Thursday, December 31, 2009
David Cay Johnston looks at changes in the tax burden for high income and lower income taxpayers since 1961. The bottom line: 90% of the population did not do well over this time period:
Is Our Tax System Helping Us Create Wealth?, by David Cay Johnston, Commentary, Tax Analysts: ...We have data on the 400 highest-income taxpayers only from 1992 to 2006, and then only thanks to Joel Slemrod of the University of Michigan and others who had these data analyzed, and the Obama administration, which overturned the George W. Bush policy of treating the data as a state secret.
[B]ecause of a quirk in the Statistics of Income report for [1961, it is] easy to compare those at the very top with the bottom 90 percent of Americans. ...[I]t turns out that in 1961, the top income category [had] 398 taxpayers... So by comparing the average income of the top 398, and the taxes they paid, with 2006 dollars, we can compare how people at the apex of the economy were doing 45 years apart. And then by looking at the bottom 90 percent of taxpayers in 1961 and 2006, we can compare the very top with the rest of taxpayers.
The vast majority of Americans saw their incomes rise only modestly in those 45 years. Measured in 2006 dollars, the average income of the bottom 90 percent grew from $22,366 in 1961 to $31,642 in 2006. That is a real increase of $9,276 in average income. But it was also after 45 years, longer than the careers of most workers. ...
For the vast majority, federal income taxes declined. In 1961 these people paid on average 9.6 percent of their income to the federal government. By 2006 this burden had been cut to 7.2 percent. That tax rate reduction saved each of these taxpayers about $760...
That tiny increase in pay does not represent a real increase in wages, only total income. That is because in the middle of that 45-year era, a profound transformation took place in America. In 1961 most families lived on one income, maybe supplemented by some part-time work by the wife... Now two-income households are the norm. ...
America grew and grew during this era. GDP, adjusted for inflation and increased population, was up 227 percent. But wages and fringe benefits did not grow with the economy. For most workers, they fell. Wages peaked way back in 1972-1973, were on a mostly flat trajectory for more than two decades, rose briefly in the late 1990s, and then fell sharply in the new century. ... Millions are out of work, and the jobs they once held are ... not coming back. And even if the Great Recession is coming to an end, we face years of jobs growing more slowly than the working-age population, which could radically transform America’s culture, work ethic, and sense of progress.
In 2006 families worked on average about 900 more hours than families did in the 1960s and early 1970s. That is a roughly 45 percent increase in hours worked... For many, the reality is that two jobs produce the same or a smaller after-tax income than just one job did three and four decades ago. ...
During the 45 years starting in 1961, payroll taxes have gone from a minor levy to almost a sixth of wages for the bottom 90 percent of American households. This $760 in income tax savings that the average taxpayer enjoyed in 2006 was taken back, and more, by the increased tax rates for Social Security and Medicare. Those rates rose from 3 percent withheld from pay in 1961 to 7.65 percent in 2006. Not all income is from wages, of course, but those higher payroll taxes wiped out the seeming reduction in the income tax and more. ...
And at the top? Now, that’s a different story. The average income for the top 400 taxpayers rose over the 45 years from $13.7 million to $263.3 million. That is 19.3 times more.
The income tax bill went up too, but only 7.8 times as much because tax rates plunged. Income tax rates at the top fell 60 percent, three times the percentage rate drop for the vast majority. And at the top, the savings were not offset by higher payroll taxes, which are insignificant to top taxpayers. ...
This combination of explosive growth in income and a 60 percent cut in effective tax rates meant that average after-tax income rose to $210 million in 2006, compared with $7.9 million in 1961. ..
Without a doubt, the much lower tax rates at the top encouraged people to realize more income in the tax system. And if the only measure is that some people made more, then this would be a good. But let’s ask the question that the classical economists would have asked back when they were known as moral philosophers and their leaders spoke of policies that benefited the majority. Let’s go back to a time before Vilfredo Pareto’s observations began what is the overwhelmingly dominant orthodoxy today, neoclassical economics with its focus on gain.
What is the social utility of creating a society whose rules generate a doubling of output per person but provide those at the top with 37 times the gain of the vast majority? ...
Is a ratio of gain of 37 to 1 from the top to the vast majority beneficial? Is it optimal? Does it provide the development, support, and initiative to maximize the nation’s gain? Are we to think that the gains of the top 398 or 400 taxpayers are proportionate to their economic contributions? Does anyone really think that heavily leveraged, offshore hedge fund investments are creating wealth, rather than just exploiting rules to concentrate wealth, while shifting risks to everyone else?
Under the overwhelmingly dominant economic theory of today, this is all good. Pareto argued that if no one was harmed, then all gain was good. Carried to an extreme, neoclassical economics would say that if the bottom 99.9999997 percent had the same income in 1961 and 2006, and all of the gain went to the one other person in America, that would be a good. ...
Is our tax system helping us create wealth and build a stable society? Or is it breeding deep problems by redistributing benefits to the top while maintaining burdens for the rest of Americans?
Think about that in terms of this stunning fact teased from the latest Federal Reserve data by Barry Bosworth and Rosanna Smart for the Brookings Institution: The average net worth of middle-income families with children whose head is age 50 or younger, is smaller today than it was in 1983.
[Note: Tax Notes is a weekly 100-or-so page publication with no ads that is entirely supported by subscribers, as are State Tax Notes and Tax Notes International. It is put out by nonprofit Tax Analysts, to whom we owe a great deal for fighting for almost 40 years to strip away the secrecy behind taxes. David Cay Johnston's column appears every other Monday.]
Wednesday, December 30, 2009
Will the crisis teach economists not to be overconfident about their abilities?
My answer is here.
Sudeep Reddy summarizes a report from the Dallas Fed on "Labor Market Globalization in the Recession and Beyond":
'Virtual' Immigration Continued Rising During Recession, by Sudeep Reddy, Real Time Economics: The global economic downturn spurred declines in physical immigration — the movement of people across borders — in 2008 and 2009. But a new Federal Reserve Bank of Dallas report says “virtual” immigration — moving the work rather than the workers — continued to grow.
“Most likely, the difference stems from the jobs the two types of immigrants typically do,” authors Michael Cox, Richard Alm and Justyna Dymerska write in the Dallas Fed’s Economic Letter. “Physical immigrants work in construction and other highly cyclical industries. Virtual immigrants are more likely to work in the services economy. It has traditionally been less sensitive than goods to cyclical fluctuations, largely because services aren’t subject to the kind of inventory bulges that make goods production unstable.”
Still, virtual immigration increased at a slower pace during the downturn. ... For instance, India’s exports in software and IT services are forecast to continue expanding. But the projected growth rate of 17% for 2009 is less than half the pace of the prior four years. ...
Here are some charts from the report (click on figures for larger versions):
Tuesday, December 29, 2009
It's looking as though the recovery of labor markets will follow the pattern of the last two recessions and lag significantly behind the recovery of output. Additional fiscal policy measures could be used to help employment markets recover faster, so this statement from Christina Romer about the administration's plans to create jobs is good to see. But how much of a priority will job creation be for the administration given that it has other things it would like to accomplish? The amount of political capital that the administration is willing to use to push an expanded version of this legislation forward will say a lot about its true commitment to job creation:
Making job creation a priority, by Christina Romer, Commentary, sfgate.com: President Obama has laid out a series of steps that should be at the heart of our continuing efforts to accelerate job growth, rebuild our economy for the long term, and bring American families relief during these difficult times. ...
Our nation faces double-digit unemployment. Far too many Americans still are struggling to make ends meet. But to understand where we need to go, it's important to look back at where we started. On the first days after the president was elected, our economy was rolling toward the edge of a cliff with ever-increasing momentum.President Obama instructed his economic team to take swift action to stem the tide of crisis. And we did..., we took unprecedented - and often unpopular - action to stave off a total economic collapse.
We worked with Congress to pass the American Recovery and Reinvestment Act, which has already provided tax relief to millions of small businesses and families, saved more than a million jobs and begun to lay the foundation for lasting recovery. ... Today, our economy is growing for the first time in more than a year. Last month, employment was nearly stable and the unemployment rate dropped slightly.
But we understand that talking about what we've accomplished may mean little to someone who is still out of a job. That's why President Obama outlined plans earlier this month to accelerate private-sector job creation in three key areas.
First, because small businesses are the No. 1 driver of job growth in America, the president's plan encourages investment by ... proposing a one-year elimination of the tax on capital gains from new investments in small businesses.
We're also calling for the extension of Recovery Act provisions to give small businesses tax incentives to invest in new equipment and other types of capital goods. We will work with Congress to create a tax cut for small businesses that hire new workers. And we will eliminate fees and increase loan guarantees for small businesses that borrow through the Small Business Administration.
Second, because smart, targeted investments in energy efficiency can help create jobs, we will create new incentives for consumers who invest in energy-efficient retrofits to their homes. And we will expand Recovery Act programs to leverage private investment in energy efficiency and create clean-energy manufacturing jobs.
Finally, the president is calling for investments in a wide range of infrastructure, designed to get out the door as quickly as possible while continuing a sustained effort at creating jobs and improving America's long-run productivity. The infrastructure projects include highway, transit, rail aviation and water projects. ...
These are important steps, but there is still so much work that remains. President Obama ... will not rest until every American who wants a job has one.
State and local governments also need more help, and this could do a lot to save existing jobs, so I'd like to see that on the list as well.
Brad DeLong says the undesirable act of bailing out those who helped to cause the financial crisis is justified by the greater good that came from this policy, but the public does not see it that way:
The Fairness of Financial Rescue, by J. Bradford DeLong, Commentary, Project Syndicate: Perhaps the best way to view a financial crisis is to look at it as a collapse in the risk tolerance of investors in private financial markets. ... [W]hen the risk tolerance of the market crashes, so do prices of risky financial assets. ... This crash in prices of risky financial assets would not overly concern the rest of us were it not for the havoc that it has wrought on the price system... The price system is saying: shut down risky production activities and don’t undertake any new activities that might be risky.
But there aren’t enough safe, secure, and sound enterprises to absorb all the workers laid off from risky enterprises. ... Ever since 1825, central banks’ standard response in such situations – except during the Great Depression of the 1930’s – has been the same: raise and support the prices of risky financial assets, and prevent financial markets from sending a signal to the real economy to shut down risky enterprises and eschew risky investments.
This response is understandably controversial, because it rewards those who ... bear some responsibility for causing the crisis. But an effective rescue cannot be done any other way. A policy that leaves owners of risky financial assets impoverished is a policy that shuts down dynamism in the real economy.
The political problem can be finessed: as Don Kohn, a vice-chairman of the Federal Reserve, recently observed, teaching a few thousand feckless financiers not to over-speculate is much less important than securing the jobs of millions of Americans and tens of millions around the globe. Financial rescue operations that benefit even the unworthy can be accepted if they are seen as benefiting all – even if the unworthy gain more than their share of the benefits.
What cannot be accepted are financial rescue operations that benefit the unworthy and cause losses to other important groups – like taxpayers and wage earners. And that, unfortunately, is the perception held by many nowadays, particularly in the United States.
It is easy to see why.
When Vice Presidential candidate Jack Kemp attacked ... the Clinton administration’s decision to bail out Mexico ... during the 1994-1995 financial crisis, Gore responded that America made $1.5 billion on the deal.
Similarly, Clinton’s treasury secretary, Robert Rubin, and IMF Managing Director Michel Camdessus were attacked for committing public money to bail out New York banks that had loaned to feckless East Asians in 1997-1998. They responded that they had not rescued the truly bad speculative actor, Russia; that they had “bailed in,” not bailed out, the New York banks, by requiring them to cough up additional money to support South Korea’s economy; and that everyone had benefited massively, because a global recession was avoided.
Now, however, the US government can say none of these things. Officials cannot say that a global recession has been avoided; that they “bailed in” the banks; that – with the exception of Lehman Brothers and Bear Stearns – they forced the bad speculative actors into bankruptcy; or that the government made money on the deal.
It is still true that the banking-sector policies that were undertaken were good – or at least better than doing nothing. But the certainty that matters would have been much worse under a hands-off approach to the financial sector, à la Republican Treasury Secretary Andrew Mellon in 1930-1931, is not concrete enough to alter public perceptions. What is concrete enough are soaring bankers’ bonuses and a real economy that continues to shed jobs.
Monday, December 28, 2009
Why Christmas Eve?, by Tim Duy: One would think that policymakers would treat the day before Christmas as sacrosanct, if not for the sake of their employees, but to avoid the endless conspiracy theories that naturally arise when you partake in activities that look like they are intended to fly under the radar. Has US Treasury Secretary Timothy Geithner learned nothing in his long tenure serving Goldman Sachs the people of the United States of America? Ignoring the wisdom of the ages, Geithner made what appears to be unlimited funds available to Freddie Mac and Fannie Mae on the day when most of the nation is more concerned about getting presents under the tree (myself personally content that I can squeeze yet another year of magic under the Santa Claus myth) than the policy machinations of Washington.
But do we really care? Is this really a new news, or just a matter of questionable timing? Would the same announcement today have raised the ire of the blogoshpere?
To get at this issue, we should back up to a New York Times article a few weeks back (hat tip to Dean Baker):
Fannie Mae and Freddie Mac, which buy and resell mortgages, have used $112 billion — including $15 billion for Fannie in November — of a total $400 billion pledge from the Treasury. Now, according to people close to the talks, officials are discussing the possibility of increasing that commitment, possibly to $400 billion for each company, by year-end, after which the Treasury would need Congressional approval to extend it. Company and government officials declined to comment.
Apparently this little item was lost in the Christmas rush - seriously, could this even compare to the endless fascination with the status of holiday sales? The point is that hanging in the background was the likelihood that Mae and Mac were expecting some very, very bad fourth quarter numbers. Indeed, despite the massive efforts to support the housing market, Fannie Mae reported today that serious delinquencies continue to climb at an alarming rate. So, at second glance, Treasury's Christmas Eve announcement looks somewhat less disconcerting. The timing questionable, but the outcome expected. But why the essentially unlimited access to funds? I think this is pretty straightforward - Geithner simply lifted illusion (delusion?) that the GSEs were anything less than backed by the full faith and credit of the Uncle Sam. Seriously, at this juncture who believes that GSE debt is any different than Treasury debt? Or that the US will not pump in any amount of dollars necessary to keep the GSEs afloat?
That said, the Treasury's press release was bereft of explanatory information, giving rise to a host of theories as chronicled by Calculated Risk. In my mind, the most appealing of these explanations (other than that stated above) is the supposed intention to use the GSEs to absorb dysfunctional mortgages in an effort to revive floundering modification programs. Why? Because, as structured, modifications just simply don’t work in aggregate. I have thought this from day one of the modification story. And, frankly, I don’t think I am particularly insightful on this point. Seems obvious. Suppose homeowner A is underwater on a mortgage costing $4,000 a month for a property that now has a rental equivalent of $2,000. How exactly does it help that homeowner to "modify" their mortgage to $3,000 a month? They are still underwater, and they will likely have to sacrifice any potential gains (10-20 years down the road!). The modification leaves you with the choice of being a virtual renter for $3,000 a month or an actual renter for $2,000 a month. Moreover, what truly is better for the economy? To free up $2,000 in the household's monthly budget via a balance sheet restructuring, or to weigh down the household balance sheet with an impossible debt burden?
The Wall Street Journal recently printed a front page article on this topic that I thought was spot on:
Did Enron change everything?:
Might Krugman's polemic prediction about Enron vs. 9-11 ever come true?, by Michael Roberts: I look at our financial and economic system in dumbfounded awe as to how it all works. We shovel trillions of dollars into banks, stocks and mutual funds, rarely knowing the first thing about how well the underlying companies are managed or how profitable they are or what they are truly doing with our money. While I think I'm more informed than the average investor, I couldn't tell you which 10 CEOs are most responsible for my investments. I couldn't even tell you the top 10 companies! ...
The fact that I do invest shows I have remarkable confidence in our financial system. That confidence is based on history, the fact that firms and CEOs have been honest and transparent enough in their accounting and that, over the long run, the stock market has performed extremely well. The long sweep of history says I'm crazy not to invest.
But then I look at recent history and I wonder how the long history came to be. Honest and transparent are not adjectives that come easily to mind when looking at our modern financial system and events over the last decade.
This issue is in fact the lynch pin to modern capitalism. At a fundamental level what makes it all work is to having institutions that deal effectively with asymmetric information (the econ jargon). If one cannot see exactly what they are buying with their investment money, little investment will take place, and economies don't grow. So modern capitalism requires rock solid institutions that reduce information asymmetries and allow dollars to flow toward investments with the greatest potential returns.
This is why, back in 2002, Paul Krugman made what I think was his most polemic prediction ever:
I predict that in the years ahead Enron, not Sept. 11, will come to be seen as the greater turning point in U.S. society.
Many, including me, thought this was a bit much, even if Krugman made some good points in that old column. His column today, a tribute the naughties, echos similarly to his 2002 prediction...
Krugman was worried about the collapse of our financial institutions and saw Enron as an omen. ... And here we are. Things didn't collapse completely but it wasn't pretty. While we've begun to recover (barely) many problems still need fixing, particularly re-regulation of financial markets.
I still think Krugman overstepped when he made that prediction in 2002, not just because the Enron fallout blew over relatively quickly, but because the sweeping fallout of 9/11 has been so great. But today I do think there is a chance ... that Krugman's prediction might eventually turn out to be right after all. ...
What's disappointing is that after Enron, and after what just happened, things might not change, at least not by very much. As Krugman notes, we seem unwilling to learn from our mistakes:
Even as the dot-com bubble deflated, credulous bankers and investors began inflating a new bubble in housing. Even after famous, admired companies like Enron and WorldCom were revealed to have been Potemkin corporations with facades built out of creative accounting, analysts and investors believed banks’ claims about their own financial strength and bought into the hype about investments they didn’t understand. Even after triggering a global economic collapse, and having to be rescued at taxpayers’ expense, bankers wasted no time going right back to the culture of giant bonuses and excessive leverage.
Part of it is transparency, and more is certainly needed, and perhaps it is an inability to learn from mistakes, but a bigger problem is the distribution of economic and political power. Business interests are dominant in Washington, and these powerful interests will do what they can to resist constraints on their behavior no matter what lessons the rest of us may have learned from their actions in the past. It is not at all clear that the political will needed to overcome the opposition of business groups and make the needed regulatory and legislative changes is present. Unless and until the political will is there, and if this crisis doesn't do it I'm not sure what will, we'll be in danger of repeating the same mistakes yet again. Congress might surprise and take tough action if and when the financial reform process currently underway is complete, but I'm not expecting that to happen.
It is not illegal to have monopoly power, but there are limits on how that power can be used. Has Google crossed over the line?:
Search, but You May Not Find. by Adam Raff, Commentary, NY Times: ...Today, search engines like Google, Yahoo and Microsoft’s new Bing have become the Internet’s gatekeepers, and the crucial role they play in directing users to Web sites means they are now as essential a component of its infrastructure as the physical network itself. The F.C.C. needs to look [at]... “search neutrality”: the principle that search engines should have no editorial policies other than that their results be comprehensive, impartial and based solely on relevance.
The need for search neutrality is particularly pressing because so much market power lies in the hands of one company: Google. With 71 percent of the United States search market (and 90 percent in Britain), Google’s dominance of both search and search advertising gives it overwhelming control. ...
One way that Google exploits this control is by imposing covert “penalties” that can strike legitimate and useful Web sites, removing them entirely from its search results or placing them so far down the rankings that they will in all likelihood never be found. For three years, my company’s vertical search and price-comparison site, Foundem, was effectively “disappeared” from the Internet in this way.
Another way that Google exploits its control is through preferential placement. With the introduction in 2007 of what it calls “universal search,” Google began promoting its own services at or near the top of its search results... Google now favors its own price-comparison results..., its own map results..., its own news results..., and its own YouTube results for video queries. And Google’s stated plans for universal search make it clear that this is only the beginning.
Because of its domination of the global search market and ability to penalize competitors while placing its own services at the top of its search results, Google has a virtually unassailable competitive advantage. And Google can deploy this advantage well beyond the confines of search to any service it chooses. Wherever it does so, incumbents are toppled, new entrants are suppressed and innovation is imperiled. ...
The preferential placement of Google Maps helped it unseat MapQuest from its position as America’s leading online mapping service virtually overnight. ... Without search neutrality rules to constrain Google’s competitive advantage, we may be heading toward a bleakly uniform world of Google Everything — Google Travel, Google Finance, Google Insurance, Google Real Estate, Google Telecoms and, of course, Google Books.
Some will argue that Google is itself so innovative that we needn’t worry. But the company isn’t as innovative as it is regularly given credit for. Google Maps, Google Earth, Google Groups, Google Docs, Google Analytics, Android and many other Google products are all based on technology that Google has acquired rather than invented. Even AdWords and AdSense ... are essentially borrowed inventions...
Google ... now faces a difficult choice. Will it embrace search neutrality...? Or will it try to argue that discriminatory market power is somehow ... harmless in the hands of an overwhelmingly dominant search engine? ...
Will the beginning of a new decade bring an end to the Great Stagnation?:
The Big Zero, by Paul Krugman, Commentary, NY Times: Maybe we knew, at some unconscious, instinctive level, that it would be an era best forgotten. Whatever the reason, we got through the first decade of the new millennium without ever agreeing on what to call it. The aughts? The naughties? Whatever. ...
But from an economic point of view, I’d suggest that we call the decade past the Big Zero. It was a decade in which nothing good happened, and none of the optimistic things we were supposed to believe turned out to be true.
It was a decade with basically zero job creation..., private-sector employment has actually declined — the first decade on record in which that happened.
It was a decade with zero economic gains for the typical family. Actually, even at the height of the alleged “Bush boom,” in 2007, median household income adjusted for inflation was lower than it had been in 1999. And you know what happened next.
It was a decade of zero gains for homeowners...: right now housing prices, adjusted for inflation, are roughly back to where they were at the beginning of the decade. ... Almost a quarter of all mortgages ... are underwater, with owners owing more than their houses are worth.
Last and least for most Americans — but a big deal for retirement accounts, not to mention the talking heads on financial TV — it was a decade of zero gains for stocks, even without taking inflation into account. Remember the excitement when the Dow first topped 10,000...? Well, that was back in 1999. Last week the market closed at 10,520.
So there was a whole lot of nothing going on in measures of economic progress or success. Funny how that happened.
For as the decade began, there was an overwhelming sense of economic triumphalism in America’s business and political establishments, a belief that we — more than anyone else in the world — knew what we were doing. ...
Let me quote from a speech that Lawrence Summers, then deputy Treasury secretary..., gave in 1999. ... [quote] ... Mr. Summers — and ... just about everyone in a policy-making position at the time — believed ... America has honest corporate accounting; this lets investors make good decisions, and also forces management to behave responsibly; and the result is a stable, well-functioning financial system.
What percentage of all this turned out to be true? Zero.
What was truly impressive about the decade past, however, was our unwillingness, as a nation, to learn from our mistakes.
Even as the dot-com bubble deflated, credulous bankers and investors began inflating a new bubble in housing. Even after famous, admired companies like Enron and WorldCom were revealed to have been Potemkin corporations with facades built out of creative accounting, analysts and investors believed banks’ claims about their own financial strength and bought into the hype about investments they didn’t understand. Even after triggering a global economic collapse, and having to be rescued at taxpayers’ expense, bankers wasted no time going right back to the culture of giant bonuses and excessive leverage.
Then there are the politicians. Even now, it’s hard to get Democrats, President Obama included, to deliver a full-throated critique of the practices that got us into the mess we’re in. And as for the Republicans: now that their policies of tax cuts and deregulation have led us into an economic quagmire, their prescription for recovery is — tax cuts and deregulation.
So let’s bid a not at all fond farewell to the Big Zero — the decade in which we achieved nothing and learned nothing. Will the next decade be better? Stay tuned. Oh, and happy New Year.
Sunday, December 27, 2009
Arvind Subramanian defends economics:
How economics managed to make amends, by Arvind Subramanian, Commentary, Financial Times: In 2008, as the global financial crisis unfolded, the reputation of economics as a discipline and economists as useful policy practitioners seemed to be irredeemably sunk. Queen Elizabeth captured the mood when she asked pointedly why no one (in particular economists) had seen the crisis coming. There was no doubt that, notwithstanding the few Cassandras who correctly prophesied gloom and doom, the profession had failed colossally. ...
But crises will always happen and ... their timing, form and provenance will elude prognostication. Most crises, notably the big ones, creep up on us from unsuspected quarters. ... So, if the value of economics in preventing crises will always be limited (although hopefully not non-existent), perhaps a fairer and more realistic yardstick should be its value as a guide in responding to them. Here, one year on, we can say that economics stands vindicated.
How so? Recall that the recession of the late 1920s in the US became the Great Depression, owing to a combination of three factors: overly tight monetary policy; overly cautious fiscal policy...; and dramatic recourse to beggar-thy-neighbour policies, including competitive devaluations ... and increases in trade barriers. The impact of this global financial crisis has been significantly limited because on each of these scores, the policy mistakes of the past were strenuously and knowingly avoided. ...
What is striking about the influence of economics is that similar policy responses in the fiscal and monetary areas, and non-responses in relation to competitive devaluations and protectionism, were crafted across the globe. They were evident in emerging market economies and developing countries as much as in the industrial world; in red-blooded capitalist countries as well as in communist China and still-dirigiste India. If ever there was a Great Consensus, this was it.
If the Great Depression had not happened 80 years before,... perhaps 2009 might have turned out differently. But... We were not condemned to repeat the mistakes of history because the economics profession had learnt and distilled the right lessons from that event.
For sure, we have not learnt all the lessons; we may even have learnt some wrong ones. It is also probable that we are setting the stage for future crises... So, economics is bound to fail again. But the avoidance of the Greatest Depression that could so easily have happened in 2009 is an outcome the world owes to economics; at the least, it is the discipline’s atonement for allowing the crisis of 2008 to unfold.
The split developing within the Democratic Party is worrisome. Old fault lines that were on display in events like the WTO protests in Seattle are opening again. They were never really closed, just united against a common cause, that of defeating Republicans. But now that Democrats have power again, we are seeing the reemergence of the evil multinational corporations and the politicians they control as the focal point of anger for one side of the dispute. Health care reform and the bailout of the financial system, both of which are seen as serving the needs of corporations rather than the populace, have helped to stir things up.
The other side doesn't think corporations are evil per se, e.g. both globalization and financial innovation have their positive aspects. This side believes bailout of the financial system was necessary to save Main Street, it wasn't just a giveaway to the executives in mega-banks, and that health care reform makes real progress, it is not just a giveaway to insurance companies. Progress toward goals is important, even if political realities mean that some principles must compromised in order to move forward. The nature of those compromises, and the extent to which they are driven by money and power rather than the needs of the people politicians are supposed to represent, is part of the dispute.
With financial reform still to come, I'm not sure I want to tone down the anger just yet -- it could be useful in getting politicians to enact needed reform of the financial sector (though I worry they will go to far and do damage to institutions such as the Fed). This could also be useful when the deficit hawks turn their sights on programs such as Social Security. But more generally this is not a healthy state of affairs for Democrats, and it's a split that could easily be exploited by Republicans in coming elections.
I'm not sure I've fully captured or correctly characterized the source of the division, so let me turn it over to all of you. How would you characterize the split? Can the two sides be brought together?
Saturday, December 26, 2009
Robert Shiller wants people to be able to take stock in America:
A Way to Share in a Nation’s Growth, by Robert J. Shiller, Commentary, NY Times: Corporations raise money by issuing both debt and equity, the latter giving investors an implicit share in future profits. Governments should do something like this, too, and not just rely on debt.
Borrowing a concept from corporate finance, governments could sell a new type of security that commits them to paying shares in national “profit,” as measured by gross domestic product. ... Such securities might help assuage doubts that governments can sustain the deficit spending required to keep sagging economies stimulated... In a recent pair of papers, my Canadian colleague Mark Kamstra ... and I have proposed a solution. We’d like our countries to issue securities that we call “trills,” short for trillionths. ...
Each trill would ... pay in perpetuity, and in domestic currency, a quarterly dividend equal to a trillionth of the nation’s quarterly nominal G.D.P. If substantial markets could be established..., trills would be a major new source of government funding. Trills would be issued with the full faith and credit of the respective governments. ... The market price of trills would fluctuate, reflecting the changing prospects for future G.D.P. growth, just as the market price of stocks reflects the changing prospects for future earnings growth. There is no complexity here. It is all plain-vanilla financing, though unconventional by today’s standards.
There are indications that officials in China are starting to worry about threats to their huge investment in United States debt from a possible outbreak of high inflation. The trills, tied to nominal G.D.P., would protect them. Right now TIPS, or Treasury Inflation-Protected Securities, are offering disappointingly low yields... Trills, even at an ultralow dividend yield, would seem more exciting as an inflation-protected prospect, because they represent a share in future economic growth.
The United States government is highly unlikely to default on its debt, but even this remote possibility would be virtually eliminated by trills, because the government’s dividend burden would automatically decline in tough times, when G.D.P. declined. ...
In fact, issuing shares in G.D.P. might even be viewed as a policy that systematically rectifies a wide array of imbalances in capital flows. People who expect strong economic growth in a country would bid up the price of a claim on its G.D.P., creating a cheap source of funding for the issuing government. So a country with good investment prospects gets the resources at a low current cost. There would be no need for central bank machinations to try to correct global imbalances. ...
Someday, China might issue shares in its G.D.P..., and international investors who would love to participate in its economic miracle might put a very high price on them. That could help secure international financing of future growth without relying on the enormous government and enterprise saving that is now suppressing China’s standard of living.
Proposals for securities like trills have been aired many times over the years. ... So far, these proposals have gone unheeded. But the current environment may be more suitable for them.
This shifts risk around a bit, etc., but I can't say I'm convinced this is some sort of magic means of financing government activities.
Does gold provide a good hedge against inflation and exchange rate risk?:
Is Gold a Good Hedge?, by Martin Feldstein, Commentary, NY Times: As I walked through the airport in Dubai recently, I was struck by the large number of travelers who were buying gold coins. They were ... joining the eager rush to own gold before its price rises even further. Such behavior has pushed the price of gold from $400 an ounce in 2005 to more than $1100 an ounce in December 2009.
Individual buying of gold goes far beyond ... gold coins... In addition to buying coins..., individuals are buying kilogram gold bars, exchange-traded funds that represent claims on physical gold, gold futures, and shares in gold-mining companies... And gold buyers include ... sophisticated institutions and sovereign wealth funds. ...
Many gold buyers want a hedge against the risk of inflation or possible declines in the value of the dollar or other currencies. Both are serious potential risks that are worthy of precautionary hedges. ... But is gold a good hedge against these two risks? ... The short answer is no...
Consider first the potential of gold as an inflation hedge. The price of an ounce of gold in 1980 was $400. Ten years later, the ... price of gold was still $400, having risen to $700 and then fallen back.... And by the year 2000, when the US consumer price index was more than twice its level in 1980, the price of gold had fallen to about $300 an ounce. Even when gold jumped to $800 an ounce in 2008, it had failed to keep up with the rise in consumer prices since 1980.
So gold is a poor inflation hedge. Moreover, the US government provides a very good inflation hedge in the form of Treasury Inflation Protected Securities (TIPS). ... Of course, investors who don’t want to tie up their funds in low-yielding government bonds can buy explicit inflation hedges as an overlay to their other investments.
Gold is also a poor hedge against currency fluctuations. A dollar was worth 200 yen in 1980. Twenty-five years later, the exchange rate had strengthened to 110 yen per dollar. Since gold was $400 an ounce in both years, holding gold did nothing to offset the fall in the value of the dollar. A Japanese investor who held dollar equities or real estate could instead have offset the exchange rate loss by buying yen futures. The same is true for the euro-based investor who would not have gained by holding gold but could have offset the dollar decline by buying euro futures.
In short, there are better ways than gold to hedge inflation risk and exchange-rate risk. TIPS, or their equivalent..., provide safe inflation hedges, and explicit currency futures can offset exchange-rate risks. Nevertheless,... gold ... may be a very good investment. After all, the dollar value of gold has nearly tripled since 2005. And gold is a liquid asset that provides diversification in a portfolio of stocks, bonds, and real estate.
But gold is also a high-risk and highly volatile investment. Unlike common stock, bonds, and real estate, the value of gold does not reflect underlying earnings. Gold is a purely speculative investment. Over the next few years, it may fall to $500 an ounce or rise to $2,000 an ounce. There is no way to know which it will be. Caveat emptor .
Friday, December 25, 2009
I hope everyone had a nice Christmas.
Why are so many people complaining about the health reform legislation that just passed the Senate?:
Tidings of Comfort, by Paul Krugman, Commentary, NY Times: Indulge me while I tell you a story — a near-future version of Charles Dickens’s “A Christmas Carol.” It begins with sad news:... Tiny Tim, is sick. And his treatment will cost far more than his parents can pay out of pocket.
Fortunately, our story is set in 2014, and the Cratchits have health insurance. Not from their employer: Ebenezer Scrooge doesn’t do employee benefits. And just a few years earlier they wouldn’t have been able to buy insurance on their own because Tiny Tim has a pre-existing condition, and, anyway, the premiums would have been out of their reach.
But reform legislation enacted in 2010 banned insurance discrimination on the basis of medical history and also created ... subsidies to help families pay for coverage. Even so, insurance doesn’t come cheap — but the Cratchits do have it, and they’re grateful. God bless us, everyone.
O.K., that was fiction, but there will be millions of real stories like that in the years to come. ... So why are so many people complaining? There are three main groups of critics.
First, there’s the crazy right, the tea party and death panel people — a lunatic fringe that ... has moved into the heart of the Republican Party. In the past, there was a general understanding ... that major parties would at least pretend to distance themselves from irrational extremists. But those rules are no longer operative. No, Virginia, at this point there is no sanity clause.
A second strand of opposition comes from ... the Bah Humbug caucus: fiscal scolds who routinely issue sententious warnings about rising debt. By rights, this caucus should find much to like in the Senate health bill, which the Congressional Budget Office says would reduce the deficit...
But, with few exceptions, the fiscal scolds have had nothing good to say about the bill. ... As Slate’s Daniel Gross says, what really motivates them is “the haunting fear that someone, somewhere, is receiving social insurance.”
Finally, there has been opposition from some progressives... Some would settle for nothing less than a full, Medicare-type, single-payer system. Others had their hearts set on ... a public option... And there are complaints that the subsidies are inadequate... But those complaints don’t add up to a reason to reject the bill. ...
The truth is that there isn’t a Congressional majority in favor of anything like single-payer. There is a narrow majority in favor of a ... moderately strong public option. ... But given the ... Senate rules..., it takes 60 votes to do almost anything. And that..., combined with total Republican opposition, has placed sharp limits on what can be enacted.
If progressives want more, they’ll have to make changing those Senate rules a priority. They’ll also have to work long term on electing a more progressive Congress. But, meanwhile, the bill the Senate has just passed ... is more or less what the Democratic leadership can get.
And for all its flaws..., it’s a great achievement. It will provide real, concrete help to tens of millions of Americans and greater security to everyone. And it establishes the principle — even if it falls somewhat short in practice — that all Americans are entitled to essential health care.
Many people deserve credit for this moment. What really made it possible was the remarkable emergence of universal health care as a core principle during the Democratic primaries... — an emergence that, in turn, owed a lot to progressive activism. ...
So progressives shouldn’t stop complaining, but they should congratulate themselves on what is, in the end, a big win for them — and for America.
Thursday, December 24, 2009
Here's a repeat from previous years, the Gutenberg EBook: Twas The Night Before Christmas (other repeats, some of which didn't go over so well with everyone: What Happens at the North Pole Stays at the North Pole..., Is There a Santa Clause?, and "Sinte Klaas"):
The excess capacity series (red line) peaked in June of this year, and has been moving downward ever since. If the pattern in the two most recent recessions holds, those in 1990-91 and 2001, the peak in the unemployment rate will come between 16 and 19 months after the peak in excess capacity, i.e. around a year from today (though prior to 1990 the peaks were coincident).
The most recent data on the unemployment rate showed a downward tick from 10.2 percent to 10.0 percent, so perhaps unemployment has already peaked and the lag will be shorter this time. But perhaps not. As an inspection of the unemployment series in the graph shows, the unemployment rate bounces around even when it is trending upward or downward. So it's hard to tell from one month's data whether the downward tick in the unemployment rate is temporary and unemployment still has a ways to go before peaking (as in the last two recessions), or a sign that a turning point has been reached and things are getting better (which would represent a reversion to the more coincident movement in the two series observed before 1990).
Note, however, that in the 2001 recession, unemployment fell briefly just after excess capacity peaked, but then resumed its upward movement for several more months before reaching a turning point 19 months after the turning point in excess capacity. Thus, while the recent downward tick in the unemployment rate is good news, certainly better than an uptick, we should be prepared for the possibility that the pattern in the last recession might repeat itself and unemployment will head back upward for several more months before it reaches its peak. I hope that doesn't happen, the sooner unemployment returns to normal the better, but we need to be better prepared than we are for the very real possibility that unemployment will continue to trend upward. I'd like to see more done on both the monetary and fiscal policy fronts as a preemptive measure, we can always ease off if things turn our better than expected, but at the very least we need to resist calls from the deficit and inflation hawks to begin pulling back and continue the programs that are already in place.
[Question: What happened from mid 1997 through the beginning of 1999 that caused the two series to move in opposite directions and separate?]
Update: Paul Krugman follows up here.
Wednesday, December 23, 2009
Hans-Werner Sinn is unhappy with the US financial system. He says "Europeans trusted a system that was untrustworthy," and that resulted in big losses for European banks:
Insecure Securities, by Hans-Werner Sinn, Commentary, Project Syndicate: ...For years, hundreds of billions of new mortgage-backed securities (MBSs) and collateralized debt obligations (CDOs) generated from them were sold to the world to compensate for the lack of savings in the United States and to finance American housing investment. Now virtually the entire market for new issues of such securities – all but 3% of the original market volume – has vanished.
To compensate for the disappearance of that market, and for the simultaneous disappearance of non-securitized bank lending to American homeowners, 95% of US mortgages today are channeled through the state institutions Fannie Mae, Freddie Mac, and Ginnie Mae. Just as there was a time when collateralized securities were safe, there was also a time when economies with so much state intervention were called socialist.
Most of these private securities were sold to oil-exporting countries and Europe, in particular Germany, Britain, the Benelux countries, Switzerland, and Ireland. China and Japan shied away from buying such paper.
As a result, European banks have suffered from massive write-offs on toxic American securities. According to the International Monetary Fund, more than 50% of the pre-crisis equity capital of Western Europe’s national banking systems, or $1.6 trillion, will have been destroyed by the end of 2010... Thus, the resource transfer from Europe to the US is similar in size to what the US has spent on the Iraq war ($750 billion) and the Afghanistan war ($300 billion) together.
Americans now claim caveat emptor : Europeans should have known how risky these securities were when they bought them. But even AAA-rated CDOs, which the US ratings agencies had called equivalent in safety to government bonds, are now only worth one-third of their nominal value. Europeans trusted a system that was untrustworthy. ...
For years, the US had a so-called “return privilege.” It earned a rate of return on its foreign assets that was nearly twice as high as the rate it paid foreigners on US assets. One hypothesis is that this reflected better choices by US investment bankers. Another is that US ratings agencies helped fool the world by giving triple-A ratings to their American clients, while aggressively downgrading foreign borrowers. This enabled US banks to profit...
Indeed, it is clear that ratings were ridiculously distorted. While a big US rating agency gave European companies, on average, only a triple-B rating in recent years, CDOs based on MBSs easily obtained triple A-ratings. ... And according to an NBER working paper by Efraim Benmelech and Jennifer Dlugosz, 70% of the CDOs received a triple-A rating even though the MBSs from which they were constructed had just a B+ rating, on average, which would have made them unmarketable. The authors therefore called the process of constructing CDOs “alchemy,” the art of turning lead into gold.
The main problem with US mortgage-based securities is that they are non-recourse. A CDO is a claim against a chain of claims that ends at US homeowners. None of the financial institutions that structure CDOs is directly liable for the repayments they promise...
Only the homeowners are liable. However, the holder of a CDO or MBS would be unable to take these homeowners to court. And even if he succeeded, homeowners could simply return their house keys...
The problem was exacerbated by fraudulent, or at least dubious, evaluation practices. ... The US will have to reinvent its system of mortgage finance in order to escape the socialist trap into which it has fallen. A minimal reform would be to force banks to retain on their balance sheets a certain proportion of the securities that they issue. That way, they would share the pain if the securities are not serviced – and thus gain a powerful incentive to maintain tight mortgage-lending standards.
An even better solution would be to go the European way: get rid of non-recourse loans and develop a system of finance based on covered bonds, such as the German Pfandbriefe . If a Pfandbrief is not serviced, one can take the issuing bank to court. If the bank goes bankrupt, the holder of the covered bond has a direct claim against the homeowner... And if the homeowner goes bankrupt, the home can be sold to service the debt.
Since their creation in Prussia in 1769 under Frederick the Great, not a single Pfandbrief has defaulted. Unlike the financial junk pouring out of the US in recent years, covered bonds are a security that is worthy of the name.
"I meant what I said and I said what I meant, an elephant's faithful, 100 percent":
Everyone's Defaulting, Why Don't You?, by Daniel Gross, Commentary, Slate: Strategic defaults—...people who could continue to make payments on ... their homes deciding to walk away...—are rising. According to the Wall Street Journal, strategic defaults are likely to exceed 1 million in 2009. This is making some worry about the very future of capitalism. Georgetown University business ethics professor George Brenkert told the Journal that borrowers who can afford to stay current are morally required to do so, and that were Americans to conclude they could just walk away from obligations, it would be disastrous. ... Megan McArdle expressed disdain for people who chose to indulge themselves on consumer goods and services while not keeping current with their mortgages.
Um, do any of these people read the Wall Street Journal? Strategic defaults are the American way... Deep-pocketed companies, billionaires, and institutions that can afford to stay current on payments strategically default all the time.
Morgan Stanley, for example, is a gigantic corporation. As of the second quarter, it boasted total capital of $213.2 billion. It certainly has the ability to make good on obligations... But earlier this month Morgan Stanley said it would turn over five San Francisco office buildings to lenders rather than pay the debt on them. Why? ... "This isn't a default or foreclosure situation," spokeswoman Alyson Barnes told Bloomberg News. "We are going to give them the properties to get out of the loan obligation." Smells like a strategic default to me.
It's not just happening in real estate. According to Standard & Poor's, through Dec. 18, 262 corporations had defaulted on bonds they had sold to the public, twice the total of 2008 and "the highest default count since our series began in 1981."... Sometimes companies default on these bonds because they're broke (see: Lehman Bro.). But sometimes they simply default because they don't want to pay out for them. Investors and managers, who have spent hundreds of millions of dollars on personal toys, aircraft, headquarters buildings, and compensation, simply can't seem to find the cash to stay current on debts. ...
There's no doubt that homeowners are defaulting strategically. And the surprise may be that, given market conditions, there aren't more strategic defaults. A paper by University of Arizona law professor Brent White suggests that bourgeois values are actually keeping people from walking away from bad home loans. Most people underwater on their mortgages stay current "as a result of two emotional forces: 1) the desire to avoid the shame and guilt of foreclosure; and 2) exaggerated anxiety over foreclosure's perceived consequences." In addition, he notes, societal norms push individuals "to ignore market and legal norms under which strategic default might not only be a viable option, but also the wisest financial decision."
Of course, corporate managers and financiers don't suffer from these neuroses. Do you think billionaire investor Sam Zell feels any guilt or shame because his buyout of the Tribune Co., which had $12.9 billion in debt, ended in a Chapter 11 filing...? Rather than worry about whether Americans will take cues from modest homeowners who make a tough decision not to stay current on debt, perhaps we should worry about middle-class Americans taking cues from billionaires and Fortune 500 companies...
Tuesday, December 22, 2009
I have been more skeptical than most about the ability of quantitative easing to stimulate output and employment, so I thought I'd counter that with this explanation of how QE works, what might go wrong, and some of the evidence in its favor.
[My doubts come on two fronts. The first is the ability of QE to affect long-term real rates, and the evidence is somewhat favorable on this point, though not 100 percent compelling. It does seem that the Fed can lower long-term real rates, mortgage rates in particular, though why we want to stimulate investment in new housing in the aftermath of an housing bubble is a question we might want to ask.
My second objection is related to this - even if we do lower long-run real mortgage rates, will that stimulate new investment in housing given the inventory problem that already exists, and given the condition of the economy? I'm doubtful, and that doubt extends generally. The mechanism described below relies upon lower real interest rates stimulating new investment, but even if long-term rates fall across the board, will firms be inclined to go out and buy new factories and equipment when so much of what they have is sitting idle?
Fiscal policy can put these resources to work directly, but monetary policy must induce firms to invest (or induce households to purchase housing and durables), and in a recession that may be hard to do. That's why I've emphasized fiscal policy, and that is what my objection is mostly about. The focus on the Fed has made it appear that monetary rather than fiscal policy is our best bet at this point. Monetary policy might be able to help for the reasons explained below, so I have no objection to trying, but fiscal policy needs to take the lead.
I should acknowledge that it may not be politically possible at this point to do more on the fiscal policy front, and the 3.5 percent growth rate for third quarter GDP that turned out to be a false signal didn't help at all (note, however, that the Fed is equally unlikely to respond to calls for it to do more). But there did seem to be momentum building toward providing more help through fiscal policy -- there was even a jobs summit -- however the talk about fiscal policy suddenly ended as people turned their guns on the Fed. While that may have been needed to get the Fed thinking harder about what more it can do, we should have also kept up the pressure on fiscal authorities. That fiscal authorities have been let off the hook is disappointing]:
Conducting Monetary Policy when Interest Rates Are Near Zero, by Charles T. Carlstrom and Andrea Pescatori, Economic Commentary, FRB Cleveland: This Economic Commentary explains the concerns that are associated with the combination of deflation, low economic activity, and zero nominal interest rates and describes how monetary policy might be conducted in such a situation. We argue that avoiding expectations of deflation is key and that the monetary authority needs to demonstrate an unequivocal commitment to preventing deflation. We also argue that price-level targeting might be a good device for communicating such a commitment.
While business cycles are inevitable, there is quite broad agreement among economists and policymakers that monetary policy can and should be used to damp fluctuations in economic activity. But some fluctuations can occur in an unusual economic environment in which the traditional tools of monetary policy become useless. When short-term interest rates are at or near zero, for example, monetary policy cannot be implemented in the usual way—by adjusting these short-term interest rates. If policymakers want to lower rates in such an environment, they must look for alternative ways of conducting policy. With the federal funds rate hovering just above zero since December 2008, the current U.S. economic situation is a case in point. To conduct monetary policy under these conditions, the Federal Reserve has had to turn to a new strategy and new tools.
Some economists have pointed to another problem that an environment of near-zero interest rates could pose for monetary policy. They suggest that the inability to lower interest rates could allow a sudden and unexpected fall in the demand for goods and services to push the economy into a deflationary spiral, a situation in which falling prices and falling output feed upon each other. The fear is that a negative demand shock that pushes down prices (in short, a deflationary shock) could further decrease output, thereby accentuating the deflationary process. This additional deflation will then lead to further output decline. Paul Krugman, the economist and New York Times columnist, has dubbed this downward spiral a “black hole,” from where there is no return.1
This Economic Commentary explains the concerns that are associated with the combination of deflation, low economic activity, and zero nominal interest rates and describes some of the ways in which monetary policy might be conducted in this situation. We conclude by emphasizing that to be effective in an environment of zero short-term nominal interest rates, monetary policy needs to be unequivocally committed to avoiding expectations of deflation. We also argue that price-level targeting might be a good device for communicating such a commitment. While this policy prescription follows from the assumption that the zero interest rate bound is a consequence of a negative demand shock hitting the economy, it is worth stressing that falling prices can also be the consequence of a supply shock, namely particularly high productivity growth (not a bad thing!). This would clearly call for different policy actions than the ones described here.
[Also posted at CBS MoneyWatch]
When it was announced two months ago that GDP had grown by 3.5 percent in the third quarter of this year, it took the sails out of any movement toward another stimulus package. Now the number has been revised downward to 2.2 percent.
At a growth rate of 3.5 percent, the economy would be growing slightly faster than the long-run trend so that, although progress would be very, very slow, the economy would at least be catching up to the long-run trend (in the recovery from previous recessions, it was not unusual for GDP to grow at 6 or 7 percent, but even at those high growth rates the recovery takes time). At a growth rate of 2.2 percent, the economy is not even treading water let alone making up for past losses.
The economy needs more help, but they way in which the GDP numbers arrived, with the 3.5 percent initial figure heralded as the sign that better times were just around the corner, undermined the case for a new fiscal stimulus package and likely caused the Fed to back off of any further plans it might have had to do more to help the economy recover. Now we know the 3.5 percent figure was overly optimistic, but two months have passed and any momentum towards providing additional stimulus has largely faded from discussion.
This points to the fact that policymakers need better and more timely data. The fourth quarter is almost over yet we are still trying to figure out what happened in the third quarter, and we still don't know for sure. There has been lots of criticism of how policymakers have reacted in this recession, much of it deserved, but little of that discussion has recognized the data problems. I don't know for sure what the problems are in collecting data in nearly real time, or if data collection can be improved, but it seems we can do better in the digital age sand it would certainly be worthwhile for Congress to look into this carefully and see if some investment into data collection would be helpful. If we can give policymakers better and more timely guidance about the state of the economy, it could improve policy considerably, and that would be money well spent.
In any case, let me say one more time as loudly as I can that given the data that we do have, it's clear that the economy -- the labor market in particular -- needs more help.
It seems that Harvard's Raj Chetty was a motivated student:
Chetty finished his bachelor’s degree, wrote a prize-winning thesis, and completed the course work for a doctorate in economics — all in three years. ...
Sounds like he's some kind of human calculator:
Chetty, who just turned 30, is looking for ways to make ... mathematical economic theory more descriptive of the tangle of economics in the real world. “People are not human calculators,” he said...
OK, maybe not. His goal is to "refine the economic models behind public policy ... to ... save money and align government programs more closely with everyday life." An example is his work on government safety nets for the unemployed:
Chetty’s 2003 Ph.D. dissertation..., called “Consumption, Commitments, and Risk Preferences,”... [studies] the optimal level of unemployment benefits. When someone is laid off, should the government provide high benefits? Traditional theory says no, since big benefits seemingly reduce the incentive to find a job. “Standard models predict that we should have no safety net,” said Chetty.
But in reality, higher benefits are more in line with actual needs, because most Americans have so much income tied up in fixed commitments, such as payments for houses, cars, and furniture. “There are a lot of things you can’t adjust in the short term,” he said.
So the traditional economic models that are used to determine unemployment benefits miss a simple fact: People have bills to pay. “You miss certain features of reality,” said Chetty, “when you’re trying to write down simple models of the world.”
Unfortunately, in reality, some bills for houses, cars, furniture, etc. may not get paid:
States' jobless funds are being drained in recession, by Peter Whoriskey, Washington Post: The recession's jobless toll is draining unemployment-compensation funds so fast that ... 25 states have run out of unemployment money and have borrowed $24 billion from the federal government to cover the gaps. By 2011, according to Department of Labor estimates, 40 state funds will have been emptied by the jobless tsunami. ...
State unemployment-compensation funds are separated from general budgets, so when there is a shortfall, only two primary solutions are typically considered -- either cut the benefit or raise the payroll tax. ...
The troubles the state programs face can be traced to a failure during the economic boom to properly prepare for a downturn, experts said.
Unemployment benefits are funded by the payroll tax on employers that is collected at a rate that is supposed to keep the funds solvent. Firms that fire lots of people are supposed to pay higher rates. ... But over the years, the drive to minimize state taxes on employers has reduced the funds to unsustainable levels.
"The benefits haven't grown -- that's not the problem," said Richard Hobbie, director of the National Association of State Workforce Agencies. Even so, he said, he expects to see unemployment checks reduced. A shortfall in a state unemployment fund, he said, "usually means cuts in eligibility or benefits." ...
Wayne Vroman, an expert in unemployment insurance at the Urban Institute, said that entering the recession, state programs were on average funded at only one-third the level they should have been, according to generally accepted funding guidelines.
"If you fund a program adequately, you don't need to come to these kinds of difficult decisions," he said. Before the recession, he said, the funding guidelines "were rarely honored." ...
We can add the inadequate funding of unemployment compensation programs to the ever growing list of things that the crisis has revealed need to be fixed.
Andy Harless joins Rajiv Sethi in calling for more discussion about how the government debt is financed:
The Treasury’s Monetary Policy, by Andy Harless: ...Treasury ... is now ... financing more of its debt long-term. If you’re worried (as I am) about the persistence of a weak and potentially deflationary economic environment, then you should be critical of the Treasury’s policy. By increasing its maturities the Treasury is essentially following a tight-money policy exactly when a loose-money policy is needed.
The Treasury, of course, has its reasons. Officials expect interest rates to rise over the next several years and would like to lock in today’s low rates, to limit how much it will cost to service the national debt over a longer horizon. I’m skeptical, however, of the assumptions underlying these reasons.
You might argue that it’s a matter of risk. When the Treasury locks in today’s low interest rates, it may not end up paying less (since it gives up even lower short-term rates), but it makes the payments more predictable. Even if the Treasury is likely to end up paying more, the hedge is worth the price, because the Treasury receives some insurance for the worst case, where rates rise more than expected.
But are rising interest rates really the worst case?
Monday, December 21, 2009
Many of you will likely disagree with this:
The rule of 60 needs to be changed:
A Dangerous Dysfunction, by Paul Krugman, Commentary, NYTimes: Unless some legislator pulls off a last-minute double-cross, health care reform will pass the Senate this week. Count me among those who consider this an awesome achievement. It’s a seriously flawed bill, we’ll spend years if not decades fixing it, but it’s nonetheless a huge step forward.
It was, however, a close-run thing. And the fact that it was such a close thing shows that the Senate — and, therefore, the U.S. government as a whole — has become ominously dysfunctional.
After all, Democrats won big last year... In any other advanced democracy this would have given them the mandate and the ability to make major changes. But the need for 60 votes to ... end a filibuster — a requirement that appears nowhere in the Constitution, but is simply a self-imposed rule — turned what should have been a straightforward piece of legislating into a nail-biter. And it gave a handful of wavering senators extraordinary power to shape the bill.
Now consider what lies ahead. We need fundamental financial reform. We need to deal with climate change. We need to deal with our long-run budget deficit. What are the chances that we can do all that — or, I’m tempted to say, any of it — if doing anything requires 60 votes in a deeply polarized Senate?
Some people will say that it has always been this way... But it wasn’t... Yes, there were filibusters in the past — most notably by segregationists trying to block civil rights legislation. But the modern system, in which the minority party uses the threat of a filibuster to block every bill it doesn’t like, is a recent creation. ...
Some conservatives argue that the Senate’s rules didn’t stop former President George W. Bush from getting things done. But this is misleading, on two levels.
First, Bush-era Democrats weren’t nearly as determined to frustrate the majority party, at any cost, as Obama-era Republicans. Certainly, Democrats never did anything like what Republicans did last week: G.O.P. senators held up spending for the Defense Department — which was on the verge of running out of money — in an attempt to delay action on health care.
More important, however, Mr. Bush was a buy-now-pay-later president. He pushed through big tax cuts, but never tried to pass spending cuts to make up for the revenue loss. He rushed the nation into war, but never asked Congress to pay for it. He added an expensive drug benefit to Medicare, but left it completely unfunded. Yes, he had legislative victories; but he didn’t show that Congress can make hard choices and act responsibly, because he never asked it to.
So now that hard choices must be made, how can we ... make such choices possible?
Back in the mid-1990s two senators — Tom Harkin and, believe it or not, Joe Lieberman — introduced a bill to reform Senate procedures. ... Sixty votes would still be needed to end a filibuster at the beginning of debate, but if that vote failed,... eventually a simple majority could end debate. Mr. Harkin says that he’s considering reintroducing that proposal, and he should. ...
Remember, the Constitution sets up the Senate as a body with majority — not supermajority — rule. So the rule of 60 can be changed. ...
Nobody should meddle lightly with long-established parliamentary procedure. But our current situation is unprecedented: America is caught between severe problems that must be addressed and a minority party determined to block action on every front. Doing nothing is not an option — not unless you want the nation to sit motionless, with an effectively paralyzed government, waiting for financial, environmental and fiscal crises to strike.
Sunday, December 20, 2009
More unhappiness with Obama:
Obama as Climate Change Villain, by Jeffrey D. Sachs, Commentary, Project Syndicate: Two years of climate change negotiations have now ended in a farce in Copenhagen. ... Responsibility for this disaster reaches far and wide. Let us start with George W. Bush, who ignored climate change for the eight years of his presidency, wasting the world’s precious time. Then comes the United Nations, for managing the negotiating process so miserably during a two-year period. Then comes the European Union for pushing relentlessly for a single-minded vision of a global emissions-trading system, even when such a system would not fit the rest of the world.
Then comes the United States Senate, which has ignored climate change for 15 consecutive years since ratifying the UN Framework Convention on Climate Change. Finally, there is Obama, who effectively abandoned a systematic course of action under the UN framework, because it was proving nettlesome to US power and domestic politics.
Obama’s decision to declare a phony negotiating victory amounts to a declaration that rich countries will do what they want and must no longer listen to the “pesky” concerns of many smaller and poorer countries. Some will view this as pragmatic, reflecting the difficulty of getting agreement with 192 UN member states. But it is worse than that. International law, as complicated as it is, has been replaced by the insincere, inconsistent, and unconvincing word of a few powers, notably the US, which has never shown goodwill to the rest of the world on this issue, nor the ability or interest needed to take the lead on it.
From the standpoint of actual reduction of greenhouse-gas emissions, this agreement is unlikely to accomplish anything real. ... The reality is that the world will now wait to see if the US accomplishes any serious emissions reduction. Grave doubts are in order... Obama does not have the votes in the Senate, has not displayed any willingness to expend political capital to reach a Senate agreement, and may not even see a Senate vote on the issue in 2010...
The Copenhagen summit also fell short on financial help from rich countries to poor countries. Plenty of numbers were thrown around, but ... the big news was a commitment of $100 billion per year for the developing countries by 2020. ... Experience with financial aid for development teaches us that announcements about money a decade from now are mostly empty words. ...
One of the most notable features of the US-led document is that it doesn’t mention any intention to continue negotiations in 2010. This is almost surely deliberate..., in effect declaring that the US will ... not become further entangled in messy UN climate processes in 2010.
That stance might well reflect the upcoming 2010 mid-term Congressional elections... Obama does not want to be trapped in the middle of unpopular international negotiations when election season arrives. He may also feel that such negotiations would not achieve much. Right or wrong on that point, the intention seems to be to kill the negotiations. If so, Obama will prove to have been even more damaging to the international system of environmental law than George Bush was.
For me, the image that remains of Copenhagen is that of Obama appearing at a press conference to announce an agreement that only five countries had yet seen, and then rushing off to the airport to fly back to Washington, DC, to avoid a snowstorm... If ... the voluntary commitments of the US and others prove insufficient, it will have been Obama who single-handedly traded in international law for big-power politics on climate change.
Perhaps the UN will rally itself to get better organized. Perhaps Obama’s gambit will work, the US Senate will pass legislation, and other countries will do their part as well. Or perhaps we have just witnessed a serious step towards global ruin...
Update: See also: What Hath Copenhagen Wrought? A Preliminary Assessment of the Copenhagen Accord, by Robert Stavins (wonkish, relatively positive assessment).
Saturday, December 19, 2009
Frans de Waal says many people believe that "the economy was killed by irresponsible risk-taking, a lack of regulation or a bubbling housing market, but the problem goes deeper. ... The ultimate flaw was the lure of bad biology, which resulted in a gross simplification of human nature," In particular, the reduction of human behavior to one motive, self-interest, is at fault (this is a much shortened version of the original):
How bad biology killed the economy, by Frans de Waal, RSA Journal: ...The book of nature is like the Bible: everyone reads into it what they like, from tolerance to intolerance and from altruism to greed. But it’s good to realize that, if biologists never stop talking about competition, this doesn’t mean that they advocate it, and if they call genes selfish, this doesn’t mean that genes actually are. Genes can’t be any more ‘selfish’ than a river can be ‘angry’ or sun rays ‘loving’. Genes are little chunks of DNA. At most, they are self-promoting, because successful genes help their carriers spread more copies of themselves. ...
[Many people have] fallen hook, line and sinker for the selfish-gene metaphor, thinking that if our genes are selfish, then we must be selfish, too. ... [T]oo many economists and politicians ... model human society on the perpetual struggle that they believe exists in nature, which is actually no more than a projection. Like magicians, they first throw their ideological prejudices into the hat of nature, then pull them out by their very ears to show how much nature agrees with them. It’s a trick for which we have fallen for too long. Obviously, competition is part of the picture, but humans can’t live by competition alone. ...
Lovers of open competition can’t resist invoking evolution. The e-word even slipped into the infamous ‘greed speech’ of Gordon Gekko, the corporate raider played by Michael Douglas in the 1987 movie Wall Street: “The point is, ladies and gentleman, that ‘greed’ – for lack of a better word – is good. Greed is right. Greed works. Greed clarifies, cuts through and captures the essence of the evolutionary spirit.” ... Is the evolutionary spirit really all about greed, as Gekko claimed, or is there more to it?
Friday, December 18, 2009
Jeffrey Sachs says the administration needs to lead the way forward on important legislation instead of brokering deals that emerge through a "lobby-infested bargaining process" in Congress:
Looking for Change in the Beltway: The Need for Open Process, by Jeffrey D. Sachs, Scientific American: When President Barack Obama promised change, he put two kinds on the agenda. The first was substantive change: reforms to key sectors of the economy, such as health care, climate change, financial markets and arms procurement.
The second was process change: improvements to how public policies are shaped and how decisions over public funding are made. Against the odds, the Obama administration is making some progress on the first—but at the sacrifice of the second.
The important health care legislation inching its way through Congress ... will help expand the number of Americans covered by health care insurance and will limit some of the abuses by the private insurance industry in denying coverage and reimbursements to the public. Similarly, climate change legislation is also moving forward, with the chance that a permit system will begin to limit the emissions of greenhouse gases and start the lengthy shift of the U.S. economy to lower-emissions technologies.
Yet how this modest progress is being achieved is alarming. The Obama administration has not put forward one coherent plan as a detailed policy proposal. Every major piece of public policy has been turned over to the backrooms of Congress, emerging through the lobby-infested bargaining process among vested and regional interests. There was no overarching plan for the economic stimulus; no clear plan for health care reform; no defined strategy for climate change control; and so forth. ...
The complex, crucial issues we face require both expert inputs and public understanding. On each major issue of public policy, the administration should first put forward a white paper explaining why it is calling for a policy initiative, what it will cost, what benefits it will bring and how it will work. Legislative proposals should be shaped around these strategy documents. Independent expert groups should be invited to draft responses.
Most important, lobbying needs to be scorned rather than promoted. If given a chance, the public would back the Obama administration in facing down these narrow interests, the very interests that have contributed so much to our financial meltdowns, overpriced health care, clunker automobiles and energy insecurity. Scientists, engineers and public policy specialists can help craft real solutions, and an enlightened and trusted public would help put those solutions into place above the opposition of narrow interests. [full article]
At CBS MoneyWatch, why I haven't joined the loud calls for the Fed to engage in quantitative easing as a means of creating jobs:
The Fed Can Help, But Fiscal Policy Is The Key To Job Creation, by Mark Thoma: There are many people currently criticizing the Fed for worrying too much about inflation and not enough about employment. They want the Fed to use quantitative easing - the purchase of financial assets when interest rates are already at zero - as a means of stimulating the economy and creating jobs. I think it's a mistake ...[...continue reading...]...
The health care reform bill is nowhere near perfect, but it's still worth passing:
Pass the Bill, by Paul Krugman, Commentary, NY Times: A message to progressives: By all means, hang Senator Joe Lieberman in effigy. Declare that you’re disappointed in and/or disgusted with President Obama. Demand a change in Senate rules that, combined with the Republican strategy of total obstructionism, are in the process of making America ungovernable.
But meanwhile, pass the health care bill.
Yes, the filibuster-imposed need to get votes from “centrist” senators has led to a bill that falls a long way short of ideal. Worse, some of those senators seem motivated largely by a desire to protect the interests of insurance companies — with the possible exception of Mr. Lieberman, who seems motivated by sheer spite.
But let’s all take a deep breath, and consider just how much good this bill would do, if passed — and how much better it would be than anything that seemed possible just a few years ago. With all its flaws, the Senate health bill would be the biggest expansion of the social safety net since Medicare, greatly improving the lives of millions. Getting this bill would be much, much better than watching health care reform fail.
At its core, the bill would do two things. First,... Americans could no longer be denied health insurance because of a pre-existing condition, or have their insurance canceled when they get sick. Second, the bill would provide substantial financial aid to those who don’t get insurance through their employers, as well as tax breaks for small employers that do provide insurance.
All of this would be paid for in large part with the first serious effort ever to rein in rising health care costs.
The result would be a huge increase in the availability and affordability of health insurance, with more than 30 million Americans gaining coverage, and premiums for lower-income and lower-middle-income Americans falling dramatically. That’s an immense change from where we were just a few years ago: remember, not long ago the Bush administration and its allies in Congress successfully blocked even a modest expansion of health care for children.
Bear in mind also the lessons of history: social insurance programs tend to start out highly imperfect and incomplete, but get better and more comprehensive as the years go by. Thus Social Security originally had huge gaps in coverage — and a majority of African-Americans, in particular, fell through those gaps. But it was improved over time, and it’s now the bedrock of retirement stability for the vast majority of Americans. ...
Whereas flawed social insurance programs have tended to get better over time, the story of health reform suggests that rejecting an imperfect deal in the hope of eventually getting something better is a recipe for getting nothing at all. Not to put too fine a point on it, America would be in much better shape today if Democrats had cut a deal on health care with Richard Nixon, or if Bill Clinton had cut a deal with moderate Republicans back when they still existed. ...
Beyond that, we need to take on the way the Senate works. The filibuster, and the need for 60 votes to end debate, aren’t in the Constitution. They’re a Senate tradition, and that same tradition said that the threat of filibusters should be used sparingly. Well, Republicans have already trashed the second part of the tradition: look at a list of cloture motions over time, and you’ll see that since the G.O.P. lost control of Congress it has pursued obstructionism on a literally unprecedented scale. So it’s time to revise the rules.
But that’s for later. Right now, let’s pass the bill that’s on the table.
Daniel Gross says the threat of restrictions on how much executives can be paid has motivated banks subject to the limits to "get their houses in order":
It's Payback Time!, by Daniel Gross: One of the main criticisms of the massive bank bailouts was that the Feds didn't get sufficiently medieval on bank shareholders, including top executives who owned big chunks of stock. ... And yet, by design or dumb luck, it turns out that the government did have one powerful stick that has pushed banks and their shareholders to reform themselves sooner rather than later: the ability to regulate banks' compensation. ...
From the outset, healthy banks were eager to get out from under the TARP because they wanted to avoid discussions about appropriate levels of executive compensation. The investment banks that were capable of paying back did so in June, the month when lawyer Kenneth Feinberg was appointed as TARP's special master for executive compensation. Coincidence?
In October, Feinberg issued compensation guidelines for the companies receiving special assistance... That, and the approach of the bonus season, lit a fire under executives at the largest remaining TARP recipients. ... They cut costs, shrank their balance sheets, and raised capital from new investors.
Look what's happened in the past two weeks. First, Bank of America agreed to pay back $45 billion in TARP funds. Bank of America found that the pay restrictions were complicating the search for a new boss to replace Ken Lewis. It raised $20 billion from the public and agreed to sell $3 billion in assets. The smaller, leaner, better-capitalized bank was able to hire a new CEO on Wednesday.
Citigroup ... also sprang into action. Earlier this week, it announced it would pay back $20 billion in TARP funds... Citi raised $20.5 billion of capital, said it would give employees $1.7 billion in stock rather than cash for bonuses. Once the money was paid back to the Treasury, Citi noted, "it will no longer be deemed to be a beneficiary of ... TARP..." Translation: Ken Feinberg won't be allowed to tell us how much to pay our folks. Because of its desire to get out from under such scrutiny, Citi has aggressively cut costs (by $15 billion annually), shed assets, and vastly improved its capital position. ...
Also this week, Wells Fargo announced it would repay $25 billion in TARP funds by selling $10.4 billion of stock and selling off assets. It, too, will be a smaller, leaner, better-capitalized bank.
Among the three, that's $90 billion in repayments to the taxpayers in a week and more than $50 billion raised from the public. Of course, these offerings came at a cost. The banks essentially created new shares... They diluted existing shareholders, which is what is supposed to happen when companies suffer losses and need to raise capital. And because of these offerings, future earnings will be spread across a much larger share base. As ... much as anything else, the threat of the government having limiting bankers' compensation spurred the banks to get their houses in order.
Thursday, December 17, 2009
On Partial Equilibrium Models of Demand and Supply, by Rajiv Sethi: My last post on the aggregate demand effects of changes in nominal wages has attracted some attention, so I'd like to clarify a couple of things.
It was not the point of the post to claim that declines in nominal wages would lower or increase aggregate demand. The point was to argue that the simple partial equilibrium models of demand and supply that were being used by some to address the question were simply not up to the task of answering it. It was a reaction against the view -- expressed by Bryan Caplan and endorsed by Tyler Cowen -- that such effects could easily be deduced from textbook microeconomic theory. And it was a plea to move beyond partial equilibrium analysis in addressing such questions.
Tyler Cowan responded to this with yet another partial equilibrium model of supply and demand:
Graph a monopolist and shift the marginal cost curve down. Watch what happens. The first main paragraph of Sethi simply doesn't consider this mechanism but rather it assumes that changes at the margin don't matter.
That was in the comments section of Mark Thoma's blog. A similar claim now appears on his own page:
There is a simple story here. Lower the minimum wage and firms with market power will in general hire more labor. (Sethi's critique refuses to consider that mechanism but simply shift the MC curve and watch it happen.)
By all means, shift the MC curve and watch what happens. But please keep in mind not a single firm but a population of firms, some of which do not pay minimum wage at all. And be sure to shift the demand functions for all firms producing goods and services that minimum wage workers currently purchase. And now tell me whether it is self-evident that aggregate demand will rise in response to a decline in nominal wages.
It is not self-evident. In order to address the question it is necessary at a minimum to work with a model with multiple firms, in which the expenditure patterns from wage and capital income are properly specified, and some alternatives to immediate consumption (such as financial assets) exist. Simulate this model on a computer if you like, and watch what happens. I would be interested to know. But please don't make definitive claims about aggregate demand effects of changes in nominal wages based on an introductory textbook model that is simply incapable of carrying the weight.
Andrew Gelman is puzzled by all of this:
But, politically, of course nobody's going to cut the minimum wage. Can you imagine the unpopularity of a minimum wage cut during a recession? I can't imagine that all the editorial boards of all the newspapers in the country could convince a majority of Congress to vote for this one, whatever its economic merits.
Which makes me wonder why the idea is being discussed at all. Is it an attempt to shoot down a minimum wage increase that might be in the works? Krugman mentions that Serious People are proposing a minimum wage cut, but he doesn't mention who those Serious People are. I can't imagine that they're serious about thinking this might happen.
P.P.S. I posted this at the sister blog to see if anyone could tell me how anyone could be considering minimum wage cuts as a serious political option. Nobody bit, but Tom Beecroft wrote that "it's a theoretical economics argument, rather than a political reality argument." That makes sense, but it still seems to me that something more is going on here than a dispute over pure theory. As a political scientist, it just seems funny for me to see people debating a policy that has no chance of being implemented. There must be something else going on here.
In the background is a more general and long-standing argument about whether falling wages is a good thing or a bad thing when an economy is in a deep recession. For example, this is Krugman back in May of this year:
Falling Wage Syndrome, by Paul Krugman, Commentary, NY Times: Wages are falling all across America. Some of the wage cuts, like the givebacks by Chrysler workers, are the price of federal aid. Others, like the tentative agreement on a salary cut here at The Times, are the result of discussions between employers and their union employees. Still others reflect the brute fact of a weak labor market: workers don’t dare protest when their wages are cut, because they don’t think they can find other jobs.
Whatever the specifics, however, falling wages are a symptom of a sick economy. And they’re a symptom that can make the economy even sicker. ...
Not everyone believes that falling wages make an economy sicker, some people generally believe that falling wages are a necessary part of the adjustment process, and that falling wages would speed the adjustment to shocks. This group also believes that any attempt to support wages makes things worse (which is the heart of the debate where the minimum wage is concerned). Here's more from Krugman from November 2008:
Not much point in going through Amity Shlaes’s latest: after having inadvertently revealed that she has no idea what Keynesian economics is, she’s back on the warpath against FDR, and me. The main line of empirical argument seems to be that FDR didn’t succeed in ending the Great Depression. Since that’s also what my side of the debate says — fiscal expansion was too cautious, and disastrously abandoned in 1937 — I don’t see what this is supposed to prove.
But I think it’s worth pointing out why Ms. Shlaes thinks the New Deal was destructive of employment: namely, that it raised wages. Funny she should mention that — because the effect of wage changes on employment was the subject of a whole chapter in Keynes’s General Theory.
And what Keynes had to say then is as valid as ever: under depression-type conditions, with short-term interest rates near zero, there’s no reason to think that lower wages for all workers — as opposed to lower wages for a particular group of workers — would lead to higher employment. ...
Update: More from Paul Krugman: Dining room tables and minimum wages.
[In the above, I should have also added that the continuing debate over the effect that the minimum wage has on employment -- which is always spirited -- is also part of the reason this topic is receiving so much attention.]
Ben Bernanke answers some questions:
Sen. Vitter Presents End-of-Term Exam For Bernanke, by Sudeep Reddy, WSJ: Earlier this month, Real Time Economics presented questions from several economists for the confirmation hearing of Federal Reserve Chairman Ben Bernanke. Many of the questions were addressed at the hearing, though not always directly. Sen. David Vitter (R., La.) submitted them in writing and received the responses from Bernanke, along with his own other questions. We offer them here.
The Wall Street Journal reported on some questions that different economists felt that you should answer. Let me borrow from some of those and I will credit them with their questions accordingly:
A. Anil Kashyap, University of Chicago Booth Graduate School of Business: With the unemployment rate hovering around 10%, the public seems outraged at the combination of three things: a) substantial TARP support to keep some firms alive, b) allowing these firms to pay back the TARP money quickly, c) no constraints on pay or other behavior once the money was repaid. Was it a mistake to allow b) and/or c)?
TARP capital purchase program investments were always intended to be limited in duration. Indeed, the step-up in the dividend rate over time and the reduction in TARP warrants following certain private equity raises were designed to encourage TARP recipients to replace TARP funds with private equity as soon as practical. As market conditions have improved, some institutions have been able to access new sources of capital sooner than was originally anticipated and have demonstrated through stress testing that they possess resources sufficient to maintain sound capital positions over future quarters. In light of their ability to raise private capital and meet other supervisory expectations, some companies have been allowed to repay or replace their TARP obligations. No targeted constraints have been placed on companies that have repaid TARP investments. However, these companies remain subject to the full range of supervisory requirements and rules. The Federal Reserve has taken steps to address compensation practices across all firms that we supervise, not just TARP recipients. Moreover, in response to the recent crisis, supervisors have undertaken a comprehensive review of prudential standards that will likely result in more stringent requirements for capital, liquidity, and risk management for all financial institutions, including those that participated in the TARP programs.
B. Mark Thoma, University of Oregon and blogger: What is the single, most important cause of the crisis and what s being done to prevent its reoccurrence? The proposed regulatory structure seems to take as given that large, potentially systemically important firms will exist, hence, the call for ready, on the shelf plans for the dissolution of such firms and for the authority to dissolve them. Why are large firms necessary? Would breaking them up reduce risk?
The principal cause of the financial crisis and economic slowdown was the collapse of the global credit boom and the ensuing problems at financial institutions, triggered by the end of the housing expansion in the United States and other countries. Financial institutions have been adversely affected by the financial crisis itself, as well as by the ensuing economic downturn.
This crisis did not begin with depositor runs on banks, but with investor runs on firms that financed their holdings of securities in the wholesale money markets. Much of this occurred outside of the supervisory framework currently established. An effective agenda for containing systemic risk thus requires elimination of gaps in the regulatory structure, a focus on macroprudential risks, and adjustments by all our financial regulatory agencies.
Supervisors in the United States and abroad are now actively reviewing prudential standards and supervisory approaches to incorporate the lessons of the crisis. For our part, the Federal Reserve is participating in a range of joint efforts to ensure that large, systemically critical financial institutions hold more and higher-quality capital, improve their risk-management practices, have more robust liquidity management, employ compensation structures that provide appropriate performance and risk-taking incentives, and deal fairly with consumers. On the supervisory front, we are taking steps to strengthen oversight and enforcement, particularly at the firm-wide level, and we are augmenting our traditional microprudential, or firm-specific, methods of oversight with a more macroprudential, or system-wide, approach that should help us better anticipate and mitigate broader threats to financial stability.
Although regulators can do a great deal on their own to improve financial regulation and oversight, the Congress also must act to address the extremely serious problem posed by firms perceived as “too big to fail.” Legislative action is needed to create new mechanisms for oversight of the financial system as a whole. Two important elements would be to subject all systemically important financial firms to effective consolidated supervision and to establish procedures for winding down a failing, systemically critical institution to avoid seriously damaging the financial system and the economy.
Some observers have suggested that existing large firms should be split up into smaller, not-toobig- to-fail entities in order to reduce risk. While this idea may be worth considering, policymakers should also consider that size may, in some cases, confer genuine economic benefits. For example, large firms may be better able to meet the needs of global customers. Moreover, size alone is not a sufficient indicator of systemic risk and, as history shows, smaller firms can also be involved in systemic crises. Two other important indicators of systemic risk, aside from size, are the degree to which a firm is interconnected with other financial firms and markets, and the degree to which a firm provides critical financial services. An alternative to limiting size in order to reduce risk would be to implement a more effective system of macroprudential regulation. One hallmark of such a system would be comprehensive and vigorous consolidated supervision of all systemically important financial firms. Under such a system, supervisors could, for example, prohibit firms from engaging in certain activities when those firms lack the managerial capacity and risk controls to engage in such activities safely. Congress has an important role to play in the creation of a more robust system of financial regulation, by establishing a process that would allow a failing, systemically important non-bank financial institution to be wound down in an orderly fashion, without jeopardizing financial stability. Such a resolution process would be the logical complement to the process already available to the FDIC for the resolution of banks.
C. Simon Johnson, Massachusetts Institute of Technology and blogger: Andrew Haldane, head of financial stability at the Bank of England, argues that the relationship between the banking system and the government (in the U.K. and the U.S.) creates a “doom loop” in which there are repeated boom-bust-bailout cycles that tend to get cost the taxpayer more and pose greater threat to the macro economy over time. What can be done to break this loop?
The “doom loop” that Andrew Haldane describes is a consequence of the problem of moral hazard in which the existence of explicit government backstops (such as deposit insurance or liquidity facilities) or of presumed government support leads firms to take on more risk or rely on less robust funding than they would otherwise. A new regulatory structure should address this problem. In particular, a stronger financial regulatory structure would include: a consolidated supervisory framework for all financial institutions that may pose significant risk to the financial system; consideration in this framework of the risks that an entity may pose, either through its own actions or through interactions with other firms or markets, to the broader financial system; a systemic risk oversight council to identify, and coordinate responses to, emerging risks to financial stability; and a new special resolution process that would allow the government to wind down in an orderly way a failing systemically important nonbank financial institution (the disorderly failure of which would otherwise threaten the entire financial system), while also imposing losses on the firm’s shareholders and creditors. The imposition of losses would reduce the costs to taxpayers should a failure occur.
D. Brad Delong, University of California at Berkeley and blogger: Why haven’t you adopted a 3% per year inflation target?
The public’s understanding of the Federal Reserve’s commitment to price stability helps to anchor inflation expectations and enhances the effectiveness of monetary policy, thereby contributing to stability in both prices and economic activity. Indeed, the longer-run inflation expectations of households and businesses have remained very stable over recent years. The Federal Reserve has not followed the suggestion of some that it pursue a monetary policy strategy aimed at pushing up longer-run inflation expectations. In theory, such an approach could reduce real interest rates and so stimulate spending and output. However, that theoretical argument ignores the risk that such a policy could cause the public to lose confidence in the central bank’s willingness to resist further upward shifts in inflation, and so undermine the effectiveness of monetary policy going forward. The anchoring of inflation expectations is a hard-won success that has been achieved over the course of three decades, and this stability cannot be taken for granted. Therefore, the Federal Reserve’s policy actions as well as its communications have been aimed at keeping inflation expectations firmly anchored.
What is the cause of large and continuing budget deficits? The Bush tax cuts, the wars in Iraq and Afghanistan, and the economic downturn explain "explain virtually the entire deficit over the next ten years."
Notice the tiny contribution of Tarp, Fannie, and Freddie (shaded red) and the stimulus package (shaded yellow, just below the red area) to the deficit from 2012 onward. These are not the source of our long-term budget problems.
For more, see the source of the graph: President Obama Largely Inherited Today’s Huge Deficits, CBPP.