Saturday, June 20, 2009
Friday, June 19, 2009
A few excerpts from the second part of Conor Clarke's interview with Paul Samuelson:
I have a couple of questions about the current debate. Do you think large fiscal stimulus should be controversial? ... Would you like to see a second or third stimulus, depending on where you start counting?
Well, in the first place, the E. Carey Brown analysis stressed that one shot spending gives you only one-shot response. It's gotta be sustained. The way we got out of the 1929 Great Depression in the US -- and this happened not only in the US but also in Germany... --- was heavy deficit spending. ...
For really depressed situations, unorthodox central banking is [also] needed. We're almost getting there. In one of Greg Mankiw's articles, he said that maybe when the interest rate gets down to zero and it's threatening to be negative, you should give a subsidy with it. Well, that's what fiscal policy is!
By the way, I don't want you to think that I think that everything for the next 15 years will be cozy. I think it's almost inevitable that, with a billion people in China wide awake for the first time, and a billion people in India, there's going to be some kind of a terrible run against the dollar. And I doubt it can stay orderly, because all of our own hedge funds will be right in the vanguard of the operation. And it will be hard to imagine that that wouldn't create different kind of meltdown.
Last thing. Mea culpa, mea culpa. MIT and Wharton and University of Chicago created the financial engineering instruments, which, like Samson and Delilah, blinded every CEO -- they didn't realize the kind of leverage they were doing and they didn't understand when they were really creating a real profit or a fictitious one. ...
Back to some middle-term and long-term policy questions..., do you worry about the rising deficit and the potential risk of inflation? There's been a lot of articles on this in the past two weeks -- Paul Krugman and Niall Ferguson and others.
I think it would be surprising if, down the road -- not in the long long run but in the somewhat short run -- we don't have some return of inflation. On the other hand, I'm of the view that if we come out of this with some kind of temporary stabilization at least, and the price level is let's say 10-12% above what it was before we got into the meltdown, I think that's a price I would be willing to pay! ...
Very last thing. What would you say to someone starting graduate study in economics? Where do you think the big developments in modern macro are going to be, or in the micro foundations of modern macro? Where does it go from here and how does the current crisis change it?
Well, I'd say, and this is probably a change from what I would have said when I was younger: Have a very healthy respect for the study of economic history, because that's the raw material out of which any of your conjectures or testings will come. And I think the recent period has illustrated that. ...
But history doesn't tell its own story. You've got to bring to it all the statistical testings that are possible. And we have a lot more information now than we used to.
Are you happy with the way economics is being taught now? You've mentioned Greg Mankiw's textbooks.
Well to say that I've read them would be an exaggeration. I looked into them, and I was disappointed that they were so bland. [Laughs] No, he's a gifted writer. But an economist with a facile pen isn't necessarily an overnight expert on the likelihoods in our inexact science.
My entry at the Romer Roundtable:
Don't "Nullify" Fiscal Policy, by Mark Thoma: When deciding between two alternatives such as whether the government should intervene in the economy with a fiscal stimulus or not, the choice of the null and alternative hypotheses influences the type of errors we are likely to make.
A standard example to illustrate this is the problem of deciding guilt and innocence. If we make guilt the null hypothesis, and only reject the null when there is overwhelming evidence to the contrary, then we are going to find people guilty unless there is enough evidence presented to convince jurors the person did not act as charged. The biggest risk here is that innocent people will be sent to jail since innocence must be established through overwhelming evidence, but guilt is presumed. It's possible that a guilty person will be found innocent, but the more evidence that we require to find someone innocent—e.g. a strict standard like beyond a reasonable doubt—the smaller the chance that the guilty will be set free.
If we make innocence the null hypothesis, then things are reversed. In this case we will only send someone to jail if the evidence overwhelmingly points to guilt, so the biggest risk under this null is that guilty people will be found innocent. Again, it's possible that an innocent person will be found guilty, but the system requires a high burden of proof so as to minimise the possibility of this happening.
In the US, we think sending innocent people to jail is a bigger mistake than setting guilty people free, so we make innocence the null hypothesis in court cases rather than guilt, and we require a high level of "proof" before rejecting the null. (When money rather than freedom is at stake as in civil cases, the standard for conviction is often lower. This causes more innocent people to have to pay fines, but fewer guilty people escape them).
What does this have to do with deficit spending and recessions? Our tendency is to assume that the economy is doing fine and doesn't need help from fiscal authorities unless there is clear evidence the economy is crashing. Only then does the government intervene with deficit spending.
Thus, our null hypothesis is that the economy does not need any help, and we require a fairly high burden of proof to overcome that presumption. Because of this, the error we are most likely to make is to do nothing when action is called for, and that includes ending help too soon, particularly given the information lags we face in assessing the state of the economy. It's possible that we could get fooled by the data into acting when it isn't necessary, but since we require clear signals that the economy is in trouble before we act, and because data are slow to arrive, acting when it isn’t needed is less likely than doing nothing when, in fact, active intervention is called for.
Unlike in court cases, however, where a null of innocence allows us to minimise the costly error of jailing the innocent, the null that the economy is "innocent", i.e. that intervention from authorities is not required, leads us to minimise the wrong outcome.
Which is the bigger error, to deficit spend when it's not needed, or to fail to do so when it is? I think the bigger risk is doing nothing when it's needed, particularly when the economy has the type of difficulties we are seeing now. The risk of doing nothing is a severe depression, while the risk of overreacting is inflation or, perhaps, slightly slower growth for a period of time in the future. I don't see those risks as balanced at all, allowing a depression is—to me—the more severe error, the equivalent of sending the innocent to jail.
We saw the problem with having the wrong null hypothesis when the economy was slipping into the recession. The stimulus package should have been in place long before it was actually implemented in order to be maximally effective, but policymakers were reluctant to act until there could be no doubt that action was called for.
And we are seeing this again now. We may very well need another stimulus package, and we ought to be doing the work to get it ready, but there just isn’t enough evidence to convince policymakers that's the case. They will have to see clear evidence of continuing troubles and also believe there's no chance that recovery is just around the corner before they will act, and that’s a high standard to meet. And worse, as we’ve seen recently, as soon as the evidence that we are still in a recession becomes a bit foggy—at the first sign of green shoots—many people will be ready to end the intervention even though that may not be the right course of action.
I can understand the tendency to resist intervention at the first inkling of troubles. So on the front side of a recession, I can understand a null hypothesis that no action is needed, but it ought to be one that can be overturned with a fairly low burden of proof. We shouldn't have a "beyond a reasonable doubt" standard, it's not criminal to mistakenly intervene, it should be more like the "clear and convincing" standard sometimes used in civil procedures, or, even better, the weaker "preponderance of the evidence" standard used in civil cases.
But once we are in a recession, as now, I cannot understand why the null does not change to being one where the economy is presumed to need help until there is—beyond any reasonable doubt—evidence that the economy is on the path to recovery. Look at the 1937 experience on the graph in Mrs Romer's article again and see how costly it is to pull back too soon, then compare that to what the cost would have been to continue the policies for a year, or several years, even though they weren't needed. It seems pretty clear to me that the cost of pulling back too soon was the much bigger worry. We are facing the same choice now, or will soon. Do we pull back at the very first signs of green shoots, as we seem to want to do, or do we wait until we are much, much more certain that things have, in fact, improved to the point where recovery is all but certain before withdrawing stimulus measures?
As Brad DeLong notes, if it is the long-run budget you are worried about, ending the stimulus package, say, six months or a year earlier makes little difference to the long-term budget outlook. That being the case, and given the dangers of not doing enough and the dangers of ending the help too soon, why are we in such a hurry to end the stimulus package, and we are we so reluctant to consider doing more?
Other entries from:
- Allan Meltzer: Think, plan, and tell us the plan
- Brad DeLong: Worse than we planned for
- Harold James: Develop an exit strategy
- Tyler Cowen: An unprecedented experiment
- Michael Bordo: Avoid monetary tightening
- Barry Eichengreen: Inflation signs are misleading
- Ray Stone: An imperfect parallel
Update: See also:
The good, the bad, and the ugly parts of the administration's financial reform proposal:
Out of the Shadows, by Paul Krugman, Commentary, NYTimes: Would the Obama administration’s plan for financial reform do what has to be done? Yes and no. ...
Let’s start with the good news. Our current system of financial regulation dates back to a time when everything that functioned as a bank looked like a bank. As long as you regulated big marble buildings with rows of tellers, you pretty much had things nailed down.
But ..., as Mr. Geithner pointed out, by 2007 more than half of America’s banking ... was being handled by a “parallel financial system” — others call it “shadow banking” — of largely unregulated institutions. These non-bank banks, he ruefully noted, were “vulnerable to a classic type of run, but without the protections such as deposit insurance that the banking system has in place to reduce such risks.”
When Lehman fell, we learned just how vulnerable shadow banking was: a global run on the system brought the world economy to its knees. One thing financial reform must do, then, is bring non-bank banking out of the shadows.
The Obama plan does this by giving the Federal Reserve the power to regulate any large financial institution it deems “systemically important” ... whether or not that institution is a traditional bank. ... And the government would have the authority to seize such institutions if they appear insolvent — the kind of power that ... has been lacking with regard to institutions like Lehman or A.I.G.
Good stuff. But what about the broader problem of financial excess?
President Obama’s speech outlining the financial plan described the underlying problem very well. Wall Street developed a “culture of irresponsibility,” the president said. Lenders didn’t hold on to their loans, but instead sold them off to be repackaged into securities, which in turn were sold to investors who didn’t understand what they were buying. “Meanwhile,” he said, “executive compensation — unmoored from long-term performance or even reality — rewarded recklessness rather than responsibility.”
Unfortunately, the plan as released doesn’t live up to the diagnosis.
True, the proposed new Consumer Financial Protection Agency would help control abusive lending. And the proposal that lenders be required to hold on to 5 percent of their loans, rather than selling everything off to be repackaged, would provide some incentive to lend responsibly.
But 5 percent isn’t enough to deter much risky lending, given the huge rewards to financial executives who book short-term profits. So what should be done about those rewards?
Tellingly, the administration’s executive summary of its proposals highlights “compensation practices” as a key cause of the crisis, but ... [gives] a description of what should happen, rather than a plan to make it happen.
Furthermore, the plan says very little of substance about reforming the rating agencies, whose willingness to give a seal of approval to dubious securities played an important role in creating the mess we’re in.
In short, Mr. Obama has a clear vision of what went wrong, but aside from regulating shadow banking — no small thing, to be sure — his plan basically punts on the question of how to keep it from happening all over again, pushing the hard decisions off to future regulators.
I’m aware of the political realities: getting financial reform through Congress won’t be easy. And even as it stands the Obama plan would be a lot better than nothing.
But to live up to its own analysis, the Obama administration needs to come down harder on the rating agencies and, even more important, get much more specific about reforming the way bankers are paid.
Thursday, June 18, 2009
Is Greg Mankiw correct to say that deflation worries are overstated? Here's Laurel Graefe of the Atlanta Fed:
CPI: The left and the right of it, macroblog: We got a good reading of May's inflation numbers this week. On both the producer and the consumer sides, price measures for the month came in well short of market expectations. The prospect of deflation has been getting a good deal of coverage in the blogosphere; see Andy Harless' blog, Economist's View, and Paul Krugman's column.
Greg Mankiw, however, points out that a trimmed mean estimate of the consumer price index (CPI), which removes the large relative price changes in each month, makes the deflation story seem a bit, uh, exaggerated.
"As every grade school student learns when the
teacher reports results of the latest test, the average of any data set can be
thrown off by a few extreme outliers; the median is a more robust statistic to
estimate the central tendency in the data.
"Right now, the two measures of inflation are diverging substantially. The standard CPI shows deflation over the past year, but that average is due to a few anomalous sectors, such as energy. If you look at the median CPI, which shows what a more typical price is doing, the inflation rate does not look very unusual."
While the median is certainly a valuable way to look at inflation, there is also some interesting information that can be gleaned from breaking down the whole distribution of prices.
The chart below (hat tip to Brent Meyer at the Cleveland Fed) shows another interesting feature of yesterday's CPI release. Notice the clear downward shift in the distribution of CPI component price changes. Over half of the prices within the CPI market basket posted declines at or below 1 percent last month, up from an average of 29 percent in 2008, with a whopping one-third of the price index posting declines in May.
Of course, one month does not a trend make, but the month's price numbers were nonetheless noteworthy.
Olivier Blanchard argues that global imbalances must be resolved in order to put the world economy on a sustainable path to recovery:
What is needed for a lasting recovery, by Olivier Blanchard, Commentary, Financial Times: In 2007, worried about the growing size of current account imbalances, the IMF organised multilateral consultations to see what should be done about it. There was wide agreement that the solution was conceptually straightforward. To caricature: get US consumers to spend less. Get Chinese consumers to spend more. This would be good for the US, good for China, and good for the world. ...
It was an impressive piece of global macroeconomic planning. But, at least until the crisis, not much happened. ... And, since the beginning of the crisis, dealing with global imbalances has gone down the priority list. ... As the crisis evolves, however,... the issue of global imbalances is likely to return to the fore. Again, a central role will have to be played by the US and by China.
Bill Easterly is worried that the Army's "utopian dreams" for conquered societies will lead to the "excessive use of military force, which kills real human beings":
J’accuse: the US Army’s Development Delusions, by Bill Easterly: A wise economist that I met recently tipped me off that I would find the latest Army field manual interesting reading. He was more than right about that. The 2009 US ARMY STABILITY OPERATIONS FIELD MANUAL (available in a University of Michigan paperback as well as an earlier version online ) is remarkably full of utopian dreams of transforming other societies into oases of prosperity, peace, and democracy through the coordinated use of military force, foreign aid, and expert knowledge.
My usual MO is to ridicule such documents. But my wells of satire are starting to run dry after years of deployment against utopians like Jeffrey Sachs and Paul Collier. More in sorrow than in anger, I see the utopian social engineering craze might affect actions of people with guns. I am sad for Iraqis and Afghans that the U.S. Army is operating in their countries guided by such misguided ideas.
To document a little of what seems utopian, the foreword by Lieutentant General William B. Caldwell IV, Commander, US Army Combined Arms Center, says:
Kenneth "The Hawk" Rogoff:
America should also look to its fiscal health, by Kenneth Rogoff, Commentary, Financial Times: America desperately needs a better framework for providing healthcare and Barack Obama’s administration is right to press on for change... Yet given the explosion of the federal debt, it is extremely important to craft a plan that will not excessively risk the government’s own fiscal health. The risks cannot easily be overstated.
The US government is already entering a prolonged period where it is extremely vulnerable to a loss in investor confidence from the Chinese and other main holders of its Treasury securities. Foreign investors are rightly concerned about the deeply ingrained reluctance of Americans to tax themselves. The last thing the US needs is to be viewed as one giant California, rich but unwilling to pay enough taxes to fund the services its citizens demand. A sharp rise in taxes to pay for healthcare initiatives could potentially weaken the credibility of the government’s promise to raise taxes as needed to pay off debtors. ...
[I]n principle, fixing the imbalances in the Social Security and, especially, the Medicare programmes could provide a powerful offset to the huge increase in debt burdens visited by the financial crisis.
Unfortunately, the idea that healthcare reform will alleviate debt problems rather than exacerbate them is far-fetched..., many proposed healthcare reforms are more likely to worsen the government’s budgetary health than to improve it. This should hardly be surprising, given that a main purpose of reform is to help provide better care for Americans who cannot afford insurance.
Higher taxes to pay for healthcare are also likely to reduce US growth, making it far more difficult to escape the debt trap. This comes at a time when other policy initiatives, such as tackling environmental degradation and income inequality, are also likely to imply higher tax burdens... In addition, the continuing weakness of the financial sector weighs on growth, and it is by no means clear yet when and how some semblance of normality will be restored. ...
All of these considerations appear to underscore the importance of finding ways to keep the new health plan from being overly burdensome, and to avoid unduly optimistic projections on efficiency savings. Healthcare reform is no substitute for finding a credible path to fiscal sustainability. ...
Make no mistake, the US and much of the developed world is in a frighteningly precarious fiscal state. ... It is a disgrace that the world’s richest country cannot provide reliable basic care for its poorest citizens. But if the politics of reform produces too extravagant a plan when the nation’s fiscal health is already so weak, the US may experience a form of financial crisis even more virulent than the one it is recovering from. Any healthcare plan would then be dead on arrival.
Setting the fear mongering about the future aside - and there's no evidence in long-term interest rates that financial market participants are worried about these issues - here are a few things to keep in mind when thinking about health care reform First, it is not a demographic problem. This graph is from a CBO presentation on this point, and is fairly self-explanatory:
Second, rising health care costs is not just an issue for Medicare and Medicaid, the same rise in costs is also projected to hit private sector health care. Again, from the CBO:
Projected Spending on Health Care Under an Assumption That Excess Cost Growth Continues at Historical Averages (Percentage of GDP)
Going back to the question of the effect of health care reform on the long-run budget, though expanding coverage will expand increase the total amount of medical care that is provided, and hence increase costs, there seems to be some confusion between expanding overall coverage and simply moving the dividing line between the public and private sectors upward so that the public sector expands and the private sector contracts by the same amount. Changing the dividing line, all else equal, simply changes how the bills are paid, it has no effect at all on the overall health care burden that people face (it moves the dividing line in a graph like the one above showing the public and private sectors explcitly without changing the total area). So it's hard to see why higher taxes driven by this type of a change would have the negative economic effects Rogoff is worried about.
But he is more worried that expanding the size of the public sector both by moving the dividing line up and by including more people - the latter in particular - will increase increases health care costs and add to the debt burden, which in turn would require higher taxes. Is that true? It would if the only effect of the expansion of the public sector was to increase the number of people receiving care, and his claim that costs won't fall, or at least not by much, presumes this is how it will work. But when we look at other countries that have substantially expanded the public sector we see lower costs - on the order of 50% lower - and no reduction in the quality of the care that people receive. That's a huge reduction in costs, a reduction large enough to allow a significant expansion of coverage without increasing costs at all. I don't think we'll reduce costs by that magnitude, 50% seems like a lot to hope for, but it does imply that it's possible to reform the system without compromising quality or experiencing the dire consequences Rogoff fears.
Daniel Little discusses three components that underlie Marx's analysis of the political behavior of class. One component is the existence of ideologies (the other two are rationality and class consciousness):
...Marx’s theory of political behavior incorporates the concept of ideology. Ideologies, or "false consciousness", are systems of ideas that affect the worker's political behavior by instilling false beliefs and self-defeating values in the worker. An ideology may instill a set of values or preferences that propel individual behavior in ways that are contrary to the individual's objective material interests. Further, ideologies modify purposive individual action by instilling a set of false beliefs about the causal properties of the social world and about how existing arrangements affect one's objective interests. Rational individuals, operating under the grip of an ideology, will undertake actions that are contrary to their objective material interests, but are fully rational given the false beliefs they hold about the social world they inhabit and their mistaken assumptions about their real interests and values. An ideology is an effective instrument, then, in shaping political behavior within a class system; it induces members of exploited classes to refrain from political action directed at overthrowing the class system. And this is indeed Marx's use of the concept; an ideology functions as an instrument of class conflict, permitting a dominant class to manipulate the political behavior of subordinate classes. It is an important task to try to identify the institutions and mechanisms through which an ideology is conveyed to a population.
Interesting how much Marx's theory of ideology sounds like the right wing's "Noise Machine," and how it relates to questions like this:
What's the matter with San Francisco?, by Andrew Leonard: Are "rich liberals" who vote for Democrats and higher taxes for themselves displaying the same irrational behavior as working-class men and women who vote for Republicans and lower taxes... for the rich?
Yes, says Derek Thompson, blogging at the Atlantic Business Channel (which he also produces). ...
Thompson is annoyed with Thomas Franks' argument in "What's the Matter with Kansas" suggesting that Republicans "tricked" working class voters to go against their economic self-interest by mobilizing them on social "value" issues like abortion and gay rights. Thompson's position is that liberals who believe that government will actually improve the lives of Americans with their taxpayer dollars are demonstrating their own economically irrational "values" voting behavior. ...
But to take that position seems to me to be ignoring the reality of what we've just witnessed in this country. In a time of great economic turmoil, working class voters appear to have suddenly decided that Republican "family values" aren't such a sexy turn-on after all. The latest polling indicates that only 25 percent of the country views the GOP favorably. As far as I can guess, rich liberals did not change their views of what the government economic policy should be because of the downturn, but working class voters experienced a sudden dose of "rationality."
So yeah, working class voters who voted Republican did get tricked. Either that, or they just rationally changed their mind when they saw that trickle-down economics and irresponsible deregulation was a big failure.
Wednesday, June 17, 2009
Did the false belief that land suitable for building houses was becoming scarce help to drive the housing bubble?:
Unlearned lessons from the housing bubble, by Robert J Shiller, Project Syndicate: There is a lot of misunderstanding about home prices. Many people all over the world seem to have thought that since we are running out of land in a rapidly growing world economy, the prices of houses and apartments should increase at huge rates.
That misunderstanding encouraged people to buy homes for their investment value – and thus was a major cause of the real estate bubbles around the world whose collapse fuelled the current economic crisis. This misunderstanding may also contribute to an increase in home prices again, after the crisis ends. Indeed, some people are already starting to salivate at the speculative possibilities of buying homes in currently depressed markets.
But we do not really have a land shortage. Every major country ... has abundant land in the form of farms and forests, much of which can be converted someday into urban land. ...There are often regulatory barriers to converting farmland into urban land, but these barriers tend to be thwarted in the long run if economic incentives to ... become sufficiently powerful. It becomes increasingly difficult for governments to keep telling their citizens that they can’t have an affordable home because of land restrictions. ...
Many people seem to think that the US experience is not generalisable, because the US has so much land relative to its population. ... But, to the extent that the products of land (food, timber, ethanol) are traded on world markets, the price of any particular kind of land should be roughly the same everywhere. ...
Shortages of construction materials do not seem to be a reason to expect high home prices, either. For example, in the US, the ... Building Cost Index ... has actually fallen relative to consumer prices over the past 30 years. To the extent that there is a world market for these factors of production, the situation should not be entirely different in other countries.
The ... expectations for real estate prices ... during the recent bubbles were often totally unrealistic. A few years ago Karl Case and I asked random home buyers in US cities undergoing bubbles how much they think the price of their home will rise ... on average over the next ten years. The median answer was sometimes 10% a year. ... Home prices cannot have shown such increases over long time periods, for then no one could afford a home.
The sobering truth is that the current world economic crisis was substantially caused by ... speculative bubbles ... made possible by widespread misunderstandings of the factors influencing prices. These misunderstandings have not been corrected, which means that the same kinds of speculative dislocations could recur.
In general, even though I don't always share Shiller's psychological approach to economic problems, it seems to be a bad idea to bet against his forecasts, in this case that people will once again misperceive that the real cost of housing is flat or slightly declining in the long-run, instead they will forecast long-run increases, and this will generate yet another housing bubble.
Update: Richard Green says "Shiller is largely right but for two things."
Conor Clarke interviews Paul Samuelson:
An Interview With Paul Samuelson, Part One, by Conor Clarke: ...Paul Samuelson ... has a long list of accomplishments -- A John Bates Clark Medal, a Nobel Prize -- that I won't try to recap here. But by most accounts he is responsible for popularizing Keynesian economics...
I've decided to break the transcript into two parts. I'll publish part two tomorrow morning. The first part ... is mostly economic history -- the rise and fall (and rise) of Keynes, the influence of Milton Friedman, and the era of Alan Greenspan. Part two covers current events -- the need for a more stimulus spending and how his nephew (one Larry Summers) is doing running the economy. ...
The basic economic problem is how to allocate a finite amount of resources among practically unlimited wants. Suppose there are seven kids, but only five tickets to an amusement park, and all seven kids would all like to go to. How do you decide who gets to go and who stays home? You could use non-market schemes such as drawing who gets to go randomly, giving them to the youngest kids who might enjoy this particular park a little more, hold a contest of some sort, or you could use price mechanisms such as asking them to give up allowance and awarding the tickets to the highest bidder, or allowing them to barter against future trips where space is also limited. The prices can be implicit as well, e.g. you could find out who is willing to stand in place saying absolutely nothing the longest, and those who are willing to do so get the tickets.
For the most part, we use market mechanisms to solve these problems, but not always. Market outcomes are efficient, or as efficient as we know how to be, but they are not necessarily equitable in any grand sense and sometimes we believe that equity is the dominant principle. National parks, for example, are often under priced so that everyone can afford to go. In such cases, the government intervenes and allocates spaces randomly, on a first come first serve basis, by seeing who will wait in line for hours to get in, etc.
I believe that when it comes to health care, equity is the dominant principle. Everyone should have the chance to go to a beach, or the redwoods, or the Grand Canyon if they want to, these places shouldn't be locked up as private property and completely inaccessible to those without the means to buy their way in. Everyone should have access to education as well, and in the same way everyone should have the access to health care. Access to life-saving and life-improving technology and treatments should not depend upon having sufficient household income.
But if we don't use the price mechanism to allocate health care resources, what mechanism do we use? As I've said, I believe that there ought to be a broad set of treatments and care available to everyone, without exception, but where do we draw the line? If we don't use the price mechanism, how do we properly and fairly allocate resources both between health care and the production of other goods, and within the health care system itself? Within the system is easy, equal access ought to prevail, but how much of GDP to allocate to health care overall is a hard question, and it depends in part on something discussed below, the relative effectiveness of various medical procedures. It also depends upon our general level of wealth. As we get wealthier as a nation over time, as we will with economic growth, we will be able to afford to spend a greater share of output on medical care, and will likely be willing to do so, but how much more? In any case, one way or another, it's a question we'll have to find a way to answer:
Health Care Rationing Rhetoric Overlooks Reality, by David Leonhardt, NY Times: Rationing. More to the point: Rationing! ... The r-word has become a rejoinder to anyone who says that this country must reduce its runaway health spending, especially anyone who favors cutting back on treatments that don’t have scientific evidence behind them. ...
Today, I want to try to explain why the case against rationing isn’t really a substantive argument. It’s a clever set of buzzwords that tries to hide the fact that societies must make choices.
In truth, rationing is an inescapable part of economic life. It is the process of allocating scarce resources. ... We ration lakefront homes. We ration the best cuts of steak and wild-caught salmon. Health care, I realize, seems as if it should be different. But it isn’t. Already, we cannot afford every form of medical care that we might like. So we ration. ...
The choice isn’t between rationing and not rationing. It’s between rationing well and rationing badly. Given that the United States devotes far more of its economy to health care than other rich countries, and gets worse results by many measures, it’s hard to argue that we are now rationing very rationally. ...
Given recent debates around here on regulating the shadow banking sector, it was nice to see that the first thing Obama mentions in response to a question about why financial markets failed is an outdated "regulatory system that ... did not encompass the non-bank sector":
Transcript of Obama’s Interview With the Journal, Washington Wire: A transcript of The Journal’s interview with President Obama, which touches on financial-regulatory reform, the power of free markets, health care and Bernanke’s future at the Fed. ...
Question: Thank you for doing this, very much. ... Obviously a lot of things went wrong in the markets in the last year. Where do you think they failed?
THE PRESIDENT: Well, I think that there are some immediate and obvious culprits. We had a regulatory system that was outdated that did not encompass the non-bank sector. We had a securitization market that had separated borrowers and lenders and investors in ways that allowed everybody to take risks, with nobody feeling accountable or feeling their money was at stake. We had I think banks who were incented to boost their profits with some of these same risky financial instruments, and you didn’t have the kind of systemic oversight that would anticipate the enormous failures that could arise if any link in the chain broke. So that set of regulatory problems is what we are looking to solve in the proposals I’ll put forward tomorrow.
You then have, though, just to finish up, I think you’ve got a broader structural problem in our economy in which our last two recoveries had been based on bubbles, and a massively overleveraged consumer, a massively overleveraged corporate sector, and a financial system that didn’t have much restraint.
And so the question for us is how do we create the foundation for a more sustainable model of economic growth, one that doesn’t impinge on the dynamism of the free market, the innovative products that are critical and the entrepreneurship that creates jobs, but also recognizes that the levels of debt and a model that’s premised on an endless supply of foreign dollars is not one that is going to be sustainable over the long term. ...
Andy Harless says we're not even close to experiencing an outbreak of inflation:
A Long Way to Inflation, by Andy Harless: Most of the media seem to have interpreted today’s lower-than-expected increase in the producer price index as good news. ... Personally, I was more worried about deflation, and I still am. The inflation risk, if it exists at all, is in the distant future, and you could even argue that deflation in the short run increases the risk of high inflation in the long run. It’s hard for me to see how falling prices today are good news at all. And prices – excluding food and energy – did fall in May according to the PPI.
You might worry about energy and commodity prices feeding through to the broader price level. I’m worried about that too, but not in the way you might think. Undoubtedly some of that feed-through is already happening, and it hasn’t been enough to keep core producer price growth on the positive side of zero. I’m worried about what happens when commodity prices (1) stop rising (which they must do eventually) and/or (2) start falling again (which they may well do if the recent increases have been driven largely by unsustainable forces such as stockpiling by China). If core prices are already falling, and only energy prices are keeping the overall PPI inflation rate positive, what happens when energy prices stop rising?
Francesco Caselli of the London School of Economics rebuts a recent attack on the economics profession:
Economists are actively engaged in seeking remedies to the crisis, by Francesco Caselli, CIF: Larry Elliott's claim that "as a profession, economics not only has nothing to say about what caused the world to come to the brink of financial collapse last autumn, but also a supreme lack of interest", deserves a rebuttal.
The alleged lack of interest is belied by the outpouring of commentary and discussion that has swept the profession over the last couple of years and shows no sign of abating. I can think of few of the top academic stars in macroeconomics who have not been busy editorialising, blogging, and participating in discussions and policy events.
The evidence for the lack-of-interest charge is that "if, for example, you scroll down the list of papers scheduled for publication by the Review of Economic Studies, one of the prestigious UK journals, there is not the slightest sense that the world of general equilibrium and real business cycle models has been turned upside down in the past two years".
Tuesday, June 16, 2009
Mike at Rortybomb:
Atlantic Business and the Shadow Banks, Rortybomb: So Mark Thoma wrote a piece saying “The development of the shadow banking system is important because the troubles we are seeing today are not the result of problems in the traditional, regulated sector of the financial industry. The problems began in the unregulated shadow banking system.” The Atlantic Business Dr. Manhattan responded:
the systemic breakdowns we have been experiencing over the past 18 months have been caused by problems at the major banks (even the former investment-only banks which weren’t regulated by the Fed or FDIC cannot be called part of the “shadow banking system”), AIG (regulated by the state insurance commissioners, even if they’d rather you didn’t remember) and let’s not forget Fannie and Freddie, which had their own regulator.
Brad Delong declares [the Atlantic's reply] a “crash and burn” with some fun Watchmen allusions.
When people mention “The Unregulated Shadow Banking System” (TUSBS) they are often talking about different things and thus past each other, so let’s refocus. In general, I hear three things people invoke when they mention TUSBS. ...
I don’t feel that Thoma’s critics are getting his point, much less providing a counter-narrative. Now granted, there were government agents hanging around all these firms. So correct me if I’m wrong, there were no mechanism to handle this liquidity-backstop-for-regulation prior to the crisis. And that’s a problem that we all need to deal with.
There's quite a bit more in his post, including a substantive argument to support his conclusion.
Do tax cuts increase productivity?:
Study separates Russian flat tax myth and fact. EurekAlert: Proponents of a flat rate income tax often point to Russia's 2001 switch to a 13 percent flat tax as nothing short of an economic miracle.
The new tax policy slashed taxes for higher-income Russians who previously paid rates of 20 and 30 percent. Despite the savings to taxpayers, real tax revenues reaped by the government increased by 25 percent in the year after the reform. The windfall, flat tax advocates say, happened because a simpler, fairer tax system leads to better compliance, and because lower taxes spur productivity.
That assessment is half right, according to a study published this month in the Journal or Political Economy. The study by economists Yuriy Gorodnichenko (University of California, Berkeley), Jorge Martinez-Vazquez and Klara Sabirianova Peter (both of Georgia State University) looked at household level data to see how tax reform influenced tax evasion and real income. The study found that tax evasion decreased under the flat tax, but the reform did little to increase real income for taxpayers.
The lesson? Where underreporting of income is widespread, a flat tax can produce a revenue increase, but don't expect massive economic productivity gains.
Tax evasion by nature is tough to quantify. To get an estimate of the extent to which Russians hide income from the tax collector, the researchers used what they call the "consumption-income gap." They gathered data from household surveys conducted in 1998 and from 2000 to 2004 by the University of North Carolina. The surveys asked respondents to catalog their monthly spending on everything from food to entertainment. The data from these surveys show that Russians generally spend 30 percent more than they report receiving in income. It's unlikely that households are getting the extra buying power by dipping into savings accounts, because most of those surveyed had little or no savings. So the gap between household consumption and reported income is largely explained by an underreporting of income.
Looking at the survey data over time, the researchers found that the consumption-income gap shrank substantially in the years after the tax reform. In other words, the amount of income Russians reported got closer to the amount they spent. This effect was strongest for households who had been in the highest tax brackets before the reform. That's a good indication that the flat tax was directly responsible for decreasing tax evasion in Russia.
The other implication in these data is that the flat tax seems to have done little to increase real income for taxpayers. If real income had increased substantially, one would expect consumption to increase as well. That wasn't the case. Taxpayers whose tax rates were cut increased their consumption net of windfall gains by less than 4 percent.
"The results of this paper have several important policy implications," the authors write.
"The adoption of a flat rate income tax is not expected to lead to significant increases in tax revenues because the productivity response is shown to be fairly small. However, if the economy is plagued by ubiquitous tax evasion, as was the case in Russia, the flat rate income tax reform can lead to substantial revenue gains via increases in voluntary compliance."
The lack of a significant productivity response undercuts the main supply-side argument that cuts in taxes produce increased growth in output that generates a partial offset (some even argue a more than full offset) to the revenue lost from the tax cut. So many supply-siders have switched to the compliance argument for the US, but I doubt this effect would be large, and certainly not large enough to pay for the tax cut, and compliance can be increased in other ways such as closing loopholes and better enforcement of existing tax law.
First, Robert Reich:
The Three Essentials of Financial Reform, by Robert Reich: As the White House unveils its long-awaited proposals to prevent another Wall Street meltdown in the future, keep a lookout for three essentials. Without them the Street will revert to its old ways as soon as the coast clears. ...
1. Stop bankers from making huge, risky bets with other peoples’ money. At the least, require they back their bets with a large percentage of their own capital, and bar them from raising money off their balance sheets through derivative trades. Also require they take their pay in stock options or warrants that can’t be cashed in for at least three years, so they’ll take a longer-term view. Best of all would be a requirement that investment banks return to being partnerships and the capital on their books be their own, not yours or your pension fund’s. When investment banks were partnerships, every partner took an active interest in what every other partner and trader was doing. The real mischief started once they started selling shares to the public.
2. Prevent any bank from becoming too big to fail. Separate commercial from investment banking... Combining the basic utility with the casino only made bankers far richer and subjected you and me to risks we didn’t bargain for. If separating commercial from investment banking isn’t enough to bring all banks down to reasonable size, use antitrust laws to break them up.
3. Root out three major conflicts of interest. (1) Credit-rating agencies should no longer be paid by the companies whose issues are being rated; they should be paid by those who use their ratings. (2) Institutional investors like pension funds and mutual funds should not be getting investment advice from the same banks that profit off their investments... (3) the regional Feds that are responsible for much bank oversight should no longer be headed by presidents appointed by the region’s bankers; non-bankers should have the major say, and the regional presidents should have to be confirmed by the Senate.
..[T]he big bankers will fight every one of these with all guns blazing, and their lobbyists in full force. ... Bottom line: Genuine financial reform will be almost as difficult to achieve as real universal health care. Immense private interests are amassed against the public interest in both cases because staggering amounts of money are at stake. ...
Second, George Soros:
The three steps to financial reform, by George Soros, Commentary, Financial Times: ...I am not an advocate of too much regulation. ... While markets are imperfect, regulators are even more so. ... Three principles should guide reform. First, since markets are bubble-prone, regulators must accept responsibility for preventing bubbles from growing too big. Alan Greenspan ... expressly refused that responsibility. ...
Second,... we must also control the availability of credit..., we must ... use credit controls such as margin requirements and minimum capital requirements. ... Margin and minimum capital requirements should be adjusted to suit market conditions ... to forestall ... bubbles.
Third, we must reconceptualise the meaning of market risk. The efficient market hypothesis postulates that markets tend towards equilibrium and deviations occur in a random fashion...
But the efficient market hypothesis is unrealistic. Markets are subject to imbalances... If too many participants are on the same side, positions cannot be liquidated without causing a discontinuity or, worse, a collapse. In that case the authorities may have to come to the rescue. That means that there is systemic risk ... in addition to the risks most market participants perceived prior to the crisis.
The securitisation of mortgages added a new dimension of systemic risk. Financial engineers claimed they were reducing risks through geographic diversification: in fact they were increasing them by creating an agency problem. The agents were more interested in maximising fee income than in protecting the interests of bondholders. ...
To avert a repetition, the agents must have “skin in the game” but the five per cent proposed by the administration is more symbolic than substantive. ...
It is probably impractical to separate investment banking from commercial banking as the US did with the Glass Steagull Act of 1933. But there has to be an internal firewall...
Finally, I have strong views on the regulation of derivatives. The prevailing opinion is that they ought to be traded on regulated exchanges. That is not enough. The issuance and trading of derivatives ought to be as strictly regulated as stocks. ... Custom made derivatives only serve to improve the profit margin of the financial engineers designing them. In fact, some derivatives ought not to be traded at all. ... Consider the recent bankruptcy of AbitibiBowater and that of General Motors. In both cases, some bondholders owned CDS and stood to gain more by bankruptcy than by reorganisation. It is like buying life insurance on someone else’s life and owning a licence to kill him. CDS are instruments of destruction that ought to be outlawed.
Third, in response to this, and more generally to the recent argument that calls to extend regulation to the shadow banking sector are unfounded because this sector had nothing to do with the crisis (which is incorrect), for the second time recently here's well-know socialist sympathizer Robert Lucas, the Nobel prize winning economist at the University of Chicago. It seems he also favors extending regulation to the unregulated banking sector:
The regulatory structure that permitted these events to occur will have to be redesigned... The regulatory problem that needs to be solved is roughly this: The public needs a conveniently provided medium of exchange that is free of default risk or "bank runs." The best way to achieve this would be to have a competitive banking system with government-insured deposits.
But this can only work if the assets held by these banks are tightly regulated. If such an equilibrium could be reached, it would still be possible for an institution outside this regulated system to offer deposits that are only slightly more risky but that also pay a higher return than deposits at the regulated banks. Some consumers and firms will find this attractive and switch their deposits. But if everyone does, the regulations will no longer protect anyone. The regulatory structure designed in the 1930s seemed to solve this problem for 60 years, but something else will be needed for the next 60.
And you don't need everyone to switch, just enough to create systemic risk.
According to this, "the US is actually a net insourcer" of jobs:
How many jobs are onshorable? Re-interpreting the Blinder numbers in the light of new trade theory, by Richard Baldwin, Vox EU: Before the global crisis hit, offshoring was one of the scarcest things on rich nations’ economic radar screens – especially the offshoring of “good” service sector jobs. Alan Blinder was one of the first to point out the threat in his 2006 Foreign Affairs article “Offshoring: The Next Industrial Revolution?” He wrote: “constant improvements in technology and global communications virtually guarantee that the future will bring much more offshoring of ‘impersonal services’’— that is, services that can be delivered electronically over long distances with little or no degradation in quality.”
Blinder has more recently produced some estimates of the size of the revolution. And they make it look like “the big one”. Blinder (2009): "I estimated that 30 million to 40 million US jobs are potentially offshorable."
This sort of media-friendly statement is part of what I consider to be very confused thinking by non-specialists – not that the economists involved are necessarily confused, but tacitly or not, they are allowing the media to misinterpret the numbers.
Let me start off by saying that I consider Alan Blinder to be one of the world’s leading macroeconomic policy specialists. Moreover, I greatly appreciate the way he uses his knowledge of economics to make this a better world (rather than focusing entirely on impressing the other inhabitants of academe). This time, however, I’m not sure it has worked out right.
I don’t wish to take issue with his numbers or methods. I wish to question the implications of those numbers. The trouble is that his numbers are being interpreted in the light of the “old paradigm” of globalisation – the world of trade theory that existed before Paul Krugman, Elhanan Helpman, and others led the “new trade theory” revolution in the 1980s.
- Department of "Huh?" (Eric Zitzewitz Department) - Brad DeLong
- Who wants school vouchers? Rich whites and poor nonwhites - Andrew Gelman
- Supply chains and financial shocks - voxeu.org
- A Real Regulatory Review: Interview with Bill Singer - Sense on Cents
- A Prescription for a Crippling Recession - Ezra Klein
- Unemployment claims and employment change - Paul Krugman
- The Dollar as a Reserve Currency: Apres le Deluge - Econbrowser
- The Decoupling Debate Is Back! - Foreign Policy
- Moral Hazard and the Crisis - Paul Volcker
- Principles that must guide financial regulation - FT
- The Effect of Legislation of Credit Card Interest Rates... - Credit Slips
- Get it wrong this time, and this won’t be our last meltdown - New Deal 2.0
- Nontraditional Monetary Policy - Charles Evans
- The Great Depression II meme - Credit Writedowns
- Persia: Ancient Soul of Iran - Photo Gallery - National Geographic Magazine
Monday, June 15, 2009
Someone name Dr. Manhattan at The Atlantic's Business Blog, in a post entitled "Sentences that Don't Compute" says:
Today's entry comes from Mark Thoma, who writes in a guest-blog at the Washington Post:
The development of the shadow banking system is important because the troubles we are seeing today are not the result of problems in the traditional, regulated sector of the financial industry. The problems began in the unregulated shadow banking system.
Is Dr. Manhattan seriously arguing that the financial market troubles began in the traditional, regulated banking sector even though commercial banks with insured deposits are doing just fine, it's the other sectors that are in trouble? Yes he or she is:
...the systemic breakdowns we have been experiencing over the past 18 months have been caused by problems at the major banks (even the former investment-only banks which weren't regulated by the Fed or FDIC cannot be called part of the "shadow banking system"), AIG (regulated by the state insurance commissioners...) ...
Here's why this is wrong. It defines sectors by institutions rather than by particular activities or products. Suppose there is a multi-product firm that produces products A and B, so it operates in two different sectors. Product A is heavily regulated, B is not regulated at all. If product B causes troubles, can we argue that ithis shows that the problems started in the regulated sector? That's what's being argued above.
For example, let's look at the AIG case a bit closer and see where they got into trouble, with the regulated or unregulated part of their business (I bet you can guess which it is):
Propping up a House of Cards, by Joe Nocera, NY Times: Next week, perhaps as early as Monday, the American International Group is going to report the largest quarterly loss in history. Rumors suggest it will be around $60 billion ...
To be sure, most of A.I.G. operated the way it always had, like a normal, regulated insurance company. (Its insurance divisions remain profitable today.) But one division, its “financial practices” unit in London, was filled with go-go financial wizards who devised new and clever ways of taking advantage of Wall Street’s insatiable appetite for mortgage-backed securities..., it sold credit-default swaps.
These exotic instruments acted as a form of insurance for the securities. ... When a company insures against, say, floods or earthquakes, it has to put money in reserve in case a flood happens. That’s why, as a rule, insurance companies are usually overcapitalized, with low debt ratios. But because credit-default swaps were not regulated, and were not even categorized as a traditional insurance product, A.I.G. didn’t have to put anything aside for losses. And it didn’t. ... So when housing prices started falling, and losses started piling up, it had no way to pay them off. ...
So Dr. Manhattan's example proves my point, it was the unregulated component of AIG - the part operating within the shadow banking sector - that caused them problems. Thank you. The Dr. even cites Fannie and Freddie who, as has been well documented, followed the shadow sector down into the dumps when they began losing market share, in no sense did they lead the process. So the Fannie and Freddie example also proves the opposite case. Had the shadow sector been regulated in the same way that Fannie and Freddie were, that market share pressure would not have existed since the regulation would have taken away the advantage enjoyed by the unregulated banks, and Fannie and Freddie would have had no reason to follow the unregulated shadow banks downward.
Here's a simple rule to follow. If you are going to set yourself up as a critic, it's a good idea to have some idea what you're talking about.
Update: See also The Atlantic Monthly Crashes and Burns... by Brad DeLong for more on this.
Here's something I've been wondering. Now that we have blogs and the internet, why do high ranking government officials - Timothy Geithner and Larry Summers today in the Washington Post, or Peter Orszag in the Financial Times for example - publish op-eds behind paywalls?
Why should people be forced to pay to hear read important policy discussions? Doesn't that exclude a lot of people from participating in the discourse? Even if the policy discussions aren't behind paywalls, other papers don't reprint the remarks in full, at least hardly ever, so the distribution is still limited.
When, say, the president wants to say something, why publish it on the op-ed pages of the New York Times, the Washington Post, the Wall Street Journal, the Financial Times, etc.? Why not simply post it on the White House web site, and make it absolutely clear that anyone who wants to can republish it in its entirety. Instead of one paper publishing the remarks, wouldn't they likely appear in several if not all major papers, or at least be discussed in some fashion, and wouldn't the remarks also be reprinted in local papers and in many blogs? Wouldn't a lot more people be able to read the discussion, and, in fact, wouldn't it be likely that a lot more people would read it?
So why do they still use the old model? Is it because the general public isn't the real target of these communications, or have I missed something essential? [Note: added a bit more in comments.]
Update: My daughter Amy is political consultant, and she helps politicians and others build support for their candidacy or for a particular side of an issue (and her dad thinks she is very good at it). She sends this along to straighten me out:
There are a few reasons for putting op-eds in Tier 1 newspapers:
1. Having your op-ed in a newspaper that is well-established gives your point a seal of legitimacy.
2. Once your op-ed is published, the goal is to move it around to bloggers, other reporters, etc. who will reprint it. But, being in “old media” gives your point gravitas.
3. The audience is NEVER the general public, ever. Your audience is always opinion leaders, policy makers and lobbyists. Oh, and reporters who may be covering your issue.
4. There is value to being able to use the masthead of the paper where your op-ed was published in campaign commercials, mailers, etc. You can only do that if it’s been published.
5. Not everyone is new media savvy.
Peter Orzag, Director of the White House Office of Management and Budger, describes the administration's health care plans:
A plan to boost America’s fiscal health, by Peter Orszag , Commentary, Financial Times: As the healthcare debate picks up in the US, there has been much discussion about how to pay for it. Coinciding with this debate are vocal concerns about the country’s underlying fiscal position – which some have suggested as a reason to delay healthcare reform.
What this argument ignores is that healthcare is central to the long-term fiscal and economic prospects of the US. If costs per enrollee in Medicare and Medicaid grow at the same rate over the next four decades as they have over the past four, those two programmes will increase from 5 per cent of gross domestic product today to 20 per cent by 2050. ... Nothing else we do on the fiscal front will matter much if we fail to address rapidly rising healthcare costs.
I thought maybe conservatives should hear from one of their own. Nobel prize winner Robert Lucas of the University of Chicago said the following in November:
The recession is the more immediate problem, Robert Lucas: In a financial crisis things happen fast... The responsibility of the Federal Reserve in this situation is to provide more cash reserves, and in that sense they are doing their job. ... This is good central banking.
Should we be concerned that people will just hold on to the new reserves and continue to reduce spending? Some of that is surely happening, but more reserves can always be added.
Should we be concerned about inflation? Of course, always.
But right now the recession is the more immediate problem. If inflation resumes, reserves can be taken out as quickly as they were added. This is a classic lender-of-last-resort situation and it is important to maintain focus.
In my view, these are the most important considerations for US policy today. I think if the current Federal Reserve lending policies are continued aggressively our chances of avoiding a recession larger than that of 1982 are very good. At this point, I think this is the best that can be hoped for and it is a lot better than a replay of the 1930s.
Importantly: "reserves can be taken out as quickly as they were added."
It's too soon to ease up on monetary and fiscal policy:
Stay the Course, by Paul Krugman, Commentary, NY Times: The debate over economic policy has taken a predictable yet ominous turn: the crisis seems to be easing, and a chorus of critics is already demanding that the Federal Reserve and the Obama administration abandon their rescue efforts.
For those who know their history,... this is the third time ... that a major economy has found itself in a liquidity trap, a situation in which interest-rate cuts ... have reached their limit. ...
The first example of policy in a liquidity trap comes from the 1930s. The U.S. economy grew rapidly from 1933 to 1937, helped along by New Deal policies. America, however, remained well short of full employment.
Yet policy makers stopped worrying about depression and started worrying about inflation. The Federal Reserve tightened monetary policy, while F.D.R. tried to balance the federal budget. Sure enough, the economy slumped again, and full recovery had to wait for World War II.
The second example is Japan in the 1990s. After slumping early in the decade, Japan experienced a partial recovery... Policy makers responded by shifting their focus to the budget deficit, raising taxes and cutting spending. Japan proceeded to slide back into recession.
And here we go again.
On one side, the inflation worriers are harassing the Fed. The latest example: Arthur Laffer... Meanwhile, there are demands from several directions that President Obama’s fiscal stimulus plan be canceled. Some ... argue ... the economy is already turning around. Others claim that government borrowing is driving up interest rates, and that this will derail recovery.
And Republicans, providing a bit of comic relief, are saying that the stimulus has failed, because the enabling legislation was passed four months ago — wow, four whole months! — yet unemployment is still rising. This suggests an interesting comparison with ... Ronald Reagan, whose 1981 tax cut was followed by no less than 16 months of rising unemployment.
O.K., time for some reality checks.
First of all,... unemployment is very high and still rising. That is, we’re not even experiencing the kind of growth that led to the big mistakes of 1937 and 1997. It’s way too soon to declare victory.
What about the claim that the Fed is risking inflation? It isn’t. Mr. Laffer seems panicked by a rapid rise in the monetary base... But a rising monetary base isn’t inflationary when you’re in a liquidity trap. America’s monetary base doubled between 1929 and 1939; prices fell 19 percent. Japan’s monetary base rose 85 percent between 1997 and 2003; deflation continued apace.
Well then, what about all that government borrowing? All it’s doing is offsetting a plunge in private borrowing — total borrowing is down, not up. Indeed, if the government weren’t running a big deficit right now, the economy would probably be well on its way to a full-fledged depression.
Oh, and investors’ growing confidence that we’ll manage to avoid a full-fledged depression — not the pressure of government borrowing — explains the recent rise in long-term interest rates. These rates, by the way, are still low by historical standards.
To sum up: A few months ago the U.S. economy was in danger of falling into depression. Aggressive monetary policy and deficit spending have, for the time being, averted that danger. And suddenly critics are demanding that we call the whole thing off, and revert to business as usual.
Those demands should be ignored. It’s much too soon to give up on policies that have, at most, pulled us a few inches back from the edge of the abyss.
This is something I did for the The Hearing blog at the Washington Post:
Making Financial Regulation Work: 50 More Years, by Mark Thoma: Banking regulation imposed in response to the Great Depression and the recurrent panics of the 1800s and early 1900s gave us 50 years of stability in the financial system without impeding economic growth. That's quite a record to overcome for those who say regulation does not work.
But the stability began to break down with the savings and loan problems in the 1980s, and the growing instability since that time is evident in the severe meltdown we are experiencing today.
What happened? Deregulation beginning with the Reagan administration combined with financial innovation and digital technology led to the emergence of what is known as the shadow banking system. These are financial institutions that, for all intents and purposes, function just like banks but are not subject to the same rules and regulations and, in some cases, are hardly regulated at all.
The development of the shadow banking system is important because the troubles we are seeing today are not the result of problems in the traditional, regulated sector of the financial industry. The problems began in the unregulated shadow banking system.
We need to bring the shadow banking system - essentially any institution that takes deposits and makes loans either directly or indirectly - under the same regulatory umbrella as the traditional banking system.
What type of regulation should we impose to give us the best chance of achieving another 50 years or more of relative calm?
Initially my concerns were with the economic issues, and the focus was on
designing a regulatory system that would overcome the market failures that led to excess risk-taking and to institutions that were too big and too interconnected to fail.
But large financial firms exert more than their share of political power, and this adds another dimension to the problem. Banks that are too big and too interconnected to fail pose an economic risk to the overall economy. However, firms can also be "too big for politicians to ignore." When this happens, they can exert undue influence on legislation or capture the regulatory process in ways that allow them to escape enforcement of rules already in place. So regulation is needed to limit political power as well as economic power.
But that is not enough. The environment the regulatory process operates in must also be changed if we are going to bring about a more stable, more reliable financial system.
Today's problems could have been eased or perhaps even avoided entirely if regulators would have simply enforced regulations already in place, or called for new ones when existing tools were inadequate. But instead, regulations were not enforced to the extent they could have been, and there was little internal opposition when they were lifted.
The attitudes within regulatory agencies were driven by the widely held belief that the discipline of the marketplace would not allow the accumulation of excessive risk. Regulators did not believe that the type of meltdown we have just experienced could occur. Problems could develop in individual markets, and those could be troublesome, but the system-wide, falling-domino-type collapse we've just observed just couldn't happen -- not in modern financial markets with all their digital technology, fancy mathematics, and complicated risk-dispersing products. Or so it was believed.
If you don't believe something can occur, you won't be sensitive to signs that it might be about to happen. Regulators missed the signs of the crash because they didn't think a crash of this breadth and magnitude was possible. Besides, more benign explanations could be made to fit the facts.
We now know that a system-wide financial breakdown was in the realm of possibility, and that should change how regulators view market developments in the future. They won't soon forget that markets can and do collapse when left unattended, and they will interpret developments in financial markets with that in mind.
So what should we do? In very broad terms, we need:
- Regulations that limit both economic and political power and discourage the buildup of excessive risk.
- Regulators willing to assertively enforce existing regulation, think outside the ideological box and take an active role in identifying areas where regulation is inadequate.
- Regulators with the means and power to stand up to the biggest and most powerful financial institutions. Making financial institutions less powerful by breaking them up into smaller entities is one means to this end.
- A culture within regulatory agencies and their supporting institutions that reinforces and encourages the regulatory process.
It won't be easy to bring about the needed regulatory change, not with still-too-powerful financial companies lobbying against it, but it's essential that we do.
[You can leave comments here as usual, and, if you want to extend the reach of what you have to say, you can comment here too.]
Here is a "brief preview of the administration's forthcoming proposals" to strengthen regulation of the financial sector.
A New Financial Foundation, by Timothy Geithner and Lawrence Summers, Commentary, Washington Post: Over the past two years, we have faced the most severe financial crisis since the Great Depression. The financial system failed to perform its function as a reducer and distributor of risk. Instead, it magnified risks, precipitating an economic contraction that has hurt families and businesses around the world. ...
This current financial crisis had many causes. ... But it was also the product of basic failures in financial supervision and regulation. Our framework for financial regulation is riddled with gaps, weaknesses and jurisdictional overlaps, and suffers from an outdated conception of financial risk. In recent years, the pace of innovation in the financial sector has outstripped the pace of regulatory modernization, leaving entire markets and market participants largely unregulated.
That is why, this week ... the administration will put forward a plan to modernize financial regulation and supervision. ... In developing its proposals, the administration has focused on five key problems in our existing regulatory regime...
Sunday, June 14, 2009
I don't know the details of this beyond what's given in the article below, but it sounds like anti-dumping claims and calls for "tougher safety and quality checks" are being used in an attempt to protect domestic industries in India from competition from Chinese manufacturers:
China accused of ‘predatory pricing’ tactics, by Amy Kazmin: India’s small and medium enterprises have warned that they are suffering because of cheap imports from China. They are urging New Delhi to accelerate anti-dumping investigations and impose tougher safety and quality checks on Chinese products. The appeal for greater government protection came amid rising tensions between New Delhi and Beijing over trade, after a high-profile dispute over an Indian ban on Chinese made toys.
Clive Crook says "there are worse things than Medicare for all – and the present system might be one of them":
Medicare for all may be the best cure for the US, by Clive Crook, Commentary, FT: For the past few months, Barack Obama and his allies in Congress have been striding towards far-reaching reform of the US healthcare system... But the Democrats ... are divided.
They agree on several elements. At least to begin with, private employer-provided insurance will remain the norm. ... New mandates, subsidies and a regulated insurance exchange would widen coverage... But controversy surrounds three points: what the reform will cost, how it will be paid for and, especially, what role a new public insurance plan might play. ...
Saturday, June 13, 2009
Tyler Cowen is not a fan of Obama's health care reform plan. He thinks we should use comparative effectiveness studies to "cut areas of Medicare spending." (Update: In comments, Tyler says, "I don't quite agree with your opening sentence characterizing my piece. I think Obama would like to do something along the lines of what Cutler proposes and along the lines of what I defend. I think it is Congress that will not let him."):
Something’s Got to Give in Medicare Spending, by Tyler Cowen, Commentary, NY Times: Medicare expenditures threaten to crush the federal budget... It’s not the profits of the drug companies or the overhead of the insurance companies that make American health care so expensive, but the financial incentives for doctors and medical institutions to recommend more procedures, whether or not they are effective. So far, the American people have been unwilling to say no.
Drawing upon the ideas of the Harvard economist David Cutler, the Obama administration talks of empowering an independent board of experts to judge the comparative effectiveness of health care expenditures; the goal is to limit or withdraw Medicare support for ineffective ones. This idea is long overdue ...
This was written by Thorstein Veblen in 1898. It's long, but if you have the time to read it, it's worth it. To me, there is an important lesson here that has been forgotten even by those - or perhaps especially by those - at places like the University of Chicago who proclaim themselves to be positivists in search of the truth.
Jeffrey Sachs says markets alone are not enough to solve the climate change problem, we also need strategic direction from "detailed and coherent" government plans:
Still Needed: A Climate Plan, by Jeffrey Sachs, Scientific American: There is a myth in America that markets, not plans, are the key to success. Markets will supposedly decide our climate future on their own once we institute cap-and-trade legislation to put a market price on carbon emissions. But this is silly: both markets and planning are essential in any successful large-scale undertaking, whether public or private. We need a detailed yet adaptable road map for action that goes far beyond cap and trade. ...
The administration’s climate negotiator has called cap and trade "the centerpiece" of the domestic climate program. A moment’s reflection shows why that cannot be right. Cap and trade will have little effect, for example, on whether the U.S. revives its nuclear power industry, as it should to meet climate objectives. A renaissance for nuclear will depend on regulations, public attitudes, liability laws, and both administration leadership and public education much more than on cap and trade, which would play at most a supporting role.
It appears that the election in Iran was rigged.
I don't feel like I understand what's going on in Iran as well as I should. Comments? One thing I haven't seen at all and am interested in is how what's happening right now in Iran might relate to the war in Iraq - if it is related to any significant extent - that's part of what I want to understand. How what's happening now relates to our policy toward Iran in recent years is also of interest.
[And since this is an economics blog, predictions and explanations about how this might affect the world economy - oil markets for example - are also welcome, though I am not expecting much effect, at least not at this point.]
Friday, June 12, 2009
What is authenticity? When people begin selling authentic artifacts, and market preferences alter what is produced, are the items still authentic, or has the interaction with the market changed the authenticity of what is produced?:
Cultural authenticity and the market, by Daniel Little: People often return from their travels with objects they've purchased to represent the culture and traditions of the place they've visited -- Alsatian pottery from Betschdorf, masks from Kenya, or Navajo pots from Arizona. And sometimes they purchase such artifacts at home in Cleveland or Sacramento to gain a little resonance from a distant culture -- Tibetan temple bells, Chinese funeral figures, Mayan woven goods. And there is generally a desire that these goods should be "authentic" -- that is, they should have been produced by artisans situated in a continuous tradition with the culture the artifact represents. Imagine the traveler's disappointment to find that his beautiful artisanal Alsatian vase was mass-produced in a factory in Guangdong.
It's been many weeks since I did this so I don't really remember what I said, and I'm too chicken to watch myself, so hopefully I don't say anything more foolish than usual (update: thanks for the nice comments here and by email):
Kenneth Rogoff is worried that we'll rebuild the same economy we had before the crisis and risk another financial meltdown:
Rebalancing the US-China Economic Relationship, by Kenneth Rogoff, Commentary, Project Syndicate: As the global economy stabilizes, there is a growing danger that the United States and China will slip back into their pre-crisis economic patterns, placing themselves and the rest of the world at risk. ... Short-run stability certainly seems attractive right now. But if the US-China trade and debt relationship merely picks up where it left off, what will prevent recurrence of the same unsustainable dynamic that we just witnessed? After all, huge US foreign borrowing was clearly a key factor in creating the recent financial mess, while China’s excessive reliance on export-driven growth has made it extraordinarily vulnerable to a sudden drop in global demand.
A giant fiscal stimulus in both countries has helped prevent further damage temporarily, but where is the needed change? Wouldn’t it be better to accept more adjustment now in the form of slower post-crisis growth than to set ourselves up for an even bigger crash?
True, both the US administration and China’s leadership have made some sensible proposals for change. But is their heart in it? US Treasury Secretary Timothy Geithner has floated a far-reaching overhaul of the financial system, and China’s leaders are starting to take steps towards improving the country’s social safety net.
Both of these measures should help... Nevertheless, there is cause for concern. As the world seems to emerge from its horrific financial crisis, it is human nature for complacency to set in, and the domestic politics of the US-China trade and financial relationship is deeply rooted. ...
Another reason to worry is that the global recovery is still fragile. US and Chinese leaders have fought the crisis with not only massive fiscal stimulus, but also deep intervention into credit markets. Such extraordinary fiscal largesse, all at taxpayers’ expense, cannot continue indefinitely.
World Bank President Robert Zoellick has rightly warned that all this massive temporary fiscal stimulus is a “sugar high” that will ultimately pass without deeper reforms. As I have argued before, the endgame to the financial bailouts and fiscal expansion will almost certainly mean higher interest rates, higher taxes, and, quite possibly, inflation.
For better or for worse, it may not be possible to turn back the clock. The US consumer, whose gluttony helped fuel growth throughout the world for more than a decade, seems finally set to go on a diet. ...
Frankly, higher US personal saving rates would not be a bad thing. It would almost certainly help reduce the risk of an early repeat of the financial crisis. The obvious candidates to replace them are Chinese and other Asian consumers...? Outside Japan, Asia policymakers certainly don’t seem amenable to exchange-rate appreciation
Since the beginning of this decade, at least a few economists (including me) have warned that the global trade and current-account imbalances needed to be reined in to reduce the chance of a severe financial crisis. The US and China are not solely responsible for these imbalances, but their relationship is certainly at the center of it.
Prior to the crisis, there was plenty of talk, including high-level meetings brokered by the International Monetary Fund, but only minimal action. Now, the risks have spilled out to the entire world. Let’s hope that this time there is more than talk. If US and Chinese policymakers instead surrender to the temptation of slipping back to the pre-crisis imbalances, the roots of the next crisis will grow like bamboo. And that would not be good news for the US and China, or anyone else.
I think he gives himself a bit too much credit for foreseeing the crisis, the type of financial meltdown he and others predicted - a sudden unwinding of international imbalances - didn't occur.
But the question is how much risk there is of a big international meltdown in the future, and this is what Rogoff is worried about. On that score:
Where’s the money coming from?, by Paul Krugman: The huge borrowing by major governments, the U.S. government in particular, has confused many people — and not just Niall Ferguson. What I hear again and again is either the assertion that all this borrowing must drive up interest rates, or worries that the Chinese won’t be willing to lend us the money.
We know as a matter of principle that these concerns are misplaced: if there were a shortage of savings, the economy wouldn’t be depressed. Indeed, one way to think about our current problem is that the world as a whole wants to save more than it’s willing to invest.
But it’s always nice to have some real-world data illustrating a principle. From Brad Setser, private and public borrowing in America, as a percentage of GDP:
We’re actually borrowing less from foreigners than we were before.
Rogoff asks "where is the needed change?" We are already undergoing structural change, we have a smaller financial sector, a smaller housing sector, a smaller domestic automobile sector, and an increase in household saving. And though the actual degree of change that we will see in things like household saving is unknown, we will see permanent change. Thus, the type of structural reforms Rogoff would like to see are, in fact, underway already and they will continue. But because so much has to change - minor tweaks to the economy won't be enough - it will delay the recovery relative to the more usual case when the economy is able to return to what it was doing before.
As the financial, housing, and domestic automobile industries shrink, resources and labor are freed up and become unemployed. They must, somehow, find their way into other sectors. Some have to move geographically, and that process can be lengthy. Building new industries that can absorb the idle resources takes time, rebuilding the financial sector, household deleveraging, one of this will happen overnight. (And it doesn't help that, on top of all this, housing markets are notoriously slow to adjust so that the needed shrinkage and adjustment driving the structural change is itself a slow process.)
So the process will be slow. Does deficit spending to combat the recession slow this adjustment process down even further? Is Rogoff right that we'd be better off just letting things crash and burn so that the new and improved version can be rebuilt faster?
The economy is already changing as described above, and in other ways too, and it is doing so about as fast as it can. Any faster than this, which would involve even more unemployment and more stagnation of resources and the economy, more ensuing foreclosures, etc., and we'd risk undermining the very foundation we want to rebuild upon. Structural change and social programs to help people who are struggling due to poor economic conditions are not at odds with each other, and infrastructure spending supports rather than hinders future growth and change.
We will get the change we need, it's underway already, and that change does not require the government to sit by idly while people struggle with the poor economic conditions. Worries about inflation and high interest rates, and about the negative effects of higher taxes on those who can more than afford them are overblown. Those worries should not stand in the way of extending a compassionate hand to the struggling, or to spending money to stimulate the economy and build the social and physical infrastructure we need to support robust economic growth in the future.
The conservative media and political establishment are aiding and abetting "the mainstreaming of right-wing extremism":
The Big Hate, by Paul Krugman, Commentary, NY Times: Back in April, there was a huge fuss over an internal report by the Department of Homeland Security warning that current conditions resemble those in the early 1990s — a time marked by an upsurge of right-wing extremism that culminated in the Oklahoma City bombing.
Conservatives were outraged. ... But with the murder of Dr. George Tiller by an anti-abortion fanatic, closely followed by a shooting by a white supremacist at the United States Holocaust Memorial Museum, the analysis looks prescient.
There is, however, one important thing that the D.H.S. report didn’t say: Today, as in the early years of the Clinton administration but to an even greater extent, right-wing extremism is being systematically fed by the conservative media and political establishment.
Now, for the most part, the likes of Fox News and the R.N.C. haven’t directly incited violence, despite Bill O’Reilly’s declarations that “some” called Dr. Tiller “Tiller the Baby Killer,” that he had “blood on his hands,” and that he was a “guy operating a death mill.” But they have gone out of their way to provide a platform for conspiracy theories and apocalyptic rhetoric, just as they did the last time a Democrat held the White House.
And at this point, whatever dividing line there was between mainstream conservatism and the black-helicopter crowd seems to have been virtually erased.
Exhibit A for the mainstreaming of right-wing extremism is Fox News’s new star, Glenn Beck...—... a commentator who, among other things, warned viewers that the Federal Emergency Management Agency might be building concentration camps as part of the Obama administration’s “totalitarian” agenda (although he eventually conceded that nothing of the kind was happening).
But let’s not neglect the print news media. ...The Washington Times ... saw fit to run an opinion piece declaring that President Obama “not only identifies with Muslims, but actually may still be one himself,” and that in any case he has “aligned himself” with the radical Muslim Brotherhood.
And then there’s Rush Limbaugh. ...[W]hen Mr. Limbaugh peddles conspiracy theories — suggesting, for example, that fears over swine flu were being hyped “to get people to respond to government orders” — that’s a case of the conservative media establishment joining hands with the lunatic fringe.
It’s not surprising, then, that politicians are doing the same thing. The R.N.C. says that “the Democratic Party is dedicated to restructuring American society along socialist ideals.” And when Jon Voight, the actor, told the audience at a Republican fund-raiser this week that the president is a “false prophet” and that “we and we alone are the right frame of mind to free this nation from this Obama oppression,” Mitch McConnell, the Senate minority leader, thanked him, saying that he “really enjoyed” the remarks.
Credit where credit is due. Some figures in the conservative media have refused to go along with the big hate... But this doesn’t change the broad picture ... that supposedly respectable news organizations and political figures are giving aid and comfort to dangerous extremism.
What will the consequences be? Nobody knows, of course, although the analysts at Homeland Security fretted that things may turn out even worse than in the 1990s — that thanks, in part, to the election of an African-American president, “the threat posed by lone wolves and small terrorist cells is more pronounced than in past years.”
And that’s a threat to take seriously. Yes, the worst terrorist attack in our history was perpetrated by a foreign conspiracy. But the second worst, the Oklahoma City bombing, was perpetrated by an all-American lunatic. Politicians and media organizations wind up such people at their, and our, peril.
Thursday, June 11, 2009
The Atlanta Fed's David Altig takes issue with Arthur Laffer. This is another way of saying that money sitting in banks as excess reserves is not inflationary (my related comments are here and here - scroll down in both cases):
Price stability and the monetary base, by David Altig: Arthur Laffer, as several readers (and friends) have pointed out to me, is taking aim at the Fed:
"… as bad as the fiscal picture is, panic-driven monetary policies portend to have even more dire consequences. We can expect rapidly rising prices and much, much higher interest rates over the next four or five years, and a concomitant deleterious impact on output and employment not unlike the late 1970s.
"About eight months ago, starting in early September 2008, the Bernanke Fed ... radically increased the monetary base—which is comprised of currency in circulation, member bank reserves held at the Fed, and vault cash—by a little less than $1 trillion. The Fed controls the monetary base 100%..."
...The increase in the U.S. monetary base has indeed been something to behold, and the Laffer article gives a good explanation about why you might be worried about that:
"Bank reserves are crucially important because they are the foundation upon which banks are able to expand their liabilities and thereby increase the quantity of money.
"...Banks now have huge amounts of excess reserves, enabling them to make lots of net new loans…
"At present, banks are doing just what we would expect them to do. They are making new loans and increasing overall bank liabilities (i.e., money). The 12-month growth rate of M1 is now in the 15% range, and close to its highest level in the past half century."
OK, but in my opinion it is a bit of a stretch—so far, at least—to correlate monetary base growth with bank loan growth:
Let's call that more than a bit of a stretch.
The Laffer argument is in large part about what the future will bring. But we know that the payment of interest on bank reserves—which we have discussed in this forum many times (here and here, for example)—means a higher demand for reserves in the future than in the past. This change, of course, means that levels of the monetary base that would have seemed scary in the past will become the new normal. How big can the "new normal" be? That's a good question, and one I will continue to contemplate. But the assertion in the Laffer article that "a major contraction in monetary base" is required cannot be supported by either current evidence or simple economic theory.
There is, however, more. Whatever policy choices are required to deliver a noninflationary environment going forward, Mr. Laffer seems convinced that the central bank is not up to making them:
"Alas, I doubt very much that the Fed will do what is necessary to guard against future inflation and higher interest rates. If the Fed were to reduce the monetary base by $1 trillion, it would need to sell a net $1 trillion in bonds. This would put the Fed in direct competition with Treasury's planned issuance of about $2 trillion worth of bonds over the coming 12 months. Failed auctions would become the norm and bond prices would tumble, reflecting a massive oversupply of government bonds."
On this I will just turn to my boss, Atlanta Fed President Dennis Lockhart, who addressed this very issue in a speech given today at the National Association of Securities Professionals Annual Pension and Financial Services Conference in Atlanta:
"The concerns about our economic path are crystallized in doubts expressed in some quarters about the Federal Reserve's ability to fulfill its obligation to deliver low and stable inflation in the face of very large current and prospective federal deficits. In a word, the concerns are about monetization of the resulting federal debt.
"I do not dismiss these concerns out of hand. I also recognize that the task of pursuing the Fed's dual mandate of price stability and sustainable growth will be greatly complicated should deliberate and timely action to address our fiscal imbalances fail to materialize. But I have full confidence in the Federal Reserve's ability and resolve to meet its inflation objectives in whatever environment presents itself. Of the many risks the U.S. and global economies still confront, I firmly believe the Fed losing sight of its inflation objectives is not among them."
'Nuff said, for now.
Robert Reich is worried that the "Great Debt Scare" will lead to a repeat of the Clinton administration's abandonment of its investment agenda due to concerns over the deficit:
The Great Debt Scare: Why Has It Returned?, by Robert Reich: It’s the kind of thing I expect to hear from deficit hawks and chicken littles -- from the self-described "fiscally responsible" right, from the scolds Ross Perot and Pete Peterson, from my former cabinet colleague Bob Rubin. But yesterday I was shown slides developed by the putatively liberal Center for American Progress intended to make the point. And today’s front page story in the New York Times, by the eminent David Leonhardt, entitled "Sea of Red Ink: How It Spread From A Puddle," puts the issue right before our progressive noses, so to speak.
The Great Debt Scare is back.
Odd that it would return right now, when the economy is still mired in the worst depression since the Great one. ...
Odder still that the Debt Scare returns at the precise moment that bills are emerging from Congress on universal health care, which, by almost everyone’s reckoning, will not increase the long-term debt one bit because universal health care has to be paid for in the budget. In fact, universal health care will reduce the deficit and cumulative debt -- especially if it includes a public option capable of negotiating lower costs from drug makers, doctors, and insurers, and thereby reducing the future costs of Medicare and Medicaid.
Even odder that the Debt Scare rears its frightening head just as the President’s stimulus is moving into high gear with more spending on infrastructure. Every expert who has looked closely at the nation’s crumbling infrastructure knows how badly it suffers from decades of deferred maintenance... These public investments are as important to the nation’s future as are private investments.
First, some background: Deficit and debt numbers ... take on meaning only in relation to ... the size of the national economy..., in particular, to the debt/GDP ratio. True, that ratio is heading in the wrong direction right now. It may reach 70 percent by the end of 2010. That’s high, but it’s not high compared to the 120 percent it was in 1946, after the ravages of Depression and war.
Over time, the basic way America has reduced the debt/GDP ratio is by growing the U.S. economy. GDP growth makes even large debts manageable. When the economy is cooking, more people have jobs and better wages. So they pay more taxes. And they require less unemployment assistance and other social insurance. That’s why it’s so important now, in the depths of depression, that government, as purchaser of last resort, steps in and runs large deficits. Without large deficits this year and next, and perhaps the year after, the economy doesn’t have a prayer of getting back on a growth path, and the debt/GDP ratio could really get ugly. ...
In this respect, national budgets are like family budgets. It’s dumb for an indebted family to borrow more money to take a world cruise. But it’s smart even for an indebted family to borrow money to send their kids to college. So too with the Obama budget. Public investments, just like family investments, build future wealth. They allow faster growth. They make the debt/GDP ratio even lower and more manageable over time.
Don't get me wrong. I'm not saying there's nothing to worry about when it comes to long-term deficit and debt projections. I'm just saying now's not the time to worry, and we ought to temper our worries by understanding the larger context.
Not every expert agrees that a deficit-driven stimulus is the best and fastest way to get the economy back on a growth track, or that public investments can speed growth. Conservative economists, Republicans, and many Wall Streeters are skeptical because they don’t think government can do anything well. But look at the record of the last seventy-five years -- look at how the nation got out of the Great Depression, and consider the critical role public investments have played since then in speeding the nation’s growth, investments such as the interstate highway system -- and you have ample evidence that the deficit hawks are wrong. They were wrong when they convinced Bill Clinton to chuck a large part of his investment agenda (the nation is now paying the price) and they're wrong now.
So, back to the mystery. Why are the ostensibly liberal Center for American Progress and New York Times participating in the Debt Scare right now? Is it possible that among the President’s top economic advisors and top ranking members of the Fed are people who agree ... with conservative Republicans...? Is it conceivable that they are quietly encouraging the Debt Scare even in traditionally liberal precincts, in order to reduce support in the Democratic base for what Obama wants to accomplish? Hmmm.
Not so sure about that, but the larger point is certainly valid. The economy needs short-term demand stimulus, and that stimulus can be from spending on infrastructure, or it could be on something with little long-run benefit such as large firework shows held throughout the nation - big extravagant events that spend millions and millions of dollars in the most depressed economic areas. In the short-run the goal is to kick start the economy, and a firework show is just as good at that task as infrastructure spending if the spending is approximately the same.
Where they differ is in the long-run. The firework show leaves only memories - and sometimes that's enough to justify an expenditure - but let's assume that for the most past the shows were nothing more than an excuse to spend money to get the local economies moving (not that there's anything wrong with that; also, perhaps a series of shows would be better so that the impulse is spread out over time and sustains the economy through the downturn, but the idea is the same). However, as Robert Reich explains above in his example of borrowing to go on a cruise versus borrowing to go to college, infrastructure spending does have long-run benefits and can help the economy grow faster.
So, to the extent that we can, we should do both - deficit spend to get the economy moving in the short-run, and spend the money on infrastructure so the spending has long-run benefits. But the main thing is to get the economy moving again through deficit spending, it doesn't have to be on infrastructure (and there are plenty of things to spend the money on in the short-run that don't necessarily help with long-run growth but are nevertheless justified, there are choices other than firework shows and cruises, but the politics work against this).
So deficit spend in the short-run and target infrastructure as much as possible - until further spending on infrastructure begins to threaten short-run goals because, for example, it can't be done fast enough - then switch to other types of spending to give aggregate demand the kick it needs.
It may seem like I disagree with Robert Reich in that he is insisting that the spending be to rebuild our physical and social infrastructure, where I am saying it doesn't matter, but that's because we need to separate two reasons for deficit spending. What I have just described is deficit spending to offset cyclical swings in the economy, so called countercyclical policy. What Robert Reich describes in his example with the family is spending that is an investment in the future. You borrow money now in the hopes of a higher return in the future (in terms of economic growth), a return that is high enough to justify the costs. Note that this type of spending is entirely justified independently of spending to offset recessionary conditions. However, because of the politics involved, and because it can be efficient in any case, combing the two types of spending - i.e. using infrastructure spending to stimulate the economy - has benefits.
But although right now deficit spending is justified by countercyclical policy and by the need for social and physical infrastructure, we also need a plan for the long-run that credibly manages the resulting debt. Not immediately, but slowly over a long period of time. Importantly, however, that plan should not threaten or compromise our ability to do what's needed to offset the effects of this recession. I wouldn't mind having the conversation about managing the long-run debt now if it didn't do exactly that, i.e. cause policymakers to be wary of deficit spending and do less than is needed to combat the recession. But it does, and as Robert Reich notes, that is likely the point of the conversation.
I want both monetary and fiscal policy to have the best possible chance for success in dealing with our present difficulties, and that requires a large sustained shock to the system both in term of Fed actions and deficit spending. But success also requires managing the long-run appropriately. When things improve we have to pay for the stimulus to the economy (i.e. pay for all of the countercyclical part plus our share of the investment in infrastructure) and take the steps necessary to bring the budget into long-run alignment. If we don't do that, the conclusion will be that we can deficit spend when times are bad without any problem, and sure, that is helpful, but we simply do not have the discipline to pay for what we borrowed when times are better. Our inability to implement countercyclical policy effectively could then mean that future generations would not have countercyclical fiscal policy at their disposal when they need it.
But for now the main thing to realize is that "This thing ain’t over yet," and we need to continue to support aggressive policy action. We do have work to do to get the long-run budget fixed, and working on health care is a large step in that direction, but for now short-run policy goals must come first.
Wednesday, June 10, 2009
Tim Duy responds to talk of a rate hike:
Rate Hike?, by Tim Duy: Seriously, a rate hike in this environment? Or anytime before the end of 2009? At the moment, I just can't see it happening. That said, long rate are higher, and inflation expectations in some corners of the market are rising. What is going on? My explanation for recent market action revolves around three themes:
1.)Financial Armageddon appears to have been avoided - at least for the moment. The "all but explicit" implicit guarantee that no significant US financial institution will be allowed to fail established a return to financial stability. And with that stability comes an end to the flight to safety that buoyed Treasury prices. Something off a conundrum for Treasury Secretary Timothy Geithner - cheap financing of the staggering US deficit appears to be dependent on financial instability.
2.)Recent inflation numbers are not exactly what I would call benign. The trend in core PCE is not deflationary:
I think deflation fears were always overblown - the current batch of monetary policymakers are simply dead set against such an outcome. The deflation trade, like the flight to safety, needed to be priced out of Treasury's and TIPS. The outcome: Breakeven spreads are up sharply.
3.) The US, in aggregate, is borrowing less from the world than a year ago. But make no mistake, we still rely on capital inflows to maintain a substantial US current account deficit. Lacking a flight to safety, it is not clear that private investors are willing to support that deficit at 2.75%. Or even 4%, for that matter. That fact that foreign central banks are accumulating Dollars is proof positive that private investors don't want to do the job - and the transition in central bank purchases from the long end to the short end suggest that even they grow weary of this game. Remember, the argument that "Japan ran a massive budget deficit so we can too" falls apart when you recognize that for decades Japan has been able to rely entirely on internal savings to finance the deficit. My interpretation: The invisible hand (apologies to Gavin Kennedy) is still pushing for lower US consumption to bring the external accounts into better balance - and that means higher rates to maintain inflows while suppressing the pace of economic growth. I understand this is in direct conflict with the output gap story; reconciling the two, I believe, requires an admission that the US economy is terribly structurally imbalanced internally. We may have excess capacity, but not excess capacity to make anything anybody real wants.
Where do Federal Reserve policymakers stand on recent dynamics? Turning to Federal Reserve Chairman Ben Bernanke:
I disagree with Anna Schwartz with respect to the Lehman Brothers bailout - she contends that the trouble started when the (ill-advised) rescue of Bear Stearns set up expectations that Lehman would be treated similarly - but if Bear Stearns or another large bank had been allowed to fail instead, I think we would have seen the same panic in financial markets. But as noted below, I don't disagree with all of her criticisms of the Fed:
Taking Stock: Lessons from History, MarketPlace [audio]: Kai Ryssdal: ...Anna Schwartz [is] 93 years old, an economist for more than 60 of them. Still working, every day, at the National Bureau of Economic Research in New York City. Her area of expertise is monetary policy... Specifically, she's an expert in how the Fed blew it during the Great Depression... When I sat down with her in her office..., she made it clear she's none too happy about all of Washington's bailouts, or how the Fed and the Treasury chose who got one and who didn't.
Schwartz: I think both Bush and the Obama administration have not been as hard headed with banks, it has been too lax. And instead if they had said if you cannot raise capital in the market, there is no reason for the government, the people of this country, to provide capital.
Ryssdal: OK, but wait a minute. Didn't we try that with Lehman Brothers last September? And there are people who will say that only made everything worse. ...
Schwartz: No, the trouble with the way the Fed operated when it rescued Bear Stearns, the market then believed this was a signal of the way the Federal Reserve would perform. If the Fed and the Treasury made a candid statement to the market: We will help a bank, which basically is solvent. We will not do that for a bank, which is on the verge of bankruptcy. And then the market understands there are principles. That's why when Lehman Brothers was permitted to fail, the market was simply bewildered. Because here you had treated Bear Stearns in this kindly fashion, and what reason was there not to do the same when Lehman Brothers arose?
Ryssdal: Now do you think the market has figured out what the policy of the federal government is toward these rescues by now? It's been six, seven months since Lehman Brothers.
Schwartz: The market is just bewildered. Bernanke came into office insisting that the Fed would be much more transparent... But I don't believe that it's lived up to that. If the market understood what the Fed was planning in each case, and could see a design, then I think the market would have reacted much more positively.
Ryssdal: It sounds like you're frustrated with Chairman Bernanke...
Schwartz: Well, I think that that's a fair statement. ...Bernanke's ... performance ...[s]eemed to be ... ad hoc and introduced without considering all the implications.
Ryssdal: You know, Alan Greenspan was lionized in this country for many years. And then a year ago went up to Capitol Hill and said, "You know what, I blew it." Does he get the appropriate amount of credit and/or blame for this whole thing?
Schwartz: Well, I think the verdict of history will be different with regard to his stature than it has been so far.
Ryssdal: In your mind, these toxic assets, the bad assets that these banks still have on their books, are they still a big problem or have they worked their way through the system now?
Schwartz: No, and I think the big shortcoming of the Obama administration, and Bush before that, was that it didn't make a concerted effort to get rid of these assets. I mean in a sense it's a condemnation of the Federal Reserve. They did not respond to securitization, which is the basic condition for the creation of these toxic assets. Neither Alan Greenspan or anybody else at the Fed seemed to be concerned.
Ryssdal: Securitization, that is the buying and selling of these packages of mortgages. There are those who will say it contributed a lot to the economic growth in this country. Do you buy that?
Schwartz: Well, I suppose the people who made money on it will say, Sure. But you have to be able to divine what you're letting yourself in for,... nobody took action to say, "Wait a minute. What are we doing when we are permitting these mortgage companies to issue these securities backed by a pool of mortgages of varying quality, and you don't know how to price the security?" Nobody raised that question.
Ryssdal: When an economic historian comes along in 25 or 30 years and tries to do for this episode what you and Professor Friedman did for the Great Depression, what's their verdict going to be...?
Schwartz: ...I don't know whether the verdict will be charitable. It's always possible to find reasons why other alternatives were not really available. But I think on the whole the performance has been disappointing. Because now two years and more after Bernanke came into office we don't see visible signs of change for the better.
For me, the failure to develop and quickly implement a plan for removing toxic assets from bank balance sheets has been the biggest policy failure. It's looking now like we may eventually get through this downturn without having ever put an effective toxic asset removal plan in place (though the administration claims they are still trying), and some contend that means we never needed a plan in the first place. But I disagree. We will never know the answer to this counterfactual, but I believe that if we has responded with a program quickly - a year an a half ago say and maybe even before that - I don't think the downturn would have been as severe. Yes, it's a hard problem to value these assets, but that's what made it essential to get it resolved - having assets on bank books that nobody wants anything to do with because their value is unknown is partly what has kept asset markets frozen (and banks that are allowed to overvalue these assets to appear solvent are in no hurry to get this resolved). Getting a toxic asset program in place quickly - even if it meant assuming some risk of losses by the government - would have made a difference.