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Friday, October 31, 2008

"Financial Crises and Democracy"

James Kwak on "the role of democratic politics in responding to the financial crisis":

Financial Crises and Democracy, James Kwak: Lorenzo Bini Smaghi, a member of the Executive Board of the European Central Bank, gave a thought-provoking speech in Milan last week. In particular, he focused on the role of democratic politics in responding to the financial crisis and, more broadly, in how governments manage their economies. Smaghi begins with the premise that it was a mistake to let Lehman fail in mid-September (not everyone agrees with this, but many people do), thereby triggering the acute phase of the credit crisis. He then asks why this happened.

As subsequent events have shown,... when the first rescue package was rejected by the US Congress, opposition to providing the financial sector with public funds came not only from within the government, but also from parliament. The Members of the US Congress, many of whom face voters at the beginning of November, feared that such a decision would compromise their re-election. There was opposition to rescuing Lehman Brothers, therefore, not only from within the Administration, but also from Congress and, more broadly, from public opinion. In other words, the decision was largely the result of a democratic process.

For Smaghi (and for many others), however, the systemic importance of the financial sector meant that it was actually in the interests of US citizens to bail out Lehman and, later, much of the financial sector. ...

Smaghi continues by investigating why the public is opposed to a rescue of the financial system that is actually in its own interests.

My opinion is that this doesn’t require investigation, as there is little reason to expect people to vote in their own economic interests since, in most cases, thick screens of political rhetoric make it extremely difficult for them to identify where their interests lie. To take the most obvious example of the moment: According to the non-partisan Tax Policy Center, Barack Obama’s tax plan will be better for the bottom four quintiles of the income distribution, and John McCain’s plan will only be better for the top quintile (see the figure on page 41); yet more Americans think that Obama will raise their taxes than that McCain will (50% to 46%), thanks to the constant repetition of the “spreading the wealth” sound bite (note how the numbers have reversed in just the last two weeks). If governments make the right economic choices on occasion, it is sometimes in spite of popular opinion but, most often, because the public does not have a strong opinion on the topic. (How many people get worked up about the Fed Funds rate, at least in normal times?)

In some respects, it may actually be good that the economy is being overseen by a lame-duck administration that is largely free to ignore public sentiment, and therefore has been able to ditch its vocal anti-regulatory ideology in favor of a series of pragmatic steps that, collectively, constitute the largest direct government intervention into the economy in my lifetime. There are certainly aspects of the intervention that reflect the free-market instincts of the players concerned, such as the outsourcing of TARP to banks and asset management firms and the relatively gentle recapitalization program. But on the whole, it is an exercise of government power in the economy that until a few months ago was anathema to the conservatives in the administration. ...

We will need to decide how much of the power to respond to financial crises we want concentrated in the hands of an independent Federal Reserve who can react with less concern for the political consequences of their actions, and how much of the power we want in the hands of congress so that policy choices are subject to legislative debate and procedures, and there is accountability to voters. We've seen that too much concentration of power can be risky - the original Paulson bailout plan showed us that we shouldn't trust all that power in the hands of one person, and we were fortunate that checks and balances led to modification of the plan into something more acceptable. Even so, my own preference is to put quite a bit of the authority in the hands of the Fed even when it involves actions such as the purchase of risky securities that put taxpayer money at risk (but I should acknowledge that view does not appear to be a widely held).

Putting the power in the hands of a single individual gives us the ability to respond quickly to any financial crisis, but this represents too much concentration of power and is risky for that reason. But congress is overly deliberative and can be too slow to react to problems, it is subject to myopic political concerns that can come at the expense of the long-run health of the economy, and members of congress often lack the knowledge needed to understand the full implications of alternative policy choices. So perhaps the Fed represents a workable medium between these extremes that offers relatively speedy action, deliberation among the board memebers, bank presidents, and staff, implicit oversight from congress, and shared consent for policy choices that gives us, on average, better and less costly policy outcomes.

    Posted by on Friday, October 31, 2008 at 05:40 PM in Economics, Financial System, Politics | Permalink  TrackBack (0)  Comments (28) 

    "Greenspan's Folly"

    Jeff Sachs says that Greenspan's bubbles and the problems they have caused make clear that it's time to abandon "the economic model adopted since president Ronald Reagan came to office in 1981." I think Fed policy contributed to the housing bubble, but I am not convinced it was the primary cause. However, whatever the primary cause of the problems we are experiencing, I have no disagreement with Sach's call for "a new economic strategy":

    Greenspan Folly makes room for a new New Deal, by Jeff Sachs, Project Syndicate: This global economic crisis will go down in history as Greenspan’s Folly. This is a crisis made mainly by the US Federal Reserve Board during the period of easy money and financial deregulation from the mid-1990s until today. ...

    At the core of the crisis was the run-up in housing and stock prices... Greenspan stoked two bubbles — the Internet bubble of 1998-2001 and the subsequent housing bubble that is now bursting. In both cases, increases in asset values led US households to think that they had become vastly wealthier, tempting them into a massive increase in their borrowing and spending — for houses, automobiles and other consumer durables.

    Financial markets were eager to lend to these households, in part because the credit markets were deregulated... This has all come crashing down. ...

    The challenge for policymakers is to restore enough confidence that companies can again obtain short-term credit to meet their payrolls and finance their inventories. The next challenge will be to push for a restoration of bank capital so that commercial banks can once again lend for longer-term investments.

    But these steps, urgent as they are, will not prevent a recession... The US will be hardest hit, but other countries with recent housing and consumption booms (and now busts) — particularly the UK, Ireland, Australia, Canada and Spain — will be hit as well. Iceland ... now faces national bankruptcy...

    It is no coincidence that, with the exception of Spain, all of these countries explicitly adhered to the US philosophy of “free market” and under-regulated financial systems.

    Whatever the pain felt in the deregulated Anglo-Saxon-style economies, none of this must inevitably cause a global calamity. I do not see any reason for a global depression, or even a global recession.

    Yes, the US will experience a decline..., lowering the rest of the world’s exports to the US. But many other parts of the world will still grow. Many large economies, including China, Germany, Japan and Saudi Arabia, have very large export surpluses and so have been lending to the rest of the world — especially to the US — rather than borrowing.

    These countries are flush with cash and not burdened by the collapse of a housing bubble. Although their households have suffered to some extent from the fall in equity prices, they not only can continue to grow, but can also increase their internal demand to offset the decline in exports to the US.

    They should now cut taxes, ease domestic credit conditions and increase government investments in roads, power and public housing. They have enough foreign-exchange reserves to avoid the risk of financial instability from increasing their domestic spending — as long as they do it prudently.

    As for the US, the current undeniable pain for millions of people, which will grow..., is an opportunity to rethink the economic model adopted since president Ronald Reagan came to office in 1981. Low taxes and deregulation produced a consumer binge that felt good while it lasted, but also produced vast income inequality, a large underclass, heavy foreign borrowing, neglect of the environment and infrastructure, and now a huge financial mess.

    The time has come for a new economic strategy — in essence, a new New Deal.

      Posted by on Friday, October 31, 2008 at 12:24 PM in Economics, Financial System, Monetary Policy, Social Insurance | Permalink  TrackBack (0)  Comments (30) 

      Paul Krugman: When Consumers Capitulate

      It's time for "a major fiscal stimulus":

      When Consumers Capitulate, by Paul Krugman, Commentary, NY Times: The long-feared capitulation of American consumers has arrived. According to Thursday’s G.D.P. report, real consumer spending fell at an annual rate of 3.1 percent in the third quarter; real spending on durable goods (stuff like cars and TVs) fell at an annual rate of 14 percent.

      To appreciate the significance of these numbers, you need to know that American consumers almost never cut spending...; the last time it fell even for a single quarter was in 1991, and there hasn’t been a decline this steep since 1980...

      So this looks like the beginning of a very big change in consumer behavior. And it couldn’t have come at a worse time.

      It’s true that American consumers have long been living beyond their means... Lately,... the savings rate has generally been below 2 percent — sometimes it has even been negative — and consumer debt has risen to 98 percent of G.D.P., twice its level a quarter-century ago.

      Some economists told us not to worry because Americans were offsetting their growing debt with the ever-rising values of their homes and stock portfolios. Somehow, though, we’re not hearing that argument much lately.

      Sooner or later, then, consumers were going to have to pull in their belts. But the timing of the new sobriety is deeply unfortunate. ...

      Some background: one of the high points of the semester, if you’re a teacher of introductory macroeconomics, comes when you explain how individual virtue can be public vice, how attempts by consumers to do the right thing by saving more can leave everyone worse off. The point is that if consumers cut their spending, and nothing else takes the place of that spending, the economy will slide into a recession, reducing everyone’s income.

      In fact, consumers’ income may actually fall more than their spending, so that their attempt to save more backfires — a possibility known as the paradox of thrift.

      At this point, however, the instructor hastens to explain that virtue isn’t really vice: in practice, if consumers were to cut back, the Fed would respond by slashing interest rates, which would ... lead to a rise in investment. So virtue is virtue after all, unless for some reason the Fed can’t offset the fall in consumer spending.

      I’ll bet you can guess what’s coming next.

      For the fact is that we are in a liquidity trap right now: Fed policy has lost most of its traction. It’s true that Ben Bernanke hasn’t yet reduced interest rates all the way to zero, as the Japanese did in the 1990s. But it’s hard to believe that cutting the federal funds rate from 1 percent to nothing would have much positive effect on the economy. ...

      The capitulation of the American consumer, then, is coming at a particularly bad time. But it’s no use whining. What we need is a policy response.

      The ongoing efforts to bail out the financial system, even if they work, won’t do more than slightly mitigate the problem. Maybe some consumers will be able to keep their credit cards, but as we’ve seen, Americans were overextended even before banks started cutting them off.

      No, what the economy needs now is something to take the place of retrenching consumers. That means a major fiscal stimulus. And this time the stimulus should take the form of actual government spending rather than rebate checks that consumers probably wouldn’t spend.

      Let’s hope, then, that Congress gets to work on a package to rescue the economy as soon as the election is behind us. And let’s also hope that the lame-duck Bush administration doesn’t get in the way.

        Posted by on Friday, October 31, 2008 at 12:42 AM in Economics, Fiscal Policy | Permalink  TrackBack (0)  Comments (121) 

        "The Economics of Labour Market Intermediation"

        Why hasn't the increased availability of information reduced the demand for labor market intermediaries?

        The economics of labour market intermediation, by David Autor, Vox EU: The labour market depicted by undergraduate textbooks (e.g. Mankiw 2006) is a pure spot market with complete information and atomistic price-taking. Labour economists have long understood that this model is highly incomplete. Search is costly, information is typically imperfect and often asymmetric, firms are not always price takers, and atomistic actors are typically unable to resolve coordination and collective action failures.

        In this ‘second-best of all worlds,’ numerous third parties inevitably arise to respond to, and profit from, market imperfections. I refer to these third parties as Labour Market Intermediaries – entities or institutions that interpose themselves between workers and firms to influence who is matched to whom, how work is accomplished, and how conflicts are resolved.[1]

        Labour market intermediaries have been around in various guises for centuries, as labour unions, craft guilds, and occupational licensing boards. But they have also gained prominence in contemporary incarnations as temporary help agencies, Internet job search boards, and centralised job-matching institutions like the ‘medical match’ that allocates physicians completing medical school to medical residencies. The venerable history and continued re-emergence of intermediaries in various forms raises the question: what precise economic function do these institutions serve? And are they likely to improve labour market operation or merely tax it?

        Though heterogeneous, it is my contention that labour market intermediaries serve a common role. They address – and in some case exploit – a set of endemic departures of labour market operation from the first-best benchmark of full information, perfect competition, and decentralised price taking. Three labour market deficiencies, in particular, appear to ‘call forth’ the involvement of intermediaries: costly information, adverse selection, and (failures of) coordination or collective action. I give examples of each below. A unifying observation that ties these examples together is that participation in the activities of a given labour market intermediary is typically voluntary for one side of the market and compulsory for the other; workers cannot, for example, elect to suppress their criminal records and firms cannot opt out of collective bargaining. I argue below that the nature of participation in an intermediary’s activities – voluntary or compulsory, and for which parties – is largely dictated by the market imperfection that it addresses, and thus tells us much about its economic function.

        Continue reading ""The Economics of Labour Market Intermediation"" »

          Posted by on Friday, October 31, 2008 at 12:24 AM in Economics, Unemployment | Permalink  TrackBack (0)  Comments (11) 

          links for 2008-10-31

            Posted by on Friday, October 31, 2008 at 12:06 AM in Links | Permalink  TrackBack (0)  Comments (14) 

            Thursday, October 30, 2008

            Credit Markets and Macroeconomic Performance in the Great Depression

            Given all the discussion recently about the relationship between credit flows and the macroeconomy, it seemed worthwhile to review what Ben Bernanke says about this topic with respect to the Great Depression. Bernanke's analysis concludes that the effects work through aggregate demand, not aggregate supply, i.e. that the problem was not one of "greater difficulties in funding large, indivisible projects." Instead, the "reluctance of even cash-rich corporations to expand production during the depression suggests ... consideration of the aggregate demand channel for credit market effects":

            Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression, by Ben bernanke, American Econonomic Review, June 1983: During 1930-33, the U.S. financial system experienced conditions that were among the most difficult and chaotic in its history. Waves of bank failures culminated in the shutdown of the banking system (and of a number of other intermediaries and markets) in March 1933. On the other side of the ledger, exceptionally high rates of default and bankruptcy affected every class of borrower except the federal government.

            An interesting aspect of the general financial crises - most clearly, of the bank failures - was their coincidence in timing with adverse developments in the macroeconomy.[l] Notably, an apparent attempt at recovery from the 1929-30 recession[2] was stalled at the time of the first banking crisis (November- December 1930); the incipient recovery degenerated into a new slump during the mid-1931 panics; and the economy and the financial system both reached their respective low points at the time of the bank" holiday" of March 1933. Only with the New Deals rehabilitation of the financial system in 1933-35 did the economy begin its slow emergence from the Great Depression. A possible explanation of these synchronous movements is that the financial system simply responded, without feedback, to the declines in aggregate output. This is contradicted by the facts that problems of the financial system tended to lead output declines, and that sources of financial panics unconnected with the fall in U.S. output have been documented by many writers. (See Section IV below.)

            Among explanations that emphasize the opposite direction of causality, the most prominent is the one due to Friedman and Schwartz. Concentrating on the difficulties of the banks, they pointed out two ways in which these worsened the general economic contraction: first, by reducing the wealth of bank shareholders; second, and much more important, by leading to a rapid fall in the supply of money. There is much support for the monetary view. However, it is not a complete explanation of the link between the financial sector and aggregate output in the 1930's. One problem is that there is no theory of monetary effects on the real economy that can explain protracted nonneutrality. Another is that the reductions of the money supply in this period seems quantitatively insufficient to explain the subsequent falls in output. (Again, see Section IV.)

            The present paper builds on the Friedman- Schwartz work by considering a third way in which the financial crises (in which we include debtor bankruptcies as well as the failures of banks and other lenders) may have affected output. The basic premise is that, because markets for financial claims are incomplete, intermediation between some classes of borrowers and lenders requires nontrivial market-making and information gathering services. The disruptions of 1930-33 (as I shall try to show) reduced the effectiveness of the financial sector as a whole in performing these services. As the real costs of intermediation increased, some borrowers (especially households, farmers, and small firms) found credit to be expensive and difficult to obtain. The effects of this credit squeeze on aggregate demand helped convert the severe but not unprecedented downturn of 1929-30 into a protracted depression. ...

            Continue reading "Credit Markets and Macroeconomic Performance in the Great Depression" »

              Posted by on Thursday, October 30, 2008 at 06:39 PM in Economics, Financial System | Permalink  TrackBack (0)  Comments (12) 

              Feldstein: Avoiding a "Deep and Prolonged Recession"

              Marty Feldstein says it's time to dampen the downward movement in housing prices to prevent overshooting the bottom, and to use government spending, including spending on infrastructure, to try to avoid a deepening recession:

              The Stimulus Plan We Need Now, by Martin Feldstein, Washington Post: Further legislation to deal with the economic crisis should not wait until the new president takes office. Fortunately, the president-elect will be a senator and can propose legislation... Immediately after Nov. 4, the winner could, and should, take the lead in the legislative process.

              The economy faces two separate problems: the downward spiral of home prices ... and the decline in aggregate spending, which could cause a deep and prolonged recession.

              Home prices ... must fall an additional 10 to 15 percent to get back to pre-bubble levels. But they could fall much further than that as a result of mortgage defaults and foreclosures. ... Congress should enact policies to reduce defaults that could drive prices down much further. ... The mortgage replacement loan plan that I suggested on this page in June ... is one possible way to do that. ...

              With the Fed's benchmark interest rate down to 1 percent, there is no scope for an easier monetary policy to stop the downward spiral in aggregate demand. Another round of one-time tax rebates won't do the job. ...

              The only way to prevent a deepening recession will be a temporary program of increased government spending. Previous attempts to use government spending to stimulate an economic recovery, particularly spending on infrastructure, have not been successful because of long legislative lags... But while past recessions lasted an average of only about 12 months, this downturn is likely to last much longer, providing the scope for successful countercyclical spending.

              A fiscal package of $100 billion is not likely to be large enough... The fall in household wealth resulting from the collapse of the stock market and the decline of home prices may cut aggregate spending by $300 billion a year or more.

              The president-elect should focus on ... initiatives that can occur quickly and that would otherwise not be done. While it would be good if some of the increased spending also contributed to long-term productivity, the key is to stimulate demand. ...

              The increased government spending should include not only money for infrastructure such as bridges and roads but also for a wide range of equipment. Rebuilding some of the military capacity that has been depleted by the wars in Iraq and Afghanistan could be done relatively quickly and should be part of the overall package.

              Although the economy is facing severe challenges, the president-elect can turn the situation around by introducing legislation to deal with the downward spiral in home prices and with the declining level of aggregate demand ... as quickly as possible.

              Since I've made many of the same points, it would be hard to disagree with the overall message. One thing though, the military will get its share one way or the other, so I'd rather see the increased spending directed elsewhere. Things, for example, "that would otherwise not be done."

              Update: GDP falls in third quarter:

              The Commerce Department reported this morning that consumers sharply cut their spending this summer, causing the United States economy to shrink at annual rate of 0.3 percent. By almost all accounts, the economy is now in recession.

              The last quarter in which consumers reduced their spending came in 1991. ... Personal consumption fell at an annual rate of 3.1 percent in the third quarter of this year, its biggest drop since 1980, when the economy was in a deep recession. ...

                Posted by on Thursday, October 30, 2008 at 12:42 AM in Economics, Financial System, Fiscal Policy | Permalink  TrackBack (0)  Comments (129) 

                Fed Watch: More Easing Expected

                Today, the Fed lowered the target interest rate to 1%. Will the Fed lower the target rate even further if things don't improve?:

                More Easing Expected, by Tim Duy: The FOMC performed as expected today, delivering a 50bp cut that returns rates to their lows of the Greenspan era. More importantly, Bernanke & Co. made clear that further policy easing remains on the table.

                The FOMC statement describes an economy in recession without actually using the “R” word:

                The pace of economic activity appears to have slowed markedly, owing importantly to a decline in consumer expenditures. Business equipment spending and industrial production have weakened in recent months, and slowing economic activity in many foreign economies is damping the prospects for U.S. exports. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit.

                Any other assessment would have been surprising; by all measures, economic activity fell off a cliff as we entered the second half of this year. Today’s durable goods report is no exception, with nondefense, nonair capital goods declining 1.4% in September, extending a 2.2% decline the previous month. The intensification of the credit crunch (yes, Virginia, it is a crunch), increased hesitation to expand capital outlays in the current environment, and slowing global growth suggest that investment activity will show even greater declines in the months ahead.

                Consistent with the darkening outlook, the incoming flow of data is likely to be horrid, especially during the next two quarters. In particular, the employment report will soon reveal the big declines in nonfarm payrolls consistent with a recession. An increased pace of job losses will sap aggregate household budgets of the real gains afforded by falling energy prices. Consequently, spending data will remain weak. Overall, the data will argue for additional policy response, and the Fed’s statement makes clear that they are prepared to ease policy further as required.

                But will that easing come in the form of lower rates? And how far would the Fed go?

                Continue reading "Fed Watch: More Easing Expected" »

                  Posted by on Thursday, October 30, 2008 at 12:33 AM in Economics, Fed Watch, Monetary Policy | Permalink  TrackBack (0)  Comments (20) 

                  The DOJ Blesses Merger between Delta and Northwest

                  James Kwak at Baseline Scenario:

                  Things That Don’t Make Sense, Airline Edition, by James Kwak: ...Earlier today, the Department of Justice approved the merger of Delta and Northwest, which I believe closed later this evening. In its statement, the Antitrust Division blessed the merger, saying:

                  the proposed merger between Delta and Northwest is likely to produce substantial and credible efficiencies that will benefit U.S. consumers and is not likely to substantially lessen competition. . . .

                  Consumers are also likely to benefit from improved service made possible by combining under single ownership the complementary aspects of the airlines’ networks.

                  Now, for literally years, every expert on the airline industry has been saying that the industry needs less competition, less capacity, and higher prices (bad for consumers), and consolidation is the way to achieve that end. Put another way, if Delta and Northwest actually believed the DOJ’s statement, they wouldn’t have bothered merging in the first place.

                  I’m not saying that the DOJ should have blocked the merger - not being an expert on the airline industry (although I am an expert on flying on airlines), I defer to those who say mergers are necessary for the health of the industry. But since when did the DOJ become their PR firm?

                    Posted by on Thursday, October 30, 2008 at 12:24 AM in Economics | Permalink  TrackBack (0)  Comments (8) 

                    links for 2008-10-30

                      Posted by on Thursday, October 30, 2008 at 12:06 AM in Links | Permalink  TrackBack (0)  Comments (35) 

                      Wednesday, October 29, 2008

                      Econ Bloggers

                      From Tyler Cowen:

                      Econ bloggers gain clout in financial crisis, Marginal Revolution: Here is the article, there is lots from me and from Mark Thoma, among others.

                      On a more casual note, I've enjoyed blogging the same topic week after week after week.  I wonder at what point I will feel like cracking?

                      I'm not sure the quote about doctors came out quite right:

                      Are the econ bloggers able to better explain and analyze the often-complex factors that have led to the current crisis?

                      "I'm in academics," he replied. "On the academics side, you don't ever diagnose the patient. It's all theoretical, and what I'm doing now, especially with the financial crisis, is like having a patient show up at the doctor's office and say, 'I've got these symptoms, what's wrong with me?' And the doctor sticks him. That's a completely different use of economics -- a real time analysis -- that I haven't seen before."

                      Instead of "and the doctor sticks him," I meant that the doctor is asked to diagnose what is wrong and recommend a prescription - a cure of some sort - that will fix the problem (or explain why no cure is available and the patient will have to suffer through the problem until it fixes itself). You don't have the luxury  you have as an academic of waiting until it's all over, looking at the data, and then figuring out how well the policy worked, what could have been done better, etc. Part of real-time policymaking is learning what to look at ("Get me a TED spread, stat!"), and then learning how to interpret the diagnostics that you get so that you can understand what is happening and recommend a course of action. Real-time policy making is not easy, and you find out very fast just how good your models really are, and I've gained a lot of respect for those who do it and do it well since I've started doing this.

                      As in the medical profession, we need an interface between theory and practice - in economics the gulf has been too wide for too long - and I think blogs are one way the profession has started to close the gap between the theoretical community and policymakers. Practitioners have a lot to learn from the theoretical research in medicine and in economics, but there also has to be a feedback in the other direction where the practitioners can say, "this treatement doesn't work, has the following flaws, etc., and it would work better if..." so that the theorists can provide better tools for polcymakers and other practitioners. The Fed and other policymaers have always had to do this - make policy decisions in real-time - but the process wasn't very visible. With blogs, it's starting to come out into the open, e.g. look what Krugman did on his as policies to abate the financial crisis were proposed, and I think that's a very healthy development.

                        Posted by on Wednesday, October 29, 2008 at 01:35 PM in Economics, Methodology, Policy, Universities, Weblogs | Permalink  TrackBack (0)  Comments (29) 

                        Fed Cuts Target Rate to 1 Percent

                        As expected:

                        Press Release Release Date: October 29, 2008

                        The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 1 percent.

                        The pace of economic activity appears to have slowed markedly, owing importantly to a decline in consumer expenditures. Business equipment spending and industrial production have weakened in recent months, and slowing economic activity in many foreign economies is damping the prospects for U.S. exports. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit.

                        In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate in coming quarters to levels consistent with price stability.

                        Recent policy actions, including today’s rate reduction, coordinated interest rate cuts by central banks, extraordinary liquidity measures, and official steps to strengthen financial systems, should help over time to improve credit conditions and promote a return to moderate economic growth. Nevertheless, downside risks to growth remain. The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.

                        Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh.

                        In a related action, the Board of Governors unanimously approved a 50-basis-point decrease in the discount rate to 1-1/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Cleveland, and San Francisco.

                          Posted by on Wednesday, October 29, 2008 at 11:16 AM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (15) 

                          "Destructive Protectionism"

                          Richard Baldwin:

                          The bindings that tie trade together, Free Exchange: You know the world is knee deep in it when Jeff Sachs says the International Monetary Fund has a role to play in global governance! More generally, the crisis is proving the worth of our global economic institutions, but one has been woefully under-noticed—the World Trade Organisation.

                          The WTO is a set of fair-play rules and a list of tariff ceilings that its members have negotiated over the past 60 years (and much else). ...

                          But the bindings (as ceilings are called in WTO jargon) do not apply to all WTO members. Under a principle called the “Enabling Clause”..., developing nations are bound by only some of their tariffs, and the bound ones have ceilings far above the tariff rates that actually apply today.

                          This means they are free to snap their tariffs back up to the ceilings—that is, engage in the mutually destructive beggar-thy-neighbour policies of the 1930s. Consider some history.

                          In the 1997 Asian Crisis ... all five "crisis" countries temporarily raised tariffs in 1998. ... Back then, America played the role of importer-of-last-resort, but this time, even the big boys will be hurting, and likely to pull out the stops when it comes to anti-dumping measures. 

                          I would be very surprised if we don’t see this same Prisoner’s Dilemma tragedy playing out as the global recession deepens. National politicians, who have not had the wisdom to constrain themselves in the WTO, will find it almost irresistible to attempt to shift demand to local producers by raising tariffs on final goods.

                          On the bright side, this destructive protectionism will highlight the value of the tariff bindings that developing nations are offering in the Doha Round negotiations. So far, industrialised country exporters have turned their noses up at the tariff bindings offered by developing countries in the negotiation since they often don’t lower the actual tariff rates.

                          In financial terms, tariff bindings are options. The value of options rise with volatility—a fact that will become abundantly clear as recession spreads around the globe via trade accounts.

                          World leaders should seize the moment and "buy" these options now by finishing the Doha Round negotiations. This would send a great positive signal that they are aware that coordinated action is needed on the current account as well as the capital account.

                            Posted by on Wednesday, October 29, 2008 at 02:07 AM in Economics, International Trade | Permalink  TrackBack (0)  Comments (60) 

                            Shared Appreciation Mortgages

                            Not too long ago, in response to a suggestion for a mortgage foreclosure voucher program, I said:

                            Whatever plan is ultimately implemented to stave off foreclosures, should taxpayers demand a share of any profit (equity) the bailed out homeowner makes if the house is sold later, much like the equity stakes taxpayers will have in banks that are bailed out? ...

                            My impression from comments is that people do not favor this approach.

                            Here's Andrew Caplin , Thomas Cooley , Noel Cunningham and Mitchell Engler in the WSJ:

                            We Can Keep People in Their Homes: ...[W]hile the rescue plan may help the balance sheets of financial institutions, it does nothing to help the balance sheets of households. Their problems must be addressed.

                            The way to do so is through the shared appreciation mortgage, or SAM. The concept is simple: Homeowners are offered the chance to write down a portion of their mortgage debt, but at the same time, they are required to share future appreciation gains with those who helped them out. ...

                            By the time housing prices stabilize, as many as 20 million households may be upside down on their mortgages, creating incentives to default.

                            These defaults set in motion a vicious cycle. Foreclosure is a slow and costly process. Foreclosed properties diminish the worth of nearby homes, driving yet more homeowners into default. Taxpayers are the next casualties. ...

                            The federal government needs to give taxpayers an ownership stake in the future. The SAM does just this. For example, a homeowner unable to support payments on a house purchased for $200,000 that today is worth only $150,000 might be offered a write-down of up to $50,000. But this would not be a free lunch.

                            With the SAM, once the value began appreciating above $150,000, the mortgage holders would be due their share. ...[O]ne way to give lenders a share of the upside would be to pay back some of the write down if the house is later sold, in the scenario above, for more than $150,000. This is a model in which both parties benefit, preventing default while giving future taxpayers a fighting chance at some real upside to the investment we're forcing on them. ...

                            The SAM was pioneered by banks in the U.S. some 40 years ago, but it has been allowed to languish due to an archaic, IRS-imposed block. (The IRS hasn't ruled whether such a contract is a mortgage because it combines elements of equity and debt.) This block could be removed at the stroke of the Treasury secretary's pen. ...

                              Posted by on Wednesday, October 29, 2008 at 12:24 AM in Economics, Financial System, Housing, Policy | Permalink  TrackBack (0)  Comments (23) 

                              links for 2008-10-29

                                Posted by on Wednesday, October 29, 2008 at 12:06 AM in Links | Permalink  TrackBack (0)  Comments (60) 

                                Tuesday, October 28, 2008

                                Financial Stability and the Fed

                                Stephen Roach says the Fed needs to broaden its mandate:

                                Add ‘financial stability’ to the Fed’s mandate, by Stephen Roach, Commentary, NY Times: A regulatory backlash is under way as the US body politic comes to grips with the financial crisis. ... As Washington creates a new system, it must also redefine the role of the Federal Reserve.

                                Specifically, the US Congress needs to alter the Fed’s policy mandate to include an explicit reference to financial stability. The addition of those two words would force the Fed not only to aim at tempering the damage from asset bubbles but also to use its regulatory authority to promote sounder risk management practices. Such reforms are critical...

                                By focusing on financial stability, the Fed will need to adjust its tactics in two ways. Firstly, monetary policy will need to shift from the Greenspan-Bernanke reactive, post-bubble clean-up approach towards pre-emptive bubble avoidance. Second, the bank will need to be tougher in its neglected regulatory oversight capacity. ...

                                I am not suggesting the Fed develops numerical targets for asset markets. It should have discretion as to how it interprets the new mandate. Yes, it is tricky to judge when an asset class is in danger of forming a bubble. But hindsight offers little doubt of the bubbles that developed over the past decade – equities, residential property, credit and other risky assets. The Fed wrongly dismissed these developments, harbouring the illusion it could clean up any mess later. Today’s problems are a repudiation of that approach.

                                There is no room in a new financial stability mandate for bubble denialists such as Alan Greenspan.. He argued that equities were surging because of a new economy; that housing forms local not national bubbles and that the credit explosion was a by-product of the American genius of financial innovation. ... Under a financial stability mandate, the Fed will need to replace its ideological convictions with common sense. When investors buy assets in anticipation of future price increases the Fed will need to err on the side of caution and presume that a bubble is forming that could threaten financial stability.

                                The new mandate would also encourage the Fed to ... deploy... other tools. In times of asset-market froth, I favour the “leaning against the wind” approach with regard to interest rates – pushing the Federal funds rate higher than a narrow inflation target might suggest. But there are other Fed tools that can be directed at financial excesses – margin requirements for equity lending as well as controls on the issuance of exotic mortgage instruments... In addition, the Fed should not be bashful in using the bully pulpit of moral persuasion to warn against the impending dangers of asset bubbles.

                                Of equal importance is the need for the Fed to develop a clearer understanding of the linkage between financial stability and the open-ended explosion of derivatives and structured products. Over the past decade, an ideologically-driven Fed failed to make the distinction between financial engineering and innovation. It understood neither the products nor their scale, even as the notional value of global derivatives hit $516,000bn in mid-2007, the eve of the subprime crisis – up 2.3 times over the preceding three years to a level that was 10 times the size of world gross domestic product. The view in US central banking circles was that an innovations-based explosion of new financial instruments was a huge plus for market efficiency.

                                Driven by its ideological convictions, the Fed flew blind on the derivatives front. ... Like all crises, this one is a wake-up call. The Fed made policy blunders of historic proportions that must be avoided in the future. Adding financial stability to its mandate is vital to preventing such errors again.

                                To the extent that instability in the financial sector impacts employment and price stability, it's already part of the mandate. To the extent that it doesn't, why should the Fed care?

                                In any case, it's already implicitly part of the mandate, e.g. Mishkins says:

                                [T]he Federal Reserve's mandate is "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." Because long-term interest rates can remain low only in a stable macroeconomic environment, these goals are often referred to as the dual mandate; that is, the Federal Reserve seeks to promote the two coequal objectives of maximum employment and price stability. ... (By the way, I wish that I could also discuss the Federal Reserve's role in promoting the stability of the financial system, another key objective of central banks, but unfortunately that would violate my own personal mandate of finishing this speech in the allotted time.)

                                Or, for a more explicit statement, see here.

                                The issue isn't whether preemption of bubbles falls under the Fed's mandate, it's whether a bubble-popping policy can help the Fed to achieve it's goals of maximum employment and stable prices. Greenspan advocated a clean up after the mess philosophy because he thought that preemption did more harm than good (the harm comes from popping misidentified bubbles due to very noisy information), but recent experience has led the Fed to reconsider this approach.

                                I think there's a broader issue here that's important. Popping the next bubble will take courage, the ability to hold steady in the face of severe criticism. It won't be as simple as raising interest rates, though that could help, it will require forceful action by the Fed on other fronts including communication with the public about why it's necessary to reduce the opportunities for people to make money during the boom. The Fed will need to explain why the action isn't choking off productive, innovative activity and that's not a message people will want to hear. If Greenspan had started announcing that he thought housing was overvalued and that people should think twice before purchasing a home, and then think again, the protests would have been heard far and wide. It wouldn't have been easy to do, and I can imagine congress objecting and asking the Fed to explain itself as an implicit threat to its independence. I think Roach is asking for more instutitonal support and guidance in taking such action so that it can be defended more easily as a group decision based upon pre-existing policy, it shouldn't be viewed as an ad hoc move by the Fed or the policy of a single individual. That's why the Fed's announcement that it will reconsider it's approach to bubbles is a good sign, it's a first step toward providing the institutional cover and guidance that will be needed to pursue such strategies.

                                  Posted by on Tuesday, October 28, 2008 at 02:43 AM in Economics, Financial System, Monetary Policy | Permalink  TrackBack (0)  Comments (52) 

                                  "Focus on the Unemployed"

                                  Robert Reich says you should never trust a lame duck:

                                  The Lame-Duck Stimulus, by Robert Reich: When even the chairman of the Federal Reserve Board says Congress should pass a stimulus package we know we're in trouble. The last stimulus of tax rebates stimulated lots of people to pay off some of their debts, which hardly stimulated the economy at all.

                                  The coming stimulus package could be even more nonsensical. It will be voted on by a lame-duck Congress, many of whose members will want to reward campaign donors with juicy pieces of pork. Other lawmakers will see it as their last opportunity to include their pet project or tax perk, and some who won't be accountable because they'll be out of office in a few weeks anyway. In other words, it'll be less a stimulus than a Christmas Tree.

                                  Instead of this, Congress should do just one thing when it returns right after Election Day: Extend unemployment benefits. ...

                                  More than 1 in every 5 people out of work the unemployed have been looking for six months or more. And many are running out of unemployment benefits. ... That means they won't be able to pay their bills, including their mortgages. Already this year, almost half of mortgage delinquencies have been caused by homeowners' lacking of income or employment.

                                  America needs a comprehensive stimulus package, but it should be voted on by the next Congress under a new Administration. And it should be part of a broader jobs strategy that would include rebuilding the nation's crumbling infrastructure, funding alternative sources of energy, and creating tax incentives for businesses that generate new jobs.

                                  For now, focus on the unemployed.

                                  One reason we don't extend unemployment benefits is that we worry about moral hazard, i.e. that some people will simply live off the benefits until they run out, however long that might be, and only then will they be motivated to look for and accept a job (or some milder version of this behavior). However, given our willingness to overlook moral hazard concerns for the time being in the bailout of financial institutions due to the urgency of the situation, is it fair to use the argument that a few people will misbehave as a reason to deny extending benefits to all the people who really need it? Shouldn't the seriousness of the situation and our desire to avoid a severe downturn play a role here too?

                                    Posted by on Tuesday, October 28, 2008 at 01:23 AM in Economics, Fiscal Policy, Unemployment | Permalink  TrackBack (0)  Comments (81) 

                                    Where Did the Bailout Plan Originate?

                                    I also want to know the story of what went on between the Fed and the Treasury during the development of the original bailout plan, and during subsequent revisions:

                                    What Just Happened?, by David Warsh:  The emergency continues, a little less desperate than before. ... A number of mysteries remain.  For instance:

                                    How deep has been the opposition between the Federal Reserve Board and the US Treasury Department these last fifteen months? Fed chairman Ben Bernanke and Treasury Secretary Henry Paulson have presented a generally united front. But what goes on behind the scenes? What of their staffs? The sheer opacity of Paulson’s initial plan to buy and hold troubled securities, and the clumsiness with which it was presented, has yet to be explained. What was the process by which it was developed and internally reviewed?

                                    And where did the ultimately successful plan come from, anyway? Ten days ago it appeared that it was UK Prime Minister Gordon Brown’s idea (doubtless crafted for him by Bank of England Governor Mervyn King). True enough, Brown boldly and confidently tackled his banking crisis at its root. A cartoon in the Financial Times depicted leaders of other industrial nations following him along in a cheerful dance. There followed the standard paeans to John Maynard Keyes.

                                    But the basic blueprints Brown adopted had been drawn up in Stockholm in late 1992, when central bankers in Sweden, Norway and Finland moved swiftly to rescue their big banks after the collapse of a property bubble. The rescue succeeded, though its aftermath lingered on for four years.

                                    What were the channels through which Swedish influence flowed to London and Washington? This is an especially interesting question because of the experience of the early 1930s, when Gustav Cassel argued without success that overly restrictive American monetary policy was making matters worse, and Gunnar Myrdal devised budgetary policies implemented by the new Social Democratic government in 1933 that spared Sweden the worst of the Great Depression.

                                    In other words, economists of the Stockholm School implemented successful macroeconomic policies several years before John Maynard Keynes published his General Theory of Employment, Interest and Money, even if they were unable to make the case for what they were doing to the wider world. The Swedes have taken economics very seriously ever since. Would they sit on their hands at a time when the world was threatened with another serious depression? What overtures would they make instead? ...

                                    I think there were other channels of influence as well, e.g. the wide call from economists for recapitalization likely made it easier to alter course once the the UK took the lead.

                                      Posted by on Tuesday, October 28, 2008 at 12:24 AM in Economics, Financial System, Policy | Permalink  TrackBack (0)  Comments (10) 

                                      links for 2008-10-28

                                        Posted by on Tuesday, October 28, 2008 at 12:06 AM in Links | Permalink  TrackBack (0)  Comments (39) 

                                        Monday, October 27, 2008

                                        The Financial Crisis and Short-Run Stabilization Policy

                                        Short-run stabilization policy for the economy during a downturn involves either cutting taxes to stimulate consumption and investment (and sometimes net exports), or increasing government spending. Which of these is used and the specific policy adopted has important implications for the effectiveness of policy, but no matter how it is done it will raise the deficit, and the increase in the deficit is often used to oppose the policy.

                                        Theoretically, however, there is no reason at all why short-run stabilization policy ought to impact the long-run budget picture. Ideally, the deficits that accumulate during bad times are paid for by raising taxes or cutting spending during the good times so that there is no net change in the budget in the long-run.

                                        Historically, we have been pretty good at spending money in bad times, but not so good at paying for the spending when times are better. But if we are serious about stabilization, that's what we need to do. When output is below the long-run sustainable rate we increase economic activity by deficit spending, and when output exceeds the long-run sustainable rate, we decrease activity by running a surplus. Doing this fills the troughs with the shaved peaks from the booms and keeps the economy closer to the long-run trend value.

                                        I've been wondering if the current crisis will change our attitude about paying for stabilization policy, i.e. if it will make us more willing to raise taxes and cut spending when times are good. One of the problems with the last two boom-bust cycles was unchecked exuberance. Any calls to raise taxes or interest rates were met with howls about how it would cut off the boom, and who would want to do that? But tempering the boom might have helped to reduce the size of the meltdown we are experiencing now and left us much better off.

                                        When the next boom develops, will we be more willing to raise taxes, cut spending, and tighten Fed policy? Will we remember what happened when the previous two booms ended and be more willing to step in and slow down the booming economy, will we be less susceptible to the argument that doing so will eliminate creative and productive innovation (as opposed to misdirecting resources during the mania phase)? This doesn't mean creating a recession or slamming on the brakes so hard we hit our heads, it doesn't mean ending innovative activity, it simply means what it says, bringing the growth rate down to its sustainable rate, and attenuating the exuberance that leads to housing and dot.com bubbles. Will we be more willing to take the necessary steps the next time the economy begins to boom?

                                        I doubt it.

                                        And the problem is that if we aren't willing to pay our bills during the good times, then it will be much harder to spend the money we need to spend when times are bad -- our hands will be tied when it comes to stabilization policy.

                                        So perhaps a business cycle version of Paygo is needed. Legislation could be clearly identified as a countercyclical measure, and it would contain both the deficit spending to address the downturn along with an explicit plan to pay for the policy when times get better. That is, the legislation would contain a specific trigger saying that when the recession is over and GDP growth, employment growth, etc. exceed some predefined amount (e.g. two quarters of strong growth), taxes would go up or spending would be cut by enough to pay for the stabilization package.

                                        My concern is that worries over the deficit will prevent us from taking the countercyclical policy steps we need to take to protect people who are vulnerable to job loss, etc. in a downturn. Thus, the goal here is to find a way to ease the long-run budget worries so that we don't hesitate to do what's needed to stabilize the economy. I'm not sure if a business cycle version of Paygo is the answer, it may be just as hard to promise to raise taxes in the future as it is at any other time (though perhaps this would be easier if it returned rates to old levels), and the triggers would be hard to define, but somehow we need to learn to pay for the policies we put in place so that they will still be there the next time we need them.

                                        A better answer would be a legislature that does this on its own without the need for mechanisms such as Paygo to force them to do what is best for the economy over the long-run, but that hasn't worked. Maybe we''l get a better class of legislators in the future, but I'm not counting on that.

                                        Finally, this is separate from spending on infrastructure, health care, etc., and whether we can afford it. I think we can afford it, and that we should invest in infrastructure to enhance future productivity, that we should take on health care (our biggest long-run budget worry), and that we should make other investments in our future, but that is a different discussion. They can be connected - short-run stabilization can be directed a longer-run problems when it's feasible to do so - but the case for short-run stabilization can be made independent of whether or not it contributes to solving longer run issues. If it does, so much the better.

                                          Posted by on Monday, October 27, 2008 at 02:25 PM in Budget Deficit, Economics, Fiscal Policy | Permalink  TrackBack (0)  Comments (52) 

                                          Paul Krugman: The Widening Gyre

                                          The financial crisis is still spreading, and emerging market economies are now "in big trouble":

                                          The Widening Gyre, by Paul Krugman, Commentary, NY Times: Economic data rarely inspire poetic thoughts. But as I was contemplating the latest set of numbers, I realized that I had William Butler Yeats running through my head: “Turning and turning in the widening gyre / The falcon cannot hear the falconer; / Things fall apart; the center cannot hold.”

                                          The widening gyre, in this case, would be the feedback loops (so much for poetry) causing the financial crisis to spin ever further out of control. The hapless falconer would, I guess, be Henry Paulson...

                                          And the gyre continues to widen in new and scary ways. Even as Mr. Paulson and his counterparts in other countries moved to rescue the banks, fresh disasters mounted on other fronts. ...

                                          The really shocking thing ... is the way the crisis is spreading to emerging markets — countries like Russia, Korea and Brazil.

                                          These countries were at the core of the last global financial crisis, in the late 1990s... They responded to that experience by building up huge war chests of dollars and euros, which were supposed to protect them... And not long ago everyone was talking about “decoupling,” the supposed ability of emerging market economies to keep growing even if the United States fell into recession. ...

                                          That was then. Now the emerging markets are in big trouble. ... What happened? In the 1990s, emerging market governments ... made a habit of borrowing abroad; when the inflow of dollars dried up, they were pushed to the brink. Since then they have been careful to borrow mainly in domestic markets, while building up lots of dollar reserves. But all their caution was undone by the private sector’s obliviousness to risk.

                                          In Russia, for example, banks and corporations rushed to borrow abroad, because dollar interest rates were lower than ruble rates. So while the Russian government was accumulating an impressive hoard of foreign exchange, Russian corporations and banks were running up equally impressive foreign debts. Now their credit lines have been cut off, and they’re in desperate straits.

                                          Needless to say, the existing troubles in the banking system, plus the new troubles ... are all mutually reinforcing. Bad news begets bad news, and the circle of pain just keeps getting wider.

                                          Meanwhile, U.S. policy makers are still balking when it comes to doing what’s necessary to contain the crisis.

                                          It was good news when Mr. Paulson finally agreed to funnel capital into the banking system in return for partial ownership. But ... the ... plan ... contains no safeguards against the possibility that banks will simply sit on the money. ... And sure enough, the banks seem to be hoarding the cash.

                                          There’s also bizarre stuff going on with regard to the mortgage market. I thought that the whole point of the federal takeover of Fannie Mae and Freddie Mac ... was to remove fears about their solvency and thereby lower mortgage rates. But top officials have made a point of denying that Fannie and Freddie debt is backed by the “full faith and credit” of the U.S. government — and as a result, markets are still treating the agencies’ debt as a risky asset, driving mortgage rates up at a time when they should be going down.

                                          What’s happening, I suspect, is that the Bush administration’s anti-government ideology still stands in the way of effective action. Events have forced Mr. Paulson into a partial nationalization of the financial system — but he refuses to use the power that comes with ownership.

                                          Whatever the reasons for the continuing weakness of policy, the situation is manifestly not coming under control. Things continue to fall apart.

                                            Posted by on Monday, October 27, 2008 at 12:42 AM in Economics, Financial System, International Finance | Permalink  TrackBack (0)  Comments (46) 

                                            Kotlikoff and Leamer: We Need a National Fire Sale

                                            Larry Summers says spend money on infrastructure to stimulate the economy, which is my preference as well, at least as one part of a fiscal stimulus package. Laurence Kotlikoff and Ed Leamer have a different idea. They say we should hold a national "fire sale" to stimulate consumption:

                                            Running a National Sale, by Laurence J Kotlikoff and Edward Leamer, Martin Wolf's Forum: The demise of financial titans and the incessant warnings of economic Armageddon have unleashed a tidal wave of asset sales across the globe, eviscerating trillions in personal wealth. ...

                                            The same defensive mentality that allowed the sale of equities at fire sale prices threatens to cause a sharp drop in consumer spending, which accounts for 72 per cent of US GDP. If this happens, the economy will slide into deep recession.

                                            We need to put a halt to self-fulfilling prophecies of doom. The key is realising that recessions are usually consumer cycles, not business cycles. They’re driven by weakening demand first for homes, then for consumer durables, and finally for nondurables and services. As consumers stop spending, businesses stop investing, and the economy “recedes”. ...

                                            [O]ur instinct now is to hoard every dollar for fear it’s our last. If we all do this, firms will find no customers to whom to sell their wares. Thus, collective ... attempts to save can undermine the economy, leaving us with less output and, ultimately, less saving. This is Keynes’ Paradox of Thrift.

                                            To escape the panicked-saving trap, we need to immediately and directly stimulate consumption. Having Uncle Sam send us cheques won’t work. Some 80 cents of every dollar of the stimulus checks we received last spring appears to have been saved, not consumed. ...

                                            A better way to spur consumer spending is for Uncle Sam to run a six-month national sale by having a) state governments suspend their sales taxes and b) the federal government make up the lost state sales revenues. The national sale could be implemented immediately. ...

                                            For states with low or zero sales tax rates, implementing this policy requires making their sales tax rates negative, ie subsidising purchases. Shoppers would see a negative tax on their sales receipts, lowering their outlays. State governments would reimburse businesses ... and, in turn, be reimbursed by the Feds.

                                            States would be free to broaden their sales tax bases to apply the National Sale to all retail sales... To make the policy progressive, states could also reduce sales tax rates by more for goods and services that are disproportionately consumed by the poor. ...

                                            How big should this stimulus be? A 5 per cent national sale extending for six months would cost the Treasury about $250bn. Can the government afford this? Yes...

                                            No plan is perfect... But it will apply economic medicine where it’s most needed – on consumer spending, giving everyone an incentive to spend now and begin again to trust our economy and its institutions.

                                              Posted by on Monday, October 27, 2008 at 12:33 AM in Economics, Fiscal Policy | Permalink  TrackBack (0)  Comments (65) 

                                              links for 2008-10-27

                                                Posted by on Monday, October 27, 2008 at 12:06 AM in Links | Permalink  TrackBack (0)  Comments (20) 

                                                Sunday, October 26, 2008

                                                "Is The New York Times Giving Us a Bad Read?"

                                                John Hempton has a question:

                                                Is the New York Times giving us a bad read on the newspaper business?, by John Hempton: News Corp’s newspaper advert numbers are bad – but they are not catastrophic. ... The death of newspapers looked exaggerated if your benchmark was News Corp.

                                                The WSJ is doing OK- not stellar – but OK. Murdoch clearly has plans to turn it (a) into a national paper, and (b) into the dominant paper in NYC. In that he is helped by the seeming failures of the New York Times.   

                                                The New York Times is a paper I want to like, but in fact like less and less. It is falling into catastrophic disrepair and the stock price shows it.

                                                The New York Times has become the poster boy for the demise of newspapers everywhere. Revenue and profitability is weak – and the paper looks doomed. Well is it possible – just possible – that the NYT editorial policies are giving us all a false read about the demise of papers? 

                                                • Why is it that the paper employs Ben Stein despite the regular and ludicrous columns so well criticised by Felix Salmon?
                                                • Does anybody still read Maureen Dowd? As far as I can tell the same incoherent column has been repeated for about a decade. (Maybe I am just insensitive to "gender issues"?) Is this worth a regular editorial column in what purports to be the world’s greatest paper?
                                                • Bob Herbert suits my liberal predisposition – but I don’t bother reading him because I learn little new or useful. He is too predictable. And he has been that predictable for fifteen years...
                                                • Friedman seems to know less about foreign affairs (outside Israel and Beirut) than I do. And I know very little. He has been spectacularly wrong quite often. Unlike Friedman though I know I know little about foreign affairs - he has a platform to show off his ignorance twice a week...
                                                • David Brooks is a poor replacement for the conservative William Safire. Safire wrote better – and more to the point I had little idea what he was going to say and sometimes I was forced by sheer power of argument to agree with him. David Brooks has never done that for me. Safire was a disingenous guy who twisted facts to suit his political views - but he was darn clever about how he did it...
                                                • In the editorial area all they have is the very clever Krugman. I agree with Krugman a good proprotion of the time - but I am forced to think. He drives conservatives to apoplexy for the same reasons that Safire drove liberals to apoplexy. He is too darn good. Unlike Safire he doesn't twist the facts - at least in my view. If only the paper could find five writers the standard of Krugman covering most political persuasons. But then it would need to sack the others!

                                                And that is when I get to the editorial policy. Need I repeat that this was the paper that employed Jayson Blair (who just made it up with little consequence for the world) and Judith Miller (whose seemingly made up stories helped propel America to the Iraq war). 

                                                The New York Times is failing... In the past the New York Times would be forgiven their failures – because there were few alternative sources of information. But now there are plenty… competition is rife.

                                                Competition is seldom good for shareholders. It hurts well run businesses but competition has a knack of totally disposing of badly run businesses. Indeed that is the real charm of competition. 

                                                I want to ask a question: how much of the awful results of the New York Times are because of the demise of newspapers generally – and how much are newspaper specific?  How would we know?  ...

                                                  Posted by on Sunday, October 26, 2008 at 04:32 PM in Economics, Press | Permalink  TrackBack (0)  Comments (57) 

                                                  Creative Reconstruction

                                                  Larry Summers argues the financial crisis is an opportunity to address some long-standing structural problems, and to implement "transformational technologies" that "stimulate demand in the short run and have a positive impact on productivity":

                                                  The pendulum swings towards regulation, by Lawrence Summers, Commentary, Financial Times: ...Discussions of the policy implications of the crisis have primarily focused on the immediate economic demands. The need to ensure the capital adequacy of financial institutions, maintain important credit flows, support the housing sector and the real economy, contain international spillovers and reform regulation ... have rightly been the priority. ...

                                                  However, policies that contain the crisis, support the economy and generate recovery are not sufficient to meet the historic challenge of this moment. ... In important ways,... the crisis creates space to address longer standing problems. Just as patients hear advice regarding diet and exercise differently after a heart attack, so recent events should make it possible for the next US administration to accomplish more than might previously have been thought possible.

                                                  Continue reading "Creative Reconstruction" »

                                                    Posted by on Sunday, October 26, 2008 at 03:33 PM in Economics, Fiscal Policy | Permalink  TrackBack (0)  Comments (22) 

                                                    Is a Currency Crisis Next?

                                                    Paul Krugman says there are "clear signs of currency crises throughout the world of emerging markets":

                                                    The mother of all currency crises, by Paul Krugman: ...I’ve been reading reports from Stephen Jen, a former student of mine who’s now the chief currency strategist at Morgan Stanley. He points out that since the fall of Lehman, we’ve been seeing clear signs of currency crises throughout the world of emerging markets, including Eastern Europe. This time, it’s not an Asian crisis or a Latin American crisis, it’s a global crisis. ...

                                                    Dani Rodrik calls for the IMF to take immediate action to avoid "the mother of all currency crises," and the potential for a "vicious cycle of unemployment and protectionism":

                                                    Urgent need for IMF action, by Dani Rodrik: Paul Krugman frets that we are about to witness the mother of all currency crises in emerging markets, and I am afraid that he is right. As I wrote in my previous post, the financial crisis in the developing world has just started and there are indications that it will get a lot, a lot worse.  What is different with this phase of the crisis is that it cannot be addressed by governments in the affected countries issuing their own fiscal guarantees and domestic currency. These countries need external lines of credit, and they need it fast before the scale of the problem becomes truly unmanageable.   

                                                    The solution is clear. The IMF, possibly along with central banks of the G7, has to act as a global lender of last resort to emerging markets. These countries have to have ample access to liquidity in reserve currencies--quickly and with few strings attached--for them to be able to fend off what may otherwise become a historic rout of their currencies.  And China should join in: it should make a portion of its near-$2 trillion of reserves available in support of this global enlargement of credit lines.

                                                    Emerging markets have every right to say that they are being swept under by a crisis that is not their own doing. But the real reason the rest of the world needs to move on this front is naked self-interest. Combine a deep recession in the advanced countries with an uncontrolled depreciation of emerging-market currencies, and the pressure to erect trade barriers in the U.S. and Europe will be impossible to withstand.  A vicious cycle of unemployment and protectionism feeding on each other a la 1930s could transform the deep recession everyone is already expecting into a second great depression. It can get worse...

                                                    I have a feeling that this will be the make-it-or-break-it week for emerging markets. I hope the IMF will make an announcement in time to make a difference.

                                                    Update: See also Currency crisis is gathering storm from Edward Harrison at Credit Writedowns. Also, "Waiting for G7 Currency Intervention: It Won’t Be Long by Simon Johnson.

                                                      Posted by on Sunday, October 26, 2008 at 12:33 PM in Development, Economics, Financial System, International Finance | Permalink  TrackBack (2)  Comments (19) 

                                                      Paul Krugman: Desperately Seeking Seriousness

                                                      Why was the financial crisis a turning point in the election?:

                                                      Desperately Seeking Seriousness, by Paul Krugman, Commentary, NY Times: Maybe the polls and the conventional wisdom are all wrong... But right now the election looks like a ... solid victory, maybe even a landslide, for Barack Obama...

                                                      Yet just six weeks ago the presidential race seemed close, with Mr. McCain if anything a bit ahead. The turning point was the middle of September, coinciding precisely with the sudden intensification of the financial crisis... But why has the growing financial and economic crisis worked so overwhelmingly to the Democrats’ advantage? ...

                                                      I’d like to believe that the bad news convinced many Americans, once and for all, that the right’s economic ideas are wrong and progressive ideas are right. And there’s certainly something to that. ...

                                                      But I suspect that the main reason for the dramatic swing in the polls is something less concrete... As the economic scene has darkened, I’d argue, Americans have rediscovered the virtue of seriousness. And this has worked to Mr. Obama’s advantage, because his opponent has run a deeply unserious campaign.

                                                      Think about the themes of the McCain campaign... Mr. McCain reminds us, again and again, that he’s a maverick — but what does that mean? His maverickness seems to be defined as a free-floating personality trait, rather than being tied to any specific objections ... to the way the country has been run for the last eight years.

                                                      Conversely, he has attacked Mr. Obama as a “celebrity,” but without any specific explanation of what’s wrong with that...

                                                      And the selection of Sarah Palin ... clearly had nothing to do with what she knew or the positions she’d taken — it was about who she was, or seemed to be. Americans were supposed to identify with a hockey mom who was just like them.

                                                      In a way, you can’t blame Mr. McCain for campaigning on trivia — after all, it’s worked in the past. Most notably, President Bush got within hanging-chads-and-butterfly-ballot range of the White House only because much of the news media, rather than focusing on the candidates’ policy proposals, focused on their personas: Mr. Bush was an amiable guy you’d like to have a beer with, Al Gore was a stiff know-it-all, and never mind all that hard stuff about taxes and Social Security. And let’s face it: six weeks ago Mr. McCain’s focus on trivia seemed to be paying off handsomely.

                                                      But that was before the prospect of a second Great Depression concentrated the public’s mind.

                                                      The Obama campaign has hardly been fluff-free — in its early stages it was full of vague uplift. But the Barack Obama voters see now is cool, calm, intellectual and knowledgeable, able to talk coherently about the financial crisis in a way Mr. McCain can’t. And when the world seems to be falling apart, you don’t turn to a guy you’d like to have a beer with, you turn to someone who might actually know how to fix the situation.

                                                      The McCain campaign’s response to its falling chances of victory has been telling: rather than trying to make the case that Mr. McCain really is better qualified to deal with the economic crisis, the campaign has been doing all it can to trivialize things again. Mr. Obama consorts with ’60s radicals! He’s a socialist! He doesn’t love America! Judging from the polls, it doesn’t seem to be working.

                                                      Will the nation’s new demand for seriousness last? Maybe not — remember how 9/11 was supposed to end the focus on trivialities? For now, however, voters seem to be focused on real issues. And that’s bad for Mr. McCain and conservatives...: right now, to paraphrase Rob Corddry, reality has a clear liberal bias.

                                                      Brad DeLong disagrees.

                                                        Posted by on Sunday, October 26, 2008 at 12:33 AM in Economics, Politics | Permalink  TrackBack (1)  Comments (47) 

                                                        "Escaping from a Combined Liquidity Trap and Credit Crunch"

                                                        This argues that we are "in a liquidity trap ...that ... is occurring at significantly positive interest rates."  The proposed solution is to "temporarily guarantee a lower bound for the S&P 500 through targeted purchases of market portfolios via open-market operations and financed by injecting cash." I have to agree with the bottom line, "it would not seem to be a popular way to solve the crisis":

                                                        Escaping from a Combined Liquidity Trap and Credit Crunch, by Frank Heinemann, Vox EU: Between the collapse of Lehman Brothers on 15 September and the announcements of European and US bank recapitalizations on 13 and 14 October, stock prices fell daily, producing double-digit percentage-point losses in most major markets. The muscular interventions agreed on 13 and 14 October seem to have quelled the worst of the panic, but stock prices have not rebounded.

                                                        The current situation is worrisome. Private investors are liquidating all kinds of real-valued assets and are instead hoarding liquidity at banks considered safe due to government guarantees. Banks are selling their shares and are calling in debts to minimize loses and save their remaining equity and to simply remain solvent. They are parking their liquidity at central banks and are not issuing new loans.

                                                        Monetary policy is currently ineffectual. Interest rate cuts are not being passed on and the expansion of the money supply has also failed to influence credit terms.

                                                        We are in a credit crunch – albeit not for lack of liquidity in the banking sector, but rather due to banks’ naked fear of having to write off more debts and, thereby, of endangering their own solvency.

                                                        As monetary policy can presently neither reduce market interest rates nor stimulate the issuance of private loans, we are, furthermore, in a liquidity trap. The novelty here is that this liquidity trap is occurring at significantly positive interest rates, whereas it appeared in Japan through the zero bound on nominal interest rates.

                                                        Continue reading ""Escaping from a Combined Liquidity Trap and Credit Crunch"" »

                                                          Posted by on Sunday, October 26, 2008 at 12:21 AM in Economics, Financial System, Policy | Permalink  TrackBack (1)  Comments (18) 

                                                          links for 2008-10-26

                                                            Posted by on Sunday, October 26, 2008 at 12:06 AM in Links | Permalink  TrackBack (0)  Comments (10) 

                                                            Saturday, October 25, 2008

                                                            "But Have We Learned Enough?"

                                                            Greg Mankiw would like to say we know enough to guarantee we won't repeat the mistakes that the led to the Great Depression, but he can't rule out the possibility that it will happen again:

                                                            But Have We Learned Enough?, by N. Gregory Mankiw, Economic View, NY Times: ...[W]hen Olivier Blanchard, the I.M.F.’s chief economist, was asked about the possibility of the world sinking into another Great Depression, he reassuringly replied that the chance was “nearly nil.” He added, “We’ve learned a few things in 80 years.”

                                                            Yes, we have. But ... have we learned enough to avoid doing the same thing again? ...

                                                            Perhaps the most troubling study of the 1930s economy was written in 1988 by the economists Kathryn Dominguez, Ray Fair and Matthew Shapiro; it was called “Forecasting the Depression: Harvard Versus Yale.” ...

                                                            The three researchers show that the leading economists at the time, at competing forecasting services run by Harvard and Yale, were caught completely by surprise by the severity and length of the Great Depression. What’s worse, despite many advances in the tools of economic analysis, modern economists armed with the data from the time would not have forecast much better. In other words, even if another Depression were around the corner, you shouldn’t expect much advance warning from the economics profession.

                                                            Let me be clear: Like Mr. Blanchard at the I.M.F., I am not predicting another Great Depression. We have indeed learned a lot over the last 80 years. But you should take that economic forecast, like all others, with more than a single grain of salt.

                                                              Posted by on Saturday, October 25, 2008 at 01:17 PM in Economics, Methodology | Permalink  TrackBack (0)  Comments (21) 

                                                              "There is a Credit Crunch"

                                                              Tyler Cowen does some digging and concludes:

                                                              I still cannot agree with Alex and Bryan: ...I remain stubborn in my belief that there is a credit crunch.  Here is one report:

                                                              How is trade finance coping with the credit crunch Badly. Steve Rodley, director of London-based shipping hedge-fund Global Maritime Investments, puts it bluntly: "The whole shipping market has crashed." The trouble is that credit ... has evaporated...

                                                              Here is another report.  Here are other reports.  Or read this account:...

                                                              Here are simple and in my view decisive quantitative indicators of the current domestic credit crisis.  Or here is another report:

                                                              According to experts interviewed by Bloomberg, "letters of credit and the credit lines for trade currently are frozen," and as a result, "nothing is moving".

                                                              Or here is a recent survey of U.S. retailing CFOs:

                                                              Some 41 percent of US retailers are seeing tight credit as a result of the crisis in the banking sector, and many will cut staff and reduce buying as a result...

                                                              Many other surveys paint a similar picture. I can only repeat my earlier words that immediate credit flows are demand-driven and they do not measure bad credit conditions concurrently because they stem from prior bank commitments. ...  Here is Wikipedia on lagging indicators and yes it tells you that standard forms of credit fall into this category and this has been understood for some time.  Look instead at the currently informative pieces of the evidence and you will see that they point in a very consistent direction. 

                                                              It is true that many credit channels have not shut down.  But the ones that are shutting down are enough to cause a severe global recession.

                                                              Update: James Kwak has more.

                                                                Posted by on Saturday, October 25, 2008 at 01:08 PM in Economics, Financial System | Permalink  TrackBack (1)  Comments (10) 

                                                                Redistribution of Opportunity

                                                                What if we redistribute opportunity instead of redistributing wealth?:

                                                                Equal Chances for Equal Talent, by Will Wilkinson: The first part of Rawls’ Second Principle of Justice says, in Joshua Cohen’s words, “people who are are equally talented and motivated are to have equal chances to attain desirable positions, so far as this is consistent with maintaining equal basic liberties…”

                                                                This has always thrown me for a loop. ...

                                                                Maybe this is how you approach it, and I do wonder why we don’t see more proposals like the following from those egalitarians who do tend to see the desirable positions as more or less fixed… How about a quota system for firms that limits hiring from high-status schools and mandates a certain number from low-status schools, so that it’s better to be the best kid from the University of North Dakota than the median kid at Princeton? Radical high school-quality affirmative action quotas for college admissions. No Supreme Court justice can have more than one clerk from a top-ten law school. It is illegal ever to hire someone who is a relative, or a friend, or a friend of a friend. Randomized assignments to a vast network of national boarding schools. Combat self-reinforcing prestige by picking an athletic conference at random and then mandating that all Federal Reserve governors for the next ten years be professors at schools from that conference. (So Harvard and MIT econ depopulates as everyone rushes to Creighton and Indiana State. Etc.) Examples of this sort can be multiplied. So would these strategies be “consistent with maintaining equal basic liberties”? Are they necessary for maintaining equal basic liberties, but egalitarians are simply missing the real issue by going on and on about income redistribution? ...

                                                                  Posted by on Saturday, October 25, 2008 at 03:06 AM in Economics, Income Distribution | Permalink  TrackBack (0)  Comments (43) 

                                                                  Bill Moyers Interviews James Galbraith


                                                                  Update: Review of Jamie Galbraith's The Predator State from the Journal of Economic Issues.

                                                                    Posted by on Saturday, October 25, 2008 at 01:17 AM in Economics, Video | Permalink  TrackBack (0)  Comments (12) 

                                                                    links for 2008-10-24

                                                                      Posted by on Saturday, October 25, 2008 at 12:06 AM in Links | Permalink  TrackBack (0)  Comments (16) 

                                                                      Friday, October 24, 2008

                                                                      "Free Trade with a Human Face"

                                                                      Because I know how much you like talking about immigration and free trade:

                                                                      Free trade with a human face, by Jorge G. Castañeda, Project Syndicate: ...For many Latin American nations, not just Mexico, immigration is the single most important issue in their relations with the US. The Caribbean islands all have a similarly high proportion of their citizens residing in the US and depend as much as Mexico on remittances. The same is true for much of Central America. And no part of South America is exempt from this pattern.

                                                                      So almost all of Latin America is deeply affected by the current immigration climate in the US, and would benefit greatly from the type of comprehensive immigration reform that both John McCain and Barack Obama have supported. The Bush administration’s regrettable decision to build fences along the US-Mexico border, raid workplaces and housing sites, detain and deport foreigners without papers, is viewed in Latin America as being hypocritical and offensive. The issue is all the more painful and disappointing since most Latin American foreign ministries know full well that these attitudes are pure politics, nothing more. ...

                                                                      If immigration is to become a less heated issue, the US must address the needs of Latin America’s economies. Here, one of the key challenges facing the next US administration lies in the existing and pending free-trade agreements between the US and Latin America. ...

                                                                      If recession drags on and Americans continue to blame trade agreements – erroneously – for growing unemployment, falling wages, and yawning inequality, opposition to these deals will grow. Instead of waiting for the pressure to mount, the next president would do well to preempt it with an ambitious agenda on free-trade reform that would benefit everyone. ...

                                                                      First, clear and explicit human rights and democracy clauses should be included, along the lines of similar clauses in the Mexican and Chilean Economic Association treaties with the EU. Second, more specific provisions on labor, the environment, gender equality, and indigenous rights are needed, as well as anti-trust, regulatory, and judicial reform provisions, for reasons both of principle and political expediency.

                                                                      Although there have been enormous improvements in most of these areas, there remains a huge agenda, particularly with regard to breaking up or regulating monopolies – public, private, commercial, trade union-based – that plague nearly every country in the region.

                                                                      These revised agreements should include bold, enlightened provisions for infrastructure and “social-cohesion” funds, since these can make the difference between muddling through and true success. Free-trade advocates should not view Obama’s demand that these deals be revisited as a mistake, but rather as an opportunity to improve and deepen them; McCain’s supporters should not see the incorporation of all of the aforementioned inclusions as “European nonsense,” but rather as a way to narrow the gap between the agreements’ promise and their actual results.

                                                                      Improving Mexican and Central American infrastructure, education, and rule of law, or improving Colombian and Peruvian drug-enforcement efforts and respect for labor laws and human rights, are all in America’s interest, and-free trade agreements can help rather than harm such efforts.

                                                                      If the US and Latin America can face up to the challenges of trade and immigration together, the next US president may leave a weightier mark on the hemispheric relationship than any American leader in three generations.

                                                                        Posted by on Friday, October 24, 2008 at 01:26 PM in Development, Economics, International Trade | Permalink  TrackBack (0)  Comments (45) 

                                                                        The Goal of Increasing Home Ownership

                                                                        If someone has been paying rent month after month, year after year, and has a good credit record, it seems to me there ought to be some way for them to buy a house.

                                                                        We are about to start passing rules and regulations to try to prevent another financial crisis from happening, and I don't want to see people excluded from home ownership unnecessarily. I know it's unfashionable to stick up for the poor right now, to advocate for increased home ownership, and in particular to say that it was not a mistake to try to increase home ownership rates at lower income levels, but (1) poor households didn't cause the financial crisis, though in many cases they were victims of it, and (2) it's the right thing to do in any case.

                                                                        One thing I hear is that lower income households should just rent, as though that's equivalent to owning a home except for the financial arrangement. But renting is not the same as owning a home. I'm not saying one is better than the other, though I have a preference, but they are different. Each has advantages and disadvantages that suit different preferences, and those who prefer ownership shouldn't be needlessly excluded.

                                                                        I would be willing to pay quite a bit not to have to ask if I can paint a bedroom the color that I want, change the landscaping, hang a picture securely on the wall, have a dog or a cat, not to even have to think about whether something is okay or not with the owner if I want to change it. I don't want to have to let someone in with 24 hours notice. If I want a  basketball hoop above the garage, that's my choice. As an owner, I don't have to worry about my rent going up over time - I can lock into a fixed payment - or not having the lease renewed because the landlord has decided to do something else with the property.

                                                                        However, if the roof leaks, the hot water heater stops working, a pipe breaks, anything like that, then it's my responsibility to pay for it. If I want to move it's a lot harder, I can't just give notice, pack up and go once the lease ends. Instead I have to worry about selling my house, and maybe losing money on it.

                                                                        But there's something about owning I can't quite explain, but it's different, at least to me. I don't like that, when I rent, I'm only able to live somewhere so long as someone else gives me permission to do so. As long as I make my house payment every month, I have a place to live. Always. I don't know why that is comforting, but it is.

                                                                        If we, say, require a 10% or 20% down payment for all buyers, that will impose a substantial barrier to purchasing a home. Many people can get access to a down payment somehow - real estate agents will fill you in on tricks such as how to borrow the money from family and have it look like a gift - but many others don't have access to those resources, and saving money when you are living close to the edge is not easy at all.

                                                                        But what about all the lower income households who have never missed a rent payment, that have decent credit, but cannot possibly meet even, say, a 10% down payment hurdle, how do we ensure that they have a path to home ownership? They have shown themselves to be able to reliably pay a particular amount, and there ought to be a house they could buy with a similar payment profile.

                                                                        I don't know the data well enough to conclude this for sure, but if my impression is correct, many of these households weren't sold houses they could afford, houses with payments, say, equivalent to the rent they had been paying. Instead, they were sold houses far above that rate, and probably sold a plan along with it for how they could meet the payments, and how they could escape if things didn't work out (since prices would, of course, continue rising). I don't know whose fault it is that the households ended up in highly risky positions that would, in many cases, lead to default - the homeowner surely wanted a dream house and to join in the money-making, the real estate agent certainly wanted a large sale since they earn more when the sales price is higher, the broker incentives were to get the deal done, and so on. But something went wrong and these households did not end up in the right houses, or with the right financial arrangements.

                                                                        So let's fix that instead of excluding them from ownership. Households with a verifiable, reliable payment history and with decent credit need a way to buy a house if that's what they have their heart set on doing. But it has to be a house they can afford, the payments have to match their income and their rental history. The process has to ensure that this happens.

                                                                        [Sketching something out quickly without intending to get every detail correct, perhaps something like the following would work. First, you only get one shot at this program. If you walk away or default, that's it, you can't ever use this program again. That probably means not buying a house again for a long, long time, if ever. The program would involve mortgage loans with minimal down payment requirements.

                                                                        Second, if your household income is in the qualifying range, the government will grant you an equity stake in the house of, say, $5,000 (or pick an amount you like better). If you stay in the house for seven years or more, then the $5,000 is yours if you ever sell the house (perhaps as a tax credit).  [There could be some payback mechanism if the homeowner makes an excessive amount on the sale, or not. Also, I don't like that there is an incentive to sell the house after seven years, so perhaps the $5,000 could go into an IRA or something similar if it is not used to purchase a new house, that way the cash would not be immediately available if the household went back to renting.]

                                                                        Third, a big problem would be repairs - roofs, plumbing, that sort of thing. Big expenditures like that could cause problems and lead to default. Some sort of insurance against this could be made available and required as part of the house payment (along with co-pays to create better incentives but still keep the cost reasonable).

                                                                        And so on, someone else can take the time to get all the details and incentives right, feel free to offer your own, but the main thing is to find a way to allow households with lower incomes to purchase a house with little or no down payment, yet still give the buyers some equity stake in the purchase so that they have something at risk giving them less incentive to walk away or default (hence the restriction on only using the program once).

                                                                        There ought to be a way to get this done.]

                                                                          Posted by on Friday, October 24, 2008 at 02:34 AM in Economics, Financial System, Housing | Permalink  TrackBack (0)  Comments (89) 

                                                                          "Keynes and the Crisis"

                                                                          Chris Dillow follows up his argument that "Marx has much to tell us today - but not about the financial crisis" with a similar argument about Keynes:

                                                                          Keynes and the crisis, by Chris Dillow: Robert Skidelsky thinks our crisis revives Keynes’s thinking:

                                                                          What was left out of the mainstream economics of his day, and its “post-Keynes” successor, was the acknowledgement of radical uncertainty. “The outstanding fact,” he wrote in his magnum opus, The General Theory of Employment, Interest and Money (1936) “is the extreme precariousness of the basis of knowledge on which our estimates of prospective yield have to be made…we know very little about the future”.

                                                                          Ignorance of the future leads to waves of irrational exuberance and panic. And when panic sets in, there’s a flight to cash and an unwillingness to lend so great that, in Skidelskly’s words:

                                                                          that there may be no automatic barrier to the slide into depression, unless a government intervenes to offset extreme reluctance to lend by huge injections of cash into the economy.

                                                                          This raises (at least) three issues.

                                                                          1.Is a flight to cash really a cause of a downturn, or a symptom of it? Keynes wrote:

                                                                          A more typical, and often the predominant, explanation of the crisis is, not primarily a rise in the rate of interest, but a sudden collapse in the marginal efficiency of capital. (General Theory ch 22)

                                                                          The marginal efficiency of capital, stressed Keynes, depended upon “animal spirits” as much as real factors such as the causes of actual profits. However, this suggests that Keynes, like Marx, saw crises as originating in the “real“ economy - and in attitudes thereto - more than the financial system. Which means it's not clear that our current crisis is especially "Keynesian."

                                                                          2. Why is radical uncertainty confined only to the private sector? If governments know no more than the private sector, they’ll be unable to prevent depression because they’ll no more see it coming than will the private sector. The best governments can do then will be to ameliorate the recession once it’s begun. But as Keynes himself acknowledged, slumps often tend to correct themselves eventually anyway.

                                                                          3. Are injections of cash really the solution? If governments can’t see downturns coming, they might not be. Again, Keynes was explicit here.

                                                                          With markets organised and influenced as they are at present, the market estimation of the marginal efficiency of capital may suffer such enormously wide fluctuations that it cannot be sufficiently offset by corresponding fluctuations in the rate of interest.

                                                                          As injections of cash work by reducing interest rates, this means they are not the solution. Instead, Keynes had another:

                                                                          The duty of ordering the current volume of investment cannot safely be left in private hands.

                                                                          Now, by all means argue whether Keynes was right on this. But please don’t think Keynes thought booms and slumps could be prevented merely by pulling fiscal and monetary policy levers.

                                                                            Posted by on Friday, October 24, 2008 at 01:26 AM in Economics, Financial System | Permalink  TrackBack (0)  Comments (28) 

                                                                            "Urban Inequality"

                                                                            Glaeser, Resseger, and Tobio:

                                                                            Urban Inequality, by Edward L. Glaeser, Matthew G. Resseger, and Kristina Tobio, NBER Working Paper No. 14419, October 2008 [Open link]: Abstract What impact does inequality have on metropolitan areas? Crime rates are higher in places with more inequality, and people in unequal cities are more likely to say that they are unhappy. There is also a negative association between local inequality and the growth of both income and population, once we control for the initial distribution of skills. What determines the degree of inequality across metropolitan areas? Twenty years ago, metropolitan inequality was strongly associated with poverty, but today, inequality is more strongly linked to the presence of the wealthy. Inequality in skills can explain about one third of the variation in income inequality, and that skill inequality is itself explained by historical schooling patterns and immigration. There are also substantial differences in the returns to skill, related to local concentrations in different industries, and these too are strongly correlated with inequality.

                                                                            The paper concludes with:

                                                                            Area-level income inequality does not create the same policy implications as national income inequality. At the nation level, an egalitarian, Rawlsian social welfare function implies the need to reduce income inequality. However, egalitarianism does not provide the same implications about local inequality. Shuffling people across the country in a way that creates more homogeneity at the local level would not seem like a natural means of increasing social welfare given standard social welfare functions. Instead, such functions would instead push towards a focus on policies like human capital development that would promote equality nationwide. We concluded by noting that localities are poorly poised to reduce inequality on their own. Any attempt at local redistribution is likely to lead to out-migration of the wealthy. Poor localities don’t have the resources to improve failing schools. However, if national policies are going to try to reduce inequality by making the distribution of human capital more equal, then inevitably localities must be involved. Schools are run at the local level. The combination of national resources and local operation seems most likely to improve the quality of the poorly performing schools. Unfortunately, bringing together such different levels of government is inevitably quite difficult. Moreover, the strong correlation between human capital today and human 34 capital more than fifty years ago suggests that any change will not happen overnight.

                                                                              Posted by on Friday, October 24, 2008 at 12:42 AM in Economics, Income Distribution | Permalink  TrackBack (0)  Comments (9) 

                                                                              links for 2008-10-23

                                                                                Posted by on Friday, October 24, 2008 at 12:06 AM in Links | Permalink  TrackBack (0)  Comments (31) 

                                                                                Thursday, October 23, 2008

                                                                                "Greenspan Follies"

                                                                                Dean Baker on Greenspan's admission that he made a mistake in resisting regulation of credit markets:

                                                                                Greenspan Follies: The World Is as Ayn Rand Would Have Predicted, by Dean Baker: Alan Greenspan has finally acknowledged that he may have made some mistakes in allowing an $8 trillion housing bubble to grow unchecked. (Look for rivers flowing upstream.)

                                                                                This modest act of contrition should be welcomed, but analysts have been far too quick to describe Greenspan as a prisoner of his free market ideology and the current crisis as a story of the free market running wild. ...

                                                                                First, insofar as Greenspan acted (or didn't act) out of ignorance of the true situation, it was because he was ignoring Ayn Rand, not because he was following her.

                                                                                Let's set the stage. Bear Stearns, Goldman Sachs, Citigroup and the rest of the big banks are run by hotshot Ivy League business school types. These are bright, hard working ambitious people who want to make lots and lots of money.

                                                                                The executives at these banks are sitting on enormous piles of money that they can get access to as a result of being at these huge banks. The hotshot executives know that they can get huge bonuses by taking risky gambles with the banks' money.

                                                                                The executives can make bets, that if they pay off, will get tens of millions a year in bonuses and other compensation. Of course, if they lose they can bring down the house, meaning that they bankrupt Bear Stearns, Lehman, etc.

                                                                                What would Ayn Rand expect to happen? On the one hand we have the hot shot executives, on the other hand the schmucks who own stock in these banks. Would Ayn Rand expect that the executives would put aside their ambition, their lust for success, their greed, in order to benefit shareholders who are too dumb to even know what a credit default swap is?

                                                                                Not for a second; Ayn Rand would watch the Wall Street big boys run roughshod over their shareholders' interests and be applauding them every step of the way. That is how the game is played. If Greenspan didn't think the Wall Street crew would rip off their shareholders for every last penny, then he was not a worthy disciple of Ayn Rand.

                                                                                As far as this being a story of the market having run amok, that is only partially true. The banks were able to get access to vast amounts of capital because everyone had faith in the "too big to fail" doctrine. In other words, all the people who lent Bear Stearns, Lehman, AIG, Goldman and the rest money felt secure because they thought the government would come to the rescue at the end of the day if the hotshots messed up big time.

                                                                                With the exception of Lehman Brothers, these folks were right..., they were gambling with the taxpayers' money...

                                                                                This is not to say that we would want a real free market in finance. It's not even clear what that would look like. But it is clear that Wall Street hotshots who brought us this disaster ... want to be able to operate with a government security blanket while not being required to contain risk or pay for this insurance. Calling them, or their patron Alan Greenspan, free market ideologues is far too generous.

                                                                                I always wonder if the people making the decisions actually had these thoughts, i.e. if they explicitly made decisions based upon the assumption that there was a large possibility of a bailout if they blew things up. Do you think they did?

                                                                                Update: Arnold Kling answers.

                                                                                  Posted by on Thursday, October 23, 2008 at 04:50 PM in Economics, Financial System, Housing, Monetary Policy | Permalink  TrackBack (1)  Comments (53) 

                                                                                  Four "Myths"?

                                                                                  In response to this post, Alex Tabarrok says:

                                                                                  Do either of the cited links present any data at all on the quantity of credit?  No.  Many people cite prices/rates/spreads as evidence for the crisis but what we ultimately care about is quantity not price. The Fed. piece had lots of data on the quantity of credit.  Where is the rebuttal? 

                                                                                  Here is every loan series the Federal Reserve Band of St. Louis finds it worthwhile to report in FRED (the title of the section is "Banking: Loans"). These are all percentage changes in quantities (expressed in billions of dollars) from a year earlier, not prices:

                                                                                  Continue reading "Four "Myths"?" »

                                                                                    Posted by on Thursday, October 23, 2008 at 02:25 PM in Economics, Financial System | Permalink  TrackBack (0)  Comments (32) 

                                                                                    "Taxes, Bailouts and Socialism"

                                                                                    Is it socialism?

                                                                                    Taxes, Bailouts and Socialism, by James Edward Maule: ...When Senator Barack Obama replied to the question ... about his tax plan by noting that "I think when you spread the wealth around, it's good for everybody," he opened the floodgates of accusations that his tax proposals would amount to socialism. ...

                                                                                    Obama's tax plan is to increase taxes for individuals with incomes exceeding $250,000. Most Americans do not fall into that category, and 95 percent are unaffected by this particular proposal. Americans in that category are paying taxes at lower rates than they were paying a decade ago. The theory was that reducing rates on the rich would generate benefits not only for the rich, but also for everyone else. This "trickle down" theory turned out to be a failed experiment. All that trickled down was the economic pain inflicted on America by the casino capitalist gamblers. Technically, Obama proposes revocation of tax cuts for the wealthy. They had their chance. It failed, other than to make the wealthy wealthier, the middle class smaller, and the gap between the haves and have-nots wider. ...

                                                                                    Will Obama's tax plan redistribute wealth? Hardly. The additional revenue generated by the revocation of tax cuts for the wealthy very well may end up paying the interest on the national debt that was incurred because taxes were cut and kept too low during wartime. One could consider those tax cuts to have been a loan to the wealthy, and the events of the past month have demonstrated what they did with it.

                                                                                    But perhaps there's some wealth redistribution involved. One reasonably can argue that the revenue raised by revoking the tax cuts for the wealthy will be used to fund government programs that help only the poor or only the middle class or only the poor and middle class. Does that make it socialism? More important, does that make it bad policy? ...

                                                                                    Colin Powell has suggested that "Taxes are always a redistribution of money. Most of the taxes that are redistributed go back to those who pay them -- in roads and airports and hospitals and schools. And taxes are necessary for the common good, and there's nothing wrong with examining what our tax structure is or who should be paying more, who should be paying less. For us to say that makes you a socialist, I think, is an unfortunate characterization that isn't accurate." Hooray for Colin Powell. I might disagree that taxes always are a redistribution, because to the extent that they pay for services being rendered to the paying taxpayer, they do not transfer wealth. They simply represent an exchange of cash for services or property. But that articulation technicality aside, there are, and have been for decades, valid arguments for imposing higher taxes on those on whom America has bestowed better opportunities and greater fortune. Undoing the mistaken tax cuts, and fixing the problems caused by trying to fight a war without raising taxes, isn't socialism. It's an attempt to undo the problems caused by welfare for the wealthy. ...

                                                                                    A total ban on wealth redistribution would mean tens of millions of people in need would not get assistance, and in many instances would die. Social Security is wealth redistribution. So, too, is Medicare. So, too, are food stamps. So, too, is the program that provides breakfasts and lunches to school children who would otherwise go unfed. So, too, are all sorts of other programs. If these programs are socialism, and if support for these programs make someone a socialist, then here's some news: by that definition, America has been a socialist nation for decades, and most of its Presidents and legislators have been socialists. So what would it mean to purge "socialism" from public policy? What then would life in America be?

                                                                                      Posted by on Thursday, October 23, 2008 at 03:06 AM in Economics, Income Distribution, Social Insurance, Taxes | Permalink  TrackBack (0)  Comments (153) 

                                                                                      Letting Lehman Fail "Was a Genuine Error"

                                                                                      Treasury Secretary Paulson tries to defend his policy decisions during the crisis:

                                                                                      Struggling to Keep Up as the Crisis Raced On, by Joe Nocera and Edmund Andrews, NY Times: ...It was the weekend of Sept. 13, and the moment Treasury Secretary Henry M. Paulson Jr. had feared for months was finally upon him: Lehman Brothers was hurtling toward bankruptcy — fast.

                                                                                      Knowing that Lehman had billions of dollars in bad investments..., Mr. Paulson had long urged Lehman ... to find a solution for his firm’s problems. ...

                                                                                      But Lehman could not — despite what Mr. Paulson described as personal pleas to other firms... With all options closed, he said, the government’s hands were tied. Although the Federal Reserve had helped bail out Bear Stearns — and was within days of bailing out ... American International Group — it could not help Lehman, even as its default threatened to wreak havoc on financial markets.

                                                                                      “We didn’t have the powers,” Mr. Paulson insisted... By law, he continued, the Federal Reserve could bail out Lehman with a loan only if the bank had enough good assets to serve as collateral, which it did not.

                                                                                      “If someone thinks Hank Paulson could have made the Fed save Lehman Brothers, the answer is, ‘No way,’ ” he said.

                                                                                      But that is not the way that many who have scrutinized his actions see it. Bankers involved say they do not recall Mr. Paulson talking about Lehman’s impaired collateral. And they said that buyers walked away for one reason: because they could not get the same kind of government backing that facilitated the Bear Stearns deal. In retrospect, they added, it was emblematic of the miscalculations by the government in reacting to the crisis. ...

                                                                                      In an hour long interview..., Mr. Paulson defended Treasury’s actions, saying that he and his aides had done everything they could, given the deep-rooted problems of financial excess that had built up over the past decade.

                                                                                      “I could have seen the subprime problem coming earlier,” he acknowledged..., “but I’m not saying I would have done anything differently.”

                                                                                      History will be the final judge. But in contrast with Mr. Paulson’s perspective, other government officials and financial executives suggest that Treasury’s epic rescue efforts have evolved as chaotically as the crisis itself. ... Executives on Wall Street and officials in European financial capitals have criticized Mr. Paulson and Mr. Bernanke for allowing Lehman to fail, an event that sent shock waves through the banking system, turning a financial tremor into a tsunami.

                                                                                      “For the equilibrium of the world financial system, this was a genuine error,” Christine Lagarde, France’s finance minister, said recently. ...

                                                                                      In addition, Mr. Paulson and Mr. Bernanke have been criticized for squandering precious time and political capital with their original $700 billion bailout plan...

                                                                                      [M]any complain the worst of the turmoil might have been avoided if it hadn’t been for Mr. Paulson sticking with an original bailout plan that they viewed as poorly conceived and unworkable. ...

                                                                                      He also defended Treasury’s recapitalization plan against critics who say that he did not extract a high enough price from the banks getting taxpayers’ money. “I could not see the United States doing things like putting in capital on a punitive basis that hurts investors. And we don’t want to run banks.”

                                                                                      Asked what he might have done better, Mr. Paulson replied, “I could have made a better case to the public.”

                                                                                      He added, “I never felt worse than when the House voted no” on the bailout plan Sept. 26, its initial rejection before ultimately passing the plan.

                                                                                      As for Lehman, Mr. Paulson insisted that it was “a symptom and not a cause” of the financial meltdown that took place in recent weeks. The real problem, he contended, is that banks all over the world made wrong-headed loans that have now come back to haunt them. ... Mr. Paulson added, “Ten years from now no one is going to say that this crisis was brought about because Lehman Brothers went down.”

                                                                                      Letting Lehman fail was a mistake, and it made the crisis much worse.

                                                                                        Posted by on Thursday, October 23, 2008 at 02:07 AM in Economics, Financial System | Permalink  TrackBack (0)  Comments (40) 

                                                                                        links for 2008-10-23

                                                                                          Posted by on Thursday, October 23, 2008 at 12:06 AM in Links | Permalink  TrackBack (0)  Comments (59) 

                                                                                          Wednesday, October 22, 2008

                                                                                          "Some of the Conclusions Drawn are Simply False"

                                                                                          Pushback against this:

                                                                                          Analysis!, Free Exchange: If you have been paying attention to the news, to financial experts, to economists ... then you may have heard that there have been some recent problems...

                                                                                          Alex Tabarrok ... has been pushing the argument that we may face recession, but that the financial crisis never threatened the real economy, and so the big government bail-outs were unnecessary. And now he has proof. Three economists from the research department of the Federal Reserve Bank of Minneapolis have produced a working paper purporting to debunk four myths about the financial crisis. Those myths are:

                                                                                          1. Bank lending to non-financial corporations and individuals has declined sharply.
                                                                                          2. Interbank lending is essentially nonexistent.
                                                                                          3. Commercial paper issuance by non-financial corporations has declined sharply and rates have risen to unprecedented levels.
                                                                                          4. Banks play a large role in channeling funds from savers to borrowers.

                                                                                          The authors of the paper next provide a damning analysis. In the best tradition of lazy undergraduates everywhere, they plot lines on graphs and draw wild conclusions. And on the basis of these conclusions, Mr Tabarrok writes his post, and credulous bloggers begin analogising the bail-out to the Bush administration's bogus claims about Iraq's weapons of mass destruction.

                                                                                          There are a few problems with all of this. First of all, some of the conclusions drawn are simply false. While rates on the highest quality non-financial commercial paper have behaved fairly well in recent weeks, rates for lower quality stuff have soared. The spread between the two, actually, is one of Calculated Risk's credit market indicators.

                                                                                          The failure to distinguish between the two types of paper is indicative of the broader, unwarranted credulity of the authors. For instance, many of the series they present actually show an unusual spike in bank lending during the crisis period. Are we to understand that for most banks, conditions actually improved, suddenly, sharply, and atypically while the rest of the financial world went to hell? Well, we might do that. Or we might suspect that the increase in bank lending was itself a product of tight credit conditions elsewhere—that borrowers were falling back onto lines of credit they normally wouldn't use thanks to the severity of lending conditions.

                                                                                          And of course, there is the inconvenient matter that the Federal Reserve and the Treasury went out and did all that stuff they did in order to prevent a massive breakdown in lending to the real economy. ... Now this does allow sceptics to say, "Well, how do we know things would have collapsed"? We don't, of course, but that doesn't change the fact that current lending takes into account massive government intervention to make sure that lending continued. The latter therefore can't be used to argue that the former wasn't necessary.

                                                                                          Maybe at some point we'll see some careful research that suggests that the threat the financial crisis posed to the real economy was drastically oversold. This, I'm afraid, isn't it.

                                                                                          Consider Figure 2B from their paper:


                                                                                          Here is their entire analysis of what this shows:

                                                                                          Figures 2A and 2B display analogous data for loans and leases made by U.S. commercial banks. Again, we see no evidence of any decline during the financial crisis.

                                                                                          Here's what I see. The bump in loans between September 10 and September 17 was probably this (9/14):

                                                                                          Federal Reserve Board announces several initiatives to provide additional support to financial markets, including enhancements to its existing liquidity facilities

                                                                                          Then, we see the Lehman collapse, and this caused the Fed induced substitute lending to fall off from 9/17 to 9/24. Next, after the bailout plan is proposed lending takes off again (see the change between 9/24 and 10/1), but then it falls off again and turns negative after WaMu fails (see the change between 10/1 and 10/8). I don't see how you can look at this figure and come to the conclusion that there have been no disturbances in financial markets from the crisis generally, or from specific events.

                                                                                          And here's figure 2A which shows the same data since 2001:


                                                                                          Yep, no sign of any changes due to financial market problems and then recovery after Fed action in that series.

                                                                                          These three economists, V.V. Chari, Lawrence Christiano, and Patrick J. Kehoe, have done some excellent work in the past, and I expect better than this. Disclaimer or not, the first thing you see when you open the paper is "Federal Reserve Bank of Minneapolis Research Department," and this reflects poorly on the Minnesota Fed.

                                                                                          [Update: See also Credit Crunch: Did We Make It All Up?. Also: The Credit Crunch Isn't a Myth.]

                                                                                          Update: Evidence on the quantity of loans.

                                                                                            Posted by on Wednesday, October 22, 2008 at 03:06 PM in Economics, Financial System | Permalink  TrackBack (2)  Comments (26) 

                                                                                            "A Crisis in Confidence"

                                                                                            Joseph Stiglitz:

                                                                                            A crisis of confidence, by Joseph Stiglitz, Commentary, CIF: Our financial system has failed us. Part of the reason it has performed so poorly is inadequate regulations and regulatory structures. ...

                                                                                            It is hard to have a well-performing modern economy without a good financial system... They are supposed to mobilise savings, allocate capital and manage risk, transferring it from those less able to bear it to those more able. In America, and some other countries, financial markets have not performed these functions well. They encouraged spendthrift patterns, which led to near-zero savings. They massively misallocated capital. And they created risk, did not manage it well and left huge risks with ordinary Americans, who are now bearing huge costs...

                                                                                            There are three related reasons for these failures: poorly designed incentive structures, inadequate competition and inadequate transparency.

                                                                                            Strong competition is an essential aspect of well-functioning markets. But information imperfections often limit the extent of competition. America's financial markets have gone beyond these natural limitations of competition to engage in anti-competitive practices. Lack of competition helps explain banks' supernormal returns in good years. In many markets, small- and medium-size businesses have access to only one or two lenders. That is part of the reason that bank failures are of such concern. ...

                                                                                            The failure to have strong competition enforcement has meant that there are a number of institutions that are so large that they are too big too fail. That provided an incentive to engage in excessively risky practices. It was heads I win..., tails you lose (we, the taxpayers, assume the losses, because we simply couldn't let them fail). ...

                                                                                            Markets only work well when private rewards are aligned with social returns. Incentives matter, but when incentives are distorted, we get distorted behaviour. In spite of their failure to perform their key social functions, financial markets have garnered for themselves in the US and some other of the advanced industrial countries 30% or more of corporate profits - not to mention the huge compensation received by their executives. But the problem with incentive structures is not just the level, but the form - designed to encourage excessive risk-taking and short-sighted behaviour.

                                                                                            Finally, markets often fail to produce efficient outcomes (let alone fair or socially just outcomes) when information is imperfect or asymmetric. But information imperfections and asymmetries are at the centre of financial markets - that is what they are about. Our financial markets have even worked hard to exacerbate these problems, as they created non-transparent products that were so complex that not even those who created them fully understood them. This non-transparency is a key part of the credit crisis we have experienced over recent weeks.

                                                                                            We need to ring-fence the core financial system... We have seen the danger of allowing them to trade with risky unregulated parties. ...

                                                                                            We need more transparency to ensure that incentive structures do not encourage excessively risky short-sighted behaviour and to reduce the scope of conflicts of interest - our financial markets are rife with them. ... We need countercyclical capital adequacy/provisioning requirements and speed limits. We need to proscribe predatory lending... We need a financial products safety commission...; and a financial systems stability commission...

                                                                                            Part of the problem has been our regulatory structures. If government appoints as regulators those who do not believe in regulation, one is not likely to get strong enforcement. ...

                                                                                            Well-designed regulations may protect us in the short run and encourage real innovation in the long. Much of our financial market's creativity was directed to circumventing regulations and taxes. Accounting was so creative that no one, not even the banks, knew their financial position. Meanwhile, the financial system didn't make the innovations that would have addressed the real risks people face - such as how to stay in their homes when interest rates change - and indeed, have resisted many of the innovations that would have increased the efficiency of our economy. By reducing the scope for these socially unproductive innovations, we can divert creative activity in more productive directions. ...

                                                                                              Posted by on Wednesday, October 22, 2008 at 01:17 PM in Economics, Financial System, Regulation | Permalink  TrackBack (0)  Comments (31) 

                                                                                              "The Monetary Policy - Long Term Interest Rate Link"

                                                                                              Following up this post, some pushback on how important monetary policy was in providing the fuel for the financial crisis, but the "key point here is that there is evidence monetary policy still matters in a meaningful way for long-term interest rates"

                                                                                              The Monetary Policy - Long Term Interest Rate Link: Tyler Cowen argues that the Fed's low interest rate policy in the early-to-mid 2000s may have been a contributing factor, but certainly was not the most important one leading to the financial crisis. In making his case, Tyler says the following:

                                                                                              [O]ther reasons also suggest that monetary policy was not the main driver. Money has a much bigger effect on short-term rates than long-term rates.

                                                                                              I am not sure what Tyler exactly means by "bigger", but I do know there has been a spate of empirical studies showing monetary policy affects long-term rates in a non-trivial manner. Richard Froyen and Hakan Berument (F&B) provide a good survey of this literature in their forthcoming paper, "Monetary policy and U.S. long-term interest rates: How close are the linkages?" From their introduction is the following:

                                                                                              [T]he effect of monetary policy on long-term interest rates is a subject of considerable interest. Given current U.S. monetary policy procedures, this question reduces to that of how a change in the federal funds rate affects the yields on longer-term securities. A decade ago a reading of theliterature would have indicated considerable doubt about even the direction of this effect. There was also a view that the size and persistence of the effect of the federal funds rate on longerterm yields would vary with economic conditions. The prevailing theory of the term-structure of interest rates, the expectations hypothesis, by itself provides little guidance about the effect monetary policy actions will have on longer-term interest rates: the nature of the effect depends on the way in which the policy action affects expected future short-term interest rates and risk premiums imbedded in long rates.

                                                                                              Research since 2000 has changed the situation. Studies by Kuttner (2001), Cochrane and Piazzesi (2002), Gurkaynak, Sack, and Swanson (2005a), Ellingsen and Soderstrom (2003), Ellingsen, Soderstrom, and Masseng (2004) and Beechey (2007) provide evidence that unanticipated changes in the federal funds rate have significant effects on U.S. interest rates at maturities as long as 10 or 30 years. Kuttner’s estimates, for example, indicate that an unanticipated rise ofone-percentage point in the federal funds target rate will increase the interest rate on a 10-year government security by 32 basis points and the rate on a 30-year security by almost 20 basis points.

                                                                                              (F&B also note that though some research based on vector autoregressions (VAR) show results more consistent with Tyler's view, these studies ultimately are flawed.) Now if we make the reasonable assumption that the drop of the fed funds rate (ffr) all the way to 1% for a sustained period was unexpected by several percentage points--the ffr has not been dropped that low since the 1950s--and adopt Kuttner's magnitudes then it is easy to imagine the Fed having a significant influence on long term interest rates during the early-to-mid 2000s.

                                                                                              One could also argue that some of the "global saving glut" and its influence on long-term interest rates was simply an amplification of the Fed's easy monetary policy via the dollar block countries' central banks. But I digress. The key point here is that there is evidence monetary policy still matters in a meaningful way for long-term interest rates.

                                                                                                Posted by on Wednesday, October 22, 2008 at 01:17 AM in Economics, Financial System, Monetary Policy | Permalink  TrackBack (0)  Comments (43) 

                                                                                                An Economic Model of Voting in U.S. Presidential Elections

                                                                                                Two colleagues, Joe Stone and Steve Haynes, have been estimating economic models of voting in presidential elections for many years. Here's the latest iteration:

                                                                                                A disaggregate approach to economic models of voting in U.S. presidential elections: forecasts of the 2008 election, by Stephen Haynes and Joe Stone, Economics Bulletin: 1. Introduction Well before the 1982 William Clinton campaign phrase "it's the economy, stupid," Kramer 1971, Stigler 1973, and Fair 1978 proposed that voting in Presidential elections is largely determined by economic factors. These models emphasize economic growth, price stability, and the role of parties, and despite very limited degrees of freedom, have significant predictive power for the popular vote for the President. For some elections, however, the predictions of these models go awry, including two recent elections.

                                                                                                In the election of 1992, the models falsely predicted a landslide victory for the incumbent, President George H.W. Bush. Instead, he lost in a close election to Governor William Clinton. In response to this errant forecast, subsequent studies (e.g., Gleisner 1992, Haynes and Stone 1994, and Fair 1996) introduced additional determinants, e.g., the number of consecutive terms the incumbent party held the Presidency, the rate of change in the Dow-Jones stock market average, and changes in the proportion of the population in the military (a proxy for national security concerns). These determinants improved estimates and forecasts of voting models, yet each newly proposed variable raised the danger of "overfitting" given the small number of elections.

                                                                                                The 2004 election again appeared to pose a puzzle. As in 1992, the models (e.g., Fair 2004) predicted a landslide victory in the popular vote for the incumbent President ... George W. Bush,..., yet ... President Bush won by a small margin. One obvious omitted factor was the ongoing conflict in Iraq. To address this omission, in Haynes and Stone 2004 we introduced two factors, working in opposition, to account more fully for the potential role of armed conflicts and national security: the first, a "rally round the flag" proxy, which would increase support for an incumbent President, and the second, a proxy for the economic cost of national defense, which can draw support away from an incumbent. We showed that this second factor outweighed the first one in the 2004 election, reducing President Bush's predicted vote share and thereby narrowing the divergence between the model's prediction and both the pre-election polls and the final vote.

                                                                                                A major limitation with all previous tests of models of Presidential elections is the reliance on aggregate voting data, with very few Presidential elections (most estimates are based upon only 20 to 25 observations). Nevertheless, researchers have attempted to address perceived model limitations by introducing additional determinants of voting, e.g., for the 1992 and 2004 elections, which further increases the danger of "overfitting." In this note, we reexamine traditional economic voting models of U.S. Presidential elections by exploring disaggregate state-level data for the U.S. from 1916 through 2008. Our results reaffirm the general findings in previous aggregate estimates, but also reveal novel monotonic patterns in the disaggregate estimates, including that voters in high income states respond to inflation but voters in low income states respond to real growth. We also show that these income-contingent voting patterns have dramatic implications for forecasts of the upcoming 2008 Presidential election between Senator Barack Obama and Senator John McCain. ...

                                                                                                Continue reading "An Economic Model of Voting in U.S. Presidential Elections" »

                                                                                                  Posted by on Wednesday, October 22, 2008 at 12:24 AM in Economics, Politics | Permalink  TrackBack (0)  Comments (4) 

                                                                                                  Real-Time Wal-Mart Data

                                                                                                  Purchases of essentials are increasingly clustering around payday:

                                                                                                  Wal-mart: Scenes from the Economic Front Lines, by Paul Kedrosky: Wal-mart is like the Bureau of Economic Analyst of retail: It has all the data you wish you had about what's going on in the economy, plus more -- and it has it all in realtime. With that in mind, here are some alternately choice and concerning nuggets from a speech today by the company's president in Los Angeles:

                                                                                                  • Credit is declining as a form of payment at Wal-mart. It will be down double-digits this year, he said.
                                                                                                  • Spending spikes around pay periods have become much more pronounced, implying that many Wal-mart shoppers are living check-to-check.
                                                                                                  • For the first time the company is seeing a paycheck-related spike in purchases of baby formula, suggesting some real teetering out there.

                                                                                                  More here.

                                                                                                    Posted by on Wednesday, October 22, 2008 at 12:15 AM in Environment | Permalink  TrackBack (0)  Comments (36) 

                                                                                                    links for 2008-10-22

                                                                                                      Posted by on Wednesday, October 22, 2008 at 12:06 AM in Links | Permalink  TrackBack (0)  Comments (40)