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April 24, 2009

Economist's View - 5 new articles

Fed Watch: TALF Disappointment and the Fed's Balance Sheet

Tim Duy says the Fed is likely to step up its purchases of long-term sucurities:

TALF Disappointment and the Fed's Balance Sheet, by Tim Duy: Mark Thoma directs us to a Washington Post article detailing the slow start-up of the Federal Reserve's much discussed but little used TALF program. At this juncture, a critical constraint appears to be counterparty risk - no one trusts the US government to hold parties to their contractual obligations:

Sources involved in the program said private investors have been reluctant to work with the government, which they view as an unreliable business partner. ... There are restrictions on the business activities of participants in the program. ... But perhaps more significant ... is a fear that the government could retroactively change the terms, exacting new limits on what investors can pay their executives, for example, or trying to claw back profits that firms make in the program. ...

Perhaps TALF will gain traction in the months ahead. For now, however, I imagine that no amount of lipstick is able to conceal what must be official disappointment with the program. The question on my mind is will slow take up on TALF induce the Federal Reserve to step up its purchases of mortgage assets and longer term Treasuries. From the last Fed minutes:

Members expressed a range of views as to the preferred size of the increase in purchases. Several members felt that the significant deterioration in the economic outlook merited a very substantial increase in purchases of longer-term assets. In contrast, the potential for a large increase over time in the size of the balance sheet from the TALF program was seen as supporting a more modest, though still substantial, increase in asset purchases.

It looks like the expected success of TALF was a reason for moderating the size of the balance sheet expansion via longer term assets. It would stand to reason, all else equal, that TALF's slow start would trigger the Fed to step up purchases of other assets.

Also, one would think the Fed would take note that expanding their purchases of longer term assets has been a relatively successful policy, especially if the goal was to pull mortgage and Treasury rates lower. To be sure, the ultimate impact on spending in the near term is likely to be muted - the benefits of lower mortgage rates are limited to households that are not credit impaired or underwater on their homes, and we are not likely to see much equity withdrawal this time around. But lower rates are triggering a wave of refinancings, which will lessen the cash drain of maintaining household balance sheets, and free up some additional spending power. Overall, however, the Fed will be wary that the benefits of their last policy expansion will wane if Treasury rates pull above 3%, and thus will be induced to expand purchases of those assets, trying to offset the impact of the massive supply issuing forth from Treasury.

It is interesting that a relatively simply policy - one that does not require and army of lawyers and financial managers - has been much more successful and quick to execute than the exceedingly complex TALF program. If policymakers were not so blinded by the fetish of finance, they would see this as an example of the time honored KISS principle.

Another policy change to be watching for - when will the Fed commit to a quantitative goal for a sustained rate of expansion in the balance sheet? From Federal Reserve Vice-Chair Donald Kohn:

In gauging the effects of market interventions in the current crisis, one approach is to look to the size of increases in the quantity of reserves and money to judge whether sufficient liquidity is being provided to forestall deflation and support a turnaround in growth--an approach often known as quantitative easing. The linkages between reserves and money and between either reserves or money and nominal spending are highly variable and not especially reliable under normal circumstances. And the relationships among these variables become even more tenuous when so many short-term interest rates are pinned near zero and monetary and some nonmonetary assets are near-perfect substitutes. In our approach to policy, the amount of reserves has been a result of our market interventions rather than a goal in itself. And, depending on the circumstances, declines in reserves may indicate that markets are improving, not that policy is effectively tightening or failing to lean against weaker demand. Still, we on the Federal Open Market Committee (FOMC) recognize that high levels of Federal Reserve assets and resulting reserves are likely to be essential to fostering recovery, and we have discussed whether some explicit objectives for growth in the size of our balance sheet or for the quantity of the monetary base or reserves would provide some assurance that policy is pointed in the right direction.

What conditions could force the Fed from "credit" easing to "quantitative" easing, the latter being explicit policy guides for monetary expansion? The Fed could seek to force a firmer lid on longer-term Treasury rates. Another is that the Fed believes that setting a quantitative target is necessary to keep inflation expectations anchored in the face of the deflationary potential of persistently wide output gaps. Alternatively, the Fed could choose to forgo quantitative targets as they evaluate the durability of the green shoots emerging from the economic wasteland.

Bottom line: The challenges of setting in motion the complex TALF program suggests that the Fed will step up purchases of longer term Treasuries. The next policy line to cross is the formation of explicit policy objectives for the growth of a monetary aggregate. I would be looking for language in Fedspeak that points in that direction.

Paul Krugman: Reclaiming America's Soul

We need to "regain our moral compass":

Reclaiming America's Soul, by Paul Krugman, Commentary, NY Times: "Nothing will be gained by spending our time and energy laying blame for the past." So declared President Obama, after his commendable decision to release the legal memos that his predecessor used to justify torture. Some people in the political and media establishments have echoed his position. We need to look forward, not backward, they say. No prosecutions, please; no investigations; we're just too busy.

And there are indeed immense challenges out there: an economic crisis, a health care crisis, an environmental crisis. Isn't revisiting the abuses of the last eight years, no matter how bad they were, a luxury we can't afford?

No, it isn't, because ... never before have our leaders so utterly betrayed everything our nation stands for. "This government does not torture people," declared former President Bush, but it did, and all the world knows it.

And the only way we can regain our moral compass ... is to investigate how that happened, and, if necessary, to prosecute those responsible.

What about the argument that investigating the Bush administration's abuses will impede efforts to deal with the crises of today? Even if that were true — even if truth and justice came at a high price — ...laws aren't supposed to be enforced only when convenient. But is there any real reason to believe that the nation would pay a high price for accountability? ...

Tim Geithner ... wouldn't be called away... Peter Orszag, the budget director, wouldn't be called away... Even the president needn't, and indeed shouldn't, be involved. All he would have to do is let the Justice Department do its job... America is capable of uncovering the truth and enforcing the law even while it goes about its other business.

Still, you might argue — and many do — that revisiting the abuses of the Bush years would undermine the political consensus the president needs to pursue his agenda.

But the answer to that is, what political consensus? There are still, alas, a significant number of people in our political life who stand on the side of the torturers. But these are the same people who have been relentless in their efforts to block President Obama... The president cannot lose their good will, because they never offered any.

That said, there are a lot of people in Washington who ... probably just don't want an ugly scene... But the ugliness is already there, and pretending it isn't won't make it go away.

Others, I suspect, would rather not revisit those years because they don't want to be reminded of their own sins of omission.

For the fact is that officials in the Bush administration instituted torture as a policy, misled the nation into a war they wanted to fight and, probably, tortured people in the attempt to extract "confessions" that would justify that war. And during the march to war, most of the political and media establishment looked the other way.

It's hard, then, not to be cynical when some of the people who should have spoken out against what was happening, but didn't, now declare that we should forget the whole era — for the sake of the country, of course.

Sorry, but what we really should do for the sake of the country is have investigations both of torture and of the march to war. These investigations should, where appropriate, be followed by prosecutions — not out of vindictiveness, but because this is a nation of laws.

We need to do this for the sake of our future. For this isn't about looking backward, it's about looking forward — because it's about reclaiming America's soul.

I wrote this several days ago, but never posted it. It echoes much of the above:

When asked whether people will be held accountable for their actions during the time the last administration was in power, this administration says that it's time to move on, to put the past behind us, to let bygones be bygones. But that is not a reason to prevent people from having to take responsibility for their actions.

So I am not convinced. If the country were to fall apart should the rule of law prevail, then perhaps the calculation changes. Is that what would happen? Will the country fall apart if the guilty are pursued? No, it won't, we'll be better for it. Will it make it harder to form a coalition with people on the right in order to get other things such as health care reform done? Yes, it probably will, but so what? Bringing people to justice is always inconvenient and costly, there are almost always externalities, but we bring people to trial anyway.

What will happen that's so bad, other than the president will have a much tougher time with the opposition? If that's all it is, that's no reason to stop the pursuit of justice. Sure, you can argue that more people will be hurt if we fail to pass health care than will be helped by prosecuting, some argument like that, but that's not how we make these decisions. If a factory owner commits a crime, and sending that owner to jail will cost the town many, many jobs and create hardship, do we say, that's okay, you have us over a barrel, so go ahead and do whatever you want? If the entire nation is seriously at risk, then, sure, intervene, but that's not the case.

What about the argument that it would harm the CIA? If we are afraid people who will do these things won't want to work there, so what? In any case, start with the people in charge, those at the highest levels who made the decisions, and work down from there. We can figure out where the line is. If people knew, reasonably, that they were breaking the law, then hold them accountable. Some were relying upon shaky legal foundations (shaky gives it more credit that it deserves since it implies it was standing at all, however unsteadily), and that makes it harder, but not impossible.

And why is up to one person anyway? I thought we had a legal process, not a king. The power of the pardon is available, of course, but shouldn't we find out what happened and establish guilt before we start handing out the pardons? The truth matters too.

Furthermore, the president is not an unbiased, impartial observer here. If people are pursued for their crimes and he doesn't stop it, he can well imagine acts of retaliation later, where people attempt to try him or members of his administration for violating laws. But that's not a reason for him to intervene and stop prosecutions, the conflict of interest is a reason to step aside. If there's a flaw in the system that allows frivolous attempts to prosecute the president or his close associates, then fix it, but don't let it stop people from being held accountable for their choices. Again, if the nation comes under threat from the pursuit of justice, that's a different matter, but that case has yet to be made.

There are probably constitutional and legal principles I'm unaware of that are at play here, but this stinks. The rule of law applies to everyone, not just when it's convenient.

"The Recovery to Come"

Jamie Galbraith explains why he believes the recovery will be slow, and what we might do to speed it up:

The Recovery to Come, Remarks to the 18th Annual Conference Honoring Hyman Minsky, by James K. Galbraith: ...The question before us is:... Will what went down, come back up? ... It seems to me that there are four essential points to make about the expansion to come.

- It will surely be very slow to restore employment. At present writing jobs are being lost at the rate of over 600,000 per month. To reverse this in six months would require a swing to job creation of the same amount, or a net swing of 1.2 million jobs a month for half a year. This is not going to happen - not even close. ... As a result, we can expect the human wreckage of this slump to persist... Without direct employment measures, many of the people most hurt will not again find decent jobs.

- As a result of the administration's determination to save the big banks, we will emerge from this slump with an unreformed financial sector in the hands of the same people who produced the disaster in the first place. ...

- In the expansion the early easy buck, especially for speculators, may well be in commodities, especially oil. A rapid increase in imported energy costs would reverse the effective stimulus now being given by low oil prices. It will also generate CPI inflation, perhaps inducing the Federal Reserve to slam on the brakes. There is little reason to hope that the recovery will be allowed to march us all the way back to full employment unless we overcome our vulnerability to volatile oil prices, and nothing in the plans so far suggests we have...

- A turnaround could bring the deficit hawks back out of the woodwork, arguing vociferously that "now is the time" for tax increases and entitlement cuts. Should they prevail, the process could be thrown into reverse, in a recapitulation of Roosevelt's balance-the-budget recession of 1937-38.

The British used to call this scenario "stop-and-go." A future of short and incomplete expansions may be the most likely case, with no prospect for a return to full employment. For the working population of the country, this is no recovery at all. And it will be made all the worse rising financial markets and premature declarations of victory, the gloating of the bailed-out. ...

Let me close by laying out four steps that would help to avert this future, and help to assure a long and relatively stable expansion, leading ultimately back to high employment.

- Treasury should change its bank plan, recognize that too-big-to-fail is also too-big-to- regulate, and too-big-to-regulate is also too-big-to-manage. ... That choice is between preserving vast rogue companies whose major functions are tax and regulatory arbitrage, or allowing the smaller banks that have largely played by the rules to grow into the legitimate market niches the big players may vacate. Apart from the vast political power of the big banks, this is not a difficult choice.

- The unmet human disaster of this slump remains urgent, and the way to meet it is to strengthen, not weaken, the social safety net. ...

- For the long term, we should build institutions now, including a National Infrastructure Fund and a cabinet Department for Energy and Climate, capable of planning and funding the reconstruction of the country. The point of this is to build expectations for a sustained expansion and also to give it a direction, charting the course that private investments will follow when they eventually return.

- Finally, we should recognize that we are fortunate in this country to have the governing institutions established for us in the New Deal and Great Society, including a central bank with unlimited lending powers, a national government that can borrow and spend at will, and the global reserve currency. These institutions have -- despite flaws and mistakes -- served us well. But we should recognize that the rest of the world is not so favored. In particular, Europe lacks the mechanisms and the inclination to take action as we can...

It is therefore quite possible that the rest of the world will not cooperate in economic recovery even if one gets started here. It is possible that credit, debt and exchange-rate crises still to come will overwhelm the capacity of the global system to cope. We should be prepared, if we can, to deal with that risk.

Blogginheads: Economics 2.0

The economy as a broken spaceship (08:02) Are macroeconomic models just hogwash? (14:10) Resizing and recasting the financial sector (30:46) Did we have to bail out the banks? (37:35) Why statistics can't predict economic future (yet) (41:16) Czar for a day: Mark and Arnold fix the economy (47:32) Play entire video (56:51)

links for 2009-04-24

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