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Dani Rodrik argues that China's currency policy has hurt other developing
countries, but "we should not hold China responsible for taking care of its own
Chinese Mercantilism Good or Bad for Poor Countries?, by Dani Rodrik,
Commentary, Project Syndicate: ...Discussion of China’s currency ... is
viewed largely as a US-China issue, and the interests of poor countries get
scarcely a hearing... Yet a noticeable rise in the renminbi’s value may have
significant implications for developing countries. Whether they stand to gain or
lose from a renminbi revaluation, however, is hotly contested. ...
Strip away the technicalities, and the debate boils down to one
fundamental question: what is the best, most sustainable growth model for
low-income countries? Historically, poor regions of the world have often relied
on ... exporting to other parts of the world primary products and natural
resources such as agricultural produce or minerals. ...
But this model suffers from two fatal weaknesses. First, it depends heavily on
rapid growth in foreign demand. When such demand falters, developing countries
find themselves with ... a protracted domestic crisis. Second, it does not
stimulate economic diversification. Economies hooked on this model find
themselves excessively specialized in primary products that promise little
Indeed, the central challenge of economic development is not foreign demand, but
domestic structural change. The problem for poor countries is that they are not
producing the right kinds of goods. ... The real exchange rate is of paramount
importance here, as it determines the competitiveness and profitability of
modern tradable activities. When developing nations are forced into overvalued
currencies, entrepreneurship and investment in those activities are depressed.
From this perspective, China’s currency policies not only undercut the
competitiveness of African and other poor regions’ industries; they also
undermine those regions’ fundamental growth engines. What poor nations get out
of Chinese mercantilism is, at best, temporary growth of the wrong kind.
Lest we blame China too much, though, we should remember that there is little
that prevents developing countries from replicating the essentials of the
Chinese model. They, too, could have used their exchange rates more actively in
order to stimulate industrialization and growth. True, all countries in the
world cannot simultaneously undervalue their currencies. But poor nations could
have shifted the “burden” onto rich countries, where, economic logic suggests,
it ought to be placed.
Instead, too many developing countries have allowed their currencies to become
overvalued... And they have made little systematic use of explicit industrial
policies that could act as a substitute for undervaluation.
Given this, perhaps we should not hold China responsible for taking care of its
own economic interests, even if it has aggravated in the process the costs of
other countries’ misguided currency policies.
I don't think I have anything to say about this that hasn't already been said, many times, and I'm running behind at the moment, so I am am going to leave comments to you. One question might be whether or not rich nations are, in fact, obligated to pay part of the "burden" for the development of poorer countries. If so, why, and if not, why not?
Posted by Mark Thoma on Thursday, September 9, 2010 at 11:07 AM in China, Development, Economics, Financial System |
Here's a follow-up to Menzie Cinn's post showing changes in government employment since 2000: Government Employment since 1976, by Calculated Risk
Posted by Mark Thoma on Thursday, September 9, 2010 at 09:35 AM in Economics |
The WSJ asked several people, mostly on the right, about whether the Fed has
the power to do more.
John Taylor's answer was predictable, the problem is that they aren't
following the Taylor rule and the sooner they get back to it, the better, so
I'll move on to the next participant, Richard Fisher of the Dallas Fed.
Fisher is predictably hawkish, adopts the GOP line on business uncertainty
causing problems, and concludes:
The minutes of the last Federal Open Market Committee (FOMC) meeting noted that
"a number of participants reported that business contacts again indicated that
uncertainty about future taxes, regulations, and health-care costs made them
reluctant to expand their workforces." ... Can the Fed do more to propel job
creation? Barring an unforeseen shock, I would be reluctant to expand the Fed's
balance sheet... Of course, if the fiscal and regulatory authorities are able to
dispel the angst that FOMC participants are reporting, further accommodation may
not be needed. If businesses are more certain about future policy, they'll
release the liquidity they're now hoarding.
The claim that business uncertainty is holding up the recovery will appear
again below, so I'll hold off with the evidence against it.
Next is Frederic Mishkin. I wasn't sure how he'd answer. He's fearful that
debt monetization will lead to lack of fiscal discipline, that losses on asset
purchases might lead to a loss of Fed independence, and that all roads lead to
The ... Fed's recent announcement that it will reinvest payments from agency
debt and mortgage-backed securities into long-term Treasurys has opened the door
to large-scale asset purchases. Should the Fed pull the trigger?
Purchasing long-term Treasurys might suggest that the Fed is accommodating the
fiscal authorities by monetizing the debt—thereby weakening the government's
incentives to come to grips with our long-term fiscal problems. In addition,
major holdings of long-term securities expose the Fed's balance sheet to
potentially large losses if interest rates rise.
Such losses would result in severe criticism of the Fed and a weakening of its
independence. Both the weakening of its independence and the perception that the
Fed is willing to monetize the debt could lead to increased expectations for
inflation sometime in the future. That would make it much harder for the Fed to
contain inflation and promote a healthy economy.
Expanding the Fed's balance sheet through large-scale asset purchases can be
necessary in extraordinary circumstances, such as during the depths of the
recent financial crisis. But in relatively normal times, the costs of using this
tool are sufficiently high that it should not be used lightly.
Relatively normal times? Now? Ah, he means relatively normal on Wall Street,
not Main Street. Anyway,
next up, Ronald McKinnon. He wants to "spring the near zero interest rate
liquidity trap" by, essentially, increasing interest rates. That's a
bad policy, so let's move on.
I didn't expect Vincent Reinhart to be the most reasonable of the bunch,
though perhaps given the bunch that was selected it might have been a good bet. I could sign on to something along these lines:
The Fed should promise to purchase government and mortgage-related securities
between its regularly scheduled meetings as long as activity is forecast to be
subpar and inflation is low or headed down. Purchases of, say, $100 billion
every six-to-eight weeks would add up to a number worthy of shock and awe for
those with a somber economic outlook.
But those foreseeing a quick return to above-trend growth or expecting a slower
trend would similarly be reassured that the Fed would not keep its foot on the
accelerator for too long. Most importantly, by linking to economic conditions,
the Fed would not be providing an open-ended promise to monetize the federal
Last up is Allan Meltzer, and he follows Taylor in calling for the Taylor
rule, and he, like Fisher, adopts the "government policy is creating business
When Congress established the Fed in 1913, it gave it a dual mandate: high
employment and price stability. In its nearly 100-year history, the Fed has
achieved both objectives only rarely: 1923-1928, a few years in the mid-1950s
and early 1960s, and from 1985 to 2004, when the Fed followed the Taylor rule
that incorporates Congress's mandate. Those 20 years when the Fed followed the
rule were the longest sustained period of stable growth and low inflation in
Federal Reserve history.
In "A History of the Federal Reserve," I concluded that the principal mistakes
the Fed has made have resulted from giving excessive attention to current
events... By focusing on the short-term, the Fed neglects the longer-term
consequences of its actions. ... A rule would change that. ... At times like the
present, a rule helps the Fed to recognize that current problems are mainly the
result of mistaken government policies that create massive uncertainty.
The Fed added more than a trillion dollars of excess reserves to respond to the
financial crisis. ... Adding a few hundred billion to the trillion dollars
already available would ... do little for the economy that banks could not do
There is very little that the Fed can do to change the near-term, but it can
have important influence on the future. The Fed has sacrificed much of its
independence during this crisis by helping the Treasury carry out fiscal policy.
Adopting and following a rule, like the Taylor rule, is an effective way to
The second to the last paragraph misstates the case that people are making
for Quantitative Easing. First, as
Joe Gagnon, and others have pointed out, research indicates that the Fed
could move long-term rates down a bit with QE. If the Fed does this, it then
creates an incentive for more business investment and the purchase of more
consumer durables. Yes, banks have plenty of funds to lend, and this would give
them more, but the problem is lack of demand, and lower interest rates are
intended to boost demand back up a bit. It's the demand side effects that
matter, not the increased supply of funds. Now, I happen to think that those
effects wouldn't be as strong as we need by themselves, fiscal policy needs to
join the effort, but the Fed has a role to play.
As for the business uncertainty claim,
here's Paul Krugman:
So I just read the latest speech from
Fisher of the Dallas Fed; it’s one of the most depressing things I’ve read
lately, and given what I read that’s saying a lot.
Much of the speech is taken up with arguing that it’s not the Fed’s job to help
the struggling economy, because the big problem there is business uncertainty
about future regulation. Urk. Like others, I’ve tried to point out that there is
no evidence for this claim: business investment is no lower than you’d expect
given the state of the economy, while surveys say that
weak sales, not fear of regulation, are holding back business expansion. Oh,
and just to make it perfect, Fisher cites
Mort Zuckerman to bolster his case.
Back in April, I said I had given up on policy makers, they weren't going to do anything more for the economy, at least nothing beyond "token help" that they could use to political advantage. Every once in awhile I get my hopes up that monetary or fiscal policy authorities might take action after all, but I shouldn't. Lucy always takes the football away.
Posted by Mark Thoma on Thursday, September 9, 2010 at 12:42 AM in Economics, Monetary Policy |
The "Ever-Expanding" Government Sector, Illustrated: Just some numbers to
bring reality into the general discussion:
Figure 1: Employment in government (blue), in thousands,
seasonally adjusted (blue), and excluding temporary Census workers (red).
Source: BLS, August employment situation release.
Posted by Mark Thoma on Thursday, September 9, 2010 at 12:33 AM in Economics |
As many of you know I grew up in a small town, it was just a bit under 4,000 people at that time,
the same town that my mom was born in. I recently went back there for a high
school class reunion (35th). While I was there, something struck me that I've
been meaning to write about.
In the town I grew up in, pretty much everyone knows who the best doctor is,
the best dentist, the best painter, the best carpenter, and so on. There were
sometimes disagreements about exactly who was best, e.g. who had the best
restaurant, but we all knew who to choose if you needed something done,
something to eat, your house cleaned, lawn mowed, legal work, child care,
whatever. The people who didn't weren't very good at these kinds of jobs didn't survive for very long. I can think of three lawyers off the top of my head, and if I needed
one, I'd know who to choose, or certainly who to ask (growing up, my next door
neighbor was the county clerk, and she could be very helpful in navigating
anything related to the courthouse -- she saved me once when I was in court for
going 95 mph and the judge thought a night in jail would be a good lesson --
thanks to her I escaped jail, but I did get the message -- losing my license for a month helped with that).
I thought about this again yesterday as I was trying to change dentists. I've
lost confidence in the one I have, but have no idea who to choose. I asked a few
people, and they had recommendations, people mostly say the like who they have,
but it was nothing like the kind of comprehensive knowledge I had where I grew
up. Same for choosing a painter, a car mechanic, or most anything else. I never
really know if I can trust them when the initial choice is made.
In an environment like I grew up in, there is little need for many types of
regulation, it is largely redundant. If I still lived there and needed a room
added onto my house, I have a friend I grew up with who does that type of work
and I would trust him to do it right. Period. And if it wasn't right, he would
make it good. These are people you see frequently around town, or hear about
from others, people you grew up with from kindergarten through high school (even
college since many of us ended up at Chico). Sure, the doctors and dentists and
the like came from outside, but my grandmother was a nurse, one of my mom's good
friend worked for a dentist in town, people played golf with the doctors,
dentists, etc. at the local 9-hole course, socialized with them at the Tennis
Club -- you knew what you needed to know. If someone got sick at your
restaurant, it was over for the owner. Word would spread quickly and everyone
would know. If you had a good story and a good reputation -- being good in grade
school and being known as honorable has its rewards -- you might survive. The
town, person by person, would make it's call. That call wasn't always correct,
small town rumors, cliquishness and the like are known menaces, but for the most part the town took care
of itself. So while it wasn't always perfect -- there are parts of the town I
don't miss at all -- it managed well enough.
What I'm wondering is whether this can, at least in part, explain
differences in attitudes toward regulation between more conservative rural areas
and larger cities that are generally much more liberal. In a larger city, you
are much more vulnerable to predatory type behavior, unfair treatment, much more
likely to be dealing with strangers you have never seen before and will never
see again. That uncertainty, and the experience of being taken advantage of if
you aren't continuously on guard, and sometimes even if you are -- maybe a
contractor did a lousy job and refuses to fix the flaws or refund money --
might lead you to declare "there ought to be a law!," or that "someone needs to
stop this!" You would be much more inclined to think that regulation was needed.
That's not to say that things are perfect in small towns, they're not of
course, or that exploitation of the weaker by the stronger isn't present. It is. Farm labor comes to mind. And there is still a role for safety and other
types of regulation. But there does seem to be a much stronger sense that people
can take care of themselves without the need for a bunch of rules and
regulations, and without the need for police looking over your shoulder to make
sure that you comply.
And that's just the town. If you add in all the farmers who live in the
vicinity -- the reason for the town to exist at all -- farmers who are their own
bosses and think they ought to be able to do as they please with the land that has often been handed down for generations, it's easy to see how a
"leave us alone to take care of ourselves" attitude comes about.
Just a thought.
Posted by Mark Thoma on Thursday, September 9, 2010 at 12:15 AM in Economics, Regulation |
Posted by Mark Thoma on Wednesday, September 8, 2010 at 11:02 PM in Economics, Links |
Minnesota Fed president Narayana Kocherlakota
says once again that there's little that monetary policy can do for the
unemployment problem because it's largely structural (here's Brad DeLong's reaction, see here too). However,
researchers at the Cleveland Fed say their estimates tell a different story:
The dramatic jump in the actual unemployment rate we have observed since the
beginning of the recession is being interpreted in our flows-based analysis as
largely a cyclical phenomenon, with little movement in the long-term rate. The
long-run trend does appear to have increased from its prerecession level, but by
only a small margin.
The natural rate of unemployment is not 9.6 percent, the current unemployment rate. It's not even close to that
(the Cleveland Fed says it's "roughly 5.6 percent to 5.7 percent"). But even if
it was as high as 7.5 percent (to be clear, this is a hypothetical), are we just going
to give up on the other 2.1 percent? I think that the cyclical component is a lot
larger than 2.1 percent, and that even if there is a sizable structural problem there are still things we can do to help the structural
transition along, including using low long-term interest rates to encourage the investment that
helps that structural change happen faster. But even if you think the natural rate has increased quite a bit, and there's nothing the Fed can do for the structurally unemployed, it hasn't gone up as high as
9.6% and there's no reason to give up on those who can be helped.
And they do need help. As the Cleveland Fed notes in the
given above, even though the problem is largely cyclical in their view, it's looking like a long recovery is ahead:
Since we have not seen a big rise in the long-term unemployment rate, we might
expect to converge to this “natural” rate soon. Unfortunately, this is not
likely to be the case, and there are several reasons to suspect that the
adjustment might take a long time. The first is the sheer extent of the gap
between the current and long-term unemployment rates, regardless of the specific
long-term rate one believes holds (figure 6). ... When the U.S. economy
experienced a similar-size gap after the 1981–1982 recession, it took several
years for the observed unemployment rate to drop to levels closer to the trend.
And it might be even harder for the labor market to adjust this time around. The
rate of adjustment depends on how fast workers are reallocated between
unemployment and the available jobs. The slower rates of worker reallocation we
have found may act to slow the closing of the unemployment gap.
There are other reasons to believe that unemployment rates may stay well above
the long-term rate for an extended period of time. Because of the length of the
recession, there is a considerable number of potential workers who are not
formally in the labor force. We have seen one of the sharpest drops in the labor
force participation rate in the postwar data, as many unemployed workers simply
stopped looking for a job. If some of these discouraged workers decide to search
for a job as aggregate economic activity picks up, unemployment might decline at
an even slower rate because the pool of unemployed workers is being replenished
with workers re-entering the labor force.
Another concern raised by our findings is the negative impact of long-term
unemployment on the human capital of the workforce. Longer unemployment spells
are a problem because unemployed workers who are unemployed for too long can
lose industry- and job-specific skills. Losing skills can reduce their odds of
finding a job during the recovery as well as lower their productivity when they
finally do find one.
Ultimately, an increase in the demand for labor will determine how fast the
unemployment stock will be depleted. ...
Continuing the last point, we are simply not doing enough to create the labor demand that is needed. And, unfortunately, the claim that the problem is almost all structural and therefore there's little we can do is one of the things standing in the way of giving labor markets the help that they need.
Posted by Mark Thoma on Wednesday, September 8, 2010 at 04:08 PM in Economics, Fed Speeches, Monetary Policy, Unemployment |
Given all the worries Boehner and others have expressed about the bad
incentives that social insurance creates, is this one of the programs
that would be on the chopping block in his proposal to roll government spending back to 2008 (pre-ARRA) levels?
Posted by Mark Thoma on Wednesday, September 8, 2010 at 12:00 PM in Economics, Social Insurance |
On Boehner's economic "plan," pgl sets the tone:
CNNMoney Fails Introductory Macro. by pgl: OK – I just ripped off the title
of Peter Dorman’s ripping of Peter Orszag’s NYTimes oped but how else can you
describe the CNN/Money piece entitled
Boehner unveils his own plan to aid economy?. Boehner and other GOP leaders
propose to cut government spending which would deepen the recession. How can any
reporter say this is an aid to the economy? Could at least one reporter have the
intelligence and integrity to entitle such a piece Boehner unveils his own plan
to screw economy? If you any decent reporting on such GOP gibberish – let us
And Ezra Klein has backup:
John Boehner's stale 'two-step job creation plan', by Ezra Klein: Minority
Leader John Boehner is proposing what his members are calling a "two-step job
creation plan." The two steps? Pass a budget that costs only as much as the 2008
budget, and extend the Bush tax cuts for everyone, including the wealthiest
So on the one hand, a measure that will make a small dent in the deficit. On the
other hand, a measure that will lead to a huge increase in the deficit. There's
no theory of the economy in which this really makes sense: If the market is
worried about the government's finances, this makes them worse, not better. ...
It's also worth noting that these policies are both stale: The Bush tax cuts are
... tax policy from 10 years ago, designed to deal with a very different set of
circumstances. ... Our economic situation has changed dramatically in the past
few years. Don't Republicans have any fresh thinking on what to do about it?
I thought Ezra's wonk book made the salient point:
...many Republicans, at the same time that they are claiming that a $50 billion
investment in America’s infrastructure is a budget-buster, are pushing to extend
the Bush tax cuts for the wealthiest two percent of Americans. ...
And the cost of those tax cuts is much, much higher than the cost of the
infrastructure proposal. On the other side -- i.e. the benefits -- given our
infrastructure needs, which are nearly universally acknowledged to be large, the
benefits from infrastructure spending would be similarly large. As Paul Krugman
the benefits from infrastructure spending are likely to exceed the benefits from
extending the tax cuts:
So suppose we’re going to put $50 billion of resources that would otherwise be
idle to work. Is it better to use them to produce public goods like improved
roads, or private goods like more consumer durables? That’s not at all obvious —
and anyone who tells you that basic economics settles the question, that is says
that devoting more resources to production of private goods is better, doesn’t
understand Econ 101.
And there’s a pretty good argument to be made that we are, in fact,
starved for public goods in this country, so that it would actually be a
good idea to shift some resources to public goods production even if we
were at full employment; in that case, we should definitely give
priority to public goods when trying to put unemployed resources to
Would we be better or worse off today if the Bush tax cuts at the upper end of the income distribution had been used instead for a decade long program to rebuild infrastructure? My answer won't be hard to guess.
Posted by Mark Thoma on Wednesday, September 8, 2010 at 10:18 AM in Budget Deficit, Economics, Fiscal Policy, Press |
Aaron Carroll summarizes recent research on tort reform as a means of controlling health care costs:
Health Affairs covers malpractice, by Aaron Carroll: ...The
of Health Affairs focuses on medical malpractice in the United States, and there
are a number of pieces in there worth reading. I’m going to discuss just a
Costs Of Defensive Medicine, Small Savings From Tort Reform, by J. William
Thomas, Erika C. Ziller, and Deborah A. Thayer. While many seem to believe
that capping damages and awards is the panacea to the high cost of health care
in the US,... the authors ... found that a 10% reduction in premiums would lead
to behavior changes that would result in a savings of about 0.1% of health care
costs. That doesn’t mean it’s not worth doing; it does mean that those who
think simple tort reform is the real answer to lowering health care costs may be
National Costs Of The Medical Liability System, by Michelle M. Mello,
Amitabh Chandra, Atul A. Gawande, and David M. Studdert. This is the
all-star team, and they ... found that the annual medical liability system costs
are about $55.6 billion in 2008 dollars, or about 2.4% of all US health care
spending. You’ll note a theme when I say that this isn’t chump change, but
it’s not nearly the amount portrayed during the health care reform debate when
some argued tort reform would solve the health care cost issue. ...
Physicians’ Fears Of Malpractice Lawsuits Are Not Assuaged By Tort Reforms,
by Emily R. Carrier, James D. Reschovsky, Michelle M. Mello, Ralph C. Mayrell,
and David Katz ... found ... tort reform doesn’t appear to change physicians’
malpractice concerns much, and therefore may not decrease defensive medicine or
health care costs much.
There are others, and I hope to get to them soon. Since I have often
post on) that malpractice reform is not the answer to the cost problem, I
grant you that most of these conformed with my world view. ...
And, in response to some push back:
The odd logic of tort reform, by Aaron Carroll: Well, I seem to have
touched a nerve. I’m getting a lot of email telling me I’m off the
mark when it comes to tort reform. Some of this email is coming from
physicians who claim to usually agree with me. You’re sure I’m wrong here.
You’re sure that tort reform (by which you mean setting caps on damages) really
would reduce health care costs and make physicians practice differently.
Unfortunately, most of you are coming at me with anecdotes. So I’m
going to ... use data.
Let’s start with Texas. In 2003, Texas capped non-economic damages on
malpractice lawsuits at $250,000. It’s pretty much what they Republicans
wanted to do with health care reform as well (see
their plan). In an op-ed in the Washington Post, Governor Perry and
Texas, for example, has adopted approaches to controlling health-care costs
while improving choice, advancing quality of care and expanding coverage.
Consider the successful 2003 tort reform.
Well, that’s a fact we can check. Did tort reform have any of these
effects? Here’s a handy chart from
Citizen using data from the Dartmouth Atlas of Health Care (Selected
Medicare Reimbursement Measures):
dotted line is when tort reform when into effect. Not only were costs for
Medicare enrollees not controlled, they went up faster than the national
average. In fact, Texas reimbursement rates in 2007 were the second
highest in the country. What exactly did Governor Perry and Speaker
Gingrich mean by “successful”?
Maybe they were talking about health insurance premiums? Were they
controlled after reform? Again, a
chart using data from the Agency for Healthcare Research and Quality,
Medical Expenditure Panel Survey:
insurance premiums again did not see a dramatic decrease after tort reform.
Oddly enough, Governor Perry and Speaker Gingrich also claimed that
Texas-style reforms “increased coverage”. To check that you need only go
to the US census:
you see the increase in coverage? I ask, because I can’t. This claim
is actually laughable, because Texas as a state has the highest level of
uninsurance in the US. Sometimes the Washington Post baffles me. Is
there any fact-checking at all?
Some people believe – just know – that reducing malpractice awards
will lead to fewer lawsuits which will lead to a reduction in premiums which
will lead to a reduction in defensive medicine which will lead to a reduction in
health care costs. It’s a matter of faith. It has to be, because
there’s just not that much evidence it will happen.
Update: There's more, this time on California rater than Texas.
Posted by Mark Thoma on Wednesday, September 8, 2010 at 09:14 AM in Economics, Health Care, Regulation |
When I teach the History of Economic Thought, one thing we focus on is how
views on the role of the state have changed over time. It has a natural cycle to
it, with eras such as the highly interventionist Mercantilist years followed by
Physiocratic and Classical views stressing minimal government intervention. This
is followed by a rebound in the other direction, and so it goes with a Keynes
followed by a Friedman in the 50s, a rebound back to Keynes in the 60s, to
classical ideas following the experience of the 70s, and so on, and so on. We are involved in the same debate, and a smaller version of the grand historical lurches in each direction, yet again today:
What is the role of the state?, by Martin Wolf: It is ... a good time to ask
... the biggest question in political economy: what is the role of the state?
This question has concerned western thinkers at least since Plato (5th-4th
century BCE). It has also concerned thinkers in other cultural traditions... The
perspective here is that of the contemporary democratic west.
The core purpose of the state is protection. This view would be shared by
everybody, except anarchists... Contemporary Somalia shows the horrors that can
befall a stateless society. Yet horrors can also befall a society with an
over-mighty state. ...
Mancur Olson argued that the state was a “stationary bandit”. A stationary
bandit is better than a “roving bandit”, because the latter has no interest in
developing the economy, while the former does. But it may not be much better,
because those who control the state will seek to extract the surplus over
subsistence generated by those under their control.
In the contemporary west, there are three protections against undue exploitation
by the stationary bandit: exit, voice ... and restraint. By “exit”, I mean the
possibility of escaping from the control of a given jurisdiction, by emigration,
capital flight or some form of market exchange. By “voice”, I mean a degree of
control over, the state, most obviously by voting. By “restraint”, I mean
independent courts, division of powers, federalism and entrenched rights.
This, then, is a brief background to ... the problem, which is defining what a
democratic state ... is entitled to do. ...
There exists a strand in classical liberal or, in contemporary US parlance,
libertarian thought which believes the answer is to define the role of the state
so narrowly and the rights of individuals so broadly that many political choices
(the income tax or universal health care, for example) would be ruled out a
priori. ... I view this as a hopeless strategy...
So what ought the protective role of the state to include? Again, in such a
discussion, classical liberals would argue for the
“night-watchman” role. The government’s responsibilities are limited to
protecting individuals from coercion, fraud and theft and to defending the
country from foreign aggression.
Yet once one has accepted the legitimacy of using coercion (taxation) to provide
the goods listed above, there is no reason in principle why one should not
accept it for the provision of other goods that cannot be provided as well, or
at all, by non-political means.
Those other measures would include addressing a range of externalities (e.g.
pollution), providing information and supplying insurance against otherwise
uninsurable risks, such as unemployment, spousal abandonment and so forth. The
subsidization or public provision of childcare and education is a way to promote
equality of opportunity. The subsidization or public provision of health
insurance is a way to preserve life, unquestionably one of the purposes of the
state. Safety standards are a way to protect people against the carelessness or
malevolence of others or (more controversially) themselves. All these, then, are
legitimate protective measures. The more complex the society and economy, the
greater the range of the protections that will be sought.
What, then, are the objections to such actions? The answers might be: the
proposed measures are ineffective..; the measures are unaffordable...; the
measures encourage irresponsible behavior; and, at the limit, the measures
restrict individual autonomy to an unacceptable degree. These are all, we should
note, questions of consequences.
The vote is more evenly distributed than wealth and income. Thus, one would
expect the tenor of democratic policymaking to be redistributive and so, indeed,
it is. Those with wealth and income to protect will then make political power
expensive to acquire and encourage potential supporters to focus on common
enemies (inside and outside the country) and on cultural values. The more
unequal are incomes and wealth and the more determined are the “haves” to avoid
being compelled to support the “have-nots”, the more politics will take on such
What are my personal views on how far the protective role of the state should
go? In the 1970s, the view that democracy would collapse under the weight of its
excessive promises seemed to me disturbingly true. I am no longer convinced of
this... Moreover, the capacity for learning by democracies is greater than I had
realized. The conservative movements of the 1980s were part of that learning.
But they went too far in their confidence in market arrangements and their
indifference to the social and political consequences of inequality. I would
support state pensions, state-funded health insurance and state regulation of
environmental and other externalities. I am happy to debate details.
The ancient Athenians called someone who had a purely private life “idiotes”.
This is, of course, the origin of our word “idiot”. Individual liberty does
indeed matter. But it is not the only thing that matters. The market is a
remarkable social institution. But it is far from perfect. Democratic politics
can be destructive. But it is much better than the alternatives. Each of us has
an obligation, as a citizen, to make politics work as well as he (or she) can
and to embrace the debate over a wide range of difficult choices that this
Martin Wolf’s response to readers’ comments
Protection, justice, correction of externalities, social insurance, and the
provision of public goods (which I would like to have seen emphasized more
above) are, in my view, legitimate roles of the state. I have more trouble when
it comes to redistribution, I prefer that everyone have an equal chance in life
with the chips falling where they may (with insurance against outcomes where individuals end up with too few chips). But redistribution to correct problems associated with, say, uncorrected market failures that redistribute income unfairly, or
to compensate for an unequal playing field more generally, is another matter.
Posted by Mark Thoma on Wednesday, September 8, 2010 at 12:42 AM in Economics, Fiscal Policy, Market Failure, Monetary Policy, Social Insurance |
Posted by Mark Thoma on Tuesday, September 7, 2010 at 11:02 PM in Economics, Links |
I figured Tim Duy would be too shy to post this, so I posted it for him.
Posted by Mark Thoma on Tuesday, September 7, 2010 at 04:09 PM in Economics, Fed Watch, Press |
said that "the idea of 'public goods' and the need for government to provide
them has been lost in discussions over stimulus spending," I'm glad to see
Infrastructure, by Paul Krugman: Some bleary-eyed thoughts from Japan on the
reported administration proposal for $50 billion in new spending:
1. It’s a good idea
2. It’s much too small
3. It won’t pass anyway — which makes you wonder why the administration didn’t
propose a bigger plan, so as to at least make the point that the other party is
standing in the way of much needed repair to our roads, ports, sewers, and more–
not to mention creating jobs. Once again, they’re striking right at the
Beyond all that, the new initiative is a chance for me to air one of my pet
peeves: the stupidity of the claim, which you hear all the time — and you’ll
hear again now — that it’s always better to provide stimulus in the form of tax
cuts, because individuals know better than the government what to do with their
Why is this claim stupid? Because Econ 101 tells us that there are some things
the government must provide, namely public goods whose benefits can’t be
internalized by the market.
So suppose we’re going to put $50 billion of resources that would otherwise be
idle to work. Is it better to use them to produce public goods like improved
roads, or private goods like more consumer durables? That’s not at all obvious —
and anyone who tells you that basic economics settles the question, that is says
that devoting more resources to production of private goods is better, doesn’t
understand Econ 101.
And there’s a pretty good argument to be made that we are, in fact, starved for
public goods in this country, so that it would actually be a good idea to shift
some resources to public goods production even if we were at full employment; in
that case, we should definitely give priority to public goods when trying to put
unemployed resources to work.
Anyway, it’s all academic right now. My response to the administration plan, at
least as best as I can respond given a massive case of jet lag, is a big eh.
Looks like we agree on all three points, it's a good idea, but there's too little of it, and it's unlikely to pass. I would also add "much too late" to the "much too little" charge, but "too late" assumes the point of the proposal is to help people rather than play political games designed to influence the upcoming midterm elections.
But I've said all that before, many times, so let's move on to the actual reason for this post. In the NYRB, Paul Krugman and Robin
Fault Lines: How Hidden Fractures Still Threaten the World Economy by
Raghuram G. Rajan,
Crisis Economics: A Crash Course in the Future of Finance by Nouriel Roubini
and Stephen Mihm, and
The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession by
Richard C. Koo:
The Slump Goes On: Why?, by Paul Krugman and Robin Wells, NYRB: In the
winter of 2008–2009, the world economy was on the brink. Stock markets plunged,
credit markets froze, and banks failed in a mass contagion that spread from the
US to Europe and threatened to engulf the rest of the world. During the darkest
days of crisis, the United States was losing 700,000 jobs a month, and world
trade was shrinking faster than it did during the first year of the Great
By the summer of 2009, however, as the world economy stabilized, it became clear
that there would not be a full replay of the Great Depression. Since around June
2009 many indicators have been pointing up: GDP has been rising in all major
economies, world industrial production has been rising, and US corporate profits
have recovered to pre-crisis levels.
Yet unemployment has hardly fallen in either the United States or Europe—which
means that the plight of the unemployed, especially in America with its minimal
safety net, has grown steadily worse as benefits run out and savings are
exhausted. And little relief is in sight: unemployment is still rising in the
hardest-hit European economies, US economic growth is clearly slowing, and many
economic forecasters expect America’s unemployment rate to remain high or even
to rise over the course of the next year.
Given this bleak prospect, shouldn’t we expect urgency on the part of
policymakers and economists, a scramble to put forward plans for promoting
growth and restoring jobs? Apparently not: a casual survey of recent books and
articles shows nothing of the kind. Books on the Great Recession are still
pouring off the presses—but for the most part they are backward-looking, asking
how we got into this mess rather than telling us how to get out. To be fair,
many recent books do offer prescriptions about how to avoid the next bubble; but
they don’t offer much guidance on the most pressing problem at hand, which is
how to deal with the continuing consequences of the last one.
Nor can this odd neglect be entirely explained by the mechanics of the book
trade. It’s true that economics books appearing now for the most part went to
press before the disappointing nature of our so-called recovery was fully
apparent. Even a survey of recent articles, however, shows a notable
unwillingness on the part of the dismal science to offer solutions to the
problem of persistently high unemployment and a sluggish economy. There has been
a furious debate about the effectiveness of the monetary and fiscal measures
undertaken at the depths of the crisis; there have also been loud declarations
about what we must not do—warnings about the alleged danger of budget deficits
or expansionary monetary policy are legion. But proposals for positive action to
dig us out of the hole we’re in are few and far between.
In what follows, we’ll provide a relatively brief discussion of a much-belabored
but still controversial subject: the origins of the 2008 crisis. We’ll then turn
to the ongoing policy debates about the response to the crisis and its
aftermath. Not to keep readers in suspense: we believe that the relative absence
of proposals to deal with mass unemployment is a case of “self-induced
paralysis”—a phrase that Federal Reserve Chairman Ben Bernanke used a decade
ago, when he was a researcher criticizing policymakers from the outside. There
is room for action, both monetary and fiscal. But politicians, government
officials, and economists alike have suffered a failure of nerve—a failure for
which millions of workers will pay a heavy price. ...[...continue
There's a lot in the article, but I do want to point to this section in particular:
The idea that the government did it—that government-sponsored loans, government
mandates, and explicit or implicit government guarantees led to irresponsible
home purchases—is an article of faith on the political right. It’s also a
central theme, though not the only one, of Raghuram Rajan’s Fault Lines.
In the world according to Rajan, a professor of finance at the University of
Chicago business school, the roots of the financial crisis lie in rising income
inequality in the United States, and the political reaction to that inequality:
lawmakers, wanting to curry favor with voters and mitigate the consequences of
rising inequality, funneled funds to low-income families who wanted to buy
homes. Fannie Mae and Freddie Mac, the two government-sponsored lending
facilities, made mortgage credit easy; the Community Reinvestment Act, which
encouraged banks to meet the credit needs of the communities in which they
operated, forced them to lend to low-income borrowers regardless of risk; and
anyway, banks didn’t worry much about risk because they believed that the
government would back them up if anything went wrong.
Rajan claims that the Troubled Asset Relief Program (TARP), signed into law by
President Bush on October 3, 2008, validated the belief of banks that they
wouldn’t have to pay any price for going wild. Although Rajan is careful not to
name names and attributes the blame to generic “politicians,” it is clear that
Democrats are largely to blame in his worldview. By and large, those claiming
that the government has been responsible tend to focus their ire on Bill Clinton
and Barney Frank, who were allegedly behind the big push to make loans to the
While it’s a story that ties everything up in one neat package, however, it’s
strongly at odds with the evidence. And it’s disappointing to see Rajan, a
widely respected economist who was among the first to warn about a runaway Wall
Street, buy into what is mainly a politically motivated myth. Rajan’s book
relies heavily on studies from the American Enterprise Institute, a right-wing
think tank; he doesn’t mention any of the many studies and commentaries
debunking the government-did-it thesis.5 Roubini and Mihm, by
contrast, get it right:
They go on to detail some of the evidence against the Rajan view of the crisis.
Posted by Mark Thoma on Tuesday, September 7, 2010 at 09:45 AM in Economics, Fiscal Policy |
...It is as if China’s leaders were the star pupils in one of Kindleberger’s
courses. Throughout the crisis, the Chinese economy continued to grow at an
amazing pace, in part as a consequence of massive fiscal stimulus. When anyone
wants an example of how effective a Keynesian counter-cyclical strategy can be,
internationally as well as domestically, they need look no further than China’s
four-trillion-renminbi stimulus of 2008-2009.
Apart from a six-month period after the September 2008 collapse of Lehman
Brothers, in which trade finance stopped and the world did look as if it was
close to Great Depression circumstances, China and other emerging markets helped
those export-oriented industrial economies to recover. The surprising strength
of the German economy, with more vigorous growth than at any time in the past 15
years, is due to the dynamism of emerging-market – particularly Chinese –
demand, not only for investment goods, engineering products, and machine tools,
but also for luxury consumer products. Germany’s high-end automobile producers
are now operating at full capacity.
China also followed Kindleberger’s financial lessons. For a moment, it looked as
if a contagious crisis, driven by fears of government over-indebtedness, would
destroy the politically fragile compromise that European countries had carefully
constructed over a 50-year period. The turning point in this spring’s euro panic
came when big holders of reserve currencies signaled that they saw the need for
the euro as an alternative to the increasingly problematic dollar and the
equally vulnerable yen. China started to buy European Union governments’ bonds,
and a high-profile Chinese team even went to Greece to buy under-priced real
It was not just Europe that benefited from China’s willingness to take on the
mantle of “lender of last resort.” The new-found dynamism of African economies
is a consequence of the Chinese drive to build up and secure sources of raw
But there is a problem with Kindleberger’s argument. Kindleberger, a kind and
well-meaning man, could never see that the world is never entirely grateful to
the country that saves it. Being a hegemon is a thankless task. ...
Mostly just curious to see what reaction this will bring. Comments?
Posted by Mark Thoma on Tuesday, September 7, 2010 at 12:26 AM in China, Economics, Financial System, Fiscal Policy |
Posted by Mark Thoma on Monday, September 6, 2010 at 11:02 PM in Economics, Links |
Real Work Begins, by David Warsh: ...The experts’ deciphering of the crisis
is nearly complete. Now the real work begins.
The best account of what happened,..., still seems to me, as it did in
is that of Gary Gorton, of Yale University, Slapped by the Invisible Hand:
The Panic of 2007, which described the problem as the high-tech equivalent
of an old-fashion nineteenth-century banking panic. Federal Reserve chairman Ben
Bernanke shares my opinion, I was gratified to learn...
We can look forward to the report of the Financial Crisis Inquiry Commission, at
whose hearings Bernanke was testifying last week. The FCIC’s investigation,
undertaken in the spirit of various Congressional inquiries, including the
Report of the 9/11 Commission and stretching all the way back to the 1932
Pecora Hearings (which led to the passage in 1933 of ... the Glass-Steagall
Act), is due to be submitted to Congress on December 15. ...
[Most analysts agree that] the culmination of a thirty-year pulse of financial
innovation simply swamped regulators’ abilities to cope with – or even at
certain key points to understand – the nature of the unfolding crisis. This vast
new infrastructure, known collectively as the “shadow banking system,”
consists principally of the proliferation of investment instruments known as
“securitization,” on the one hand; and, on the other, the advent of myriad
other institutional investors including money market mutual funds. There is
probably no reason to want to dismantle this system, or even to think any longer
that it could be done. But new methods of regulation are definitely needed to
prevent the industry from seizing up in panic again a few years hence.
Almost none of the structural problems involved are addressed in the Dodd-Frank
Wall Street Reform and Consumer Protection Act, which President Obama signed
into law in July. Among a small circle of economists and market participants,
the deciphering is nearly complete. But popular news media haven’t yet tackled
the task of translating their findings of malfunctions into political discourse.
That probably won’t begin in earnest before the FCIC report appears in December.
So perhaps the most interesting occasion on the calendar will be the meeting of
the Brookings Panel on Economic Activity scheduled for September 16-17. Gorton
and Andrew Metrick, also of Yale, are scheduled to present a paper there –
“Regulating the Shadow Banking System” — that includes a concrete proposal to
bring the securitization industry under the regulatory umbrella.
How? By chartering – and closely supervising – a new kind of bank
(narrow-funding banks) whose sole business would be to buy asset-backed
securities from their originators and use them to conduct the banking activities
known as “repo” that were at the heart of the 2007-09 crisis.
Sound complicated? It is. Fanciful? Probably not. It was strict standards
for collateral that stabilized national banking in the nineteenth century. The
new market will be designed by experts, as opposed to a popular reform. Even so,
get ready for more stories than you will want to read about the mechanics
of big-league financial intermediation. ...
Finding ways to prevent runs in the repo market is an important component of financial market stabilization. [Note: There are citations to several accounts of the crisis in the article, including "HTML clipboard
the work of Markus Brunnermeier, of Princeton University, whose early article in
the Journal of Economic Perspectives
the Liquidity and Credit Crunch of 2007-08
” is, like the rest of that
rejuvenated journal, now available free online.]
Posted by Mark Thoma on Monday, September 6, 2010 at 08:56 PM in Economics, Financial System, Regulation |
The Economist asks:
Should the Bush tax cuts be extended?
Here are the answers, including one from me:
Yes, but only for a short period
Yes, their benefits outweigh their costs
Maintain the cuts and reduce spending to trim deficits
Yes, as the rich will drive recovery
Only some, and the saved revenue should be recycled
Given the reports this morning that the administration's is about to
propose a six year plan to rebuild infrastructure, I may want to rethink this
my answer on what to do with tax revenue gained from allowing high end tax
cuts to expire:
There are other possibilities as well. For example, since it doesn't look like
the recession is going to end anytime soon, there's still time for new
infrastructure projects. And having them kick in down the road when other types
of stimulus fade away would provide insurance against backsliding. But, as with
most alternatives, it's very unlikely that anything like this could pass
I still think that Congress is unlikely to go along. As for the proposal
itself, here are a few details:
Obama to unveil infrastructure plan, Reuters via FT: Washington – President
Barack Obama will announce on Monday a six-year plan to revamp the United
States’ road, railways and runways with a $50bn up-front investment to
jump-start job creation, the White House said.
The plan is one of several economic initiatives that Mr Obama is due to unveil
this week aimed at generating some desperately needed US job growth and limiting
predicted Democratic losses in November 2 congressional elections. ...
The argument ... is this: Democratic policies have stopped the bleeding and
produced some economic growth. Yes, more needs to be done, but Republicans would
bring back ideas, he will argue, that propelled the country into the deepest
recession in 70 years. ...
Administration officials said he will propose making permanent the business tax
credits for research, which the White House projects will cost $100bn over 10
years and would be paid for by ending some corporate tax breaks.
Other items that could also be talked about by Mr Obama are a payroll tax
holiday, extending tax cuts for the middle class and increasing money for clean
It's a bit late, and it's
much too small, but I see this as a positive evolutionary step in the
administration's approach to these issues. It's good politics as well. In fact, since the small size means it won't do much on its own to improve the employment situation, and given the timing of the proposal (why not six months or a year ago instead of near an election?), gaining political advantage is likely the main thrust of the initiative.
But, while it may not do much in the short-run, it does have attractive features in the longer run. There's talk, for example, of an "infrastucture bank." It doesn't have the automatic stabilization properties I talked about here, but it provides a good institutional foundation for countercyclical infrastructure policy in the future either through an automatic mechanism that ramps up infrastructure spending when the economy turns downward, or using discretionary authority. And, as argued here, infrastructure is a good investment in any case. But, again, no matter the merits, it seems unlikely that this will be approved by Congress. But I won't mind at all if I'm wrong about that.
Posted by Mark Thoma on Monday, September 6, 2010 at 10:16 AM in Economics |
In a deep recession, "the usual
rules don’t apply":
1938 in 2010,
by Paul Krugman, Commentary, NY Times: Here’s the situation: The U.S.
economy has been crippled by a financial crisis. The president’s policies have
limited the damage, but they were too cautious, and unemployment remains
disastrously high. More action is clearly needed. Yet the public has soured on
government activism, and seems poised to deal Democrats a severe defeat in the
The president in question is Franklin Delano Roosevelt; the year is 1938. ...
Now,... President Obama’s economists promised not to repeat the mistakes of
1937, when F.D.R. pulled back fiscal stimulus too soon. But by making his
program too small and too short-lived, Mr. Obama did just that: the stimulus
raised growth while it lasted, but it made only a small dent in unemployment —
and now it’s fading out.
And ... the inadequacy of the administration’s initial economic plan has landed
it — and the nation — in a political trap. More stimulus is desperately needed,
but in the public’s eyes the failure of the initial program to deliver a
convincing recovery has discredited government action to create jobs.
In short, welcome to 1938.
The story of 1937, of F.D.R.’s disastrous decision to heed those who said that
it was time to slash the deficit, is well known. What’s less well known is the
extent to which the public drew the wrong conclusions from the recession that
followed..., voters lost faith in fiscal expansion. ... And the 1938 election
was a disaster for the Democrats, who lost 70 seats in the House and seven in
Then came the war. ... Over the course of the war the federal government
borrowed ... the equivalent of roughly $30 trillion today.
Had anyone proposed spending even a fraction that much before the war, people
would have said the same things they’re saying today. They would have warned
about crushing debt and runaway inflation. They would also have said, rightly,
that the Depression was in large part caused by excess debt — and then have
declared that it was impossible to fix this problem by issuing even more debt.
But guess what? Deficit spending created an economic boom — and the boom laid
the foundation for long-run prosperity. ... And after the war, thanks to the
improved financial position of the private sector, the economy was able to
thrive without continuing deficits.
The economic moral is clear: when the economy is deeply depressed, the usual
rules don’t apply. Austerity is self-defeating: when everyone tries to pay down
debt at the same time, the result is depression and deflation, and debt problems
grow even worse. And conversely,... a temporary surge of deficit spending, on a
sufficient scale, can cure problems brought on by past excesses.
But the story of 1938 also shows how hard it is to apply these insights. Even
under F.D.R., there was never the political will to do what was needed to end
the Great Depression; its eventual resolution came essentially by accident.
I had hoped that we would do better this time. But ... politicians and
economists alike have spent decades unlearning the lessons of the 1930s, and are
determined to repeat all the old mistakes. And it’s slightly sickening to
realize that the big winners in the midterm elections are likely to be the very
people who first got us into this mess, then did everything in their power to
block action to get us out.
But always remember: this slump can be cured. All it will take is a little bit
of intellectual clarity, and a lot of political will. Here’s hoping we find
those virtues in the not too distant future.
Posted by Mark Thoma on Monday, September 6, 2010 at 12:33 AM in Economics, Fiscal Policy |
Posted by Mark Thoma on Sunday, September 5, 2010 at 11:02 PM in Economics, Links |
I don't have any grand, new points to make here, they've all been made before, I just want to point out that the
idea of "public goods" and the need for government to provide them has been lost
in discussions over stimulus spending.
A previous post quoting Richard Green makes the basic case that, recession or not, spending on public goods can have benefits that exceed costs:
...what if the cost to borrow for the bridge is 3 percent and the bridge's IRR
is 5%? Then doesn't the bridge stimulate spending for the simple reason that it
is a good investment? The federal government has made, it seems to me, some very
good investments. Hoover Dam is one. Rural electrification is another. The
interstate highway system. The Golden Gate Bridge. The New York City subway
system. I could continue...
I do worry about bridges to nowhere. But many macroeconomists seem to believe in
the hearts that public goods don't exist, and that there is nothing government
can do better than the private sector. I think it is here that macro takes its
cues more from religion than science.
When interest rates are low and resources such as labor are idle, costs are low, and the cost-benefit calculation is more favorable. Duncan Black has been banging this drum:
Beware Of The Bond Vigilantes, by Duncan Black:10-year Treasury at 2.51. As
I keep saying, at rates this low it's a crime not to borrow crazy amounts and
spend it on supertrains and fixing bridges and whatnot.
People To Do Stuff, by Duncan Black: When I look around my hilariously
flawed urban hellhole, I see infinite things that could use some work, both
public infrastructure and dealing with a lot of deteriorated housing stock.
That's even before we get to sexy ideas like weatherization. The idea that we
might have "structural unemployment" because there are a bunch of laid off
construction workers is absurd. Those people have skills which can be put to
good use on obvious productive activities. Someone just needs to write them a
check and tell them what to do. The possibilities are, as I said, infinite.
People have been making the argument for spending on public goods during recessions for a long time:
"We Were All Keynesians Then", by Mark Thoma: Though the idea is likely far
older, using public works projects to stimulate employment goes back at least to
the mercantilists. For example, Sir William Petty (1623-1687) believed the
government should employ the idle to work on roads, dredge rivers, build
bridges, that sort of thing, though he did say in A Treaties of Taxes and
Contributions (1662) that "tis of no matter if it be employed to build a useless
Pyramid upon Salisbury Plain, bring the Stones at Stonehenge to Tower-Hill, or
the like," so it was more of a traditional Keynesian view on stimulating
aggregate demand than one devoted purely to construction of infrastructure.
Thomas Malthus (1766-1834) believed that:
It is also of importance to know that, in our endeavors to assist the working
class in a period like the present, it is desirable to employ them in those
kinds of labour, the results of which do not come for sale into the market, such
as roads and public works, The objection to employing a large sum in this way,
raised by taxes, would not be its tendency to diminish the capital employed in
productive labour; because this, to a certain extent is exactly what is
wanted... [Political Economy, 2nd Ed., 429-430]
And, from 80 years ago, Calvin Coolidge echoes this theme:
We Were All
Keynesians Then, Journal of Political Economy, Back Cover, Vol. 104, No. 5
(Oct., 1996): The idea of utilizing construction, particularly of
public works, as a stabilizing factor in the business and employment situation
has long been a plan of perfection among students of these problems. If in
periods of great business activity the work of construction might be somewhat
relaxed; and if in periods of business depression and slack employment those
works might be expanded to provide occupation for workers otherwise idle, the
result would be a stabilization and equalization which would moderate the
alternations of employment and unemployment. This in turn would tend to
favorable modification of the economic cycle. . . The first and easiest
application of such a regulation is in connection with public works; the
construction program which involves public buildings, highways, public
utilities, and the like. Most forms of Government construction could be handled
in conformity to such a policy, once it was definitely established. . . This
applies not only to the construction activities of the Federal Government, but
to those of states, counties and cities.
More than this, the economies possible under such a plan are apparent. When
everybody wants to do the same thing at the same time, it becomes unduly
expensive. Every element of costs, in every direction, tends to expand. These
conditions reverse themselves in times of slack employment and subnormal
activity, with the result that important economies are possible.
I am convinced that if the Government units would generally adopt such a
policy, and if, having adopted it, they would give the fullest publicity to the
resultant savings, the showing would have a compelling influence upon business
generally. Quasi-public concerns, such as railroads and other public utilities,
and the great corporations whose requirements can be quite accurately
anticipated and charted, would be impressed that their interest could be served
by a like procedure.
[Calvin Coolidge, address before the Associated General Contractors of
America; quoted in L. W. Wallace, "A Federal Department of Public Works and
Domain: Its Planning, Activities, and Influence in Leveling the Business Cycle,"
Proceedings of the Academy of Political Science 12 (July 1927): 108-9]
(Suggested by David Laidler)
...Given the state of our
infrastructure and the state of the economy, both of which have crumbling
foundations, it's past time to start these projects. So what are we waiting for?
made this plea before. This was in January 2009, more than a year and a half
ago, and I was trying to make the case that there's plenty of time to put more
spending on public goods type infrastructure in place:
...right now, with so much of our infrastructure in need of attention, we
need public goods.
We tried the tax cut approach to stimulating the economy once, we had no
choice since Bush and the Republicans would not have passed any other type of
Guess what? It didn't work very well, and we have little to show for it. Had
we, say, rebuilt water systems instead, at the very worst we'd have better
water. That's not so bad in any case.
And it's been interesting, if that's the right word, to watch the same people
who delayed fiscal policy for months and months and months as they insisted that
we try tax cuts first now tell us that it will take too long to put the spending
in place. They don't seem to realize the delay is because of their insistence on
the use of tax cuts rather than spending. If we had started on these projects a
year ago instead of enacting the tax cut package to appease the right,
timeliness would not be such an issue - we might already be repairing sewage
systems, rebuilding roads, and so on. I've even heard some who ought to know
better argue that because forecasts say the recession will end soon, we can't
possibly get the spending in place soon enough. That is, they argue that by the
time the spending hits the economy, the economy will have already recovered
(these are often the same people who reassured us that there was no housing
bubble, and there was not worry anyway because the recession, if it hit at all,
would be very mild and easily absorbed by our dynamic, flexible economy). Never
mind that forecasts beyond around six months ahead are not much better than a
coin flip, and they know it, some forecast somewhere says that the recession
will end before spending is in place, and that's enough for them to take the
argument public. What if the forecast is wrong?
It's not completely clear to me that the fact that the recession might end
soon undercuts the case for government spending anyway. If the money is spent on
large, socially beneficial projects - and lots of infrastructure comes under
this heading - then so what if the economy recovers? These are things we very
much need, and that won't change just because the economy is doing better. There
will be net benefits no matter the state of the economy, but the net benefits
will be higher if we pursue these projects when the costs are low. If we are
lucky, and the economy recovers very fast, much faster than expected, then there
will still be benefits, they just won't be as large.
We need to do these things, and right now, with so many idle resources in the
economy, the opportunity cost of employing resources is low. For this reason,
this is an opportune time to meet the challenges that we face in repairing the
infrastructure and in meeting other needs that are critical to maintaining
robust economic growth, and in maintaining our health and welfare.
The tax cuts are better than spending proponents generally ignore public
goods when they argue that the private sector is always better at spending
money, but it seems to me that leaves out an important part of the argument.
If the argument that the private sector is more efficient than government
always prevailed, we wouldn't have any public goods at all, and that's not an
economy I'd want to live in. Obviously, there are times when spending on public
goods is justified economically, and I'd argue strongly that this is one of
those times, i.e. that there are lots of places the government can spend money
that have large social returns. Why would we want to wait until the opportunity
cost is very high to reap these returns instead of pursuing these projects now
when the cost is lower? If we are going to have to make these expenditures
anyway, it doesn't make any sense to wait. ...
Let me end with this from Brad DeLong:
Department of "Huh?!": Obama Election Season Edition, by Brtad DeLong:
Outsourced to Jackie Calmes, who wonders whether the Democratic establishment is
On Economy, Democrats Face a Lack of Unity: Mr. Obama spoke Thursday with
the House speaker, Nancy Pelosi, and the Senate majority leader, Harry Reid, to
coordinate on proposals.... Among the ideas favored within the administration
are tax incentives for clean energy jobs and credits for employers who increase
their work forces. The president and his team have ruled out a broad-based
payroll tax holiday to promote hiring, officials say. But they are still
considering whether to propose making permanent a tax credit for businesses’
research and development; for three decades the costly credit has been
repeatedly renewed rather than made permanent so the revenue loss does not show
up in deficit projections.
Democrats say the list of stimulus ideas is mostly tax cuts because spending
proposals would have no chance of Republican support.
Yet Republicans have opposed Democrats’ tax cutting ideas as well, so some
Democrats argue that the new ideas could further demoralize party liberals, who
want new spending for job-creating public works...
To put forward a weak, ineffective, Republican idea for further stimulus that
then does not pass seems the worst of all possible worlds.
The forecasts are that employment could take years to fully recover. There's
plenty of time for more spending on public goods, the need for such spending is
large, and right now the cost of that spending is very, very low. And, repeating from above, even if the recession ends sooner than we expect, "these are things we very
much need, and that won't change just because the economy is doing better. There
will be net benefits no matter the state of the economy, but the net benefits
will be higher if we pursue these projects when the costs are low."
[Update: Ryan Avent at The Economist's Free Exchange has more along these lines.]
Posted by Mark Thoma on Sunday, September 5, 2010 at 10:57 AM in Economics, Fiscal Policy |
Making Social Security less generous isn't the answer, by Ezra Klein, Commentary, Washington Post: ...Raising the Social Security retirement age has become as close to a consensus position as exists in American politics. ... And for a while, I agreed... People live longer today, and so they should work later into life. But as I've looked at the issue, I've decided that I was wrong. ... We should leave the retirement age alone. In fact, we should leave Social Security alone...
Start with the basic rationale for raising the retirement age. As Rep. Paul D. Ryan (R-Wis.) has argued, when Social Security was signed into law, the retirement age was 65 and life expectancy was 63. "The numbers added up pretty well back then," he said on Fox News. But that's misleading. That figure was driven by high infant mortality. ...
Moreover,... averages conceal a lot of inequality. In 1972, a 60-year-old male worker who made less than the median income had a life expectancy of 78 years. By 2001, he had a life expectancy of 80 years. Meanwhile, workers in the top half of the income distribution shot to 85 years from 79. ...
Lurking beneath this conversation is an unquestioned assumption: We live longer, so we should work longer. That's pretty intuitive to members of Congress, who seem to like their jobs and don't seem to like the idea of retiring. It's also pretty intuitive to blogger/columnists, who spend their time in air-conditioned rooms opining about pension programs. But most people don't work in Congress or in the media. They work on their feet. They strain their backs. They're bored silly at the end of the day. By the time they're in their 60s, they want to retire.
You see that reflected in Social Security. Age 66 is when you get full benefits. But most people begin taking Social Security at age 62. They get less, but they can retire earlier. To them, the trade-off is worth it. ...
An August survey ... tested reactions to a variety of Social Security fixes. One of the options was raising the retirement age to 70. Two-thirds of respondents opposed it. Another option was eliminating the cap on payroll taxes so that well-off workers pay the tax on their full income, just as middle-income workers do now. A solid 61 percent supported it.
That's almost the reverse of the conversation in Washington, where affluent people who like their jobs propose cutting benefits for the poor (which is, after all, what raising the retirement age would do) rather than lowering benefits or increasing the payroll tax on, well, themselves. ...
The universally unpleasant options for reform are a testament to Social Security's efficiency. It's a simple transfer program, with administrative costs that amount to less than 0.9 percent of total spending. There's not much fat to cut.
That can't be said for much else in American public policy. Our health-care system costs twice as much as the German system and doesn't deliver better results. Our defense sector is wasteful and bloated. Our tax code could raise more money and do less to harm growth if we cleaned it out. Our home prices are driven upward by the mortgage interest tax deduction. Our health insurance premiums are goosed by the exclusion of employer-sponsored insurance from taxable income.
Reforming any of those sectors ... would be politically difficult, but would mean better policy. Reforming Social Security will be politically difficult and result in worse policy. ...
Here's what I argued in May of 2005:
1. An increase in life expectancy does not necessarily imply that people are healthier at age 65 or 70 than before. Suppose, for example, that medical advances are discovered that extend the end of life by several years, but have no effect on health prior to the last few years of life. In such a case there would be an increase in life expectancy, but no increase in the health of workers at the age of retirement. If people aren’t healthier, then increasing the retirement age imposes a hardship over and above that faced by current retirees.
2. It’s already difficult for elderly workers to find employment, and when they do they are often underemployed relative to their skill levels. Raising the retirement age will make this worse.
3. What about workers employed in physically demanding occupations? Is it reasonable to ask them to work until, say, age 72? If not, how equitable is it to have some workers work until 72, and others allowed to retire at a younger age depending on their occupation?
4. Will this distort occupational choice decisions? ... How will we decide when a worker is unable to work due to reasons associated with age?
5. The life expectancy of some groups of workers is lower than for others. If poorer workers die younger than richer workers on average, then raising the retirement age will have a larger impact on low income workers and thus, in essence, be regressive.
Posted by Mark Thoma on Sunday, September 5, 2010 at 12:34 AM in Economics, Politics, Social Security |
Posted by Mark Thoma on Saturday, September 4, 2010 at 11:01 PM in Economics, Links |
The Fed has been under considerable pressure recently by those, me among them, who believe the Fed should use quantitative easing to lower long-term interest rates.
However, a temporary investment tax credit can provide the same incentives for business investment as a Fed induced fall in the long term interest rate, and then some, and that's not the only thing fiscal policy can do.
The Fed can help, and should help, but fiscal policy can do even more.
Posted by Mark Thoma on Saturday, September 4, 2010 at 12:07 PM in Economics, Fiscal Policy, Monetary Policy, Taxes |
Illegal immigrants are
helping to finance your retirement:
The contributions by unauthorized immigrants to Social Security ... are much
larger than previously known... Stephen C. Goss, the chief actuary
of the Social Security Administration and someone who enjoys bipartisan support
for his straightforwardness, said that by 2007, the Social Security trust fund
had received a net benefit of somewhere between $120 billion and $240 billion
from unauthorized immigrants. The cumulative contribution is surely higher
now. Unauthorized immigrants paid a net contribution of $12 billion in 2007
alone... Somebody ought to say thank you.
Posted by Mark Thoma on Saturday, September 4, 2010 at 12:03 PM in Economics, Social Security |
Joseph Stiglitz and Linda Bilmes:
The true cost of the Iraq war: $3 trillion and beyond, by Joseph E. Stiglitz and
Linda J. Bilmes, Commentary, Washington Post: Writing in these pages in
early 2008, we put the total cost to the United States of the Iraq war at $3
trillion. This price tag dwarfed previous estimates, including the Bush
administration's 2003 projections of a $50 billion to $60 billion war.
But today, as the United States ends combat in Iraq, it appears that our $3
trillion estimate (which accounted for both government expenses and the war's
broader impact on the U.S. economy) was, if anything, too low. For example, the
cost of diagnosing, treating and compensating disabled veterans has proved
higher than we expected.
Moreover, two years on, it has become clear to us that our estimate did not
capture what may have been the conflict's most sobering expenses: those in the
category of "might have beens," or what economists call opportunity costs. For
instance, many have wondered aloud whether, absent the Iraq invasion, we would
still be stuck in Afghanistan. And this is not the only "what if" worth
contemplating. We might also ask: If not for the war in Iraq, would oil prices
have risen so rapidly? Would the federal debt be so high? Would the economic
crisis have been so severe?
The answer to all four of these questions is probably no. ... [...continue reading...]
There are some costs -- the harm that something like torture does to our collective sense of morality for example -- that I have no idea how to evaluate.
Posted by Mark Thoma on Saturday, September 4, 2010 at 10:01 AM in Economics, Iraq and Afghanistan |
I probably should have posted this discussion of naked CDS from Yeon-Koo Che and Rajiv Sethi, but for some reason I felt like something different from the usual fare:
Stephen Hawking's big bang gaps, by Paul Davies, CIF: Cosmologists are
agreed that the universe began with a big bang 13.7 billion years ago. People
naturally want to know what caused it. A simple answer is nothing: not because
there was a mysterious state of nothing before the big bang, but because time
itself began then – that is, there was no time "before" the big bang. The idea
is by no means new. In the fifth century, St Augustine of Hippo wrote that "the
universe was created with time and not in time".
Religious people often feel tricked by this logic. They envisage a
miracle-working God dwelling within the stream of time for all eternity and
then, for some inscrutable reason, making a universe (perhaps in a spectacular
explosion) at a specific moment in history.
That was not Augustine's God, who transcended both space and time. Nor is it the
God favored by many contemporary theologians. In fact, they long ago coined a
term for it – "god-of-the-gaps" – to deride the idea that when science leaves
something out of account, then God should be invoked to plug the gap. The origin
of life and the origin of consciousness are favorite loci for a
god-of-the-gaps, but the origin of the universe is the perennial big gap.
In his new book, Stephen Hawking reiterates that there is no big gap in the
scientific account of the big bang. The laws of physics can explain, he says,
how a universe of space, time and matter could emerge spontaneously, without the
need for God. And most cosmologists agree: we don't need a god-of-the-gaps to
make the big bang go bang. It can happen as part of a natural process. A much
tougher problem now looms, however. What is the source of those ingenious laws
that enable a universe to pop into being from nothing?
Traditionally, scientists have supposed that the laws of physics were simply
imprinted on the universe at its birth, like a maker's mark. As to their origin,
well, that was left unexplained.
In recent years, cosmologists have shifted position somewhat. If the origin of
the universe was a law rather than a supernatural event, then the same laws
could presumably operate to bring other universes into being. The favored view
now, and the one that Hawking shares, is that there were in fact many bangs,
scattered through space and time, and many universes emerging therefrom, all
perfectly naturally. The entire assemblage goes by the name of the multiverse.
Our universe is just one infinitesimal component amid this vast – probably
infinite – multiverse, that itself had no origin in time. So according to this
new cosmological theory, there was something before the big bang after all – a
region of the multiverse pregnant with universe-sprouting potential.
A refinement of the multiverse scenario is that each new universe comes complete
with its very own laws – or bylaws, to use the apt description of the
cosmologist Martin Rees. Go to another universe, and you would find different
bylaws applying. An appealing feature of variegated bylaws is that they explain
why our particular universe is uncannily bio-friendly; change our bylaws just a
little bit and life would probably be impossible. The fact that we observe a
universe "fine-tuned" for life is then no surprise: the more numerous
bio-hostile universes are sterile and so go unseen.
So is that the end of the story? Can the multiverse provide a complete and
closed account of all physical existence? Not quite. The multiverse comes with a
lot of baggage, such as an overarching space and time to host all those bangs, a
universe-generating mechanism to trigger them, physical fields to populate the
universes with material stuff, and a selection of forces to make things happen.
Cosmologists embrace these features by envisaging sweeping "meta-laws" that
pervade the multiverse and spawn specific bylaws on a universe-by-universe
basis. The meta-laws themselves remain unexplained – eternal, immutable
transcendent entities that just happen to exist and must simply be accepted as
given. In that respect the meta-laws have a similar status to an unexplained
According to folklore the French physicist Pierre Laplace, when asked by
Napoleon where God fitted into his mathematical account of the universe,
replied: "I had no need of that hypothesis." Although cosmology has advanced
enormously since the time of Laplace, the situation remains the same: there is
no compelling need for a supernatural being or prime mover to start the universe
off. But when it comes to the laws that explain the big bang, we are in murkier
Posted by Mark Thoma on Saturday, September 4, 2010 at 01:11 AM in Economics, Science |
Posted by Mark Thoma on Friday, September 3, 2010 at 11:02 PM in Economics, Links |
Dennis Lockhart, president of the Atlanta Fed, makes it clear that presently he sees no
need for more stimulus -- a slow, plodding recovery like we had in the
previous two recession is the best we can expect. If we're on track to match those,
there's no need to try to do better.
Here's David Altig of the Atlanta Fed discussing Lockhart's speech earlier today:
Optimism…pessimism…and a bit of perspective, by David Altig, macroblog:
Here's how I'm tempted to summarize today's release of
the August employment
report from the U.S. Bureau of Labor Statistics: more of the same. That
theme fits nicely with comments this morning from Atlanta Fed President Dennis
Lockhart, in a
East Tennessee State University. Here he calls for a little perspective:
"Some commentators are reading recent economic data as suggesting the onset
of a second recession and deflationary cycle. Quite naturally, business people
and consumers aren't sure what to believe.
"At the last meeting of the Federal Open Market Committee (FOMC) in
Washington, the committee made a decision that has been widely interpreted as
signaling declining confidence in the strength and sustainability of the
"In my remarks today, I will provide a less alarmist interpretation of recent
economic information and the Fed's recent policy decision. I will argue that,
generally speaking, there was too much optimism in the early months and quarters
of the recovery and now there may be excessive pessimism."
One point is that recoveries are not generally linear affairs:
"Growth at the end of last year and early part of this year was stronger than
I anticipated while economic activity in the second and third quarters seems
weaker than I expected.
"But such ups and downs are not unusual during a recovery. A little history:
following the 2001 recession, gross domestic product (GDP) grew at the
annualized rate of 3.5 percent in early 2002. Growth then decelerated to about 2
percent for the next two quarters then fell to almost zero in the fourth
quarter. Entering 2003, growth edged up to a little over 1.5 percent and then
accelerated from there to a sustained period of relatively strong growth for two
...Even in the rapid-growth, pre-1990 recoveries, there was generally a
quarter or two of growth that underperformed. ...
But the better benchmarks will likely prove to be the slower-growth,
low-employment recoveries post-1990. In addition to the 2001 experience noted by
President Lockhart, the expansion that followed the 1990–91 recession stumbled
along with quarterly growth rates of 2.7, 1.69, and 1.58 percent, before picking
up to above-potential growth rates. Despite that, the eighth quarter after that
recession's end clocked in at an anemic 0.75 percent.
So why are we content to match that performance instead of trying to improve? Why do we try to rationalize concerns instead (calling it "a bit of perspective")?:
What is more important is that there is a reasonably good explanation for why
we might have hit a soft patch:
"Looking at the 2009–2010 recovery, it seems clear that some of the early
strength was promoted by policies that pulled forward spending from the second
and third quarters of this year. The recent sharp decline in housing-related
indicators following the expiration of homebuyer tax credits is the most obvious
example of this effect."
Given that expectation, wouldn't it have been nice to have someone, the Fed say, try to fill this hole
until the private sector begins growing robustly on its own?
Back to David Altig:
Essentially, President Lockhart's is a simple message: don't ignore the
short-term data, but be careful with getting too carried away with it as well.
"Simply stated, I was expecting a relatively modest recovery...
And he, along with other members of the Fed, is apparently content with that. Finally:
...with respect to that meeting, here is the main policy point:
"At the last meeting there were two important considerations as I saw it.
First, as already discussed, some economic data came in weaker than expected,
shifting the balance of risks to slower growth in the near term and further
disinflation. Second, the Fed's holdings of MBS were projected to decline faster
than previously thought because lower rates were generating heavy mortgage
prepayments and refinancings.
"So, in the context of a softening economy, the FOMC was confronted with the
prospect of unintended withdrawal of support for the recovery through a decline
in the level of liquidity provided to the economy….
"That is how I interpret the decision announced following the August
meeting—a small tactical change designed to preserve the level of liquidity
provided to the system. I supported the committee's decision, but I do not view
it as a fundamental change of outlook or strategy. I do not believe this change
necessarily heralds the beginning of a period of further expansion of the Fed's
balance sheet. Nor do I think the decision precludes a return to a policy of
allowing the balance sheet to shrink on its own.
"I think the decision has been over-interpreted in some quarters."
So, again, the recovery is expected to plod along like we've seen in the
past, at least that's the hope, and though the downside risk has increased and the Fed has the tools to try to help, it doesn't think it should use them.
My view is different.
Posted by Mark Thoma on Friday, September 3, 2010 at 03:17 PM in Economics, Fed Speeches, Monetary Policy |
Will a payroll tax cut stimulate the economy? I am going to answer this in the context of Gauti B. Eggertsson' paper "What Fiscal Policy Is Effective at Zero Interest Rates?" where this question is addressed directly (the analysis begins on page 13). The model is New Keynesian.
The answer, in this model anyway, is that in normal times a payroll tax cut would be stimulative, but at the zero bound it's not so clear. Let me see if I can explain why.
When interest rates are positive, the framework is essentially a standard AS-AD model:
A payroll tax cut increases labor supply and shifts out the AS curve. The shift in the AS curve results in lower inflation and higher output/employment.
One thing that is left out of this model to simplify the analysis and keep it tractable is the demand-side effects of such policies. That is, a tax cut would also increase AD. If we add this effect, the graph then looks like:
Output goes up even more, but whether inflation goes up or down depends upon which shift is larger, the shift in the AS or the shift in the AD (based upon the evidence on how labor supply responds to changes in taxes, I would expect that the shift in the AD would be larger and come first, but ultimately that is an empirical matter).
When the economy is at the zero bound for the nominal interest rates things change. In particular, the AD curve slopes upward. This will be explained intuitively in a moment, but mechanically the effect of a positively sloped AD curve is as follows:
Thus, when we consider only the supply-side effects of a tax cut, it has a negative impact on output and employment. Why is this?
Figure 5 clarifies the intuition for why labor tax cuts become contractionary at zero interest rates while being expansionary under normal circumstances. The key is aggregate demand. At positive interest rates the AD curve is downward-sloping in inflation. The reason is that as inflation decreases, the central bank will cut the nominal interest rate more than 1 to 1 with inflation..., which is the Taylor principle... Similarly, if inflation increases, the central bank will increase the nominal interest rate more than 1 to 1 with inflation, thus causing an output contraction with higher inflation. As a consequence, the real interest rate will decrease with deflationary pressures and expanding output, because any reduction in inflation will be met by a more than proportional change in the nominal interest rate. This, however, is no longer the case at zero interest rates, because interest rates can no longer be cut. This means that the central bank will no longer be able to offset deflationary pressures with aggressive interest rate cuts, shifting the AD curve from downward-sloping to upward-sloping in (YL,πL) space...
The reason is that lower inflation will now mean a higher real rate, because the reduction in inflation can no longer be offset by interest rate cuts. Similarly, an increase in inflation is now expansionary because the increase in inflation will no longer be offset by an increase in the nominal interest rate; hence, higher inflation implies lower real interest rates and thus higher demand.
Once again, however, demand side effects are missing. Tacking those on gives:
Thus, the overall effect on employment depends upon the net effect of the AD and AS shifts. If the AD shift dominates, as I suspect it would, this policy will still have positive effects on output and employment. But the size of the effect depends upon the strength of the demand side shift, and how strong the shift would be is an open question, particularly given the degree of household balance sheet rebuilding we are seeing which causes the tax cuts to be saved rather than spent. [The timing matters as well with the AD effects generally coming first, so in the SR the demand side effects should dominate. If so, that is a reason to be a bit more supportive of these policies.]
Another way to think about this is the following. Supply is not the problem right now, it's lack of demand, and a policy that encourages more supply and threatens deflation is not helpful except to the extent that it increases aggregate demand in the process. Other types of policies can avoid this problem, see, for example the sales tax cut discussed on page 20 or the discussion of fiscal policy multipliers on page 17, but they may not have the same political feasibility as tax cut for labor, which itself doesn't seem all that likely give the degree of opposition it will likely hit in Congress (the sales tax cut would be difficult to implement given that sales taxes are levied at the state level, and there's no chance that government spending increases will pass Congress right now; on the politics of a payroll tax cut, see the end of this post).
[Note: The demand-side effects were left out of the paper to keep the mathematics tractable, and it may be that simply tacking on the demand-side effects as I've done (the red lines) isn't quite correct. I think it's okay, but if anyone can speak to this, that would be great. Also, the policy analyzed in the paper is best interpreted as a payroll tax cut on the worker side. I don't think it matters if the cut is on the employer side, and I hope the administration doesn't pursue this anyway since the employer side tax cut may not pass through to labor fully, or much at all in the very short-run, but, again, if that matters and someone can speak to this point, please do.]
Posted by Mark Thoma on Friday, September 3, 2010 at 12:33 PM in Academic Papers, Economics, Fiscal Policy, Taxes, Unemployment |
Here's my somewhat cranky response this morning's employment report showing that the unemployment rate ticked up, and that the broader U-6 measure went up even more. There was some private sector job growth, but not nearly enough to keep up
with population growth, and far from enough to make any inroads into
reemploying the millions of people who have lost jobs:
The Employment Report: “We’ve Gone Essentially Nowhere in a Year”
My fear isn't a double dip as much as it is that job and GDP growth will remain stagnant. The central valley in California is a good metaphor. It's narrow east to west, but very long north to south (think of the shape of the state). We went down into the valley as we went into the recession, and the question for me has always been whether we are heading east to west so that we will climb out of the valley relatively quickly, or north to south as we trudge along at the bottom of the valley for considerable time before finally climbing slowly back to full employment. I've been warning for a long time that it looks like north to south, and the fact that we've had essentially no growth for a year now, and no hint of change any time soon, makes the north to south fear very real. The administration is supposed to propose new policies to try to help us reach the other side faster, but the timing of that effort -- way too late except as a political ploy -- is one of the thing's I'm cranky about.
Posted by Mark Thoma on Friday, September 3, 2010 at 09:35 AM in Economics, Unemployment |
When Obama announces his new measures to boost the economy next week, will he learn from the mistakes he made the first time?:
Story, by Paul Krugman, Commentary, NY Times: Next week, President Obama is
scheduled to propose new measures to boost the economy. I hope they’re bold and
substantive, since the Republicans will oppose him regardless — if he came out
for motherhood, the G.O.P. would declare motherhood un-American. So he should
put them on the spot for standing in the way of real action.
But let’s put politics aside and talk about what we’ve actually learned about
economic policy over the past 20 months.
When Mr. Obama first proposed $800 billion in fiscal stimulus, there were two
groups of critics. Both argued that unemployment would stay high — but for very
One group — the group that got almost all the attention — declared that the
stimulus was much too large, and would lead to disaster..., skyrocketing
interest rates and soaring inflation.
The other group, which included yours truly, warned that the plan was much too
small given the economic forecasts then available...; an $800 billion program,
partly consisting of tax cuts that would have happened anyway, just wasn’t up to
Critics in the second camp were particularly worried about what would happen
this year, since the stimulus would ... gradually fade out. Last year, many of
us were already warning that the economy might stall in the second half of 2010.
So what actually happened? ... Start with interest rates. Those who said the
stimulus was too big predicted sharply rising rates. When rates rose in early
2009, The Wall Street Journal ... declared that it was all about fear of
deficits, and concluded, “When in doubt, bet on the markets.”
But those who said the stimulus was too small argued that temporary deficits
weren’t a problem as long as the economy remained depressed; we were awash in
savings with nowhere to go. Interest rates, we said, would fluctuate with
optimism or pessimism about future growth, not with government borrowing.
When in doubt, bet on the markets. The 10-year bond rate was over 3.7 percent
when The Journal published that editorial; it’s under 2.7 percent now.
What about inflation? Amid the inflation hysteria of early 2009, the
inadequate-stimulus critics pointed out that inflation always falls during
sustained periods of high unemployment... Sure enough, key measures of inflation
have fallen ... to 1 percent or less..., and Japanese-style deflation is looking
like a real possibility.
Meanwhile, the timing of recent economic growth strongly supports the notion
that stimulus does, indeed, boost the economy: growth accelerated last year, as
the stimulus reached its predicted peak impact, but has fallen off — just as
some of us feared — as the stimulus has faded. ...
The actual lessons of 2009-2010, then, are that scare stories about stimulus are
wrong, and that stimulus works when it is applied. But it wasn’t applied on a
sufficient scale. And we need another round.
I know that getting that round is unlikely... And if, as expected, the G.O.P.
wins big in November, this will be widely regarded as a vindication of the
anti-stimulus position. Mr. Obama, we’ll be told, moved too far to the left, and
his Keynesian economic doctrine was proved wrong.
But politics determines who has the power, not who has the truth. The economic
theory behind the Obama stimulus has passed the test of recent events with
flying colors; unfortunately, Mr. Obama, for whatever reason — yes, I’m aware
that there were political constraints — initially offered a plan that was much
too cautious given the scale of the economy’s problems.
So, as I said, here’s hoping that Mr. Obama goes big next week. If he does,
he’ll have the facts on his side.
Posted by Mark Thoma on Friday, September 3, 2010 at 12:24 AM in Economics, Fiscal Policy, Politics |
David Beckworth pushes back against some posts that have appeared here and
elsewhere recently (my view is that low interest rates played a
role, as did regulatory failures, but these were not the only causes of the crisis):
What Role Did the Fed Play In the Housing Bubble?, by David Beckworth: I
really did not want to revisit this question since I have already
covered it here many times before. Folks, however, are
talking about it again given its coverage at the Fed's Jackson Hole
conference. Mark Thoma, for
example, has posted several pieces on it in the past few days. Most of this
renewed discussion has taken a less critical view of the Fed's role during the
housing boom, specifically the role played by the Fed's low interest rate
policy. I feel compelled to rebut this Fed love fest since there are compelling
reasons to believe the Fed did play an important role in creating the housing
boom. To be clear, I do not see the Fed as the only contributor--far from
it--but it does appear to be one of the more important ones. Here is my list
of reasons why:
(1) The Fed kept its policy interest rate, the federal funds rate, below
the natural or neutral interest rate for an extended period. It is not
correct to say the Fed kept interest rates very low and thus monetary policy was
very loose. Interest rates can be low because the economy is weak, not just
because monetary policy is stimulative. Interest rates only indicate a
loosening of monetary policy if they are low relative to the
neutral interest rate, the interest rate level consistent with a closed
output gap ( i.e. the economy operating at its full potential). There is ample
evidence that the Fed during the 2002-2004 period pushed the federal funds rate
well below the neutral interest rate level. For example, see
Laubach and Williams (2003) or this
(2007). Below is graph that shows the Laubach and Williams natural interest
rate minus the real federal funds rate. This spread provides a measure on the
stance of monetary policy--the larger it is the looser is monetary policy and
vice versa. This figure shows that monetary policy was unusually accommodative
during this time. This figure also indicates an important development behind the
large gap was that the productivity boom at that time kept the neutral
interested elevated even as the Fed held down the real federal funds rate.
(2) Given the excessive monetary easing shown above, the Fed helped create
a credit boom that found its way--via financial innovation, lax governance (both
private and public), and misaligned incentives--into the housing market.
Housing market activity was further reinforced by "the search for yield" created
by the Fed's low interest rates. The low interest rates at the time encouraged
investors to take on riskier investments than they otherwise would have. Some
of those riskier investments end up being tied to housing. Thus, the
risk-taking channel of monetary policy added more fuel to the housing boom.
(3) Given the Fed's monetary superpower status, its loose monetary policy
got exported across the globe. As a result, the Fed helped create a global
liquidity glut that in turn helped fuel a global housing boom. The Fed is a
global monetary hegemon. It holds the world's main reserve currency and many
emerging markets are formally or informally pegged to dollar. Thus, its monetary
policy was exported to much of the emerging world at this time. This means that
the other two monetary powers, the ECB and Japan, had to be mindful of U.S.
monetary policy lest their currencies becomes too expensive relative to the
dollar and all the other currencies pegged to the dollar. As as result, the
Fed's loose monetary policy
got exported to some degree to Japan and the Euro area. From this
perspective it is easy to understand how the Fed could have created a global
liquidity glut in the early-to-mid 2000s. Inevitably, some of this global
liquidity glut got recycled back into the U.S. economy and further fueled the
housing boom (i.e. the dollar block countries had to buy up more dollars as the
Fed loosened policy and these funds got recycled via Treasury purchases back to
the U.S. economy). Below is a picture from
Sebastian Becker of Deutsche Bank that highlights this surge in global
For these reasons I believe the Fed played a major role in the credit and
housing boom during the early-to-mid 2000s. Let me close by directing you to
Barry Ritholtz who
gives more details on how the Fed's policy distorted incentives in financial
Posted by Mark Thoma on Friday, September 3, 2010 at 12:09 AM in Economics, Housing, Monetary Policy, Regulation |
Posted by Mark Thoma on Thursday, September 2, 2010 at 11:01 PM in Economics, Links |
Using a model that allows multipliers to vary over the business cycle, Alan
Auerbach and Yuriy Gorodnichenko find that the fiscal stimulus multiplier is
greater than one in recessions:
The return from a fiscal stimulus – the fiscal multiplier – remains one of
the most controversial topics in economics today. This column considers the
influence of expectations, of variation in recessions and expansions, and of
different components of government spending. It finds that the size of the
multiplier varies considerably over the business cycle: between 0 and 0.5 in
expansions and between 1 and 1.5 in recessions.
Posted by Mark Thoma on Thursday, September 2, 2010 at 05:43 PM in Economics, Fiscal Policy |
I don't like to steal other people's catch phrases (just their posts), but,
Companies Already Lobbying Fed on Financial Rules, by Michael Crittenden,
WSJ: U.S. firms eager to shape newly-passed financial laws have
wasted no time in lobbying the Federal Reserve and other agencies, according
to new details released Thursday by the central bank.
Summaries of 11 meetings involving Fed staff and outside corporations and
advocacy groups highlight the high-stakes rulemaking that will occur as U.S.
regulators seek to implement the wide-ranging financial overhaul
legislation. The meeting log shows representatives from Visa Inc. met with
Fed staff just two days after President Barack Obama signed the Dodd-Frank
bill into law on July 21.
The topics of conversation at that meeting: debit cards and interchange
rates charged to merchants. ... The records show Bank of America Corp., J.P.
Morgan Chase & Co. and American Express Co. have all met with Fed staff at
least once since mid-July to discuss the interchange issue.
Firms such as Goldman Sachs Group Inc. and Citigroup Inc. have also
discussed tough new rules for derivatives with Fed officials, among others.
It isn’t just financial firms seeking to discuss the potential changes. The
Fed on Aug. 20 hosted a discussion with a group representing firms that use
derivatives to hedge risks, so-called “end users”. Those present included
executives from Safeway Inc. and Boeing Co., as well as representatives from
the American Petroleum Institute and U.S. Chamber of Commerce. ...
Notice any interest that aren't being represented here?
The phrase "If they're too big to fail, they're too big to exist" has been
heard a lot recently, but I'd add that: "If they're too big for Congress and the Fed
to say no to, they're too big to exist."
It appears to me that many firms lobbying Congress and the Fed are, in fact, this big, and the question is whether we will do anything about it. I'm not optimistic that those with the ability to change things will do so as it would involve going against the interests of major campaign contributors. I would love to write a post entitled "Quell Surprise" about how wrong I am about this, I just don't think it's going to happen.
Posted by Mark Thoma on Thursday, September 2, 2010 at 03:20 PM in Economics, Market Failure, Politics, Regulation |
Adair Turner, Chairman of Britain’s Financial Services Authority, on the too
big to fail problem:
“Too Big to Fail”?, by Adair Turner, Commentary, Project Syndicate:
Obviously, the global financial crisis of 2008-2009 was partly one of specific,
systemically important banks and other financial institutions such as AIG. In
response, there is an intense debate about the problems caused when such
institutions are said to be “too big to fail.”
Politically, that debate focuses on the costs of bailouts and on tax schemes
designed to “get our money back.” For economists, the debate focuses on the
moral hazard created by ex ante expectations of a bailout, which reduce
market discipline on excessive risk-taking – as well as on the unfair advantage
that such implicit guarantees give to large players over their
Numerous policy options to deal with this problem are now being debated. These
include higher capital ratios for systemically important banks, stricter
supervision, limits on trading activity, pre-designated resolution and recovery
plans, and taxes aimed not at “getting our money back,” but at internalizing
externalities – that is, making those at fault pay the social costs of their
behavior – and creating better incentives.
I am convinced that finding answers to the too-big-to-fail problem is
necessary... But we must not confuse “necessary” with “sufficient”; there is a
danger that an exclusive focus on institutions that are too big to fail could
divert us from more fundamental issues.
In the public’s eyes, the focus on such institutions appears justified by the
huge costs of financial rescue. But when we look back on this crisis in, say,
ten years, what may be striking is how small the direct costs of rescue will
appear. Many government funding guarantees will turn out to have been
All of this implies that the crucial problem is not the fiscal cost of rescue,
but the macroeconomic volatility induced by precarious credit supply – first
provided too easily and at too low a price, and then severely restricted. And it
is possible – indeed, I suspect likely – that such credit-supply problems would
exist even if the too-big-to-fail problem were effectively addressed. ...
There is therefore a danger that excessive focus on “too big to fail” could
become a new form of the belief that if only we could identify and correct some
crucial market failure, we would, at last, achieve a stable and
self-equilibrating system. Many of the problems that led to the crisis – and
that could give rise to future crises if left unaddressed – originated
I mostly oppose large banks due to the political power that they have, the market power that comes with size, the unfair advantage the implicit guarantee of a bailout gives large banks over small banks (since the
large banks are perceived as less risky due to the guarantee, they can get funds
at a lower cost), and the fact that the implicit guarantee induces large banks to take on too much risk. There's also a worry that size and connectedness amplifies the effects of a crisis. However, I don't think systemic risk falls much by simply breaking
the banks into smaller pieces, so this isn't a major part of the reason why I think we should limit bank size. There are plenty of examples of crises involving
smaller banks in the U.S. and elsewhere, so breaking banks up
does not provide an impermeable defense against systemic issues.
The most frustrating part, though, is the implicit assumption in most of these discussions that big banks are inevitable. I have yet to see an analysis that convinces me that large banks provide a boost to efficiency that more than compensates for the problems their size brings about. I realize we are reluctant to impose per se rules against size for good reason, and that the fact that they may not increase efficiency is not sufficient justification to break them up, but the political power, the excessive risk taking, the economic power that come with size, etc. are. Maybe the problems aren't as large or worrisome as I believe, but it would be nice to have the sense that regulators are at least asking these questions. Instead they seem to be resigned to the fact that large banks are inevitable.
I hope to do more with this speech later -- we'll see if time permits that -- but here's Ben Bernanke talking about this issue earlier today: Notice the assumption in the background that large banks will exist:
"Too Big to Fail"
Many of the vulnerabilities that amplified the crisis are linked with the
problem of so-called too-big-to-fail firms. A too-big-to-fail firm is one whose
size, complexity, interconnectedness, and critical functions are such that,
should the firm go unexpectedly into liquidation, the rest of the financial
system and the economy would face severe adverse consequences. Governments
provide support to too-big-to-fail firms in a crisis not out of favoritism or
particular concern for the management, owners, or creditors of the firm, but
because they recognize that the consequences for the broader economy of allowing
a disorderly failure greatly outweigh the costs of avoiding the failure in some
In the midst of the crisis, providing support to a too-big-to-fail firm usually
represents the best of bad alternatives; without such support there could be
substantial damage to the economy. However, the existence of too-big-to-fail
firms creates several problems in the long run.
First, too-big-to-fail generates a severe moral hazard. If creditors believe
that an institution will not be allowed to fail, they will not demand as much
compensation for risks as they otherwise would, thus weakening market
discipline; nor will they invest as many resources in monitoring the firm's
risk-taking. As a result, too-big-to-fail firms will tend to take more risk than
desirable, in the expectation that they will receive assistance if their bets go
bad. Where they have the necessary authority, regulators will try to limit that
risk-taking, but without the help of market discipline they will find it
difficult to do so... There is little doubt that excessive risk-taking by
too-big-to-fail firms significantly contributed to the crisis...
A second cost of too-big-to-fail is that it creates an uneven playing field
between big and small firms. This unfair competition, together with the
incentive to grow that too-big-to-fail provides, increases risk and artificially
raises the market share of too-big-to-fail firms, to the detriment of economic
efficiency as well as financial stability.
Third, as we saw in 2008 and 2009, too-big-to-fail firms can themselves become
major risks to overall financial stability, particularly in the absence of
adequate resolution tools. ... The failures of smaller, less interconnected
firms, though certainly of significant concern, have not had substantial effects
on the stability of the financial system as a whole.
If the crisis has a single lesson, it is that the too-big-to-fail problem must
be solved. Simple declarations that the government will not assist firms in the
future, or restrictions that make providing assistance more difficult, will not
be credible on their own. Few governments will accept devastating economic costs
if a rescue can be conducted at a lesser cost; even if one Administration
refrained from rescuing a large, complex firm, market participants would believe
that others might not refrain in the future. Thus, a promise not to intervene in
and of itself will not solve the problem.
The new financial reform law and current negotiations on new Basel capital and
liquidity regulations have together set into motion a three-part strategy to
address too-big-to-fail. First, the propensity for excessive risk-taking by
large, complex, interconnected firms must be greatly reduced. Among the tools
that will be used to achieve this goal are more-rigorous capital and liquidity
requirements, including higher standards for systemically critical firms;
tougher regulation and supervision of the largest firms, including restrictions
on activities and on the structure of compensation packages; and measures to
increase transparency and market discipline. Oversight of the largest firms must
take into account not only their own safety and soundness, but also the systemic
risks they pose.
Second, as I already discussed, a resolution regime is being implemented that
allows the government to resolve a distressed, systemically important financial
firm in a fashion that avoids disorderly liquidation while imposing losses on
creditors and shareholders. Ensuring that that new regime is workable and
credible will be a critical challenge for regulators.
Finally, the more resilient the financial system, the less the cost of a failure
of a large firm, and thus the less incentive the government has to prevent that
failure. Examples of policies to increase resiliency include the requirements in
the recent bill to force more derivatives settlement into clearinghouses and to
strengthen the prudential oversight of key financial market utilities such as
clearinghouses and exchanges. ... In addition, prudential regulators should take
actions to reduce systemic risks. Examples include requiring firms to have
less-complex corporate structures that make effective resolution of a failing
firm easier, and requiring clearing and settlement procedures that reduce
vulnerable interconnections among firms.
I asked Bernanke if large banks are necessary. Here's what he said:
B. Mark Thoma, University of Oregon and blogger: ...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?
...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-too big- 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
So the only benefit of size he lists is "large firms may be
better able to meet the needs of global customers." I can't say I find this argument very convincing.
In addition, I am not at all convinced that the procedures to "resolve a distressed, systemically important financial
firm in a fashion that avoids disorderly liquidation" can be made credible. The first time regulators start to use this in a big crisis and markets begin to tank over worries about whether it will work or not, will the administration in power be willing to risk creating a big meltdown? Or will they resort to procedures used in the past that were problematic for all the reasons cited above, but do seem to prevent the most catastrophic outcome?
Until someone convinces me that there are significant advantages to having mega-banks that cannot be duplicated with banks that are not, by themselves, too big to fail, I will continue to call for them to be broken up. Again, I don't think it makes a big difference in terms of systemic risk, though if Bernanke's right it will reduce the magnitude of the crisis, and that reduction in risk is important to recognize. But I do think breaking them up could make a big difference in terms of addressing all the other problems that size (and connectedness) brings about.
Posted by Mark Thoma on Thursday, September 2, 2010 at 12:00 PM in Economics, Financial System |
Karl Case says the American dream is still alive:
A Dream House
After All, by Karl Case, Commentary, NY Times: If you read the coverage of
the latest figures on the sales of existing homes..., you may well have come to
the conclusion that the American dream is dead. It is indeed worrisome that
sales in July were down 25 percent from a year ago. But a little perspective is
First, the bad news. What has happened in the housing markets since 2005 is a
catastrophe that may take years for our economy to recover from. ...
Depressing, yes — but the end of a dream? Not exactly. I have never quite
understood what the American dream really means when it comes to housing. For
some people, it means having a solid and fairly safe long-term investment that
is coupled with the satisfaction of owning the house they live in. That dream is
Others, however, think the American dream is owning property that appreciates by
30 percent a year, making a house into a vehicle for paying bills. But those
kinds of dreams have become nightmares for the millions of foreclosed property
owners who have found themselves sliding toward bankruptcy.
But for people with a more realistic version of the American dream, buying a
house now can make a lot of sense. Think of it as an investment. The return or
yield on that investment comes in two forms. First, it provides what is called
“net imputed rent from owner-occupied housing.” You live in the house and so it
provides you with a real flow of valuable services. ... Consider it this way:
when Enron went belly up, shareholders ended up with nothing, but when the
housing market drops, homeowners still have a house. And this benefit is
The second part of the yield on investment in a house is the capital gain you
receive if it appreciates and you sell the house. Gains are excluded from
taxation if the property is a primary residence...
Consider a few other bonuses of buying a home today. You can deduct the interest
you pay on the mortgage. Interest rates are about as low as they can get. And,
don’t forget, home prices are down by 30 percent on average from the peak. ...
Do the math. Four years ago, the monthly payment on a $300,000 house with 20
percent down and a mortgage rate of about 6.6 percent was $1,533. Today that
$300,000 house would sell for $213,000 and a 30-year fixed-rate mortgage with 20
percent down would carry a rate of about 4.2 percent and a monthly payment of
$833. In addition, the down payment would be $42,600 instead of $60,000. ...
[H]ousing has perhaps never been a better bargain, and sooner or later buyers
will regain faith, inventories will shrink to reasonable levels, prices will
rise and we’ll even start building again. The American dream is not dead — it’s
just taking a well-deserved rest.
There's been a lot of talk about the virtues of renting lately, but for me --
and from the sounds of it perhaps I'm one of the few -- renting and owning are
nowhere near perfect substitutes. Not even close.
Posted by Mark Thoma on Thursday, September 2, 2010 at 12:42 AM in Economics, Housing |
Posted by Mark Thoma on Wednesday, September 1, 2010 at 11:04 PM in Economics, Links |
Here's a summary of:
Christina Romer’s Farewell Address
I also explain one reason I'm so furstrated with fiscal policymakers.
Posted by Mark Thoma on Wednesday, September 1, 2010 at 04:50 PM in Economics, Fiscal Policy, Monetary Policy |
As a follow-up to the post below this one on the usefulness of modern macroeconomic modes, here's Tom Sargent. Given my remarks below, I was pleased to read this:
The criticism of real business cycle models and their close cousins, the so-called New Keynesian models, is misdirected and reflects a misunderstanding of the purpose for which those models were devised.6 These models were designed to describe aggregate economic fluctuations during normal times when markets can bring borrowers and lenders together in orderly ways, not during financial crises and market breakdowns.
Here's more (and there's even more in the original interview, I left out the interesting discussion on Europe). While I don't agree with everything, I am simply going to give Sargent the floor. He's earned the right to have his say:
Interview with Thomas Sargent, by Art Rolnick, Minneapolis Fed, June 15, 2010: ...MODERN MACROECONOMICS UNDER ATTACK
Rolnick: You have devoted your professional life to helping construct and teach modern macroeconomics. After the financial crisis that started in 2007, modern macro has been widely attacked as deficient and wrongheaded.
Sargent: Oh. By whom?
Rolnick: For example, by Paul Krugman in the New York Times and Lord Robert Skidelsky in the Economist and elsewhere. You were a visiting professor at Princeton in the spring of 2009. Along with Alan Blinder, Nobuhiro Kiyotaki and Chris Sims, you must have discussed these criticisms with Krugman at the Princeton macro seminar.
Sargent: Yes, I was at Princeton then and attended the macro seminar every week. Nobu, Chris, Alan and others also attended. There were interesting discussions of many aspects of the financial crisis. But the sense was surely not that modern macro needed to be reconstructed. On the contrary, seminar participants were in the business of using the tools of modern macro, especially rational expectations theorizing, to shed light on the financial crisis.
Rolnick: What was Paul Krugman’s opinion about those Princeton macro seminar presentations that advocated modern macro?
Sargent: He did not attend the macro seminar at Princeton when I was there.
Sargent: I know that I’m the one who is supposed to be answering questions, but perhaps you can tell me what popular criticisms of modern macro you have in mind.
Rolnick: OK, here goes. Examples of such criticisms are that modern macroeconomics makes too much use of sophisticated mathematics to model people and markets; that it incorrectly relies on the assumption that asset markets are efficient in the sense that asset prices aggregate information of all individuals; that the faith in good outcomes always emerging from competitive markets is misplaced; that the assumption of “rational expectations” is wrongheaded because it attributes too much knowledge and forecasting ability to people; that the modern macro mainstay “real business cycle model” is deficient because it ignores so many frictions and imperfections and is useless as a guide to policy for dealing with financial crises; that modern macroeconomics has either assumed away or shortchanged the analysis of unemployment; that the recent financial crisis took modern macro by surprise; and that macroeconomics should be based less on formal decision theory and more on the findings of “behavioral economics.” Shouldn’t these be taken seriously?
Sargent: Sorry, Art, but aside from the foolish and intellectually lazy remark about mathematics, all of the criticisms that you have listed reflect either woeful ignorance or intentional disregard for what much of modern macroeconomics is about and what it has accomplished. That said, it is true that modern macroeconomics uses mathematics and statistics to understand behavior in situations where there is uncertainty about how the future will unfold from the past. But a rule of thumb is that the more dynamic, uncertain and ambiguous is the economic environment that you seek to model, the more you are going to have to roll up your sleeves, and learn and use some math. That’s life.
Continue reading "Thomas Sargent on Modern Macroeconomic Models" »
Posted by Mark Thoma on Wednesday, September 1, 2010 at 12:33 PM in Economics, Macroeconomics, Methodology |
Jean Pisani-Ferry argues that "In extraordinary times, history is, in fact, a better guide than models estimated with data from ordinary times":
The Great Depression in Economic Memory, by Jean Pisani-Ferry, Commentary, Project Syndicate: The dispute that has emerged in the United States and Europe between proponents of further government stimulus and advocates of fiscal retrenchment feels very much like a debate about economic history. Both sides have revisited the Great Depression of the 1930’s – as well as the centuries-long history of sovereign-debt crises – in a controversy that bears little resemblance to conventional economic-policy controversies.
The pro-stimulus camp often refers to the damage wrought by fiscal retrenchment in the US in 1937... So, are we in 1936, and does the budgetary tightening contemplated in many countries risk provoking a similar double-dip recession?
Clearly there are limits to the comparison. ... Nevertheless, the 1937 episode does seem to illustrate the dangers of attempting to consolidate public finances at a time when the private sector is still too weak for economic recovery to be self-sustaining. (Another case with similar consequences was Japan’s value-added tax increase in 1997, which precipitated a collapse of consumption).
Fiscal hawks also rely on history-based arguments. The economists Carmen Reinhart and Kenneth Rogoff have studied centuries of sovereign-debt crises, and remind us that today’s developed world has a forgotten history of sovereign default. A particularly telling example is the aftermath of the Napoleonic wars of the early nineteenth century, when a string of exhausted states defaulted on their obligations. The 1930’s are relevant here as well, given another series of defaults among European states, not least Germany.
What history tells us here is that defaults are not the privilege of poor, under-governed countries. They are a threat to all... Again, there are limits to comparisons...
In normal times, history is left to historians and economic-policy debate relies on models and econometric estimates. But attitudes changed as soon as the crisis erupted in 2007-2008. Indeed, central bankers and ministers were obsessed at the time by the memory of the 1930’s, and they consciously did the opposite of what their predecessors did 80 years ago.
They were right to do so. In extraordinary times, history is, in fact, a better guide than models estimated with data from ordinary times, because it captures variance that standard time-series techniques ignore. If one wants to know how to deal with a banking crisis, the risk of a depression, or the threat of a default, it is natural to examine times when those dangers were around, rather than to rely on models that ignore such dangers or treat them as distant clouds. In times of crisis, the best guides are theory, which captures the essence of a problem, and the lessons of past experience. Everything in between is virtually useless.
The danger with relying on history, however, is that we have no methodology to decide which comparisons are relevant. Loose analogies can easily be regarded at proofs, and a vast array of experiences can be enrolled to support a particular view. Policymakers (whose knowledge of economic history is generally limited) are therefore at risk of being drowned in contradictory historical references.
History can be an essential compass when past experience provides unambiguous headings. But an undisciplined appeal to history risks becoming a confusing way to express opinions. Governance by analogy can easily lead to muddled governance.
My argument is a bit different. In "extraordianry times," the questions that are important change, and economists build models to answer those questions. When those same questions are asked again, it's natural to look to the models built to answer them:
Models are built to answer questions, and the models economists have been using do, in fact, help us find answers to some important questions. But the models were not very good (at all) at answering the questions that are important right now. They have been largely stripped of their usefulness for actual policy in a world where markets simply break down.
The reason is that in order to get to mathematical forms that can be solved, the models had to be simplified. And when they are simplified, something must be sacrificed. So what do you sacrifice? Hopefully, it is the ability to answer questions that are the least important, so the modeling choices that are made reveal what the modelers though was most and least important.
The models we built were very useful for asking whether the federal funds rate should go up or down a quarter point when the economy was hovering in the neighborhood of full employment, or when we found ourselves in mild, "normal" recessions. The models could tell us what type of monetary policy rule is best for stabilizing the economy. But the models had almost nothing to say about a world where markets melt down, or when prices depart from fundamentals. When this crisis hit, I looked into our tool bag of models and policy recommendations and came up empty (for the most part). It was disappointing. There was really no choice but to go back to older Keynesian style models for insight.
The reason the Keynesian model is finding new life is that it specifically built to answer the questions that are important at the moment. The theorists who built modern macro models, those largely in control of where the profession has spent its effort in recent decades,; did not even envision that this could happen, let alone build it into their models. Markets work, they don't break down, so why waste time thinking about those possibilities.
So it's not the math, the modeling choices that were made and the inevitable sacrifices to reality those choices entail reflected the importance the people making the choices gave to various questions. We weren't forced to this end by the mathematics, we asked the wrong questions and built the wrong models. ...
The fight - and main question in academics - has been about what drives macroeconomic variables in normal times, demand-side shocks (monetary policy, fiscal policy, investment, net exports) or supply-side shocks (productivity, labor supply). And it's been a fairly brutal fight at times - you've seen some of that come out during the current policy debate. That debate within the profession has dictated the research agenda.
What happens in non-normal times, i.e. when markets break down, or when markets are not complete, agents are not rational, etc., was far down the agenda of important questions, partly because those in control of the journals, those who largely dictated the direction of research, did not think those questions were very important (some don't even believe that policy can help the economy, so why put effort into studying it?).
I think that the current crisis has dealt a bigger blow to macroeconomic theory and modeling than many of us realize.
Brother, Can You Paradigm?: A few months back one of my original mentors in economics — someone who got his graduate training in the pre-fresh-water era — asked me whether there was anything about the current crisis that required fundamentally new analysis. We agreed that there wasn’t.
This is one of the untold tales of the mess we’re in. Contrary to what you may have heard, there’s very little that’s baffling about our problems — at least not if you knew basic, old-fashioned macroeconomics. In fact, someone who learned economics from the original 1948 edition of Samuelson’s textbook would feel pretty much at home in today’s world. If economists seem totally at sea, it’s because they have carefully unlearned the old wisdom. If policy has failed, it’s because policy makers chose not to believe their own models.
On the analytical front: many economists these days reject out of hand the Keynesian model, preferring to believe that a fall in supply rather than a fall in demand is what causes recessions. But there are clear implications of these rival approaches. If the slump reflects some kind of supply shock, the monetary and fiscal policies followed since the beginning of 2008 would have the effects predicted in a supply-constrained world: large expansion of the monetary base should have led to high inflation, large budget deficits should have driven interest rates way up. And as you may recall, a lot of people did make exactly that prediction. A Keynesian approach, on the other hand, said that inflation would fall and interest rates stay low as long as the economy remained depressed. Guess what happened?
On the policy front: there’s certainly a real debate over whether Obama could have gotten a bigger stimulus. What we do know, however, is that his top advisers did not frame the argument for a small stimulus compared with the projected slump purely in political terms. Instead, they argued that too big a plan would alarm the bond markets, and that anyway fiscal stimulus was only needed as an insurance policy. Neither of these arguments came from macroeconomic theory; they were doctrines invented on the fly. Samuelson 1948 would have said to provide a stimulus big enough to restore full employment — full stop.
So what we have here isn’t really a lack of a workable analytical framework. The disaster we’re facing is the result of the refusal of economists, both in and out of the corridors of power, to go with the perfectly good framework we already had.
As the video from George Evans hopefully makes clear, we are starting to ask the right questions and building the models we need to answer them. Hopefully, decades from now when economists have moved on to other questions and another crisis hits, the theorists who are so defensive of the models being built today won't mind if economists of the future try to learn something from their work.
Posted by Mark Thoma on Wednesday, September 1, 2010 at 09:53 AM in Economics, Macroeconomics, Methodology |
Dear Deficit Hawks:
Bring Back the Estate Tax Now, by Robert Rubin and Julian Robertson,
Commentary, WSJ: ...Congress is
finally turning its attention to the expiring 2001 and 2003 tax cuts. But
there is one tax issue that should have long since been addressed: the
federal estate tax. That tax expired at the end of last year, and there have
been no estate taxes levied this year. If a new estate tax is not enacted as
soon as Congress returns from its August recess, this void will continue
until the end of the year.
We would recommend continuing 2009's regime, with a top rate of 45% and a
$3.5 million individual exemption. Small businesses and family farms can be
protected both through the exemption (which is $7 million for a couple) and
through special deferred payment rules.
We both believe that the estate tax should be a component of any federal tax
system. ... A key criterion in choosing taxes is to have the least negative
impact on economic activity. The estate tax, in our opinion, meets that
test. An estate tax can provide revenue—with little, if any, adverse supply-side
economic impact—to fund deficit reduction, additional public investment or
added assistance to those affected by the economic crisis. ...
We also share the view that the estate tax is grounded in powerful
philosophical underpinnings. Our nation views itself as a meritocracy and a
land of opportunity and we have a proud legacy of upward mobility. An estate
tax helps us promote this legacy, by avoiding the accumulation of inherited
economic—and political—power that is antithetical to this historical vision
of our society and to the vitality and dynamism that has contributed so much
to our success. ...
Our country is losing revenue that, with its stressed fiscal conditions, it
can ill afford to forego.
I don't have any disagreement with this. If anything, I'd favor even higher rates once the estate value passes certain thresholds, i.e. additional steps in the rates.
Posted by Mark Thoma on Wednesday, September 1, 2010 at 12:42 AM in Budget Deficit, Economics, Equity, Taxes |
[This one is, as they say, wonkisk.] As James Bullard noted in the previous post, we "have one of the world's experts on the question of the dynamics" of dynamic stochastic general equilibrium (DSGE) models here at the University of Oregon, particularly models that involve learning.
There has been considerable controversy recently about the dynamic properties of DSGE models near the zero bound, in particular whether raising the federal funds rate target can help to avoid falling into a deflationary trap. So I asked George to explain this on video, and he graciously agreed to do so. The bottom line is that in these models, the type of policy discussed by Minnesota Fed President Narayana Kocherlakota increases rather than decreases the chance of a deflationary spiral. Here's George Evans
Please note: As soon as we were done, George realized there was a typo on the whiteboard. The horizontal axis on both graphs should have the low inflation steady state inflation value labeled β instead of β-1. The value of .99 on the right-hand graph is correct. Here are corrected versions of the graphs in the video: Figure 1 (on the left in the video), Figure 2 (on the right).
Papers mentioned in the video:
- P. Howitt, Interest rate control and nonconvergence, Journal of Political Economy (1992), vol. 100, pp. 776-800.
- G. Evans, E. Guse and S. Honkapohja, Liqudity traps, learning and stagnation, European Economic Review (2008), vol. 52, pp. 1438-1463.
- J. Benhabib, S. Schmitt-Grohe and M. Uribe, The Perils of Taylor rules, Journal of Economic Theory (2001), vol. 96, pp. 40-69.
Posted by Mark Thoma on Wednesday, September 1, 2010 at 12:24 AM in Economics, Macroeconomics |