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December 12, 2007

Economist's View - 6 new articles

The Big Divide in Economics

Greg Mankiw:

How do the right and left differ?, by Greg Mankiw: The conclusion of today's ec 10 lecture: In today's lecture, I have discussed a number of reasons that right-leaning and left-leaning economists differ in their policy views, even though they share an intellectual framework for analysis. Here is a summary.

  • The right sees large deadweight losses associated with taxation and, therefore, is worried about the growth of government as a share in the economy. The left sees smaller elasticities of supply and demand and, therefore, is less worried about the distortionary effect of taxes.
  • The right sees externalities as an occasional market failure that calls for government intervention, but sees this as occasional exception to the general rule that markets lead to efficient allocations. The left sees externalities as more pervasive.
  • The right sees competition as a pervasive feature of the economy and market power as typically limited both in magnitude and duration. The left sees large corporations with substantial degrees of monopoly power that need to be checked by active antitrust policy.
  • The right sees people as largely rational, doing the best the can given the constraints they face. The left sees people making systematic errors and believe that it is the government role's to protect people from their own mistakes.
  • The right sees government as a terribly inefficient mechanism for allocating resources, subject to special-interest politics at best and rampant corruption at worst. The left sees government as the main institution that can counterbalance the effects of the all-too-powerful marketplace.
  • There is one last issue that divides the right and the left—perhaps the most important one. That concerns the issue of income distribution. Is the market-based distribution of income fair or unfair, and if unfair, what should the government do about it? That is such a big topic that I will devote the entire next lecture to it.

Quick reaction: I wouldn't agree with the fourth reason. I believe people are rational maximizers in the economic arena, or at least well-modeled that way, though problems such as limited or asymmetric information can confound choices. On the fifth, I would not term a competitive market-place as too powerful. It's non-competitive markets, e.g. monopolies, that are the worry. On the sixth, fair or unfair depends upon how well markets are functioning. If you do not believe that markets are competitive, or that opportunity is equal, then the intervention and redistribution may be correcting the outcome toward what a perfectly competitive, equal opportunity system would produce rather than away from it. It's not that we don't believe that competitive markets are fair, though I can only speak for myself, it's that we don't believe markets that deviate from perfect competition in important ways, i.e. have important market failures, produce outcomes that have defensible equity properties.

Getting Liquidity to the Choke Points

Recently, in a post titled Can Policymakers Keep Credit Markets from Freezing Up?, I said:

Getting liquidity to the choke points, many of which are outside the traditional banking system, is a tough problem for the Fed to solve since most of its tools operate within the traditional banking system. It has been creative, e.g. changing collateral rules so that banks could act as intermediaries between mortgage lenders and the discount window, but there are limits to what it can do within the existing regulatory structure.

The Fed has now taken another creative, and likely useful step in getting liquidity to the "choke points" outside the traditional banking system:

Fed Joins Other Banks in Measures To Inject More Funds Into Markets, by Greg IP, WSJ: The Federal Reserve has joined with four other major central banks to announce a series of measures designed to inject added cash into global money markets in hopes of thawing a credit freeze that threatens their economies.

The Fed said today it would create a new "term auction facility" under which it would lend at least $40 billion and potentially far more, in four separate auctions starting this week. The loans would be at rates far below the rate charged on direct loans from the Fed to banks from its so-called "discount window." But the new loans can still be secured by the same, broad variety of collateral available that banks pledge for discount window loans.

The European Central Bank, Bank of England, Bank of Canada and Swiss National Bank simultaneously announced parallel measures. "This is not about particular financial institutions with particular problems. It is about market functioning," said a senior Federal Reserve official...

The Fed also said it had created reciprocal "swap" lines with the European Central Bank, for $20 billion, and the Swiss National Bank, for $4 billion. These will enable the ECB and SNB to make dollar loans to banks in their jurisdiction, in hopes of putting downward pressure on interbank dollar rates in the offshore markets, principally the London Interbank Offered Rate, or Libor, market. The inability of foreign central banks to inject funds in anything other than their own currency has been a factor creating the squeeze on bank funding in those markets.

The Fed has worried that banks' growing reluctance to lend either to other financial institutions or to businesses and consumers could cause the flow of credit to dry up and drag the weak economy into recession. ...

The new loans will be auctioned off with a minimum rate linked to the expected actual federal funds rate over the duration of the loan. Since the federal funds rate is expected to decline over the next two months, when the loans will be outstanding, the loan rate could end up being close to or even below the current federal funds rate. ...

The Fed indicated that the new facility could become a permanent addition to its monetary policy toolkit. ...

It remains unclear whether the new operation will do the trick. But the early reaction was favorable: Treasury bond prices plunged and their yields shot up in early trading, a sign that investors are abandoning the relative safety of Treasurys and preparing to bid up riskier debt. Futures markets suggested stocks would rise at the opening.

I'm sure we'll hear the usual bailout and moral hazard objections, but this sounds like a good idea to me. Think of it this way, if the economy does go into a recession, it will be far more costly than the 40 billion the Fed plans to loan financial firms, and the costs will not be limited to those who bear responsibility for the problems, they will be widely felt. Thus, if this works, it will be money well spent.

Update: Steve Waldman at Interfluidity with his first reactions to the plan. [Apologies to Steve for the confusion on the name which has since been corrected.]

"In Your Face" Political Television and Democracy

How well do "in your face" type televised political debates inform viewers about the content and legitimacy of each sides views?:

The effect of 'in your face' political television on democracy, EurekAlert: Television can encourage awareness of political perspectives among Americans, but the incivility and close-up camera angles that characterize much of today's "in your face" televised political debate also causes audiences to react more emotionally and think of opposing views as less legitimate.

These findings come from a research project conducted by political scientist and communications scholar Diana C. Mutz (University of Pennsylvania) and published in the November issue of the American Political Science Review... The full article is available online.

Conflict is inherent in any democracy, but the legitimacy of democratic systems rests on the extent to which each side in any controversy perceives the opposition as having some reasonable foundation for its position. Mutz's research investigates two key questions. First, does televised political discourse familiarize viewers with political perspectives they disagree with? Second, if so, do viewers perceive such oppositional views as more legitimate after seeing them hashed out on television?

The research involved three distinct experiments and a laboratory setting that presented adult subjects with televised political debate including professional actors, a professional studio talk show set, a political discussion between two purported congressional candidates, and a moderator. All participants saw the exact same exchange of political arguments, but some viewed these arguments presented in a civil and polite tone, whereas others saw an uncivil exchange that resembled so-called "shout show" political conversations. In addition, some saw the exchange of political views from a close-up camera angle, whereas others saw the same event from a more distant camera perspective. Key findings include:

  • Uncivil exchanges of political views featuring tight close-up shots generated the strongest emotional reactions from viewers and the most attention.
  • Viewer recall of arguments was enhanced by incivility and close-up camera perspectives.
  • Watching the political television programs improved people's awareness of issue arguments, regardless of whether viewers watched civil, uncivil, close-up, or medium camera perspectives.
  • Incivility affected audience perspectives most significantly when shown in an up-close camera perspective.
  • The uncivil expression of views reinforced the viewers' tendency to de-legitimize oppositional views, while the civil expression of the same views enhanced their perceived legitimacy.

"Televised political discourse would seem to be in the service of a deliberative body politic," observes Mutz, as "any exposure is better than nothing at all." But she concludes by noting that "when uncivil discourse and close-up camera perspectives combine to produce the unique 'in-your-face' perspective, then the high levels or arousal and attention come at the cost of lowering regard for the other side…[discouraging] the kind of mutual respect that might sustain perceptions of a legitimate opposition." When people experience politicians with whom they disagree from the uniquely intimate perspective of television, their dislike for them only intensifies. This makes it more difficult for the winner in any given context to acquire the respect of the opposition that is often necessary for governing.

If I am the director of a television program featuring political debates on a network interested in promoting the views of one side over the other, I could probably use this information to my advantage - e.g., lots of baiting of the other side, and lots of close-up camera shots whenever the other side displays incivility in response.

Alan Greenspan: The Roots of the Mortgage Crisis (or, It Wasn't My Fault)

Alan Greenspan defends monetary policy during his reign as Chair of the Fed. He says the Fed's low interest rates did not play a major role in creating the subprime crisis, instead, factors such as the fall of the Berlin Wall were much more important:

The Roots of the Mortgage Crisis, by Alan Greenspan, Commentary, WSJ [Free Link]: On Aug. 9, 2007, and the days immediately following, financial markets in much of the world seized up. ... Over the past five years, risk had become increasingly underpriced as market euphoria, fostered by an unprecedented global growth rate, gained cumulative traction.

The crisis was thus an accident waiting to happen. If it had not been triggered by the mispricing of securitized subprime mortgages, it would have been produced by eruptions in some other market. As I have noted elsewhere, history has not dealt kindly with protracted periods of low risk premiums.

The root of the current crisis, as I see it, lies back in the aftermath of the Cold War, when the economic ruin of the Soviet Bloc was exposed with the fall of the Berlin Wall. Following these world-shaking events, market capitalism quietly, but rapidly, displaced much of the discredited central planning that was so prevalent in the Third World.

A large segment of the erstwhile Third World, especially China, replicated the successful economic export-oriented model of the so-called Asian Tigers ... to unleash explosive economic growth. ...

The surge in competitive, low-priced exports from developing countries ... flattened labor compensation in developed countries, and reduced the rate of inflation expectations..., including those inflation expectations embedded in global long-term interest rates.

In addition, there has been a pronounced fall in global real interest rates since the early 1990s, which, of necessity, indicated that global saving intentions chronically had exceeded intentions to invest. ... Asset prices accordingly moved dramatically higher. Not only did global share prices recover from the dot-com crash, they moved ever upward. ...

After more than a half-century observing numerous price bubbles evolve and deflate, I have reluctantly concluded that bubbles cannot be safely defused by monetary policy or other policy initiatives before the speculative fever breaks on its own. There was clearly little the world's central banks could do to temper this most recent surge in human euphoria...

I do not doubt that a low U.S. federal-funds rate in response to the dot-com crash, and especially the 1% rate set in mid-2003 to counter potential deflation, ... may have contributed to the rise in U.S. home prices. In my judgment, however, the impact on demand for homes financed with ARMs was not major.

Demand in those days was driven by the expectation of rising prices -- the dynamic that fuels most asset-price bubbles. If low adjustable-rate financing had not been available, most of the demand would have been financed with fixed rate, long-term mortgages. ...

I and my colleagues at the Fed believed that the potential threat of corrosive deflation in 2003 was real, even though deflation was not thought to be the most likely projection. We will never know whether the temporary 1% federal-funds rate fended off a deflationary crisis, potentially much more daunting than the current one. But I did fret that maintaining rates too low for too long was problematic. The failure of either the growth of the monetary base, or of M2, to exceed 5% while the fed-funds rate was 1% assuaged my concern that we had added inflationary tinder to the economy.

In mid-2004, as the economy firmed, the Federal Reserve started to reverse the easy monetary policy. I had expected ... a consequent increase in long-term interest rates, which might have helped to dampen the then mounting U.S. housing price surge. It did not happen. We had presumed long-term rates, including mortgage rates, would rise, as had been the case at the beginnings of five previous monetary policy tightening episodes, dating back to 1980. But after an initial surge in the spring of 2004, long-term rates fell back and, despite progressive Federal Reserve tightening through 2005, long-term rates barely moved.

In retrospect, global economic forces, which have been building for decades, appear to have gained effective control of the pricing of longer debt maturities. Simple correlations between short- and long-term interest rates in the U.S. remain significant, but have been declining for over a half-century... More generally, global forces, combined with lower international trade barriers, have diminished the scope of national governments to affect the paths of their economies.

Although central banks appear to have lost control of longer term interest rates, they continue to be dominant in the markets for assets with shorter maturities, where money and near monies are created. Thus central banks retain their ability to contain pressures on the prices of goods and services, that is, on the conventional measures of inflation.

The current credit crisis will come to an end when the overhang of inventories of newly built homes is largely liquidated, and home price deflation comes to an end. ... Very large losses will, no doubt, be taken as a consequence of the crisis. But after a period of protracted adjustment, the U.S. economy, and the world economy more generally, will be able to get back to business.

I don't think Bernanke would fully agree that the Fed has lost control of long-term rates:

Globalization and Monetary Policy, by Ben Bernanke: ...The empirical literature supports the view that U.S. monetary policy retains its ability to influence longer-term rates and other asset prices. Indeed, research on U.S. bond yields across the whole spectrum of maturities finds that all yields respond significantly to unanticipated changes in the Fed's short-term interest-rate target and that the size and pattern of these responses has not changed much over time (Kuttner, 2001; Andersen and others, 2005; and Faust and others, 2006). Empirical studies also find that U.S. monetary policy actions retain a powerful effect on domestic stock prices. ...

I draw two conclusions... First, the globalization of financial markets has not materially reduced the ability of the Federal Reserve to influence financial conditions in the United States. But, second, globalization has added a dimension of complexity to the analysis of financial conditions and their determinants, which monetary policy makers must take into account.

The Fed did what it needed to do in 2003 to keep the economy moving forward, but that doesn't mean the policy could not have been improved. In any case, the policy, however necessary, had subsequent consequences that Greenspan seems unwilling to take responsibility for. In addition, the role that his laissez faire attitude may have had in blocking regulatory interventions that might have prevented or attenuated the crisis is conveniently omitted from the story Greenspan tells. Was the crisis his fault? I wouldn't go that far. Could he have done more to prevent it or reduce its severity? Here I think the answer is yes.

Update: The WSJ's Economics blog summarizes reaction to Greenspan's column.

It's *Not* Social Security

This is from Peter Orszag, Director of the CBO:

The Biggest Budget Buster, by Peter Orszag, Commentary, WSJ: The nation's economic outlook may look troubling in the short run, but these difficulties pale beside the economic consequences that will follow if we don't address the nation's long-term fiscal gap...

The fiscal gap does not arise, as many believe, primarily from the coming retirement of the baby boomers. Rather, the rate at which health-care costs grow will be the primary determinant of the nation's long-term budget picture. ...

The bottom line is that while we need to address the effects of the coming retirement of the baby boomers and the projected imbalance in Social Security, we have to pay even more attention to the health-care costs that exert the dominant influence on our fiscal future. ...

Over long periods, the cost growth per beneficiary in the Medicare and Medicaid programs has tracked cost trends in private-sector health-care markets. As a result, many analysts believe that significantly constraining the growth of costs for the public programs while maintaining broad access to hospitals and doctors under them will be possible only in conjunction with slowing cost growth in the health sector as a whole. ...

But it's too soon to conclude that the fiscal picture is hopelessly dismal. There remains the promising possibility of restraining health-care costs without incurring adverse health consequences. It may even be possible in some cases to reduce cost growth and improve health at the same time. Costs per beneficiary in Medicare, for example, vary substantially across the U.S. for reasons that cannot be explained fully by the characteristics of the patients or price levels in different areas.

High-spending regions do not generate better health outcomes, on average, than the lower-spending ones. ... Some academic research suggests that national costs for health care can be reduced by perhaps 30% without harming quality. ...

Here's a graph and accompanying report.

links for 2007-12-12

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