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Sunday, April 19, 2009

Feldstein: Inflation is Looming

Martin Feldstein is worried about inflation

Inflation is looming on America’s horizon, by Martin Feldstein, Commentary, Financial Times: ...The unprecedented explosion of the US fiscal deficit raises the spectre of high future inflation. According to the Congressional Budget Office, the president’s budget implies a fiscal deficit of 13 per cent of gross domestic product in 2009 and nearly 10 per cent in 2010. Even with a strong economic recovery, the ratio of government debt to GDP would double to 80 per cent in the next 10 years.

There is ample historic evidence of the link between fiscal profligacy and subsequent inflation. But historic evidence and economic analysis also show that the inflationary effects can be avoided if the fiscal deficits are not accompanied by a sustained increase in the money supply and, more generally, by an easing of monetary conditions. ...

A fiscal deficit raises demand when the government increases its purchase of goods and services or, by lowering taxes, induces households to increase their spending. ... If the fiscal deficit is not accompanied by an increase in the money supply, the fiscal stimulus will raise short-term interest rates, blocking the increase in demand and preventing a sustained rise in inflation.

So the potential inflationary danger is that the large US fiscal deficit will lead to an increase in the supply of money. This inevitably happens in developing countries that do not have the ability to issue interest-bearing debt and must therefore finance their deficits by printing money. ...

[T]he large US fiscal deficits are being accompanied by rapid increases in the money supply and by even more ominous increases in commercial bank reserves that could later be converted into faster money growth. ...

The link between fiscal deficits and money growth is about to be exacerbated by “quantitative easing”, in which the Fed will buy long-dated government bonds. While this may look like just a modified form of the Fed’s traditional open market operations, it cannot be distinguished from a policy of directly monetising some of the government’s newly created debt. Fortunately, the amount of debt being purchased in this way is still small relative to the total government borrowing.

The Fed is also creating a massive increase in liquidity by its policy of supplying credit directly to private borrowers. Although these credit transactions do not add to the measured fiscal deficit, the unprecedented Fed purchases of more than $1,000bn of private securities have led to the enormous $700bn increase in the excess reserves of the commercial banks. The banks now hold these as interest-bearing deposits at the Fed. But when the economy begins to recover, these reserves can be converted into new loans and faster money growth.

The deep recession means that there is no immediate risk of inflation. ... But when the economy begins to recover, the Fed will have to reduce the excessive stock of money and, more critically, prevent the large volume of excess reserves in the banks from causing an inflationary explosion of money and credit.

This will not be an easy task since the commercial banks may not want to exchange their reserves for the mountain of private debt that the Fed is holding and the Fed lacks enough Treasury bonds with which to conduct ordinary open market operations. It is surprising that the long-term interest rates do not yet reflect the resulting risk of future inflation.

The government budget constraint is:

(Government spending including interest on the debt) - (Taxes) =
      (Change in the Money supply) + (Change in the Bond supply)

Or, more simply:

G - T = ΔM + ΔB

The left-hand side, government spending (G) - taxes (T), is the government deficit (surplus if the value is negative). The right-hand side shows the two ways of paying for the deficit, printing new money, ΔM, (the change in the money supply can raise prices) and borrowing from the public by issuing new bonds, ΔB (the change in debt can raise interest rates and lower growth).

Let's start with Feldstein's comments about developing countries. Suppose you are a developing country and you want to improve your country's growth rate, and you think the key is infrastructure spending. You run a deficit to accomplish this, fully intending to pay it back out of higher future growth (which may not actually happen).

But how will you pay for that spending on new infrastructure? You, as the dictator, could raise taxes but you are a poor country and the wealth and income base just isn't there to support a higher tax level. You could borrow the money, but once again the wealth level in your own country isn't high enough to allow that, so if you borrow, it will have to be from foreigners. But, unfortunately, there are some defaults in your country's recent past and the international community won't lend to you without restrictions that you just aren't willing to take on.

So once international credit dries up, becomes prohibitively expensive, or comes with too many restrictions, and if taxes cannot be raised enough, there is but one choice to pay for the infrastructure spending and the deficit it causes, print the money, and it's a choice developing countries often find themselves making. The result of these persistent deficits, then, is persistent growth in the money supply - month after month more money has to be printed to cover government operations - and the result is inflation.

Feldstein's point about quantitative easing monetizing debt can also be explained in terms of this equation. Under quantitative easing, the Fed prints new money, and uses it to purchase long-term government bonds. Thus, the right-hand side of the equation above is unchanged overall, but the money component gets larger while the bond component gets smaller as the Fed purchases government debt. (Note that the money supply also goes up if the Fed purchases private sector bonds rather than government bonds since new money has to be printed to pay for them, another one of Feldstein's points.)

Once we begin to recover, there are three ways to reduce the inflationary pressures from the growing money supply. First, we could simply reduce the money supply. How do you do that? By selling bonds to the public. Feldstein's worry is that the Fed has bought so many private sector bonds (and traded for government bonds in the process) that it won't have enough government bonds to reduce the money supply by as much as needed, and nobody will want to purchase the private sector bonds unless the price is very low, or, saying the same thing, the interest rate is [excessively] high. But high interest rates are undesirable so reducing the money supply may be difficult.

The second choice is to raise taxes. It might happen, but my inclination is to say good luck with that. But I hope I'm wrong, and maybe we can make some headway here. Third, we could reduce government spending. I don't know what the administration's goals are as to the size of government over the long-term, so I can't say for sure how much of the stimulus spending is considered to be temporary, and how much is intended to be permanent, e.g. for health care reform. But much of it was sold to the public as temporary, and I expect the administration to make good on that commitment (though "good luck with that" comes to mind again, but I'm still hopeful). If it doesn't, other goals such as health care reform could be compromised.

And speaking of health care reform, that's where the focus needs to be. The budget worries twenty years from now have little to do with the temporary stimulus measures we are taking today, going forward health care costs are the most important issue by far in terms of the budget, and everything else revolves around solving that problem.

So am I worried about inflation? Somewhat, particularly when I hear that the Fed's independence is likely to come under review by congress. Whatever doubts you have about the Fed's commitment and ability to keep inflation low in the future, I have little doubt that congress would choose to monetize the debt when faced with tough choices about how to solve a deficit problem (would congress have done what Volcker did?). I still have faith in the Fed, but as you can see from the government budget constraint above, what the Fed can do is dependent upon the actions of congress. If deficits persist, it could come down to a choice by the Fed to monetize the deficit - and risk inflation - or allow government debt to pile up and risk high interest rates. Volcker chose low inflation over high interest rates when confronted with a similar choice, but it's not completely clear to me at this point what this Fed will do in the same situation, and how much cooperation they can expect from congress in terms of reducing the deficit.

    Posted by on Sunday, April 19, 2009 at 01:08 PM in Economics, Fiscal Policy, Inflation, Politics | Permalink  TrackBack (0)  Comments (46) 


    links for 2009-04-19

      Posted by on Sunday, April 19, 2009 at 12:06 AM in Economics, Links | Permalink  TrackBack (0)  Comments (29) 


      Saturday, April 18, 2009

      Tax Cuts, Household Balance Sheets, and the Duration of Recessions

      Greg Mankiw:

      It May Be Time for the Fed to Go Negative, by N. Gregory Mankiw, Commentary, NY Times: ...What is the best way for an economy to escape a recession? Until recently, most economists relied on monetary policy. ... The problem today ... is that the Federal Reserve has done just about as much interest rate cutting as it can. Its target for the federal funds rate is about zero, so it has turned to other tools...

      So why ... not lower the target interest rate to, say, negative 3 percent? ... The problem with negative interest rates ... is quickly apparent: nobody would lend on those terms. Rather than giving your money to a borrower who promises a negative return, it would be better to stick the cash in your mattress. Because holding money promises a return of exactly zero, lenders cannot offer less.

      Unless, that is, we figure out a way to make holding money less attractive. ... At one of my recent Harvard seminars, a graduate student proposed a clever scheme to do exactly that. ... Imagine that the Fed were to announce that, a year from today, it would pick a digit from zero to 9 out of a hat. All currency with a serial number ending in that digit would no longer be legal tender. Suddenly, the expected return to holding currency would become negative 10 percent.

      That move would free the Fed to cut interest rates below zero. People would be delighted to lend money at negative 3 percent, since losing 3 percent is better than losing 10.

      Of course, some people might decide that at those rates, they would rather spend the money — for example, by buying a new car. But because expanding aggregate demand is precisely the goal..., such an incentive isn’t a flaw — it’s a benefit.

      The idea of making money earn a negative return is not entirely new. In the late 19th century, the German economist Silvio Gesell argued for a tax on holding money. He was concerned that during times of financial stress, people hoard money rather than lend it. John Maynard Keynes approvingly cited the idea of a carrying tax on money. ...

      If all of this seems too outlandish, there is a more prosaic way of obtaining negative interest rates: through inflation. Suppose that, looking ahead, the Fed commits itself to producing significant inflation. In this case, while nominal interest rates could remain at zero, real interest rates — interest rates measured in purchasing power — could become negative. If people were confident that they could repay their zero-interest loans in devalued dollars, they would have significant incentive to borrow and spend.

      Having the central bank embrace inflation would shock economists and Fed watchers who view price stability as the foremost goal of monetary policy. But there are worse things than inflation. And guess what? We have them today. A little more inflation might be preferable to rising unemployment or a series of fiscal measures that pile on debt...

      Ben S. Bernanke, the Fed chairman, is the perfect person to make this commitment to higher inflation. Mr. Bernanke has long been an advocate of inflation targeting. In ... the current environment, the goal could be to produce enough inflation to ensure that the real interest rate is sufficiently negative.

      The idea of negative interest rates may strike some people as absurd, the concoction of some impractical theorist. Perhaps it is. But remember this: Early mathematicians thought that the idea of negative numbers was absurd. Today, these numbers are commonplace. ...

      This reminds of the the gift card idea to make sure people spend their tax cuts. Under these proposals, instead of giving people tax cuts, which they are likely to save instead of spend, the government gives them cards worth a given amount, say $1,000, and has the cards expire after, say, three months (you could stagger the issue of the cards over a three month time period so that purchases don't bunch up at the beginning and the end). The connection to the above is, of course, that the expiring gift card is just like the "expiring" money drawn through the serial number lottery (except, of course, that in one case it was a "gift" from the government, while in the other it is your savings). In both cases you are inducing people to spend rather than save through the threat that their saving will become worthless in the future (hyper-inflation does this too).

      The reason for gift cards is to prevent the tax cuts from being saved. Initially, I opposed tax cuts that would mostly be saved rather than spent because it wouldn't stimulate aggregate demand, and that's what the economy needed. But I've changed my mind about that, and I think tax cuts can be an important part of the solution in a recession like this one.

      Here's why. This recession has wiped out a lot of balance sheets in the financial sector, and it has also done severe damage to the balance sheets of individuals, especially those with a large proportion of their savings in financial assets or real estate (equity in their homes). Those households are not going to spend until those savings for retirement and other purposes are replenished, so how soon the end of the recession comes depends, in part, on how fast those balance sheets are repaired. Tax cuts help to do this, some types better than others. The effect of these balance sheet repairing tax cuts may not be immediately obvious since they are going toward saving, but it helps the recession end earlier than otherwise. Big ticket items, in particular, are less likely to be purchased so long as balance sheets still have big, missing pieces.

      So tax cuts should be part of a recovery package, and they can be used in two ways. Some tax cuts can be used to stimulate the economy immediately by helping families who are having trouble and cannot save even if they want to, they have no choice but to consume it all, and part can be targeted at speeding up the recovery by helping households make up for losses. We have to understand, though, that this component of the package will not stimulate aggregate demand immediately, the main effect is to bring an end to the recession sooner, and other measures - increase government spending or additional tax cuts targeted at people who will spend it all - must be increased to compensate.

      Recessions can be characterized by their depth and their duration, and my initial opposition to tax cuts underplayed, I think, the role they can play in reducing the duration. I still think the best and most certain way to stimulate aggregate demand is through government spending, and that government spending can itself help to end a recession sooner, but there's a role for tax cuts too. Not in every recession, at least not to the same extent, it's not always the case that a recession wipes out household balance sheets like this one did. But when that happens, household balance sheets are one of the things that must be repaired before we can fully recover.

        Posted by on Saturday, April 18, 2009 at 02:16 PM in Economics, Fiscal Policy, Taxes | Permalink  TrackBack (0)  Comments (69) 


        "Bank Regulators Clash Over Endgame"

        The bank stress tests are nearly complete, and there's apparently a debate over what to do with the stress test information on individual banks. Shouldn't Geithner have known what they were going to do with the stress test information before announcing the program in February? Or maybe figured out what those plans were over the last two months as they've been conducting the tests? Did they have plans and then realize they hadn't fully thought them through? Didn't we learn the dangers of going to battle without thinking carefully about the endgame and planning accordingly?

        This exercise was supposed to build confidence in the system, but that doesn't happen when you put a policy in place before thinking it through thoroughly. Instead of testing banks, it's ending up as a test of Geithner's credibility as a policymaker, and instead of building confidence, it threatens to undermine it:

        Bank Regulators Clash Over Endgame of U.S. Bank Stress Tests, by Robert Schmidt, Bloomberg: The U.S. Treasury and financial regulators are clashing with each other over how to disclose results from the stress tests of 19 U.S. banks, with some officials concerned at potential damage to weaker institutions.

        With a May 4 deadline approaching, there is no set plan for how much information to release, how to categorize the results or who should make the announcements... While the Office of the Comptroller of the Currency and other regulators want few details about the assessments to be publicized, the Treasury is pushing for broader disclosure.

        The disarray highlights what threatens to be a lose-lose situation for Treasury Secretary Timothy Geithner: If all the banks pass, the tests’ credibility will be questioned, and if some banks get failing grades and are forced to accept more government capital and oversight, they may be punished by investors and customers. ...

        Fed officials have pushed for the release of a white paper laying out the methodology of the assessments in an effort to bolster their credibility. ... A statement on the methods is scheduled for release April 24. ... The 19 companies may get preliminary results as soon as April 24, a person briefed on the matter said.

        Regulators, all of which regularly administer exams to the lenders they oversee, have privately expressed concern about the tests and whether they will be effective, the two people said.

        While weaker banks deemed to need additional capital will be given six months to raise it, financial markets may have little more than six minutes of patience before punishing them if the information is publicly released, one official said.

        Geithner has said he crafted the stress test program in an effort to provide more transparency about the health of banks’ balance sheets. ... How the market handles the results is a chief worry of banks and regulators... Banking lawyers and industry officials said that the Treasury needs to be very clear with the public about the reviews, which by their design test events that may not happen. ...

          Posted by on Saturday, April 18, 2009 at 01:26 AM in Economics, Financial System, Politics | Permalink  TrackBack (0)  Comments (35) 


          The Cost of CAFE Standards

          How much does it cost in terms of lost profit per vehicle to mandate a one mile per gallon increase in fuel efficiency? According to this research, not as much as you might think:

          The cost of CAFE standards: Not as high as we thought?, Greed, Green and Grains: Yesterday's TREE Seminar featured Jim Sallee of the University of Chicago. Sallee presented an interesting paper that uses a clever yet simple method to estimate the cost to car companies of meeting CAFE standards.
          Here's the abstract:

          Automakers can comply with fuel economy regulations by exploiting a loophole that gives a bonus to flexible-fuel vehicles. Under certain conditions, firms will equate the marginal cost of using the loophole, which is observable, with the unobservable costs of other compliance strategies, such as selling smaller cars or upgrading technology. After verifying that these conditions hold empirically, we estimate that tightening standards by one mile per gallon would cost automakers $8–$18 in lost profit per vehicle. Our estimates are considerably lower than other recent estimates based on structural identification. Our approach may help reveal compliance costs for other regulations.

          So car companies can achieve CAFE standards by either making their cars more fuel efficient or, alternatively, exploiting a loophole that allows them to instead make more "flex fuel vehicles" that can run on both ethanol (E85) or regular gasoline. The CAFE credit they get for these conversions combined with the cost of converting a regular gasoline car to a flex-fuel car turns out to be between $8 and $18 per car per MPG.

          Continue reading "The Cost of CAFE Standards" »

            Posted by on Saturday, April 18, 2009 at 12:15 AM in Economics, Environment, Regulation | Permalink  TrackBack (0)  Comments (31) 


            links for 2009-04-18

              Posted by on Saturday, April 18, 2009 at 12:06 AM in Economics, Links | Permalink  TrackBack (0)  Comments (25) 


              Friday, April 17, 2009

              "Something Went Wrong"

              Ben Bernanke:

              Bernanke Says Crisis Damage Likely to Be Long-Lasting,  by Craig Torres, Bloomberg: Federal Reserve Chairman Ben S. Bernanke said the collapse of U.S. lending will probably cause “long-lasting” damage to home prices, household wealth and borrowers’ credit scores.

              “One would be forgiven for concluding that the assumed benefits of financial innovation are not all they were cracked up to be,” the Fed chairman said... “The damage from this turn in the credit cycle -- in terms of lost wealth, lost homes, and blemished credit histories -- is likely to be long-lasting.” ...

              “Something went wrong,” Bernanke said. “We have come almost full circle with credit availability increasingly restricted for low- and moderate-income borrowers.” ...

              Update: I should add this part about defending financial innovation:

              U.S. Federal Reserve Chairman Ben Bernanke Friday defended financial innovation but said the current crisis proves that policy makers must make sure new, complex financial products are transparent enough to enable customers to make reasonable decisions.

              "Regulation should not prevent innovation, rather it should ensure that innovations are sufficiently transparent and understandable to allow consumer choice to drive good market outcomes," said Mr. Bernanke in a speech at a community-affairs forum in Washington. "We should be wary of complexity whose principal effect is to make the product or service more difficult to understand by its intended audience."

                Posted by on Friday, April 17, 2009 at 12:33 PM in Economics | Permalink  TrackBack (0)  Comments (48) 


                Paul Krugman: Green Shoots and Glimmers

                Glimmers of nope, not yet:

                Green Shoots and Glimmers, by Paul Krugman, Commentary, NY Times: Ben Bernanke ... sees “green shoots.” President Obama sees “glimmers of hope.” And the stock market has been on a tear. So is it time to sound the all clear? Here are four reasons to be cautious....

                1. Things are still getting worse. Industrial production just hit a 10-year low. Housing starts remain incredibly weak. Foreclosures ... are surging again. The most you can say is that there are scattered signs that ... the economy isn’t plunging quite as fast as it was. And I do mean scattered...

                2. Some of the good news isn’t convincing. The biggest positive news in recent days has come from banks, which have been announcing surprisingly good earnings. But some of those earnings reports look a little ... funny.

                Wells Fargo, for example, announced its best quarterly earnings ever. But ... reported earnings ... depend a lot on the amount the bank sets aside to cover expected future losses on its loans. And some analysts expressed considerable doubt about Wells Fargo’s assumptions...

                Meanwhile, Goldman Sachs announced a huge jump in profits... But as analysts quickly noticed, Goldman changed its definition of “quarter” ... so that — I kid you not — the month of December,... a bad one..., disappeared from this comparison.

                I don’t want to go overboard... Maybe the banks really have swung from deep losses to hefty profits in record time. But skepticism comes naturally in this age of Madoff.

                Oh, and for those expecting the Treasury Department’s “stress tests” to make everything clear: the White House spokesman, Robert Gibbs, says that “you will see in a systematic and coordinated way the transparency of determining and showing to all involved some of the results of these stress tests.” No, I don’t know what that means, either.

                3. There may be other shoes yet to drop. Even in the Great Depression, things didn’t head straight down. There was, in particular, a pause in the plunge about a year and a half in — roughly where we are now. But then came a series of bank failures on both sides of the Atlantic, combined with some disastrous policy moves...

                Can this happen again? Well, commercial real estate is coming apart at the seams, credit card losses are surging and nobody knows yet just how bad things will get in Japan or Eastern Europe. We probably won’t repeat the disaster of 1931, but it’s far from certain that the worst is over.

                4. Even when it’s over, it won’t be over. The 2001 recession officially lasted only eight months... But unemployment kept rising for another year and a half. The same thing happened after the 1990-91 recession. And there’s every reason to believe that it will happen this time too. Don’t be surprised if unemployment keeps rising right through 2010. ... Employment will eventually recover... But it probably won’t happen fast.

                So now that I’ve got everyone depressed, what’s the answer? Persistence.

                History shows that one of the great policy dangers, in the face of a severe economic slump, is premature optimism. F.D.R. responded to signs of recovery by cutting the Works Progress Administration in half and raising taxes; the Great Depression promptly returned in full force. Japan slackened its efforts halfway through its lost decade, ensuring another five years of stagnation.

                The Obama administration’s economists understand this. They say all the right things about staying the course. But there’s a real risk that all the talk of green shoots and glimmers will breed a dangerous complacency.

                So here’s my advice, to the public and policy makers alike: Don’t count your recoveries before they’re hatched.

                  Posted by on Friday, April 17, 2009 at 12:42 AM in Economics, Policy | Permalink  TrackBack (0)  Comments (69) 


                  "Tax Tea Party Time"

                  Bruce Bartlett says tax protesters "are not entitled to be taken seriously":

                  Tax Tea Party Time, Part Two, by Bruce Bartlett, Commentary, Forbes: Last week, I presented data comparing taxation in the United States to other major countries and concluded that Americans are not especially overtaxed. ... But what if we compare U.S. taxes today to those in the past? Are Americans more heavily taxed than those in earlier years, and do polls show greater dissatisfaction with taxes today? ... [I]t is hard to find evidence that taxes are rising or unusually high. ...

                  In response to these facts, some critics say that it is not today's taxes that concern them, but those that will have to be paid in coming years as a result of the large spending and deficits being projected. ...

                  I have problems with this argument as a justification for the sudden appearance of tea parties to protest taxes. First, many protesters implicitly assume that that the deficit has increased solely as a result of Barack Obama's policies. But in fact, the Congressional Budget Office was projecting a deficit of more than $1 trillion this year back in January...

                  It's true that projected deficits have gotten larger since January. But much of this resulted from deteriorating economic conditions that would have occurred even if John McCain were president. Moreover, it is absurd to assume that McCain would not have enacted any stimulus programs had he been elected.

                  More than likely, McCain would have proposed a stimulus plan of roughly the same size as that proposed by Obama. No doubt, it would have had a different composition--heavier on tax cuts, different kinds of tax cuts, less spending, different spending--but it wouldn't have been all that different from Obama's package given large Democratic majorities in the House and Senate and the pressure to act quickly.

                  I strongly suspect that many of those that loudly denounced the Obama stimulus package for its impact on the deficit would have cheered the McCain stimulus package even though it would have increased the deficit by about the same amount.

                  Proof of this proposition is that there were no tea parties during the years when George W. Bush was turning the surpluses of the Clinton years into massive deficits. ... Those protesting this week were only protesting because it is a Democrat who has increased the deficit. When a Republican did worse, it's like Emily Litella used to say, "Never mind."

                  Of course, people are free to protest whatever they want whenever they want, and are also free to change their minds. Maybe this week's tax protesters would have been out protesting even if McCain were president, but I don't think so. I believe this was largely a partisan exercise designed to improve the fortunes of the Republican Party, not an expression of genuine concern about taxes or our nation's fiscal future.

                  People should remember that while they have the right to their opinion, they are not entitled to be taken seriously. That only comes from having credibility gained by the correct presentation of facts and analysis and a willingness to be even-handed--criticizing one's own side when it is wrong and not only speaking up when the other party does the same thing.

                    Posted by on Friday, April 17, 2009 at 12:33 AM in Economics, Politics, Taxes | Permalink  TrackBack (0)  Comments (50) 


                    links for 2009-04-17

                      Posted by on Friday, April 17, 2009 at 12:06 AM in Economics, Links | Permalink  TrackBack (0)  Comments (9) 


                      Thursday, April 16, 2009

                      Roubini: End of Gloom?

                      Nouriel Roubini cautions not to get your hopes up too high:

                      End of economic gloom?, by Nouriel Roubini, Project Syndicate: Mild signs that the rate of economic contraction is slowing in the United States, China and other parts of the world have led many economists to forecast that positive growth will return to the US in the second half of the year, and that a similar recovery will occur in other advanced economies. ...

                      Investors are talking of 'green shoots' of recovery... As a result, stock markets have started to rally... This consensus optimism is, I believe, not supported by the facts. Indeed, I expect that while the rate of US contraction will slow ... in the last two quarters, US growth will still be negative .... in the second half of the year... Moreover, growth next year will be so weak ... and unemployment so high ... that it will still feel like a recession.

                      In the euro zone and Japan, the outlook for 2009 and 2010 is even worse... Given this weak outlook for the major economies, losses by banks and other financial institutions will continue to grow. My latest estimates are $3.6 trillion in losses for loans and securities issued by US institutions, and $1 trillion for the rest of the world. ...

                      By this standard, many US and foreign banks are effectively insolvent and will have to be taken over by governments. The credit crunch will last much longer if we keep zombie banks alive despite their massive and continuing losses. ... So, while this latest bear-market rally may continue for a bit longer, renewed downward pressure on stocks and other risky assets is inevitable.

                      To be sure, much more aggressive policy action (massive and unconventional monetary easing, larger fiscal-stimulus packages, bailouts of financial firms, individual mortgage-debt relief, and increased financial support for troubled emerging markets) in many countries in the last few months has reduced the risk of a near depression. That outcome seemed highly likely six months ago, when global financial markets nearly collapsed.

                      Still, this global recession will continue for a longer period than the consensus suggests. There may be light at the end of the tunnel -- no depression and financial meltdown. But economic recovery everywhere will be weaker and will take longer than expected. ...

                      Let's hope the end is near, but if you are a monetary or fiscal policymaker, it's far to soon to let down your guard and declare victory. You have to assume it won't be over for some time yet, and plan accordingly. If things turn out better than expected the plans can stay on the self, and existing programs can be scaled back accordingly, but that can't happen until we are certain that recovery is around the corner and we are nowhere near that point yet.

                      [Also see the commentary surrounding the IMF's World Economic Outlook from Yves Smith, Dani Rodrik, and Real time Economics.]

                        Posted by on Thursday, April 16, 2009 at 01:17 PM in Economics, Financial System | Permalink  TrackBack (0)  Comments (49) 


                        "The Asset Bubble Theory of Income Inequality"

                        Awhile back, I asked "Do large bubbles cause income to become more concentrated, or does the concentration of income cause the bubbles?" There are other possibilities too, causation could be simultaneously and run in both directions, or it could be that there is no causation at all and both bubbles and inequality are driven by a third factor. Justin Fox says he's looked at the data, and the answer is that inequality is driven by bubbles:

                        The asset bubble theory of income inequality, by Justin Fox: There's been a debate going on for a few years about whether the big rise in income inequality in the U.S. over the past three decades has been at least partly a political phenomenon or purely an economic one. The first camp, whose members include political scientist Larry Bartels and economists Thomas Piketty and Emmanuel Saez (pdf), argues that decisions about taxing and government spending made since the early 1980s have increased the disparity of incomes. The second ... contends that globalization and technological advance have increased the rewards to the most skilled and reduced pay for those whose work can be done by machines or lower-paid workers overseas. Since globalization and technological advance are good things, the increase in inequality thus isn't really something we'd want to stop.

                        Well now, after looking at the data about the country's 400 highest earners and reading the comments by pneogy and shepherdwong, I am ready to offer an important new theory (well, not entirely new): The rise in income inequality over the past 30 years has to a significant extent been the product of a series of asset-price bubbles. Whenever the market (be it the market in stocks, junk bonds, real estate, whatever) booms, the share of income going to those at the very top increases. When the boom goes bust, that share drops somewhat, but then it comes roaring back even higher with the next asset bubble. It's not the same people raking it in every time—there's lots of turnover in the top 400—but skimming the top off of asset bubbles appears to have become the leading way to get rich in these United States in the past three decades. ...

                          Posted by on Thursday, April 16, 2009 at 12:42 AM in Economics, Equity, Income Distribution, Politics | Permalink  TrackBack (0)  Comments (48) 


                          More than Projected, Less than Feared

                          David Altig wonders if there's any lessons in the parallels he sees between the current financial crisis and the "saga of the Resolution Trust Corporation":

                          Déjà vu all over again, by David Altig: I have, recently, been experiencing a strange sense of familiarity watching the Congressional Budget Office's (CBO) efforts to monitor the budgetary implications of the Troubled Asset Relief Program (TARP). On the one hand, the long-term costs are rising...

                          On the other hand, the CBO wants to book less spending in the near term than what the Treasury has in mind, for reasons that have to do with accounting procedures and the pace of actual TARP spending...

                          After a few minutes of pondering why it seemed like I had seen this before, I flashed back to my early days in the Federal Reserve System and the saga of the Resolution Trust Corporation, the Congress-created vehicle that helped the country work its way through the aftermath of the 1980s savings and loan crisis. ...

                          The last great experiment in working through financial crisis took longer than expected, involved some accounting pushing and shoving at the outset, confronted a skeptical Congress, and cost more than initially projected, but quite a lot less than feared.

                          Make of it what you will.

                            Posted by on Thursday, April 16, 2009 at 12:33 AM in Economics, Financial System, Policy | Permalink  TrackBack (0)  Comments (4) 


                            "What Counts is the Spirit of Willingness"

                            An example of the claim that "many of the [G20] initiatives were more show than substance":

                            The world's shortest blacklist, FP Passport: I was already kind of skeptical about the G-20's pledge to crack down on tax havens, but after reading Alexander Neubacher's Der Spiegel piece on the tax haven "black list," which contains a whopping zero countries, I'm only more so:

                            Less than 120 hours after the close of the London summit, the ... OECD ... published the shortest blacklist of all time -- with exactly zero entries. ...

                            The fact that all the world's tax havens seem to have disappeared overnight is primarily the result of skillful diplomacy. Even the most notorious offshore financial centers have managed to quickly purge themselves of all suspicions of aiding and abetting tax evaders.

                            At one point, the OECD was vowing to expand the list to include countries like Switzerland, but now even the Cayman Islands -- a country with more registered companies than people -- managed to get itself moved to the "gray list" of countries that are supposedly working to clean up their act:

                            On April 1, just one day before the London summit, the Cayman Islands managed to sign seven bilateral treaties -- with the Faeroe Islands, Iceland and Greenland, for example -- to cooperate on matters of taxation. Although the specific concessions made by the Caymans, a British overseas territory, are modest, what counts is the spirit of willingness. ...

                            I feel like this can't have been what Sarkozy had in mind.

                              Posted by on Thursday, April 16, 2009 at 12:24 AM in Economics, International Finance, Regulation, Taxes | Permalink  TrackBack (0)  Comments (2) 


                              links for 2009-04-16

                                Posted by on Thursday, April 16, 2009 at 12:06 AM in Economics, Links | Permalink  TrackBack (0)  Comments (16) 


                                Wednesday, April 15, 2009

                                On the Economy with Tom Keene

                                Here's an interview I did yesterday for "On the Economy" with Bloomberg's Tom Keene: Listen/Download.[Alternate link: "Thoma Says Politics Limiting U.S. Efforts to Aid Banks. April 14 (Bloomberg)"]

                                  Posted by on Wednesday, April 15, 2009 at 02:07 PM in Economics, Media | Permalink  TrackBack (0)  Comments (5) 


                                  "Kooks, Demagogues, and Right-Wingers On Tax Day"

                                  Robert Reich is tired of hearing complaints about taxes:

                                  A Short Citizen's Guide to Kooks, Demagogues, and Right-Wingers On Tax Day, by Robert Reich: No one likes to pay taxes, so tax day typically attracts a range of right-wing Republicans, kooks, and demagogues, all of whom tell us how awful we have it. Herewith a short ... guide ... responding to the predictable charges:

                                  1. "Americans pay too much in taxes." Wrong: The United States has the lowest taxes of all developed nations.

                                  2. "The rich pay too much! The top ten percent of income earners pay over 72 percent of all income taxes!" Misleading: The main reason the rich pay such a large percent is they've become so much richer ... in recent years. If you look at what they pay as individuals ... you'll see a steady decline over the years. ...

                                  3. "The bottom 60 percent pay only 3.3 percent of the taxes!" Misleading again. Most Americans are paying more in sales taxes than they ever have. Property taxes have also been rising at a steady clip. And Social Security taxes have also risen (thanks to the Greenspan Commission), while earnings over about $100,000 aren't subject to Social Security taxes. So-called "sin" taxes (mostly beer and cigarettes) have also skyrocketed. All of these taxes take a bigger bite out of the paychecks of people with lower incomes than they do people with higher incomes.

                                  4. "Obama is raising your taxes!" Wrong. Obama is cutting taxes for 95 percent of Americans, by about $400 per person a year... Only the top 2 percent will have a tax increase, but even this tax increase is modest. Basically, they go back to the rates they were paying under Bill Clinton... And they won't start paying this until 2011 anyway.

                                  5. "The huge debts we're wracking up will cause your taxes to rise!" Wrong again. When it comes to the national debt, as I've said before, the relevant statistic is the ratio of debt to the gross domestic product. The only sure way to bring that debt down and make it manageable in future years is to get the economy growing again -- which requires that, in the short term, the government spend a lot of money... In the long term, the biggest source of concern is rising health-care costs. And that's something Obama and Congress are aiming to tackle.

                                  6. "We have a patriotic duty to stand up against Washington taxes!" Just the opposite. We have a patriotic duty to pay taxes. ... President Teddy Roosevelt made the case in 1906 when he argued in favor of continuing the inheritance tax. "The man of great wealth owes a particular obligation to the state because he derives special advantages from the mere existence of government."

                                  An acquaintance from law school, now a partner in one of Washington's biggest and wealthiest law firms, explained to me one day over lunch how he and his partners use tax rules to create offsetting taxable gains and losses, and then allocate the gains to the firm's foreign partners who don't pay taxes in the United States. That way, they keep the losses here and shelter their income abroad. I noticed he had an American flag lapel pin. "You're supporting our troops," I said, referring to his pin. "Yup," he replied, entirely missing my point.

                                  True patriotism isn't cheap. It's about taking on a fair share of the burden of keeping America going.

                                    Posted by on Wednesday, April 15, 2009 at 12:06 PM in Economics, Politics, Taxes | Permalink  TrackBack (0)  Comments (134) 


                                    Deflation?

                                    With the decline in consumer prices announced today, people are beginning to talk about the risk of deflation once again, though it doesn't appear there's much worry since the decline was driven mainly by energy prices:

                                    For the first time in over a half century, the prices U.S. consumers pay for goods and services are lower on average than they were one year ago.

                                    Still, government price data for March suggest the risk of sustained, broad-based price declines known as deflation remains fairly remote, since the drops are still mostly centered in energy and energy-related products.

                                    Separately, capacity use at U.S. factories fell to a record low in March, reflecting the severe toll the recession is taking on manufacturing.

                                    Here's how John Williams at the SF Fed sees it:

                                    Deflation-frbsf

                                    Core and overall measures of price inflation have fallen considerably, reflecting declines in commodity prices and the emergence of considerable economic slack. We expect core inflation to continue to edge down, reaching 1 percent in 2010. Given the weakness of the U.S. and global economies, the outlook for inflation is highly uncertain. Some Phillips-curve inflation forecasting models based on the view that inflation expectations are unanchored predict a high probability of deflation next year. In contrast, Phillips-curve models based on the well-anchored inflation expectations seen over the past 16 years indicate little probability of deflation and predict inflation rising towards 2 percent over the next two years.

                                      Posted by on Wednesday, April 15, 2009 at 09:36 AM in Economics, Inflation | Permalink  TrackBack (0)  Comments (26) 


                                      "Depression Lurks Unless There’s More Stimulus"

                                      Robert Shiller says we need to continue with the monetary and fiscal policies we are pursuing, but both efforts need to be larger:

                                      Depression Lurks Unless There’s More Stimulus, by Robert Shiller, Commentary, Bloomberg: In the Great Depression ... the U.S. government had a great deal of trouble maintaining its commitment to economic stimulus. “Pump- priming” was talked about and tried, but not consistently. The Depression could have been mostly prevented, but wasn’t. ...

                                      In the face of a similar Depression-era psychology today, we are in need of massive pump-priming again. We appear to be in a much better situation due to the stronger efforts to date. Still, there is a danger that, because of a combination of faulty economic theory and inadequate appreciation of human psychology, as well as deep public anger, we will not continue with such stimulus on a high enough level. ...

                                      In our analysis of the current economic crisis, we conclude that the government should have two targets. One would be a joint fiscal-monetary policy target. The same kind of expansionary policies embodied in the government expenditure stimulus and tax cuts that are already being tried have to be done on a big enough scale and for a long enough time in the future. ...

                                      The government should also have a credit target. Once again, we are calling for more of the same kinds of existing policies... Achieving this requires new approaches, like those announced by the Bernanke Fed and the Obama administration, but on a continuing and even larger scale. ...

                                      In this crisis, acceptance of these measures is being replaced with outrage. It is increasing the blood pressure of the public, and that can’t continue without damage to our system. ... It is time to face up to what needs to be done. The sticker shock involved will be large, but the costs in terms of lost output of not meeting either the credit target or the aggregate demand target will be yet larger.

                                      It would be a shame if we are so overwhelmed by anger at the unfairness of it all that we do not take the positive measures needed to restore us to full employment. That would not just be unfair to the U.S. taxpayer. That would be unfair to those who are living in Hoovervilles...; it would be unfair to those who are being evicted from their homes, and can’t find new ones because they can’t find jobs. That would be unfair to those who have to drop out of school because they, or their parents, can’t find jobs.

                                      It is now time to keep our eye on the ball and set clear targets to fix a system that broke when our animal spirits got out of bounds.

                                        Posted by on Wednesday, April 15, 2009 at 01:17 AM in Economics, Fiscal Policy, Monetary Policy | Permalink  TrackBack (0)  Comments (32) 


                                        The Need for Cooperative Economic Policy

                                        At TPMCafe Bookclub:

                                        ...This is not an imagined problem, we've seen the difficulties in coordinating monetary and fiscal policy across countries in response to the present crisis, we've seen moves toward protectionism, and I hope we can find a way to improve and do collectively what Kindleberger would have had the global leader do. That will require, for one, that the US realize that it must be part of a team rather than the person in charge giving all the orders, and giving the rest of the world the respect it deserves in formulating these decisions. There have been some encouraging signs, notably the decision at the recent G20 meetings to enhance the resources available to the IMF, the meetings themselves seemed to move toward a more cooperative governing structure, something that certainly wasn't hurt by having a new US administration, and some common views on global financial regulation emerged. But at the same time there was little cooperation on fiscal policy measures, and many of the initiatives were more show than substance. So we shall see.

                                          Posted by on Wednesday, April 15, 2009 at 12:24 AM in Economics, Policy | Permalink  TrackBack (0)  Comments (20) 


                                          links for 2009-04-15

                                            Posted by on Wednesday, April 15, 2009 at 12:06 AM in Economics, Links | Permalink  TrackBack (0)  Comments (41) 


                                            Tuesday, April 14, 2009

                                            Regulating Risk

                                            More Blog Wars:

                                            Don’t Leave the Door Open to Another Financial Crisis: ...perhaps the work on complexity analysis used in analyzing network connections in fields like physics and computer science can be used to analyze  the connectedness of financial firms. The mathematics to do this are already well-developed, and this should be feasible. Both the number and size of the connections would need to be tracked, and a risk index could then be developed.

                                            Then, and this is the regulation part, I would propose developing something like the measures used to assess market or monopoly power discussed here. To determine if a firm is too large and powerful, a measure of its market share is constructed, and if that share crosses a predetermined threshold, further action is pursued by regulators. There’s no reason we can’t do the same with measures of connectedness among financial firms...

                                            Response from Houman Shadab: Why Too Much Regulation Increases Risk.

                                              Posted by on Tuesday, April 14, 2009 at 06:21 PM in Economics, Media, Regulation | Permalink  TrackBack (0)  Comments (11) 


                                              "Uncertainty and Capitalism"

                                              Edmund Phelps defends capitalism:

                                              Uncertainty bedevils the best system, by Edmund Phelps, Commentary, Financial Times: In countries operating a largely capitalist system, there does not appear to be a wide understanding among its actors and overseers of either its advantages or its hazards. Ignorance of what it can contribute has in the past led some countries to throw out the system or clip its wings. Ignorance of the hazards has made imprudence in markets and policy neglect all the more likely. Regaining a well-functioning capitalism will require re-education and deep reform.

                                              Capitalism is not the “free market” or laisser faire – a system of zero government “plus the constable”. Capitalist systems function less well without state protection of investors, lenders and companies against monopoly, deception and fraud. These systems may lack the requisite political support and cause social stresses without subsidies to stimulate inclusion of the less advantaged in society’s formal business economy. Last, a huge social insurance system, with resulting high taxes, low take-home pay and low wealth, may not hurt capitalism. ...

                                              From the outset, the biggest downside [to capitalism] was that creative ventures caused uncertainty not only for the entrepreneurs themselves but also for everyone else in the global economy. Swings in venture activity created a fluctuating economic environment. ...

                                              Unfortunately, there is still no wide understanding among the public of the benefits that can fairly be credited to capitalism and why these benefits have costs. This intellectual failure has left capitalism vulnerable to opponents and to ignorance within the system.

                                              Capitalism lost much of its standing in the interwar period, when many countries in western continental Europe shifted to corporatist systems. This was a low point in the public’s grasp of political economy. In the end, the promises of greater prosperity and lesser swings could not be delivered. The nations that kept capitalism while making reforms, some good and others maybe not, ultimately performed well again – until now. Those that broke from capitalism were less innovative. After the disturbances of the 1970s, they saw unemployment rise far more than the capitalist nations did. They were worse on economic inclusion too.

                                              Now capitalism is in the midst of its second crisis. An explanation offered is that ... the crisis flowed from a failure of corporate governance to curb bonuses and of regulation to rein in leveraging of bank capital...

                                              But why did big shareholders not move to stop over-leveraging before it reached dangerous levels? Why did legislators not demand regulatory intervention? The answer, I believe, is that they had no sense of the existing Knightian uncertainty. So they had no sense of the possibility of a huge break in housing prices and no sense of the fundamental inapplicability of the risk management models used in the banks. “Risk” came to mean volatility over some recent past. The volatility of the price as it vibrates around some path was considered but not the uncertainty of the path itself: the risk that it would shift down. The banks’ chief executives, too, had little grasp of uncertainty. Some had the instinct to buy insurance but did not see the uncertainty of the insurer’s solvency.

                                              Much is dysfunctional in the US and the UK... If we still have our humanist values we will try to restructure these sectors to make capitalism work well again – to guard better against reckless disregard of uncertainty in the financial sector while reviving innovativeness in business. We will not close the door on systems that gave growing numbers rewarding lives.

                                              I was glad, and somewhat surprised, to hear Phelps say that "a huge social insurance system ... may not hurt capitalism." However, he does imply that economic growth is necessarily lower as a consequence and I'm not sure that follows. But even if growth is lower - and again, I'm not conceding that - it doesn't mean that people are necessarily worse off. If people value economic stability, and I believe it is highly valued, then this benefit has to be counted against any potential loss of growth. Thus, when this benefit is factored in, even if growth is lower, people may still be better off due to the greater amount of economic stability that they enjoy.

                                              To cast this in terms of a recent (re)post from Brad DeLong, part of what matters here is whose utility function gets the most weight in the social welfare function that is implicitly maximized by policymakers. If the people who benefit most from growth and suffer least from uncertainty get the most weight in this function, and the wealthy fall into this category, then policy will be devoted mostly to growth and security will take a back seat (even if the tradeoff between growth and security is imagined rather than real). But if the weights are changed, then policymakers might be guided to a different choice, one that places a high value on stability. Thus, the choices we have made relative to other countries - the choice of growth versus security - may reflect who has the most influence over the political process as much as anything else, and may have also been driven by a false sense of the size of the tradeoff that exists between the two supposedly opposite goals. (I think the relationship between growth and security is shaped like an inverted-U. If security is very low or non-existent, growth will also be low. Growth-and-security Then, as security increases growth also increases and reaches some maximum shown as point A on the diagram, and any further increases in sucurity do harm economic growth. The argument above is that the point where societal welfare is maximized is not necessarily the point where economic growth is maximized. The maximum could lie to the right of point A if security is valued over growth, i.e. there is no reason why point B cannot be the point where the measure of social welfare is highest).

                                                Posted by on Tuesday, April 14, 2009 at 03:33 PM in Economics, Social Insurance | Permalink  TrackBack (0)  Comments (42) 


                                                "Just How Progressive Is the Tax System?"

                                                Catherine Rampell at Economix presents and discusses data on the progressivity of taxes (federal, state, and local, calculations from the Citizens for Tax Justice). As she notes, this comes in rebuttal to claims based upon CBO data that taxes are highly progressive, and that the wealthy pay far more than their share:

                                                Progressive1
                                                Horizontal axis shows the income group. Vertical axis shows the percentage of income that the average member of that group pays in taxes. Taxes include all federal, state and local taxes (personal and corporate income, payroll, property, sales, excise, estate, etc.). Incomes include cash income, employer-paid FICA taxes and corporate profits net of taxable dividends.

                                                Progressive2
                                                Horizontal axis shows the income group. Taxes include all federal, state and local taxes (personal and corporate income, payroll, property, sales, excise, estate, etc.). Incomes include cash income, employer-paid FICA taxes and corporate profits net of taxable dividends.

                                                Update: pgl follows up.

                                                  Posted by on Tuesday, April 14, 2009 at 12:42 AM in Economics, Equity, Taxes | Permalink  TrackBack (0)  Comments (99) 


                                                  Stavins: The Making of a Conventional Wisdom

                                                  Robert Stavins wonders why people have become more receptive to market based solutions to environmental problems:

                                                  The Making of a Conventional Wisdom, by Robert Stavins: Despite the potential cost-effectiveness of market-based policy instruments, such as pollution taxes and tradable permits, conventional approaches ... have been the mainstay of U.S. environmental policy since before the first Earth Day in 1970.  Gradually, however, the political process has become more receptive to innovative, market-based strategies.  ...[gives examples]...

                                                  Why has there been a relatively recent rise in the use of market-based approaches?  For academics like me, it would be gratifying to believe that increased understanding of market-based instruments had played a large part..., but how important has this really been?  In 1981, my Harvard colleague, political scientist Steven Kelman surveyed Congressional staff members, and found that support and opposition to market-based environmental policy instruments was based largely on ideological grounds: Republicans, who supported the concept of economic-incentive approaches, offered as a reason the assertion that “the free market works,” or “less government intervention” is desirable, without any real awareness or understanding of the economic arguments for market-based programs.  Likewise, Democratic opposition was based largely upon ideological factors, with little or no apparent understanding of the real advantages or disadvantages of the various instruments.  What would happen if we were to replicate Kelman’s survey today?  My refutable hypothesis is that we would find increased support from Republicans, greatly increased support from Democrats, but insufficient improvements in understanding to explain these changes.  So what else has mattered?

                                                  Continue reading "Stavins: The Making of a Conventional Wisdom" »

                                                    Posted by on Tuesday, April 14, 2009 at 12:33 AM in Economics, Environment, Politics, Regulation | Permalink  TrackBack (0)  Comments (24) 


                                                    The Need to Monitor and Regulate Risk

                                                    I'm participating in this week's TPMCafe Bookclub:

                                                    Liaquat Ahamed joins us this week at Book Club for a discussion of Lords of Finance: The Bankers Who Broke The World. An economic history of the liquidity crisis from 1914 through the Great Depression, Ahamed focuses on four central bankers and their larger-than-life personalities: Montagu Norman of the Bank of England, Emile Moreau of Banque de France, Hjalmar Schacht of Reichsbank, and Benjamin Strong of the Federal Reserve Bank of New York. Lords of Finance details the four men's attempts to return the economy to the gold standard - and how a series of bad decisions brought the four major banks (and their respective economies) to the brink of collapse. ...

                                                    Joining the discussion are James Galbraith,... of ... the University of Texas at Austin; Sidney Blumenthal, former aide to President Clinton and Senior Fellow for the New York University Center on Law and Security; Julian Zelizer, Professor of History and Public Affairs at Princeton University; Randall Wray, Professor of Economics at the University of Missouri-Kansas City; Mark Thoma, Professor of Economics at the University of Oregon; and Nathan Newman, Policy Director for the Progressive Legislative Action Network.

                                                    Here's my first entry:

                                                    The Need to Monitor and Regulate Risk: At the end of his introductory essay, Liaquat Ahamed asks two questions. One is:

                                                    ...has the structure of the economy changed so much ... that the traditional instruments of policy we thought we could rely on to jumpstart the economy will no longer work?

                                                    New approaches are required, but it's not so much the nature of the economy that has changed, it's that we forgot or never fully learned the lessons of the Great Depression.

                                                    One of the lessons of the Great Depression should have been that the financial authorities need to monitor and regulate excessive build-ups of systemic risk. In addition, once a crash occurs and fear is one of the main factors that is causing markets to freeze up, financial authorities need to know how to quickly reduce risk - they need some means of removing the questionable assets from the market place - and this must be done in a politically palatable, least cost manner.

                                                    The Fed can manage risk in two ways, through regulation and through the buying and selling of financial assets. For example, the Fed can use regulation to prevent firms from holding some types of risky assets, or to limit the amounts they can hold, and it can use things such as margin requirements to help to control leverage. Through open market operations, the Fed can trade safe assets such as Treasury Bills for risky assets, and in the process change the proportion of risky to non-risky assets held on the balance sheets of the public and private sectors.

                                                    I think policymakers failed on two counts. ...[...continue reading...] [Full discussion]

                                                      Posted by on Tuesday, April 14, 2009 at 12:24 AM in Economics, Financial System, Monetary Policy | Permalink  TrackBack (0)  Comments (1) 


                                                      links for 2009-04-14

                                                        Posted by on Tuesday, April 14, 2009 at 12:06 AM in Economics, Links | Permalink  TrackBack (0)  Comments (8) 


                                                        Monday, April 13, 2009

                                                        How Long?

                                                        This argues that the administration is in denial about the need to recapitalize the banking system:

                                                        Geithner and Summers need to address the banking problems square-on, by Michael Pomerleano, Economists' Forum: The Obama administration program to address the fragility of the banking system is based on a two major initiatives. First, it has proposed the Geithner- Summers Plan to buy subprime securitized assets from the banks. The toxic assets plan deals with less that 40 percent of the balance sheet of the banks that is in marketable securities. It does not deal with the 60 percent of the balance sheets of US banks that are loans and are not marked to market. Further, it will take six months to get the program in motion. The plan elicited deserved criticism...

                                                        The second part of the administration program is the now famous stress test of the nation’s largest banks. ... This article argues that The Obama administration is in denial regarding the problems in the financial system. The losses in the banking system are not an “unknown unknown”. As shown below, the stress test calculations can be conducted by any informed analyst, and the losses are known with a reasonable degree with approximation. The stress test is simply a “smoke screen” designed to postpone the inevitable moment when the administration has to deal with the well known and severe problems in the banking system. ...

                                                        The banking system is severely undercapitalized, with numerous insolvent banks. Clearly a more robust banking system requires far more capital and a robust loan loss reserve adding to the capital cushion. Until the trillion plus of impaired assets are removed and the banking system is recapitalized, credit flows will be restricted. In this context, it is puzzling why the administration is tinkering at the fringes with programs designed to enrich Wall Street. Geithner and Summers need to address the banking problems square-on.

                                                        Six months "to get the program in motion"? That detail is new to me, but if that's the case, if they are kicking the can down the road that far, that's far too long to wait. Six months?

                                                          Posted by on Monday, April 13, 2009 at 04:05 PM in Economics, Financial System, Policy | Permalink  TrackBack (0)  Comments (25) 


                                                          Extend the Regulatory Umbrella

                                                          My opening entry in the Blog Wars at CBS Marketwatch.com:

                                                              We Need to Extend the Regulatory Umbrella.

                                                          [This was written before Paul Krugman's Making Banking Boring, which makes similar points. Also, last week Tyler Cowen and Brad DeLong discussed fiscal policy - see here.]

                                                          Update: Here is Houman Shadab's response:

                                                              Regulate the Relationships, Not the Institutions and Instruments

                                                          I have a counter response, and a proposal for regulating systemic risk, that will appear tomorrow.

                                                            Posted by on Monday, April 13, 2009 at 09:45 AM in Economics, Financial System, Regulation | Permalink  TrackBack (0)  Comments (9) 


                                                            Paul Krugman: Tea Parties Forever

                                                            Has defeat changed the Republican Party?:

                                                            Tea Parties Forever, by Paul Krugman, Commentary, NY Times: This is a column about Republicans — and I’m not sure I should even be writing it. Today’s G.O.P. is, after all,... embarrassing to watch. And it doesn’t feel right to make fun of crazy people. ...

                                                            But here’s the thing: the G.O.P. looked as crazy 10 or 15 years ago as it does now. That didn’t stop Republicans from taking control of both Congress and the White House. And they could return to power if the Democrats stumble. ...

                                                            One way to get a good sense of the current state of the G.O.P., and also to see how little has really changed, is to look at the “tea parties”... These parties — antitaxation demonstrations... — have been the subject of considerable mockery, and rightly so.

                                                            But everything that critics mock about these parties has long been standard practice within the Republican Party.

                                                            Thus, President Obama is being called a “socialist” who seeks to destroy capitalism. Why? Because he wants to raise the tax rate on the highest-income Americans back to, um, about 10 percentage points less than it was for most of the Reagan administration. Bizarre. ...

                                                            Then there are the claims made at some recent tea-party events that Mr. Obama wasn’t born in America, which follow on earlier claims that he is a secret Muslim. Crazy stuff — but nowhere near as crazy as the claims, during the last Democratic administration, that the Clintons were murderers, claims ... supported by a campaign of innuendo on the part of big-league conservative media outlets and figures, especially Rush Limbaugh.

                                                            Speaking of Mr. Limbaugh: the ... abject apologies he has extracted from Republican politicians who briefly dared to criticize him have been right out of Stalinist show trials. But while it’s new to have a talk-radio host in that role, ferocious party discipline has been the norm since the 1990s when Tom DeLay ... became known as “The Hammer”...

                                                            Going back to those tea parties, Mr. DeLay, a fierce opponent of the theory of evolution — he famously suggested that the teaching of evolution led to the Columbine school massacre — also foreshadowed the denunciations of evolution that have emerged at some of the parties.

                                                            Last but not least: it turns out that the tea parties don’t represent a spontaneous outpouring of public sentiment. They’re AstroTurf (fake grass roots) events, manufactured by the usual suspects. In particular, a key role is being played by FreedomWorks, an organization run by Richard Armey..., and supported by the usual group of right-wing billionaires. And the parties are, of course, being promoted heavily by Fox News.

                                                            But that’s nothing new, and AstroTurf has worked well for Republicans in the past. The most notable example was the “spontaneous” riot back in 2000 — actually orchestrated by G.O.P. strategists — that shut down the presidential vote recount in Florida’s Miami-Dade County.

                                                            So what’s the implication of the fact that Republicans are refusing to grow up, the fact that they are still behaving the same way they did when history seemed to be on their side? I’d say that it’s good for Democrats, at least in the short run — but it’s bad for the country.

                                                            For now, the Obama administration gains a substantial advantage from the fact that it has no credible opposition, especially on economic policy, where the Republicans seem particularly clueless.

                                                            But ... the G.O.P. remains one of America’s great parties, and events could still put that party back in power. We can only hope that Republicans have moved on by the time that happens.

                                                              Posted by on Monday, April 13, 2009 at 12:33 AM in Economics, Politics | Permalink  TrackBack (0)  Comments (88) 


                                                              International Policy Coordination or Protectionism?

                                                              Lots of worry about the global economy, the lack of an internationally coordinated policy response to the downturn, and about the imposition of protectionist measures. First, Joseph Stiglitz:

                                                              A globally coordinated stimulus package needed, by Joseph E Stiglitz, Project Syndicate: This year is likely to be the worst for the global economy since World War II... Unless something is done, the crisis will throw as many as 200mn additional people into poverty.

                                                              This global crisis requires a ... globally coordinated stimulus package... [W]hile it is recognised that almost all countries need to undertake stimulus measures (we’re all Keynesians now), many developing countries do not have the resources to do so. Nor do existing international lending institutions.

                                                              But if we are to avoid winding up in another debt crisis, some, perhaps much, of the money will have to be given in grants. And, in the past, assistance has been accompanied by extensive “conditions,” some of which enforced contractionary monetary and fiscal policies – just the opposite of what is needed now – and imposed financial deregulation, which was among the root causes of the crisis.

                                                              In many parts of the world, there is a strong stigma associated with going to the International Monetary Fund, for obvious reasons. ... It is thus imperative that assistance be provided through a variety of channels, in addition to, or instead of, the IMF...

                                                              Continue reading "International Policy Coordination or Protectionism?" »

                                                                Posted by on Monday, April 13, 2009 at 12:24 AM in Economics, International Trade | Permalink  TrackBack (0)  Comments (3) 


                                                                links for 2009-04-13

                                                                  Posted by on Monday, April 13, 2009 at 12:06 AM in Economics, Links | Permalink  TrackBack (0)  Comments (42) 


                                                                  Sunday, April 12, 2009

                                                                  Woodward and Hall: The Fed Needs to Make a Policy Statement

                                                                  Susan Woodward and Robet Hall on concerns about inflation:

                                                                  More and more one hears the concern that the Fed has embarked on an expansionary policy that will result in high inflation once the economy returns to normal. John Taylor, a leading expert in this area, put the argument as follows...

                                                                  [T]he question John Taylor posed–how can the Fed control inflation in coming years when it is committed to have a large volume of reserves outstanding to finance its purchases of illiquid assets?–has a simple and effective answer...

                                                                  The (good, but wonkish) answer is here.

                                                                    Posted by on Sunday, April 12, 2009 at 02:43 PM in Economics, Inflation, Monetary Policy | Permalink  TrackBack (0)  Comments (17) 


                                                                    Interview

                                                                    I was on KLCC's Sunday at Noon earlier today (there is also a taped interview of Tim Duy about halfway through). The interview is archived here.

                                                                      Posted by on Sunday, April 12, 2009 at 01:44 PM in Economics, Media | Permalink  TrackBack (0)  Comments (5) 


                                                                      "The Case for Waste"

                                                                      Is the government too worried about preventing waste in the spending associated with the stimulus package, so worried that it is causing harmful delays in putting the spending in place?:

                                                                      The Case for Waste , by Alec MacGillis, Commentary, Washington Post: As the $787 billion stimulus package starts to flow, the message from on high is clear: No one dare waste a dime of it. "This plan cannot and will not be an excuse for waste and abuse," President Obama declared last month... Sen. Susan Collins (R-Maine) has warned ... that "we must ensure that haste does not make waste" and that even minimal amounts of misspent money would be simply "unacceptable." And California Gov. Arnold Schwarzenegger has appointed an inspector general to oversee "every single dollar" of the $50 billion flowing into his state.

                                                                      Missing amid all these high-minded calls to protect taxpayer dollars is an awkward question: When the whole point of a major government spending program is to stimulate the faltering economy as quickly as possible, what exactly counts as "wasted" money? After all, if some stimulus cash is misspent -- say an errant official or contractor buys himself a Cadillac or a Harley Davidson, only to suffer the full force of law -- might not such fraud boost the economy more than if the cash languished in a law-abiding state account? All that monitoring, however well-intentioned, may undercut recovery by compelling officials to spend more slowly to avoid hearings, prosecution, or embarrassment in the media. ...

                                                                      Underlying this contradiction is a broader tension... Obama sold the package as a "down payment" on his goals for energy, education and health care and has expressed the hope that it will also renew confidence in government. From that perspective, it's crucial that the money have the desired policy impact and be spent in an above-board manner. Members of Congress calling for close oversight cite notorious examples of waste in Iraq war contracts and the Hurricane Katrina recovery.

                                                                      But the stimulus package's main stated goal was to jumpstart the economy by getting billions of dollars into circulation fast, and that requires a different mindset. ... It was John Maynard Keynes who famously said that paying unemployed men simply to dig up bottles filled with cash and buried in abandoned coal mines would be "better than nothing" as economic stimulus.

                                                                      Instead of catching a break because of the time pressures, the stimulus is receiving far greater scrutiny than regular government spending. ... Rob Nabors,... the White House's point man for the stimulus,... said that the increased oversight is justified because the legislation's policy aims are as much a part of it as the stimulus.

                                                                      "Yes, from an economic perspective, the money is spent when the money is spent, but we are planning for this money to leave a lasting legacy," he said. "We expect to show not just X numbers of jobs created but X number of homes weatherized. We're looking to improve our parks system, modernize our infrastructure. Any dollar distracted from those purposes really is a wasted dollar." He added: "...and if that means we have to take an extra day to make sure the reporting is in line and we're doing things right, we tend to push the agencies to . . . slow down a little." ...

                                                                      For all the political benefit of promising to protect taxpayer dollars, the rhetoric around accountability may also unintentionally raise the stakes when the eventual spending scandals do surface. ... "There may be a naive impression that, given the amount of transparency and accountability called for by this Act, little or no fraud or waste will occur... Some level of waste or fraud is, regrettably, inevitable."

                                                                      It is politically harder to argue for spending that does not produce a tangible asset you can point to, a bridge or something like that (it can even be named after the stimulus package to maximize the political benefit). But even so, I think they have over-emphasized long-term investments that are really about the supply-side of the economy, and under-emphasized policies that can boost demand in the short-run quickly and effectively, but do not have the kinds of long-run impacts that provide "a lasting legacy."

                                                                        Posted by on Sunday, April 12, 2009 at 02:34 AM in Economics, Fiscal Policy, Politics | Permalink  TrackBack (0)  Comments (24) 


                                                                        Predicting Turning Points is Hard

                                                                        This sounds familiar:

                                                                        Confusing Patterns With Coincidences, by Susan Hough, Commentary, NY Times: In the aftermath of the earthquake at L’Aquila, Italy, on Monday that killed nearly 300 people, splashy headlines suggested that these victims didn’t have to die.

                                                                        An Italian researcher, Giampaolo Giuliani, began to sound alarm bells a month earlier, warning that an earthquake would strike near L’Aquila on March 29. ... Mr. Giuliani was denounced for inciting panic..., and he was forced to take his warning off the Web after March 29 came and went without significant activity.

                                                                        Should Italian officials have listened? Should the public have heeded the warnings? With 20-20 hindsight the answer certainly appears to be yes. The real answer is no.

                                                                        Scientists have been chasing earthquake prediction — the holy grail of earthquake science — for decades. ... Yet we have little to no real progress to show for our efforts. ... We’re pretty good at forecasting the long-term rates of earthquakes in different areas. But prediction per se, which involves specifying usefully narrow windows in time, location and magnitude, has eluded us.

                                                                        Continue reading "Predicting Turning Points is Hard" »

                                                                          Posted by on Sunday, April 12, 2009 at 02:25 AM in Economics, Science | Permalink  TrackBack (0)  Comments (8) 


                                                                          links for 2009-04-12

                                                                            Posted by on Sunday, April 12, 2009 at 12:06 AM in Economics, Links | Permalink  TrackBack (0)  Comments (8) 


                                                                            Saturday, April 11, 2009

                                                                            Blinder: Focus on Winning the War

                                                                            Alan Blinder says you may need to hold your nose as the financial sector is repaired. The repair is necessary, but the fix stinks:

                                                                            Restore Order and Win a Financial War, by Alan Blinder, Commentary, NY Times: Many Americans are bewildered, aggrieved and even angry about the financial shenanigans that led to the current mess...

                                                                            A bunch of wealthy, supposedly smart financial “experts” made irresponsible bets that went bad, pushing our economy to the brink and taking the rest of us down with them. ... And taxpayers are being handed monstrous bills for mistakes that were not their doing.

                                                                            It is maddening that hardly any of the miscreants have been punished, not to mention that many remain well paid. But foolishness is not a crime, and most of them broke no laws. ...

                                                                            Continue reading "Blinder: Focus on Winning the War" »

                                                                              Posted by on Saturday, April 11, 2009 at 05:49 PM in Economics, Financial System, Policy | Permalink  TrackBack (0)  Comments (32) 


                                                                              Quick Note

                                                                              I will be on the Mark Martinez radio show (Bakersfield, CA) today at 3:06 p.m. PST (streaming audio). The call-in number is 661 631-1230. [Update: ended at 3:33].

                                                                                Posted by on Saturday, April 11, 2009 at 02:34 PM in Economics | Permalink  TrackBack (0)  Comments (0) 


                                                                                Macroeconomic Meltdown?

                                                                                The state of macroeconmics:

                                                                                Are those who sweat the big stuff in meltdown?, by Tim Harford, Commentary, Financial Times: ...I am struck by the soul-searching that has gripped the [macroeconomics] profession in the face of the economic crisis. The worry is not so much that macroeconomists did not forecast the problem – bad forecasts are more a sign of a complex world than intellectual bankruptcy – but that macroeconomics seems unable to provide answers. Sometimes it cannot even ask the right questions.

                                                                                Willem Buiter ... complains that macroeconomists have simply discarded the difficult stuff to make their models more elegant: “They took these non-linear stochastic dynamic general equilibrium models into the basement and beat them with a rubber hose until they behaved.”

                                                                                He is not alone in his frustration. Paul Krugman ... thinks macroeconomics is in a dark age, in the sense that rather than discovering new insights, we are actually going backwards and forgetting what we used to know. Mark Thoma ... opines: “I think that the current crisis has dealt a bigger blow to macroeconomic theory and modelling than many of us realise.”

                                                                                We shall see. While many commentators have reached for Keynes – or some caricature of Keynes – as a solution to this crisis, this is not because he is the fount of all knowledge, but because he was asking good questions about problems that now seem relevant again.

                                                                                Economists now understand much more than Keynes ever could about networks and complex interactions (thanks to agent-based modelling), psychology (thanks to behavioural economics) and the real world (thanks to econometrics). In principle, these advances should inform our understanding of the crisis. An early attempt is Animal Spirits, a book by George Akerlof, a Nobel laureate, and Robert Shiller, who identified the housing bubble early. But macroeconomics has a lot of momentum and it will take time to turn the oil tanker around.

                                                                                Justin Wolfers,... an unabashed microeconomist, says that, “formally elegant but empirically irrelevant macroeconomists had a much harder time getting hired this year,” while Buiter reckons that the central banks have already jettisoned conventional macroeconomics in favour of a pragmatic combination of hunches and judgment calls. If so, the market for macroeconomic ideas seems to be self-correcting – much like the market for financial weapons of mass destruction. It is just a shame, in both cases, that the correction did not come more smoothly and much, much earlier.

                                                                                Let me a bit more specific, and add something more to problems with macroeconomics I discussed in The Great Multiplier Debate and "The Unfortunate Uselessness of Most 'State of the Art' Academic Monetary Economics". The main mechanism generating fluctuations and policy effects in modern New Keynesian models is Calvo type sluggish price adjustment. I think this model is useful for “normal” times as a way of understanding economic fluctuations, and for learning about optimal policy, and it represents a step forward in understanding monetary policy in particular. But do people really think that all would be fine right now if prices – and they must have housing prices in mind when they think about sticky prices as an explanation for the current episode – had only adjusted faster? If housing prices had dropped even faster than they have already, all would be well in the world?

                                                                                Okay, so maybe they don’t have housing prices in mind. Still, do we really think that sluggish price adjustment is the main mechanism at work in the present crisis? If not, then what use is the evidence from those models? Why do we keep hearing about theoretical simulations that give values for the multiplier that are small, large, zero, less than one, whatever? Do we really think that sluggish price adjustment captures the essence of the factors driving the present crisis? I don't.

                                                                                The fundamental mechanism driving the economic fluctuations is wrong, and people seem to be missing that when they try to use the evidence from this model to comment on the present situation. There are two big problems. First, we have very little data from episodes like the current one to calibrate these models. What should, say, the elasticity of labor supply be in a severe recession? Do we know? That's a key parameter in these models, and we can only guess what it's value ought to be. Second, even if we have good data from similar episodes, why run it through a model that does not capture the fundamental problem driving the downturn?

                                                                                Again, I think the New Keynesian model is very useful for understanding "normal" business cycles, but I am very hesitant to use this model as the basis for policy advice in the present crisis.

                                                                                So where does that leave us? We do not have either the theoretical models or the empirical evidence we need to understand this episode thoroughly and completely, and to provide the policy advice that will cure the problem with any degree of certainty. Without solid theoretical models and the associated empirical evidence, we really have no choice but to fall back upon older models that were "built to answer the questions that are important at the moment," i.e. the old-fashioned Keynesian model, and to rely upon loose, but solid theoretical principles rather than a tightly constructed model and vast amounts of empirical evidence. It's quite understandable that economists who have been striving to push the profession in a positive, scientific, solidly theoretical and evidence based direction would resist going backward, and resist strongly, but what choice do we have? Until we have a better mousetrap, the simple, old fashioned one will have to suffice.

                                                                                  Posted by on Saturday, April 11, 2009 at 01:17 AM in Economics, Macroeconomics, Methodology | Permalink  TrackBack (0)  Comments (50) 


                                                                                  links for 2009-04-11

                                                                                    Posted by on Saturday, April 11, 2009 at 12:06 AM in Economics, Links | Permalink  TrackBack (0)  Comments (8) 


                                                                                    Friday, April 10, 2009

                                                                                    Revisions to Payroll Employment

                                                                                    Payroll-adjust
                                                                                    [months yet to be revised are omitted from source graph]

                                                                                    Rationality prevents us from making persistent, one-sided estimation and forecasting errors.

                                                                                      Posted by on Friday, April 10, 2009 at 05:31 PM in Economics, Unemployment | Permalink  TrackBack (0)  Comments (56) 


                                                                                      "Neural Mechanisms of Social Influence in Consumer Decisions"

                                                                                      Today's seminar:

                                                                                      Neural Mechanisms of Social Influence in Consumer Decisions, by Gregory Berns, C. Monica Capra, Sara Moore, and Charles Noussai: Abstract It is well-known that social influences affect consumption decisions.  Although a number of different mechanisms have been hypothesized, a consumer's tendency to purchase a product is influenced by the choices made by his associative reference group.  Here, we use functional magnetic resonance imaging (fMRI) to elucidate the neural mechanisms associated with social influence on a common consumer good: music.  We restricted our study population to adolescents between the ages of 12-17 because music is a common purchase in this age group, and it is widely believed that adolescent behavior is particularly influenced by perceptions of popularity in their reference group.  Using 15-second clips of songs downloaded from MySpace, we obtained behavioral measures of preferences and neurobiological responses to the songs. The data were gathered with, and without, the popularity of the song revealed. The popularity had a significant effect on the participants' ratings of how much they liked the songs.  The fMRI results showed a strong correlation between the participants' rating and activity in the caudate nucleus, a region previously implicated in reward-driven actions.  The tendency to change one's evaluation of a song was correlated with activation only in the anterior insula, a region associated with physiological arousal, particularly to negative affective states.  Our results suggest that a principal mechanism whereby popularity ratings affect consumer choice is through the anxiety generated by the mismatch between one's own preferences and others'.  This mismatch anxiety motivates people to switch their choices in the direction of the consensus, suggesting that this is a major force behind conformity observed in music tastes in teenagers.

                                                                                      This may also explain why economists generally adopt the consensus forecast, and how this tendency to conform to respected opinion within the field due to "mismatch anxiety" can lead to herd-like behavior that causes us to miss things like a housing bubble. Why take the time to think hard about the problem yourself if, in the end, you are going to adopt the view of the most respected and powerful voices in the field anyway?

                                                                                        Posted by on Friday, April 10, 2009 at 02:25 PM in Economics, Science | Permalink  TrackBack (0)  Comments (9) 


                                                                                        Paul Krugman: Making Banking Boring

                                                                                        Does congress have the will to pursue serious financial reform?:

                                                                                        Making Banking Boring, by Paul Krugman, Commentary, NY Times: Thirty-plus years ago, when I was a graduate student in economics, only the least ambitious of my classmates sought careers in the financial world. Even then, investment banks paid more than teaching or public service — but not that much more, and anyway, everyone knew that banking was, well, boring.

                                                                                        In the years that followed, of course, banking became anything but boring. Wheeling and dealing flourished, and pay scales in finance shot up... And we were assured that our supersized financial sector was the key to prosperity. Instead, however, finance turned into the monster that ate the world economy. ...

                                                                                        Thomas Philippon and Ariell Reshef ... show that banking in America has gone through three eras over the past century. Before 1930, banking was an exciting industry featuring a number of larger-than-life figures, who built giant financial empires (some ... based on fraud). This highflying finance sector presided over a rapid increase in debt: Household debt as a percentage of G.D.P. almost doubled between World War I and 1929.

                                                                                        During this first era of high finance, bankers were, on average, paid much more than their counterparts in other industries. But finance lost its glamour when the banking system collapsed during the Great Depression.

                                                                                        The banking industry that emerged from that collapse was tightly regulated, far less colorful than it had been before the Depression, and far less lucrative.... Banking became boring, partly because bankers were so conservative about lending: Household debt ... stayed far below pre-1930s levels.

                                                                                        Strange to say, this era of boring banking was also an era of spectacular economic progress for most Americans.

                                                                                        After 1980, however, as the political winds shifted, many of the regulations on banks were lifted — and banking became exciting again. Debt began rising rapidly, eventually reaching just about the same level relative to G.D.P. as in 1929. And the financial industry exploded in size. By the middle of this decade, it accounted for a third of corporate profits.

                                                                                        As these changes took place, finance again became a high-paying career... Indeed, soaring incomes in finance played a large role in creating America’s second Gilded Age. Needless to say, the new superstars believed that they had earned their wealth. ... And many economists agreed.

                                                                                        Only a few people warned that this supercharged financial system might come to a bad end. Perhaps the most notable Cassandra was Raghuram Rajan... But other[s]..., including Lawrence Summers..., ridiculed Mr. Rajan’s concerns.

                                                                                        And the meltdown came.

                                                                                        Much of the seeming success of the financial industry has now been revealed as an illusion. ... Worse yet, the collapse of the financial house of cards has wreaked havoc with the rest of the economy, with world trade and industrial output actually falling faster than they did in the Great Depression. And the catastrophe has led to calls for much more regulation of the financial industry.

                                                                                        But my sense is that policy makers are still thinking mainly about rearranging the boxes on the bank supervisory organization chart. They’re not at all ready to do what needs to be done — which is to make banking boring again.

                                                                                        Part of the problem is that boring banking would mean poorer bankers, and the financial industry still has a lot of friends in high places. But it’s also a matter of ideology: Despite everything that has happened, most people in positions of power still associate fancy finance with economic progress.

                                                                                        Can they be persuaded otherwise? Will we find the will to pursue serious financial reform? If not, the current crisis won’t be a one-time event; it will be the shape of things to come.

                                                                                          Posted by on Friday, April 10, 2009 at 12:42 AM in Economics, Financial System, Regulation | Permalink  TrackBack (0)  Comments (88) 


                                                                                          Using Inheritance Taxes to Promote Equal Opportunity

                                                                                          Michael Kinsley is mystified by ten Democratic senators:

                                                                                          Democrats for Rich Heirs?, by Michael Kinsley, Commentary, Washington Post: ...Meanwhile, the Senate is considering what to do about the estate tax. It is scheduled to be abolished next year, in one of several landmines the Bush administration set to go off after it left town. Obama proposes to reinstate the tax, at a 45 percent rate, on estates worth more than $3.5 million. Since there's no tax on what you leave to your spouse, married couples could pass on $7 million before needing to pay a dollar -- or needing to consult a lawyer who can use loopholes to save millions more.

                                                                                          The House has passed this measure as part of the budget. In the Senate, there's trouble. Ten Democrats have joined the Republicans in calling for a $10 million exclusion and a 35 percent rate. This is amazing. The number of people who leave estates of even $7 million is minuscule. The number leaving more than $10 million is smaller still. Yet to save these very few very wealthy people a small fraction of their estates, these senators are willing to hand their party's president an embarrassing defeat. Why on earth?

                                                                                          Oh, small business blah blah blah. ... To be affected by the estate tax, a business must be owned by someone of large means: at least $7 million. ...

                                                                                          But why the populist fury over those AIG bonuses of a few million dollars while no one seems to care much about billions being transferred through inherited wealth? The obvious answer -- that there's a difference between what people do with our hard-earned money and what they do with their own hard-earned money -- isn't actually as persuasive as it seems.

                                                                                          Perusing the Forbes 400 list of America's richest people, it's striking how few of them made the list by building the proverbial better mousetrap. The most common route to gargantuan wealth, like the route to smaller piles, remains inheritance. ...

                                                                                          Dozens of Forbes 400 fortunes derive from the rising value of land or other natural resources. These businesses are fundamentally different from mousetrap building. Land does not need to become "better" to increase in value, and that value increase doesn't produce more land. Yet other fortunes depend directly on the government. The large fortunes based on health care and pharmaceuticals would not exist if not for Medicare and Medicaid. The government hands out large fortunes even more directly in forms as varied as cable-TV franchises; cellphone licenses; drilling, mining and mineral rights; minority small-business loans; and other special treatment.

                                                                                          Most important, every American selling anything benefits from doing so in the world's richest market. An American doctor earns many times what the same doctor would earn in, say, India. This is not because he or she works many times harder. ... It's because we are a richer society, for reasons the American doctor had nothing to do with.

                                                                                          The debate over whether the estate tax should start at $7 million or $10 million is largely symbolic. That makes the push by those 10 Democratic senators for the higher amount even more mysterious.

                                                                                          Via Brad DeLong:

                                                                                          Think Progress: Lincoln’s $250 billion estate tax plan would cut taxes for only 60 ’small businesses.’: Last week, 10 Democrats in the Senate joined all 41 Republicans in voting for a $250 billion proposal to cut estate taxes... Touting the tax cut in a press release, Lincoln claimed that it was “aimed at farms and small businesses.” However, according to an analysis by the Tax Policy Center, Lincoln’s $250 billion proposal would save just 60 small businesses or farms from the estate tax:

                                                                                          An always charged issue is how the estate tax affects small farms and family-owned businesses. We estimate that under the Obama proposal, 100 family farms and businesses [a year] would owe tax.... The Lincoln-Kyl proposal would cut the number to 40.

                                                                                          According to the Congressional Budget Office, “almost all such estates are able to pay the tax bill without having to sell business assets.”

                                                                                          To try to overcome the political opposition, and to try to meet a worthy goal, I would increase and broaden the tax, and then earmark the revenues specifically for programs designed to promote equal opportunity, e.g. Head Start programs, funds to allow anyone to attend the college of their choice without running up large debts, or alternatively to help to start a business, and so on. To further help with the political opposition, the collected funds, or more precisely the programs the funds support, would be made available to everyone on an equal basis.

                                                                                            Posted by on Friday, April 10, 2009 at 12:33 AM in Economics, Equity, Saving, Taxes | Permalink  TrackBack (0)  Comments (48) 


                                                                                            links for 2009-04-10

                                                                                              Posted by on Friday, April 10, 2009 at 12:06 AM in Economics, Links | Permalink  TrackBack (0)  Comments (8) 


                                                                                              Thursday, April 09, 2009

                                                                                              "Rationality versus Intelligence"

                                                                                              This argues that intelligence and other aspects of cognitive functioning aren't necessarily related to each other, and that our focus on intelligence rather than rationality may be misplaced:

                                                                                              Rationality vs. Intelligence, by Keith E. Stanovich, Project Syndicate: ...To be rational means to adopt appropriate goals, take the appropriate action given one's goals and beliefs, and hold beliefs that are commensurate with available evidence. It means achieving one's life goals using the best means possible. ...

                                                                                              Research conducted in my own laboratory has indicated that there are systematic individual differences in ... judgment and decision-making skills ...  that are entirely missing from the most well-known mental assessment device in the behavioral sciences: intelligence tests. ... Intelligence tests measure important things, but they do not assess the extent of rational thought. This might not be such a grave omission if intelligence were a strong predictor of rational thinking. But my research group found ... it is a mild predictor at best, and some rational thinking skills are totally dissociated from intelligence.

                                                                                              To an important degree, intelligence tests determine the academic and professional careers of millions of people in many countries. ... Perhaps some of this attention to intelligence is necessary, but what is not warranted is the tendency to ignore cognitive capacities that are at least equally important: the capacities that sustain rational thought and action.

                                                                                              Critics of intelligence tests have long pointed out that the tests ignore important parts of mental life, mainly non-cognitive domains such as socio-emotional abilities, empathy, and interpersonal skills. But intelligence tests are also radically incomplete as measures of cognitive functioning, which is evident from the simple fact that many people display a systematic inability to think or behave rationally despite having a more than adequate IQ.

                                                                                              For a variety of reasons, we have come to overvalue the kinds of thinking skills that intelligence tests measure and undervalue other important cognitive skills, such as the ability to think rationally. ... Intelligence tests measure mental skills that have been studied for a long time, whereas psychologists have only recently had the tools to measure the tendencies toward rational and irrational thinking. Nevertheless, recent progress in the cognitive science of rational thought suggests that nothing ― save for money ― would stop us from constructing an "RQ" test.

                                                                                              Such a test might prove highly useful. Suboptimal investment decisions have, for example, been linked to overconfidence in knowledge judgments, the tendency to over-explain chance events, and the tendency to substitute affective valence for thought. Errors in medical and legal decision-making have also been linked to specific irrational thinking tendencies...

                                                                                              There are strategies and environmental fixes for the thinking errors that occur in all of these domains. But it is important to realize that these thinking errors are more related to rationality than intelligence. They would be reduced if schools, businesses, and government focused on the parts of cognition that intelligence tests miss. ...It is as if intelligence has become totemic in our culture. But what we should really be pursuing is development of the reasoning strategies that could substantially increase human well-being.

                                                                                              It's also possible that some disciplines such as economics would be attractive to people who tend toward rational thinking (where rationality is defined more narrowly than above), and that this self-selection mechanism in terms of who becomes an economist would affect the behavioral models that are built by those within the profession. That is, once a model of rational behavior is built for whatever reason, it would then be attractive to people who think this way. It would be music to their ears in terms of explaining behavior as they understand it. As the rationalists then choose to become economists in greater and greater numbers, the models would become increasingly reliant upon rationality as a behavioral foundation as these two effects - who is attracted to the profession and the type of models that they build - become mutually reinforcing over time (and choices within the profession matter too, e.g. Richard Green's statement that "I am not a macroeconomist. One of the reasons for this, I suppose, is that I was taught a lot of rational expectations overlapping generations stuff in graduate school and while I found it elegant, I did not believe it.").

                                                                                                Posted by on Thursday, April 9, 2009 at 06:39 PM in Economics | Permalink  TrackBack (0)  Comments (24) 


                                                                                                I Feel Your Pain

                                                                                                Gavin Kennedy of Adam Smith's Lost Legacy recommends this essay on The Theory of Moral Sentiments:

                                                                                                Cut-throat behaviour makes empathy flow, by Nicholas Gruen, Commentary, Sydney Morning Herald: ...Smith's Theory Of Moral Sentiments argued that people seeking their own interests in a society were united by their sympathy or fellow feeling for others. If that sounds a bit lame to you - a monopolist's sympathy for his customers rarely stops him exploiting them - Smith wasn't arguing that people always do the right thing. His point was subtler and more powerful. Smith observed the way we internalise others' values and live enmeshed in social meanings and expectations.

                                                                                                In thrall to Newton's explanation of the movement of planets via a single, uniform principle - that of gravity - he looked for a similar foundation for human behaviour in society. In modern parlance Smith argued that we were hard-wired for sympathy or fellow feeling with others, not in the sense that we always take their side, but in the deeper sense that our understanding and ultimate judgment of them depends on an imaginative sympathy, on the process of being able to place ourselves in their position, to see the world through their eyes.

                                                                                                We feel others' pain and elation (though not usually as strongly as them) but we do so through some act of imaginative sympathy. Horror, fear, pain and elation are all "infectious" in this way, sometimes viscerally so. ...

                                                                                                The whole of human sociality is built on these foundations. Indeed, armed with his theory, Smith argued that those who strive for riches do it not principally because of the utility it buys but because they crave the esteem of others. Smith despaired that we were so impressed by the wealthy. ...

                                                                                                [He also recommends Dan klein's podcast on the same topic- see today's daily links.]

                                                                                                  Posted by on Thursday, April 9, 2009 at 01:35 PM in Economics, History of Thought | Permalink  TrackBack (0)  Comments (1) 


                                                                                                  Thomas Friedman is "Head-Slappingly Wrong"

                                                                                                  Here's a (shrill) response from Dave Roberts at Grist to the Thomas Friedman article on greenhouse gas legislation:

                                                                                                  Somebody hide Tom Friedman’s ball, Grist: Tom Friedman has been doing great work on green issues for a while now, certainly given them a higher profile than any mere green blogger could. So I guess he’s owed some latitude. But his recent column is just an outright nuclear disaster:  head-slappingly wrong on the merits, politically naive and tone deaf to the point of autism, and timed so poorly as to be malicious. Just about every single sentence is a train wreck. ... [...continue reading...]

                                                                                                    Posted by on Thursday, April 9, 2009 at 12:15 PM in Economics, Environment, Politics, Regulation | Permalink  TrackBack (0)  Comments (35) 


                                                                                                    Counter-Cyclical Regulation

                                                                                                    My entry at the Free Exchange Raghuram Rajan roundtable on Counter-cyclical regulation:

                                                                                                    Seize the Moment, by Mark Thoma: I've also worried about the regulatory cycles discussed by Raghuram Rajan, but I don't see the problem in quite the same way. How you should view the regulatory cycles he describes depends upon your view of the average level of regulation at the centre of these cycles. Rajan appears to take the view that the regulatory oscillations are centered on the correct level of regulation, leaving us with too much regulation just after the reactionary bad times, and too little regulation during the good times when regulation tends to be eased either implicitly, by the market, or explicitly by regulators.

                                                                                                    Rajan's piece has recommendations for ways to offset the regulatory cycles, but if the average level of regulation over the entire cycle is too high or too low, the recommendations would differ, or at least require augmentation. Suppose, for example, that the level of regulation is too low on average, a view I have much sympathy with. ... [...continue reading...]

                                                                                                    The lead article is here. There are also responses from Charles Goodhart, Arnold Kling, Hyun Song Chin, and Martin Baily. [Entire roundtable]

                                                                                                      Posted by on Thursday, April 9, 2009 at 10:08 AM in Economics, Financial System, Regulation | Permalink  TrackBack (0)  Comments (5)