Saturday, November 06, 2010
Comments on this argument from Jamie Galbraith?:
Obama’s Problem Simply Defined: It Was the Banks, by James K. Galbraith, New Deal 2.0: Bruce Bartlett says it was a failure to focus. Paul Krugman says it was a failure of nerve. Nancy Pelosi says it was the economy’s failure. Barack Obama says it was his own failure — to explain that he was, in fact, focused on the economy.
As Krugman rightly stipulates, Monday-morning quarterbacks should say exactly what different play they would have called. Paul’s answer is that the stimulus package should have been bigger. No disagreement: I was one voice calling for a much larger program back when. Yet this answer is not sufficient.
The original sin of Obama’s presidency was to assign economic policy to a closed circle of bank-friendly economists and Bush carryovers. Larry Summers. Timothy Geithner. Ben Bernanke. These men had no personal commitment to the goal of an early recovery, no stake in the Democratic Party, no interest in the larger success of Barack Obama. Their primary goal, instead, was and remains to protect their own past decisions and their own professional futures.
Up to a point, one can defend the decisions taken in September-October 2008 under the stress of a rapidly collapsing financial system. The Bush administration was, by that time, nearly defunct. Panic was in the air, as was political blackmail — with the threat that the October through January months might be irreparably brutal. Stopgaps were needed, they were concocted, and they held the line.
But one cannot defend the actions of Team Obama on taking office. Law, policy and politics all pointed in one direction: turn the systemically dangerous banks over to Sheila Bair and the Federal Deposit Insurance Corporation. Insure the depositors, replace the management, fire the lobbyists, audit the books, prosecute the frauds, and restructure and downsize the institutions. The financial system would have been cleaned up. And the big bankers would have been beaten as a political force.
Team Obama did none of these things. ...[continue reading]...
Bernanke says he's not trying to create inflation as a means of stimulating the economy:
After its big move to boost economy, Federal Reserve reflects on its history, by Neil Irwin, Washington Post: ...Fed Chairman Ben S. Bernanke and a long list of past and present Fed officials gathered this weekend for a conference on the history of the central bank...
That conversation, particularly a Saturday panel discussion featuring Bernanke, his predecessor, Alan Greenspan, and former New York Fed president Gerald Corrigan... Speaking at the "Return to Jekyll Island" conference sponsored by the Atlanta Fed, Bernanke argued that the steps are not as revolutionary as many observers in the financial markets and the news media have suggested.
"There's a sense out there that, quote, quantitative easing or asset purchases are some completely foreign, new, strange kind of thing and we have no idea what . . . is going to happen," Bernanke said, sitting on stage in a conference space that was once J.P. Morgan's indoor tennis court. "Quite the contrary - this is just monetary policy. . . . It will work or not work in much the same way that ordinary, more conventional, familiar monetary policy works."
Corrigan, who was a key lieutenant of Fed Chairman Paul A. Volcker and now a Goldman Sachs managing director, acknowledged some "uneasiness" with that approach.
"If you seek to nudge up the inflation rate," he said, "even with very, very low rates of capacity utilization in the labor market . . . is there a risk that getting inflation to 2 percent may turn out to be easier than capping it at 2 percent?" "That's the source of uneasiness that I wanted to register," Corrigan added.
Bernanke defended the action. "I have rejected any notion that we are going to try to raise inflation to a super-normal level in order to have effects on the economy," he said. "We're not in the business of trying to create inflation," Bernanke said. Rather, he said, the Fed is trying to avoid a further drop in inflation. ...
Since an increase in inflationary expectations is one potential way to stimulate the economy, Bernanke is "blocking one of the main channels through which his policy might actually work."
The "Greenspan Put" also came up:
To many Fed critics, a central failure over the past three decades has been the perceived willingness of the central bank to take action to prop up financial markets whenever they are faltering, a phenomenon known as the "Greenspan Put," which uses the term for an option that protects against an asset losing value.
The criticism is that by standing in to prevent precipitous declines in financial markets, the Fed made it appear that one could invest without risk...
Given that his own policies have helped prop up stock prices in the past year, Bernanke echoed the phraseology of some of his critics and referred to the phenomenon, almost sheepishly, as the "Greenspan/Bernanke Put."
Greenspan was unrepentant.
"If in effect the Greenspan Put is the notion which says you're stabilizing the system, then I hope so - that's what we're here for," the former Fed chairman said. "I don't really have an understanding of why that has become a pejorative term. . . . If I understand it, what we're doing is what we should be doing." ...
In looking through past comments on the Greenspan put, I found this from 2005:
...the broader question of whether the perception that the Fed will protect asset markets is causing overconfidence and excessive risk taking among investors is an interesting issue. For some reason, I’ve been reminded lately of the overconfidence among policymakers in the early 1960s. After the discovery of the Phillip’s curve and the belief that it represented a permanent inflation-unemployment tradeoff, policymakers were very confident in their ability to pick a particular point on the Phillip’s curve and it was widely believed that the stabilization problem was largely solved. History teaches us that such overconfidence in any discipline is generally a bad idea, and the 1970s showed economists that humility is always a valuable trait. Has a run of good luck caused a misperception of the risk of losses so that such overconfidence has emerged again?
I think it's safe to say now that it had. As for the Greenspan put, I had always argued there was no such thing, based partly on quotes like this:
Neither Mr. Bernanke nor his closest colleagues, some of whom served under Mr. Greenspan, believe there ever was a "Greenspan put," a reference to a contract that protects an investor from loss. Yet officials acknowledge the perception that the Fed has bailed out investors in the past. When the stock market crashed in 1987, Mr. Greenspan, then on the job for just two months, used aggressive open-market operations -- buying and selling government securities -- to pump banks full of cash...
What's best for the stock market isn't always what's best for the economy, and when there is a tension between the two, the economy should come first. While this is what I *think* Greenspan is saying above by redefining the Greenspan put to mean "stabilizing the system," it's disappointing to see him embrace the term without cautioning that the Fed shouldn't always try to prevent a fall in the stock market, and that it sometimes has to temper a stock market boom, e.g. by raising interest rates to prevent the economy from overheating, or by popping asset bubbles.
Richard Thaler says the positions that Republicans take on the estate tax will be revealing:
Estate Tax Issue Offers Quick Test for Congress, by Richard Thaler, Commentary, NY Times: After their election victory on Tuesday, Republican leaders in the House promised progress on many fronts, including a turn toward more fiscal discipline and less economic uncertainty.
They have a chance to start work on these goals almost immediately, because the lame-duck Congress soon will face a pressing issue that directly concerns both themes: the estate tax. The uncertainty imbedded in this tax was actually written into the law in 2001 by a Republican-controlled Congress.
In what some wags have called the “throw momma from the train” provision, the law stipulated that the estate tax would disappear in 2010, only to reappear in 2011 at the lower exemption level and higher rates that were in place in 2001. (To give proper credit, this provision should really be called the “planned Bush tax increase.”) The law has made 2010 the best time for tax-conscious rich people to die.
Right now, no one has any idea what rules will be in place in January... What should Congress do? The most important step would be to end the uncertainty by legislating a permanent set of rules. ...
The Congressional Joint Committee on Taxation estimates that eliminating the estate tax would cost about $500 billion over the next decade. The Obama proposal, if indexed to inflation, reduces that loss of revenue by about half. Some Republicans will want to hold out for a complete elimination of the tax and may try to postpone acting until the new Congress convenes. If a spike in deaths occurs in late December, we will know whom to blame.
So let’s be serious. There are lots of ways to spend $250 billion. Trim the deficit, improve education, support the troops, or make sure heiresses like Paris Hilton have the proper attire for trips to St.-Tropez. At this time in our history, which of them seem prudent?
Bernanke And The Shibboleths, by Paul Krugman: Everyone hates quantitative easing. The inflationistas believe that it’s the end of Western civilization (but as a correspondent points out, we want them to believe that; similar beliefs about the end of the gold standard helped recovery in the 1930s); meanwhile, the rest of the world is furious at the Fed’s actions.
Clearly, Bernanke must be doing something right. As Greg Ip says, all the objections currently being offered to QE would apply equally well to conventional monetary policy — and given high US unemployment and sagging inflation, how can you argue that monetary expansion is unjustified?
But what we’re seeing worldwide right now is an inability to think clearly about economics. In particular, the unconventional nature of our situation is making it clear how many people rely not on any model of how the economy works but rather on what the late Paul Samuelson called shibboleths — by which he meant slogans that take the place of hard thinking.
The basic situation of the world economy is simple: we have an excess of desired saving over desired investment, even at a zero interest rate. ...
How did this happen? The answer, mainly, is that over-borrowing in the past has left large parts of the world credit-constrained, forced to deleverage by cutting spending; and even a zero interest rate isn’t enough to persuade the unconstrained players to increase spending by enough to offset these cuts.
Yet interest rates can’t go below zero; which poses a problem. For the world as a whole, savings must equal investment, or, equivalently, spending must equal income. So this incipient excess of savings leads to a depressed world economy, in which income falls to match the amount people are able/willing to spend.
So what can policy do?
1. It can try to achieve negative real interest rates by creating expectations of inflation. ...
2. Alternatively, governments can step in and spend while the private sector won’t.
3. Finally, central banks can try to circumvent the zero lower bound by buying long-term debt. The point here is that we only have zero rates at the short end, and it’s possible, though not certain, that you can get at least some traction by buying those longer-term bonds.
But now that we’re in this situation, VSPs around the world are objecting to all of these possible actions. Inflation targets are horrible because we must have price stability. Fiscal policy is unacceptable because we must have balanced budgets. QE is outrageous because that’s not what central banks are supposed to do.
Notice that in each case the objection is based on a shibboleth. Price stability is treated as an absolute virtue, without any model to explain why. The same with budget balance. And those who are horrified at the idea of expansionary monetary policy have been inventing concepts on the fly to justify their position.
The simple fact is that we have a global excess supply of savings, which is doing terrible things to workers. The reasonable thing is to do something about it; it’s deeply unreasonable, and deeply irresponsible, to invent reasons not to act because you’re clinging to simplistic slogans.
Here's an example of someone worried that QEII will result in uncontrollable inflation. Steven Williamson has trouble being civil -- I suspect it's the frustration from thinking he's built a better theoretical mousetrap yet the world keeps beating a path to someone else's door -- so I'm sure this will bring some response about how stupid I am for not understanding this or that, and how stupid anyone who might disagree with him is. But his objections are hard to understand or, as Krugman predicted, left unexplained.
His first fear is that:
One possibility is that economic growth picks up, of its own accord, reserves become less attractive for the banks, and inflation builds up a head of steam. The Fed may find this difficult to control, or may be unwilling to do so.
If the economy begins growing so robustly that inflation breaks out, and as posited by Williamson, QEII has nothing to do with that growth ("growth picks up, of its own accord"), why, exactly, would the Fed be reluctant to remove reserves from the system? If the system is overheating due to high rates of growth, what harm will the Fed fear? If adding the reserves didn't stimulate the economy, how will removing them harm it? QEII didn't help, but ending it will harm the economy? I suspect Williamson has an asymmetric loss function of some sort -- creating inflation, or the expectation of it in the future, doesn't stimulate the economy but lowering it does harm -- but we aren't told what that story is. We're simply told the Fed "may find this difficult" or "may be unwilling." There are certainly stories one can tell about the harmful effects of reducing inflation, e.g. a standard Phillips curve model, but what story does he have in mind? I doubt very much that it's the New Keynesian Phillips curve story, but can't really say -- it's hard to evaluate an objection when you aren't told what it is.
(The reason I am saying that Williamson is assuming QEII will do no good at all is that he only identifies costs and objects on that basis. If there are benefits, then they ought to be weighed against the costs if you are doing an economic analysis. But he doesn't do that. That means he either thinks there are no benefits, as I've assumed, or that he is presenting a one-sided, misleading argument based only on costs to make his case.).
His second objection is that:
Even worse is the case where growth remains sluggish, but inflation well in excess of 2% starts to rear its ugly head anyway. Bernanke is telling us that he "has the tools to unwind these policies," but if the inflation rate is at 6% and the unemployment rate is still close to 10%, he will not have the stomach to fight the inflation.
But how does inflation pick up if aggregate demand remains stagnant? If the reserves are simply piling up in banks, how, exactly does the inflation occur? (Does he mean asset price inflation perhaps? Worried about a bubble maybe?). Waving your hands and saying the economy is sluggish, but there's inflation without explaining how that inflation happens is simply assuming the bad results you want. Maybe Williamson has a story in mind about how prices get driven upward without an increase in aggregate demand, and I expect a (less than civil) response detailing this, but we aren't told what that story is.
Williamson's final paragraph says:
My concern here is that, given the specifics of the QE2 policy that was announced, the FOMC will be reluctant to cut back or stop the asset purchases, even if things start looking bad on the inflation front. Once inflation gets going, we know it is painful to stop it...
This completely ignores Bernanke's clear statement that the Fed will reevaluate the program in light of changing economic circumstances. The Press Release announcing the QEII program was very clear about that, and Bernanke made sure to repeat it in his Washington Post editorial the next day. Williamson clearly does not believe the Fed will actually do what it says it will do since he thinks the costs of ending the QEII program prematurely or reversing it would be so large. But, again, what are those costs? To summarize my questions, why is it painful to stop inflation when the economy is overheating due to excessive demand? We're told the Fed may be "reluctant," but why would they be reluctant to temper inflation in an overheating economy? Why would reducing inflation be so harmful in the Fed's eyes in this case? And if the economy is not overheating, if demand remains stagnant, how exactly does the inflation occur to begin with?
Let me add one more thing. This statement made me chuckle:
Predictably, Krugman and this two buddies DeLong and Thoma think the asset purchase program should have been larger.
First, anytime anyone wants to put me in the same group with DeLong and Krugman, that's fine with me, even if it is to claim we're all idiots. I don't mind being told I'm as dumb as those two. If the phrase "Krugman, DeLong, and Thoma" catches on, as opposed to, say, just "Krugman and DeLong," no problem here. But the funny part to me is that in his desire to put the three of us into the same group so he can summarily dismiss two of us as nothing more than Krugman echoes, he seems to have missed that the three of us don't agree on how well QE will work. I guess pointing out that "predictably" we disagree on some aspects of quantitative easing sort of ruins his effort to undermine us, but at least it would be accurate.
Update: Please see my follow-up post on this: Williamson Responds to "Grumpy Thoma".
Friday, November 05, 2010
- Obama’s Problem Simply Defined: It Was the Banks - Jamie Galbraith
- Electric Jolt to Brain Boosts Math Skills - National Geographic
- Economic stimulus: At least the Fed is trying - latimes.com
- Latest Employment Data - Arnold Kling
- The Rule Obama Forgot: “It’s the economy, stupid.” - Bruce Bartlett
- The ageing, crisis-prone welfare and welfare migration - voxeu.org
An Open Letter to the President, by Michael Perelman: This letter was sent to the President, who failed to heed the warning, which turned out to be correct.
You have made yourself the Trustee for those in every country who seek to mend the evils of our condition by reasoned experiment within the framework of the existing social system. If you fail, rational change will be gravely prejudiced throughout the world, leaving orthodoxy and revolution to fight it out. But if you succeed, new and bolder methods will be tried everywhere, and we may date the first chapter of a new economic era from your accession to office.
I wish I had the foresight to have written this letter, but it was sent to the new president in 1933. The author was John Maynard Keynes. Although the letter is old, it is absolutely on target in predicting, “If you fail, rational change will be gravely prejudiced throughout the world.”
Wake up Obama before you do more damage by imagining that cooperation with the Right rather than leadership is the way forward.
By the way, in 1938 Keynes also warned the president that because of the 1937 austerity, “the present slump could have been predicted with absolute certainty.” Brad DeLong reprinted that letter.
Here's a shortened version of the letter from the first link above. The letter is organized by numbered points. I found point 18 interesting in light of recent calls to use quantitative easing to bring down the long end of the yield curve. Keynes is talking about changing the average maturity of the Fed's bond holdings by trading short-term for long-term bonds rather than purchasing long-term bonds through an expansion of the Fed's balance sheet, so he isn't calling for quantitative easing. But he does "attach great importance" to movement at the long end of the yield curve. I also found point 8 interesting since World War II -- which came after this letter -- is generally credited with validating Keynes' ideas:
An Open Letter to President Roosevelt
By John Maynard Keynes
Dear Mr President,
1. You have made yourself the Trustee for those in every country who seek to mend the evils of our condition by reasoned experiment within the framework of the existing social system. If you fail, rational change will be gravely prejudiced throughout the world, leaving orthodoxy and revolution to fight it out. But if you succeed, new and bolder methods will be tried everywhere, and we may date the first chapter of a new economic era from your accession to office. This is a sufficient reason why I should venture to lay my reflections before you, though under the disadvantages of distance and partial knowledge.
2. At the moment your sympathisers in England are nervous and sometimes despondent. We wonder whether the order of different urgencies is rightly understood...
3. You are engaged on a double task, Recovery and Reform;--recovery from the slump and the passage of those business and social reforms which are long overdue. For the first, speed and quick results are essential. The second may be urgent too; but haste will be injurious, and wisdom of long-range purpose is more necessary than immediate achievement. It will be through raising high the prestige of your administration by success in short-range Recovery, that you will have the driving force to accomplish long-range Reform. On the other hand, even wise and necessary Reform may, in some respects, impede and complicate Recovery. For it will upset the confidence of the business world and weaken their existing motives to action, before you have had time to put other motives in their place. It may over-task your bureaucratic machine, which the traditional individualism of the United States and the old "spoils system" have left none too strong. And it will confuse the thought and aim of yourself and your administration by giving you too much to think about all at once.
4. Now I am not clear, looking back over the last nine months, that the order of urgency between measures of Recovery and measures of Reform has been duly observed, or that the latter has not sometimes been mistaken for the former. ...
5. My second reflection relates to the technique of Recovery itself. The object of recovery is to increase the national output and put more men to work. In the economic system of the modern world, output is primarily produced for sale; and the volume of output depends on the amount of purchasing power... Broadly speaking, therefore, an increase of output cannot occur unless by the operation of one or other of three factors. Individuals must be induced to spend more out o their existing incomes; or the business world must be induced, either by increased confidence in the prospects or by a lower rate of interest, to create additional current incomes in the hands of their employees, which is what happens when either the working or the fixed capital of the country is being increased; or public authority must be called in aid to create additional current incomes through the expenditure of borrowed or printed money. In bad times the first factor cannot be expected to work on a sufficient scale. The second factor will come in as the second wave of attack on the slump after the tide has been turned by the expenditures of public authority. It is, therefore, only from the third factor that we can expect the initial major impulse. ...
8. Thus as the prime mover in the first stage of the technique of recovery I lay overwhelming emphasis on the increase of national purchasing power resulting from governmental expenditure which is financed by Loans and not by taxing present incomes. Nothing else counts in comparison with this. In a ... slump governmental Loan expenditure is the only sure means of securing quickly a rising output at rising prices. That is why a war has always caused intense industrial activity. In the past orthodox finance has regarded a war as the only legitimate excuse for creating employment by governmental expenditure. You, Mr President, having cast off such fetters, are free to engage in the interests of peace and prosperity the technique which hitherto has only been allowed to serve the purposes of war and destruction. ...
10. I am not surprised that so little has been spent up-to-date. Our own experience has shown how difficult it is to improvise useful Loan-expenditures at short notice. There are many obstacle to be patiently overcome, if waste, inefficiency and corruption are to be avoided. There are many factors, which I need not stop to enumerate, which render especially difficult in the United States the rapid improvisation of a vast programme of public works. I do not blame Mr Ickes for being cautious and careful. But the risks of less speed must be weighed against those of more haste. He must get across the crevasses before it is dark.
11. The other set of fallacies, of which I fear the influence, arises out of a crude economic doctrine commonly known as the Quantity Theory of Money. Rising output and rising incomes will suffer a set-back sooner or later if the quantity of money is rigidly fixed. Some people seem to infer from this that output and income can be raised by increasing the quantity of money. But this is like trying to get fat by buying a larger belt. In the United States to-day your belt is plenty big enough for your belly. It is a most misleading thing to stress the quantity of money, which is only a limiting factor, rather than the volume of expenditure, which is the operative factor. ...
15. If you were to ask me what I would suggest in concrete terms for the immediate future, I would reply thus.
16. In the field of gold-devaluation and exchange policy the time has come when uncertainty should be ended. ...
17. In the field of domestic policy, I put in the forefront, for the reasons given above, a large volume of Loan-expenditures under Government auspices. It is beyond my province to choose particular objects of expenditure. But preference should be given to those which can be made to mature quickly on a large scale, as for example the rehabilitation of the physical condition of the railroads. The object is to start the ball rolling. The United States is ready to roll towards prosperity, if a good hard shove can be given in the next six months. ... You can at least feel sure that the country will be better enriched by such projects than by the involuntary idleness of millions.
18. I put in the second place the maintenance of cheap and abundant credit and in particular the reduction of the long-term rates of interest. The turn of the tide in great Britain is largely attributable to the reduction in the long-term rate of interest which ensued on the success of the conversion of the War Loan. This was deliberately engineered by means of the open-market policy of the Bank of England. I see no reason why you should not reduce the rate of interest on your long-term Government Bonds to 2½ per cent or less with favourable repercussions on the whole bond market, if only the Federal Reserve System would replace its present holdings of short-dated Treasury issues by purchasing long-dated issues in exchange. Such a policy might become effective in the course of a few months, and I attach great importance to it.
19. With these adaptations or enlargements of your existing policies, I should expect a successful outcome with great confidence. How much that would mean, not only to the material prosperity of the United States and the whole World, but in comfort to men's minds through a restoration of their faith in the wisdom and the power of Government!
With great respect,Your obedient servant
J M Keynes
Via History of Economics Playground (from 2007):
"Conversations host Harry Kreisler welcomes Professor J. Bradford DeLong of Berkeley's Economics Department for a discussion of economics and public policy. Reflecting on his work as deputy assistant secretary in the Treasury Department in the Clinton administration, Professor DeLong discusses the dilemma posed by the breakdown of the political center, the strengths and weaknesses of the NAFTA agreement, and Alan Greenspan's record at the Federal Reserve. He also reflects on the quality of public discussion of economic issues."
The video opens with some of Brad's personal history.
The BLS reports that unemployment was unchanged in October at 9.6%, and Nonfarm payroll employment increased by 151,000.
I've seen some people calling this a strong report. It's certainly better than lower job growth numbers, so it could have been worse, but in past recoveries we've had job growth of hundreds of thousands, far more that this. So let's try to put it in perspective. Many people estimate that 7.5 million jobs have been lost since the start of the recession (and some people estimate it's even more than this). Suppose it takes 100,000 jobs per month to keep up with population growth. I think it's a bit more than this, but let's take an estimate that is generous in terms of making up lost ground. With a net gain of 50,000 jobs (rounding from 51,000), how long would it take to reemploy the 7.5 million who need jobs? The answer is (7.5 million)/(50,000) = 150 months = 12.5 years. That gives an indication of the strength of the report. Some of the 7.5 million might drop out of the labor force reducing the time a bit, but having people drop out of the labor force is not good news either.
The Report is better than it could have been, but we need more job growth than this. Let's hope it picks up in coming months.
[Also posted at MoneyWatch.]
What's at the locus of the focus hocus-pocus? Not much:
The Focus Hocus-Pocus, by Paul Krugman, Commentary, NY Times: Democrats, declared Evan Bayh..., “overreached by focusing on health care rather than job creation during a severe recession.” Many others have been saying the same thing: the notion that the Obama administration erred by not focusing on the economy is hardening into conventional wisdom.
But I have no idea what, if anything, people mean when they say that. The whole focus on “focus” is, as I see it, an act of intellectual cowardice — a way to criticize President Obama’s record without explaining what you would have done differently.
After all, are people ... saying that he should have pursued a bigger stimulus package? Are they saying that he should have taken a tougher line with the banks? If not, what are they saying? That he should have walked around with furrowed brow muttering, “I’m focused, I’m focused”?
Mr. Obama’s problem wasn’t lack of focus; it was lack of audacity. At the start of his administration he settled for an economic plan that was far too weak. ... Mr. Obama ... could have chosen to be bold — to make Plan A the passage of a truly adequate economic plan, with Plan B being to place blame for the economy’s troubles on Republicans if they succeeded in blocking such a plan.
But he chose a seemingly safer course: a medium-size stimulus package that was clearly not up to the task. ... Worse, there was no Plan B. ... Instead, he and his officials continued to claim that their original plan was just right, damaging their credibility ... as the economy continued to fall short.
Meanwhile, the administration’s bank-friendly policies and rhetoric — dictated by fear of hurting financial confidence — ended up fueling populist anger, to the benefit of even more bank-friendly Republicans. Mr. Obama added to his problems by effectively conceding the argument over the role of government in a depressed economy.
I felt a sense of despair during Mr. Obama’s first State of the Union address, in which he declared that “families across the country are tightening their belts and making tough decisions. The federal government should do the same.” Not only was this bad economics ... it was almost a verbatim repeat of what John Boehner, the soon-to-be House speaker, said when attacking the original stimulus. If the president won’t speak up for his own economic philosophy, who will?
So where, in this story, does “focus” come in? Lack of nerve? Yes. Lack of courage in one’s own convictions? Definitely. Lack of focus? No.
And why would failing to tackle health care have produced a better outcome? The focus people never explain.
Of course, there’s a subtext to the whole line that health reform was a mistake: namely, that Democrats should stop acting like Democrats and go back to being Republicans-lite. Parse what people like Mr. Bayh are saying, and it amounts to demanding that Mr. Obama spend the next two years cringing and admitting that conservatives were right.
There is an alternative: Mr. Obama can take a stand.
For one thing, he still has the ability to engineer significant relief to homeowners, one area where his administration completely dropped the ball during its first two years. Beyond that, Plan B is still available. He can propose real measures to create jobs and aid the unemployed and put Republicans on the spot for standing in the way of the help Americans need.
Would taking such a stand be politically risky? Yes, of course. But Mr. Obama’s economic policy ended up being a political disaster precisely because he tried to play it safe. It’s time for him to try something different.
Is Stan Collender correct? Will the GOP shut down government in December?:
Can The GOP Really Wait Until Next Year To Shut Down The Government?, by Stan Collender: ...Even though the smaller Senate GOP minority and House Republican majority won't officially be in place until January, the leadership will be facing a very difficult decision over federal spending in less than a month when the the current continuing resolution -- which is funding all federal agencies and departments that operate with annual appropriations -- expires.
That's the first point at which the GOP will have to face up to one of its most prominent campaign pledges: To significantly cut federal spending. The vote to extend the CR will be the first opportunity to face that challenge head on because it can be filibustered in the Senate. The Republicans there -- (Actually, all you need is one: Can you say Jim DeMint?) are in a position to prevent the current CR from being extended if the new version doesn't reduce spending to the level they want.
It's certainly possible that the Senate GOP leadership will decide ... that they want to wait until their colleagues in the House are in the majority so that they can work together to cut spending...
But there are four reasons why waiting isn't the best strategy.
First, from a strictly technical budget (and likely least important) perspective, waiting until next January or February will make it much more difficult to come up with the actual budget cuts that will be needed to achieve the lower spending levels the GOP says it wants. At that point there will only be eight or seven months left in fiscal 2011 and that will mean that the spending reductions will ... have to be much larger and the political difficulty in doing so much, much greater than will be the case if the process begins in December .
Second, the tea partiers insisted it would not be politics as usual in Washington if they were elected and this will be their first opportunity to show they meant it. ...
Third, shutting down the government in December might be the best way to seal the deal with the party base that was all but guaranteed this type of confrontation during the campaign and will still be walking around with its chest puffed out in December. By contrast, not taking advantage of the opportunity might well begin to alienate some...
Finally, December might well be the best time to push a Democratic Party that is disillusioned and depressed from the election and a White House that is reeling from the election results. It is not at all clear that congressional Democrats or the Obama administration will have a plan in place during the lame duck session to deal with the extreme political and communications challenge a shutdown will create. By contrast, a threatened shutdown in February would definitely provide the time to come up with a plan to deal with it.
I was going to say that worries over the economy might hold them back -- they could then be blamed for any subsequent problems -- but then I realized they actually think spending reductions will help.
Thursday, November 04, 2010
Joe Stiglitz on "corruption, American-style":
Justice for Some, by Joseph E. Stiglitz, Commentary, Project Syndicate: The mortgage debacle in the United States has raised deep questions about “the rule of law”... The rule of law is supposed to protect the weak against the strong...
Part of the rule of law is security of property rights... But in recent weeks and months, Americans have seen several instances in which individuals have been dispossessed of their houses even when they have no debts. To some banks, this is just collateral damage... Most people evicted from their homes have not been paying their mortgages... But Americans are not supposed to believe in justice on average. ... The US justice system demands more...
To some, all of this is reminiscent of what happened in Russia, where the rule of law – bankruptcy legislation in particular – was used as a legal mechanism to replace one group of owners with another. Courts were bought, documents forged, and the process went smoothly.
In America, the venality is at a higher level. It is not particular judges that are bought, but the laws themselves, through campaign contributions and lobbying, in what has come to be called “corruption, American-style.”
It was widely known that banks and mortgage companies were engaged in predatory lending practices, taking advantage of the least educated and most financially uninformed... But banks used all their political muscle to stop states from enacting laws to curtail predatory lending. When it became clear that people could not pay back what was owed, the rules of the game changed. Bankruptcy laws were amended...
With one out of four mortgages in the US under water ... there is a growing consensus that the only way to deal with the mess is to write down the value of the principal... America has a special procedure for corporate bankruptcy, called Chapter 11, which allows a speedy restructuring by writing down debt... It is important to keep enterprises alive ... in order to preserve jobs and growth. But it is also important to keep families and communities intact. So America needs a “homeowners’ Chapter 11.” ...
Growing inequality, combined with a flawed system of campaign finance, risks turning America’s legal system into a travesty of justice. Some may still call it the “rule of law,” but it would not be a rule of law that protects the weak against the powerful. Rather, it would enable the powerful to exploit the weak.
In today’s America, the proud claim of “justice for all” is being replaced by the more modest claim of “justice for those who can afford it.” And the number of people who can afford it is rapidly diminishing.
There's been a lot of talk today about how the election will affect financial regulation. I don't think there's much to worry about for the next two years (though if big holes in regulation are discovered they will be difficult to plug), but there may be more to worry about over the longer term both in terms of enforcement and the rollback of new regulation. Here's part of what I said about this yesterday at MoneyWatch:
What Impact Will the Election Have on Financial Reform?: How will the takeover of the House of Representatives by Republicans affect recent regulation to reform the financial sector, in particular the Dodd-Frank bill and the recent Basel III agreement
Since the Senate remains in Democratic hands, we shouldn’t expect any significant changes to the Dodd-Frank bill, particularly since Obama would likely veto any attempts to significantly alter the bill if it somehow reached his desk.
But the election does bring to mind questions about potential changes in financial regulation over the next few years, and over the longer-run, particularly if this is a sign of larger Republican gains in the future. One question is whether existing changes to financial regulation in the Dodd-Frank bill that appear to be working to restrict financial markets will be enforced and preserved. A second is whether we’ll be able to fix holes in the existing regulatory structure that Dodd-Frank left unfilled. And a third question concerns the extent to which we will continue to participate on the international stage as we did in the Basel III process.
What are the most important parts of the legislation to reform the financial sector? And are they out the window now?
The most important change in regulation is the resolution authority regulators now have over large financial institutions that get into trouble. When the crisis hit, regulators did not have the authority they needed to take over a failing financial institution. That authority exists for traditional banks, and is used frequently, but it had never been extended to financial institutions that are part of what is known as the shadow banking system. That left regulators with only two choices, neither of them good ones. They could let large institutions fail and risk a meltdown of the entire system, or they could bail out the banks and, in the process, reward those who caused the problems in the first place. If a traditional bank had been involved, they would have had other options that allowed them to minimize the costs of a meltdown while imposing losses on equity holders and removing management, but no such option existed for shadow banks.
Will resolution authority survive? I don’t expect that resolution authority will be impacted much if at all by the change in the political atmosphere. Both sides of the political fence are in general agreement that this is a good idea.
The second important regulatory change in the Dodd-Frank legislation is the Volcker rule. This rule limits the ability to make speculative investments with government insured money. The regulatory restrictions the legislation imposes are weaker than many people would prefer, and banks are already pushing against the boundaries.
Will the Volcker rule be changed? Republicans would like to weaken the Volcker rule, but any attempt to further weaken this provision would likely be vetoed (though after two years all bets are off). However, Republican opposition will prevent anything from being done to strengthen the bill should banks discover ways to bypass the legislation’s intent.
A third feature to highlight in the Dodd-Frank legislation is the attempt to make derivative markets more transparent by forcing the trades through organized markets. Again, I don’t expect big changes here, but Republicans have, in general been more sympathetic to arguments that some derivatives must be traded outside of over-the-counter markets. They will likely push for exceptions, and the more exceptions that are granted, the more likely it is that banks can find creative ways to bypass the legislation. So this could, over time, weaken this provision of the bill
What is the biggest remaining issue in terms of financial regulation? And will the election results help or hurt our chances of fixing it?
The most important thing left to do is to stop the bank run problem in the shadow banking system. As I explain here, the problems we experienced in the financial system can be viewed as a traditional bank run on the modern banking sector.
We are still vulnerable to these runs, and hence to the type of financial meltdown that we just experienced. The problem is that deposits in the shadow banking system are not insured the way the FDIC insures deposits in ordinary banks. Instead the deposits are backed by high quality collateral.
Or at least it was supposed to be high quality. As the recent crisis unfolded the collateral turned out to be relatively worthless, a AAA rating didn’t mean AAA after all, and as people realized their deposits were at risk they rushed to get their money out of these financial institutions. The result was severe liquidity problems in the financial system, and a financial crash.
One way to fix the problem is to improve the quality of the collateral standing behind deposits in the shadow banking system. Another, and probably better way, is to extend a version of FDIC deposit insurance and the regulatory regime that comes with it to the shadow banks. However, extension of deposit insurance to the shadow banking system was unlikely even before Republicans made political gains, and it is even less likely now. Treasury is working on a proposal to improve the collateral, but the Treasury proposal is not, in my view, enough to get the job done. Improving collateral will help some, however, and it is unlikely to be challenged by Republicans, and it’s the best we can get for now.
Will recent international agreements on financial reform survive the election?
In September, financial officials from 27 major countries endorsed what is known as Basel III. The most important thing that the Basel III agreement does is to specify bank capital requirements, and, as a consequence, place limits on bank leverage.
Though many people feel the provisions are too weak, and that they come online too slow, the fact that there is an agreement at all is an accomplishment. The agreement requires that banks hold 7% of common equity against the risky assets in their portfolios. This is better than under Basel I and Basel II, but it is still not strict enough in the opinion of many observers, and the phase in period for the new capital requirements that is not complete until 2019 is much too slow.
Will the election change this? The Basel III agreement is already in place, so the question is whether the existing agreement will be honored, and whether the US will push for changes in the future.
The agreement will be honored, particularly since enforcement of the capital requirements is not up to Congress. I don’t expect there will be any attempt to alter the agreement, but if there is, the balance would shift somewhat toward weakening rather than strengthening what has been done so far. Republicans were not in favor of the legislation in the first place, and they would be unlikely to support higher capital requirements, a faster phase in period, or any other attempt to impose stricter regulations on financial institutions.
What's the bottom line?
At least for the next two years, we should not expect any big changes. If there are changes, they will likely be incremental and move toward less rather than more strict regulation and enforcement. In the longer run, i.e. beyond the next two years, if there is divided government then gridlock is likely to persist and there will be no big changes. If Democrats retake control, the tilt will be toward stricter regulation and enforcement, but I wouldn’t anticipate any major new regulatory initiatives. However, if Republicans take broad based control, we should expect an attempt to undue many of the more restrictive provisions of recent bills, regulations, and agreements as the free market approach they favor would be likely to prevail.
I haven't posted weekly unemployment claims for awhile, but not much has changed since the last time. Via Calculated Risk:
Weekly Initial Unemployment Claims increase to 457,000, by Calculated Risk: The DOL reports on weekly unemployment insurance claims:In the week ending Oct. 30, the advance figure for seasonally adjusted initial claims was 457,000, an increase of 20,000 from the previous week's revised figure of 437,000. The 4-week moving average was 456,000, an increase of 2,000 from the previous week's revised average of 454,000.
This graph shows the 4-week moving average of weekly claims since January 2000.
The dashed line on the graph is the current 4-week average. The four-week average of weekly unemployment claims increased this week by 2,000 to 456,000.
The 4-week moving average has been moving sideways at an elevated level for almost a year - a sign of a weak job market.
We'll get more information when the employment report comes out tomorrow, but I'm not expecting the news to be very good.
In the discussion earlier today of the Fed's announcement that it intends to purchase $600 billion in government bonds, I used the term "communications strategy" to describe some of the language in the Press Release. The language in the Press Release does attempt to communicate a commitment from the Fed to meet its inflation and employment targets, but the term "communications strategy" implies something beyond what the Fed announced it is doing (see here for a discussion). Using the term implies the Fed is taking bolder steps than it is actually taking.
The purchase should be much larger, and it should involve longer term Treasury securities (the plan is for 5 to 6 year bonds). The language in the Press Release about maintaining stable expectations is also disappointing to those who have been advocating a higher inflation target. This is not, by any means, a bold plan.
That's unlikely to change. Even if the economy continues to struggle, it's hard to imagine the Fed doing anything more than moving at a "measured pace," a pace too slow to do much except chip away at the margins.
With fiscal policy out the window and a timid, tip-toeing Fed, we're likely headed for an agonizingly slow recovery.
Here's Ben Bernanke's explanation of the Fed's policy and the reasoning behind it:
What the Fed did and why: supporting the recovery and sustaining price stability, by Ben S. Bernanke, Commentary, Washington Post: ...The Federal Reserve's objectives - its dual mandate, set by Congress - are to promote a high level of employment and low, stable inflation. Unfortunately, the job market remains quite weak; the national unemployment rate is nearly 10 percent, a large number of people can find only part-time work, and a substantial fraction of the unemployed have been out of work six months or longer. The heavy costs of unemployment include intense strains on family finances, more foreclosures and the loss of job skills.
Today, most measures of underlying inflation are running somewhat below 2 percent, or a bit lower than the rate most Fed policymakers see as being most consistent with healthy economic growth in the long run. ...
The FOMC decided this week that, with unemployment high and inflation very low, further support to the economy is needed. With short-term interest rates already about as low as they can go, the FOMC agreed to deliver that support by purchasing additional longer-term securities, as it did in 2008 and 2009. The FOMC intends to buy an additional $600 billion of longer-term Treasury securities by mid-2011 and will continue to reinvest repayments of principal on its holdings of securities, as it has been doing since August.
This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. ...
While they have been used successfully in the United States and elsewhere, purchases of longer-term securities are a less familiar monetary policy tool than cutting short-term interest rates. That is one reason the FOMC has been cautious, balancing the costs and benefits before acting. We will review the purchase program regularly to ensure it is working as intended and to assess whether adjustments are needed as economic conditions change.
Although asset purchases are relatively unfamiliar as a tool of monetary policy, some concerns about this approach are overstated. Critics have, for example, worried that it will lead to excessive increases in the money supply and ultimately to significant increases in inflation.
Our earlier use of this policy approach had little effect on ... broad measures of the money supply... Nor did it result in higher inflation. We have made all necessary preparations, and we are confident that we have the tools to unwind these policies at the appropriate time. The Fed is committed to both parts of its dual mandate and will take all measures necessary to keep inflation low and stable.
The Federal Reserve cannot solve all the economy's problems on its own. That will take time and the combined efforts of many parties, including the central bank, Congress, the administration, regulators and the private sector. But the Federal Reserve has a particular obligation to help promote increased employment and sustain price stability. Steps taken this week should help us fulfill that obligation.
I comfort myself with the opening of Adam Smith's Theory of Moral Sentiments:
How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it. Of this kind is pity or compassion, the emotion which we feel for the misery of others, when we either see it, or are made to conceive it in a very lively manner. That we often derive sorrow from the sorrow of others, is a matter of fact too obvious to require any instances to prove it; for this sentiment, like all the other original passions of human nature, is by no means confined to the virtuous and humane, though they perhaps may feel it with the most exquisite sensibility. The greatest ruffian, the most hardened violator of the laws of society, is not altogether without it.
Wednesday, November 03, 2010
The Federal Reserve has decided to purchase $600 billion in Treasury securities through the end of the second quarter of 2011. As they note, this is around $75 billion per month. That is not enough to do much by itself (update: see here on this point), but this is an important addition to the policy:
The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed
The intent is to communicate a commitment to do whatever is necessary to hit inflation and employment targets, and the commitment is intended to impact expectations and hence impact expected inflation and real interest rates. The statement that we should expect "exceptionally low levels for the federal funds rate for an extended period" is part of this communications strategy.
As I've said many times, I'm skeptical about this doing much, but it could help some -- though a higher level of purchases each month would have been much better (update: and the bonds should be of longer duration than the 5-6 years bonds the Fed is planning to purchase). But with fiscal policy all but off the table, with tax cuts being the possible exception, it's the best we can hope for right now.
Here's the entire statement:
Press Release, November 3, 2010, For immediate release: Information received since the Federal Open Market Committee met in September confirms that the pace of recovery in output and employment continues to be slow. Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, though less rapidly than earlier in the year, while investment in nonresidential structures continues to be weak. Employers remain reluctant to add to payrolls. Housing starts continue to be depressed. Longer-term inflation expectations have remained stable, but measures of underlying inflation have trended lower in recent quarters.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate. Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow.
To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.
The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Sandra Pianalto; Sarah Bloom Raskin; Eric S. Rosengren; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.
Voting against the policy was Thomas M. Hoenig. Mr. Hoenig believed the risks of additional securities purchases outweighed the benefits. Mr. Hoenig also was concerned that this continued high level of monetary accommodation increased the risks of future financial imbalances and, over time, would cause an increase in long-term inflation expectations that could destabilize the economy. [Statement from Federal Reserve Bank of New York]
Also posted at MoneyWatch.
Update: I may not have been clear enough -- I agree with this assessment.
The editors at MoneyWatch asked me to look at how the election might impact efforts to reform the financial sector:
What Impact Will the Election Have on Financial Reform?: How will the takeover of the House of Representatives by Republicans affect recent regulation to reform the financial sector, in particular the Dodd-Frank bill and the recent Basel III agreement?
Since the Senate remains in Democratic hands, we shouldn’t expect any significant changes to the Dodd-Frank bill, particularly since Obama would likely veto any attempts to significantly alter the bill if it somehow reached his desk.
But the election does bring to mind questions about potential changes in financial regulation over the next few years, and over the longer-run, particularly if this is a sign of larger Republican gains in the future. One question is whether existing changes to financial regulation in the Dodd-Frank bill that appear to be working to restrict financial markets will be preserved. A second is whether we’ll be able to fix holes in the existing regulatory structure that Dodd-Frank left unfilled. And a third question concerns the extent to which we will continue to participate on the international stage as we did in the Basel III process. ...[continue]...
Jeff Madrick at Triple Crisis:
US Elections: The Deficit Hawks Have Already Won, by Jeff Madrick: Austerity economics has won in Europe. But there is a mythology ... that the U.S., at least, has retained the Keynesian orientation... Not so. The deficit hawks have also largely won in the U.S. The announcement last week that GDP grew at an annual rate of 2 percent only brings the point home: the U.S. needs a serious fiscal injection quickly. But it is not going to get it. ...
Unemployment stands at 9.6 percent and underemployment above 17 percent. The Congressional Budget Office figures GDP could be six percentage points higher before the economy reaches full capacity—that is, before inflation is any real threat. ... With such weakness, a substantial fiscal stimulus will likely have a high multiplier if it is designed correctly– aid to the states, unemployment insurance, some serious investment in infrastructure, and federal employment of idle workers.
But the deficit hawks, backed by many millions of dollars from powerful interests, will hear none of this. ... The fear-mongering has suppressed serious discourse about the need for stimulus now.
President Obama has himself joined the deficit hawks by endorsing a fiscal commission to find ways to reduce the future deficit. ... The administration is also endorsing a three-year freeze on discretionary spending.
With no strong sponsors for stimulus in Washington, the likelihood that the American economy will muddle along at high unemployment rates is now great. Quantitative easing by the Fed won’t do the trick alone. Lower rates are only one side of the equation, demand for loans and investment in a growing economy is the critical other side. Oh, that’s, right, that’s Keynesianism. ...
The deficit hawks now have their sights on bigger game, however. The main cause of the sudden deficit surge is the recession, and after that, the Bush tax cuts and war spending. But the deficit hawks are targeting Social Security, Medicare and Medicaid, which have had nothing to do with the sudden deficit increase.
Their advocacy is based on a disinformation campaign, one so effective they seem to fool themselves. They talk mostly about how an aging population will place an impossible burden on American children when they reach adulthood. And then they focus on Social Security, I suppose because it is the biggest social program out there—so far, that is.
As the CBO notes time and again, however, Social Security payments will only rise from 5 percent to 6 percent of GDP in the 2030s or so and then stay there. Medicare and Medicaid payments will rise from 5 percent of GDP to 10 percent in 2035 and 13 percent in 2050.
Why all the talk about reducing Social Security benefits, then? ... Medicare and Medicaid are going up much faster, not due to aging but mostly because health care costs in general in the U.S. will rise so rapidly. ...
Let’s get Social Security off the table. Let’s put back on the table serious health care reform and then serious increases in taxes to close the looming fiscal gap. We can get the long-term budget deficit down to 3 percent of GDP and not cut social programs, which are among America’s greatest achievements.
Tuesday, November 02, 2010
If Congress doesn't act to prevent it, tax cuts granted as part of the stimulus package will expire at the end of the year, and taxes will go up by $80 billion:
An Overlooked Tax Increase, by Catherine Rampell: Roberton Williams of the Tax Policy Center makes a good point. Why aren’t we paying more attention to the tax increase that is coming at the end of the year when certain stimulus provisions expire?:Congress and the administration have been arguing for months over extension of the Bush tax cuts: Should we extend them for everyone or only for the poorest 98.3 percent of Americans (which would also maintain some tax cuts for the rich)? Disagreement revolves around roughly $68 billion…But nobody’s talking about the nearly $80 billion hit that expiration of the 2009 stimulus bill will inflict.The stimulus bill (the American Recovery and Reinvestment Tax Act of 2009) provided $287 billion in tax cuts for 2009 and 2010 but most provisions expire at the end of this year. ... The big kahuna is the Making Work Pay credit — nearly $60 billion a year going to most workers — but partial exemption of unemployment compensation, expansion of EITC and education credits, and greater refundability of the child credit deliver nearly $20 billion more. Taxes will jump for more than 95 percent of Americans when those cuts evaporate come January…Arguably taking $80 billion away from all but the richest Americans would hurt spending more than pulling $68 billion out of fat wallets. Low- and moderate-income households save less of their income than do wealthier people, so raising their taxes causes a bigger drop in consumer demand. ...
Will Republicans fight for an extension of the Obama tax cuts for at least as long as the try to extend tax cuts for the wealthy, if not longer? Even better, though Republicans would never support it, allow the Bush tax cuts for the wealthy to expire and use the $68 billion that is gained to fund a temporary extension of tax cuts for people who need the money a whole lot more. The tax cuts could expire when, say, the unemployment rate crosses some threshold. (I'd go quite a bit beyond $68 billion -- if the deficit didn't matter when the tax cuts were for the wealthy and intended to be permanent, it shouldn't matter here either). I'd also like to see additional government spending to spur the economy, but there's little chance of that happening with the change in control of the House. So temporary tax benefits to those who need the money the most is the best we can hope for, and I doubt we will get even that.
Kenneth Rogoff says the rest of the world should not ignore the recent threats of protectionist measures coming from the US:
Beware of Wounded Lions, by Kenneth Rogoff, Commentary, Project Syndicate: G-20 leaders who scoff at the United States’ proposal for numerical trade-balance limits should know that they are playing with fire. ...
According to a recent ... report..., fully 25% of the rise in unemployment since 2007, totaling 30 million people worldwide, has occurred in the US. If this situation persists, as I have long warned it might, it will lay the foundations for huge global trade frictions. The voter anger expressed in the US mid-term elections could prove to be only the tip of the iceberg..., the ground for populist economics is becoming more fertile by the day. ...
True, today’s trade imbalances are partly a manifestation of broader long-term economic trends, such as Germany’s aging population, China’s weak social safety net, and legitimate concerns in the Middle East over eventual loss of oil revenues. And, to be sure, it would very difficult for countries to cap their trade surpluses in practice: there are simply too many macroeconomic and measurement uncertainties.
Moreover, it is hard to see how anyone – even the IMF, as the US proposal envisions – could enforce caps on trade surpluses. The Fund has little leverage over the big countries that are at the heart of the problem.
Still,... world leaders ... must recognize the pain that the US is suffering in the name of free trade. Somehow, they must find ways to help the US expand its exports. Fortunately, emerging markets have a great deal of scope for action.
India, Brazil, and China, for example, continue to exploit World Trade Organization rules that allow long phase-in periods for fully opening up their domestic markets to developed-country imports... A determined effort by emerging-market countries that have external surpluses to expand imports from the US (and Europe) would do far more to address the global trade imbalances ... than changes to their exchange rates or fiscal policies. ...
American hegemony over the global economy is perhaps in its final decades. China, India, Brazil, and other emerging markets are in ascendancy. Will the transition will go smoothly and lead to a global economy that is both fairer and more prosperous?
However much we may hope so, the current rut in which the US finds itself could prove to be a problem for the rest of the world. Unemployment in the US is high, while fiscal and monetary policies have been stretched to their limits. Exports are the best way out, but the US needs help. Otherwise, simmering trade frictions could suddenly throw globalization sharply into reverse. It wouldn’t be the first time.
We'll know for sure later today, but from all indications we are headed for gridlock. With control of the House in the hands of Republicans, and the Senate and executive branch in the hands of Democrats, legislation will be stalled unless it somehow manages to please all sides, an unlikely proposition for the most part.
What I haven't seen much discussion of is how Republicans are likely to take advantage of this by introducing legislation they know won't pass, but scores political points by forcing Democrats to vote against it (this is something the Democrats don't so as well as Republicans). They'll then use the noise machine to talk about how terrible this is for America. We'll see Tax cuts for Working Americans (where you give a few pennies to the masses, much, much more to the upper echelon, then, since there are so many people getting small breaks, claim that the majority of the tax cuts go to the middle and lower classes), the Deregulation of Apple Pie Act (which somehow turns into an attack on the FDA, financial regulation, etc., etc.), we'll see poison pills attached to legislation that must be passed to operate government (e.g. budget bills), it will be one bill after another designed purely to bring about a political fight. There may be legislative gridlock, but there will be anything but political gridlock.
One more thought. I understand that it's the economy that is hurting Democrats most, and that better policy might have helped quite a bit. But policy cannot be enacted unless the political groundwork has been prepared first. It's true that policy can make, say, the middle class believe the administration is fighting for them, something I have argued the administration failed to do. But it's also true that the legislation is unlikely to pass unless there is support for your side of the argument. That requires more than simply introducing legislation. The administration needed to take its arguments to the public and convince them that they were, in fact, fighting for their interests. Saying "I care" matters. Instead, they allowed the other side to take the initiative and demagogue the policies without much of a challenge. The administration surely made mistakes in policy and those mistakes were were exploited successfully, e.g. the political optics of the financial bailout were horrible, something that could have been avoided, but it was more than that and the passiveness in the face of aggressiveness from the other side was a prescription for failure.
Robert Reich on the politics of the financial bailout:
SPIEGEL ONLINE: ...it is no surprise that candidates opposing government spending appear likely to win many of the open Congressional seats.
Reich: This is one of the areas that are very easy to demagogue. By accusing government of being the enemy and promising people that if we simply shrink government they will be better, some politicians and ideologues are attempting to improve their own positions of power. They are misleading the voters. We know that when the private sector is unwilling or unable to spend and when consumers are under a huge debt load, government is the last remaining spender, at least in the short term. Long term deficits do have to be reduced, but unless we get the economy growing in the short term through government spending, we're all going to be experiencing a much longer and more painful so called recovery. We need a bigger stimulus now.
SPIEGEL ONLINE: Why then is President Barack Obama's Democratic Party so wary of considering an increase in government spending?
Reich: It started with the bailout of Wall Street. The so called Tea Party movement that's gradually taking over the Republican Party began when President George W. Bush and, after him, President Obama provided Wall Street with $700 billion. It looked and felt like an insider job, a rigged deal to many Americans. In the US, when there is a sense that government and business are in cahoots, the tendency is to blame government rather than business. Had Obama put very strict conditions on that bailout, requiring for example, that Wall Street firms lend to small businesses, that homeowners be allowed to reorganize their mortgage debts under personal bankruptcy, that they limited their own pay, I don't think we would have had the kind of reaction we did. Obama also failed to connect the dots, showing America that the financial reform bill, the health care bill, and the jobs bill, the stimulus package, were all part of a broader effort to restore the middle class and fairness in the American economy.
The administration was warned about this contemporaneously, but refused to listen. Anyway, is there a way out? Robert Reich thinks there is:
Why Obama Should Learn the Lesson of 1936, not 1996, by Robert Reich: ...For the next two years Republicans will try to paint Obama as a big-government liberal out of touch with America, who’s responsible for the continuing bad economy.
Obama won’t be able to win this argument by moving to the center — seeking to paint himself as a smaller-government moderate. This only confirms the Republican’s views... On the Republican playing field, Republicans always win.
Obama’s best hope of reelection will be to reframe the debate, making the central issue the power of big businesses and Wall Street to gain economic advantage at the expense of the rest of us. This is the Democratic playing field, and it’s more relevant today than at any time since the 1930s.
The top 1 percent of Americans, by income, is now taking home almost a quarter of all income, and accounting for almost 40 percent of all wealth. ...
With Republicans controlling more of Congress, their pending votes against extended unemployment benefits, jobs bills, and work programs will more sharply reveal whose side they’re on. Their attempt to extort extended tax cuts for the wealthy by threatening tax increases on the middle class will offer even more evidence. As will their refusal to disclose their sources of campaign funding.
The relevant political lesson isn’t Bill Clinton in 1996. It’s Franklin D. Roosevelt in 1936.
By the election of 1936 the Great Depression was entering its eighth year. Roosevelt had already been President for four of them. Yet he won the biggest electoral victory since the start of the two-party system in the 1850s. How?
FDR shifted the debate from what he failed to accomplish to the irresponsibility of his opponents. Again and again he let the public know whose side he was on, and whose side they were on. Republicans stood for “business and financial monopoly, speculation, and reckless banking,” he said over and over.
And he made it clear they wanted to prevent him from helping ordinary Americans. “Never before have these forces been so united against one candidate as they stand today,” he thundered. “They are unanimous in their hate for me – and I welcome their hatred.” ...
I have a hard time picturing Obama as the hard-hitting, combative, no retreat, I'm on your side type Reich envisions (and this is reflected in the people around him, they have not, for the most part, engaged the battle either). People want to know who's fighting for their interests, and the administration has not convinced them that it is willing and able to take on the entrenched powers that are standing in the way of the change they desire.
Sometimes government is the solution:
Maxine Udall: ...My own personal favorite example of the government being an important part of the solution is penicillin, an antibiotic that has saved many lives.
In 1940, Howard Florey and Ernst Chain, at Oxford University, produced enough stable chemical from a mold, penicillium, to test on mice infected with streptococcus. Of eight infected, 4 were treated and recovered rapidly. "Eureka!," you say. "The rest is history, yes?"
Well, no. Not quite.
Florey and a colleague packed up their penicillin and their results and took them to major pharmaceutical companies in the UK, the US, and Canada. None wanted to invest the capital in scaling it for production, mainly because there were signs that bacteria were becoming resistant to the sulfa drugs they were already manufacturing. Even if penicillin were effective for a while, it would eventually become ineffective and demand would dwindle. Where's the profit in that, they rightly asked?
So how did we the people get penicillin (and the many subsequent antibiotics...)? The US government stepped in. The US military pushed a bit on this. After all, who better to sense on the eve of war the potential gains from a new antibiotic? Roughly half of all deaths in at least one previous war had been from infection.
It was a group of government scientists at the US Department of Agriculture who scaled production and increased the drug's efficacy four-fold. And in record time. Imagine. Guvmint scientists produced something quickly, efficiently, and made it (and us) better... The private sector and "markets" would not have developed and delivered penicillin without help from US taxpayers and the US government. ...
Monday, November 01, 2010
As a follow up to the post below this one on whether QEII will work, here's Paul Krugman:
If I Were
KingBernanke, by Paul Krugman: I’ve been asked by various people what I would do if I were Bernanke, and/or if I were in charge of the Fed. Those aren’t the same thing: Ben Bernanke isn’t a dictator, and the evidence suggests that he’d be substantially more aggressive in both his actions and his rhetoric if he weren’t constrained by the need to bring his colleagues with him.
So I don’t know what I’d do in his place. What I’d do if I were really in charge of the Fed, however, is the same thing I advocated for Japan way back when: announce a fairly high inflation target over an extended period, and commit to meeting that target.
What am I talking about? Something like a commitment to achieve 5 percent annual inflation over the next 5 years — or, perhaps better, to hit a price level 28 percent higher at the end of 2015 than the level today. (Compounding) Crucially, this target would have to be non-contingent — not something you’ll call off if the economy recovers. Why? Because the point is to move expectations, and that means locking in the price rise whatever happens.
It’s also crucial to understand that a half-hearted version of this policy won’t work. If you say, well, 5 percent sounds like a lot, maybe let’s just shoot for 2.5, you wouldn’t reduce real rates enough to get to full employment even if people believed you — and because you wouldn’t hit full employment, you wouldn’t manage to deliver the inflation, so people won’t believe you. Similarly, targeting nominal GDP growth at some normal rate won’t work — you have to get people to believe in a period of way above normal price and GDP growth, or the whole thing falls flat.
As I wrote way back, the Fed needs to credibly promise to be irresponsible — at least from the point of view of the VSPs.
The sad truth, of course, is that the chance of actually getting anything like this are no better than those of getting an adequate fiscal stimulus — at least for now. QE as currently contemplated is mild mitigation at best. What one has to hope is that as the reality that we’re in a liquidity trap sinks in (amazing how long that’s taking), as the fact that we’re doing worse than Japan starts to finally penetrate our arrogance, we’ll eventually get there. But it’s not going to happen this month.
Donald Kohn, who knows more than a little about the inside workings of the Fed, has something to say about whether the Fed is willing to promise to be irresponsible. He says the Fed is not about to let inflation get out of control, or even rise much:
The DNA of the FOMC [Federal Open Market Committee] is very focused on preventing a rise in inflation and inflation expectations that would be bad for the economy. I’m not worried about inflation getting out of control. Even if [the Fed] waits too long [to raise interest rates] when the time comes, they’ll be very alert and if necessary they’ll tighten up faster than they would have.
How is this policy going to generate an increase in expected inflation to the degree that is needed?
QEII: Even if Real Rates Fall and Expected Inflation Increases, Will Firms and Households be Induced to Increase Consumption and Investment?
It seems to me that everyone fighting today over whether QEII will work are worried about whether the Fed can affect real rates, but are forgetting about the second step in the process. Once real rates rates fall, firms and households then have to be induced to borrow more, then consume or invest (I'm including the response to expected inflation in this). Even if we manage to change real rates, and I have never quarreled with the Fed's ability to do this (though the extent depends upon their ability to affect expectations), why do people think it will bring about a strong consumption and investment response in the current environment? As Paul Krugman notes today, firms are already sitting on mountains of low opportunity cash and they aren't investing, and loans to consumers are already pretty cheap and they aren't increasing their consumption [Update: Or maybe you are hoping for a boom in exports as other countries allow the dollar to depreciate against their currency?]. Can the Fed create a enough expected of inflation (which it would have to validate later, or it will lose credibility and this will never work again) to change the behavior of firms and consumers enough to really matter?
My colleague George Evans has an interesting new paper. He shows that when there is downward wage rigidity, the "asymmetric adjustment costs" referenced below, the economy can get stuck in a zone of stagnation. Escaping from the stagnation trap requires a change in government spending or some other shock of sufficient size. If the change in government spending is large enough, the economy will return to full employment. But if the shock to government spending is below the required threshold (as the stimulus package may very well have been), the economy will remain trapped in the stagnation regime.
(I also highly recommend section 4 on policy implications, which I have included on the continuation page. It discusses fiscal policy options, quantitiative easing, how to help to state and local governments, and other policies that could help to get us out of the stagnation regime):
The Stagnation Regime of the New Keynesian Model and Current US Policy, by George Evans: 1 Introduction The economic experiences of 2008-10 have highlighted the issue of appropriate macroeconomic policy in deep recessions. A particular concern is what macroeconomic policies should be used when slow growth and high unemployment persist even after the monetary policy interest rate instrument has been at or close to the zero net interest rate lower bound for a sustained period of time. In Evans, Guse, and Honkapohja (2008) and Evans and Honkapohja (2010), using a New Keynesian model with learning, we argued that if the economy is subject to a large negative expectational shock, such as plausibly arose in response to the financial crisis of 2008-9, then it may be necessary, in order to return the economy to the targeted steady state, to supplement monetary policy with fiscal policy, in particular with temporary increases in government spending.
The importance of expectations in generating a “liquidity trap” at the zero-lower bound is now widely understood. For example, Benhabib, Schmitt-Grohe, and Uribe (2001b), Benhabib, Schmitt-Grohe, and Uribe (2001a) show the possibility of multiple equilibria under perfect foresight, with a continuum of paths to an unintended low or negative inflation steady state. Recently, Bullard (2010) has argued that data from Japan and the US over 2002-2010 suggest that we should take seriously the possibility that “the US economy may become enmeshed in a Japanese-style deflationary outcome within the next several years.”
The learning approach provides a perspective on this issue that is quite different from the rational expectations results. As shown in Evans, Guse, and Honkapohja (2008) and Evans and Honkapohja (2010), when expectations are formed using adaptive learning, the targeted steady state is locally stable under standard policy, but it is not globally stable. However, the potential problem is not convergence to the deflation steady state, but instead unstable trajectories. The danger is that sufficiently pessimistic expectations of future inflation, output and consumption can become self-reinforcing, leading to a deflationary process accompanied by declining inflation and output. These unstable paths arise when expectations are pessimistic enough to fall into what we call the “deflation trap.” Thus, while in Bullard (2010) the local stability results of the learning approach to expectations is characterized as one of the forms of denial of “the peril,” the learning perspective is actually more alarmist in that it takes seriously these divergent paths.
As we showed in Evans, Guse, and Honkapohja (2008), in this deflation trap region aggressive monetary policy, i.e. immediate reductions on interest rates to close to zero, will in some cases avoid the deflationary spiral and return the economy to the intended steady state. However, if the pessimistic expectation shock is too large then temporary increases in government spending may be needed. The policy response in the US, UK and Europe has to some extent followed the policies advocated in Evans, Guse, and Honkapohja (2008). Monetary policy has been quick, decisive and aggressive, with, for example, the US federal funds rate reduced to near zero levels by the end of 2008. In the US, in addition to a variety of less conventional interventions in the financial markets by the Treasury and the Federal Reserve, including the TARP measures in late 2008 and a large scale expansion of the Fed balance sheet designed to stabilize the banking system, there was the $727 billion ARRA stimulus package passed in February 2009.
While the US economy has stabilized, the recovery has to date been weak and the unemployment rate has been both very high and roughly constant for about one year. At the same time, although inflation is low, and hovering on the brink of deflation, we have not seen the economy recording large and increasing deflation rates. From the viewpoint of Evans, Guse, and Honkapohja (2008), various interpretations of the data are possible, depending on one’s view of the severity of the initial negative expectations shock and the strength of the monetary and fiscal policy impacts. However, since recent US (and Japanese) data may also consistent with convergence to a deflation steady state, it is worth revisiting the issue of whether this outcome can in some circumstances arise under learning.
In this paper I develop a modification of the model of Evans, Guse, and Honkapohja (2008) that generates a new outcome under adaptive learning. Introducing asymmetric adjustment costs into the Rotemberg model of price setting leads to the possibility of convergence to a stagnation regime following a large pessimistic shock. In the stagnation regime, inflation is trapped at a low steady deflation level, consistent with zero net interest rates, and there is a continuum of consumption and output levels that may emerge. Thus, once again, the learning approach raises the alarm concerning the evolution of the economy when faced with a large shock, since the outcome may be persistently inefficiently low levels of output. This is in contrast to the rational expectations approach of Benhabib, Schmitt-Grohe, and Uribe (2001b), in which the deflation steady state has output levels that are not greatly different from the targeted steady state.
In the stagnation regime, fiscal policy, taking the form of temporary increases in government spending, is important as a policy tool. Increased government spending raises output, but leaves the economy within the stagnation regime until raised to the point at which a critical level of output is reached. Once output exceeds the critical level, the usual stabilizing mechanisms of the economy resume, pushing consumption, output and inflation back to the targeted steady state, and permitting a scaling back of government expenditure.
Here is the section on policy options recommended above (it is relatively non-technical):