and for responding to its eventual bursting with such low interest rates that housing prices subsequently soared.
Mr. Greenspan writes that in early 1997, he told his colleagues the Fed should raise interest rates as a "preemptive" move against a stock-market bubble. But transcripts of Fed meetings from that period do not support his book's version of events: They show Mr. Greenspan argued for a rate increase principally because of inflation.
This NBER paper by MIT's Michael Greenstone reinforces Paul Krugman's message (in the post below this one) that the "smart money" is betting against Iraq's survival. According to this analysis of the Iraqi state bond market, since the Surge began there has been "a 40% increase in the market's expectation that Iraq will default. This finding suggests that to date the Surge is failing to pave the way toward a stable Iraq and may in fact be undermining it." Here's the abstract, introduction, and conclusion the paper:
Is The 'Surge' Working? Some New Facts, by Michael Greenstone, SSRN, September 14, 2007: Abstract There is a paucity of facts about the effects of the recent military Surge on conditions in Iraq and whether it is paving the way for a stable Iraq. Selective, anecdotal and incomplete analyses abound. Policy makers and defense planners must decide which measures of success or failure are most important, but until now few, if any, systematic analyses were available on which to base those decisions. This paper applies modern statistical techniques to a new data file derived from more than a dozen of the most reliable and widely-cited sources to assess the Surge's impact on three key dimensions: the functioning of the Iraqi state (including civilian casualties); military casualties; and financial markets' assessment of Iraq's future. The new and unusually rigorous findings presented here should help inform current evaluations of the Surge and provide a basis for better decision making about future strategy.
The analysis reveals mixed evidence on the Surge's effect on key trends in Iraq. The security situation has improved insofar as civilian fatalities have declined without any concurrent increase in casualties among coalition and Iraqi troops. However, other areas, such as oil production and the number of trained Iraqi Security Forces have shown no improvement or declined. Evaluating such conflicting indicators is challenging.
There is, however, another way to assess the Surge. This paper shows how data from world financial markets can be used to shed light on the central question of whether the Surge has increased or diminished the prospect of today's Iraq surviving into the future. In particular, I examine the price of Iraqi state bonds, which the Iraqi government is currently servicing, on world financial markets. After the Surge, there is a sharp decline in the price of those bonds, relative to alternative bonds. The decline signaled a 40% increase in the market's expectation that Iraq will default. This finding suggests that to date the Surge is failing to pave the way toward a stable Iraq and may in fact be undermining it.
Paul Krugman says if you follow the money, it will lead to the truth:
A Surge, and Then a Stab, by Paul Krugman, Commentary, NY Times: To understand what’s really happening in Iraq, follow the oil money, which already knows that the surge has failed.
Back in January, announcing his plan to send more troops to Iraq, President Bush declared that ... “...Iraq will pass legislation to share oil revenues among all Iraqis.”...
Two-thirds of Iraq’s GDP and almost all its government revenue come from the oil sector. Without an agreed system for sharing oil revenues, there is no Iraq, just ... armed gangs fighting for control of resources.
Well, the legislation Mr. Bush promised never materialized, and on Wednesday attempts to arrive at a compromise oil law collapsed.
What’s particularly revealing is the cause of the breakdown..., a Kurdish ... provincial government ... production-sharing deal with the Hunt Oil Company of Dallas ... seems to have been the last straw.
Now here’s the thing: Ray L. Hunt, the chief executive and president of Hunt Oil, is a close political ally of Mr. Bush. More than that, Mr. Hunt is a member of the President’s Foreign Intelligence Advisory Board, a key oversight body... By putting his money into a deal with the Kurds.., he’s essentially betting ... against the survival of Iraq...
The smart money, then, knows ... that the war is lost, and that Iraq is going the way of Yugoslavia. And I suspect that most people in the Bush administration — maybe even Mr. Bush himself — know this, too.
After all, if the administration had any real hope..., officials would be making an all-out effort to get the government ... to start delivering on some of those benchmarks, perhaps using the threat that Congress would cut off funds otherwise. Instead, the Bushies are making excuses, minimizing Iraqi failures, moving goal posts and, in general, giving the Maliki government no incentive to do anything differently.
And for that matter, if the administration had any real intention of turning public opinion around, as opposed to merely shoring up the base enough to keep Republican members of Congress on board, it would have sent Gen. David Petraeus ... to as many news media outlets as possible — not granted an exclusive appearance to Fox News...
All in all, Mr. Bush’s actions have ... been what you’d expect from a man whose plan is to keep up appearances for the next 16 months, never mind the cost in lives and money, then shift the blame for failure onto his successor.
In fact, that’s my interpretation of something that startled many people: Mr. Bush’s decision last month, after spending years denying that the Iraq war had anything in common with Vietnam, to suddenly embrace the parallel.
Here’s how I see it: At this point, Mr. Bush is looking forward to replaying the political aftermath of Vietnam, in which the right wing eventually achieved a rewriting of history that would have made George Orwell proud, convincing millions of Americans that our soldiers had victory in their grasp but were stabbed in the back by the peaceniks back home.
What all this means is that the next president, even as he or she tries to extricate us from Iraq — and prevent the country’s breakup from turning into a regional war — will have to deal with constant sniping from the people who lied us into an unnecessary war, then lost the war they started, but will never, ever, take responsibility for their failures.
David Wessel has a nice description of how financial market problems could impact the economy more generally:
Banks' New Credit Austerity To Help Set Economy's Path, by David Wessel, WSJ: The outlook for the U.S. economy turns on two factors: One is how much worse the nation's housing market gets. ... The other is how much of the continuing disturbance in financial markets infects the rest of the economy. ...
The key is what banks will do and how much impact it will have. There's irony in that because ... banks have become increasingly less important players.
In the old days, banks made loans carefully -- because they got burned if the borrower didn't repay. ... Today, banks make loans, turn many of them into securities, and sell them to investors, pocketing the fees. Someone else gets burned if the borrower defaults. ...
But, it turns out, banks may not have unloaded as much of the risk as they thought. And that's the rub.
Wall Street firms and commercial banks ... hold about $250 billion in bridge loans made to finance acquisitions -- loans they intended to lay off in markets that are no longer quite so interested in them. The banks may be stuck with those merger loans. ...
Then there's the mushrooming problem -- one hardly anyone saw coming -- of entities called structured investment vehicles and conduits. Many of them hold subprime mortgages and related securities, and counted on selling more than $1 trillion in short-term IOUs called commercial paper to finance their holdings. Investors no longer want that commercial paper.
So what do these entities do now? They turn to U.S. and European banks, some of which sponsored the conduits, and remind them of the commitments the banks made to provide credit if the commercial-paper market dried up. ...
Suddenly, banks find themselves with all sorts of unanticipated loans on their books. So what? In the antiseptic language of central bankers, Mr. Bernanke explained, "These banks" -- the ones stuck with merger loans they didn't intend to hold and those providing backup lines of credit to conduits -- "have become more protective of their liquidity and balance-sheet capacity." They are hoarding cash or buying short-term Treasurys, and that means making fewer new loans. ...
Saddled with loans to finance mergers or back-stop conduits that can't sell commercial paper, banks are likely to be less willing to lend to ordinary consumers and businesses or, at the very least, will be charging more for those loans. So, consumers and businesses are likely to borrow a little less -- and spend a little less -- and a financial disturbance could be transmitted through the banking system to the rest of the economy.
No wonder there's growing worry the U.S. is going to slide into recession. ...
As if that wasn't enough, there's another layer: Everyone knows banks have a lot of loans on their books that they'd like to sell, but can't -- or won't at today's prices. So some deep-pocketed speculators, the ones who buy when prices plummet and then help bring them back up, are waiting for prices to fall further. And that increases the risk of a prolonged period of financial market turmoil which, in turn, increases the risks to the rest of the economy which, in turn, makes bankers -- understandably -- a little more wary about lending.
The issue isn't whether all this is happening. It is. The issue is how big an impact banks' behavior will have on the economy. ...
No doubt it will be one of the big issues on the table when Mr. Bernanke and his colleagues meet next week to ponder how much to cut interest rates to offset the markets' tightening of the credit spigot.
What is the purpose of an education?:
Revisiting the Canon Wars, by Rachel Donadia, NY Times: Twenty years ago, ... a book arrived like a shot across the bow of academia: “The Closing of the American Mind,” by Allan Bloom ... at the University of Chicago. Subtitled “How Higher Education Has Failed Democracy and Impoverished the Souls of Today’s Students,” it spent more than a year on the best-seller list...
Bloom’s book was full of bold claims: that abandoning the Western canon had dumbed down universities, while the “relativism” that had replaced it had “extinguished the real motive of education, the search for a good life”; ... that America had produced no significant contributions to intellectual life since the 1950s; and that many earlier contributions were just watered-down versions of Heidegger, Nietzsche, Weber, Freud and other Continental thinkers. For Bloom, things had gone wrong in the ’60s, when universities took on “the imperative to promote equality, stamp out racism, sexism and elitism..., as well as war,” he wrote, because they thought such attempts at social change “possessed a moral truth superior to any the university could provide.”
“The Closing of the American Mind” hit the scene at a time when universities were embroiled in the so-called canon wars, in which traditionalists in favor of centering the curriculum on classic works of literature faced off against multiculturalists who wanted to include more works by women and members of minorities. In early 1988, students at Stanford held a rally with Jesse Jackson, where they shouted, “Hey hey, ho ho, Western culture’s got to go,” to protest a required Western civilization course. ... Bloom’s book shared space at the top of the best-seller list with E. D. Hirsch’s “Cultural Literacy” (1987), which argued that progressive education had left Americans without a grasp of basic knowledge. It also inspired further conservative attacks against the university, including Roger Kimball’s “Tenured Radicals” (1990) and Dinesh D’Souza’s “Illiberal Education” (1991).
Although it had great popular appeal, “The Closing of the American Mind” did not go over well among academics. ... “The amazing thing about Allan Bloom’s book was not just its prodigious commercial success ... but the depth of the hostility and even hatred that it inspired among a large number of professors,” John Searle, the Berkeley philosophy professor and former proponent of the ’60s radical Free Speech Movement wrote in The New York Review of Books in 1990. Searle also noted a “certain irony” that the Western canon, from Socrates to Marx, which had once been seen as “liberating,” was now seen as “oppressive.” ...
Thursday, September 13, 2007
Looks like the magic of the "tax-cuts fix everything" message is wearing off:
GOP Forced to Pivot on Taxes, by Erin Billings, Roll Call: Senate Republicans are likely to engage in a more serious message makeover than they previously thought following a private strategy session ... where they reviewed new polling data showing tax cuts are no longer priority No. 1 with key independent voters. The news, GOP Senators acknowledged..., served as an important wake-up call as the party undergoes its massive internal image overhaul. The theme of lower taxes has been a cornerstone of the Republican platform ...
The findings ... showed Senators that Americans are far more focused on key domestic reforms like health care reform and the level of government spending rather than on previously enacted GOP tax reductions. ... Republican Senate sources said the latest information ... shows Republicans relied too easily on tax cuts as the answer to every domestic problem... [E]xplained one senior GOP Senate aide. "We've worn out the message."...
"If The Uncertainties Are Not Small, Standard Cost–Benefit Analysis As Applied To The Economics Of Climate Change Becomes Incoherent"
Partha Dasgupta reviews Cool It: The Skeptical Environmentalist's Guide to Global Warming, by Bjorn Lomborg (via email):
A challenge to Kyoto, by Partha Dasgupta, Nature: Bjorn Lomborg's The Skeptical Environmentalist created a sensation six years ago. The author offered figures to dismiss claims that the ecological-resource base in many parts of the world is deteriorating, and argued that the costs of reducing ecological losses are usually higher than the benefits. Never mind that several of the world's foremost environmental scientists expressed more than mere scepticism towards Lomborg's grasp of their science: prominent publications such as The Economist promoted the book vigorously... People learning of my own work in developing ecological economics would ask, "And have you read Lomborg?" — implying, "Why have you thrown away so much of your working life?"
Things have changed over the past year. Former US vice-president Al Gore's film An Inconvenient Truth and the Fourth Report of the Intergovernmental Panel on Climate Change have given rise to great public concern, and many now regard global warming to be the central problem facing humanity. Lomborg's latest book, Cool It, is a response to that change in public perception. He doesn't question the science...; he questions whether we should do much about it. ...
This is Ronald Suny of the University of Michigan:
Office hours: Professor's column, What's left of Marx?, by Ronald Suny, Michigan Daily: When I was a young professor..., a senior professor of religion came into my modest office ... and asked me, "Is it true that you are a Marxist?" In those days, confident in my radicalism, I assured him I was. "How quaint!" he said. "You know," he continued, "you on the Left believe in the goodness of man and therefore are always disappointed, while we who believe in Original Sin expect the worst and are never disappointed by what happens."
For the Left, in so far as a Left actually exists in the United States, ... certainly the next few decades were ones of disappointment, even disenchantment. The last spasm of hope for many of us came with Mikhail Gorbachev, former president of the ex-Soviet Union, who led an experiment in radical reform ... that ended only too quickly in the catastrophic collapse, not only of Soviet Communism, but of any real "third way" alternatives to the triumph of neoliberal economics and eventually neoconservative politics.
The end of Communism and the Soviet empire ... appeared to confirm the perversity of Marxism as political practice and as a view of history. The principal critical analysis of capitalism and imperialism, the major opponent of Western capitalism ..., Marxism was swept from the field, driven underground. Or at least driven into the academy, the universities, where it is occasionally taught to freshmen. In the absence of significant secular revolutionary or reformist alternatives to the "new world order" of Western capitalism and democracy, unanticipated new forces, much more conservative and religious, appeared, first in Iran in the revolution of the ayatollahs in 1979, in the Muslim Brotherhood movements in Egypt and elsewhere, in the mujaheddin resistance to the radical Islamic movements of the present. A Green Menace replaced the Red!
People still ask me, on occasion, "Are you a Marxist?" My answer now is different. "We're not allowed to tell."
When the Soviet Union set itself up as the guardian of the faith, Marxism and socialism were identified ... as being consonant with the practices and achievements of the USSR. Stalin defanged Marx, eliminated the critical power of Marxism and turned it into a legitimizing ideology. Russia was conceivably the worst place to attempt to build the kind of socialism that Marx envisioned coming after capitalism had exhausted all its potential. This is a country that is still today trying to get capitalism right. Actually, many historians claim, this is a country that could not get feudalism right. My own sense is that Marx would have been the most fervent critic, from the Left, of the disempowering of the working class and the exploitative character of the Soviet regime... He would have been appalled...
In my view, what is most important in Marx are his questions, critiques, his values and his moral vision - all part of a legacy that remains a powerful specter that still haunts global capitalism and (what Marxists call) bourgeois democracy at the beginning of the 21st century. Those values continue to inspire people in many parts of the world who without them would be even more disempowered before the onslaught of global capitalism and American hegemony.
For Marx, history did not end with capitalism. He did not legitimize the present as the best of all possible worlds, even as he appreciated the power and productivity of capitalism. Socialists aimed to subvert and supercede bourgeois society in the interest of a more egalitarian, socially just and democratic form of society. This vision certainly contains within it a utopia, as does any politics except conservative acceptance of the way the world exists at the moment. That utopia - that different and better future which the overwhelming one-dimensionality of current political imagination makes appear ridiculous, retains enormous power as an immanent critique of the limits, mystifications, apologetics, and deceptions of bourgeois democracy and market capitalism. Utopia, in other words, might be thought of, not in the usual sense of an impossible dream, but rather a far off goal toward which one directs one's politics, even if the ultimate goal might not be reached. ...
Rahm Emanuel has a proposal to increase personal savings:
Supplementing Social Security, by Rahm Emanuel, Commentary, WSJ: ...In the past two years, America's personal savings rate reached its lowest level since the Great Depression. And in comparison to other industrialized countries, the United States ranked second to last in personal savings.
Most people intuitively understand the importance of saving as a way to finance education or a dignified retirement, but the benefits to the overall economy are also important. An increase in savings enlarges the pool of capital...
Every American who works ought to have the chance to save. But today ... nearly half the work force ... lack[s] access to an employer-sponsored savings plan ... for retirement. At the same time, too many who have access to a savings plan contribute too little or don't participate... In addition, Americans don't start saving early enough. ...
Over the past 30 years, we have offered a blizzard of tax initiatives to encourage individuals to save for their retirement. .... Yet the national savings rate has plummeted. ...
In the last Congress, I proposed legislation that took a different approach. Instead of offering a new tax subsidy, my proposal helped companies automatically enroll employees in their 401(k) plans, rather than relying on workers to fill out the forms necessary to participate in a plan. ... If we make saving simple by limiting the amount of time, effort and decisions that people have to make, we can dramatically increase the number of people who save. In short, simplicity trumps choice.
Making saving easy is half the battle. The next step is to make saving universal. ... Republicans have long advanced the idea of personal accounts inside of Social Security. An accounts-based system that supplements, not supplants, Social Security can work. Democrats have argued that 401(k)s and personal savings are important supplements to Social Security, but we should ensure that fees are low and that lower-income Americans have the same opportunity to save that upper-income Americans enjoy. ...
I believe we should create Universal Savings Accounts. Like 401(k)s, the accounts would supplement Social Security. Employers and employees would contribute 1% of paychecks on a tax-deductible basis. Additional contributions could be made to the accounts at the discretion of the company or individual worker.
To ensure low management fees, these accounts would be managed by the private sector but overseen by a quasi-public board that would be given fiduciary responsibility for the types of investment options that workers could select. This system is used by the successful federal 401(k) program, or Thrift Savings Plan, where ... fees have averaged 30 cents for every $1,000 invested. By comparison, the typical mutual fund charges $15.50 per $1,000 invested. ...
To help achieve universal participation and simplicity, employers would automatically enroll their employees in these accounts, allowing employees to opt out if they ... did not want to participate. ... Since low-income workers have the hardest time saving for retirement, we should provide ... a federal tax credit that matches savings put into retirement accounts.
I believe that this type of approach ... is a necessary pre-condition to reforming Social Security. ... American people like the security that comes with Social Security. In order for us to tackle the problems of Social Security, Washington must provide solutions that make the American people feel more financially secure. If this anxiety is not addressed first, neither party will be given the opportunity to constructively address the challenges facing Social Security.
My approach protects the sanctity of the Social Security... It also expands individual savings opportunities outside of Social Security... Strengthening Social Security for the long term will take a sustained commitment to fiscal discipline and bipartisanship, commodities that can become scarce as we head into the presidential election season. But while Americans wait for long-term answers on Social Security, we should act now to give them more ways to start building retirement savings of their own.
I doubt this has much of a chance of going anywhere. I have no objection to the proposal, though the motivation used to sell the program - the implication that Social Security is headed for disaster if something isn't done - is overwrought. I also believe that these types of programs can easily turn from "add-ons" to "carve-outs" down the road which undermines their attractiveness, and I don't think these programs will increase savings as much as people predict once they become widespread and opting out is as simple as checking a box on a computer screen the first time finances get tight.
[Update: Andrew Samwick: A New Approach on Social Security Reform?]
What are the keys to Malaysia's unexpected success?:
The Malaysian miracle, by Joseph Stiglitz, Commentary, Project Syndicate: August 31 marked the 50th anniversary of Malaysia's Merdeka: independence after more than 400 years of colonialism. Malaysia's peaceful, non-violent struggle may not have received the attention that Mahatma Gandhi's did in India, but what Malaysia has accomplished since then is impressive - and has much to teach the world, both about economics, and about how to construct a vibrant multiracial, multi-ethnic, multicultural society.
The numbers themselves say a lot. At independence, Malaysia was one of the poorest countries in the world. ... Today, ..[i]n the global growth league tables, Malaysia is in the top tier, along with China, Taiwan, South Korea, and Thailand.
Moreover, the benefits of the growth have been shared. Hard-core poverty is set to be eliminated by 2010... Malaysia has succeeded in markedly reducing the income divides that separated various ethnic groups, not by bringing the top down, but by bringing the bottom up...
There were many reasons not to have expected Malaysia to be a success. ... Malaysia is rich in natural resources. But, with few exceptions, such countries are afflicted with the so-called "natural resource curse": countries with an abundance of resources ... actually do worse than countries without such benefits. While natural resource wealth should make it easier to create a more equalitarian society, countries with more resources, on average, are marked by greater inequality.
Moreover, Malaysia's multiracial, multicultural society made it more vulnerable to civil strife, which has occurred in many other resource-rich countries, as one group tried to seize the wealth for itself. ...
At independence, Malaysia also faced a communist insurgency. The "hearts and minds" of those in the countryside had to be won, and that meant bringing economic benefits and minimising "collateral" damage to innocent civilians - an important lesson for the Bush administration in Iraq, if it would only listen to someone outside its closed circle.
And Malaysia had a third strike against it: ... the European powers did little to improve living standards in the countries they ruled. ... The colonial powers' divide-and-rule tactics enabled small populations in Europe to rule large numbers outside of Europe, pillaging natural resources while investing little in the physical, human capital, and social capital necessary for an economically successful, democratic self-governing society. It has taken many of the former colonies decades to overcome this legacy.
How, then, does an economist account for Malaysia's success? Economically, Malaysia learned from its neighbours. Too many of the ex-colonies, rejecting their colonial heritage, turned to Russia and communism. Malaysia wisely took an alternative course, looking instead to the highly successful countries of east Asia. It invested in education and technology, pushed a high savings rate, enacted a strong and effective affirmative action programme, and adopted sound macroeconomic policies.
Malaysia also recognised that success required an active role for government. It eschewed ideology, following or rejecting outsiders' advice on a pragmatic basis. Most tellingly, during the financial crisis of 1997, it did not adopt IMF policies - and as a result had the shortest and shallowest downturn of any of the afflicted countries. ...
This success was, of course, not only a matter of economics: had Malaysia followed the policies recommended by the IMF, it would have torn apart the social fabric created over the preceding four decades.
Malaysia's success thus should be studied both by those looking for economic prosperity and those seeking to understand how our world can live together, not just with toleration, but also with respect, sharing their common humanity and working together to achieve common goals.
Wednesday, September 12, 2007
I find myself resistant to "culture" as an explanation for differences in economic outcomes among groups of people, but I shouldn't let that stop me from passing along work in the area. This paper asks why Europe is ahead of Asia today in terms of wealth and knowledge when a thousand years ago their positions were reversed. The answer, according to this work, is the relative degrees of cultural assimilation and cultural diffusion due predominantly to differences in geography:
Asia was geographically less vulnerable to cultural diffusion and thus benefited from enhanced assimilation, lower cultural diversity and greater accumulation of society-specific human capital; this was an edge in the agricultural stage. Greater cultural rigidity, however, diminished the ability to adapt to a new technological paradigm, delaying their industrialisation.
The theory "is distinctive in its abstraction from cultural traits themselves... It is the variation in ... cultural assimilation and cultural diffusion, governed partly by geography, which is crucial." Here's more:
Cultural assimilation, cultural diffusion and the origin of the wealth of nations, by Quamrul Ashraf and Oded Galor, Vox EU: At the start of the 2nd millennium CE, civilisations of Asia were arguably well ahead of European societies in both wealth and knowledge. By the 12th century, China employed water-driven machinery to make textiles and coke-based smelting to produce iron, technologies that would not appear in Europe for more than five hundred years. Yet, during the process of the Industrial Revolution, the technological leaders of the pre-industrial era were leapfrogged by European economies that accelerated into the modern age of sustained economic growth.
What can explain the delayed emergence of sustained growth in China and other leading agricultural societies?
Does the dollar auction provide a model for the war in Iraq?:
Lessons on the surge from economics 101, by Oliver R. Goodenough, Commentary, Rutland Herald: Economics professors have a standard game they use to demonstrate how apparently rational decisions can create a disastrous result. They call it a "dollar auction." The rules are simple. The professor offers a dollar for sale to the highest bidder, with only one wrinkle: the second-highest bidder has to pay up on their losing bid as well. Several students almost always get sucked in. The first bids a penny, looking to make 99 cents. The second bids 2 cents, the third 3 cents, and so on, each feeling they have a chance at something good on the cheap. The early stages are fun, and the bidders wonder what possessed the professor to be willing to lose some money.
The problem surfaces when the bidders get up close to a dollar. After 99 cents the last vestige of profitability disappears, but the bidding continues between the two highest players. They now realize that they stand to lose no matter what, but that they can still buffer their losses by winning the dollar. They just have to outlast the other player. Following this strategy, the two hapless students usually run the bid up several dollars, turning the apparent shot at easy money into a ghastly battle of spiraling disaster.
Theoretically, there is no stable outcome once the dynamic gets going. The only clear limit is the exhaustion of one of the player's total funds. In the classroom, the auction generally ends with the grudging decision of one player to "irrationally" accept the larger loss and get out of the terrible spiral. Economists call the dollar auction pattern an irrational escalation of commitment. We might also call it the war in Iraq.
America is long past the possibility of some kind of profitable outcome in Iraq. Neo-con dreams of a quick, cheap victory, delivering democracy and peace and self-financed from Iraq's own oil revenue, got us started on this misadventure. ... And like the economics class, suddenly we were in the thing up to our necks, with only bad choices available at an ever-escalating cost.
We can cut our losses now and take our lumps, or we can keep throwing good money after bad until maybe we wear the other side out, but in the process raising our own ultimate losses substantially. And in Iraq, the losses are already desperately high, on both sides, in blood, in money, and in the erosion of institutions like law and national cohesion. ...
As our commitment to this war once again comes up for public deliberation, listen to the arguments being made for staying in the game.
"We must honor our dead." ... "The other side is giving up the fight." ... "We can't afford to lose." ... Remember the dynamic of the dollar auction, and think carefully when such plausible and emotionally appealing short-term logic is used to justify putting another whopping bid on the table.
Oh yes, there is one other way out of the spiral — in the classroom, if you allow some kind of negotiated settlement between the two sides, they can sometimes agree to split the dollar and halt the contest. ... Of course..., we are told ... that such dialogue would only serve to reward their evil actions. Victory is the only acceptable result. ...
Martin Feldstein says it's time to begin lowering the federal funds rate "substantially"
Liquidity Now!, by Martin Feldstein, Commentary, WSJ: The time has come for the Federal Reserve to cut the federal funds interest rate substantially, starting on a path from the current 5.25% to 4.25% and possibly even less. Without such a policy shift, the U.S. economy faces the risk of a significant economic downturn.
Three separate but related forces are now threatening economic activity: a credit market crisis, a decline in house prices and home building, and a reduction in consumer spending. These developments compound the general weakening of the economy earlier in the year, marked by slowing employment growth and declining real spendable incomes. ...
Fed action to lower interest rates cannot solve the credit market problems, but it would help the economy: by stimulating the demand for housing, autos and other consumer durables; by encouraging a more competitive dollar to stimulate increased net exports; by raising share prices to increase both business investment and consumer spending; and by freeing up spendable cash for homeowners with adjustable-rate mortgages.
A reduction of the federal funds rate would not be a bailout for individual borrowers and lenders who are suffering from their past mistakes. Any such targeted bailout would be wrong, encouraging more reckless behavior in the future. But it would also be a mistake to resist an interest rate cut and risk a serious economic downturn merely to avoid the indirect effect of helping those market participants. ...
Although the extent of the possible decline in economic activity is uncertain, the economy could suffer a very serious downturn if the triple threat from the credit market, housing construction, and consumer spending materializes with full force. A sharp reduction in the interest rate would attenuate that very bad outcome. ...
Setting the federal funds rate requires a balancing of risks. If the economy would have continued to expand in the absence of a large rate cut, Fed easing now would produce an unwanted rise in inflation, an unwelcome outcome but the lesser of two evils. If that happens, the Fed would have to engineer a longer period of slow growth to achieve price stability. The economic cost of reducing that inflation would depend on the Fed's ability to persuade the market that easing under current conditions is an appropriate risk-based strategy and not an abrogation of its fundamental duty to pursue price stability.
Thomas Palley and I have different views on globalization:
The Fed and America’s Distorted Expansion, by Thomas I. Palley: The U.S. economy has been in expansion mode since November 2001. Though of reasonable duration, the expansion has been persistently fragile and unbalanced. That is now coming home to roost in the form of the sub-prime mortgage crisis and the bursting house price bubble.
As part of the fallout, the Federal Reserve is being criticized for keeping interest rates too low for too long, thereby promoting credit and housing market excess. However, the reality is low rates were needed to sustain the expansion. Instead, the root problem is a distorted expansion caused by record trade deficits and manufacturing’s failure to fully participate in the expansion.