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Nouriel Roubini is gloomy and doomy:
American Pie in the Sky, by Nouriel Roubini, Commentary, Project Syndicate: While the risk of a disorderly crisis in the eurozone is well recognized, a more sanguine view of the United States has prevailed. For the last three years, the consensus has been that the US economy was on the verge of a robust and self-sustaining recovery that would restore above-potential growth. That turned out to be wrong, as a painful process of balance-sheet deleveraging – reflecting excessive private-sector debt, and then its carryover to the public sector – implies that the recovery will remain, at best, below-trend for many years to come.
Even this year, the consensus got it wrong, expecting a recovery to above-trend annual GDP growth – faster than 3%. But the first-half growth rate looks set to come in closer to 1.5% at best, even below 2011’s dismal 1.7%. And now, after getting the first half of 2012 wrong, many are repeating the fairy tale that a combination of lower oil prices, rising auto sales, recovering house prices, and a resurgence of US manufacturing will boost growth in the second half of the year and fuel above-potential growth by 2013.
The reality is the opposite: for several reasons, growth will slow further in the second half of 2012 and be even lower in 2013 – close to stall speed.
After explaining the reasons, Roubini concludes:
Policy responses will have very limited effect in stemming the US economy’s deceleration toward stall speed: even with only a mild fiscal drag on growth, the US dollar is likely to strengthen as the eurozone crisis weakens the euro and as global risk aversion returns. The US Federal Reserve will carry out more quantitative easing this year, but it will be ineffective: long-term interest rates are already very low, and lowering them further would not boost spending. Indeed, the credit channel is frozen and velocity has collapsed, with banks hoarding increases in base money in the form of excess reserves. Moreover, the dollar is unlikely to weaken as other countries also carry out quantitative easing.
Similarly, the gravity of weaker growth will most likely overcome the levitational effect on equity prices from more quantitative easing, particularly given that equity valuations today are not as depressed as they were in 2009 or 2010. Indeed, growth in earnings and profits is now running out of steam, as the effect of weak demand on top-line revenues takes a toll on bottom-line margins and profitability.
A significant equity-price correction could, in fact, be the force that in 2013 tips the US economy into outright contraction. And if the US (still the world’s largest economy) starts to sneeze again, the rest of the world – its immunity already weakened by Europe’s malaise and emerging countries’ slowdown – will catch pneumonia.
I'm more optimistic than he is that coordinated monetary and fiscal policies -- both within and across countries -- could help, though I am more bullish on fiscal policy and less so on monetary policy than most. But I am discouraged -- gloomy and doomy -- at the prospect that the needed policies have any chance at being enacted. (To be clear, I don't think monetary policy is a magic bullet, but I do think it can help. However, many, many people I respect think monetary policy can have significant effects, even now, I have to consider the chance that I am wrong, the threat of inflation seems remote, and unemployment is at crisis levels, so I support the calls for the Fed to do much more -- the chance that aggressive policy will help is much larger than the [very small] chance that it will do harm. I just don't want to let fiscal policymakers off the hook by setting expectations about what the Fed can do to revive the economy too high.)
Posted by Mark Thoma on Friday, July 20, 2012 at 07:11 AM in Economics |
David Glasner objects to Edmund Phelps diagnosis and cure for the eurocrisis:
It’s Déjà vu All Over Again, by David Glasner: ...Edmund Phelps in the Financial Times ... tells us ... that the cause of the crisis is not Chancellor Merkel’s insistence on austerity measures and labor-market reforms, but the failure of the governments on the verge of insolvency to emulate the German model.
Chancellor Angela Merkel and Wolfgang Schäuble, her finance minister, are right to oppose fiscal and bank unions without political union. Without any teeth in such agreements, the nations now besotted with wealth, private and social, could use the loans and grants for financing more deficits and more entitlements – another round of corporatist excess – rather than for smoothing the way to fiscal responsibility.
It is entirely possible, even likely, that wage reductions and labor-market liberalization would be beneficial for all European countries. But that is not the issue. France and Italy and other European countries can choose their own budgetary and labor-market policies. Those choices imply costs and consequences. High taxes and unproductive government expenditures will tend to depress growth rates. If France and Italy choose to grow at a slower rate than Germany, they have the right, as sovereign countries, to do so. The choice of a reduced rate of growth need not entail insolvency, and it is not Germany’s job to impose a higher rate of growth on France and Italy than they want. Except for Greece, which is a special case, the potentially insolvent countries in Europe are facing insolvency not because of their budgetary and labor-market policies, but because of a sharp slowdown since 2008 in rate of growth in nominal GDP in the Eurozone as a whole (averaging just 0.6% a year since the third quarter of 2008). Why has nominal GDP not increased as rapidly since 2008 as it did before 2008? Some of us think that that it has something to do with policies followed by the European Central Bank, policies that by and large are determined by the country in which the ECB is domiciled. (Can you guess which country that is?)
But for some reason – I can’t imagine what it would be — in the 670 words in his piece in the Financial Times, Professor Phelps, in discussing the causes of the Eurozone crisis and in defending Chancellor Merkel’s role in the crisis, didn’t mention the European Central Bank even once. Go figure.
Posted by Mark Thoma on Friday, July 20, 2012 at 07:02 AM in Economics |
What happens when the rich are not "safely ensconced in a bubble of deference and flattery"?:
Pathos of the Plutocrat, by Paul Krugman, Commentary, NY Times: ... It’s no secret that, at this point, many of America’s richest men — including some former Obama supporters — hate, just hate, President Obama. Why? Well, according to them, it’s because he “demonizes” business — or as Mitt Romney put it earlier this week, he “attacks success.” ...
Needless to say, this is crazy. In fact, Mr. Obama always bends over backward to declare his support for free enterprise and his belief that getting rich is perfectly fine. All that he has done is to suggest that sometimes businesses behave badly, and that this is one reason we need things like financial regulation. No matter: even this hint that sometimes the rich aren’t completely praiseworthy has been enough to drive plutocrats wild. ...
Wait, there’s more. Not only do many of the superrich feel deeply aggrieved at the notion that anyone in their class might face criticism, they also insist that their perception that Mr. Obama doesn’t like them is at the root of our economic problems. Businesses aren’t investing, they say, because business leaders don’t feel valued. Mr. Romney repeated this line, too, arguing that because the president attacks success “we have less success.”
This, too, is crazy... Because the rich are different from you and me, many of them are incredibly self-centered. They don’t even see how funny it is — how ridiculous they look — when they attribute the weakness of a $15 trillion economy to their own hurt feelings. After all, who’s going to tell them? They’re safely ensconced in a bubble of deference and flattery.
Unless, that is, they run for public office.
Like everyone else following the news, I’ve been awe-struck by the way questions about Mr. Romney’s career at Bain Capital,... and his refusal to release tax returns have so obviously caught the Romney campaign off guard... Clearly, Mr. Romney believed that he could run for president while remaining safe inside the plutocratic bubble and is both shocked and angry at the discovery that the rules that apply to others also apply to people like him. ...
O.K., let’s take a deep breath. ... There are plenty of very rich Americans who have a sense of perspective, who take pride in their achievements without believing that their success entitles them to live by different rules.
But Mitt Romney, it seems, isn’t one of those people. And that discovery may be an even bigger issue than whatever is hidden in those tax returns he won’t release.
Posted by Mark Thoma on Friday, July 20, 2012 at 12:33 AM in Economics, Politics |
Pro-cyclical fiscal policy should be avoided, "Yet many politicians in the United States, the United Kingdom, and the eurozone seem to live by it":
The First World’s Fiscal Follies, by Jeff Frankel, Commentary, Project Syndicate: ...Keynesian macroeconomic policy lost its luster mainly because politicians often failed to time countercyclical fiscal policy – “fine tuning” – properly. ... But that is no reason to follow a destabilizing pro-cyclical fiscal policy, which piles spending increases and tax cuts on top of booms, and cuts spending and raises taxes in response to downturns.
Pro-cyclical fiscal policy worsens the dangers of overheating, inflation, and asset bubbles during booms, and exacerbates output and employment losses during recessions, thereby magnifying the swings of the business cycle. Yet many politicians in the United States, the United Kingdom, and the eurozone seem to live by it. They argue against fiscal discipline when the economy is strong, only to become deficit hawks when the economy is weak.
Consider the positions taken over the last three decades by ... Ronald Reagan..., George H.W. Bush ..., Republican congressmen...,George W. Bush..., Republicans... In my view, the government spending cutbacks of the last two years are the most important reason why the economic recovery that began in June 2009 subsequently stalled in 2011.
Here ... are three generations of politicians who favored fiscal expansion during booms (1982-1989, 1992-2000, 2002-2007) and austerity during recessions (1980, 1981, 1990, 2008-09). ...
But the pattern is understandable: when the economy is booming, there is no political support for painful spending cuts or tax increases. There is a hole in the roof, but the sun is shining. Then, when the thunderstorms roll in, sinners suddenly get religion and proclaim the necessity of reforming – just when it is most difficult to fix the problem.
Historically, it used to be developing countries whose dysfunctional political systems produced pro-cyclical fiscal policies. ... But things have changed..., a majority of the governments that have pursued countercyclical fiscal policies since 2000 are in emerging-market or developing countries. They figured out how to achieve countercyclical fiscal policy during precisely the decade when so many politicians in “advanced countries” forgot.
Posted by Mark Thoma on Friday, July 20, 2012 at 12:24 AM in Economics, Fiscal Policy, Politics |
Posted by Mark Thoma on Friday, July 20, 2012 at 12:06 AM in Economics, Links |
Amir Sufi of the University of Chicago Booth School of Business:
Seizures May Be Cities’ Last Hope in Mortgage Crisis, by Amir Sufi, Commentary, Bloomberg: The failure to address crippling household-debt burdens is leading local governments to embrace the radical idea of using eminent domain to seize and write down mortgages.
Over the past month, two cities in California -- Stockton and San Bernardino -- have made moves to file for bankruptcy. ... The San Bernardino and Stockton episodes are representative of a national crisis: Crippling household-debt burdens and foreclosures have been dragging down the economy for the past five years. Renegotiation of underwater mortgages by the private sector has been almost nonexistent. Despite strong evidence that frictions related to securitized mortgages are preventing the efficient restructuring of household-debt burdens, policy makers have largely sat on the sidelines.
With local governments feeling directly threatened, some cities have put forth a bold solution: Governments should use eminent-domain powers to buy mortgages, impose losses on bondholders, and write down principal amounts owed by the borrower. The argument is pretty simple: Debt burdens and foreclosures are crushing our cities; private lenders are showing no willingness to renegotiate; and there are no meaningful attempts at the federal level to help. San Bernardino and Stockton are Exhibits A and B.
Using eminent domain to impose losses on bondholders is unquestionably a radical idea. ... There comes a point, however, when it becomes impossible to impose further losses on debtors. And when that happens, creditors are expected to take losses on their positions. This is exactly why restructuring debt contracts is a valuable and important part of the financial system. In corporations and commercial real estate, such restructuring happens every day.
But this isn’t happening in mortgage markets. ... Bondholders and other creditors are understandably furious at the violation of private contracts implied by the eminent- domain proposals. They shouldn’t be surprised, though. Everyone has a breaking point. Proposals to write down debt will become even more radical unless the private sector shows a greater willingness to renegotiate mortgages.
I hope we have learned a point I've tried to make again and again here, that helping households with their balance sheet problems is essential in curing a balance sheet recession. Banks got plenty of help with their balance sheet problems based upon the "too big to fail" argument, but households didn't get as much attention. Collectively, households are too big to fail as well, but we let them fail anyway and are now paying a much higher cost than if we'd done more to address household balance sheet problems early in the recession.
[See here for a recent link/discussion to additional research from Mian and Sufi on What Explains High Unemployment? The Aggregate Demand Channel.]
Posted by Mark Thoma on Thursday, July 19, 2012 at 06:48 AM
I forgot to link to my comments on Bernanke's testimony the other day. They were a bit rushed anyway (supposed to be on vacation, and was traveling to a new place, so I wrote this stopped along the side of the road):
Bernanke gives little indication that QE3 is on the way
However, as I noted, if economic conditions continue as they are -- employment basically stalled, inflation below target -- the Fed is very likely to act at its next meeting, if not before.
[But if a few encouraging signals arrive amidst the gloom, they may latch onto those observations as a reason to stay the current policy course. I can't hope against good news, but I can hope that Fed officials will see the bigger picture and ease more despite a few contrary indicators that give them an excuse to avoid tough decisions and forestall further action.
Are they worried, as Paul Krugman has wondered, about being seen as helping Obama? I've always taught that the Fed is reluctant to make big moves near elections, monetary policymakers don't want to be seen as helping one side or the other, but not doing anything more will be viewed as giving in to Republicans in the House and elsewhere who have all but threatened the Fed's independence if it tries to do more to help the economy. So no matter what they do, or don't do, it will be seen as taking sides, so monetary policymakers may as well do what's best for the economy (a truly independent Fed would stand above such threats). In my view, that means more easing even if a few contrary data points between now and the next meeting point in another direction.]
Posted by Mark Thoma on Thursday, July 19, 2012 at 05:49 AM
Simon Wren-Lewis is tired of making the same old arguments. I am too, so I'll let him take this one on:
Tired Old Debates: Daniel Gros has a Vox piece attacking the Krugman/Layard manifesto. Like Stephanie Flanders here, there is part of me that is tired of going over this again and again, as the arguments on the other side do not get any better. But I know that this is a battle we have to win, if only so that others do not need to fight it a third time. And I did have one new thought.
Before that, let’s just go through the economics one more time. Macroeconomic theory is as clear as it can be that austerity in the current situation will reduce output and raise unemployment. ... The evidence is also about as clear as it ever is in macro.
On the other hand, the ‘evidence’ Daniel Gros uses is of the following kind. The US recovery has been similar to that in the Eurozone, and the US had more initial fiscal expansion, so therefore austerity is not that important. These are the kind of arguments we use to persuade our students that they should take a course in econometrics.
But here is my new thought. Why not apply the same arguments to monetary policy. Interest rates were reduced faster and by more in the US than in the Eurozone, but the recovery has been similar, so clearly monetary policy does not matter much either. In the UK the recovery has stalled even though interest rates are zero. In addition keeping interest rates very low can cause longer term problems, so start raising them now, if not yesterday! No one (almost) makes this argument, because it is so obviously silly. So why do good economists think they can make the same argument for fiscal policy?
The only defensible argument for austerity now is that we have reached some critical debt limit, but the low level of interest rates on UK and US debt (and everywhere else besides the Eurozone) kill that dead. Everyone is agreed that once recovery is complete, we do need to start reducing debt. Everyone also agrees that when the recovery is complete, interest rates need to rise. But almost no one is arguing for higher interest rates now. So why fiscal austerity now?
One quick comment: Too many economists are calling for interest rate increases now, not later, so while it is "obviously silly," it is not as rare as it ought to be.
Posted by Mark Thoma on Thursday, July 19, 2012 at 05:31 AM in Economics |
Posted by Mark Thoma on Thursday, July 19, 2012 at 12:06 AM in Economics, Links |
Decoupled and Divided, by Paul Krugman: And so, predictably, Romney is accusing Obama of “attacking capitalism” and “dividing America” by raising questions about Bain and those hidden tax returns. This is all par for the course; many of us remember how any criticism of Bush was unpatriotic, and if I recall correctly, during the dotcom bubble the Wall Street Journal argued that any skepticism about stock market valuations showed a lack of faith in free markets.
The special Romney twist– aside from the willful misrepresentation of what Obama actually said about business success — is Mitt’s desire to have it both ways. He’s proud of his business record and his success, he says, but at the same time wants us to believe that he had nothing to do with Bain’s actions over a three-year period when he was still its CEO, and is completely unwilling to let us see the tax returns that would tell us something about exactly how he achieved his current wealth. ...
Anyway, just a reminder about what’s really dividing America: the fact that a rising tide no longer raises all boats,... there has been a dramatic decoupling between overall economic growth and the fortunes of the typical family:
It’s not an “attack on capitalism” to suggest that growing income disparities and the corresponding failure of most Americans to benefit from rising productivity are problems. Still, what can be done? Well, you can ask the rich to pay somewhat higher taxes, and you can strengthen the safety net — which is what Obama actually advocates. But Romney wants to do the reverse.
So Romney wants us to celebrate the success of people like him, even though their success doesn’t seem to have benefited ordinary families, and even though he stands for policies that would aggravate the gap between a fortunate few and everyone else. And then he accuses Obama of dividing America.
As I've argued many times, the idea that those at the top of the income distribution, particularly the people involved in finance, were paid according to their contribution to national GDP (i.e. their marginal product) is hard to swallow (no matter how often the right tries to jam it down our throats). I understand why those who benefit the most from the way things work now are defending the system tooth and nail, but it seems clear to me that the mechanism that allocates income to various strata of society is broken and in need of repair.
More from Paul Krugman here: Finance Capitalism and here: Thirty Troubling Years.
Posted by Mark Thoma on Wednesday, July 18, 2012 at 06:48 AM in Economics, Income Distribution, Politics |
Mankiw on the US Olympic Uniforms Made in China, Econospeak: Greg picks on Senator Reid:
Hey – I think we all get the point about comparative advantage. Larry Popelka made the case for Greg:
Will some enterprising reporter please ask Senator Reid for the opportunity to inspect the senator's closet and check the labels of his clothing to make sure they are all American-made? I look forward to seeing Mr. Reid's bonfire. In the alternative, I would be happy to send the senator of copy of my favorite textbook. He should pay particular attention to Chapters 3 and 9.
Look – we all understand that Ralph Lauren did what was best for Ralph Lauren and if the US Olympic Committee wanted these uniforms to be both designed by both Ralph Lauren and Made in America, maybe the contract with Ralph Lauren should have said so. But Larry also noted that politicians in BOTH parties are angry at Ralph Lauren. So why is Greg lecturing Senator Reid and not certain Republicans. For example, Donald Trump loves to China bash even though his clothing line is also Made in China. Of course, Trump is not the GOP Presidential candidate – that would be Mitt Romney:
Garment manufacturing is a low-cost commodity business. Most of the value in the apparel industry comes from design, technology, sales, marketing, and distribution—not manufacturing. The successful players in apparel, such as Ralph Lauren and Nike (NKE), figured this out long ago
On the campaign trail, Romney labels China’s leaders as “cheaters” and “currency manipulators.” His ads say the Republican nominee would be a president who “stands up to China on trade and demands they play by the rules.” He has vowed to issue, on his first day in office, an executive order labeling China a currency manipulator.
Posted by Mark Thoma on Wednesday, July 18, 2012 at 06:21 AM in Economics, International Trade, Politics |
Chris Sims explains why he got a Nobel Prize:
Tapp: So, if I asked you to describe the main contribution of your work to the field of economic modeling and maybe relating back to the traditional model, how would you describe that?
Sims: I think that what the Noble Prize people were singling out was that my work helped sort out the dispute between the monetarists and Keynesians. They, in part by introducing new approaches to statistical modeling in the '60s and early '70s, monetarists were claiming that the main source of business cycle fluctuations was bad monetary policy. The monetary authority was making mistakes, making the growth rate of money vary a lot, and all those variations resulted in recessions and booms, and if only we could force the monetary authority to stop messing with the economy and just keep money growth steady, the business cycle would be greatly reduced or even vanish.
And then the Keynesians were saying that can't be true, but they didn't have statistical models in which they could each put forward their position and ask, well, what did the data say? There were lots of attempts to do that, but with very awkward statistical modeling.
Over the course of about 10 years, things that I did and other people followed up on managed to sort out what the effects of monetary policy changes are and distinguish those from co-movements in money and prices and income that didn't have anything to do with policy. There's now pretty much a consensus on how monetary policy affects the economy, and on what the size of that effect is. The general conclusion is that it accounts for maybe somewhere between zero and 20 or 25 percent of the fluctuations we see, but if you try to trace out historically, you can't blame any recession on monetary policy.
Now we need Chris Sims, or someone like him, to lead the charge against the idea that the problem with the economy is bad fiscal policy. Even better would be if they could overcome the objections to the use of fiscal policy in severe recessions -- i.e. the type of recession that monetary policy alone cannot cure even if the interest rate is lowered to zero and non-traditional policies are put into place. In this case though, the empirical evidence is already mounting, what is needed are strong, respected voices to counter the objections to fiscal policy coming from the right (particularly, though not exclusively, objections to infrastructure investment). The politics of fiscal policy will always be a problem, but it would be less so if economists had the same unity on fiscal policy, particularly its ability to help the economy is severe recessions, that they have on monetary policy.
Posted by Mark Thoma on Wednesday, July 18, 2012 at 06:12 AM in Economics, Fiscal Policy, Monetary Policy |
I don't agree with everything in this column, but I've long thought that the Obama administration's lack of effective spokespeople -- the Carville, Reich, etc. types that give a strong voice to the Clinton administration for example -- is a problem:
The White House has a surrogate problem, by Ed Rogers, Commentary, Washington Post: The White House does not have compelling surrogates who can effectively represent the president, his campaign or his domestic policies on TV. This will become more of a problem as the campaign progresses. How did this happen with a supposedly media-savvy Obama political team?
They seem to be doing a little better lately, but I think this is a problem. One thought, which I stole from someone else, is that Obama has a "distrust of populists even when he needs them."
Posted by Mark Thoma on Wednesday, July 18, 2012 at 06:03 AM in Economics, Politics |
Posted by Mark Thoma on Wednesday, July 18, 2012 at 12:06 AM in Economics, Links |
Posted by Mark Thoma on Tuesday, July 17, 2012 at 02:25 PM in Economics, Health Care |
Is the housing market bottoming out? Joshua Abel, Richard Peach, and Joseph Tracy of the NY Fed have a highly hedged answer:
Just Released: Housing Checkup–Has the Market Finally Bottomed Out?, by Joshua Abel, Richard Peach, and Joseph Tracy, Liberty Street Economics: In this post, we examine a number of important housing market “vital signs” that collectively help to indicate the health status of local markets at the county level. The post also serves as an introduction to a set of interactive maps, based on home price index data from CoreLogic, that we will regularly update on the New York Fed's website for readers interested in continuing to track the convalescence of the U.S. housing markets. The maps show the year-over-year change in home prices for nearly 1,200 counties through May and include a video sequence tracking these price changes since 2003.
Over the past few months, some national housing market indicators have begun to look a bit brighter. As of May, the CoreLogic national home price index had risen three months in a row. While still at a relatively low level, housing starts now have a clear upward trend. These developments have led some analysts to declare that, after five years of generally declining prices and activity, the housing market has finally bottomed out. While the national statistics are encouraging, whether or not the housing market has bottomed out is actually a much more difficult question to address for a couple of reasons. First, the United States is not a single housing market but rather a collection of numerous local housing markets. Second, the health of a local housing market is determined by a variety of indicators in addition to prices....
And the conclusion:
Overall Health Assessment
The stabilization of the housing market suggested by various national indicators is corroborated by looking at a number of indicators disaggregated to the county level. Importantly, the median county is now experiencing stable house prices on a year-over-year basis. Transaction volumes in most markets, while still far below normal, have steadied. Finally, the share of distressed sales, although still very high in many markets, appears to have peaked. If these trends continue, then local housing markets are making progress in their convalescence. However, our analysis indicates that most local housing markets still have a way to go to achieve a clean bill of health.
Calculated Risk says:
... I think it is likely that prices have bottomed, although I expect prices to be choppy going forward - and I expect any nominal price increase over the next year or two to be small.
I've seen some forecasts of additional 20% price declines on the repeat sales indexes. Three words: Not. Gonna. Happen.
Others, like Barry Ritholtz at the Big Picture, have argued that we could see an additional 10% price decline in the Case-Shiller indexes. I think that is unlikely, but not impossible. The argument for further price declines is that there are still a large number of distressed properties in the foreclosure pipeline - and that there are over 10 million property owners with negative equity, and that could lead to even more distressed sales. So even though prices are pretty much back to "normal" based on real prices and price-to-rent ratio (see below), the argument is that all of these distressed sales could push prices down further. Also, Barry argues that prices following a bubble usually "overshoot".
Those are solid arguments, but I think that some of the policy initiatives (refinance programs, emphasis on modifications, REO-to-rental and more) will lessen the downward pressure from distressed sales - and I also think any "overshoot" will be in real terms (inflation adjusted) as opposed to nominal terms. It is probably correct that any increase in house prices will lead to more inventory (sellers waiting for a "better market"), but that is an argument for why prices will not increase - as opposed to an argument for further price declines.
My view is prices will be up slightly year-over-year next March (when prices usually bottom seasonally for the repeat sales indexes). Some analysts see a small decrease (like 1% to 2%) over the next 12 months, but that isn't much different than a small increase (when compared to forecasts of 10% or 20% declines). ...
Posted by Mark Thoma on Tuesday, July 17, 2012 at 02:07 PM in Economics, Housing |
A defense of some, but not all economists:
Why Some Economists Failed
I assert that some economists got things mostly right about the recession and what was needed to fix it, but they have been ignored in policy discussions. Conversely, those who got things mostly wrong were given prominent seats at the policy-setting table where they continued to make errant forecasts even as the evidence piled up against them. One attempt at rebuttal is, I suppose, is to ask how we know who was correct? The answer is that unlike the economists who continue to promote austerity, fear of inflation, and so on, the assertion is based upon the empirical evidence on these issues. [See Paul Krugman for a related issue, why fear of inflation, deficits, and so on "resonates with a lot of people no matter how often and how badly the worldview fails in practice." Part of my point is that I don't think economists are free of blame for this.]
Posted by Mark Thoma on Tuesday, July 17, 2012 at 12:42 AM in Economics, Fiscal Times, Politics |
A Slap in The Face, by Tim Duy: The retail sales number should be a slap in the face for any FOMC members sitting on the fence. Stripping out autos and gas gives us this picture:
Clearly, sales growth has rolled over. But what is more startling is the pace of the deceleration. The three-month change:
The three-month change is severe, to say the least, and since 1992 unseen in the absence of recession with the exception of the deceleration in June and July of 2010. The deceleration also lends credence to the theory that the jobs slowdown this summer is not entirely an artifact of seasonal variation but also reflects a general softness in economic activity. The rapid downgrades of Q2GDP estimates reflects that softness.
Note, however, that the 2010 slowdown in sales did not foreshadow a recession. But it did foreshadow the Jackson Hole speech and QE2. With that in mind, I would expect Federal Reserve Chairman Ben Bernanke to acknowledge the deceleration of activity when he marches up to Capitol Hill this week. And such acknowledgement would be a signal that more easing is on its way. Moreover, given the pace of deterioration in the data, the Fed may not have time to find any new tricks, and thus be forced to deliver that easing in the form of additional balance sheet action.
Posted by Mark Thoma on Tuesday, July 17, 2012 at 12:24 AM in Economics, Fed Watch, Monetary Policy |
Posted by Mark Thoma on Tuesday, July 17, 2012 at 12:06 AM in Economics, Links |
I am supposed to be on vacation this week. I am going to try to keep up, links will still appear daily for example, but realistically posting will likely slow from its normal rate. For now, let me send you to an "annoyed" Aaron Carroll:
Let’s try to stick to the real world when we talk about Medicaid, by Aaron Carroll: Tyler Cowen had a piece in the NYT this weekend on Medicaid. He doesn’t seem too thrilled with its use in the ACA’s coverage expansion. ... I have to admit that his article set me off a bit. It could be that he didn’t have space in the NYT for more nuance. Perhaps he’ll provide it on his blog. In particular, I’d love him to address some of the points below…
I get a bit annoyed when people claim that we can’t “afford” more government intervention or, god-forbid, single-payer. That kind of statement willfully ignores the fact that every country that has MORE government intervention spends LESS.
I get a bit annoyed by the claim that an expansion of government insurance leads to lines and waiting when lots of countries have universal access and less of a wait-time problem than we do. Moreover, almost no one makes this argument when we expand private insurance, only government.
I get a bit annoyed by blanket claims that doctors won’t accept Medicaid. Such statements often ignore the fact that the majority of Medicaid beneficiaries are children and pregnant women. We don’t need all types of doctors to accept Medicaid patients in equal numbers. ...
I get a bit annoyed when people just claim government programs are “unpopular”. Like Medicare? I don’t think so..., polling shows the opposite of what Tyler (and lots of others) suggest.
I get a bit annoyed at the blanket acceptance of the awesomeness of the free market in health care, when there is no phenomenal evidence of its success. And again, those countries with less free market are cheaper, universal, and often just as good. ...
Look, I get that people may not like the political implications of those systems. They may not like the governments that produce them. They may not like the lack of choice inherent in such systems. They may not like the potential limitations within them for making money, and therefore for innovation. But we need to stop making stuff up about them.
Posted by Mark Thoma on Monday, July 16, 2012 at 08:37 AM in Economics, Health Care |
Cutting through the "political and media fog":
Policy and the Personal, by Paul Krugman, Commentary, NY Times: A lot of people inside the Beltway are tut-tutting about the recent campaign focus on Mitt Romney’s personal history ... at Bain Capital... Some of the tut-tutters are upset at any suggestion that this election is about the rich versus the rest. Others decry the personalization: why can’t we just discuss policy?
And neither group is living in the real world. First of all, this election really is ... about the rich versus the rest.
The story so far: ... taxes on the very rich are currently the lowest they’ve been in 80 years. President Obama proposes letting those high-end Bush tax cuts expire; Mr. Romney, on the other hand, proposes big further tax cuts for the wealthy. ... Realistically, those big tax cuts for the rich would be offset, sooner or later, with higher taxes and/or lower benefits for the middle class and the poor.
So as I said, this election is ... about the rich versus the rest, and it would be doing voters a disservice to pretend otherwise.
In that case, however, why not run a campaign based on that substance, and leave Mr. Romney’s personal history alone? The short answer is, get real. ... Perhaps in a better world we could count on the news media to sort through the conflicting claims. ...
So how can the Obama campaign cut through this political and media fog? By talking about Mr. Romney’s personal history, and the way that history resonates with the realities of his pro-rich, anti-middle-class policy proposals.
Thus the entirely true charge that Mr. Romney wants to slash historically low tax rates on the rich even further dovetails perfectly with his own record of extraordinary tax avoidance — so extraordinary that he’s evidently afraid to let voters see his tax returns from before 2010. The equally true charge that he’s pushing policies that would benefit the rich at the expense of ordinary working Americans meshes with Bain’s record of earning big profits even when workers suffered — a record so stark that Mr. Romney is attempting to distance himself from part of it ...
The point is that talking about Mr. Romney’s personal history isn’t a diversion from substantive policy discussion. On the contrary, in a political and media environment strongly biased against substance, talking about Bain and offshore accounts is the only way to bring the real policy issues into focus. And we should applaud, not condemn, the Obama campaign for standing up to the tut-tutters.
Posted by Mark Thoma on Monday, July 16, 2012 at 12:24 AM in Economics, Politics |
Posted by Mark Thoma on Monday, July 16, 2012 at 12:06 AM in Economics, Links |
Larry Summers argues that the key to solving the inequality problem is to equalize opportunity, and that "By far the most important step that can be taken to enhance opportunity is strengthening public education." I agree we should try to improve public education, but it will take much more than that to solve the inequality problem (the kinds of things he mentions elsewhere in his argument are a start). We've been trying to improve education for decades and it hasn't solved the inequality problem yet, and it's folly to think some magic education bullet is just around the corner:
Changing focus to inequalities in opportunity, by Lawrence Summers, Commentary, Washington Post: Even if the process proves protracted, the U.S. economy will eventually recover. When it does, issues relating to inequality are likely to replace cyclical issues at the forefront of our economic conversation. ...
The global track record of populist policies motivated by inequality concerns is hardly encouraging. However, passivity in the face of dramatic economic change is equally unlikely to be viable. Perhaps the debate and policy focus needs to shift from inequality in outcomes, where attitudes divide sharply and there are limits to what can be done, to inequalities in opportunity. ...
By far the most important step that can be taken to enhance opportunity is strengthening public education. ... Over the past 40 years, with the strong support of the federal government, the nation’s leading universities have made a major effort to recruit, admit, support and graduate minority students. These efforts will and should continue.
But as things stand, a minority youth with strong test scores is considerably more likely to apply and be admitted to a top school than a low-income student. The leading U.S. institutions must make the kind of focused commitment to economic diversity that they have long mounted toward racial diversity. It is unrealistic to expect that schools that depend on charitable contributions will not be attentive to offspring of their supporters. Perhaps though, the custom could be established that for each “legacy slot” room would be made for one “opportunity slot.”
What about the perpetuation of privilege? Parents always seek to help their children. But there is no reason the estate tax should decrease relative to the economy at a time when great fortunes are increasingly dominant. Nor should we continue to permit tax-planning techniques that are de facto tax cuts only for those with millions of dollars of income and tens of millions in wealth.
These are just a few ideas for advancing equality of opportunity. There are many more. It is an aspiration those of every political stripe should share.
Posted by Mark Thoma on Sunday, July 15, 2012 at 04:05 PM in Economics, Income Distribution |
No Bain, No Gain, by Paul Krugman: There is, predictably, a mini-backlash against the Obama campaign’s focus on Bain. Some of it is coming from the Very Serious People, who think that we should be discussing their usual preoccupations. But some of it is coming from progressives...
This is remarkably naive. I agree that the awfulness of Romney’s policy proposals is the main argument against his candidacy. But the Bain focus isn’t a diversion from that issue, it’s complementary. ...
The first point is that voters are not policy wonks. ... Nor, alas, can we rely on the news media to get the essentials of the policy debate across to the public... The sad truth is that the cult of balance still rules. If a Republican candidate announced a plan that in effect sells children into indentured servitude, the news reports would be that “Democrats say” that the plan sells children into indentured servitude, with each quote to that effect matched by a quote from a Republican saying the opposite. ...
So running on the real policy issues by itself isn’t going to work. By all means, run on the real issues — but do so by creating a narrative, a pattern that registers with the public.
And Romney’s biography offers a golden opportunity to do just that. His policy proposals amount to a radical redistribution of income away from the middle class to the very rich; he’s also being highly dishonest about budgets and just about everything else. How to make those true facts credible? By associating them with his business career, which involved a lot of profiting by laying off workers and/or taking away their benefits; his personal finances, which involved so much tax avoidance that he’s afraid to let us see his returns before 2010; his shiftiness over when exactly he left Bain.
You could criticize the biographical focus if it were being used to convey a false impression of where Romney stands, but that’s not what’s going on here; instead, it’s being used to get the truth about the candidate past the noise and the media barrier. The truth is that the Obama campaign would be doing the American people a disservice if it didn’t make the most of Bain.
Posted by Mark Thoma on Sunday, July 15, 2012 at 06:03 AM in Economics, Politics |
Posted by Mark Thoma on Sunday, July 15, 2012 at 12:06 AM in Economics, Links |
Watching Amir Sufi give this paper arguing that a fall in aggregate demand rather than uncertainty, structurual change, and so forth is the major reason for the fall in employment (with the implication that replacing the lost demand can help the recovery):
What Explains High Unemployment? The Aggregate Demand Channel, by Atif Mian, University of California, Berkeley and NBER Amir Sufi University of Chicago Booth School of Business and NBER, November 2011: Abstract A drop in aggregate demand driven by shocks to household balance sheets is responsible for a large fraction of the decline in U.S. employment from 2007 to 2009. The aggregate demand channel for unemployment predicts that employment losses in the non-tradable sector are higher in high leverage U.S. counties that were most severely impacted by the balance sheet shock, while losses in the tradable sector are distributed uniformly across all counties. We find exactly this pattern from 2007 to 2009. Alternative hypotheses for job losses based on uncertainty shocks or structural unemployment related to construction do not explain our results. Using the relation between non-tradable sector job losses and demand shocks and assuming Cobb-Douglas preferences over tradable and non-tradable goods, we quantify the effect of aggregate demand channel on total employment. Our estimates suggest that the decline in aggregate demand driven by household balance sheet shocks accounts for almost 4 million of the lost jobs from 2007 to 2009, or 65% of the lost jobs in our data.
And, from the conclusion:
Alternative hypotheses such as business uncertainty and structural adjustment of the labor force related to construction are less consistent with the facts. The argument that businesses are holding back hiring because of regulatory or financial uncertainty is difficult to reconcile with the strong cross-sectional relation between household leverage levels, consumption, and employment in the non-tradable sector. This argument is also difficult to reconcile with survey evidence from small businesses and economists saying that lack of product demand has been the primary worry for businesses throughout the recession (Dennis (2010), Izzo (2011)).
There is certainly validity to the structural adjustment argument given large employment losses associated with the construction sector. However, we show that the leverage ratio of a county is a far more powerful predictor of total employment losses than either the growth in construction employment during the housing boom or the construction share of the labor force as of 2007. Further, using variation across the country in housing supply elasticity, we show that the aggregate demand hypothesis is distinct from the construction collapse view. Finally, structural adjustment theories based on construction do not explain why employment has declined sharply in industries producing tradable goods even in areas that experienced no housing boom.
Posted by Mark Thoma on Saturday, July 14, 2012 at 09:09 AM in Academic Papers, Economics |
Robert Reich says "You need to make a ruckus":
The Selling of American Democracy: The Perfect Storm, by Robert Reich: Who’s buying our democracy? Wall Street financiers, the Koch brothers, and casino magnates Sheldon Adelson and Steve Wynn. And they’re doing much of it in secret. It’s a perfect storm:
The greatest concentration of wealth in more than a century — courtesy “trickle-down” economics, Reagan and Bush tax cuts, and the demise of organized labor.
Unlimited political contributions — courtesy of Republican-appointed Justices Roberts, Scalia, Alito, Thomas, and Kennedy, in one of the dumbest decisions in Supreme Court history, “Citizens United vs. Federal Election Commission”...
Complete secrecy about who’s contributing how much to whom — courtesy of a loophole in the tax laws that allows so-called non-profit “social welfare” organizations to accept the unlimited contributions for hard-hitting political ads.
Put them all together and our democracy is being sold down the drain.
With a more equitable and traditional distribution of wealth, far more Americans would have a fair chance of influencing politics. ... Alternatively, inequality wouldn’t be as much of a problem if we had strict laws limiting political spending or, at the very least, disclosing who was contributing what.
But we have an almost unprecedented concentration of wealth and unlimited political spending and secrecy.
I’m not letting Democrats off the hook. Democratic candidates are still too dependent on Wall Street casino moguls and real casino magnates... But make no mistake. Compared to what the GOP is doing this year, Democrats are conducting a high-school bake sale. ...
You need to make a ruckus. Don’t fall into the seductive trap of cynicism. That’s what the sellers of American democracy are counting on. If you give up on our system of government, they win everything.
This coming Monday, for example, the Senate has scheduled a cloture vote on the DISCLOSE ACT, which would at least require that outfits like the Chamber of Commerce and Karl Rove’s “Crossroads GPS” disclose who’s contributing what. Contact your senators... If the DISCLOSE ACT is voted down, hold accountable those senators (and, when and if it gets to the House, those House members) who are selling out our democracy for the sake of their own personal ambitions.
I believe the political empowerment of the working class -- replacing, for example, what was lost with the demise of unions -- is the best way to make politicians more responsive to the needs of lower income households. The problem, of course, is how to make this happen.
Posted by Mark Thoma on Saturday, July 14, 2012 at 06:03 AM in Economics, Income Distribution, Politics |
Posted by Mark Thoma on Saturday, July 14, 2012 at 12:06 AM in Economics, Links |
Luigi Zingales on why some ideas get more attention than others:
Orphan Ideas, by Luigi Zingales, Commentary, Project Syndicate: Since the United States Supreme Court’s “Citizens United” decision,... concern about business interests’ influence over US elections has been growing. But political contributions are only one reason why business interests have so much power..., ideas play a big role, too. Unfortunately, rather than leveling the playing field, the battle of ideas may skew US politics even further in favor of big business. ...
Even if researchers themselves are motivated by only the noblest of goals, their need for funding forces them to take into account the demand for ideas. And, if funding is not a major issue, the mechanism of amplification of an idea (and thus its ultimate diffusion) nonetheless depends upon how appealing it is to some lobbying effort.
Consider a great researcher in my field, Michael Jensen. In 1990, he co-wrote a paper about executive pay, arguing that it was not sufficiently linked to performance. Although the authors used an untenable benchmark..., the article was published in a top economic journal, prominently discussed in the Harvard Business Review, and is one of the most cited papers in economics. Fifteen years later, Jensen wrote a paper about the costs of excessive sensitivity of pay to performance. The paper was published in a minor journal and is not very well cited. Why?
Business loved the first paper, because it ... ended up justifying an increase in pay. There was no similar love for the second paper, which languishes almost unknown, despite its important insights..., the two papers’ asymmetric citation payoff is a warning for young scholars: if they want to get ahead professionally, the position that they should take is clear. ...
Here is perhaps the biggest orphan idea: pro-market does not necessarily mean pro-business. A pro-business agenda aims at maximizing the profits of existing firms; a pro-market agenda, by contrast, seeks to encourage the best business conditions for everyone. Who benefits from evidence that an industry is too concentrated, its profit margins are too high, and consumers are being ripped off? ...
And, sure enough, in most of what we economists write – and, more important, in what we teach in business schools – it is hard to tell the difference between being pro-market and being pro-business. The battle against crony capitalism starts in the classroom, and we professors are inevitably implicated. If we are not part of the solution, we are part of the problem.
Posted by Mark Thoma on Friday, July 13, 2012 at 11:07 AM in Economics, Politics |
One more from Brad DeLong -- here he wonders why Jeff Sachs is dismissive of policies that can address the short-run problem of deficient demand, and instead focuses on long-run structural remedies that do nothing to help with our most immediate prolems:
What Is to Be Done Now?: Jeff Sachs Appears to Miss the Point by a Substantial Margin..., by Brad DeLong: Jeff Sachs:
Move America’s economic debate out of its time warp: In Krugman’s simplified Keynesian worldview, there are no structural challenges, only shortfalls in aggregate demand. There is no public debt problem. There is no global competitiveness challenge, since “competitiveness” is a myth when applied to national economies. Fiscal multipliers are predictable, timeless, persistent, and large. All growth reversals can be solved through larger deficits. Politicians can be trusted to design short-term stimulus spending programmes of hundreds of billions of dollars. Tax cuts are about as good as increases in government spending, and short-term boosts in spending are about as good as long-term public investments. Not one of these conclusions stands scrutiny.
Why have we come to this vacuous debate between a free-market extremism and a Keynesian superficiality that addresses none of the subtleties, trade-offs, and uncertainties of the real situation?… [T]he world is facing novel problems at the global level, and novelty is hard to factor into economics, which is a rigid, ideological, theoretically based, and largely backward-looking field…
I find very little here that I can agree with.
Krugman's line--Krugman's consistent line--has never been that we do not have structural problems. Krugman's consistent line has been:
- We have an urgent and dire aggregate demand shortfall problem.
- We know how to cure our urgent and dire aggregate demand shortfall problem.
- Our structural problems are a lot more manageable and a lot less daunting at full employment than in a deep depression.
It makes absolutely no sense to say that we should not solve a dire and urgent problem we can easily solve because solving that problem does not solve all of our problems. ...
What we have is a rejection of simple Keynesian remedies--Jeff calls for us to do magic ingredient Y minus simplistic Keynesian remedies.
But what is magic ingredient Y. What remedies does Jeff propose in his column?
education, skills and active labour market policies… we are in the age of the Anthropocene, where global growth is limited by natural resources, climate change and hazards… a long-term financial outlook and new approaches to pensions and healthcare delivery…. Well-designed public investments (eg in infrastructure) can unlock significant private investments as well…. [W]e need new economic strategies to overhaul broken systems of finance, labour markets, taxation, ecological management, budget management and investment incentives…. The new approaches must be long-term, structural, sensitive to inequalities of skills and education, aligned with the need for more sustainable technologies and “smarter” infrastructure (empowered by information technology) and congruent with long-term demographic trends…
Would any policies to deal with any of these structural challenges be hindered by policies to boost aggregate demand up to potential output? No. Would every policy I can think of to deal with any of these structural challenges be helped by policies to boost aggregate demand up to potential output? Yes.
And are there any action items on Jeff's list? We aggregate demand types tend to call for things like:
- Give every homeowner the opportunity to refi at the conforming loan rate, with an equity kicker if their mortgage does not meet conforming-loan standards.
- Spend an extra $100 billion a month on roads, bridges, teachers, police officers, public health workers, and tax cuts targeted at the cash-strapped until (a) the economy recovers or (b) long-term interest rates feel upward pressure pushing them above normal-time levels.
- Declare that it is the policy of the Federal Reserve to push nominal GDP up to its pre-2008 trend growth line.
- Buy $100 billion a month of long-term risky bonds until market expectations of nominal GDP have it quickly returning to its pre-2008 trend growth line.
Then we can start dealing with our other structural problems. ...
Posted by Mark Thoma on Friday, July 13, 2012 at 10:17 AM in Economics, Fiscal Policy, Monetary Policy |
Travel day and time is short, so let me hand the mic to Brad DeLong:
One-Hundred-Thirty-Seven Pinocchios for Glenn Kessler of the Washington Post, as He Tells Untruths About Mitt Romney, by Brad DeLong: In 2002 Mitt Romney decided that he had retired from Bain in 1999.
Yes, you read that correctly. When Mitt Romney took over the Salt Lake City Olympics in February 1999, he intended to come back and run Bain Capital full-time afterwards--and he wanted to make sure that everybody at Bain Capital knew that he was still the boss, that he would be coming back full-time, that nobody should try to take his seat while he was in Salt Lake City, and that everybody should be careful to make sure that their actions were things Romney approved of.
Come 2002, Mitt Romney decided that he was going to run for Governor of Massachusetts. So come 2002 Romney decides that he had retired from Bain Capital back in 1999. Yes. As Glenn Kessler says: "when Romney decided to run for governor in 2002, he received a retirement package that was dated Feb., 1999".
Now comes Glenn Kessler. What Glenn Kessler should be saying today is:
Back in January, Mitt Romney's people convinced me: (a) that Romney retired from Bain in February 1999, (b) that afterwards he was merely a passive investors, and (c ) that Romney bears no responsibility--credit or blame--for any Bain business decisions after February 1999. They snookered me. The situation is much more complicated. From February 1999 to 2002, Romney was focused on the Salt Lake City Olympics, and his subordinates at Bain Capital in Massachusetts were expecting him to return full-time and so were anxious to make decisions he approved.
Would that be so hard?
But for a Washington Post reporter to admit error is an extremely rare thing. Much better, Glenn Kessler thinks, for him to double down and hope to brazen things out.
Why oh why can't we have a better press corps? ...
Posted by Mark Thoma on Friday, July 13, 2012 at 07:38 AM in Economics, Politics |
Rajiv Sethi looks at the reaction to the Romney campaign's attempt to change the subject from Romney's role at Bain to potential picks for vice-president (as far as I can tell, Rice has no chance -- she's "mildly pro-choice" for one -- so this was nothing more than an attempt to divert attention from Bain, an attempt one that seems to have worked, at least to some extent):
Market Overreaction: A Case Study, by Rajiv Sethi: At 7:30pm yesterday the Drudge Report breathlessly broadcast the following:
ROMNEY NARROWS VP CHOICES; CONDI EMERGES AS FRONTRUNNER
Thu Jul 12 2012 19:30:01 ET
Late Thursday evening, Mitt Romney's presidential campaign launched a new fundraising drive, 'Meet The VP' -- just as Romney himself has narrowed the field of candidates to a handful, sources reveal.
And a surprise name is now near the top of the list: Former Secretary of State Condoleezza Rice!
The timing of the announcement is now set for 'coming weeks'.
The reaction on Intrade was immediate. The price of a contract that pays $10 if Rice is selected as Romney's running mate (and nothing otherwise) shot up from about 35 cents to $2, with about 2500 contracts changing hands within twenty minutes of the Drudge announcement. By the sleepy standards of the prediction market this constitutes very heavy volume. This led Nate Silver to respond on twitter at 7:49 as follows:
The Condi Rice for VP contract at Intrade possibly the most obvious short since Pets.com
Good advice, as it turned out. By 9:45 pm the price had dropped to about 90 cents a contract with about 5000 contracts traded in total since the initial announcement. Here's the price and volume chart:
One of the most interesting aspects of markets such as Intrade is that they offer sets of contracts on a list of exhaustive and mutually exclusive events. For instance, the Republican VP Nominee market contains not just the contract for Rice, but also for 56 other potential candidates, as well as a residual contract that pays off if none of the named contracts do. The sum of the bids for all these contracts cannot exceed $10, otherwise someone could sell the entire set of contracts and make an arbitrage profit. In practice, no individual is going to take the trouble to spot and exploit such opportunities, but it's a trivial matter to write a computer program that can do so as soon as they arise.
In fact, such algorithms are in widespread use on Intrade, and easy to spot. The sharp rise in the Rice contract caused the arbitrage condition to be momentarily violated and simultaneous sales of the entire set of contracts began to occur. While the price of one contract rose, the prices of the others (Portman, Pawlenty, and Ryan especially) were knocked back as existing bids started to be filled by algorithmic instruction. But as new bidders appeared for these other contracts the Rice contract itself was pushed back in price, resulting in the reversal seen in the above chart. All this in a matter of two or three hours.
Does any of this have relevance for the far more economically significant markets for equity and debt? There's a fair amount of direct evidence that these markets are also characterized by overreaction to news, and such overreaction is consistent with the excess volatility of stock prices relative to dividend flows. But overreactions in stock and bond markets can take months or years to reverse. Benjamin Graham famously claimed that "the interval required for a substantial undervaluation to correct itself averages approximately 1½ to 2½ years," and DeBondt and Thaler found that "loser" portfolios (composed of stocks that had previously experienced sharp capital losses) continued to outperform "winner" portfolios (composed of those with significant prior capital gains) for up to five years after construction.
One reason why overreaction to news in stock markets takes so long to correct is that there is no arbitrage constraint that forces a decline in other assets when one asset rises sharply in price. In prediction markets, such constraints cause immediate reactions in related contracts as soon as one contract makes a major move. Similar effects arise in derivatives markets more generally: options prices respond instantly to changes in the price of the underlying, futures prices move in lock step with spot prices, and exchange-traded funds trade at prices that closely track those of their component securities. Most of this activity is generated by algorithms designed to sniff out and snap up opportunities for riskless profit. But the primitive assets in our economy, stocks and bonds, are constrained only by beliefs about their future values, and can therefore wander far and wide for long periods before being dragged back by their cash flow anchors.
Posted by Mark Thoma on Friday, July 13, 2012 at 07:11 AM in Economics, Politics |
The wealthy aren't anywhere near as important as they think they are:
Who’s Very Important?, by Paul Krugman, Commentary, NY Times: “Is there a V.I.P. entrance? We are V.I.P.” That remark, by a donor waiting to get in to one of Mitt Romney’s recent fund-raisers in the Hamptons, pretty much sums up the attitude of America’s wealthy elite. Mr. Romney’s base — never mind the top 1 percent, we’re talking about the top 0.01 percent or higher — is composed of very self-important people.
Specifically, these are people who believe that they are, as another Romney donor put it, “the engine of the economy”; they should be cherished, and the taxes they pay, which are already at an 80-year low, should be cut even further. Unfortunately, said yet another donor, the “common person” — for example, the “nails ladies” — just doesn’t get it.
O.K., it’s easy to mock these people, but the joke’s really on us. For the “we are V.I.P.” crowd has fully captured the modern Republican Party.. And there is, of course, a good chance that Republicans will control both Congress and the White House next year.
If that happens, we’ll see a sharp turn toward economic policies ... especially solicitous toward the superrich — I’m sorry, I mean the “job creators.” So it’s important to understand why that’s wrong.
The first thing you need to know is that America wasn’t always like this. When John F. Kennedy was elected president, the top 0.01 percent was only about a quarter as rich ... and ... paid much higher taxes... Yet somehow we managed to have a dynamic, innovative economy that was the envy of the world. ...
What about the argument that we must keep taxes on the rich low lest we remove their incentive to create wealth? The answer is that we have a lot of historical evidence ... and none of it supports the view that ... tax-rate changes ... currently on the table ... would have any major effect on incentives. Remember when all the usual suspects claimed that the economy would crash when Bill Clinton raised taxes in 1993?
Furthermore, if you’re really concerned about the incentive effects of public policy, you should be focused ... on workers making $20,000 to $30,000 a year, who are often penalized for any gain in income because they end up losing means-tested benefits like Medicaid and food stamps. ...
So, are the very rich V.I.P.? No, they aren’t — at least no more so than other working Americans. And the “common person” will be hurt, not helped, if we end up with government of the 0.01 percent, by the 0.01 percent, for the 0.01 percent.
Posted by Mark Thoma on Friday, July 13, 2012 at 12:24 AM in Economics, Politics |
Posted by Mark Thoma on Friday, July 13, 2012 at 12:06 AM in Economics, Links |
Nope, there's no need for regulation of financial markets, or for something like a consumer financial protection bureau:
Justice Department Details Higher Rates Charged to Minority Borrowers, by Janet Paskin, WSJ: At least 34,000 African-American, Hispanic and other minority borrowers paid more for their mortgages or were steered into subprime loans when they could have qualified for better rates, according to the Department of Justice. The DOJ settled a fair-lending lawsuit with Wells Fargo, the nation’s largest mortgage lender, on Thursday.
That adds up to real money – and, in some cases, real stress:
As a result of being placed in a subprime loan, an African-American or Hispanic borrower… was subject to possible pre-payment penalties, increased risk of credit problems, default, and foreclosure, and the emotional distress that accompanies such economic stress.
The complaint also says that between 2004 and 2008, “highly qualified prime retail and wholesale applicants for Wells Fargo residential mortgage loans were more than four times as likely to receive a subprime loan if they were African-American and more than three times as likely if they were Hispanic than if they were white.”
During the same period, the complaint says, “borrowers with less favorable credit qualifications were more likely to receive prime loans if they were white than borrowers who were African-American or Hispanic.” ... Bank of America agreed to pay $335 million in settling similar charges in December. ...
I suppose I should add: It wasn't the CRA.
Posted by Mark Thoma on Thursday, July 12, 2012 at 12:15 PM in Economics, Housing |
The world desperately wants to loan us money, by Ezra Klein: The Financial Times reports that there was record demand for 10-year Treasurys this week. “The $21 [billion] sale of 10-year paper sold at a yield of 1.459 per cent, the lowest ever in an auction.” ...
Remember: Low yields means we’re getting the money for a cheap. It means the market thinks we’re a safe bet. And it means we have the opportunity to get capital for almost nothing and invest it productively.
Actually, I got something wrong there. I said “almost nothing.” But ... when you ... account for inflation, it’s not “almost nothing.” It’s “less than nothing.” ... They’re negative. Negative! The market will literally pay us a small premium to take their money and keep it safe for them for five, seven or 10 years. We could use that money to rebuild our roads and water filtration systems. We could use that money to cut taxes for any business that adds to its payrolls. We could use that to hire back the 600,000 state and local workers we’ve laid off in the last few years.
Or, as Larry Summers has written, we could simply accelerate payments we know we’ll need to make anyway. We could move up maintenance projects, replace our military equipment or buy space we’re currently leasing. All of that would leave the government in a better fiscal position going forward, not to mention help the economy.
The fact that we’re not doing any of this isn’t just a lost opportunity. It’s financial mismanagement on an epic scale.
Why not put people to work doing useful things at such a low cost? We all know the answer, there's no chance Republicans in Congress would allow it. For the political right, there is no greater good, only our side and your side.
Posted by Mark Thoma on Thursday, July 12, 2012 at 09:09 AM
In case you missed this:
Government documents unearthed by the Boston Globe show that Mitt Romney appeared to have remained CEO and chairman of Bain Capital three years after he said he had ceded control. The date of his departure is important because he has said his resignation in February 1999 means he can’t be held responsible for bad investments the company made or people it laid off after he left.
From the Globe:
According to a statement issued by Bain Wednesday, “Mitt Romney retired from Bain Capital in February 1999. He has had no involvement in the management or investment activities of Bain Capital, or with any of its portfolio companies, since that time.”
A former SEC commissioner told the Globe that the SEC documents listing Romney as Bain’s chief executive between 1999 and 2002 cannot be dismissed so easily.
“You can’t say statements filed with the SEC are meaningless. This is a fact in an SEC filing,” said Roberta S. Karmel, now a professor at Brooklyn Law School. ...
The Globe found nine SEC filings submitted by four different business entities after February 1999 that describe Romney as Bain Capital’s boss; some show him with managerial control over five Bain Capital entities that were formed in January 2002, according to records in Delaware, where they were incorporated.
A Romney campaign official, who requested anonymity to discuss the SEC filings, acknowledged that they “do not square with common sense.” But SEC regulations are complicated and quirky, the official argued, and Romney’s signature on some documents after his exit does not indicate active involvement in the firm. ...
Karmel, the former SEC commissioner, said the contradictory statements could have legal implications in some instances.
“If someone invested with Bain Capital because they believed Mitt Romney was a great fund manager, and it turns out he wasn’t really doing anything, that could be considered a misrepresentation to the investor,’’ she said. “It’s a theory that could be used in a lawsuit against him.”
Romney's claims about this appear to be about as accurate as his stump speech -- meaning not accurate at all.
When will the press begin to label his as the dissembler (to be kind) he appears to be?
Posted by Mark Thoma on Thursday, July 12, 2012 at 06:48 AM
The Market Has Spoken, and It Is Rigged, by Simon Johnson, Commentary, NY Times: In the aftermath of the Barclays rate-fixing scandal, the most surprising reaction has been from people in the financial sector who fully understand the awfulness of what has happened. Rather than seeing this as an issue of law and order, some well-informed people have been drawn toward arguments that excuse or justify the behavior of the Barclays employees.
This is a big mistake.. The behavior at Barclays has all the hallmarks of fraud... Anyone who takes personal responsibility seriously should want all those involved to be held accountable – to the full extent of the law in all jurisdictions. Anything that lets individuals escape consequences will further undermine the legitimacy that underpins all markets. ...
Nevertheless, five arguments put forward in the last 10 days ... attempt to provide some sort of cover for what happened at Barclays. None of these arguments have any merit.
First, it is argued that this kind of cheating around Libor has been going on for a long time. This may be true, but it is a sad and lame excuse... Second, it is also asserted that “everyone does it.” This is not any kind of defense – try it next time you are accused of fraud. ...
Third, Libor-rigging is defended as a “victimless crime.” This is untrue. Traders at Barclays and other banks gained from this series of manipulations, so someone else lost. ...
Fourth, some contend that it is the regulators’ responsibility and fault that there was cheating on Libor. It is certainly the case that there was regulatory capture at work... But who does the capturing in regulatory capture? Big banks work long and hard and lobby at many levels to push regulators toward paying less attention.
Fifth, the weakest argument is, “It was only a few basis points, here and there”... Either the Libor reporting process and, consequently, the pricing of derivatives has been corrupted by a criminal conspiracy, or it has not. There is no “just a little” in this context for the enormous global securities market. ...
How will this play in American politics? There is still time for politicians on the right and on the left of the political spectrum to get ahead of the issue. Digging in around specious arguments in favor of price-fixing cartels is not the way to go.
Power corrupts, and financial market power has completely corrupted financial markets. ...
There's also the argument that regulating the industry will harm economic growth, but look at the growth rates we currently have -- thanks in large part to an out of control financial sector -- to see the folly of that claim. Deregulation of the financial industry did not bring us the robust economy that we were promised, it brought disaster, fraud, and who knows what else, and more oversight is clearly needed.
Posted by Mark Thoma on Thursday, July 12, 2012 at 06:39 AM in Economics, Financial System, Regulation |
Posted by Mark Thoma on Thursday, July 12, 2012 at 12:06 AM in Economics, Links |
FOMC Minutes Not a Smoking Gun, by Tim Duy: The minutes of the June FOMC meeting are out, and they did not deliver the much-anticipated smoking gun that would indicate QE3 was on its way. In fact, I think the minutes raise questions about another round of QE3 at all. The minutes hold many hints that policymakers are struggling to find a new direction for policy, one not necessarily dependent on balance sheet expansion.
There will be considerable focus on this section:
A few members expressed the view that further policy stimulus likely would be necessary to promote satisfactory growth in employment and to ensure that the inflation rate would be at the Committee's goal. Several others noted that additional policy action could be warranted if the economic recovery were to lose momentum, if the downside risks to the forecast became sufficiently pronounced, or if inflation seemed likely to run persistently below the Committee's longer-run objective.
We already knew that there exists a contingent seeking additional stimulus. And we suspected that there was a sizable middle ground that could be turned to the cause of additional stimulus. But the conditions that they place on further action - lost momentum, downside risks, or low inflation - all seemed to have been met at the last meeting. Indeed, the inflation clause is especially curious because the minutes earlier noted:
Looking beyond the temporary effects on inflation of this year's fluctuations in oil and other commodity prices, almost all participants continued to anticipate that inflation over the medium-term would run at or below the 2 percent rate that the Committee judges to be most consistent with its statutory mandate.
If everyone agrees they are going to miss their target, and everyone agrees that missing the target should be cause for action, then why was action limited to simply maintaining the status quo? (See also Matthew Yglesias). I can find two reasons in the minutes to withhold more aggressive action at this time. First is uncertainty about the inflation forecast:
Most participants viewed the risks to their inflation outlook as being roughly balanced.
Maybe they need most participants to view the risks as skewed toward even lower inflation. Another possibility is that officials simply are wary about the impact of further quantitative easing at this juncture and do not want to take action that does more harm than good. And how might it do such harm?
Some members noted the risk that continued purchases of longer-term Treasury securities could, at some point, lead to deterioration in the functioning of the Treasury securities market that could undermine the intended effects of the policy. However, members generally agreed that such risks seemed low at present, and were outweighed by the expected benefits of the action.
A few members observed that it would be helpful to have a better understanding of how large the Federal Reserve's asset purchases would have to be to cause a meaningful deterioration in securities market functioning, and of the potential costs of such deterioration for the economy as a whole.
And finally, perhaps most importantly, this:
Several participants commented that it would be desirable to explore the possibility of developing new tools to promote more-accommodative financial conditions and thereby support a stronger economic recovery.
I noted after the last meeting that the "further action" clause of the statement did not specify balance sheet operations as had previous statements. This possibly signaled that the next round of easing could come in a different form. What form I do not know; I would think MBS, but that would also act via the balance sheet. Similarly, we saw comments from Fed officials that further action could come in the form of communications, presumably with respect to the forward guidance.
Bottom Line: The minutes leaves me with the sense that it isn't so much the outlook that is holding back the Fed from further stimulus, but a lack of faith in the beneficial effects of further quantitative easing. That lack of faith may be why the bar to QE3 seems so high. So high that Fed officials are searching for other tools as the next step. Until I see more specific suggestions of other tools, I would continue to expect QE as the tool of choice. Given concerns about the functioning of the Treasuries market, MBS would seem a suitable alternative. But a building desire to explore new tools could mean a delay in any additional action. Hopefully Fed officials will give us more guidance on specific alternatives in the weeks ahead.
Posted by Mark Thoma on Wednesday, July 11, 2012 at 03:24 PM in Economics, Fed Watch, Monetary Policy |
Stephen Ziliak, via email:
Does graphing improve prediction and increase understanding of uncertainty? When making economic forecasts, are scatter plots better than t-statistics, p-values, and other commonly required regression output?
A recent paper by Emre Soyer and Robin Hogarth suggests the answers are yes, that in fact we are far better forecasters when staring at plots of data than we are when dishing out – as academic journals normally do – tables of statistical significance. [Here is a downloadable version of the Soyer-Hogarth article.]
“The Illusion of Predictability: How Regression Statistics Mislead Experts” was published by Soyer and Hogarth in a symposium of the International Journal of Forecasting (vol. 28, no. 3, July 2012). The symposium includes published comments by J. Scott Armstrong, Daniel Goldstein, Keith Ord, N. Nicholas Taleb, and me, together with a reply from Soyer and Hogarth.
Soyer and Hogarth performed an experiment on the forecasting ability of more than 200 well-published econometricians worldwide to test their ability to predict economic outcomes using conventional outputs of linear regression analysis: standard errors, t-statistics, and R-squared.
The chief finding of the Soyer-Hogarth experiment is that the expert econometricians themselves—our best number crunchers—make better predictions when only graphical information—such as a scatter plot and theoretical linear regression line—is provided to them. Give them t-statistics and fits of R-squared for the same data and regression model and their forecasting ability declines. Give them only t-statistics and fits of R-squared and predictions fall from bad to worse.
It’s a finding that hits you between the eyes, or should. R-squared, the primary indicator of model fit, and t-statistic, the primary indicator of coefficient fit, are in the leading journals of economics - such as the AER, QJE, JPE, and RES - evidently doing more harm than good.
Soyer and Hogarth find that conventional presentation mode actually damages inferences from models. This harms decision-making by reducing the econometrician’s (and profit seeker’s) understanding of the total error of the experiment—or of what might be called the real standard error of the regression, where “real” is defined as the sum (in percentage terms, say) of both systematic and random sources of uncertainty in the whole model. If Soyer and Hogarth are correct, academic journals should allocate more space to visual plots of data and less to tables of statistical significance.
In the blogosphere the statistician Andrew Gelman, INET’s Robert Johnson, and journalists Justin Fox (Harvard Business Review) and Felix Salmon (Reuters) have commented favorably on Soyer's and Hogarth's striking results.
But historians of economics and statistics, joined by scientists in other fields – engineering and physics, for example – will not be surprised by the power of visualizing uncertainty. As I explain in my published comment, Karl Pearson himself—a founding father of English-language statistics—tried beginning in the 1890s to make “graphing” the foundation of statistical method. Leading economists of the day such as Francis Edgeworth and Alfred Marshall sympathized strongly with the visual approach.
And as Keynes (1937, QJE) observed, in economics “there is often no scientific basis on which to form any calculable probability whatever. We simply do not know.” Examples of variables we do not know well enough to forecast include, he said, “the obsolescence of a new invention”, “the price of copper” and “the rate of interest twenty years hence” (Keynes, p. 214).
That sounds about right - despite currently fashionable claims about the role of statistical significance in finding a Higgs boson. Unfortunately, Soyer and Hogarth did not include time series forecasting in their novel experiment though in future work I suspect they and others will.
But with extremely powerful, dynamic, and high-dimensional visualization software such as “GGobi” – which works with R and is currently available for free on-line - economists can join engineers and rocket scientists and do a lot more gazing at data than we currently do (http://www.ggobi.org).
At least, that is, if our goal is to improve decisions and to identify relationships that hit us between the eyes.
Stephen T. Ziliak
Professor of Economics
Posted by Mark Thoma on Wednesday, July 11, 2012 at 11:43 AM in Econometrics, Economics, Methodology |
Crisis, what crisis? Arrogance and self-satisfaction among macroeconomists, by Simon Wren-Lewis: My recent post on economics teaching has clearly upset a number of bloggers. There I argued that the recent crisis has not led to a fundamental rethink of macroeconomics. Mainstream macroeconomics has not decided that the Great Recession implies that some chunk of what we used to teach is clearly wrong and should be jettisoned as a result. To some that seems self-satisfied, arrogant and profoundly wrong. ...
Let me be absolutely clear that I am not saying that macroeconomics has nothing to learn from the financial crisis. What I am suggesting is that when those lessons have been learnt, the basics of the macroeconomics we teach will still be there. For example, it may be that we need to endogenise the difference between the interest rate set by monetary policy and the interest rate actually paid by firms and consumers, relating it to asset prices that move with the cycle. But if that is the case, this will build on our current theories of the business cycle. Concepts like aggregate demand, and within the mainstream, the natural rate, will not disappear. We clearly need to take default risk more seriously, and this may lead to more use of models with multiple equilibria (as suggested by Chatelain and Ralf, for example). However, this must surely use the intertemporal optimising framework that is the heart of modern macro.
Why do I want to say this? Because what we already have in macro remains important, valid and useful. What I see happening today is a struggle between those who want to use what we have, and those that want to deny its applicability to the current crisis. What we already have was used (imperfectly, of course) when the financial crisis hit, and analysis clearly suggests this helped mitigate the recession. Since 2010 these positive responses have been reversed, with policymakers around the world using ideas that contradict basic macro theory, like expansionary austerity. In addition, monetary policy makers appear to be misunderstanding ideas that are part of that theory, like credibility. In this context, saying that macro is all wrong and we need to start again is not helpful.
I also think there is a danger in the idea that the financial crisis might have been avoided if only we had better technical tools at our disposal. (I should add that this is not a mistake most heterodox economists would make.) ... The financial crisis itself is not a deeply mysterious event. Look now at the data on leverage that we had at the time, but too few people looked at before the crisis, and the immediate reaction has to be that this cannot go on. So the interesting question for me is how those that did look at this data managed to convince themselves that, to use the title from Reinhart and Rogoff’s book, this time was different.
One answer was that they were convinced by economic theory that turned out to be wrong. But it was not traditional macro theory – it was theories from financial economics. And I’m sure many financial economists would argue that those theories were misapplied. Like confusing new techniques for handling idiosyncratic risk with the problem of systemic risk, for example. Believing that evidence of arbitrage also meant that fundamentals were correctly perceived. In retrospect, we can see why those ideas were wrong using the economics toolkit we already have. So why was that not recognised at the time? I think the key to answering this does not lie in any exciting new technique from physics or elsewhere, but in political science.
To understand why regulators and others missed the crisis, I think we need to recognise the political environment at the time, which includes the influence of the financial sector itself. And I fear that the academic sector was not exactly innocent in this either. A simplistic take on economic theory (mostly micro theory rather than macro) became an excuse for rent seeking. The really big question of the day is not what is wrong with macro, but why has the financial sector grown so rapidly over the last decade or so. Did innovation and deregulation in that sector add to social welfare, or make it easier for that sector to extract surplus from the rest of the economy? And why are there so few economists trying to answer that question?
I have so many posts on the state of modern macro that it's hard to know where to begin, but here's a pretty good summary of my views on this particular topic:
I agree that the current macroeconomic models are unsatisfactory. The question is whether they can be fixed, or if it will be necessary to abandon them altogether. I am okay with seeing if they can be fixed before moving on. It's a step that's necessary in any case. People will resist moving on until they know this framework is a dead end, so the sooner we come to a conclusion about that, the better.
As just one example, modern macroeconomic models do not generally connect the real and the financial sectors. That is, in standard versions of the modern model linkages between the disintegration of financial intermediation and the real economy are missing. Since these linkages provide an important transmission mechanism whereby shocks in the financial sector can affect the real economy, and these are absent from models such as Eggertsson and Woodford, how much credence should I give the results? Even the financial accelerator models (which were largely abandoned because they did not appear to be empirically powerful, and hence were not part of the standard model) do not fully link these sectors in a satisfactory way, yet these connections are crucial in understanding why the crash caused such large economic effects, and how policy can be used to offset them. [e.g. see Woodford's comments, "recent events have made it clear that financial issues need to be integrated much more thoroughly into the basic framework for macroeconomic analysis with which students are provided."]
There are many technical difficulties with connecting the real and the financial sectors. Again, to highlight just one aspect of a much, much larger list of issues that will need to be addressed, modern models assume a representative agent. This assumption overcomes difficult problems associated with aggregating individual agents into macroeconomic aggregates. When this assumption is dropped it becomes very difficult to maintain adequate microeconomic foundations for macroeconomic models (setting aside the debate over the importance of doing this). But representative (single) agent models don't work very well as models of financial markets. Identical agents with identical information and identical outlooks have no motivation to trade financial assets (I sell because I think the price is going down, you buy because you think it's going up; with identical forecasts, the motivation to trade disappears). There needs to be some type of heterogeneity in the model, even if just over information sets, and that causes the technical difficulties associated with aggregation. However, with that said, there have already been important inroads into constructing these models (e.g. see Rajiv Sethi's discussion of John Geanakoplos' Leverage Cycles). So while I'm pessimistic, it's possible this and other problems will be overcome.
But there's no reason to wait until we know for sure if the current framework can be salvaged before starting the attempt to build a better model within an entirely different framework. Both can go on at the same time. What I hope will happen is that some macroeconomists will show more humility they've they've shown to date. That they will finally accept that the present model has large shortcomings that will need to be overcome before it will be as useful as we'd like. I hope that they will admit that it's not at all clear that we can fix the model's problems, and realize that some people have good reason to investigate alternatives to the standard model. The advancement of economics is best served when alternatives are developed and issued as challenges to the dominant theoretical framework, and there's no reason to deride those who choose to do this important work.
So, in answer to those who objected to my defending modern macro, you are partly right. I do think the tools and techniques macroeconomists use have value, and that the standard macro model in use today represents progress. But I also think the standard macro model used for policy analysis, the New Keynesian model, is unsatisfactory in many ways and I'm not sure it can be fixed. Maybe it can, but that's not at all clear to me. In any case, in my opinion the people who have strong, knee-jerk reactions whenever someone challenges the standard model in use today are the ones standing in the way of progress. It's fine to respond academically, a contest between the old and the new is exactly what we need to have, but the debate needs to be over ideas rather than an attack on the people issuing the challenges.
This post of an email from Mark Gertler in July 2009 argues that modern macro has been mis-characterized:
The current crisis has naturally led to scrutiny of the economics profession. The intensity of this scrutiny ratcheted up a notch with the Economist’s interesting cover story this week on the state of academic economics.
I think some of the criticism has been fair. The Great Moderation gave many in the profession the false sense that we had handled the problem of the business cycle as well as we could. Traditional applied macroeconomic research on booms and busts and macroeconomic policy fell into something of a second class status within the field in favor of more exotic topics.
At the same time, from the discussion thus far, I don’t think the public is getting the full picture of what has been going on in the profession. From my vantage, there has been lots of high quality “middle ground” modern macroeconomic research that has been relevant to understanding and addressing the current crisis.
Here I think, though, that both the mainstream media and the blogosphere have been confusing a failure to anticipate the crisis with a failure to have the research available to comprehend it. Predicting the crisis would have required foreseeing the risks posed by the shadow banking system, which were missed not only by academic economists, but by just about everyone else on the planet (including the ratings agencies!).
But once the crisis hit, broadly speaking, policy-makers at the Federal Reserve made use of academic research on financial crises to help diagnose the situation and design the policy response. Research on monetary and fiscal policy when the nominal interest is at the zero lower bound has also been relevant. Quantitative macro models that incorporate financial factors, which existed well before the crisis, are rapidly being updated in light of new insights from the unfolding of recent events. Work on fiscal policy, which admittedly had been somewhat dormant, is now proceeding at a rapid pace.
Bottom line: As happened in both the wake of the Great Depression and the Great Stagflation, economic research is responding. In this case, the time lag will be much shorter given the existing base of work to build on. Revealed preference confirms that we still have something useful to offer: Demand for our services by the ultimate consumers of modern applied macro research – policy makers and staff at central banks – seems to be higher than ever.
Henry and Lucy Moses Professor of Economics
New York University
[I ... also posted a link to his Mini-Course, "Incorporating Financial Factors Within Macroeconomic Modelling and Policy Analysis"... This course looks at recent work on integrating financial factors into macro modeling, and is a partial rebuttal to the assertion above that New Keynesian models do not have mechanisms built into them that can explain the financial crisis. ...]
Again, it wasn't the tools and techniques we use, we were asking the wrong questions. As I've argued many times, we were trying to explain normal times, the Great Moderation. Many (e.g. Lucas) thought the problem of depressions due to, say, a breakdown in the financial sector had been solved, so why waste time on those questions? Stabilization policy was passé, and we should focus on growth instead. So, I would agree with Simon Wren-Lewis that "we need to recognise the political environment at the time." But as I argued in The Economist, we also have to think about the sociology within the profession that worked against the pursuit of these ideas.
Perhaps Ricardo Cabellero says it better, so let me turn it over to him. From a post in late 2010:
Caballero says "we should be in “broad-exploration” mode." I can hardly disagree since that's what I meant when I said "While I think we should see if the current models and tools can be amended appropriately to capture financial crises such as the one we just had, I am not as sure as [Bernanke] is that this will be successful and I'd like to see [more] openness within the profession to a simultaneous investigation of alternatives."
Here's a bit more from the introduction to the paper:
The recent financial crisis has damaged the reputation of macroeconomics, largely for its inability to predict the impending financial and economic crisis. To be honest, this inability to predict does not concern me much. It is almost tautological that severe crises are essentially unpredictable, for otherwise they would not cause such a high degree of distress... What does concern me of my discipline, however, is that its current core—by which I mainly mean the so-called dynamic stochastic general equilibrium approach has become so mesmerized with its own internal logic that it has begun to confuse the precision it has achieved about its own world with the precision that it has about the real one. ...
To be fair to our field, an enormous amount of work at the intersection of macroeconomics and corporate finance has been chasing many of the issues that played a central role during the current crisis, including liquidity evaporation, collateral shortages, bubbles, crises, panics, fire sales, risk-shifting, contagion, and the like.1 However, much of this literature belongs to the periphery of macroeconomics rather than to its core. Is the solution then to replace the current core for the periphery? I am tempted—but I think this would address only some of our problems. The dynamic stochastic general equilibrium strategy is so attractive, and even plain addictive, because it allows one to generate impulse responses that can be fully described in terms of seemingly scientific statements. The model is an irresistible snake-charmer. In contrast, the periphery is not nearly as ambitious, and it provides mostly qualitative insights. So we are left with the tension between a type of answer to which we aspire but that has limited connection with reality (the core) and more sensible but incomplete answers (the periphery).
This distinction between core and periphery is not a matter of freshwater versus saltwater economics. Both the real business cycle approach and its New Keynesian counterpart belong to the core. ...
I cannot be sure that shifting resources from the current core to the periphery and focusing on the effects of (very) limited knowledge on our modeling strategy and on the actions of the economic agents we are supposed to model is the best next step. However, I am almost certain that if the goal of macroeconomics is to provide formal frameworks to address real economic problems rather than purely literature-driven ones, we better start trying something new rather soon. The alternative of segmenting, with academic macroeconomics playing its internal games and leaving the real world problems mostly to informal commentators and "policy" discussions, is not very attractive either, for the latter often suffer from an even deeper pretense-of-knowledge syndrome than do academic macroeconomists. ...
My main message is that yes, we need to push the DSGE structure as far as we can and see if it can be satisfactorily amended. Ask the right questions, and use the tools and techniques associated with modern macro to build the right models. But it's not at all clear that the DSGE methodology is up to the task, so let's not close our eyes -- or worse actively block -- the search for alternative theoretical structures.
Posted by Mark Thoma on Wednesday, July 11, 2012 at 09:18 AM in Economics, Macroeconomics, Methodology |
Pay for Oppression: Do Workers in Fairer or Safer Jobs Make Less Money?, econospeak: The debate over worker rights on the job has taken an interesting turn with Tyler Cowen’s defense of the compensating wage differential argument. This, for those who have not run into it before, says that workers, whether through bargaining or the labor market, get a certain amount of utility. They can take that utility in money or in better working conditions, but the sum has to add up the same. This means that workers in safe jobs, all other things being equal, will make less than workers in dangerous ones; workers subject to bosses’ sexual advances will make more than those in more respectful organizations; and so on. There are four conclusions you would draw from this if it were true:
1. Dangerous or demeaning work is not a problem per se. The workers in those jobs are just as well off as they would be in a better setting. Don’t worry about them.
2. Employers have a financial incentive to make jobs better—safer, fairer, etc. That way they have to shell out less cash. In fact, they have just the right incentive, the amount of money workers are willing to give up in order to get better treatment.
3. Regulation can’t make anything better, but it can make things worse by taking away an option that would otherwise be available to workers. Some workers would rather have the money and put up with the dangers and indignities of a crummy workplace.
4. You can measure the monetary value of such intangibles as the value of life, the value of not being harassed, of being able to pee when you want, etc. It’s simply the difference in wages between jobs that offer more versus less, scaled by how much change in risk, harassment or whatever the worker is being compensated for.
Now it happens that this is a topic I know something about. In fact, I wrote the book on it. (OK, a book.) For the full story, read the book. Here I will make a few brief comments about the evidence.
I agree that fringe benefits that are essentially monetary in character, such as pensions and insurance, are subject to this sort of process. Workers really do trade money in one form for money in another, and unions bargain explicitly over this. It is also true that public insurance, like workers comp, is largely financed out of wages too, no matter how the laws are written.
It is not true that nonmonetary costs and benefits of work are compensated—not fully at any rate, and sometimes not at all. For an empirical demonstration, see this old study I wrote with Paul Hagstrom that has, to my knowledge, never been rebutted. Tyler links to a slightly less old Viscusi/Aldy lit review that cherry-picks shamelessly, not only in its selection of what counts as a valid study, but (especially) in which results of the authors they choose to report.
For those who don’t want to go to the sources, here are the two fundamental empirical problems with studies that claim to show wage compensation for things like occupational safety: (1) They use industry-based measures of which jobs are risky, but they ignore all the other industry-level determinants of wages, like concentration, capital intensity and percent unionized (usually). (2) They show signs of potential publication bias, where specifications are selected that yield the “right” result. What signs? They don’t provide summary data on the full range of specifications tested (“taking the con out of econometrics”), so that the reader can determine whether the reported specifications are outliers or not, and the results are hardly ever tested on subsamples. Think for a moment about this last point: if there are compensating wage differentials for women exposed to sexual harassment, this should apply to black women and white women, unionized women and nonunion women, women in blue collar jobs, white collar and pink collar, and other plausible breakouts. If not, you would need to have a story to explain why some get it and not others. (Or why some subsamples even have exacerbating differentials, which I found with occupational safety—the “sweatshop effect”.) There is a small literature on subsamples in wage-risk regressions, and they are all over the map.
Note that the Joni Hersch study Tyler links to is vulnerable on all these counts. It doesn’t consider interindustry differentials. There is only one specification reported. No subsamples. Not convincing.
The bottom line is that skeptics have every reason to remain skeptical. Actually, a world of compensating wage differentials would be better than the one we live in. Some jobs are unavoidably difficult, dangerous or unpleasant, and they should pay more. But there are also human rights, like freedom from abuse and freedom of expression, that shouldn’t be for sale, even when you’re on the clock.
Posted by Mark Thoma on Wednesday, July 11, 2012 at 07:29 AM in Economics |
Back to the troubles in Europe:
Europe’s Divided Visionaries, by Barry Eichengreen, Commentary, Project Syndicate: ...Europe’s leaders now agree on a vision of what the EU should become: an economic and monetary union complemented by a banking union, a fiscal union, and a political union. ...
Vision aplenty. The problem is that there are two diametrically opposed approaches to implementing it. One strategy assumes that Europe ... cannot wait to inject capital into the banks. It must take immediate steps toward debt mutualization. It needs either the ECB or an expanded European Stability Mechanism to purchase distressed governments’ bonds today.
Over time, according to this view, Europe could build the institutions needed to complement these policies. ... The other view is that to proceed with the new policies before the new institutions are in place would be reckless. ...
Europe has been here before – in the 1990’s, when the decision was taken to establish the euro. At that time, there were two schools of thought. One camp argued that it would be reckless to create a monetary union before economic policies had converged and institutional reforms were complete.
The other school, by contrast, worried that the existing monetary system was rigid, brittle, and prone to crisis. ... At the slight risk of overgeneralization, one can say that the first camp was made up mainly of northern Europeans, while the second was dominated by the south.
The 1992 exchange-rate crisis then tipped the balance. Once Europe’s exchange-rate system blew up, the southerners’ argument that Europe could not afford to postpone creating the euro carried the day.
The consequences have not been happy. Monetary union without banking, fiscal, and political union has been a disaster. But not proceeding would also have been a disaster. The 1992 crisis proved that the existing system was unstable. ...
Not proceeding now with bank recapitalization and government bond purchases would similarly lead to disaster. Europe thus finds itself in a familiar bind. The only way out is to accelerate the institution-building process significantly. Doing so will not be easy. But disaster does not wait.
Posted by Mark Thoma on Wednesday, July 11, 2012 at 07:11 AM in Economics, Financial System |
Floor time in Congress is scarce and valuable. So why is are House Republicans wasting time with a bill they know will be vetoed when there are much bigger problems to address, the unemployment crisis for example? You'd think that politics is more important than the struggles of the unemployed:
House GOP set for health care law repeal vote, but offering no alternatives, CBS News: House Republicans generally avoided talk of replacement measures on Tuesday as they mobilized for an election-season vote to repeal the health care law that stands as President Barack Obama's signature domestic accomplishment. ... [T]he repeal vote ... will lead to nothing as the Democratic Senate won't consider it, and even if the House and Senate somehow agreed to repeal the law, Mr. Obama has the ultimate say with his veto pen. ...
I understand what's going on, but it's still disappointing to see the unemployed fall by the wayside.
Posted by Mark Thoma on Wednesday, July 11, 2012 at 06:39 AM in Economics, Health Care, Unemployment |
A puzzle from the NY Fed. Why do stock returns begin to rise prior to FOMC announcements? That is, "equity valuations tend to rise in the afternoon of the day before FOMC announcements and rise even more sharply on the morning of FOMC announcement days." The rise is substantial, enough to account for 80% of the equity premium puzzle. Thus, just before FOMC meetings investors seem, on average, to expect that the Fed will raise equity values. Is this related to (expectation of) the "Greenspan/Bernanke put?" Or is something else at work?:
The Puzzling Pre-FOMC Announcement “Drift”, by David Lucca and Emanuel Moench, Liberty Street Economics: For many years, economists have struggled to explain the “equity premium puzzle”—the fact that the average return on stocks is larger than what would be expected to compensate for their riskiness. In this post, which draws on our recent New York Fed staff report, we deepen the puzzle further. We show that since 1994, more than 80 percent of the equity premium on U.S. stocks has been earned over the twenty-four hours preceding scheduled Federal Open Market Committee (FOMC) announcements (which occur only eight times a year)—a phenomenon we call the pre-FOMC announcement “drift.”
The equity premium is usually measured as the difference between the average return on the stock market and the yield on short-term government bonds. Previous research on the size of the premium finds that it is too large for plausible levels of risk aversion (see Mehra  for a review).
The Drift: A First Take
The pre-FOMC announcement drift is best summarized in the chart below, which provides two main takeaways:
- Since 1994, there has been a large and statistically significant excess return on equities on days of scheduled FOMC announcements.
- This return is earned ahead of the announcement, so it is not related to the immediate realization of monetary policy actions.
The chart shows average cumulative returns on the S&P 500 stock market index over different three-day windows. The solid black line displays the average cumulative return starting at the market’s opening on the day before each scheduled FOMC announcement to the market’s close on the day after each announcement. Our sample period starts in 1994, when the Federal Reserve began announcing its target for the federal funds rate regularly at around 2:15 p.m., and ends in 2011. (For a list of announcement dates, see the FOMC calendars.) The shaded blue area displays the 95 percent confidence intervals around the average cumulative returns—a measure of statistical uncertainty around the average return. We see from the chart that equity valuations tend to rise in the afternoon of the day before FOMC announcements and rise even more sharply on the morning of FOMC announcement days. The vertical red line indicates 2:15 p.m. Eastern time (ET), which is when the FOMC statement is typically released. Following the announcement, equity prices may fluctuate widely, but on balance, they end the day at about their 2 p.m. level, 50 basis points higher than when the market opened on the day before the FOMC announcement.
How do these returns compare with returns on all other days over the sample period? The dashed black line, which represents the average cumulative return over all other three-day windows, shows that returns hover around zero. This implies that since 1994, returns are essentially flat if the three-day windows around scheduled FOMC announcement days are excluded.
A Deeper Look through Regression Analysis
The previous chart showed stock returns without accounting for dividends or the return on riskless alternative investments. In the table below, we account for these factors in a regression analysis by considering the return, including dividends (in percent), on the S&P 500 index in excess of the daily yield on a one-month Treasury bill rate, which is a measure of a risk-free rate. We regress this “excess return” on a constant and on a “dummy” variable, equal to 1 on days of FOMC announcements.
The coefficient on the constant (second row) measures the average return on non-FOMC days, while the coefficient on the FOMC dummy (top row) is the differential mean return on FOMC days. In the first column, we regress close-to-close stock returns and see that excess returns on FOMC days average about 33 basis points, compared with an average excess return of about 1 basis point on all other days. As seen in the previous chart, this return is essentially earned ahead of the announcement—hence our label of a pre-FOMC announcement drift. Indeed, in the third column we see a return of about 49 basis points during a 2 p.m.-to-2 p.m. window, while the FOMC releases its statement at 2:15 p.m. ET. In the second column, we repeat the regression using the close-to-close returns from 1970 to 1993, which is prior to when the Fed released its policy decisions right after each meeting, and see that essentially no such premium exists. The bottom rows of the table decompose the annual excess return of the S&P 500 index over Treasury bills on the return earned on FOMC days and the return earned on all other days. As shown in the third column, the return on the twenty-four-hour period ahead of the FOMC announcement cumulated to about 3.9 percent per year, compared with only about 90 basis points on all other days. In other words, more than 80 percent of the annual equity premium has been earned over the twenty-four hours preceding scheduled FOMC announcements, which occur only eight times per year.
The chart below visualizes this return decomposition. It shows the S&P 500 index level along with an S&P 500 index that one would have obtained when excluding from the sample returns on all 2 p.m.-to-2 p.m. windows ahead of scheduled FOMC announcements. In a nutshell, the figure shows that in the sample period the bulk of the rise in U.S. stock prices has been earned in the twenty-four hours preceding scheduled U.S. monetary policy announcements.
An International Perspective
Does this striking result apply only to U.S. stocks? While we do not find similar responses of major international stock indexes ahead of their respective central bank monetary policy announcements, we observe that several indexes do display a pre-FOMC announcement drift, as the chart below shows. Cumulative returns rise for the British FTSE 100, German DAX, French CAC 40, Swiss SMI, Spanish IBEX, and Canadian TSE index when each exchange is open for trading over windows of time around each FOMC announcement in our sample.
One might expect similar patterns to be evident also in other major asset classes, such as short-and long-term fixed-income instruments and exchange rates. Surprisingly, though, we don’t find any differential returns for these assets on FOMC days compared with other days. In other words, the pre-FOMC drift is restricted to equities. Further, we don’t find analogous drifts ahead of other macroeconomic news releases, such as the employment report, GDP and initial claims, among many others. The effect is therefore restricted to FOMC, rather than other macroeconomic, announcements. In the Staff Report, we attempt to account for standard measures considered in the economic literature that proxy for different sources of risk, such as volatility and liquidity, but they also fail to explain the return. Finally, we consider alternative theories that feature political risk, investors with capacity constraints in processing information, as well as models where stock market participation varies over time. Although these theories can help qualitatively explain the existence of a price drift ahead of FOMC announcements, they are counterfactual in some dimension of the empirical evidence.
Our findings suggest that the pre-FOMC announcement drift may be key to understanding the equity premium puzzle since 1994. However, at this point, the drift remains a puzzle.
Posted by Mark Thoma on Wednesday, July 11, 2012 at 05:04 AM in Economics, Monetary Policy |
Posted by Mark Thoma on Wednesday, July 11, 2012 at 12:06 AM in Economics, Links |
Careful With That HP Filter, by Tim Duy: reads Marcus Nunes' David Glasner's review of Stephen Williamson and concludes:
Marcus Nunes, I think properly, concludes that Williamson’s graph is wrong, because Williamson ignores the fact that there was a rising trend of NGDP during the 1970s, while during the Great Moderation, NGDP was stationary... Furthermore, Scott Sumner questions whether the application of the Hodrick-Prescott filter to the entire 1947-2011 period was appropriate, given the collapse of NGDP after 2008, thereby distorting estimates of the trend…
Williamson is here, Sumner's reply is here. DeLong jogged my memory that this topic is trapped in my computer, and this seems a good time to get it out of there.
First off, I am very cautious about mixing pre- and post-1985 data because of the impact of the Great Moderation on business cylce dynamics. This applies to Jim Hamilton's reply to my thoughts about the positive impact from housing. Hamilton points out that prior to the Great Moderation, housing would make significant contributions to GDP growth as the economy jumped back to trend. True enough; Hamilton might prove correct. But I would add that large contributions prior to 1985 would typically come in the early stages of the business cycle. I don't think the same kinds of cycles are currently at play, and that it is a little late to be expecting a V-shaped boost from housing.
As to the issue of the HP filter, this was on my radar because St. Louis Federal Reserve President James Bullard likes to rely on this technique to support his claim that the US economy is operating near potential. As he said today:
The housing bubble and the ensuing financial crisis probably did some lasting damage to the economy, suggesting that the output gap in the U.S. is not as large as commonly believed and that the growth rate of potential output is modest. This helps explain why U.S. growth continues to be sluggish, why U.S. inflation has remained close to target instead of dropping precipitously and why U.S. unemployment has fallen over the last year—from a level of 9.1 percent in June 2011 to 8.2 percent in June 2012.
I think there is more wrong than right in these two sentences. I don't see how a slower rate of potential growth necessarily implies lower actual growth in the short run. Clearly we have many instances of both above and below trend growth over the years. The failure of inflation to fall further can easily be explained by nominal wage rigidities. And the drop in the unemployment rate, in itself not impressive, should be taken in context with the stagnation of the labor force participation rate.
Bullard likes to rely on this chart as support:
For some reason, Bullard rejects entirely CBO estimates of potential output, which would reveal a smaller output gap then his linear trend decomposition. My version of this chart:
To deal with the endpoint problem, I used a GDP forecast from an ARIMA(1,1,1) model to extend the data beyond 2012:1. If you don't deal with the endpoint problem, you get this:
I believe most people would believe this result (that output is solidly above potential) to be a nonsensical. By itself, the issue of dealing with the endpoint problem should raise red flags about using the HP filter to draw policy conclusions about recent economic dynamics.
Relatedly, notice that the HP filter reveals a period of substantial above trend growth through the middle of 2008. This should be a red flag for Bullard. If he wants to argue that steady inflation now implies that growth is close to potential, he needs to explain why inflation wasn't skyrocketing in 2005. Or 2006. Or 2007. Most importantly, we should have seen the rise in headline inflation confirmed by core-inflation. The record:
Core-inflation remained remarkably well-behave for an economy operating so far above potential, don't you think?
At issue is the tendency of the HP filter to generate revisionist history. Consider the view of the world using data through 2007:4:
Suddenly, the output gap disappears almost entirely in 2005. And 2006. And 2007. Which is much more consistent with the inflation story during that period.
Bottom Line: Use the HP filter with great caution, especially around large shocks. Such shocks will distort your estimates of the underlying trends, both before and after the shock.
Posted by Mark Thoma on Tuesday, July 10, 2012 at 12:42 PM in Econometrics, Economics, Methodology |
This Economic Policy Paper is from the June 2012 issue of the Minneapolis Fed's The Region. It examines how inequality changed during the Great Recession, and illustrates the value of government intervention (i.e. social insurance) to households in the bottom 20% of the income distribution (though keep this in mind):
Inequality and Redistribution during the Great Recession, by Fabrizio Perri - Consultant, and Joe Steinberg - Research Analyst: Introduction Although there is little doubt that the Great Recession constituted a watershed for overall business cycle dynamics in the United States, the jury is still out on its distributional consequences. Did economic inequality change significantly during the recession? If so, which dimensions—income earnings, wealth and consumption—saw the largest changes? And what impact did government policies, such as taxes and transfer programs, have over this time period on both inequality and economic well-being?
Analyses focused on the first two years of the downturn seem to find no increase in economic inequality; indeed, some report a decline. For example, a recent comprehensive volume (Jenkins et al. 2011) that analyzes income distribution in 21 Organisation for Economic Co-operation and Development (OECD) countries (including the United States) across the Great Recession sees “little change in household income distributions in the two years following the downturn.” Heathcote et al. (2010b) and Petev et al. (2011) study inequality in consumption expenditures in the United States up until 2009 and also find little change (if anything, they find a decline).
A longer-term view, however, suggests that high levels of unemployment and the large drop in housing prices, both of which started during the Great Recession but persisted well after, might have had longer-term adverse distributional consequences. In particular, the recession may have left a significant fraction of the U.S. population with very little wealth (due to the fall in asset prices) and poor labor market prospects (due to high unemployment).
The goal of this paper is to paint a more complete picture of the distributional impact of the Great Recession, including more recent data from 2010 and part of 2011. Most importantly, this paper considers inequality in a wide array of variables, such as earnings, disposable income, consumption expenditures and wealth, and looks at inequality for all of these variables at different sections of the economic distribution.
Our first finding is that during and after the Great Recession, the bottom of the U.S. earnings distribution has fallen dramatically. This is the result of historically high unemployment and nonparticipation. In terms of earnings, the bottom 20 percent of the U.S. population has never done so poorly, relative to the median, during the whole postwar period. We also show that this group experienced rapidly declining wealth.
Despite this, we find that inequality in disposable income and consumption did not increase at either the top or bottom of the distribution, confirming the findings of other studies. In other words, the same bottom 20 percent of the earnings distribution that fared so poorly during the Great Recession in terms of earnings and wealth is in pretty much the same relative position in terms of disposable income and consumption in 2010, after the recession officially ended, as it was in 2006, before the start of the recession.
Such a divergence of trends in earnings and disposable income at the bottom of the distribution is unprecedented in U.S. history, and we show that it is mainly due to government transfers and taxes, as opposed to private components of unearned income.
We conclude our study using panel analysis (i.e., following a specific set of households through time) to better assess the role of government taxes and transfers. This allows us to distinguish between the experience of a given section of the income distribution (e.g., the bottom 20 percent of the distribution, whose members change each period) and the experience of a fixed group of households (e.g., those households that were at the bottom 20 percent of the distribution in 2006 but whose position may have changed by 2010. If the “Smiths,” say, were in the bottom fifth in 2006, we use panel analysis to understand where the Smiths ended up later on).
Our main finding is that although the bottom 20 percent of the earnings distribution experienced constant disposable income or consumption expenditures despite earnings losses, individual households that face earnings losses and enter the bottom 20 percent group do suffer significant losses in disposable income and small losses in consumption.
Our main substantive conclusion is that government redistribution in the Great Recession was at historical highs and partially shielded households from experiencing large declines in disposable income and consumption expenditures. The same households, though, have experienced losses in net wealth, and this might make them more vulnerable to further or more persistent earnings declines in the future.
We believe our analysis provides useful data to inform the policy debate about whether or not, looking forward, the government should take a more aggressive role in providing assistance for households that experience earnings losses. ...
Posted by Mark Thoma on Tuesday, July 10, 2012 at 10:17 AM in Economics, Income Distribution, Social Insurance |