Tuesday, July 22, 2008
Monday, July 21, 2008
"Macroeconomic Dynamics and (Present and Future) Income Distribution in Argentina: a Lucas’ Critique View"
From the Latin America EconoMonitor, a colleague, Nicolas Magud, on plans for fiscal stimulus in his native home of Argentina:
Macroeconomic Dynamics and (Present and Future) Income Distribution in Argentina: a Lucas’ Critique View, by Nicolas Magud: The export tax law that Argentina’s president submitted to Congress ended as a complete failure for the current administration—the more so since it was finally rejected by the negative vote of the vice-president. However, I look at the episode as the best outcome possible for the current administration. It actually gave the government the ability to start afresh. The vice-president rejection actually enabled the president to obtain an elegant way out of an economic mistake—with potential social unrest. Will the president take advantage of this? Although I truly hope that “words” will actually be contradicted by “facts”, as of today I am inclined to think the answer is not—details follow.
Alex Tabarrok wonders what you will think about this. I don't have the institutional details I need to comment, and time is short this morning, so I'll leave it to all of you to to analyze the claim made below that Medicare Advantage programs do not cost more than traditional Medicare programs. But there doesn't seem to be any evidence here that Medicare Advantage programs cut health care costs to any significant degree - the main concern in health care reform - nor is it clear how the program will solve the adverse selection problems. As Krugman, one of the targets of Alex's post, says, "a ... private system ... has never worked for the elderly, for whom adverse selection issues are especially acute." Alex argues that adverse selection is unimportant in these markets, but that runs counter to the general view of how these markets operate:
Democrats Proudly Cut Medicare Benefits, by Alex Tabarrok: Last week Congress cut benefits to Medicare recipients and liberal pundits applauded. Indeed, Paul Krugman said this was "Kennedy's Big Day" and "the first major health care victory that Democrats have won in a long time." Of course, Krugman and the others who applauded this "victory" didn't say that they were cutting Medicare benefits - even though that is exactly what they were doing - instead they framed the victory as one over privatization and waste. Here's the story.
Medicare beneficiaries can enroll in Medicare's fee for service plan or they can choose Medicare Advantage joining, for example, an HMO. In the latter case, Medicare pays the HMO a rate per enrollee and the HMO competes to obtain enrollees by offering them a package of benefits and premiums.
Now what you will be told about Medicare Advantage is that it is more expensive than traditional Medicare. Thus the CommonWealth Fund says:
Private Medicare Advantage (MA) plans were paid an average 12.4% more per enrollee in 2005 compared with what the same enrollees would have cost in the traditional Medicare fee-for-service program...
That much is true. But why are MA programs more expensive? The answer, which one gets by innuendo and implication, is that Medicare Advantage programs are wasteful and the extra money is being pocketed by corporations. ...
Thus the message is that traditional Medicare is cheaper because it eliminates the middleman, doesn't involve private corporations, and is more efficient at lowering costs. None of this is true. ...
Here is how the MA program pays a private provider (quoting the CBO).
Private plans that want to participate in the Medicare Advantage program must submit bids indicating the per capita payment for which they are willing to provide Medicare’s Part A (Hospital Insurance) and Part B (Supplementary Medical Insurance) benefits—and to take on the financial risk of doing so.
The government compares those bids with county level benchmarks that are determined in advance through statutory rules. The benchmarks are the maximum payment the government will make for enrollees in private plans; in most cases the plans’ bids (and the resulting payments) are lower than the benchmarks....
If a plan’s bid is less than the benchmark, Medicare pays the plan its bid plus 75 percent of the amount by which the benchmark exceeds the bid.
So far you might think that Krugman et al. have a point. If the benchmarks are set too high and Medicare pays the plan its bid plus 75% of the amount by which the benchmark exceeds the bid then the plans could bid their costs and get extra payments. ...[H]ere is the kicker (quoting the OMB again, italics added):
If a plan’s bid is less than the benchmark, Medicare pays the plan its bid plus 75 percent of the amount by which the benchmark exceeds the bid. Such a plan must return that 75 percent to beneficiaries as additional benefits or as a rebate of their Part B or Part D premiums.
Now the solution to our puzzle becomes clear. Why do beneficiaries choose MA plans?
...because such plans provide additional benefits beyond those available within traditional Medicare, including coverage for services not covered by FFS Medicare (for instance, dental services) and cash rebates of premiums or reduced cost-sharing.
In fact, the OMB estimates that the vast bulk of the increased payments to private providers flow to enrollees who get better benefits and lower payments. Indeed, in the case of HMOs enrollees benefit twice - first because the benchmarks are higher and second because, contra Krugman et al., the HMOs actually have lower costs than traditional Medicare! Thus the OMB writes:
In contrast, payments to HMOs averaged 10 percent above FFS costs...On average, HMOs offered extra benefits and rebates equal to 13 percent of FFS costs; those additional benefits and rebates reflected the difference between the benchmark (which averaged 10 percent above FFS costs) and the plans’ bids (which averaged 3 percent below FFS costs).
That could be written more clearly but what they are saying is that Medicare pays HMOs 10 percent more than they would pay for an enrollee in traditional Medicare but the HMOs offer the enrollee 13 percent more worth of extra benefits and rebates. In other words, the HMOs pass on to the enrollee all of Medicare's "extra payments" plus some. ...
Now, I am not saying that higher Medicare payments are a good idea. But I dislike the fact that politicians are being lauded for fighting "wasteful privatization" when what they are really doing is cutting medical benefits for the elderly.
Douglas Irwin reviews Jagdish Bagwati's new book:
How Free Is Free Trade?: Bhagwati's 'Termites in the Trading System', by Douglas A. Irwin, Book Review, NY Sun: ...In "Termites in the Trading System," [Jagdish Bhagwati] argues that not all trade deserves our equal support, ... and mounts a brisk and spirited attack on preferential, so-called "free trade" agreements...
Why is one of the world's staunchest supporters of free trade protesting so passionately against this method of reducing trade barriers? ... The right way to reduce trade barriers, he explains, is on a multilateral basis and in a nondiscriminatory way. After World War II, America led the world in creating the General Agreement on Tariffs and Trade (GATT), which did just that... In recent years, however, countries have increasingly bypassed this system. Now, it is common for two or more countries to agree to eliminate tariffs and reduce other trade barriers for each other, but not for others... Under Bush, America has concluded ... CAFTA ... and a series of bilateral agreements with countries ranging from Oman to Australia, and — most recently and controversially — Colombia.
The main problem with these bilateral and regional agreements is that they exclude other countries. In Mr. Bhagwati's view, they are more accurately called "preferential" trade agreements because they discriminate against non-participating countries. ...
By introducing discriminatory treatment into the trading system, the movement toward preferential trade agreements sacrifices economic efficiency and, perhaps more troublingly, throws the carefully constructed postwar system into disorder. Instead of having one common multilateral system, ... Mr. Bhagwati ... has referred to this as the "spaghetti bowl" system, in which these agreements create a tangled mess of restrictions and regulations, ultimately disrupting rather than promoting free trade.
Mr. Bhagwati ... instead ... makes a strong case for opening trade much more aggressively at the multilateral level — with all-inclusive and nondiscriminatory agreements. ... There is little doubt that Mr. Bhagwati is right in his preference for multilateral and universal agreements, but he does not resolve the problem faced by those who support free trade ... and who may need to take a position on bilateral agreements...
As the Colombian example suggests, many "free trade" agreements are motivated by foreign policy considerations. ... An alternative hypothesis is that politicians are not seeking to enhance economic efficiency or improve the world trading system, but have other, political objectives in mind.
In the end, Mr. Bhagwati concedes that "halting the formation of [preferential trade agreements] is no longer a possibility." He pins his hopes on mitigating their adverse effects on trade by reducing overall trade barriers to such an extent that preferences and discrimination do not matter all that much. That in turn depends upon future unilateral efforts at trade liberalization and further progress at the WTO. ...
For more, see this recent post, or see Richard Baldwin's "Multilateralising Regionalism: The WTO’s Next Challenge." He argues, correctly I think, that the WTO must take an active role in turning bilateral and regional agreements into multilateral, all-inclusive, nondiscriminatory arrangements.
Glenn Hubbard says the Fed can't do it alone:
We're Asking Too Much of the Fed, by R. Glenn Hubbard, Commentary, WSJ: The combination of eye-popping headline inflation of 5% year over year and dramatic expansions of the Federal Reserve's lending activities to limit the credit crunch raise a key question: Are we asking too much of monetary policy?
The simple answer is yes. The expansion of the Fed's lending has been extraordinary in scale and scope. But it is not the best response to the present credit crunch, and may bring unwelcome side effects. ... moral hazard. ... ... inflationary pressures. ...surging commodity prices ... weakness in the foreign-exchange value of the dollar. ...
It is asking a lot for monetary policy alone to carry the burden of supporting aggregate demand. Fiscal policy can play a role. Congress and President Bush did pass an economic stimulus package centered on tax rebates. But clarity about a positive future for the 2001 and 2003 tax cuts which bolster collateral values -- along with a cut in corporate tax rates to promote investment -- would offer a much more potent tonic. ...
I agree that Fed policy alone may not be enough to get the economy back on track, I've argued that for a long time. But tax cuts are not the only option for stimulating the economy, government spending can also be used, and in theory on short-run stabilization policy, a one dollar increase in government spending has a bigger impact on GDP than a one dollar tax cut. Infrastructure is an obvious target for spending, it's surely needed, but there are other areas that could use help as well.
If the worry is that the spending will be permanent, Democrats can play the Republican game, but actually mean what they say. A stimulus should be temporary, so - just like the Republicans do with tax cuts - put clauses in the legislation that say the spending expires at a certain date. There will be x dollars per year for y years to do z, and that will be it. That way, there's no long-run impact on the budget (unlike the real intent of the tax-cut advocates who, once the economy gets better, will argue against reversing the stimulus measures). If the goal is to stimulate the economy, there's just no need to limit the policies under consideration to some type of tax cut.
- Left-right ideology of voters, congress, and senators - The Monkey Cage
- McCain Still Lying or Ignorant About Tax Cuts - Economists for Obama
- Gender and performance under pressure: new evidence - Vox EU
- Shouldn't Cindy McCain release 10 years of full returns? - ataxingmatter
- Not So Bad...Yet? - Exuberant Rationality
- A housing-led recession in the making - Vox EU
Sunday, July 20, 2008
The U.S. exhibits considerable inequality relative to other countries - it ranks last in the sample of countries in the first graph in the link below. But the data shown in the graph are for a point in time, a single year - the usual measure of inequality - and thus do not capture income mobility. If there are differences in mobility across countries, then perhaps looking at a longer timeframe that allows for mobility will change the picture. Lane Kenworthy, Markus Gangl, and Joakim Palme look at this issue and find that while longer timeframes are associated with lower Gini coefficients, looking at longer timeframes does not improve the position of the U.S. relative to other countries:
I stopped reading the Washington Times for the most part (why doesn't it come under more scrutiny for the things it publishes?), so I haven't read this article. Fortunately I don't have to:
Talk about cash money, money, Sadly No!: The Washington Times ... shows it’s the go-to place for fine analysis of all budget and deficit-related matters. Especially when William F. Shughart II, the F.A.P. Barnard Distinguished Professor of Economics ... is writing.
In February, the $175.6 billion deficit was a single-month record, 46 percent higher than the previous single month high (in February 2007), and nearly $14 billion more than the deficit for all of fiscal 2007, which ended last Sept. 30.
We’ve seen a lot of nonsense written about the deficit, but this is the first time we remember someone going on about the monthly deficit. Because once you start doing that, hilarity ensues. Such as us commenting that the government’s finances are in great shape because it ran a surplus of $159 billion in April. Why — that pretty much cancels out February’s deficit! Hooray!
How should policymakers respond to a financial crisis?:
Financial crisis resolution: It’s all about burden-sharing, by Charles Wyplosz, Vox EU: An old and familiar debate is back. Should taxpayers bail out the US banking system, quite possibly the British and European ones as well?
There are two standard views on the multi-trillion dollar question of who pays for getting us out of the financial crisis.
- One view is that the situation has become so desperate that ordinary citizens will in any case be paying a high price for the crisis; throwing money at banks right now might lower the overall burden by preventing a deep, protracted recession.
- The other view is that banks ought to be left hanging to pay for their sins. Governments ought to be worried about their taxpayers, not bank shareholders.
In fact, we don’t have that much choice.
Saturday, July 19, 2008
Means Testing, for Medicare, by Tyler Cowen, Economic View, NY Times: Right now, ... pressing problems may lie ahead — and the presidential candidates aren’t addressing them.
No matter who sits in the Oval Office next year, there won’t be many degrees of freedom in the federal budget. That’s because spending on entitlement programs is largely locked into place, and the situation will become much worse as Americans age and health care costs rise. ... The main problem is Medicare, which reimburses the elderly for many of their health care expenses. ...
There’s one important idea lurking in the shadows that neither campaign is keen to talk about: paying out government benefits more efficiently. To put it bluntly, it means paying out full benefits only to those who really need them, and cutting back on payments to everybody else. ...
Iraqi Prime Minister Nouri al-Maliki doesn't say so directly, well not quite, but he makes it clear that he thinks Barack Obama's plans for Iraq are superior to John McCain's:
Iraq Leader Maliki Supports Obama's Withdrawal Plans, Speigel: Iraqi Prime Minister Nouri al-Maliki supports US presidential candidate Barack Obama's plan to withdraw US troops from Iraq within 16 months. When asked in and interview with Speigel when he thinks US troops should leave Iraq, Maliki responded "as soon as possible, as far as we are concerned." He then continued: "US presidential candidate Barack Obama talks about 16 months. That, we think, would be the right timeframe for a withdrawal, with the possibility of slight changes."
Friday, July 18, 2008
Tim Duy gives and answer to Brad DeLong's question:
Not So Bad?, by Tim Duy: Brad DeLong is puzzled. Earlier this week, defending Greenspan-era monetary policy,
Now we are not yet out of the woods. If the tide of financial distress sweeps the Fed and the Treasury away--if we find ourselves in a financial-meltdown world where unemployment or inflation kisses 10%--then I will unhappily concede, and say that Greenspanism was a mistake. But so far the real economy in which people make stuff and other people buy it has been remarkably well insulated from panic at 57th and Park and on Canary Wharf.
Today Delong adds:
I still do not understand why the real side of the economy is doing so well in relative terms. The worst financial distress since the Great Depression ought to trigger the worst downturn in demand, production, and employment since the Great Depression. It hasn't--at least not so far.
Good questions; I think economic activity has surpassed most peoples’ expectations. My answer to DeLong’s question comes in three parts:
1. The nature of the expansion defines the nature of the following contraction. The post-tech bubble expansion was anemic by most measures, and never gained much traction until the housing bubble arose. The primary channel through which housing supported the economy was via consumer spending, generating a tepid growth dynamic compared to the equipment and software investment boom of the 1990’s. The tepid upside suggests a tepid downside. I would be more worried if the chart for equipment and software:
looked like the chart for residential investment:
And given trends in new orders, I am hoping it won’t:
2. The impact of the consumer slowdown is partially offshored, a point which I think deserves greater attention. This shifts job destruction to an overseas producer. In fact, as spencer at Anger Bear shows, the recent improvement in the real trade balance has less to do with rising exports, which continue to follow recent trends, than the sharp slowdown in real import growth. Note too that exports are not falling as they were in the 2001 recession as the global economy has held up better than expected.
3. Perhaps most importantly, however, is the massive liquidity injections from the rest of the world, or what Brad Setser calls “the quiet bailout.” In the first half of this, global central banks accumulated $283.5 billion of Treasuries and Agencies, something around $1,000 per capita. This is real money – I outlined the likely implications in January. Foreign CBs are happily financing the first US stimulus package; will they be happy to finance a second? Do they have a choice? Their accumulation of Agency debt is also keeping the US mortgage market afloat. Do not underestimate the impact of these foreign capital inflows. If the rest of the world treated the US like we treated emerging Asia in 1997-1998, the US economy would experience a slowdown commensurate with the magnitude of the financial market crisis. The accumulation of US assets is also forcing an expansion of foreign CB’s balance sheets, creating global monetary stimulus that allows the rest of the world to decouple from the US economy, supporting continued US export growth (see point 2 above).
Ideally, the slowdown remains moderate, allowing for a rebalancing as we expand export and import competing industries domestically, narrowing the current account deficit and eliminating the necessity of foreign official financing. This means accepting a period of time with suboptimal domestic demand growth and structural adjustment. Excessive fiscal stimulus risks testing the willingness of foreign CBs to continue to accumulate US assets. Moreover, I believe that excessive stimulus will eventually foster a more damaging inflationary dynamic, but such a process would likely build over a long period of time – the seeds for the 1970s were planted in the 1960s.
In short: External dynamics play a significant role in explaining the relatively mild US downturn. As long as foreign CBs are willing to accumulate US debt, the US government is willing to issue debt, the Federal Reserve is willing to accommodate the debt with low interest rates, we will avoid the most dire deflationary predictions.
Clive Crook recently:
A startling and profoundly important fact about the US economy has received surprisingly little attention. The educational quality of the country's workers is starting to decline - not just relatively (because other countries are catching up and moving ahead) but also, for the first time, in absolute terms. Over the coming years, baby-boomers departing from the labour force will have better educational qualifications than the younger workers replacing them. If the ultimate source of an economy's ability to grow and prosper is its human capital, the US is in trouble.
[Update: I should have included this too.] The absolute decline is a concern, but maybe the relative comparison isn't so bad, at least for now? This Economic Letter argues that U.S. students do poorly in comparison with other students around the world when the comparison is made in high school, but if the comparison is made when they are older, 26-30 years old, the comparison looks better - U.S. students are in the middle of the group rather than at the bottom. Thus , it appears that U.S. students reap substantial benefits from college (and other post high school learning) relative to foreign students in many other countries, and U.S. students attend college in greater numbers than do foreign students. The question is, though, as foreign countries develop their higher education systems, and if we fail to make the necessary investments in education ourselves, will this advantage persist?:
Can Young Americans Compete in a Global Economy?, by Elizabeth Cascio, Economic Letter, FRBSF: Young Americans entering the labor market today face substantial competition. Employers can look all over the world for workers with the skills to meet their firms' needs. Are young Americans ready for these challenges? The answer isn't obvious. On the one hand, U.S. high school students consistently perform worse on international standardized tests than students in other industrialized countries; on the other hand, the United States generally has maintained the highest college completion rate in the world. Sorting out the net effect of these two phenomena on young Americans' readiness to compete in a global job market has been difficult given the dearth of suitable data.
This Economic Letter summarizes new research by Cascio, Clark, and Gordon (2008) (hereafter CCG) that uses data from the International Adult Literacy Survey (IALS), fielded in the 1990s, to address this issue. The authors estimate the skill levels of 16- and 17-year-olds and 26- to 30-year-olds for the United States and other high-income countries. Consistent with other assessments of the school-age population, the IALS data show that U.S. 16- and 17-year-olds perform poorly relative to their counterparts in other nations. By their late 20s, however, those in the U.S. group in the IALS data compare much more favorably to their counterparts abroad, suggesting that they are able to "catch up" in college or beyond. The authors then discuss why the U.S. "age profile of skill" is so different from that in other countries.
Paul Krugman says if Barack Obama wins the election, one of his first priorities should be to push through a stimulus plan that is "bigger, better, and more sustained than the one Congress passed earlier this year":
L-ish Economic Prospects, by Paul Krugman, Commentary, NY Times: Home prices are in free fall. Unemployment is rising. Consumer confidence is plumbing depths not seen since 1980. When will it all end?
The answer is, probably not until 2010 or later. Barack Obama, take notice.
It’s true that some prognosticators still expect a “V-shaped” recovery in which the economy springs back rapidly... On this view, any day now it will be morning in America.
But if the experience of the last 20 years is any guide, the prospect for the economy isn’t V-shaped, it’s L-ish: rather than springing back, we’ll have a prolonged period of flat or at best slowly improving performance.
Let’s start with housing. ...U.S. home prices fell 17 percent over the past year. Yet ... housing prices probably still have a long way to fall...—... they’re still more than 30 percent above the 2000 level.
Should we expect prices to fall all the way back? Well, in the late 1980s, Los Angeles experienced a large localized housing bubble: real home prices rose about 50 percent before the bubble popped. Home prices then proceeded to fall ... back to their prebubble level.
And here’s the thing: this process took more than five years... If the current housing slump runs on the same schedule, we won’t be seeing a recovery until 2011 or later.
What about the broader economy? ...[T]he last two recessions, in 1990-1991 and 2001, were both quite short. But in each case, the official end of the recession was followed by a long period of sluggish economic growth and rising unemployment that felt to most Americans like a continued recession. ...
These prolonged recession-like episodes probably reflect the changing nature of the business cycle. ... Modern slumps ... have been hangovers from bouts of irrational exuberance — the savings and loan free-for-all of the 1980s, the technology bubble of the 1990s and now the housing bubble. ...
Ending modern slumps is ... difficult because the economy needs to ... replace the burst bubble.
The Fed ... has a hard time getting traction in modern recessions. In 2002,... it kept cutting interest rates, but nobody wanted to borrow until the housing bubble took off. And now it’s happening again. The Onion ... hit the nail on the head with its recent headline: “Recession-plagued nation demands new bubble to invest in.”
But we probably won’t find another bubble — at least not one big enough to fuel a quick recovery. And this has ... important political implications.
Given the state of the economy, it’s hard to see how Barack Obama can lose the 2008 election. An anecdote: This week a passing motorist shouted at a crowd waiting outside a branch of IndyMac, the failed bank, “Bush economics didn’t work! They are right-wing Republican thieves!” The crowd cheered.
But what the economy gives, it can also take away. If the current slump follows the typical modern pattern, the economy will stay depressed well into 2010, if not beyond — plenty of time for the public to start blaming the new incumbent, and punish him in the midterm elections.
To avoid that fate, Mr. Obama — if he is indeed the next president — will have to move quickly and forcefully to address America’s economic discontent. That means another stimulus plan, bigger, better, and more sustained than the one Congress passed earlier this year. It also means passing longer-term measures to reduce economic anxiety — above all, universal health care.
If you ask me, there isn’t much suspense in this year’s election: barring some extraordinary mistakes, Mr. Obama will win. Assuming he wins, the real question is what he’ll make of his victory.
At the end of this article is this statement about the potential consequences of the U.S. government's decision to try to stabilize financial markets by transferring risk to taxpayers:
If the government’s responsibility for this risk starts to fray America’s finances in earnest, its backup plan is apparently to hope that the taxpayers’ creditors—including the Chinese government—continue to consider America too big to fail.
I'm not expecting we'll find out, but is the U.S. too big to fail?
I think that it probably is. It's not in China's interest, or in the interest of oil producing countries, to have a financial meltdown that causes the U.S. economy to go into a deep recession. A deep recession in the U.S. would likely have a large negative impact on the economies of these countries, so they ought to be willing to put some of their financial capital at risk to reduce the chances that a recession will occur.
Thursday, July 17, 2008
A colleague, Bruce Blonigen, on what it will take to revive the Doha round:
Doha’s woes and the long-gun structural issues facing trade negotiations, by Bruce Blonigen, Vox EU: As the current Doha Round languishes, the trend is obvious. Recent rounds of the General Agreement on Tariffs and Trade, and now the World Trade Organization (WTO), have become increasingly lengthy. Initial rounds after the Second World War took a matter of weeks or months. In contrast, the most recently completed negotiations – the Uruguay Round – took more than seven years to complete. The current Doha Round, which began in late 2001, has clearly stagnated – and even if completed, it is likely to achieve very little.
While the trend is obvious, the main drivers of this trend towards ever longer negotiating rounds are far from obvious, though there are a number of suspects.
Questions for William Poole:
Seven Questions: How Bad Will It Get?, Foreign Policy: When William Poole warned in 2003 that Fannie Mae and Freddie Mac lacked the capital to weather a financial storm, his advice went unheeded. Five years later, the outspoken former president of the Federal Reserve Bank of St. Louis is far too polite to say “I told you so,” but he does have a message for the Fed: Wait too long to tackle inflation, and you’ll face an even worse recession in the years to come.
Foreign Policy: What’s your diagnosis of what happened to Fannie Mae and Freddie Mac?
William Poole: First of all, they had too little capital to withstand adverse circumstances. And the adverse circumstances were the severe downturn in housing, the decline in house prices, and the rising default rate on mortgages. I don’t know of anyone who early enough was saying that there would be a major national decline in house prices, so I can’t hold them to that standard, but I can hold them to a standard of holding adequate capital to be able to withstand unforeseen circumstances. That’s what capital is for. ...
FP: Now, there has obviously been some turmoil in the banking sector. ... Analysts are wondering where the line is in terms of what banks are considered “too big to fail.” Where would you draw that line?
WP: I like the way that Greenspan used to put it and probably still does put it, that no firm should be too big to fail. Some might be too big to liquidate quickly and may require some support until they can be wound down, but there should be no firm too big to fail. We don’t know yet what the nature of the bailout of Fannie and Freddie is going to be, but I believe the plan would be to pay off at par all of the regular obligations. They are being turned into full faith and credit obligations of the United States government. ...
FP: NYU economist Nouriel Roubini, who has been sounding the alarm for quite a while, told Bloomberg News that we’re seeing the worst U.S. financial crisis since the Great Depression.
WP: I think that’s right, but let’s go back and revisit the Great Depression for a moment. ... There was a total and complete collapse of the banking system, and the economy that had functioned on credit and deposits was suddenly left to function on hand-to-hand currency. We aren’t anywhere close to that and we won’t get close to that because of ample Federal Reserve resources and also intellectual understanding that would not permit that to happen.
FP: How bad will it get, then?
WP: We are going to have failures of large numbers of firms, financial firms in particular..., failures of smaller commercial banks ... that were the most heavily involved in real estate are the ones at the greatest risk. ...
FP: Meanwhile, consumer prices are rising at their fastest rate in 17 years. Does that mean the Fed is running out of tools to keep growth going?
WP: All the financial turmoil that we’ve just been talking about—the tightening of credit...—that’s putting downward pressure on the economy, and the big increase in fuel prices is also putting downward pressure on real activity. ... There is a growing amount of unemployment in those sectors, and the Federal Reserve is trying to support economic activity by holding the federal funds rate ... at its current level. If the downturn in employment becomes much more severe, the Fed might even cut rates.
Now, to me, the inflation problem is actually part of what is depressing economic activity, because the generalized inflation that I think we have underway—although it’s not showing up in core inflation and wages just yet—is showing up in the depreciating dollar, and the depreciating dollar directly feeds through to increased energy prices and food prices. So, the depreciation itself is leading to depressed economic activity.
Moreover, if the inflation really starts to go into wages and into the core ... price indices—it will probably develop a fair amount of momentum and the Federal Reserve is not going to be able to reverse it even with a tighter monetary policy for probably a year or two, maybe even three. If the policy is too expansionary too long and we end up with a real inflation problem, all we’re doing is trading a bigger recession later for a smaller recession now.
On the too big to fail issue, I don't think it is the size of firms alone that is the problem. For example, suppose that we take a firm too big to fail and break into two smaller firms of one half the original size. If the factors that would have caused the one large firm to fail would have also caused the two smaller firms to fail, then we really haven't accomplished much, the size of the banking disaster will be the same. The problems that affected the GSEs came from factors they did not anticipate, factors that were out of their control. In such a situation, it's not clear to me that having more firms specializing in the same business is any safer than one combined firm. Maybe if there are 100 firms a few will pursue safer strategies and survive, but if we then have 97 smaller banks in trouble rather than just one large bank having problems, the scale of the problem is essentially the same and it would be harder, not easier, to take action to shore up the system since it would take 97 separate arrangements rather than just one.
For that reason, I think regulators should consider the overall size of certain classes of risky activity in addition to the size of individual firms. If a risky activity is too large a component of the financial system, and there isn't adequate backup in the event of widespread default, it doesn't matter whether problems bring down a large number of small firms or one large one, the result will be the same.
I don't mean to say that large firms shouldn't be broken up. Even with a (seemingly) well diversified portfolio, i.e. one that avoids over exposure to any particular type of risky asset, size alone could be a risk should a very large firm fail, though hopefully diversification would make failure less likely. I'm saying that breaking firms up into smaller pieces isn't enough in and of itself to reduce the risk of massive financial meltdown. We also need to worry about the overall magnitude of particular classes of risk and how concentrated those risks are within particular sectors of financial markets. If x is a big part of overall financial activity, i.e. if a bad outcome involving x could cause a financial meltdown, one firm doing nothing but risky activity x isn't much (or any) safer than ten firms doing nothing but risky activity x (scale effects could even increase the likelihood of failure).
So I think three things should come under consideration. First, the size of individual banks. Unless scale effects justify it (a natural monopoly argument, in which case it would be heavily regulated), no firm should to large enough to bring down the economy by itself in the event it fails. Second, no particular class of risky assets should be large enough to pose a threat to the financial system. Either the overall size of the asset class should be constrained, or the degree of risk should be limited. Third, the risk from particular classes of asset should not be concentrated in a small number of firms or concentrated within a particular sector if that group of firms or that sector is, collectively, too big to fail.
Harold Meyerson argues that, due to his adherence to the Republican view that government is always the problem, never the solution, and the Bush administrations realization it had no choice but to embrace government intervention to stabilize the financial sector and the economy, John McCain has little to offer in response to the current economic crisis:
What McCain Economic Policy?, by Harold Meyerson, Commentary, Washington Post: "Government is not the solution to our problem," Ronald Reagan told his fellow Americans in his first inaugural address. "Government is the problem."
For modern American conservatism, Reagan's words may as well have been inscribed on the tablets handed down at Mount Sinai. The market was god and Reagan was its Moses, and Republicans have sworn fealty to both for the past quarter-century. One invariable feature of the 2007-08 Republican primary debates was the effort of each candidate to cast himself as Reagan's one true heir. John McCain proudly recounted how he enlisted as a foot soldier in Reagan's revolution. How was he to know that government was about to become a solution again?
Over the past few months, George W. Bush's administration, which consciously modeled itself after Reagan's, has repeatedly been compelled to bail out private or semi-private financial institutions, re-regulate markets, and rescue beleaguered homeowners. Government, it turns out, is indeed a solution -- at times, the only solution -- for large-scale market failure, a problem not foreseen in the gospel according to Reagan.
Unfortunately for McCain and his fellow Republicans, it's the only gospel they've got. At the very moment when the economy looms larger in Americans' consciousness than it has in decades, McCain comes before the electorate doctrinally adrift. ...
How to explain the McCain campaign's glaring contradictions on economic policy? ... One problem is that McCain himself has no real ideas about how to fix the economy... An even deeper problem is that standard-issue Republican economic policy has run out of plausible mantras. The ritual extolling of markets and denigration of government make no sense at a moment when a conservative Republican administration is rushing to save the markets through governmental intervention.
Or, to use Reagan's construction: Republican economics is not the solution to our problem; Republican economics is the problem -- for our nation, surely, and also for candidate McCain.
Wednesday, July 16, 2008
Robert Shiller says when it comes to commodity prices, images that portray the earth as small and vulnerable matter:
Seeing is believing, by Robert Shiller, Project Syndicate: Could the television image we’ve all seen of the Greenland ice cap crumbling into the ocean because of global warming somehow - indirectly and psychologically — be partly responsible for high oil and other commodity prices? The usual explanation ... focuses on explosive growth in emerging countries, China and India in particular... But psychology also matters in speculative markets, and perhaps that image of the Greenland ice disappearing makes it seem all too plausible that everything else- land, water, even fresh air - is running out too.
Let’s take a case study, the last generalised boom-bust cycle in commodity prices, which caused these prices generally to rise (more or less) from some time in the 1960’s until the 1980’s, and then generally to fall until the mid-1990’s. ...
The conventional “fundamental” explanation for that cycle relates it to ...[t]he 1973-1974 oil crisis... [and the] 1979-1981 oil crisis... The drop in oil prices after the mid-1980’s is said to be due to the collapse of the OPEC oil cartel. But ... these events don’t really explain why prices of other commodities followed that of oil.
Maybe more important than those wars in the 1970’s was that people throughout the world got worried about running out of things. This was the time of the “great population scare,” which transformed thinking worldwide, no doubt contributing to higher commodity prices while the fear lasted.
There seemed to be some basis for this scare. The rate of increase in the world’s population rose from 1.8 per cent in 1951 to 2.1 per cent in 1971. But those were just dry statistics. Images likely mattered more. ...
I've had some differences with Barney Frank in the past over Fed policy, but here he makes an interesting point. Why do European central banks respond more aggressively to inflation than the US central bank? Could it be the difference in social safety nets?:
Frank Says Stronger Social Safety Net Would Free Fed, by –Michael S. Derby, Real Time Economics: There are many reasons why the Federal Reserve is boxed in on monetary policy, but Rep. Barney Frank Wednesday found a new dimension to the central bank’s dilemma. ...
Ben Bernanke and his fellow policy makers are facing a worrisome mix of tepid growth, troubled financial conditions and rising price pressures... The weak economy and market tumult call for rate cuts. But the energy-driven price gains and deteriorating expectations for future prices call for rate increases.
That’s left the Fed stuck at its current rate of 2%, very likely for an extended period. But according to Frank, if the U.S. social safety net weren’t so miserly, the Fed might actually have more room to take on inflation. ... “The relative insufficiency of our social safety net vis-a-vis what you have in Western Europe constrains monetary policy,” Frank said.
If the U.S. offered more support for the unemployed and displaced, “the Federal Reserve would then be freer…to slow down the economy in the knowledge this would not have a disproportionately negative effect” on the working population. That part of the population is already losing notable ground in economic terms, he said. ...
And, contrary to what you might hear - sometimes based upon the argument that we are not in a technical recession - "families are facing hardship":
Bernanke: Recession or Not, Families Are Hurting, by Sudeep Reddy: ...At a House hearing, Mr. Bernanke — responding to a lawmaker’s question about Americans’ economic pain ...[and] whether a recession is underway. ...
“Whether it’s a technical recession or not is not all that relevant,” Mr. Bernanke said. “It’s clearly the case that for a variety of reasons families are facing hardship.” ...Mr. Bernanke recounted the “numerous difficulties” facing the economy: “ongoing strains in financial markets, declining house prices, a softening labor market, and rising prices of oil, food, and some other commodities.” ...
As to whether this is a technical recession, “I don’t see why that makes a great deal of difference,” Mr. Bernanke said, adding that the terminology doesn’t play into the Fed’s policy decisions.
In other what are you whining about news, prices are up, and the ability of workers to buy goods and services is down:
U.S. consumer prices soared at their fastest annual pace in nearly two decades last month... Even more worrisome for policymakers than the headline inflation jump may be signs that food and energy prices are starting to filter through the broader economy, as evidenced by sharp price gains last month in housing, transportation and services. ...
The consumer price index jumped 1.1% in June..., the second-highest increase since 1982 and the highest since 2005. Excluding food and energy, it advanced 0.3%. ...
Consumer prices swelled 5% on a year-over-year basis, the highest rate since May 1991. The core CPI grew a more modest 2.4% compared to June 2007, though that's still well above the Fed's long-term goal of 1.5% to 2%. Over the past three months, core inflation rose at a 2.5% annual rate. ...
In a separate report, the Labor Department said the average weekly earnings of U.S. workers, adjusted for inflation, fell 0.9% in June, suggesting incomes aren't keeping pace with prices...
I'm not sure that I agree with Robert Reich that the episode we are currently experiencing proves that the Great Moderation was more luck than anything else, particularly that it disproves Fed policy made any difference. There is a lot of empirical evidence pointing to more aggressive inflation fighting as a key factor in the Great Moderation (e.g. Has Monetary Policy become More Effective? by Jean Boivin and Marc P. Giannoni, and On the Sources of the Great Moderation by Jordi Galí and Luca Gambetti are two recent contributions in this area), and we don't know how bad the current episode might have been had the Fed, say, followed a 1970s-type policy prescription (that is, even though we had bad luck - a large shock hit causing large effects - without moderation through Fed policy the state of the economy could have been much worse). But I do agree with his call for increased social insurance:
The End of the Great Moderation, the Bailouts of Freddie & Fannie and Wall Street, and the Tattered Safety Net for Everyone Else, by Robert Reich: As we bail out Wall Street along with Freddie and Fannie and all the top financial executives who have been pocketing tens of millions a year, yet allow millions of homeowners and jobless Americans to sink, it's worth contemplating what's happening to the American economy and to our social safety nets.
What economists have called "The Great Moderation" - a period when the business cycle evened out, and neither inflation nor recession posed much of a threat- began in the mid-1980s, and now appears to be over. It was good when it lasted. But it led the nation to think we didn't need much by way of social insurance.
No one knows for sure what caused the Great Moderation. Some had credited increased sophistication of financial markets and the wisdom of the Federal Reserve Board. Hindsight suggests it was more luck than anything else.
Well, folks, it turns out the great moderation was something of a fluke, and now tens of millions of Americans are in trouble with no safety net to help them.
That's because the apparent end of the boom and bust cycles led us to assume the economy would no longer impose huge, unexpected, and arbitrary losses on large numbers of Americans. So we basically got rid of the safety nets. We abolished welfare, let unemployment insurance wither, and paid scant attention when corporations eliminated defined-benefit pensions and cut health insurance benefits. We even stopped worrying about the safety of small investors, allowing federal deposit insurance to shrink as a proportion of total savings (witness the recent bank run in California).
But now we have to rethink safety nets. Right now, nets are being spread for the wrong people. The giants of Wall Street along with Fannie and Freddie get bailed out but there's still no relief in sight for most homeowners who can't pay their mortgages. Corporations that don't deliver on their pension obligations are helped but there's nothing for retirees and small investors whose savings are drying up because of Wall Street's decline. Small investors are losing their shirts but the Fed stands by to help the biggest.
Yet I have to believe the end of the Great Moderation will eventually result in a broader safety net. Maybe not the old forms of social insurance, but new ones like universal health insurance, earnings insurance, and savings accounts in which the dollars you put away are supplemented by government dollars.
The very rich, fattest investors, and the biggest corporations don't need safety nets. Now that the booms and busts are back, the rest of us do.
I don't advocate protecting the financial system to bailout the "very rich, fattest investors, and the biggest corporations," it's the people who would need the social safety net if the broader economy fails that are the concern. We need both enhanced social insurance and a stable financial system. For stabilizing the financial system, the trick going forward will be to develop mechanisms that are able to prevent financial meltdowns, but avoid rewarding the people who brought about the potential for collapse. I think regulation that prevents behaviors that lead to these kinds of problems is our best chance, but we can't anticipate everything possible problem that might occur and there are times when insuring against collapse requires us to hold our noses and clean things up as best we can. But that should be a last resort. As for how the social safety net fits into this, much like the ability to fight inflation, the ability to discipline market participants - to let those who made bad bets, bad decisions, etc. suffer losses or other penalties - is also enhanced when a stronger social safety net is present.
Jim Hamilton argues that Fannie and Freddie are partly to blame for "causing the underlying problem we face today":
Did Fannie and Freddie cause the mortgage crisis?, by Jim Hamilton: Some thoughts about the role played by the GSEs in the run-up in mortgage debt and house prices.
Paul Krugman ably lays out the case for why it's conceivable that Fannie and Freddie could have made a contribution...
Fannie and Freddie had purchased $4.9 trillion of the mortgages outstanding as of the end of 2007, 70% of which the GSEs had packaged and sold to investors with a guarantee of payment, and the remainder of which Fannie and Freddie kept for their own portfolios. The fraction of outstanding home mortgage debt that was either held or guaranteed by the GSEs (known as their "total book of business") rose from 6% in 1971 to 51% in 2003. Book of business relative to annual GDP went from 1.6% to 33%.
Sum of retained mortgage portfolio and mortgage backed securities outstanding for Fannie and Freddie (from OFHEO 2008 Report to Congress) divided by (1) total 1- to 4-family home mortgage debt outstanding (from Census for 1971-2003 and FRB for 2004-2007) and (2) annual nominal GDP.
The fact that the volume of mortgages held outright or guaranteed by Fannie or Freddie grew so much faster than either total mortgages or GDP over this period would seem to establish a prima facie case that the enterprises contributed to the phenomenal growth of mortgage debt over this period. Krugman nevertheless concludes that the GSEs aren't responsible for our current mess. ...
For my part, I have two questions for those who take the position that the GSEs played no significant role in causing our current mortgage problems. First, what economic justification is there for the dramatic increase in the share of loans guaranteed or held by the GSEs between 1980 and 2003 that is seen in the first graph presented above? What sense did it make to increase the ratio of such loans to GDP by a factor of 12 over this period?
Second, what forces caused the explosion of private participation in a much more reckless replication of the GSE game? A year ago, I suggested one possible answer-- private institutions reasoned that, because the GSEs had developed such a huge stake in real estate prices, and because they were surely too big to fail, the Federal Reserve would be forced to adopt a sufficiently inflationary policy so as to keep the GSEs solvent, which would ensure that the historical assumptions about real estate prices and default rates on which the models used to price these instruments were based would not prove to be too far off.
Is that the answer to the second question? I'm not sure. But if anybody has a better answer, I'd still like to hear it.
In the mean time, I very much agree with Krugman that the most egregious problems were not caused by anything Fannie or Freddie themselves did. But I disagree that their actions played no role in causing the underlying problem we face today.
Justin Fox has a nice summary of some of the main events in the 1980s and 1990s in terms of mortgage share:
Fannie Mae started life in 1938 as a government agency, the Federal National Mortgage Association, and was privatized in 1968. Congress created Freddie — the Federal Home Loan Mortgage Corp. — in 1970 to give it some competition. For years the two companies operated on the fringes of the mortgage market, which was dominated by savings & loan companies. But after the S&L collapse of the 1980s, Fannie and Freddie swept in to take over. The widespread assumption that government would step in if they faltered allowed them to borrow money at only slightly higher rates than the U.S. Treasury, which meant they could outbid all competitors in the secondary mortgage market. Before long 60% of all mortgages made in the U.S. were passing through their hands, and their share would have been even higher if they weren't banned from buying loans above a certain size ($417,000 in 2007) and generally required to stay away from exotic loans and borrowers with poor credit. For a time in the mid-1990s, before the wave of bank megamergers that brought us the likes of Citigroup and J.P. Morgan Chase, Fannie Mae was the biggest financial institution, by assets, in the country.
Fannie and Freddie did get lots of flak, mostly from people on the political right, for taking risks for which taxpayers might eventually have to foot the bill (and, from other quarters, for its top executives' outsized pay packages). Both companies also got tangled in accounting scandals in 2003 and 2004. But more shocking was what followed from 2004 through 2006: The two mortgage giants got muscled aside by Wall Street firms willing to underwrite bigger, riskier mortgages than Fannie and Freddie were allowed to touch. Their joint market share fell to only about 25% in 2006.
In other words, Fannie and Freddie were mostly bystanders to the worst excesses of the housing bubble. Since it popped, they and the more explicitly government-backed team of the Federal Housing Administration and Ginnie Mae (which buys FHA-insured loans) have been crucial to keeping the mortgage and housing markets going. In January, Congress raised Fannie's and Freddie's loan limit temporarily to as much as $729,750 to aid struggling high-priced housing markets on the coasts.
With house prices falling in most of the country, though, even the relatively safe loans acquired by Fannie and Freddie are starting to turn sour at much higher-than-expected rates.
Update: Paul Krugman:
Why Fannie and Freddie got so big, by Paul Krugman:...Jim Hamilton asks why Fannie and Freddie grew so much in the years before the surge in subprime lending. Justin Fox had already suggested that Fannie/Freddie were taking the place of the savings and loans, after the crisis of the 1980s. Well, if I’m reading this data (xls) right, that’s pretty much the whole story. This graph shows the share of savings institutions and “agency and government-sponsored enterprises-backed mortgage pools” in total mortgage holdings:
Now here’s the thing: S&Ls are private, profit-making institutions whose debt (in the form of deposits) is guaranteed by the federal government. Fannie and Freddie are private, profit-making institutions whose debt is implicitly guaranteed by the federal government. It’s not clear to me that the switch shown here led to any net socialization of risk.
The S&L story, of course, ended in catastrophe, because deregulation led to an explosion of bad lending. That didn’t happen with Fannie and Freddie, at least not to anything like the same extent.
What did happen was an explosion of risky lending by other parties, which crowded out the GSEs; you can see that at the end of the figure (which runs up to 2006). So I stand by my view that Fannie and Freddie aren’t the big story in this crisis.
Here's another graph with a bit more detail from the post from last year Jim Hamilton references above. Note the spike in asset backed securities at the end that matches the decline in lending from GSEs:
Tuesday, July 15, 2008
Jeff Frankel says Republican proposals to increase oil extraction within our borders are at odds with both environmental and energy security goals:
Offshoring is a More Dubious Policy, When the Question is Oil Drilling, by Jeff Frankel: President Bush yesterday removed a long-standing executive moratorium on off-shore oil drilling..., a move also supported by presidential candidate John McCain. ... No doubt ... that it is a political stunt. A Congressional ban on offshore drilling has been in effect since 1981, so the President’s action is moot. ...
[B]oth parties are responding (unsurprisingly) to the American public’s great sensitivity to short-term prices for gasoline (in the summer) and home heating oil (in the winter). No doubt high prices are causing a lot of hardship. ...But market prices are high today for a reason. What is the market failure that would call for government intervention in the oil market?
By way of The Rogues in Robes to Digby to Discourse.net to here, a graphic showing Republican dominance in appointees to the federal courts. This shows that, if anything, the courts suffer from a conservative bias, not a liberal bias as you here so often from the right:
Discourse.net adds "And just imagine how monotone this will become if McCain is elected!"
Mark Kleiman notes the implications of the McCain campaign's recent statements about taxes and Social Security:
McCain says: "Slash Social Security benefits", by Mark Kleiman: No, that's not a headline you can expect to read. But it's the truth.
Carly Fiorina says that McCain might raise taxes on rich folks as part of a Social Security deal.
Grover Norquist, speaking as the Grand Inquisitioner of the anti-taxers, more or less replies: "Bullsh*t! I wear McCain's b*lls on my keyring!"
Then comes the punchline:
A McCain campaign spokesman told ABC News Monday that McCain continues to oppose any tax increase as part of Social Security reform, notwithstanding Fiorina's comments.
"The lesson of history is that too many specifics at this point polarize the debate, that is the argument Carly was trying to make," Taylor Griffin said. "However, John McCain does believe that we can fix Social Security without raising taxes. As president, John McCain will call on Congress to develop a bi-partisan solution to Social Security — and if they won't, he will."
Three points here:
1. "Too many specifics at this point polarize the debate" translates into English as "If we told the retirees how completely we plan to shaft them, they might not vote for us."
2. The McCain camp seems to have invented a new idea: unilateral bipartisanship. If Congress doesn't come up with a bi-partisan plan, McCain will single-handedly come up with his own bi-partisan plan.
3. Since McCain has now committed to "fixing" the Social Security "problem" without raising taxes, and since the only two ways of getting projected revenues to match projected benefits is to increase revenues or reduce benefits, it follows that McCain is committed to cutting Social Security benefits. And that's before he has to reduce them again to accommodate the diversion of new money into private accounts.
So not only does McCain think that Social Security is "an absolute disgrace," he knows what he wants to do about it: he'll reduce pensions but not increase taxes on the wealthy.
This seems to me like Christmas in July.
First, I don't want to leave the impression that Social Security is a big problem - it's not. Some tweaks may be needed to bring revenue and benefits into alignment, but it's nothing that can't be handled relatively easily according to current projections.
But McCain believes there is a problem despite the projections (otherwise why would he be talking about fixing it?), and his plan for dealing with it appears to be to cut benefits (I count increasing the retirement age as a cut in benefits and, since you work and pay taxes for more years than before, an increase in taxes as well, so is he ruling this out?). Whether the problem is real or not, his choice of how to deal with it is telling.
Then here's the question. Why hasn't the Obama campaign opened their Christmas gifts and made use of them? Why haven't they gone after McCain's "disgrace" remark regarding Social Security? Have they said anything at all about that? Why haven't they hammered away at some of his statements and the inconsistencies surrounding them about carve-out privatization plans? Will they do anything with the implication identified above that McCain must be planning to cut benefits? Why so much silence from the Obama campaign on the Social Security issue?
This Economic Letter from the Dallas Fed discusses the relationship between exchange rates and economic fundamentals. Can fundamentals predict exchange rate movements? It depends upon how the question is asked, e.g. how far into the future the forecasts extend, but it doesn't look promising.
What about the other way around, can exchange rate movements be used to predict economic fundamentals? The answer here is a bit more positive as there is some evidence that exchange rates are useful in forecasting commodity prices (an NBER Digest on this point follows the Economic Letter):
Why Are Exchange Rates So Difficult to Predict?, by Jian Wang, Economic Letter, Federal Reserve Bank of Dallas: The U.S. dollar has been losing value against several major currencies this decade. Since 2001–02, the U.S. currency has fallen about 50 percent against the euro, 40 percent against the Canadian dollar and 30 percent against the British pound (Chart 1).
These steep, prolonged depreciations have brought a new urgency to understanding the factors that move exchange rates. Some way of forecasting them would allow businesses, investors and others to make better, more-informed decisions. Unfortunately, exchange rates are very difficult, if not impossible, to predict—at least over short to medium time horizons.
Economic differences between countries—in such areas as national income, money growth, inflation and trade balances—have long been considered critical determinants of currency values. However, there’s no definitive evidence that any economic variable can forecast exchange rates for currencies of nations with similar inflation rates.
Economists continue to seek the keys to predicting currency values. Some recent research supports the idea that exchange rates behave like financial assets, whose price movements are primarily driven by changes in expectations about future economic fundamentals, rather than by changes in current ones. These studies suggest that the real contribution of standard exchange rate models may not lie in their ability to forecast currency values. Instead, the models imply predictability runs in the opposite direction: Exchange rates can help forecast economic fundamentals.
John Fernald of the San Francisco Fed gives his view of the economic outlook. The bottom line?:
The relatively strong incoming data suggest that growth in the second quarter was close to trend, after two anemic quarters. Going forward, the continuing and, indeed, intensifying pressures from housing, credit markets, and commodity prices, are likely to weigh on activity for some time. However, the fiscal stimulus program should help support growth in the current quarter.
A more solid recovery should take root in 2009, reflecting some waning of the drags on the economy. In particular, housing should begin to stabilize; credit conditions should gradually ease; and energy and food prices are expected to level off. In addition, the earlier policy easing by the Federal Reserve should provide some cushion for the economy.
Here are more details. I suspect some of you will view the inflation forecast - the third graph from the bottom - with suspicion:
FedViews, by John Fernald, FRBSF: Housing and credit markets remain troubled, and commodity prices have risen further. These factors are likely to weigh on the outlook for some time. In addition, reflecting surging food and energy prices, inflation is an increasing concern.
Monday, July 14, 2008
Wow, here's what's coming (from here):
From the NY Times:
Spending $1 Billion to Restore Fiscal Sanity, by John Harwood, NY Times: Gaffes have commanded presidential campaign headlines lately... Peter G. Peterson wants people to focus on what he considers real news: the nation is going broke.
Because he wasn’t born yesterday, Mr. Peterson, co-founder of the Blackstone Group and a secretary of commerce under President Richard M. Nixon, will spend $1 billion in an effort to get the public’s attention. The money ... will finance a media blitz, starting with a documentary, “I.O.U.S.A.”
The film aims to startle voters and politicians alike, and summon them to the task of closing the long-term imbalance between what the government will take in and what it has promised to pay out, most notably through Social Security and Medicare.
Mr. Peterson, 82, says he yearns for the can-do spirit that helped politicians forged by the Depression finance the G.I. Bill of Rights, the Interstate highway system and the Marshall Plan from the ashes of World War II. ...
“Has something fundamental happened to the character of our people or our societal structure, or has no one stepped up to provide the leadership?” Mr. Peterson asked. “We’re not going to know that until we try.” ...
Though Mr. Peterson has endorsed Mr. McCain, his efforts to control debt are bipartisan, and he has enlisted Robert E. Rubin, President Bill Clinton’s treasury secretary, to make his case. The foundation does not expect the candidates to propose comprehensive solutions while chasing votes; instead, it will pursue the more limited goal of dissuading the candidates from ruling out potential solutions.
At the center of Mr. Peterson’s plan lies “I.O.U.S.A.,” which will be screened for the news media in Washington on Monday and opens in 400 theaters next month. ... “I.O.U.S.A.” hopes to give as much cachet to long-term fiscal policy as “An Inconvenient Truth” gave to environmentalism.
Mr. Peterson’s foundation is planning an active Internet strategy, tapping bloggers and social networks to reach young voters, who typically pay little heed to far-off fiscal obligations. In early 2009, as the new president takes office, the foundation will try to draw attention with programming on public television, and possibly television advertisements and infomercials.
The effort resembles those of public policy advocacy groups, with a big exception: the money Mr. Peterson has put behind it. ... “You can buy a lot of airtime” with $1 billion, Mr. Peterson said. “People are going to hear from us.”
At some point we do have to face budget realities, and if we are going to deal with this problem, which is mainly a problem with rising health care costs (and that will be a problem whether it's paid for publicly or privately), I'd rather have it happen with a Democrats in charge. That way, the process is less likely to result in large cuts to necessary social programs (and we'd be more likely to get universal health care, something that could also help with the health care cost problem).
I haven't seen the movie, so I don't know for sure how the problem is presented, but the little bits shown above lead me to worry that this will create unnecessary fear about the budget in areas where such fear is unwarranted (e.g. Social Security, a place Peterson has focused in the past). The problem is that this can lead to solutions that satisfy ideological or political goals, but don't deal with the major problem. In any case, it looks like the budget hawks are about to become more vocal and aggressive.
Paul Krugman says Fannie and Freddie won't bring down the economy, and they did not cause the difficulties they are experiencing, but that doesn't mean they don't have problems such as under-capitalization:
Fannie, Freddie and You, by Paul Krugman, Commentary, NY Times: And now we’ve reached the next stage of our seemingly never-ending financial crisis. This time Fannie Mae and Freddie Mac are in the headlines, with dire warnings of imminent collapse. How worried should we be?
Well, I’m going to take a contrarian position: the storm ... is overblown. Fannie and Freddie probably will need a government rescue. But since it’s already clear that that rescue will take place, their problems won’t take down the economy.
Furthermore, while Fannie and Freddie are problematic institutions, they aren’t responsible for the mess we’re in.
Here’s the background: Fannie Mae — the Federal National Mortgage Association — was created in the 1930s to facilitate homeownership by buying mortgages from banks, freeing up cash that could be used to make new loans. Fannie and Freddie Mac, which does pretty much the same thing, now finance most ... home loans...
The case against Fannie and Freddie begins with their peculiar status: although they’re private companies with stockholders and profits, they’re “government-sponsored enterprises” established by federal law, which means that they receive special privileges.
The most important of these privileges is implicit: it’s the belief of investors that if ... threatened with failure, the federal government will come to their rescue.
This implicit guarantee means that profits are privatized but losses are socialized. ... Heads they win, tails we lose. Such one-way bets can encourage the taking of bad risks, because the downside is someone else’s problem. ...
But here’s the thing: Fannie and Freddie had nothing to do with the explosion of high-risk lending... In fact, Fannie and Freddie, after growing rapidly in the 1990s, largely faded from the scene during the height of the housing bubble.
Partly that’s because regulators, responding to accounting scandals at the companies, placed temporary restraints on both Fannie and Freddie that curtailed their lending just as housing prices were really taking off. Also, they didn’t do any subprime lending, because they can’t ... by law...
So whatever bad incentives the implicit federal guarantee creates have been offset by the fact that Fannie and Freddie were and are tightly regulated with regard to the risks they can take. You could say that the Fannie-Freddie experience shows that regulation works.
In that case, however, how did they end up in trouble?
Part of the answer is the sheer scale of the housing bubble, and the size of the price declines taking place... The result is a rising rate of delinquency even on loans that meet Fannie-Freddie guidelines.
Also, Fannie and Freddie, while tightly regulated in terms of their lending, haven’t been required to put up enough capital — that is, money raised by selling stock rather than borrowing. This means that even a small decline in the value of their assets can leave them underwater, owing more than they own.
And yes, there is a real political scandal here: there have been repeated warnings that Fannie’s and Freddie’s thin capitalization posed risks to taxpayers, but the companies’ management bought off the political process, systematically hiring influential figures from both parties. While they were ugly, however, Fannie’s and Freddie’s political machinations didn’t play a significant role in causing our current problems.
Still, isn’t it shocking that taxpayers may end up having to rescue these institutions? Not really ..., major financial crisis ... almost always end with some kind of taxpayer bailout for the banking system.
And let’s be clear: Fannie and Freddie can’t be allowed to fail. With the collapse of subprime lending, they’re now more central than ever to the housing market, and the economy as a whole.
Barack Obama says "on my first day in office, I would give the military a new mission: ending this war." He believes that we can "safely redeploy our combat brigades at a pace that would remove them in 16 months. That would be the summer of 2010":
My Plan for Iraq, by Barack Obama, Commentary, NY Times: The call by Prime Minister Nuri Kamal al-Maliki for a timetable for the removal of American troops from Iraq presents an enormous opportunity. We should seize this moment to begin the phased redeployment of combat troops...
Unlike Senator John McCain, I opposed the war in Iraq before it began, and would end it as president. ...
In his last post, Lane Kenworthy asked: Can Mobility Offset an Increase in Inequality?. His answer, which included a series of graphs to illustrate his point, was that:
...[as] Milton Friedman ... suggested...Income mobility helps to reduce income inequality. ...
Single-point-in-time income inequality has risen sharply in the United States since the 1970s. Has mobility increased too? Stay tuned.
I did stay tuned, and here's the next installment:
Rising Inequality Has Not Been Offset by Mobility, by Lane Kenworthy: Income inequality in the United States is typically measured with data from a survey that asks around 50,000 households what their income was in the previous year. According to these data, inequality has increased sharply since the 1970s (see the second chart here).
But this survey includes different households each year. It therefore misses any mobility — movement of households up and down in the distribution over time — that occurs. If mobility has increased, the conclusion that there is more inequality might be misleading. ...
The type of mobility at issue here is relative intragenerational income mobility. Has it increased in recent decades?
To find out, we need panel data — data for the same households (or individuals) over a number of years. There are three main sources of such data. Each suggests the same conclusion: relative intragenerational income mobility in the United States has not increased.
Sunday, July 13, 2008
John Jansen at Across the Curve [followed by a series of comments on this issue gathered from various blogs, and my own comments at the end]:
More on the GSEs, by John Jansen: The financial press is replete with stories about meetings in Washington regarding the status of FNMA and Freddie Mac. The gist of the reporting is that the various parties to the conversations are busy discussing various funding options for the GSEs if such aid is warranted. One of the items mentioned in most of the stories is a previously scheduled Freddie Mac sale of $3billion of securities. Bloomberg suggests that the notes are short term and a quick check of the Freddie Mac home page informs the reader that the agency is issuing $2 billion 3 month bills and $1 billion 6 month bills.
The various articles suggest that there is some concern or angst regarding investor support for that sale. The reports suggest that these sales will be an important test of investor sentiment regarding the GSEs. I think that the success of this sale will demonstrate very little. That amount of issuance is paltry and could be funded by Secretary Paulson himself and a dozen of his former colleagues at Goldman Sachs.
In my opinion, the canary in the coal mine for the agencies is the repo market. If large institutional suppliers of funds (money funds and sec lenders) shun agency debt as collateral for their lending, that will mark the beginning of a far more serious phase of the problem and would signal hard times ahead. So I will busy myself in the early trading tomorrow observing the movements in the rate at which agency collateral trades relative to government collateral.
I also think that this entire conversation will be (for the short term) academic if the Treasury announces a substantial capital infusion sometime later this evening. If that occurs, the spread narrowing trade which began on Friday should continue with a vengeance.
The statement that Paulson delivered on Friday was meaningless and senseless. I believe that they will announce serious measures this evening to support the eviscerated and hobbled mortgage giants. ...
Update: Here's the statement from Treasury Secretary Henry Paulson. It offers "a temporary increase in the line of credit the GSEs have with Treasury," and "temporary authority for Treasury to purchase equity in either of the two GSEs if needed":
Paulson Statement on Freddie Mac, Fannie Mae, Bloomberg: Following is the text of a statement issued today by Treasury Secretary Henry Paulson:
Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies. Their support for the housing market is particularly important as we work through the current housing correction.
GSE debt is held by financial institutions around the world. Its continued strength is important to maintaining confidence and stability in our financial system and our financial markets. Therefore we must take steps to address the current situation as we move to a stronger regulatory structure. In recent days, I have consulted with the Federal Reserve, OFHEO, the SEC, Congressional leaders of both parties and with the two companies to develop a three-part plan for immediate action. The President has asked me to work with Congress to act on this plan immediately.
First, as a liquidity backstop, the plan includes a temporary increase in the line of credit the GSEs have with Treasury. Treasury would determine the terms and conditions for accessing the line of credit and the amount to be drawn.
Second, to ensure the GSEs have access to sufficient capital to continue to serve their mission, the plan includes temporary authority for Treasury to purchase equity in either of the two GSEs if needed.
Use of either the line of credit or the equity investment would carry terms and conditions necessary to protect the taxpayer. Third, to protect the financial system from systemic risk going forward, the plan strengthens the GSE regulatory reform legislation currently moving through Congress by giving the Federal Reserve a consultative role in the new GSE regulator's process for setting capital requirements and other prudential standards.
I look forward to working closely with the Congressional leaders to enact this legislation as soon as possible, as one complete package.
Update: From the Fed:
Press Release Release Date: July 13, 2008
For immediate release
The Board of Governors of the Federal Reserve System announced Sunday that it has granted the Federal Reserve Bank of New York the authority to lend to Fannie Mae and Freddie Mac should such lending prove necessary. Any lending would be at the primary credit rate and collateralized by U.S. government and federal agency securities. This authorization is intended to supplement the Treasury's existing lending authority and to help ensure the ability of Fannie Mae and Freddie Mac to promote the availability of home mortgage credit during a period of stress in financial markets.
Update: Robert Waldmann with gametheoryspeak:
Bailouts and Moral Hazard , by Robert Waldmann: Here we are again, just into a Bear (sterns) market and we have to face the fact that Fannie Mae and Freddie Mac are waaaaay to big to fail. A strong case can be made that a bailout will cost relatively little and failure to come to their assistance will cost a lot...
OK so we have to bail out the FM's. However, it is irritating that the people who made this mess obtained tens of millions in compensation doing so. I can translate my populist rage into gametheoryspeak noting that bailouts create moral hazard problems. The US government can't let Fannie or Freddie or even the medium size bad Bear fail. It shouldn't make executives decide to run risks only because they know that if they roll snake eyes, the treasury or the fed will bail them out. So What is to Be Done ?
It seems simple to me (and many many others). The institutions are too big to fail, their officers are vulnerable to bad incentives. The correct policy is to keep the institution from failing in a way which will serve as a lesson to the officers of other institutions.
I think the optimal policy is simple. The chairman of the Fed tells the CEO of To Big to Fail Bank (tbtf bank) that the FED will pick up dodgy assets with face value X if mr CEO picks up dodgy assets with face value equal to 90% of his wealth as reported in the Forbes 500 or 5 years of his (or her hah?) total compensation. Then Bernanke can mention that he is not a shareholder of tbtf bank, but, if the CEO were to say no and the bank were to go bust and he were a shareholder he sure would sue (and presumably win).
Now the CEO can appeal to the 13th amendment and resign on the spot, but he loses if he says yes and loses more if he says no. If he says he is resigning, BB (Ben Bernanke not Big Brother) says his successor will be offered the same deal with the added proviso that CEO I not be paid anything by tbtf bank beyond what CEO I can claim is due to him in court. And so on. BB will get down to someone so poor that he is willing to put 4 years of compensation at risk in order to be CEO.
Unlike the highly compensated officers, that person might even be competent to manage a bank (stranger things have happened).
Update: More from John Jansen - a bit of analysis - as much as possible anyway. As he notes, the proposals are vague, and that makes analysis difficult:
Sunday Night Stream of Consciousness on the BailoutThe Treasury announced a bailout package for the GSEs this evening. The proposal contains three pieces. The Treasury will seek to increase the nominal line of credit to the agencies (I believe a little over $2 billion currently) and will need Congressional approval for that action. They will also seek approval from the Congress to make equity investments in the GSEs.
Finally, the Federal Reserve has once again been drafted to open the discount window and make it available to both FNMA and Freddie Mac.
This would seem to make explicit the guarantee of agency debt which has always been implied. ...
Details are lacking here. ... To really formulate an opinion on this rescue I think that we need to wait and see the particulars. Until the details are available my instinct is that this is not a great idea. The taxpayers are assuming a massive set of liabilities and assets with no clear path to the ultimate outcome. I think that when we think this through the outcome will be that the laissez faire approach which has been in vogue the last three decades will be in serious jeopardy. It has been that approach which the regulators supported and allowed for the creation of organizations which are too big to fail and has now threatened the system twice in a four month period. Regulators and government have violated the most basis principals of risk management by permitting such massive accumulation of capital in the hands of a few.
I think the pendulum of history is about to sweep back in the opposite direction and it will reintroduce a level of government involvement which has not been seen in quite some time.
What type of equity will the Treasury purchase? What is the trigger for such an event? At what price will the taxpayer be long in the housing market? I suspect that the Bear Stearns model will apply here and if the treasury does get involved as an owner it will mean a very sad ending for current stockholders. ...
This has been stream of consciousness and I apologize.
One final thought which might apply to bond trading in the short run. If the agencies do need to tap the discount window, it will require the Federal Reserve to sterilize those actions with sales of treasury coupon securities. The Federal Reserve has already lent out a significant portion of its balance sheet in an earlier iteration of this crisis. To the extent that they need to supply significant liquidity to FNMA and Freddie that might engender another set of problems.
This is like something out of Alice and Wonderland as things get curiouser and curiouser.
Update: Felix Salmon chimes in with Parsing Paulson: The Fannie and Freddie Bailout:
Hank Paulson is a tough guy. He's no pushover: just look at that phone call to Jamie Dimon, telling him that anything over $2 a share was altogether far too much money to pay for Bear Stearns. So what are we to make of his statement regarding Fannie Mae and Freddie Mac? With apologies to Jack, here's the parse:
Paulson: Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies. Their support for the housing market is particularly important as we work through the current housing correction.
Translation: We can't afford for Fannie and Freddie to go bust, and we're Republicans, so there's no way we're going to nationalize them. And no one could conceivably afford to buy them. Which leaves only one option: somehow maintaining the status quo. Which is not going to be easy, seeing as how their trillions of dollars in assets are imploding daily in the biggest US housing crunch since the Great Depression.
Paulson: GSE debt is held by financial institutions around the world. Its continued strength is important to maintaining confidence and stability in our financial system and our financial markets. Therefore we must take steps to address the current situation as we move to a stronger regulatory structure.
Translation: China and other major foreign investors hold a huge amount of Agency debt, on the understanding that it's risk-free. I'm here to tell them that, yes, it's risk free. Nothing to worry about here. And to prove that there's nothing to worry about, I'll put out a press release on a Sunday night which is designed to reassure you all. There, you're reassured, right?
Paulson: Use of either the line of credit or the equity investment would carry terms and conditions necessary to protect the taxpayer.
Translation: Don't call this a bailout.
Paulson: Third, to protect the financial system from systemic risk going forward, the plan strengthens the GSE regulatory reform legislation currently moving through Congress by giving the Federal Reserve a consultative role in the new GSE regulator's process for setting capital requirements and other prudential standards.
Translation: When was the last time you saw a "two-point plan"? I needed a third point, and I thought that maybe a few phone calls between the Fed and OFHEO might count. Sound good to you?
Paulson: I look forward to working closely with the Congressional leaders to enact this legislation as soon as possible, as one complete package.
Translation: Congress thought it was just going to be messing around with OFHEO, but now they're going to be asked to authorize the purchase of billions of dollars of the most underperforming shares on the NYSE. But if they don't roll over and do just that, they'll know that I'll be pointing the finger at them if Fannie and Freddie run into any further difficulties. And who wants the blame for nobody being able to get a mortgage any more? They'll do the right thing, the craven little pols. Frankly, they're the least of my worries.
Update: Yves Smith: Thin Gruel in Paulson Statement re Fannie, Freddie; Fed Opens Discount Window and The Real Test of the Not-Yet-A-Plan Fannie & Freddie Operation, Arnold Kling: Bailed it Shall be, Tyler Cowen: Parsing Paulson.
Update: Richard Green:
Brad Delong said it first:
The chance that American taxpayers will actually lose any money if Ben Bernanke and Henry Paulson decide that Fannie and Freddie need government support is very low:
- The interest payments they have coming in are greater than the interest payments they have going out.
- Their government guarantee is itself a very valuable asset that they have made a lot of money off of in the past and will make more off of in the future.
- They are not even in liquidity trouble--unless they begin to have problems rolling over their discount notes...
- As long as it is generally understood that they are too big to fail, they should not even have liquidity problems--absent a depression that bankrupts many currently-solvent homeowners, that is.
I would like to mention three other things based on the 15 months or so that I worked at Freddie.
(1) One reason Freddie got in trouble about how it reported its earnings is that Senior Management did not believe that GAAP treatments of earnings reflected the economics of the company, and so it needed to fudge (the company's self-investigation, called the Baker-Botts report, made this quite clear). This does not excuse its behavior--publicly traded companies must comply with GAAP. The correct thing would have been for management to explain the problems with GAAP in the MD&A Statement.
But Senior Management was correct that GAAP earnings did not (and does not) give meaningful metrics of GSE corporate performance.
(2) Just my two cents, but I don't think the company's mortgage underwriting could be characterized as reflecting moral hazard. The company was quite conservative about loans that qualified for purchase, and perhaps would have been more conservative were it not for the Affordable Housing Goals (and BTW, there is no evidence that the Affordable Housing Goals in any way helped channel mortgage credit to underserved communities or families). In any event, the people running Freddie were not the Savings and Loan cowboys who would lend to anyone for anything.
(3) It is very hard to measure corporate cash flow at Fannie-Freddie, because funding and amortization are both happening constantly.
One other disclosure, I own something like 300 shares of Freddie stock that I received as compensation when I worked there. Feel free to discount anything I say about these matters as a result of this.
Update: Jim Hamilton:
The Fannie and Freddie assistance plan, econbrowser: I see much to like about this....
The first thing I like about this plan is the fact that the ultimate determination of the level of risks to be absorbed by the federal government is being left to Congress. How much risk there is to the taxpayers in the various new lending facilities introduced by the Fed is subject to some debate, but that there is some risk, and that new loans from the Fed to the GSEs would increase this risk, is indisputable. One of the clearest lessons from history is that the fiscal and monetary functions of the government must remain separate. ...
The second thing I like about the plan is that such action by Congress would take the form of a dollar limit-- here's how much we're willing to stake, and no more-- with residual losses presumably laid on the GSE creditors. I've argued that's exactly the way the debate needs to be framed. ...
Granted, action by Congress can be a cumbersome process, often painful to watch. This I presume is why the plan includes a promise by the Fed to provide immediate lending, if needed, which I'm seeing as a kind of bridge loan. I would assume that may be quite a necessary and appropriate element of the plan. ...
For my part, I urge Congress to say yes.
Update: In response to Paul Krugman's column (see above), Brad Delong says:
The way Laura Tyson puts it, a mortgage packager and guarantor is almost surely a good thing--but the GSEs should never have been privatized in the first place. Organizations with great government privilege are government responsibility--and there is no way in which they should ever have been let loose from oversight and made responsible to their private shareholders alone. ...
[Fannie and Freddie] cannot be allowed to collapse because we want to keep the economy near full employment, which means that construction-sector employment can't be allowed to fall faster than tradeable manufacturing-sector employment can rise. But they could be put into "conservatorship." And there is no reason that their stockholders need to emerge from this with any money at all.
Update: Where do I stand on all of this?
On the size of the problem, I'm with Richard Green, Brad DeLong, and Paul Krugman. A rescue may be needed, but it doesn't look like we are facing an insurmountable problem that endangers the broader economy. As for what to do going forward, increased capitalization is one step, and I think Robert Waldmann's idea of making sure owners have a substantial stake in the companies fortunes is a good one even though this is a case where risks have been regulated fairly well. On monetary authorities putting public money at risk, I'm less worried than Jim Hamilton about the strict separation of authority in these bailouts. As I've argued before (without convincing many people), even if the Fed doesn't take on any risky assets at all, it already has the power to impact the federal budget and cost taxpayers money through its decisions (e.g. if there is no action at all by policymakers in terms of a bailout, so no public money is put at risk in the sense above, or the wrong action and the economy tanks, then the resulting crash in GDP would cause social insurance payments to go up and tax payments to fall increasing the budget deficit and hence the future tax bill). In addition, congressional involvement can impede or block the quick reaction we need to deal with a financial crisis. Thus, I quite agree that this is, ultimately, a congressional matter to be decided by elected officials. But perhaps congress can extend some type of automatic authority that allows monetary authorities to step in up to a limit, and then require approval for anything beyond the preset limit. That would give monetary authorities the flexibility they need to deal rapidly and flexibly with most situations without putting more than the preset amount of public funds at stake.
Finally, like almost everyone else, I don't think we can allow these firms to fail.
Saturday, July 12, 2008
What if the Candidates Pandered to Economists?, by N. Gregory Mankiw, Economic View, NY Times: In the months to come, John McCain and Barack Obama will be vying for the support of various voting blocs. It is safe to say, however, that one group won’t get much attention: economists.
The American Economic Association represents only a small fraction of 1 percent of the electorate. In every election season, we economists expect to be largely ignored, and, unlike many of our other forecasts, that one often turns out to be right.
But suppose it were otherwise. ... What would it take to put the nation’s economists solidly behind a candidate?
On many issues, from universal health insurance to increased taxes on the rich, economists do not speak with a single voice. But on some issues we do. Here is an eight-plank platform designed to attract a majority of economists. It is based on discussions I have had with my colleagues — call them focus groups, if you’d like — and polls of my profession:
SUPPORT FREE TRADE...
OPPOSE FARM SUBSIDIES...
LEAVE OIL COMPANIES AND SPECULATORS ALONE...
TAX THE USE OF ENERGY...
RAISE THE RETIREMENT AGE...
INVITE MORE SKILLED IMMIGRANTS...
LIBERALIZE DRUG POLICY...
RAISE FUNDS FOR ECONOMIC RESEARCH...
You might view this policy as nothing more than a way to buy a few votes. Perhaps you view economists as mere mortals, as tempted as anyone else by special interests. Maybe you would regard more funding for economic research as not very different from the billions thrown every year at farmers.
If you are that cynical, I won’t try to dissuade you.
Ignoring the details that follow each proposal, there's one I'm not sure about, so seven out of eight for me (see here).
What do you think about using these techniques? I find myself wary generally, but unable to argue against using them in a case like this where the benefits are so clear:
Warning: Habits May Be Good for You, by Charles Duhigg, NY Times: A few years ago, a self-described “militant liberal” named Val Curtis decided that it was time to save millions of children from death and disease. So Dr. Curtis, an anthropologist then living in the African nation of Burkina Faso, contacted some of the largest multinational corporations and asked them, in effect, to teach her how to manipulate consumer habits...
Dr. Curtis ... had spent years trying to persuade people in the developing world to wash their hands habitually with soap. Diseases and disorders caused by dirty hands — like diarrhea — kill a child somewhere in the world about every 15 seconds, and about half those deaths could be prevented with the regular use of soap, studies indicate.
But getting people into a soap habit, it turns out, is surprisingly hard. To overcome this hurdle, Dr. Curtis called on three top consumer goods companies to find out how to sell hand-washing the same way they sell Speed Stick deodorant and Pringles potato chips.
Amity Shlaes says Phil Gramm is right, people really are whiners. This annoys me. Comments below:
Phil Gramm Is Right, by Amity Shlaes, Commentary, Washington Post: ..Phil Gramm ... is McCain's most senior economic adviser.. Now, however, Gramm faces political exile because he made the mistake of telling the truth.
What prompted the abrupt demotion? The short answer is what might be called Campaign Econ. Campaign Econ says the American economy is a certain way because Americans think it is. Campaign Econ competes with real economics and often wins -- with damage that extends way beyond, say, the political career of either Phil Gramm or John McCain.
So people are irrational in their beliefs? Must be how we got Bush as president. Anyway:
Consider what happened this week. While speaking with the Washington Times, Gramm said that the country was not in a true recession but a "mental recession." He also said, "We have sort of become a nation of whiners" and "You just hear this constant whining..."
Gramm was right about the recession and stood by his recession comments on Thursday. A recession is two consecutive quarters in which the economy shrinks, and last quarter it grew. But no matter. Voters feel they are in a recession, and so they are, at least according to Campaign Econ. ad_icon
She doesn't know what she is talking about, or she is being intentionally misleading. That's not how a recession is defined. But you don't have to believe me, here's the NBER - the people who formally date recessions:
Q: The financial press often states the definition of a recession as two consecutive quarters of decline in real GDP. How does that relate to the NBER's recession dating procedure?
A: Most of the recessions identified by our procedures do consist of two or more quarters of declining real GDP, but not all of them. ... Our procedure differs from the two-quarter rule in a number of ways. First, we consider the depth as well as the duration of the decline in economic activity. Recall that our definition includes the phrase, "a significant decline in economic activity." Second, we use a broader array of indicators than just real GDP. One reason for this is that the GDP data are subject to considerable revision. Third, we use monthly indicators to arrive at a monthly chronology.
Q: Could you give an example illustrating this point?
A: On July 31, 2002, the Bureau of Economic Analysis released revised figures for gross domestic product that showed three quarters of negative growth in 2001-quarters 1, 2 and 3-where previously the data had shown only quarter 3 as negative. This revision shows why the committee does not rely on a simple rule of thumb such as two consecutive quarters of negative growth, nor relies on GDP data alone, in making its determinations, but rather looks at a broader array of statistics. In November 2001, the ... two-quarter-decline rule of thumb would not have allowed the declaration of the recession... It was not until eight months later that revisions in the GDP data showed declining real GDP for the first, second, and third quarters of 2001.
Back to the article which, I hope you can see, is based upon a false premise due to her apparent lack of understanding of how recessions are dated. (I would have thought she'd know this claim isn't right, it's been written about so much most people who write about these issues know the NBER procedure by now, so there's a chance this is an intentional deception. If it's not intentional, if she doesn't know how recessions are dated, then she has no business writing about it.) Her claim is that because there hasn't been two consecutive declines in GNP, the economy can't be having problems. Therefore, people are nothing but whiners.
She says you can't tell people the truth, that they really are nothing but whiners, because it hurts their feelings:
Gramm's second sin was political. Calling voters whiners is to shame them. ... Campaign Econ is unabashedly populist, and to seek to elicit shame is regarded as unpardonably elitist. ...
Calling someone who has just been laid off a whiner doesn't shame them, it makes them mad. And it should.
Now she's going to tell us about the problems that don't exist:
Campaign Econ is certainly understandable. Gas prices are ruining vacation plans and killing businesses. Many Americans have lost or are about to lose their homes... inflation plagues the country. The weak dollar is altering our everyday calculations. For many, this is not a happy summer.
But don't talk about that unhappiness - you'll be called a whiner!:
Still, to liken the current moment to the Great Depression, or even the early 1980s, as Campaign Economists have, is to whine, just as Gramm said. ... The country approached double-digit unemployment in the early 1980s. This week, even as McCain was trying to talk his campaign past Gramm's comments, joblessness stood at a historically modest 5.5 percent.
If you look at the NBER definition, you will see that they look at employment and personal income as part of the dating procedure. How have those been doing? How's the employment to population ratio looking these days? Cherry picking a single statistic - unemployment - to make a case is unconvincing, especially when other labor market indicators tell a very different story.
Next, the standard blame the government for any problems that might occur. The press and politicians convince people of problems that aren't really there (they just decide one day, out of the blue, to start saying the economy is in trouble), then the evil government responds:
And Campaign Econ has costs. The first is that talk of a downturn -- or "mental recession," as Gramm put -- can itself generate a downturn. Keynesian economists say this is so because consumer spending slows when people are afraid. But there's also a non-Keynesian dynamic. Grumbling leads to costly government rescues that scare markets and slow growth.
Yes, it's wrong for government to step in and try to help all the whiners that lose their jobs in a downturn. They and their families should suffer through whatever problems they might encounter since conservatives think that helping them might slow economic growth (even though there's no evidence that slower economic grwoth is a problem we should worry about).
Oh, I forgot, there is no downturn, only the possibility of one due to evil government's support of Fannie and Freddie:
[A]s evidenced by the plummeting prices of Fannie Mae and Freddie Mac shares, serious trouble may be closer than we think. The plunging stock of the government-sponsored mortgage companies reminds us that those entities urgently require restructuring. Wall Street figures and the Senate Finance Committee ... are already talking about how to structure a bailout. But this task is about stopping recession, not luxuriating in it.
I guess it's okay to whine about the possibility of a recession if you can somehow cast it as a problem with government.
The next part is no surprise. She can't write a column without taking a swipe at Social Security and Medicare.
Social Security and Medicare also need rewriting -- and Gramm put forth one of the better proposals on Social Security in the 1990s.
How does Gramm's proposal in the 1990s relate to people whining about the non-existent problems she just identified?
So here's here solution:
In short, to fix it all, we need a frank conversation about the economy. McCain, in fact, inaugurated one back in 2006 when he gave a speech that was downright Gramm-like at the Economic Club of New York.
To "fix it all"? But I thought people were whining about nothing? Oh, I see, to fix it all we need to fix entitlements:
In that speech, McCain said that on entitlements, hard choices were necessary. He concluded: "Any politician who tells you otherwise, Democrat or Republican, is lying."
This was McCain at his best. Many voters knew it, too.
Yeah, the voters knew that was McCain at his best - and they realized if that was his best there wasn't much substance there - and they either moved on to support other candidates, or held their nose and supported McCain (some even write columns).
More on the solution:
The way to strengthen the economy right now is to elect leaders who dare to talk about problems in precise and even technical terms -- and then act on them. McCain has that capacity, but only if he can transcend Campaign Econ.
Precise, technical terms like knowing the definition of a recession? First-rate analysis of the economics of a gas tax holiday? Honest presentations about deficit reduction plans? Things like that would be nice, but as we saw from the whiner comment - a very technical and precise term - I'm afraid we won't get that from McCain's team.
You see, it's okay to whine about Social Security based upon deceptive presentations of its financial state or to whine about social programs generally, it's okay to whine about anything the government does to try to help people having troubles due to the state of the economy, it's also okay to whine about the liberal press misleading people, and it's okay to whine incessantly if anyone so much as thinks about making taxes more progressive.
But if you have lost your health insurance, had your wages stagnate, your retirement program at work eliminated or scaled back, if you are worried about job security or have been forced to look for a new job as the economy retools for the global age, if you are worried about how gas prices, food costs, and other price increases might impact your budget and have seen the value of your house plunge as those around you get into trouble, if you so much as dare to speak up about any of these or other problems, then you are nothing but a whiner.
Buck up, common folks, the rich people in the Republican party are doing just fine, thank you very much, and they really don't want to hear whining from the masses.
Update: Via Brad DeLong:
McCain Throws Phil Gramm Off the Train/Under the Bus/Over the Side:
Think Progress: Holtz-Eakin: Phil Gramm Is No Longer ‘Giving Advice To Senator McCain’» Since Thursday, Sen. John McCain’s (R-AZ) presidential campaign has been in damage control mode, attempting to distance itself from top economic adviser Phil Gramm’s belief that America is “a nation of whiners” that is only going through a “mental recession.” “Sen. Graham and I, as I said, we have a total disagreement on whether Americans are whiners or not,” McCain told reporters yesterday.
Appearing on PBS’s Nightly Business Report last night, McCain’s senior policy adviser, Douglas Holtz-Eakin, claimed that because of the comments, Gramm would no longer be giving McCain advice:
GERSH: Is Senator Gramm still giving advice to Senator McCain?
HOLTZ-EAKIN: At — I haven’t spoken to Senator Gramm since the comments took place, and I’m not expecting to...
Barkley Rosser says the period after the peak of a speculative bubble can often be broken into two periods, the first characterized by a gradual decline, i.e. a period of "financial distress," and a second where there is a massive panic and crash. He also says he has a model that can explain how this happens, though I trust he will understand if I hope that the second stage prediction of the model does not come true for the present financial crisis, or that a key condition necessary for the second stage to occur fails to be realized (I'm hoping Barkley will have the time to give the intuition behind the transition between stages, and how certain he is that the critical linkages are in place):
Falling from the Period of Financial Distress into the Panic and Crash, by Barkley Rosser: In 1972, Hyman Minsky described the "period of financial distress," in a paper in a journal that no longer exists..., "Financial Instability: The Economics of Disaster." Charles P. Kindleberger picked up on this and followed Minsky's analysis in his famous book, Manias, Panics, and Crashes: A History of Financial Crises, the 4th edn of which appeared in 2000... The period of financial distress is a gradual decline after the peak of a speculative bubble that precedes the final and massive panic and crash, driven by the insiders having exited but the sucker outsiders hanging on hoping for a revivial, but finally giving up in the final collapse. According to Appendix B of Kindleberger's 2000 edition, 37 of the 47 great historical speculative bubbles exhibited such a period before the final crash, even though all the theoretical models predict a crash immediately following the peak with no such period.
In 1991 I published the first mathematical model of such a phenomenon in my book From Catastrophe to Chaos: A General Theory of Economic Discontinuities_(Kluwer, Chap. 5)..., although nobody seems to have noticed... In 1997, I published a paper describing this model (and related matters)... This paper has never been cited. More recently I have coauthored a paper that ...[is] now under a long revise and resubmit, still waiting for an answer ... with Mauro Gallegati and Antonio Palestrini, "The Period of Financial Distress in Speculative Markets: Interacting Heterogeneous Agents and Financial Constraints" (available at my website), that lays all this out in much more up-to-date mathematical modeling.
So, why am I boring all of you with this self-citation? Well, Dean Baker is constantly claiming credit for his forecasts of doom and gloom. It looks like we might be finally reaching the big crash in the US mortgage market after a period of distress that started last August (if not earlier). I and my coauthors are the only people to have provided actually formal models of this phenomenon, beyond the verbal and historical discussions provided by the brilliant Minsky and Kindleberger (both of whom I knew...). I have been forecasting this in unpublished lectures all over the globe for years, but never have put it up into the blogosphere. So, I am claiming credit, to the extent it is due, although the basic ideas were clearly laid out earlier by Minsky and Kindleberger.
I will add one more story. Three years ago I presented an earlier version of the still-unpublished paper with Gallegati and Palestrini in Tokyo at Chuo University. In the middle of the presentation the biggest earthquake in 13 years hit Tokyo, in fact right at the moment I said the word, "crash." Some of the Japanese in the audience blamed me, not entirely humorously, for having caused it.
Friday, July 11, 2008
Brad DeLong gets Bush-whackoed:
You know something?
I hate yelling shows.
No, that is not right:
I HATE YELLING SHOWS!
No, that is still not right:
I HATE YELLING SHOWS!!
Maybe this will do it:
I HATE YELLING SHOWS!!!!
Called on forty minutes' notice, I trot over to the J-School studio to be a talking head on BBC/Newsnight about Fannie and Freddie. I have my talking points ready:
...[extensive list of points]...
In short, I trot over to the J-School TV studio as part of the sober, sensible, bipartisan consensus, intending to carry water for Ben Bernanke and Hank Paulson.
And what do I find also on BBC/Newsnight when I get there?
I FIND THAT I AM ON WITH GROVER-FRACKING-NORQUIST!! I FIND THAT I AM ON WITH GROVER-FRACKING-NORQUIST!!! WHO HAS THREE POINTS HE WANTS TO MAKE:
- Barack Obama wants to take your money by raising your taxes and pay it to the Communist Chinese.
- Oil prices are high today and the economy is in a near recession because of Nancy Pelosi: before Nancy Pelosi became speaker economic growth was fine--and she is responsible for high oil prices too.
- Economic growth is stalling because congress has not extended the Bush tax cuts. Congress needs to extend the Bush tax cuts, and if it does then that will fix the economy, and if it doesn't then the economy cannot recover.
I am not paid enough to deal with this lying bullshit. I am not paid enough to deal with Grover Norquist and his willful stream of defecation into the global information pool.
It is as Paul Krugman says somewhere: Grover Norquist's M.O.--George W. Bush's M.O.--the entire Republican Party's M.O. these days is (a) find a problem (i.e., financial crisis and threatening recession), (b) find something you want to do for other reasons unrelated to the problem (i.e., extend the Bush tax cuts), (c) claim without explanation that (b) will solve (a), and so (d) profit--because Peter Cardwell of BBC/Newsnight is too busy being the objective journalist referee of the yelling match to do his proper job and say:
Come, come, Mr. Norquist, are you serious? Your claim to believe that Nancy Pelosi's actions are responsible for the rise in oil prices is risible!
OK. Calm down. Adjust my meds...
Mr. Paulson? Ben? Are you there?
I have been carrying water for the two of you for a year now, as you have tried to do your jobs and contain the ongoing slow-motion financial crisis. Lots of us have been carrying water for you. Now you owe us a favor.
Will you please call John McCain Saturday morning. Call him jointly. Tell him that there is serious public business that needs to be done, and that pseudo-ideologues like Grover Norquist are not helping.
Tell him that unless he can control the swine like Grover Norquist and his ilk who work for him, that both of you are going to, Monday morning:
- announce your support for Barack Obama for president
- announce your change of affiliation from the Republican to the Democratic Party
You owe it. You owe it to me after that TV appearance. You owe it to all of us in the sober, sensible, bipartisan consensus. You owe it to your country. You owe it to the world.
Jamie Galbraith reviews Phil Gramm's Ph.D. dissertation:
Phil Gramm is ... John McCain’s ... closest economic adviser, and according to many reports practically the designated Secretary of the Treasury in a McCain administration. ... So it is perhaps worthwhile to ask, what kind of economist is Phil Gramm? ...
Back in 1995, when Phil Gramm was politically invincible in Texas, various so-called friends suggested that I should be the sacrificial lamb to run against him. I ducked, as any sensible person would have. But (at their request) I did supply the Dallas Morning News with a referee report on Gramm’s dissertation, along with a few notes on that of his wife. Needless to say, hers was much better.
To inject a note of academic sobriety into this election campaign, my review follows.
The review is here. A taste:
... His method is essentially, a critical review of literature.
For a Ph.D. dissertation, especially one which is not mathematical (and it isn’t), this one at 79 pages is short. It contains no advanced mathematics, no data or analysis of data, no archival or otherwise original research. It is based solely on published sources available in any well-equipped library at the time, and there is only one reference to anything written after 1960, which for a thesis submitted in 1967 is astonishing. The writing style is for the most part graceless and involute, marred here and there by misused words like “fecundities.” It is belabored and repetitive, with chapters that overlap each other. It is basically an extended discussion of a single idea. ...
Advocates of universal health care should be encouraged by "the first major health care victory that Democrats have won in a long time":
Kennedy’s Big Day, by Paul Krugman, Commentary, NY Times: ...On Wednesday, Senate Democrats ... won a huge victory on Medicare. ... Ted Kennedy, who is fighting a brain tumor, made a dramatic appearance on the Senate floor, casting the decisive vote amid cheers from his colleagues. (Only one senator was absent: John McCain.) ...
It was the first major health care victory that Democrats have won in a long time. And it was enormously encouraging for advocates of universal health care. ...
Wednesday’s vote was about restoring cuts in Medicare payments to doctors. What it was really about, however, was the fight against creeping privatization. Democrats finally took a stand...
The story really begins in 2003, when the Bush administration rammed the Medicare Modernization Act through Congress... That bill established ... Medicare Advantage plans ... in which Medicare funds are funneled through private insurance companies...
Since then, enrollment in these plans has been growing rapidly. This has had a destructive effect on Medicare’s finances: the fastest-growing type of Medicare Advantage plan ... costs taxpayers 17 percent more per beneficiary than Medicare without the middleman. It also threatens to undermine Medicare’s universality, turning it into a system in which insurance companies cherry-pick healthier and more affluent older Americans, leaving the sicker and poorer behind.
What does this have to do with cuts in doctors’ fees? Well, legislation passed a decade ago makes ... cuts automatic... This year, the automatic cuts would have reduced doctors’ payments by more than 10 percent, a pay reduction so deep that many physicians would probably have stopped taking Medicare patients.
In previous years, payments to doctors were maintained through bipartisan fudging ... to waive the rules. ...
This year, the Democratic leadership decided, instead, to link the “doctor fix” to ... reining in those expensive private fee-for-service plans. Last month, the Senate took up this bill — but Democrats failed by one vote to override a Republican filibuster. And that seemed to be that...
But then Democratic leaders decided to play brinkmanship. They let the doctors’ cuts stand for the Fourth of July holiday, daring Republicans to threaten the basic medical care of millions of Americans rather than give up subsidies to insurance companies. Over the recess period, there was an intense lobbying war between insurance companies and doctors.
And when the Senate came back in session,... the bill passed with a veto-proof majority.
If the Democrats can win victories like this now, they should be able to put a definitive end to the privatization of Medicare next year, when they’re virtually certain to have a larger Congressional majority and will probably hold the White House.
More than that, however, advocates of universal health care ... have to be very encouraged by this week’s events.
Here’s how it will play out, if all goes well: early next year, President Obama will send his health care plan to Congress. The plan will face vociferous opposition from the insurance industry — but the Medicare vote suggests that this time, unlike in 1993, Democrats will hold together.
Unless Democrats win even bigger than expected, however, they won’t have the 60 Senate votes needed to override a filibuster. What the Medicare fight shows is that the Democrats could nonetheless prevail by taking their case to the public, daring their opponents to stand in the way of health care security — so that in the end they get some Republicans to switch sides, and get the legislation through.
A lot can still go wrong with this vision. But the odds of achieving universal health care, soon, look a lot higher than they did just a couple of weeks ago.
Nicholas Crafts says Europe would be better off "if the dark side of productivity improvement implied by creative destruction – exit of established producers and re-deployment of labour – were accepted and facilitated." He also wishes that "ministers could bring themselves to think (better still occasionally to say) 'these job losses are good news.'"
Sorry, but job losses aren't good news. Structural change may require it, and we may be better off when the process is complete, but cheering the job losses themselves is heartless.
As for the more general question of whether Europe needs fixing, what do those of you who live there think? I like a "flexicurity" type approach which is, I suppose, a process of creative destruction that recognizes job losses are bad news, and tries to do something about it without interfering with the creative process:
Want faster European growth? Learn to love creative destruction, by Nicholas Crafts, Vox EU: Paul Krugman once observed that 3% per year is about as good as it gets for GDP growth in advanced economies. While the United States has achieved this since 1995, the EU15 have fallen well short – averaging only 2.3%.
The real European problem is in sluggish labour productivity growth - over the same period it averaged 1.4% per year compared with 2.1% in the United States, so that Europe has been falling behind rather than catching up during the last decade, in contrast with the whole of the post-war period until the mid-1990s.1 There is, of course, huge variation around this European average, from Irish labour productivity growing at 3.7% down to Spanish labour productivity growth of -0.2%.
Two further aspects of comparative productivity growth should be flagged:
- Weak European performance compared with United States is characterised by a shortfall in TFP growth rather than in capital deepening.
- As analysis of the EUKLEMS dataset by Bart van Ark and his colleagues has revealed, market services are the key problem area, notably, but not only, in information technology-intensive sectors such as distribution (van Ark, O'Mahony, and Timmer 2008).
Again, the variation in the contribution from labour productivity growth in the service sector is considerable, from 1.6% per year in United Kingdom to -0.1% in Italy during 1995 to 2004.
Understanding the policy implications of comparative growth outcomes requires an appropriate model. The most suitable is the Schumpeterian framework developed by Philippe Aghion and Peter Howitt.2 This places innovation and, indeed, creative destruction at the heart of the growth process and views these as determined endogenously by incentive structures.