Economist's View

The FOMC Cuts the Federal Funds Rate to 4.50%

The Federal Reserve Open Market Committee has decided to cut the federal funds rate to 4.50%. The decision was not unanimous with Kansas City Fed president Thomas Hoenig preferring no change. Thus, the vote was 9-1 (the committee currently has two positions unfilled). Also, only six banks submitted requests to lower the discount rate. It's clear from the statement that the Committee does not want to set up expectations of further cuts with the fairly direct statement that "after this action, the upside risks to inflation roughly balance the downside risks to growth."

Here's the Press Release:

Press Release

The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 4-1/2 percent.

Economic growth was solid in the third quarter, and strains in financial markets have eased somewhat on balance.  However, the pace of economic expansion will likely slow in the near term, partly reflecting the intensification of the housing correction.  Today’s action, combined with the policy action taken in September, should help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and promote moderate growth over time.

Readings on core inflation have improved modestly this year, but recent increases in energy and commodity prices, among other factors, may put renewed upward pressure on inflation.  In this context, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.

The Committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth.  The Committee will continue to assess the effects of financial 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; Charles L. Evans; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; William Poole; Eric S. Rosengren; and Kevin M. Warsh.  Voting against was Thomas M. Hoenig, who preferred no change in the federal funds rate at this meeting.

In a related action, the Board of Governors unanimously approved a 25-basis-point decrease in the discount rate to 5 percent.  In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Richmond, Atlanta, Chicago, St. Louis, and San Francisco.

"Truth About Taxes"

David Leonhardt lists "basic facts" about taxes "that ideology can’t change":

Plain Truth About Taxes and Cuts, by David Leonhardt, NY Times: You’re going to hear a lot about taxes over the next two years. ... There are big philosophical questions about taxes that facts alone can’t answer. ... But there are also some basic facts that ideology can’t change. If you keep these five in mind, you will have an easier time keeping up with the debate:

As a group, the rich pay a greater share of taxes than in the past. The top 1 percent of taxpayers — those with adjustable gross income of at least $267,000 in 2004 — paid more than 25 percent of all federal taxes that year, according to the Congressional Budget Office. That was up from 15 percent in 1979. People sometimes pick nits with these statistics... But don’t get bogged down in all this. The big picture is clear enough. The main reason for the trend is also clear.

The affluent are paying more of the taxes because they’re making so much more money. ...A family in that top 1 percent of earners paid a total federal tax rate — including everything from payroll taxes to income taxes to capital gains taxes — of 30 percent in 2004. That was down from 41 percent a decade before. Since the 1950s, tax rates on high-income families have generally been falling.

The top earners pay a bigger share of the government tab than in the past because their incomes have risen so sharply — even more sharply than their tax bills. ... The affluent, in short, are paying less in taxes on every dollar they earn but earning many more dollars.

Corporate taxes have dropped significantly in recent decades. ...Everyone from Mr. Rangel on the left to Fred Thompson on the right is saying that high corporate taxes are hurting American companies. But the effective corporate tax rate isn’t any higher than it has been on average over the last 25 years, and it’s far lower than it was in the 1960s and ’70s.

“A dirty little secret is that the corporate income tax used to raise a fair amount of revenue,” says Richard Clarida, a Columbia University economist and former Treasury Department official under Mr. Bush.

What’s going on here? This country really does have a high corporate tax rate, but it also has so many loopholes that companies can often avoid paying the tax. A much smarter policy, economists say, would include a lower rate with fewer loopholes. ...

The nation’s total tax bill hasn’t changed much over the years. Put it all together — less corporate tax collection and lower individual tax rates, combined with more income for the people who face the highest tax rates — and the trends mostly cancel each other out. The taxes that the federal government took in last year equaled 18.4 percent of the gross domestic product, almost exactly the average since 1980. ...

The obvious conclusion is that moderate shifts in taxes don’t dictate economic growth. Mr. Bush’s father and Bill Clinton raised taxes — and the economy grew for almost the entire decade of the 1990s. The current administration has cut taxes — and the economy has grown for almost all of this decade.

So if short-term economic growth were the only thing to worry about, you could make a good argument either for cutting taxes or for raising them.  Unfortunately, there is another problem out there.

The budget deficit is worse than either party says it is. ...White House officials are absolutely correct when they note that the current budget deficit isn’t especially large. But it will soar in coming years, as baby boomers ... move onto the Social Security and Medicare rolls

If nothing changes over the next couple of decades, the United States will build up a debt burden... There are several ways to prevent that. Taxes could be raised across the board, or they could be raised on the affluent. Or the Medicare budget — a much bigger problem than Social Security — could be held in check if the government figured out how to say no to some expensive medical procedures. Or all of the above could happen. But something has to give. No amount of clever argument can pay the bills.

Just one complaint: There is no direct attempt in this set of "truths" to debunk the supply-side myth that tax cuts have paid for themselves, a myth that will survive so long as those making the claim are not revealed as hacks pushing falsehoods. [Note: That tax increases increase revenues is implied in the last paragraph where raising taxes across the board fixes the deficit, but there's no direct challenge to this pervasive myth. Since the topic is "basic facts that ideology can’t change," and given the prominence of this myth among supply-side advocates, it seems to me the myth ought to be addressed directly.]

A Convenient Lie

As soon as you read this from Pete Du Pont:

Inconvenient Tax Truths: Al Gore believes global warming is "an inconvenient truth." Here are some economic truths that America's liberal leadership finds too inconvenient to support. ... Tax rate reductions increase tax revenues. This truth has been proved at both state and federal levels, including by President Bush's 2003 tax cuts on income, capital gains and dividends. Those reductions have raised federal tax receipts by $785 billion.

There's no need to read any further, he's revealed himself (yet again) as a political hack. The saddest part is that some people actually believe these lies.

It's also too bad that under Rupert Murdoch the Wall Street Journal's editorial page has continued to print these lies to support an ideology, lies that helped to push through tax cuts that did not raise revenues by $785 billion or at all, but instead lowered revenues by hundreds of billions of dollars according to Congressional Budget Office estimates. [Just to be clear, this is about the editorial pages, not the news pages, e.g. see Greg Ip's excellent story on changes in the Fed under Bernanke for an example of the difference in quality].

A Monetary Value for Almost Anything

Andrew Oswald and Nattavudh Powdthavee explain how to assess the value of losses from bereavement of loved ones, and more generally how to put "values on all sorts of things that we care for":

A New Approach to Awarding Compensations in Courts, by Andrew Oswald and Nattavudh Powdthavee, Vox EU: Economists are known to be able to put a monetary value to anything. For instance, the contingent valuation method – a survey-based method which asks individuals “how much compensation would you demand for the destruction of X” or “how much are you willing to pay to preserve X” – has been used to calculate the monetary valuations for many of the non-marketable resources that come without immediate price-tags attached. For example, the contingent valuation approach has been used in the literature to calculate the willingness to pay for contaminated residential property[1] and the willingness to pay to prevent oil spill[2].

So the question is: can judges use the same method to assign pecuniary amounts to be awarded to tort victims in situations that do not appear to have any intrinsically financial aspect such as losses from bereavement of loved ones?

Yes, at least in principle. Although we imagine that answering questions like “what number of euros would compensate you for the death of your daughter” is likely to be hard for everyone, and morally offensive to many. As a result, most judges are left to their own devices to award compensation packages they think would make sense in court, and they do so by using the rule of thumb that have no conceptual foundations that are based on solid, scientific findings. This often leads to judges awarding financial settlements that can seem so small in real life compared to the shock a loss of loved one can bring. For example, the Fatal Accident Act 1976 provides a lump-sum at currently £10,000 damages for bereavement (that is, approximately €14,000), which is available only to the husband or the wife of the deceased and not to the children for a loss of a parent. In today’s term, this makes up only around 3% of the lifetime income for a successful white-collar worker.

From a scientific point of view, this raises a question of whether we can develop a systematic method to calculate a reasonable compensation package that would reflect as close to the genuine damages generated by bereavement as possible.

links for 2007-10-31

• Why does the press cover the horse race, not policies? - Andrew Gelman
• The return of price controls - Daniel Gross
• Greenhouse gases: Demand control, supply and carbon prices - Vox EU
• Biofuels: a tale of special interests and subsidies - Martin Wolf
• Canadian government's proposed tax cuts are stupid - Stephen Gordon
• Why do so many species live in tropical forests and coral reefs? - EurekAlert
• Giuliani’s Prostate Cancer Figure Is Disputed - New York Times
• Federal Study Offers Dire Outlook on Child Insurance - New York Times

"Paul Krugman Is Right!"

Wow. Another Paul Krugman post is probably overkill, but I just noticed this paper by Anna Schwartz and Edward Nelson, "The Impact of Milton Friedman on Modern Monetary Economics: Setting the Record Straight on Paul Krugman’s “Who Was Milton Friedman?”" cites this blog in the list of references:

Krugman, Paul (2007d). “Supply-Side Economics: Paul Krugman Responds.” “Economist’s View” web site, April 11. (URL: http://economistsview.typepad.com/economistsview/2007/04/supplyside_econ.html)

That's kind of cool. Here's Brad DeLong's take on the paper and underlying debate over the 'liquidity trap':

Paul Krugman Is Right!, by Paul Krugman: Alex Tabbarrok writes:

Marginal Revolution: Assorted Links: The Impact of Milton Friedman on Modern Monetary Economics.  A nice review by Edward Nelson and Anna Schwartz of Friedman's thought and influence over monetary policy that also, in the author's words, sets the record straight on Paul Krugman's 'Who was Milton Friedman'...

I tend to be on Paul's side of this--especially on the issue of the 'liquidity trap'. In a liquidity trap, (a) short-term interest rates are essentially zero and (b) banks have excess reserves. Normally the Federal Reserve changes people's behavior by trading short-term government bonds (which pay interest) for bank reserves (which allow banks to expand their deposits and loans). Fewer government bonds in the economy means more appetite by banks to buy corporate bonds and thus to finance corporate investment. More bank reserves means banks have more freedom to make direct loans as well.

But in a liquidity trap bonds pay no interests, and banks have more than enough reserves to cover their lending to all the borrowers they think are credit worthy. So when the Federal Reserve swaps government bonds for bank reserves it is swapping two assets that are equivalent. Why should this change anybody's behavior? The only reason is that banks think that they might be short of reserves and want more at some unknown point in the future, but can this have a big impact on the economy?

I would say no: that Paul Krugman's approach to the liquidity trap is right.

Mario Cuomo Interviews Paul Krugman: The Role of Government

Paul Krugman on the role of government:

Mario Cuomo Interviews Paul Krugman: Bill Clinton

Paul Krugman on Bill Clinton:

Mario Cuomo Interviews Paul Krugman: Inequality

Paul Krugman on inequality:

Mario Cuomo Interviews Paul Krugman: International Trade

Paul Krugman on international trade and inequality:

Mario Cuomo Interviews Paul Krugman: Iraq

Paul Krugman on Iraq:

"Economic Right-Wingery"

Jonathan Chait looks at Rudy Giuliani's economic policies and his ideas about freedom:

Economaniac, by Jonathan Chait, The New Republic: ...Compared to other Republican presidential contenders, Giuliani identifies himself as a "supply-sider" ... more aggressively and has mopped up more financial support from oil, gas, and other bastions of the financial right. But economic right-wingery has conquered the GOP so thoroughly that there's not much Giuliani can do to stand out, platform-wise. What truly sets him apart is the apparent depth of his convictions, and the extent to which he is willing to follow the right's philosophical premises through to their grim conclusion.

Consider Giuliani's position on health care reform. ... Like many Republicans, Giuliani's proposed health care reform is to provide a tax deduction for individual health care. Of course, the value of a tax deduction is proportionate to your income... If you don't earn enough to owe income taxes, or if you have a pre-existing condition and can't afford coverage, a tax deduction would probably be worthless. Giuliani's tax deduction remedy would therefore do virtually nothing to cover the uninsured. ...

Giuliani ... is not indifferent to the plight of the uninsured. He actually seems to revel in it:

I don't like mandating health care ... because it erodes what makes health care work in this country--the free market, the profit motive. A mandate takes choice... We've got to let people make choices. We've got to let them take the risk--do they want to be covered? Do they want health insurance? Because, ultimately, if they don't, well, then, they may not be taken care of.

...Of course, this analysis is insane, unless you think most of the uninsured lack coverage because they'd rather splurge at Best Buy than spend money on health insurance. Alas, this appears to be exactly what Giuliani believes. "[The uninsured] may be buying a television, ... they may be buying a cell phone," he said at last week's debate. ...

Giuliani's extreme ... economic right-wingery seems to flow from a deep-seated punitive impulse, which he has transferred from the shiftless New York City underclass to vast swaths of the population. Giuliani has echoed the language of economic libertarianism with more frankness, and less pretense of compassion, than any recent Republican presidential candidate. ...

Giuliani, of course, is careful not to antagonize social conservatives. But his campaign is in fact an attempt to define social conservatism out of the Republican platform. While most Republicans define their party's values by invoking three parts--small government, strong military, social conservatism-- Giuliani only mentions the first two. A recent editorial in the pro-Giuliani New York Sun proposed a list of GOP values. Item one was a belief that tax cuts make revenues rise. Social issues did not make the list at all. Last winter, Giuliani told a crowd at the Hoover Institution that the GOP must redefine itself around economic issues--health care, school choice, taxes--as the "Party of Freedom."

Of course, Giuliani's vision of "freedom" is not necessarily about liberating the human spirit. "[F]reedom is not a concept in which people can do anything they want, be anything they can be," he once explained as mayor. "Freedom is about authority." ...

You can't be all you can be? Dang, I was counting on that. I remember hearing somewhere - I think it was from some freedom protection organization - that you could.

Fed Watch: And So It Begins

Tim makes a bold call on the outcome of the Fed's rate setting meeting:

And So It Begins, by Tim Duy: The Fed begins a two-day meeting today, with market participants widely expecting a rate cut. I am mentally prepared to be on the wrong side of this call, joining the lonely few, but I just can’t tease another rate cut out of the incoming data.

In my mind, the argument for a rate cut hinges on one crucial assumption – that the market is expecting a rate cut, and the Fed will not want to disappoint. From Bloomberg:

''The Fed is reluctant to ease,'' says Louis Crandall, chief economist at Jersey City, New Jersey-based Wrightson ICAP LLC, a unit of ICAP Plc, the world's largest broker for banks and other financial institutions. ''But it also doesn't want to unsettle the financial markets unnecessarily.''

If the Fed fails to ease, so the story goes, they will be blamed for failure to communicate effectively. After all, given their push for transparency, shouldn’t they make an effort to send a signal when the markets are headed in the wrong direction? The problem with this view is that Fed Chairman Ben Bernanke does not believe it is his job to lead markets around by the nose like his predecessor. I think under the new regime, the Fed expects their comments to be taken at face value. And I think they are pretty effectively communicating their view on the economy: Outside of housing, there is minimal spillover, and whatever spillover exists is completely expected. From Bernanke on October 15 (italics mine):

The Consumer Product Do You Feel Safer Commission

Hi. We're from the government, and we don't want to help:

Bigger Budget? No, Responds Safety Agency, by Stephen Labaton, NY Times: The nation’s top official for consumer product safety has asked Congress in recent days to reject legislation intended to strengthen the agency, which polices thousands of consumer goods, from toys to tools.

On the eve of an important Senate committee meeting to consider the legislation, Nancy A. Nord, the acting chairwoman of the Consumer Product Safety Commission, has asked lawmakers in two letters not to approve the bulk of legislation that would increase the agency’s authority, double its budget and sharply increase its dwindling staff.

Ms. Nord opposes provisions that would increase the maximum penalties for safety violations and make it easier for the government to make public reports of faulty products, protect industry whistle-blowers and prosecute executives of companies that willfully violate laws.

The measure is an effort to buttress an agency that has been under siege because of a raft of tainted and dangerous products manufactured both domestically and abroad. ...

Ms. Nord’s opposition to important elements of the legislation is consistent with the broadly deregulatory approach of the Bush administration... Tony Fratto, a White House spokesman, said that Ms. Nord had not coordinated her effort to kill the legislation with the White House. But he said that the administration shared many of her concerns and that Allan Hubbard, President Bush’s top economic adviser..., was preparing to send a letter to Congress “that is probably even more forceful than Ms. Nord’s.” ...

Ms. Nord, who before joining the agency had been a lawyer at Eastman Kodak and an official at the United States Chamber of Commerce, criticized the measure... Some of Ms. Nord’s complaints were similar to the ones that business groups and manufacturers have raised, including that the legislation would be unnecessarily burdensome. But in other areas, like whistle-blower protection, her complaints went beyond those of industry. ...

Consumer advocates also said they were stunned by the letter. ...

The agency has suffered from a steady decline in its budget and staffing in recent years. Its staff numbers about 420, about half its size in the 1980s. It has only one full-time employee to test toys. And 15 inspectors are assigned to police all imports of consumer products under the agency’s supervision...

links for 2007-10-30

• Monitoring the euro area economy in real-time - Vox EU
• The economic impacts of climate change policy - Environmental Economics
• A test case for the media - Paul Krugman Blog
• Blogonomics: Ed Glaeser Is Too a Blogger - Felix Salmon
• Economics for Adults - Economic Principals
• Your World in Charts: "It's The System, Stupid" Edition - Ezra Klein
• Selective thinking - Dean Baker
• IMF reform: a marathon, not a sprint - Vox EU
• U.S. on the Sidelines of Global Trends? - Anne-Marie Slaughter
• US private equity groups in China talks - FT.com
• Sugar’s Sweetheart Deal - NY Times
• Giuliani vs. The Facts - Ezra Klein
• The AMT Must Go - Charles Rangel
• Political Scientists Discover New Form Of Government - The Onion

"We Just Can't Afford to Cut Social Security Benefits Further"

Dean Baker is amazed:

The End Is Near! Post Publishes Column Defending Social Security, by Dean Baker: Is that a trumpet I hear in the distance? Why are the rivers flowing backwards? And who are those four guys on horses?

Yes, the Washington Post has published a column arguing against the Social Security crisis story. Robert Ball, the former Social Security commissioner, a member of the 1983 Greenspan commission, and a great defender of the system got 700 words in the paper this morning to make the case. Read it carefully, most of us will probably not live to see another such piece in the pages in the Post.

Here's the article:

A Social Security Fix For 2008, by Robert M. Ball, Washington Post: In the Oct. 19 editorial " Mr. Giuliani's No-Tax Pledge," The Post stated: "It's no more responsible for Republicans to rule out tax increases [to strengthen Social Security] than it is for Democrats to insist on no benefit cuts." The Post praised, as a "bipartisan blend," President Ronald Reagan's acceptance of a 1983 fix that included both.

I take exception. It's the essence of responsibility, in my view, to insist on no benefit cuts.

In 1983, I served on the National Commission on Social Security Reform (better known as the Greenspan Commission)... What was right in 1983 -- a balanced package of benefit cuts and tax increases as part, roughly half, of the final agreement -- would be wrong today.

Social Security benefits are modest by any measure and are already being cut -- by raising the age of eligibility for full benefits and by deducting ever-rising Medicare premiums from benefit checks. So the benefits provided for under present law will replace, on average, a lower percentage of prior earnings than in the past. To cut them further would undermine all that Social Security has achieved -- exposing millions of vulnerable people, both elderly and disabled, to needless economic hardship.

Social Security has never been more important to more Americans than it is now. Private pension plans continue to dwindle -- currently covering only about 20 percent of private-sector employees -- and the national rate of savings hovers around zero. We just can't afford to cut Social Security benefits further. ...

Social Security benefits are vital... About a third of the elderly rely on Social Security for 90 percent or more of their income; two-thirds count on it to supply at least half of their income. The program lifts 13 million elderly beneficiaries above poverty.

Without Social Security, 55 percent of the disabled -- and a million children -- would live in poverty. The program is particularly important to women and minorities. It provides 90 percent or more of the incomes of almost half of all unmarried women age 65 and older..., and it is the sole source of income for 40 percent of elderly African Americans and Hispanic Americans.

Social Security is the nation's most effective anti-poverty program. But it's much more than that. For every worker it provides a solid base on which to try to build an adequate level of retirement income. To weaken that foundation would be grossly irresponsible.

The good news is that there's no need to weaken it. ... The program can be brought into close actuarial balance over the long run with just three revenue-enhancing changes that are desirable in any case:

• Gradually increase the maximum amount of earnings covered by Social Security so that the traditional goal -- covering 90 percent of all earnings -- is once again achieved. This change would affect only the 6 percent of earners...

• Allow Social Security to improve earnings by investing some of its assets -- up to 20 percent, say -- in equities, as just about all other public and private pension plans do.

• Provide a new source of income by retaining a residual estate tax and dedicating it to Social Security. ... Dedicating the income from the tax to Social Security would considerably improve the progressivity of Social Security financing as well as increasing revenue.

Presidential candidates should be expected to discuss Social Security financing. But in 2008 they shouldn't be held to a 1983 formula. We're in a different time, with different needs -- and there are much better options available than benefit cuts.

Paul Krugman: Fearing Fear Itself

Fear the fear mongers:

Fearing Fear Itself, by Paul Krugman, Commentary, NY Times: In America’s darkest hour, Franklin Delano Roosevelt urged the nation not to succumb to “nameless, unreasoning, unjustified terror.” But that was then.

Today, many of the men ... with a significant chance of receiving the Republican nomination ... have made unreasoning, unjustified terror the centerpiece of their campaigns.

Consider ... the fact that Rudy Giuliani is taking foreign policy advice from Norman Podhoretz, who wants us to start bombing Iran “as soon as it is logistically possible.”

Mr. Podhoretz, ... a founding neoconservative, tells us that Iran is the “main center of the Islamofascist ideology against which we have been fighting since 9/11.” The Islamofascists, he tells us, are well on their way toward creating a world “shaped by their will and tailored to their wishes.” Indeed, “Already, some observers are warning that by the end of the 21st century the whole of Europe will be transformed into a place to which they give the name Eurabia.”

Do I have to point out that none of this makes a bit of sense?

For one thing, there isn’t actually any such thing as Islamofascism — it’s not an ideology; it’s a figment of the neocon imagination. ... And Iran had nothing whatsoever to do with 9/11...

Beyond that, the claim that Iran is on the path to global domination is beyond ludicrous. Yes, the Iranian regime is a nasty piece of work..., and it would be a bad thing if that regime acquired nuclear weapons. But let’s have some perspective, please: we’re talking about a country with roughly the G.D.P. of Connecticut...

Meanwhile, the idea that bombing will bring the Iranian regime to its knees ... is pure wishful thinking. ... Mr. Podhoretz, in short, is engaging in what my relatives call crazy talk. Yet he is being treated with respect by the front-runner for the G.O.P. nomination. And Mr. Podhoretz’s rants are, if anything, saner than some of what we’ve been hearing from some of Mr. Giuliani’s rivals.

Thus, ... Mitt Romney asserted that America is in a struggle with people who aim “to unite the world under a single jihadist Caliphate. To do that they must collapse freedom-loving nations. Like us.” ... And Mike Huckabee, whom reporters like to portray as a nice, reasonable guy, says that if Hillary Clinton is elected, “I’m not sure we’ll have the courage and the will and the resolve to fight the greatest threat this country’s ever faced in Islamofascism.” Yep, a bunch of lightly armed terrorists and a fourth-rate military power — which aren’t even allies — pose a greater danger than Hitler’s panzers or the Soviet nuclear arsenal ever did.

All of this would be funny if it weren’t so serious.

In the wake of 9/11, the Bush administration adopted fear-mongering as a political strategy. Instead of treating the attack as what it was — an atrocity committed by a fundamentally weak, though ruthless adversary — the administration portrayed America as a nation under threat from every direction.

Most Americans have now regained their balance. But the Republican base, which lapped up the administration’s rhetoric about the axis of evil and the war on terror, remains infected by the fear the Bushies stirred up — perhaps because fear of terrorists maps so easily into the base’s older fears, including fear of dark-skinned people in general.

And the base is looking for a candidate who shares this fear.

Just to be clear, Al Qaeda is a real threat, and so is the Iranian nuclear program. But neither of these threats frightens me as much as fear itself — the unreasoning fear that has taken over one of America’s two great political parties.

links for 2007-10-29

• Fed concern at expectation of rate cut - FT.com
• Don’t believe the hype: renminbi flexibility - Vox EU
• Ben Stein Watch - Felix Salmon
• In Defense of Beauchamp - Obsidian Wings
• Q&A With St. Louis Fed's Poole - WSJ Economics Blog
• Oil price movements in other currencies - Worthwhile Canadian Initiative
• What Kind of Caution by the Fed This Time? - New York Times
• Counting Americans - New York Times

Summers: How America Must Handle the Falling Dollar

Larry Summers on the falling dollar:

How America must handle the falling dollar, by Lawrence Summers, Commentary, Financial Times: ...The dollar’s decline may provoke anxiety but it should not be a surprise... There is nothing very new about a decline in currency of a country running a large current account deficit and whose economy is softening. But in important respects the situation of the dollar is almost without precedent.

The vast majority of the US current account deficit is now being funded by central banks accumulating reserves as they seek to avoid appreciation of their home currencies. While the US dollar is usually viewed as a floating rate currency, substantial and critical parts of the world economy operate with currencies pegged to dollar parities or at least managed with them in mind. ... Some means of engagement must be found with those who have yolked their currencies and so their financial policies to that of the US.

The US has responded in an ad hoc way by carrying on a “strategic dialogue” with China – by far the largest economy with an exchange rate linked to the dollar – backed by congressional threats ... and references to communiqués from the Group of Seven leading industrial nations. In reality the dialogue is anything but strategic. Like so much of American international policy in recent years, it seems to confuse the firm statement of legitimate desire with the serious conduct of diplomacy.

Think of the questions Chinese policymakers must ask themselves. What is the highest US priority – global financial stability or market access for well-connected US firms? Can the US take yes for an answer or is it a certainty that a new president will insist in 18 months on a new set of economic diplomacy accomplishments with China? In which areas, if any, is the US prepared to adjust its policies in response to global interests? Given that the Chinese authorities have presided over nearly double digit annual growth for a generation, do US officials who make assertions about what is in China’s interest have the experience and knowledge of China that should cause their views to be taken seriously? Why is China being singled out? How could China – even if it wished to – act in ways that the US prefers without appearing to yield to international pressure?

Maintaining global financial stability and the role of the dollar requires a more strategic approach – a task that, given the political calendar, is likely to fall to the next US administration.

The G7 process has lost its focus on exchange rate issues ... [and] is something of an anachronism in the current international context. It needs to be radically reinvented, starting with a change in its composition. ... Two principles stand out.

First, any new approach must be premised on the desirability of a strong, integrated global economy that benefits the citizens of all countries, not on the idea that economists or politicians can calculate “fair” exchange rates. The right and potentially effective case for adjustments in the current alignment of exchange rates relies on their unsustainability and the distortions they induce in macroeconomic policies, not on ideas of fairness to workers.

Second, multilateralism is better politics and economics than unilateralism but it must not become an excuse for inertia. Any new group should be as large as necessary and no larger, should meet with some frequency and should include central bankers. It should be analytically informed but everyone should know that key decisions will ultimately be taken by senior officials in the national interest, not by international organisations.

The stakes are high. Well-managed finance cannot on its own make a country stable and prosperous, let alone the world. But history tells us that poorly managed finance foments instability and economic insecurity.

See also: Is the Yuan Really Appreciating?, by pgl

"Should We Use Mercenaries at All?"

Tyler Cowen responds to a comment:

Should we use mercenaries at all?, by Tyler Cowen: Over at Mark Thoma's, Bernard Yomtov asks a very good question:

Why should there be mercenaries at all, given the existence of a large and well-trained Army? The mercenaries are former soldiers. Their functions are military and could be carried out by regular soldiers. The only reason I can see for using them is precisely to have people doing military jobs who are outside the normal chain of command, and not subject to normal laws, rules, and regulations governing the conduct of soldiers. In other words, it is to have people who do not work for government in the way that they should.

Most private contractors today do not serve in the function of soldiers but rather they deliver, ensure, and guard supplies. This should be evaluated on a case-by-case basis, but often the private sector does a better job and without major legal problems. 

Security guards, however, are often "mercenaries." A general or top Iraqi official for instance might be guarded by Blackwater employees. The critics have not shown that Blackwater employees misbehave at a higher rate than do U.S. soldiers, so the comparative case against Blackwater -- as opposed to the more general case against the war -- is mostly shrill rhetoric. It is possible to pay Blackwater employees bonuses for good performance rather than just give medals, plus they are on a higher pay scale in the first place. Nonetheless my judgment call is that issues of perception and accountability are important enough in contemporary Iraq that we should be using contractors less in these capacities (as the column indicated), but the temptation to use them is based on more than just sheer political abuse.

Contractors lower the cost of good operations, contractors lower the operational (but not social) cost of bad operations, contractors magnify the costs of mistaken Executive preferences, and contractors can raise new problems of monitoring. If you don't think the first item on this list is at work, there is good reason to cut back on contractors in Iraq.

But if you view the scope and use of contractors as a more general decision, rather than something which can be fine-tuned for each war, it is no longer such a simple choice.

I do not believe contractors should be used as combatants. Supply and support missions are another matter, and if by chance private contractors come under unexpected attack they should defend themselves, but they should not be put into such situations intentionally. Killing, if it has to be done at all, should not be done by contract, government or otherwise. Death is not just another good to be traded in the marketplace and I refuse to treat it that way even if, somehow, we do manage to save a few bucks along the way (and the economics can cut both ways, i.e., there are arguments about externalities that undercut the argument for contractors, e.g. who paid to train the people that Blackwater now uses and how much of the saving comes from taxpayers footing the bill for the training, but that just scratches the surface of externalities such as contractors not fully internalizing the cost of killing civilians or harming Iraqi property).

If I thought that using mercenaries would save lives overall, including the lives of innocent Iraqi bystanders, then I would consider the option even if it costs more, not less - as it does. These are lives we are talking about, not widgets produced by xyz. If pay for soldiers is the problem, if we get better service from Blackwater because they are paid more, then fix it - we're paying the Blackwater employees with tax dollars already and I have no problem at all with paying people willing to enter into combat as U.S. soldiers very, very well for that risk. But it's hard for me to believe that money is the motivating factor in combat when one's life is, very literally, on the line.

For me, it's akin to executions. If we have to have them (and we don't, and shouldn't), it should be the government who does the killing. Period. We might save money by contracting the executions out to the private sector, and probably would, but is that how you want it to be done? If not, how is war different? Again, for me, killing should never be part of an economic transaction between government and the private sector. If we must defend ourselves, if killing must be done, it should not be carried out as a for profit activity. I understand and support the use of contractors in support roles - providing for the needs of people in combat - but war zones are not a place where economic incentives much matter. The institutions that support markets are completely absent for one thing, staying alive trumps all, and the discipline of the military, not the discipline of the market, is what provides incentives to curtail behavior such as shooting anything that moves in order to stay alive. Markets have their places, but war zones are not among them.

Subprime Foreclosure Rates

Paul Krugman has more graphs and analysis.

links for 2007-10-28

• Kill AMT, Even If It Means Raising Some Taxes - John M. Berry
• Matthews on White House Crime & Media Failure - The Notion
• What Part of ‘Illegal’ Don’t You Understand? - New York Times
• Some housing pictures - Paul Krugman - Blog

Private Contractors and War

Tyler Cowen:

To Know Contractors, Know Government, by Tyler Cowen, Economic Scene, NY Times: Allegations of misbehavior by employees of Blackwater USA in the shooting deaths of 17 Iraqis have brought the military’s use of private contractors into question. But whatever the possible sins of the Blackwater firm, the overall problem is not private contracting in itself; ... but rather ... the sins and virtues of their customers, namely their sponsoring governments.

It is easy to rail against contractors for holding money above loyalty to country; Halliburton, for instance, has been a target of this criticism. But... private ships licensed to carry out warfare, helped win the American Revolution and the War of 1812. ... Today, many of our allies receive payment, either implicitly or explicitly, to support American efforts. War is, among other things, an economic undertaking, so the profit motive in military affairs isn’t always bad or ignoble.

When it comes to supplying troops, or protecting high-ranking officials, private military contractors often offer greater flexibility and rapidity of response. The employees, many of whom are former soldiers or operatives, tend to have more experience than current, mostly younger soldiers.

The recent comeback of private contracting suggests that central governments have become weaker again, at least relative to the tasks they are undertaking. Alexander Tabarrok ... traced the history of private contractors in a study, “The Rise, Fall, and Rise Again of Privateers” (The Independent Review, spring 2007 ). He showed that public navies and armies began to displace private contractors in the 19th century, as governments became more powerful and better funded.

Today, America no longer has a draft, its military bureaucracy can be inflexible and the public wishes to be insulated from the direct impact of war. Contractors are a symptom of government weakness, but are not the problem itself. The first Persian Gulf War, which enjoyed greater international support, was not reliant on contractors to nearly the same degree.

Among many Iraqis, Blackwater and other companies have a reputation for getting the job done without much caring about Iraqis who get in the way. But part of the problem may stem from economic incentives. If Blackwater is assigned to protect a top American official, who is later assassinated, Blackwater may lose future business. A private contractor doesn’t have a financial incentive to protect Iraqi citizens, who are not paying customers. Ultimately, this reflects the priorities of the United States military itself. American casualties are carefully recorded and memorialized, but there is no count of Iraqi civilian deaths.

It is harder to recognize when private contractors are being underemployed. During the Rwandan civil war in the 1990s, the United Nations debated using two private contractors, Executive Outcomes or Sandline International, to intervene. The U.N. rejected the notion and instead turned to a poorly trained Zairean police contingent. We’ll never know how private contractors would have fared, but the Zaireans were ineffective; some 800,000 Rwandans were murdered.

Yet the use of contractors is not a free lunch.

Compared with the military, contractors are not subject to direct scrutiny by Congress and they are not covered by international law with the same clarity. Excessive use of private contractors erodes checks and balances, and it substitutes market transactions, controlled by the executive branch, for traditional political mechanisms of accountability. When it comes to Iraq, we’ve yet to see the evidence of a large practical gain...

When private contractors are combined with government troops, the contractors usually can’t do much better than the setting in which they are asked to perform.

When things are going well and the “good guys” are in control, the flexibility and experience of military contractors can make things go even better. But when the environment is hostile and events are spiraling out of control, the incentives of private contractors may lead to many mistakes.

Note that a serious issue for Blackwater — the allegations about needless deaths of innocent civilians — has also been an issue for United States government forces from the beginning of the conflict.

Most of all, contractors are appealing when a victory is possible in relatively quick order. The potential accountability problems won’t linger for long; conversely, few contractors will look good when a conflict runs on for years.

Currently, the chances of establishing a stable Iraqi government appear quite low. ... If so, we should be cutting back on private contractors, as the critics are suggesting, because there is no desirable end in sight. Of course, those same reasons suggest troop cutbacks as well.

In the next conflict, however, the temptation to use contractors may again be strong. What if private contractors offer a real chance of making a positive difference? ...

Private contractors may not respect virtue for its own sake, but like most businesses, they will respect the wishes of their most powerful customers, in this case governments. What is wrong with Blackwater may, most of all, mirror what is wrong with Uncle Sam.

Environmental Change and Agricultural Output

New results on the impact of environmental change on the world's agricultural economy:

Human-generated ozone will damage crops, Nancy Stauffer, MIT Energy Initiative: A novel MIT study concludes that increasing levels of ozone due to the growing use of fossil fuels will damage global vegetation, resulting in serious costs to the world's economy.

The analysis, reported in the November issue of Energy Policy, focused on how three environmental changes (increases in temperature, carbon dioxide and ozone) associated with human activity will affect crops, pastures and forests.

The research shows that increases in temperature and in carbon dioxide may actually benefit vegetation, especially in northern temperate regions. However, those benefits may be more than offset by the detrimental effects of increases in ozone, notably on crops. Ozone is a form of oxygen that is an atmospheric pollutant at ground level.

The economic cost of the damage will be moderated by changes in land use and by agricultural trade, with some regions more able to adapt than others. But the overall economic consequences will be considerable. According to the analysis, if nothing is done, by 2100 the global value of crop production will fall by 10 to 12 percent.

"Even assuming that best-practice technology for controlling ozone is adopted worldwide, we see rapidly rising ozone concentrations in the coming decades," said John M. Reilly, associate director of the MIT Joint Program on the Science and Policy of Global Change. "That result is both surprising and worrisome."

"Where Does the Right-Wing End and the Media Begin?"

This is part of an interview with Paul Krugman on the relationship between the right-wing and the media, and other matters:

Where Does the Right-Wing End and the Media Begin? By Rory O'Connor, AlterNet: I had the opportunity to sit down this week with ... Paul Krugman... He certainly pulled no punches during our conversation...

Rory O' Connor: ...What role if any do the media play in movement conservatism?

Paul Krugman: The media are a very important force... They shape perceptions, and they conceal issues. Look at the 2000 presidential campaign, for example, where the media were so heavily biased against Al Gore. That's what brought Bush to within a Supreme Court decision of the White House. ...[T]he role of the media in not telling you reasons why you should be skeptical about the course of the war, for example, it's enormously important. ...

[T]here are several major parts of the news media that are for all practical purposes part of "movement conservatism" -- Fox News, the New York Post, the Washington Times -- and in which other news organizations are intimidated, at least to some extent. I sometimes talk about ... "asymmetrical intimidation." If you say a true but unflattering thing about Bush or in fact about any other prominent conservative, oh, boy! People are going to go after you. I mean, I've got people working full-time going after me, right? But if you say a false, unflattering thing about a Democrat or a progressive, no risk ... And that shapes coverage, no question about it. It's better now, but it's still very asymmetric. The other thing ... about the media is their addiction to the trivial. We've got the most substantive election coming up, I think, ever. ... And what are we seeing news stories about? John Edwards' hair and Hillary Clinton's laugh ... this is horrifying! And again -- it's asymmetric. ...

ROC: It sounds like you're saying there's a bias in the media. If you are, what is the bias?

PK: The media's bias, a large part of it is in fact right-wing bias, because they are effectively part of the right wing. Fox News ... there's ... no liberal equivalent..., there is no network that, if a conservative got the Nobel Peace Prize, would have responded the way Fox News did to Al Gore's Peace Prize...

Beyond that, there's two things at least; first, the hatred of substance -- they really want to talk about all that trivia -- and there's also the fetish of evenhandedness. ... Way back in the 2000 campaign, I wrote ... that if Bush said the earth was flat, the headline would read: "Opinions Differ on Shape of the Planet." I was thinking specifically about what Bush was saying about taxes and Social Security, which were just out and out lies! But no one would say that, and they still won't. It's better now, a little, but they still won't say it... [T]he Big Lies are all on the right right now. So it works much more to their advantage.

ROC: Do you think it's possible that economics is driving politics in the media?

Culturally Sensitive Battle

Should anthropologists help the military in Iraq?:

A True Culture War By Richard A. Shweder, Commentary, NY Times: ...A few weeks ago this newspaper reported on an experimental Pentagon “human terrain” program to embed anthropologists in combat units in Iraq and Afghanistan. It featured two military anthropologists: Tracy (last name withheld), a cultural translator viewed by American paratroopers as “a crucial new weapon” in counterinsurgency; and Montgomery McFate, who has taken her Yale doctorate into active duty in a media blitz to convince skeptical colleagues that the occupying forces should know more about the local cultural scene.

How have members of the anthropological profession reacted to the Pentagon’s new inclusion agenda?

links for 2007-10-27

• Professor Cringed (A Note on Ayn Rand) - Twenty-Cent Paradigms
• Predators and parasites may increase evolutionary stability - EurekAlert
• Years of madness - Paul Krugman - Blog
• The Beauchamp Case - The Daily Dish
• Corporate Taxes, in Need of Reform - Jason Furman
• Astronauts Add to Station - New York Times
• Dozens of Species of Primates Are Under Threat - New York Times
• The rise of the 'red capitalists' - International Herald Tribune
• World's hottest chile pepper discovered - EurekAlert

What Causes Asset Price Bubbles?

Continuing with today's housing bubble theme (Krugman, Leijonhufvud), here's the latest Economic Letter from the San Francisco Fed reviewing research that tries to explain the existence of asset price bubbles:

Asset Price Bubbles, by Kevin J. Lansing, FRBSF Economic Letter: Nowhere does history indulge in repetitions so often or so uniformly as in Wall Street. When you read contemporary accounts of booms or panics the one thing that strikes you most forcibly is how little either stock speculation or stock speculators today differ from yesterday. The game does not change and neither does human nature.
--From the thinly disguised biography of legendary speculator Jesse Livermore, by E. Lefèvre (1923, p. 180).

Speculative bubbles have occurred throughout history in numerous countries and asset markets. The term "bubble" was coined in England in 1720 following the famous price run-up and crash of shares in the South Sea Company. The run-up led to widespread public enthusiasm for the stock market and a proliferation of highly suspect companies attempting to sell shares to investors. One such venture notoriously advertised itself as "a company for carrying out an undertaking of great advantage, but nobody to know what it is." The epidemic of fraudulent stock-offering schemes led the British government to pass the so-called "Bubble Act" in 1720, which was officially named "An Act to Restrain the Extravagant and Unwarrantable Practice of Raising Money by Voluntary Subscription for Carrying on Projects Dangerous to the Trade and Subjects of the United Kingdom." Throughout history, speculative bubbles have usually coincided with outbreaks of fraud and scandal, followed by calls for more regulation once the bubble has burst (see Gerding 2006).

Economists use the term "bubble" to describe an asset price that has risen above the level justified by economic fundamentals, as measured by the discounted stream of expected future cash flows that will accrue to the owner of the asset. The dramatic rise in U.S. stock prices during the late 1990s, followed similarly by U.S. house prices during the early 2000s, are episodes that have both been described as "bubbles." This Economic Lett describes some research that attempts to account for the behavior of asset price bubbles.

Axel Leijonhufvud: Bubble, Bubble, Toil and Trouble

Axel Leijonhufvud on the linkages between monetary policy and financial instability. He argues that "Inflation targeting might mislead us into pursuing a policy that is actively damaging to financial stability":

Bubble, bubble, toil and trouble, by Axel Leijonhufvud, Project Syndicate: Editors’ note: This is shortened version of the author’s Policy Insight “Monetary and Financial Stability“.

As recently as twenty-five years ago, monetary stability in the United States was based on the Federal Reserve System’s control of the quantity of money. Financial stability was ensured by the comprehensive regulations of the Glass-Steagal act. Today, these regulations are gone and a great wave of innovations has entirely changed the financial landscape. And we no longer know how one might define the “quantity of money” for control purposes.

Paul Krugman: A Catastrophe Foretold

The causes and consequences of ineffective regulation of financial markets:

A Catastrophe Foretold, by Paul Krugman, Commentary, NY Times: “Increased subprime lending has been associated with higher levels of delinquency, foreclosure and, in some cases, abusive lending practices.” So declared Edward M. Gramlich, a Federal Reserve official. ...

Mr. Gramlich said those words in May 2004. And it wasn’t his first warning. ... Mr. Gramlich, who recently died of cancer, ... tried to get Alan Greenspan to increase oversight of subprime lending as early as 2000, but got nowhere.

So why was nothing done to avert the subprime fiasco? Before I try to answer..., there are a few things you should know.

First, the situation for both borrowers and investors looks increasingly dire. A new report from Congress ... predicts ... two million foreclosures on subprime mortgages by the end of next year. That’s two million American families facing the humiliation and financial pain of losing their homes.

At the same time, investors who bought assets backed by subprime loans are continuing to suffer severe losses. ...

Second, much if not most of the subprime lending that is now going so catastrophically bad took place after it was clear ... that there was a serious housing bubble, and after people like Mr. Gramlich had issued public warnings... As late as 2003, subprime loans accounted for only 8.5 percent of the value of mortgages issued in this country. In 2005 and 2006, the peak years of the housing bubble, subprime was 20 percent of the total — and the delinquency rates on recent subprime loans are much higher than those on older loans.

So, once again, why was nothing done to head off this disaster? The answer is ideology.

In a paper presented just before his death, Mr. Gramlich wrote that “the subprime market was the Wild West. Over half the mortgage loans were made by independent lenders without any federal supervision.” What he didn’t mention was that this was the way the laissez-faire ideologues ruling Washington — a group that very much included Mr. Greenspan — wanted it. They were and are men who believe that government is always the problem, never the solution, that regulation is always a bad thing.

Unfortunately, assertions that unregulated financial markets would take care of themselves have proved as wrong as claims that deregulation would reduce electricity prices.

As Barney Frank ... put it ... the lessons ... are clear: “To the extent that the system did work, it is because of prudential regulation and oversight. Where it was absent, the result was tragedy.” ...

In his final paper, Mr. Gramlich stressed the extent to which unregulated lending is prone to the “abusive lending practices”... The fact is that many borrowers are ill-equipped to make judgments about “exotic” loans, like subprime loans that offer a low initial “teaser” rate that suddenly jumps after two years, and that include prepayment penalties preventing the borrowers from undoing their mistakes.

Yet such loans were primarily offered to those least able to evaluate them. “Why are the most risky loan products sold to the least sophisticated borrowers?” Mr. Gramlich asked. “The question answers itself — the least sophisticated borrowers are probably duped into taking these products.” And “the predictable result was carnage.”

Mr. Frank is now trying to push through legislation that extends moderate regulation to the subprime market. Despite the scale of the disaster, he’s facing an uphill fight: money still talks in Washington, and the mortgage industry is a huge source of campaign finance. But maybe the subprime catastrophe will be enough to remind us why financial regulation was introduced in the first place.

Rich State, Poor State, and Voting Behavior

Andrew Gelman has some interesting graphs:

Some cool graphs of rich states and poor states, by Andrew Gelman: I'll take advantage of Paul Krugman's recent link to our paper on income and voting by putting up some cool scatterplots that we made recently. It started with our maps of which states Bush and Kerry would've won if only the votes of the poor, middle-income, and rich were counted:

We noticed that the familiar red-blue pattern (rich northeast and west coast supporting the Democrats, rest of the country supporting the Republicans) showed up clearly among rich voters, but not among the poor or middle class.

There are also some interesting scatterplots in Andrew's post. Summarizing the plots:

[F]or each income category, we show Bush's vote share for each state, plotted along with the state's income. For poor voters, there is no systematic difference between rich and poor states. But for middle-income and especially for rich voters, there is a very strong pattern of rich states supporting the Democrats and poor states supporting the Republicans.

links for 2007-10-26

• Why is oil above $90? - Econbrowser
• Do We Have an Inventory Problem? - Economics Blog
• Wellstone and Krugman - Ezra Klein
• New ideas about human migration from Asia to Americas - EurekAlert
• At Last, an Overhaul for a Bad [Mining] Law - New York Times
• Cap-and-trade bill is second-rate - Los Angeles Times
• Subprime Roadmap Laid Out in Gramlich's Last Act - Gene Sperling
• On the Libertarian Who Got a £16 Billion Bailout - naked capitalism

"The Right-Wing Smear Forward"

Chris Hayes on the use of email to spread rumors and the difficulty people have debunking the rumors once they have gone this route:

I’ve got a cover story in the latest issue of the Nation about the hidden but potent institution of the right-wing email forward. Here’s the first page:

On February 27, 2001, two members of the American Gold Star Mothers, an organization of women who've lost sons or daughters in combat, dropped by the temporary basement offices of the new junior senator from New York, Hillary Clinton. They didn't have an appointment, and the office, which had been up and running for barely a month, was a bit discombobulated. The two women wanted to talk to the senator about a bill pending in the Senate that would provide annuities for the parents of those killed, but they were told that Clinton wasn't in the office and that the relevant staff members were otherwise engaged. The organization later submitted a formal request in writing for a meeting, which Clinton granted, meeting and posing for pictures with four members of the group.

But the story doesn’t end there. In May of that year, the right-wing website NewsMax, a clearinghouse for innuendo and rumor, ran a short item with the headline “Hillary Snubs Gold Star Mothers.” Reporting via hearsay—a comment relayed to someone who then recounted it to the column’s author—the article claimed that Clinton and her staff “simply refused” to meet with the Gold Star Mothers, making hers the “only office” in the Senate that snubbed the group.

At first the item didn’t attract much attention, but it quickly morphed into an e-mail that started ricocheting across the Internet. “Bet this never hits the TV news!” began one version. “According to NewsMax.com there was only one politician in DC who refused to meet with these ladies. Can you guess which politician that might be?... None other than the Queen herself—the Hildebeast, Hillary Clinton.”

Before long, the Gold Star Mothers and the Clinton office found themselves inundated by inquiries about the “snub,” prompting the Gold Star Mothers to post a small item debunking the claim on their website. When that didn’t stem the tide, they posted a lengthier notice. “These allegations were not initiated by the Gold Star Mothers…. This is a fabricated report picked up by an individual using the Gold Star Mothers as an instrument to discredit Senator Clinton…. We do not need mischievous gossip and unfounded lies to promote our organization. Please help stop it now.”

That plea notwithstanding, the e-mail continues to circulate to this day. Anyone who’s been following politics for the past fifteen years won’t be surprised to find Hillary Clinton the subject of a false and damning right-wing smear. We’ve all become familiar with the ways the Republican noise machine transmits lurid bits of misinformation and tendentious attacks from the conservative fringe into the heart of American political discourse, the process by which a slightly misdelivered joke by John Kerry attracts the ire of Rush Limbaugh and ends up on the front page of the New York Times.

But in some senses, the kind of under-the-radar attack embodied in the Gold Star e-mail—which never made the jump to Fox or Drudge—is even harder to deal with. “It’s a Pandora’s box,” says Jim Kennedy, who served as Clinton’s communications director during her first Senate term. “Once [the charges] are out in the ether, they are very hard to combat. It’s very unlike a traditional media, newspaper or TV show, or even a blog, which at least has a fixed point of reference. You know they’re traveling far and wide, but there’s no way to rebut them with all the people that have seen them.”

Such is the power of the right-wing smear forward, a vehicle for the dissemination of character assassination that has escaped the scrutiny directed at the Limbaughs and Coulters and O’Reillys but one that is as potent as it is invisible. In 2004 putative firsthand accounts of Kerry’s performance in Vietnam traveled through e-mail in right-wing circles, presaging the Swift Boat attacks. Last winter a forward began circulating accusing Barack Obama of being a secret Muslim schooled in a radical madrassa (about which more later). While the story was later fed through familiar right-wing megaphones, even making it onto Fox, it has continued to circulate via e-mail long after being definitively debunked by CNN. In other words, the few weeks the smear spent in the glare of the mainstream media was just a tiny portion of a long life cycle, most of which has been spent darting from inbox to inbox.

The rest here.

Robert Reich's Postscript on Fair Taxes

Robert Reich says "the case for substantially raising marginal income tax rates on the rich" is clear:

Who Pays the Dollars that Finance Bush's War? More on a Fair Tax Burden, by Robert Reich: President Bush has just sent Congress an “emergency” request for an extra $46 billion in expedited funds for Iraq, Afghanistan and other national security needs. That’s in addition to the $145 billion in war-related spending included in Bush’s original 2008 budget. Which brings me back to the subject of who’s gonna pay for all this. ...

[T]he principle for who’s gonna pay should be equal sacrifice. Equal sacrifice means that in paying taxes, people ought to feel about the same degree of pain – regardless of whether they’re wealthy or poor. This means that someone earning $2 million a year ought to pay a larger portion of her income in taxes than someone earning $20,000 a year. Even Adam Smith saw the wisdom of a graduated tax. “The rich should contribute to the public expense, not only in proportion to their revenue, but something more in proportion,” he wrote. (Wealth of Nations, vol. 2, ed. Campbell, Oxford U Press, 1976, p. 840.)

Traditionally during wartime, taxes have been raised substantially on top incomes to help pay the extra costs of war. The estate tax was imposed by wartime Republican presidents Lincoln and McKinley. It was maintained through World War I, World War II, the Korean War, and the Cold War. Now, under Bush, with Bush's war costing more and more, it's being phased out.

During World War I the marginal income tax on the richest Americans rose to 77 percent; during World War II it was over 90 percent. In 1953, with the Cold War raging, Republican president Dwight Eisenhower refused to support a Republican bill to reduce the top rate, then 91 percent. By 1980, the top marginal rate was still at 70 percent.

Combine this logic with the facts I shared with you two blogs ago – about how large a share of national income and wealth the super-rich now claim – and the case for substantially raising marginal income tax rates on the rich should be even clearer.*
_____________
* Postscript: The blogger who asserts that 84.6 percent of all federal taxes are paid by the top 25 percent of income earners, and over a third are paid by the top 1 percent, advances a specious argument. First, most Americans pay more in payroll taxes than in income taxes; in addition, state sales taxes have grown faster than almost any other form of taxation. Both payroll taxes and sales taxes take a much bigger portion of the paychecks of lower-income Americans than of higher-income. Viewed as a whole, the current tax system is quite regressive.

Second, and more to the point, it’s irrelevant how much of the total income tax burden is paid by the top 25 percent, or even the top 1 percent. The ethical and logical issue is what sort of sacrifice individuals are making, or should be expected to make, rather than what sacrifice an economic “class” is making as a whole. The rich have become so wealthy that even if each wealthy American paid a very small share of his or her incomes in taxes, the rich would still, as a group, account for a large share of total income taxes. I find it ironic that conservatives who extol the virtues of individualism and abhor so-called “class warfare” would resort to such a deceptive argument.

And, though I think Reich has in mind a net increase in taxes rather than revenue neutral offsets that increase progressivity, along these lines:

A Tax Plan as Trial Run for ’09 Law, by Edmund L. Andrews, NY Times: The House’s leading Democratic tax writer will propose a sweeping overhaul of the tax code on Thursday that would increase taxes on many people with incomes above $200,000 but cut them for most others.

The bill, [is] to be introduced by Representative Charles B. Rangel of New York ... Mr. Rangel has acknowledged that he does not expect to enact such a bill this year, and President Bush would almost certainly veto legislation that raises taxes on the wealthy. ...

Fed Plans to Increase Transparency

The Fed is moving to increase transparency:

Fed Plans Transparency Steps, by Greg Ip, WSJ: Federal Reserve officials are nearing consensus on several steps to make their deliberations more transparent to the public, but are likely to defer one of Chairman Ben Bernanke's longstanding goals: an explicit inflation target.

The centerpiece of their new communications steps would be the release of economic forecasts of policy makers four times a year, instead of the current two times, with additional detail and background... Moreover, the horizon for those forecasts would be extended to three years from two.

The ... Fed had hoped to finalize them by this month. But the fallout of the market turmoil that erupted in August has complicated the agenda of next week's meeting of the policy-making Federal Open Market Committee and it may defer decisions on its communications policy to a later meeting. ...

While the idea of setting an inflation target hasn't been shelved, officials say it needs more discussion. ... For Mr. Bernanke, deferral of an inflation target represents a setback, but he can chalk up a tactical victory for forging a consensus on other steps. ...

At his nomination hearing in 2005, Mr. Bernanke restated his preference for a target while promising "extensive discussion and consultation" and "no precipitate steps." ...

The FOMC as a whole is still not ready to take the step. One concern is that Congress, having taken a more populist turn since Democrats took power in 2006, could perceive a target as subordinating the Fed's responsibility for employment, despite Mr. Bernanke's insistence to the contrary. Another is that officials don't think the current system is broken.

At present, the FOMC meets eight times a year, and at two of its meetings, members submit forecasts for the current and next year on growth, inflation and unemployment that are included in a report to Congress. The "central tendency" of those forecasts -- a range that excludes the extreme projections -- garners the most attention. ...

At present, the post-meeting FOMC statement and the minutes aren't expected to be altered significantly.

A recent paper by Orphanides and Wieland is related to the release of the economic forecasts more often and with more detail. According to this paper from a recent conference at the St. Louis Fed, the "midpoints of the central tendencies" used as "proxies for the modal forecasts of FOMC" are better at explaining policy decisions and deviations from the Taylor rule than data on actual economic conditions. Simply put, if you want to understand the Fed's policy decisions, look at the FOMC forecasts, not the actual data on the economy available at the time:

Economic Projections and Rules-of-Thumb for Monetary Policy, by Athanasios Orphanides and Volker Wieland, October 2007: Abstract Monetary policy analysts often rely on rules-of-thumb, such as the Taylor rule, to describe historical monetary policy decisions and to compare current policy to historical norms. Analysis along these lines also permits evaluation of episodes where policy may have deviated from a simple policy rule... One interesting question is whether such rules-of-thumb should draw on policymaker forecasts of economic conditions or recent outcomes of key variables such as inflation and unemployment. ... We investigate this proposition in the context of FOMC policy decisions over the past 20 years using publicly available FOMC projections from the biannual monetary policy reports to the Congress (Humphrey-Hawkins reports). Our results indicate that FOMC decisions can indeed be predominantly explained in terms of the FOMC's own projections rather than recent economic outcomes. Thus, a forecast-based rule-of-thumb better characterizes FOMC decision-making. We also confirm that many of the apparent deviations of the federal funds rate from an outcome-based Taylor-style rule may be considered systematic responses to information contained in FOMC projections.

links for 2007-10-25

• Fossil record supports evidence of impending mass extinction - EurekAlert
• The thesis of COAL (his book) - Paul Krugman Blog
• In praise of partisanship - Comment is free
• Worth Reading: Government Is Good - New York Times Blog
• House price bubbles made in Europe - Daniel Gros - Vox EU

The Cost of the War

The CBO has estimated the cost of the war based upon two scenarios:

Summary At the request of Chairman Spratt, the Congressional Budget Office (CBO) has totaled the funding provided through fiscal year 2007 for military and diplomatic operations in Iraq and Afghanistan and other activities associated with the war on terrorism, as well as for related costs incurred by the Department of Veterans Affairs (VA) for medical care, disability compensation, and survivors’ benefits. In addition to totaling the funding provided to date, CBO has projected the total cost over the next 10 years of funding operations in support of the war on terrorism under two scenarios specified by the Chairman. Those scenarios are meant to serve as an illustration of the budgetary impact of two different courses in the war on terrorism but are not intended to be a prediction of what will occur.

Appropriations for U.S. Operations in Iraq and Afghanistan and for the War on Terrorism (Billions of dollars)

Including both funding provided through 2007 and projected funding under the two illustrative scenarios, total spending for U.S. operations in Iraq and Afghanistan and other activities related to the war on terrorism would amount to between $1.2 trillion and $1.7 trillion for fiscal years 2001 through 2017 (see Table 1). A final section of this testimony briefly compares parts of CBO’s estimate to a frequently cited estimate prepared by two academic researchers, Linda Bilmes and Joseph Stiglitz. ...

According to this, there is an additional $700 billion in interest expenses bringing the total (under the $1.7 trillion dollar scenario) to $2.4 trillion. There is more to say but, unfortunately, I am short on time, so I will leave it to you to add more detail in comments. [Update: More here.]

Fed Watch: Runaway Rate Cut Train?

Tim is losing sleep:

Runaway Rate Cut Train?, by Tim Duy: I agonize over this stuff.  Constantly.  And it is not really part of my job. Just can’t get it out of my mind.

It is even more agonizing when expectation flip-flop so strongly, from rate cut to no rate cut back to rate cut certainty. From the Cleveland Fed:

Fed Chairman Ben Bernanke’s speech kicked off a shift in expectations, reinforced by additional Fed speakers. The ongoing risk management theme was reiterated by new Chicago Fed President Charles Evans:

To me, the uncertainties about how financial conditions might evolve and affect the real economy mean that risk management considerations have an important role in the current policy environment…However, there is a less benign possibility. Housing demand and prices could weaken a good deal more than we expect — either because a new shock hits the sector or because we have underestimated the weakness already in train….

I want to emphasize that I do not see this extreme outcome as likely. But it is one of those high cost outcomes that we should guard against. The challenge is to calibrate the insurance in light of the lower probability of the spillover event occurring.

The upshot of such speeches has been to entrench expectations that as long as housing is deteriorating, the downside risks to the economy are too great to be ignored, and therefore rate cuts will continue regardless of the relatively minimal impact the housing downturn has had on the rest of the economy. Still unsteady credit markets argue further for additional cutting.

Entitlement Hysteria

Jonathan Chait tries to figure the periodic episodes of hysteria over Social Security:

Fear Factor, by Jonathan Chait, The New Republic: The beginning of the fall season brought to Washington another periodic upsurge of entitlement hysteria. ...  Affected parties tend to furrow their brows and scold politicians in particular, and Americans in general, for our myopia in the face of the demographic tidal wave of retiring baby boomers who will drown the federal budget with unsustainable benefits. ... Those afflicted with entitlement hysteria are identifiable not by the realization that big social programs will need a fix--which is widely understood-- but by the urgency and gravity of their pleas. ...

There's some truth to their analysis, but it misses the point in a crucial way. The two largest entitlement programs, Social Security and Medicare, are in very different shape. The Social Security Trust Fund is scheduled to last until 2042, at which point we'll have to hike up taxes or trim spending a bit. Medicare, on the other hand, faces a day of reckoning in 2019.

Yet one of the oddities of the entitlement hysterics is that they are far more obsessed with the minor problems of Social Security than with the massive problems of Medicare. Indeed, ... they inevitably follow the same pattern: They begin with an ominous summation about entitlements--thus lumping together Medicare with Social Security--then swiftly proceed to demand that Social Security be shored up forthwith.

Russert's recent harangue at the Democratic presidential debate was a classic example. He began by warning of the crisis faced by "Social Security and Medicare" but proceeded to ask no fewer than 14 questions about Social Security, and zero about Medicare. ...

Should they stop being hysterical about Social Security and start being hysterical about Medicare? Well, that would be a start, but it would still elide the deeper problem. The reason Medicare is in such worse shape than Social Security is that it has to account for exploding health care costs. Their focus on demographics and greedy baby boomers is entirely misplaced. Indeed, the "entitlement problem" is mostly--three-quarters, to be precise--a function of rising health care costs.

Since you can't solve the entitlement problem without solving the health care problem, one might think that the entitlement hysterics would have gradually moved on to becoming health care hysterics. ... Yet this is another puzzling thing about entitlement hysteria: the sheer persistence of the obsession. ...[W]hy do they consider this to be a matter of such unique urgency? Put aside the war in Iraq, for which plenty of people (including me) lack any confident solution. In addition to the health care crisis, there's global warming. There are numerous loosely secured nuclear sites throughout the world... There are numerous diseases threatening the lives of millions of Africans whose deaths could be prevented at relatively modest expense. ...

Compared to such disasters, the entitlement nightmare scenario isn't so nightmarish. If we do absolutely nothing to fix Social Security, then, 35 years from now, the program will have to start paying out three-quarters benefits, or we'll have to raise taxes. It's not ideal, but it doesn't keep me awake at night.

Yes, the fix would be easier and fairer if we implemented it sooner. But the closer we get to Social Security's insolvency date, the easier it will become politically to do the fix. The last major fix to Social Security, implemented in 1983, came about just as the Trust Fund was on the verge of insolvency. ...

Ten or 20 years ago, you could plausibly deem Social Security's finances among the most pressing national problems. Those who were willing to take on the problem were admired for their farsightedness, bipartisanship, and seriousness of purpose. Social Security's place on our list of national problems has long since been overtaken, but, among Washington establishment types who remember those days, the issue retains its totemic significance. Entitlement hysteria has become less a response to a crisis than an expression of statesmanship. ...

It's an ideological fight and Social Security is the battleground. Finances are (mis)used in an attempt to motivate change, anything to shake up the system, but among the more hysterical finances are not the real concern.

Stratospheric Reflections: The Mount Pinatubo Solution to Global Warming

I hope we aren't reduced to this type of solution to the global warming problem:

How to Cool the Globe, by Ken Caldera, Commentary, NY Times:  Despite growing interest in clean energy technology, it looks as if we are not going to reduce emissions of carbon dioxide anytime soon. The amount in the atmosphere today exceeds the most pessimistic forecasts made just a few years ago, and it is increasing faster than anybody had foreseen. ...

What can be done? One idea is to counteract warming by tossing small particles into the stratosphere (above where jets fly). This strategy may sound far-fetched, but it has the potential to cool the earth within months.

Mount Pinatubo, a volcano in the Philippines that erupted in 1991, showed how it works. The eruption resulted in sulfate particles in the stratosphere that reflected the sun’s rays back to space, and as a consequence the earth briefly cooled.

If we could pour a five-gallon bucket’s worth of sulfate particles per second into the stratosphere, it might be enough to keep the earth from warming for 50 years. Tossing twice as much up there could protect us into the next century.

A 1992 report from the National Academy of Sciences suggests that naval artillery, rockets and aircraft exhaust could all be used to send the particles up. The least expensive option might be to use a fire hose suspended from a series of balloons. Scientists have yet to analyze the engineering involved, but the hurdles appear surmountable.

Seeding the stratosphere might not work perfectly. But it would be cheap and easy...

This is not to say that we should give up trying to reduce greenhouse gas emissions. ... Think of it as an insurance policy, a backup plan for climate change.

Which is the more environmentally sensitive thing to do: let the Greenland ice sheet collapse and polar bears become extinct, or throw a little sulfate in the stratosphere? The second option is at least worth looking into.

links for 2007-10-24

• White House Edits CDC Climate Testimony - AP
• Wide income gap linked to deaths in both rich and poor nations - EurekAlert
• What Nordhaus Said in 2002 - Bryan Caplan
• Entitlement Hysterics - Matthew Yglesias
• Home improvement - Dean Baker
• Climate Change Pollution Rising—Scientific American
• Helping the Fed Target Asset Prices - WSJ Economics Blog
• St. Bernard study casts doubt on creationism - EurekAlert
• I wish there were more Canadian economics blogs - Worthwhile Canadian Initiative
• Why Credit-rating Agencies Blew It: Mystery Solved - Robert Reich
• Europe Tries to Attract Migrants It Prefers - New York Times
• Solution to Energy and Climate Crises? - Scientific American

"White Male Math"

Paul Krugman defends one of the claims in his book:

White male math, Paul Krugman: So, people ask why, in The Conscience of a Liberal, I downplay the role of issues other than race in swinging the political balance in favor of the GOP. The answer, basically, is the math: once you take the great southern switch into account, there isn’t much left to explain.

In some correspondence with Larry Bartels, whose “What’s the matter with “What’s the matter with Kansas?”" is must reading for anyone trying to understand modern American political, economy, the issue of how the Democrats lost white males came up. Larry points out that you really need to separate out the South. Here’s what he had to say:

Unless you have a peculiar nostalgia for the racially coercive Democratic monopoly of the Jim Crow era, it makes sense to focus on the rest of the country. There, the Democratic share of the two-party presidential vote among white men was 40% in 1952 and 39% in 2004.

White men didn’t turn against the Democrats; Southern white men turned against the Democrats. End of story.

Here's the abstract from the Bartels article along with the table showing the numbers Krugman is referring to. The discussion surrounding the table is also included:

What’s the matter with “What’s the matter with Kansas?, by Larry Bartels: Abstract: Thomas Frank’s What’s the Matter with Kansas? asserts that the Republican Party has forged a new “dominant political coalition” by attracting working-class white voters on the basis of “class animus” and “cultural wedge issues like guns and abortion.” My analysis confirms that white voters without college degrees have become significantly less Democratic; however, the contours of that shift bear little resemblance to Frank’s account. First, the trend is almost entirely confined to the South, where Democratic support was artificially inflated by the one-party system of the Jim Crow era of legalized racial segregation. (Outside the South, support for Democratic presidential candidates among whites without college degrees has fallen by a total of one percentage point over the past half-century.) Second, there is no evidence that “culture outweighs economics as a matter of public concern” among Frank’s working-class white voters. The apparent political significance of social issues has increased substantially over the past 20 years, but more among better-educated white voters than among those without college degrees. In both groups, economic issues continue to be most important. Finally, contrary to Frank’s account, most of his white working-class voters see themselves as closer to the Democratic Party on social issues like abortion and gender roles but closer to the Republican Party on economic issues.

And on to table 1:

Table 1 provides a different way of looking at the growing electoral importance of income differences within Frank’s white working class. The rows of the table present separate tabulations of changing Democratic support over the whole period from 1952 through 2004 among voters in the upper, middle, and lower thirds of the income distribution in each election year. The first entry in the first column of the table,−5.9, represents the overall decline in Democratic presidential support among white voters without college degrees over the 14 presidential elections covered by the NES surveys. ... Reading down the first column, we see that the decline in support for Democratic candidates was much greater – almost 15 percentage points – among the most affluent members of this group (with family incomes in the top third of the national income distribution). On the other hand, the Democratic vote share among the least affluent members of this group (those in the bottom third of the national income distribution) actually increased by almost five percentage points.

It should be clear from these comparisons that material economic circumstances have become more important, not less important, in structuring the presidential voting behavior of Frank’s white working class over the course of the past half-century. While it is true that Democratic presidential candidates have lost significant support among this group, those losses turn out to be heavily concentrated among its middle- and upper-income segments, and indeed have been partially offset by increasing support for Democratic candidates among working-class whites with low incomes.

Whereas the rows of Table 1 differentiate Frank’s white working-class voters on the basis of income levels, the columns present separate tabulations of changing Democratic support for the South and for the rest of the country.[4] These separate tabulations suggest a third and even more striking lacuna in Frank’s account of the decline in Democratic support among white working-class voters over the past half-century. Focusing on the overall trends, in the first row of the table, we see that the Democratic presidential vote share has declined by almost 20 percentage points among southern whites without college degrees. Among non-southern whites without college degrees it has declined by one percentage point. That’s it. Fourteen elections, 52 years, one percentage point.

The remaining entries in the table provide similar comparisons of southerners and non-southerners within each income segment of Frank’s white working class. In every case, we see a similar 20-point gap between the South and the rest of the country. Among the most affluent segment, the difference is between a substantial ten-point Republican shift outside the South and a massive 32-point Republican shift in the South. Among the least affluent segment, a ten-point Republican shift in the South has been more than counterbalanced by an 11-point Democratic shift in the rest of the country. (On the other hand, within each region we see a similar 20-point difference in the shifts observed among voters in the top and bottom thirds of the income distribution; the economic and regional trends are largely independent and both quite powerful.)

To a good approximation, then, the overall decline in Democratic support among voters in Frank’s white working class over the past half-century is entirely attributable to the demise of the Solid South as a bastion of Democratic allegiance. In the first half of the 20th century the historical legacy of the Civil War and the contemporary reality of Jim Crow racial politics induced southern whites to maintain “unquestioning attachment, by overwhelming majorities, to the Democratic party nationally” (Key 1949, 11). However, dramatic action on civil rights issues by national Democratic leaders in the early 1960s precipitated a momentous electoral shift among white southerners (Carmines and Stimson 1989), eventually replacing an anomalous Democratic majority with a much less anomalous Republican majority.

"The Dollar's Got Further to Slide"

Richard Clarida says the fall in the dollar isn't over yet:

The Dollar's Got Further to Slide, by Richard Clarida, Commentary, WSJ: Nearly every day in recent weeks seems to bring news that the dollar has fallen to record lows against the euro and other major currencies. Important factors include the Fed's bold -- but appropriate -- 50 basis-point cuts in the Federal Funds rate and the discount rate, and the policies we are likely to see in coming months from the European Central Bank and the Bank of England. ...

Since the August 2006 [FOMC] meeting, at which the Fed announced at least a pause if not an end to the interest-rate hike cycle, the dollar [has drifted downward]. [chart] There are several reasons for this, and these reasons suggest the dollar downdraft is likely to continue for some time to come. First, the U.S. economy in the second half of 2006 slipped into what has now been more than a year of below-trend growth. Moreover, this occurred in the context of buoyant global growth...

This relative U.S. underperformance is likely to continue, as the economy works through the headwinds of the housing contraction and consumer retrenchment in the face of tighter credit conditions and a soft labor market. But a U.S. recession is not necessarily in the cards, in large part because the Fed will probably ease more in future months to provide insurance against an economic contraction. ...

It appears as though the trade deficit has peaked, and it starting to decline as a result of slower U.S. growth, a robust global economy, and a weaker dollar. Indeed, all of the increase in the trade deficit between 2004 and 2006 was due to higher oil prices. The non-oil trade deficit has been more or less constant since 2004, and is now starting to show clear evidence of decline. ...

As the U.S. economy moves from being an engine of global growth to a path that is in line with the average of other major countries, the trade deficit will narrow and a weaker dollar will be part of that adjustment. This adjustment need not be inflationary.

Currencies can depreciate because of bad monetary policy, as was the case for the U.S. in the 1970s. But they can also depreciate with sound monetary policy if currency adjustment is called for -- as it is now -- to rebalance the domestic and global economies as the U.S. trade deficit shrinks.

The world financial system is undergoing an evolution, as economies from Asia to the Middle East to Europe allow more flexibility in their exchange rates and/or peg them against a basket of currencies and not just the dollar.

Reserve diversification will continue, and sovereign wealth funds will likely invest across a broader range of assets than reserve managers do at present. All of these developments will keep the dollar downdraft going for some time.

A U.S. inflation surge is not likely, although the Fed will face upward pressures on inflation from sources that were not so prominent until recent years -- a possible slowdown in productivity growth and booming commodity prices, as well as the weaker dollar.

But ultimately the U.S. inflation rate will be up to the Fed. At present, with core inflation measures within the Fed comfort zone, and payrolls contracting, the Fed is now rightly focused on cutting interest rates to preempt a U.S. recession.

"Psychologists vs. Economists"

No comment:

Psychologists vs. economists, by Andrew Gelman: This is fun because, as an outsider to both fields, I can just stand back and watch.  Dan Goldstein writes:

Someone agreed to give a talk to the University Economics Society here next week with the title: “Why Psychologists know more about Economic Behaviour than Economists”. Any suggestions JDMers might have would be interesting.

The query led to "a flurry of responses," including:

You could exploit an inadvertent ambiguity in your talk title, and claim that you meant that psychologists know more about economic behaviour than they do about economists. Indeed, economists are mysterious beings. Many persevere in the belief that people must behave optimally, at least on average, and they seem perpetually baffled by basic psychological phenomena that seem completely intuitive to one’s proverbial grandparent. I feel that psychologists indeed understand them quite poorly.

Perhaps the core argument is that we [Psychologists] go out and look at the animals (at least now and then) while the economists very rarely do.

The answer seems to be quite simple. Economists are bound to the ‘rational model’ whereas psychologists are not.

What economists think about psychologists:
1. Psychologists only study rats, pigeons, college freshman, and crazy people.
2. (Perhaps due to the above,) psychologists are not very rational.
What psychologists think about economists:
1. Economists stubbornly hold to a rational model of man(kind) that (they must know) is obviously wrong.
2. Economists can never agree about what will happen to our economy.

I'll now give a few comments of my own. First, my impression is that, within academia, economics has a higher status than psychology. Thus you see psychologists sniping at economists but not much of the reverse: economists probably don't spend much time thinking about psychologists. It reminds me of when I used to teach at Berkeley: we could always get a rise out of the students by mentioning Stanford. But, at Stanford, if you mention Berkeley, nobody cares.

On the substance of the matter, of course psychologists will be able to explain some aspects of economic behavior better than economists can, and economists will be able to explain other aspects of economic behavior. I'd trust the economist more on the price of food and I'd trust the psychologist more on the question of what food a person will actually buy. I don't know that either side would know "more" than the other.

Is It Just Bush?

Good question:

Is the US just tired of Bush, or have conservatives had it?, by Michael Tomasky, Commentary, Comment is Free: ...Let me offer what I think is the most important undercurrent question of next year's election: have Americans tired of conservatism, or have they merely tired of corrupt and incompetent conservatism? ...

Americans have now experienced a conservative government failing them. But what lesson will they take? That conservatism itself is exhausted and without answers to the problems that confront American and the world today? Or will they conclude that the problem hasn't been conservatism per se, just Bush...? ...

Conservatives will do their best to convince us it's just Bush, it's not the movement itself that is at fault, but the Iraq war and other failures such as the push to privatize Social Security and eliminate the estate tax came with the full support and approval of conservatives. The bills the Republican congress sent to Bush that increased spending while cutting taxes were certainly not Bush acting alone. And I don't recall conservatives objecting when the administration rewarded political allies with positions within the administration or by awarding them government contracts, a key part of the administration's collapse when events like Katrina and Iraq revealed the consequences of such patronage. It's hard to deny that the Bush administration suffers from competency problems, and part of the article linked above says Republican candidates are attempting to exploit that to their advantage, but I don't think it's Bush alone that is the problem. For the most part, he has been faithful to the conservative movement and, when Republicans had a majority, rubber stamped whatever congress sent his way.

So my answer is all of the above, that it's both not one or the other. Bush certainly hasn't helped the conservative movement, but the policies and the less than desirable results that have followed in Iraq and elsewhere cannot be attributed to Bush acting outside of core conservative principles.

links for 2007-10-23

• Poole Sees Improvement but Says Threat Remains - WSJ Economics Blog
• Deflation in Japan: worse than you think - Vox EU
• Microsoft Concedes in European Antitrust Case - New York Times
• Mortgage Fraud - Arnold Kling
• Agricultural Trade Reforms - Vox EU
• Income and voting - Paul Krugman Blog
• The Long, Dark Night - Bob Herbert - New York Times
• Watching Your Neighbor's Driveway - Zubin Jelveh
• How to encourage the road-to-rail shift in Europe - Vox EU
• Which intervention would do the most to improve the health of the extreme poor? - EurekAlert

Preaching to the Converted

I hear the criticism that shrill liberals (or even shriller conservatives) do nothing but preach to the converted, hence they provide no useful function:

Malefactors of Megawealth, by David Kennedy, NY Times: ...Like the rants of Rush Limbaugh or the films of Michael Moore, Krugman’s shrill polemic may hearten the faithful, but it will do little to persuade the unconvinced or to advance the national discussion of the important issues it addresses. It may even deepen the very partisan divide he denounces.

I think this is wrong, and not just because of the silly equivalence drawn between Limbaugh and Krugman. First, I don't buy that these voices cannot reach beyond the confines of the converted. Given the responses I've seen to Krugman and others, many of these voices penetrate the other side of the political fence quite well, generate responses, and in doing so help to advance national discussion on these issues. I have no doubt, for example, that Krugman has helped to promote national discussion on a variety of issues from health care to inequality to trade policy to Iraq.

But suppose it is true - suppose one does nothing but preach to the converted - does that mean there is nothing useful happening in the exchange?

What those with a voice can do is give people the arguments they need to rebut the other side's arguments in the daily exchanges at the water cooler at work, at dinner parties, at family gatherings, and so on. Whenever political arguments come up in the course of conversation they will have heard both the arguments and the counterarguments and they will be much better able to defend their views (and much less likely to be swayed by misleading messages from the other side). Echoing good arguments on various sites can reinforce this effect even if it is mostly talking to people with similar overall views. Thus, even if it's true the someone like Krugman sways nobody directly (a proposition I doubt), there is still an indirect effect where the arguments that he gives to others can be used to win the smaller day to day discussions between people, the discussions that impact the marginal undecided voter.

That's also why I don't mind having (tolerable and rational) conservatives in comments. They make their arguments, then we hear the rebuttal, excellent rebuttal in most cases. The arguments are out there whether I allow them in comments or not, so the important part is to generate effective counterargument that can be used more generally as people interact with others and these arguments come up in the course of the discussion. Winning the little battles in social discussions is important, and preaching to the converted is a key step in enabling people to have the persuasive arguments they need to be effective in arguing for their ideas.

The Great Lie of Supply-Side Economics

I am very pleased to see this, and not just because there's a link to this site. I've been frustrated with the press on the 'Laffer curve, tax cuts have paid for themselves' issue because the press has enabled a big lie. It's a lie Republican candidates, even the president, can still repeat with very little attention from the mainstream media. No matter how often reputable economists on the right and the left have said this is a lie, the press has ignored it and allowed it to continue unquestioned. Some of you around here are probably tired of hearing about it (though see here), but it's a lie with consequences. The tax cuts that went through were sold on false premises - what it costs us is far greater than advocates said, advocates who claimed it would actually increase revenue and cost us nothing. It does cost us, hundreds of billions of dollars so far, and that cost has not been presented honestly to the public by either the advocates of the tax cuts or the press reporting on the issue. Without an adequate understanding of the true costs, the public discussion on the issue is distorted and the result is bad public policy.

The big lie matters, and the sooner the press starts to call politicians on it, the better for us all. There are encouraging signs, Jon Chait's recent book being one example and this being another, but it's still possible to tell the lie with little consequence from the mainstream media. Here's James Surowiecki (whom I've come to respect as an excellent reporter on economics):

The Tax Evasion: The Great Lie of Supply-Side Economics, by James Surowiecki, The New Yorker: In American politics, supply-side economics is the monster that will not die. The supply-side argument that, in the United States, tax-rate cuts pay for themselves ... has little or no support within the mainstream economic profession, and no hard empirical data to back it up. Myriad studies have demonstrated that both the Reagan tax cuts of the nineteen-eighties and the tax cuts put through under the current Administration shrank government revenues and led to bigger budget deficits.

Yet the absence of proof for supply-side theory has not dimmed Republicans’ devotion to it. Last month, President Bush told Fox News that his tax cuts had “yielded more tax revenues, which allows us to shrink the deficit.” Dick Cheney insists that “sensible tax cuts increase economic growth and add to the federal treasury.” Every major Republican Presidential candidate ... is on the record as saying that tax cuts pay for themselves. And, just last week, a New York Sun editorial published a list of what “the Republican Party stands for.” First on the list? “Reductions in top marginal tax rates . . . lead to greater government revenues in the long run.”

This supply-side orthodoxy is striking in a couple of ways. First, it requires Republican politicians to commit themselves publicly to a position that is wrong—and wrong not as a matter of ideology or faith but as a matter of fact. ... Second, despite the fact that the supply-side faith has no grounding in reality, within the Republican Party there is little room for dissent on the subject, as Jonathan Chait details in his new book, “The Big Con.” Last week, the blogger Megan McArdle wrote that she had a book review for an unnamed right-wing publication spiked because in it she dared suggest that, in the U.S., tax cuts decreased government revenues.

The cynical explanation for the persistence of the supply-side dogma is that it’s simply cover for cutting taxes for the rich. But the supply-side orthodoxy has flourished for other reasons, too. To begin with, the absurd idea that tax cuts pay for themselves is based on an idea that is not at all absurd, which is that tax rates can have an impact on people’s behavior. Increase taxes too much, and people may work less ... and invest less..., and so the economy will grow more slowly. The opposite can happen if you cut taxes. (How much of an impact tax rates have ... is a subject of much debate in economics, but it’s inarguable that they do matter.) What supply-siders have done is start with that reasonable idea and extrapolate it to unreasonable lengths.

They’re aided in that extrapolation by the simple fact that the American economy grows over time. As a result, even if you cut taxes the federal government will eventually take in more tax revenue than it once did. And that allows supply-siders to fashion a spurious syllogism: taxes were cut in 2001, government revenues are higher in 2007 than they were in 2001, therefore the tax cuts increased revenue. The comparison that really matters in analyzing the impact of the tax cuts, of course, is ... the comparison between actual tax revenue in 2007 and what tax revenue would have been in 2007 had there been no tax cuts in 2001. And studies that make these types of comparisons—including one by Bush’s own Treasury Department ... find that government revenues would be greater had taxes not been cut. But that hasn’t stopped President Bush from claiming victory.

In one sense, of course, it’s odd that a Republican President should treat higher government revenues as a point of pride. Historically, after all, Republicans have been the party of small government...

The conservative pundit Larry Kudlow recently attacked the Republican candidates for failing, in their most recent debate, to explain what spending cuts they would advocate to accompany the tax cuts they propose. But Kudlow should hardly have been surprised, because supply-side rhetoric suggests that spending cuts aren’t really necessary. ... This tax-cut-and-spend approach is the promise of a free lunch, something that voters like to hear. The appeal of that promise may make it easier for politicians to run a campaign. But the fraudulence of the promise makes it awfully hard to run a government.

Update: Maybe I spoke too soon:

The Case of the Missing Surowiecki Column, by Felix Salmon: Memo to Jeff Bercovici: What's with Jim Surowiecki's column in this week's New Yorker? It's right there on the website – complete with no fewer than nineteen hyperlinks. (Someone give this guy a blog!) But it's in the "online only" section: if you pick up the actual magazine, it skips straight from the Talk of the Town section to the feature well, which means that Surowiecki's "Financial Page" is a page only in metaphor.

The most charitable explanation I can think of is that the New Yorker decided the column was simply too reliant on its hyperlinks to work in print. But if that's the case, why didn't they just ask Surowiecki to write a different column, or to rewrite this one so that it worked in print form? ...

I can't remember Surowiecki ever being banished from the print edition like this before, which is why it's so bittersweet to read this, from Mark Thoma:

I am very pleased to see this, and not just because there's a link to this site. I've been frustrated with the press on the 'Laffer curve, tax cuts have paid for themselves' issue because the press has enabled a big lie. It's a lie Republican candidates, even the president, can still repeat with very little attention from the mainstream media. No matter how often reputable economists on the right and the left have said this is a lie, the press has ignored it and allowed it to continue unquestioned.

He's writing, of course, about Surowiecki's column, which is about supply-side economics. And it turns out that the one time he singles out "the press" for praise in exposing the lie is also the one time that the article remains unprinted by any physical press.

Paul Krugman: Gone Baby Gone

Paul Krugman is unimpressed with Treasury Secretary Paulson’s rescue plan for financial markets:

Gone Baby Gone, by Paul Krugman, Commentary, NY Times: It pains me to say this, but this time Alan Greenspan is right about housing. ...[H]is latest pronouncement — that the market rescue plan being pushed by Henry Paulson, the Treasury secretary, is likely to make things worse rather than better — looks all too accurate.

To understand why, we need to talk about the nature of the mess. ... Today, when a bank makes a home loan, it ... quickly sells the mortgage off to financial engineers, who chop up, repackage and resell home loans pretty much the way supermarkets chop up, repackage and resell meat.

It’s a business model that depends on trust. You don’t know anything about the cows that contributed ... to your ... ground beef, so you have to trust the supermarket when it assures you that the beef is U.S.D.A. prime. You don’t know anything about the subprime mortgage loans that were sliced, diced and pureed to produce that mortgage-backed security, so you have to trust the seller — and the rating agency — when they assure you that it’s a AAA investment.

But in the case of housing-related investments, investors’ trust was betrayed. Supposedly safe investments suddenly turned into junk bonds when the housing bubble burst. ...

Thus, when two hedge funds run by Ralph Cioffi of Bear Stearns imploded last summer, it came as a huge shock to many investors, and helped trigger a market panic. ...

The funds borrowed huge amounts, and invested the proceeds in questionable mortgage-backed securities. Even worse, “more than 60 percent of their net worth was tied up in exotic securities whose reported value was estimated by Cioffi’s own team.” We’re profitable because we say we are — just trust us. That hasn’t ever caused problems, has it?

Stories like this have led to a crisis of confidence..., and ... people are parking their money in government debt because they don’t trust private borrowers. And the result is a shortage of liquidity — the ability to raise cash — that is greatly damaging the economy.

Which brings us to the rescue plan proposed by a group of large banks, with Mr. Paulson’s backing.

Right now the bleeding edge of the crisis in confidence involves worries that there may be large losses hidden inside so-called “structured investment vehicles” — basically hedge funds that borrow from the public and invest the proceeds in mortgage-backed securities. The new plan would create a “super-fund” ... which would seek to restore confidence by, um, borrowing from the public and investing the proceeds in mortgage-backed securities.

The plan, in other words, looks like an attempt to solve the problem with smoke and mirrors. ...

[T]he bursting of the housing bubble means that someone, somewhere, has to accept several trillion dollars in losses. A significant part of these losses will fall on mortgage-backed securities. And given this reality, the “conduit” looks like a really bad idea.

I’d put it like this: Investors aren’t putting their money to work because they don’t know where the bad debts are. And when investors need clarity, the last thing you want to be doing is pumping out more smoke.

Mr. Greenspan’s take ... seems broadly similar. “If you believe some form of artificial non-market force is propping up the market,” he said, “you don’t believe the market price has exhausted itself.”

Translated: this rescue scheme could be seen as an attempt to hide the bad debts everyone knows are out there, and as a result could delay any return of trust to the markets.

Alan Greenspan is making sense.

Leonid Hurwicz

The "oldest person ever to be recognized by the Swedes, in any discipline":

The Road to a System that Works (Without Shooting People), by David Warsh, Economic Principles: ...It is a truism that most Nobel Prizes are won by researchers who tumble onto their topics in their twenties and often have all but nailed them down by their late thirties. Thus, even before they left Harvard University, where they had been undergraduates and graduate students in the 1970s, Eric Maskin ... and Roger Myerson ... were firmly on the trail of the ideas that led to their recognition last week, "implementation theory" and "the revelation principle." Both men are 56.

How is it that Leonid Hurwicz, of the University of Minnesota, shares the spotlight with two economists more than thirty years younger? At 90, Hurwicz is the oldest person ever to be recognized by the Swedes, in any discipline. There has to be a story in that.

The modern theory of mechanism design, as presented today in microeconomics texts, is a hard-edged and high-tech topic, especially auction theory -- a body of knowledge that informs the sale of radio-spectrum licenses and timber-harvest rights; structures cap-and-trade emissions schemes and incentive systems designed to lead expert panelists to tell the truth; and which determines the price of advertising on Google and the mechanics of transactions on eBay. The theory is not complete, of course; far from it. Even the best-understood mechanisms, auctions, are no more than a metaphor for more general forms of competition.

But in fact the roots of our understanding of economic mechanisms trace back to a topic intensely debated by European intellectuals in the years immediately after World War I -- could a planned economy, such as that of Germany during the war, succeed? Could patriotic bureaucrats, operating without the benefit of markets, prices and money, be depended on to make better decisions than self-interested entrepreneurs? ...