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July 20, 2009

Economist's View - 5 new articles

The State of Macroeconomics

Because of these three articles in The Economist, everyone seems to be weighing in on the state of macroeconomics. I haven't because I've already said everything I want to say about this, and I didn't want to be repetitive. The links are:

Here's one bit:

Let me a bit more specific, and add something more to problems with macroeconomics I discussed in The Great Multiplier Debate and "The Unfortunate Uselessness of Most 'State of the Art' Academic Monetary Economics". The main mechanism generating fluctuations and policy effects in modern New Keynesian models is Calvo type sluggish price adjustment. I think this model is useful for "normal" times as a way of understanding economic fluctuations, and for learning about optimal policy, and it represents a step forward in understanding monetary policy in particular. But do people really think that all would be fine right now if prices – and they must have housing prices in mind when they think about sticky prices as an explanation for the current episode – had only adjusted faster? If housing prices had dropped even faster than they have already, all would be well in the world?

Okay, so maybe they don't have housing prices in mind. Still, do we really think that sluggish price adjustment is the main mechanism at work in the present crisis? If not, then what use is the evidence from those models? Why do we keep hearing about theoretical simulations that give values for the multiplier that are small, large, zero, less than one, whatever? Do we really think that sluggish price adjustment captures the essence of the factors driving the present crisis? I don't.

That is, the mechanism driving real effects in the standard versions of these models is sluggish price adjustment, but do we really believe this is the main mechanism through which real effects are being generated in the current crisis? if not, how much faith should we put in estimates derived from these models?

Update: Mark Gertler emails a response to this post (this also appeared at Free exchange earlier today):

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.
Mark Gertler, Henry and Lucy Moses Professor of Economics New York University

I have also posted a link to his Mini-Course, "Incorporating Financial Factors Within Macroeconomic Modelling and Policy Analysis" in the daily links for tomorrow. 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. We still have work to do, but as Mark Gertler notes, "economic research is responding," and as I noted at the end of one of the posts linked above, "The models will be built - I guarantee you they are being built presently."


"Obamacare Is At War With Itself"

Robert Reich believes that if health care reform is delayed beyond the August recess, it's unlikely to happen:

Universal health care is so complicated -- touching on so much of the economy, stepping on the toes of so many vested interests -- that to allow the bills to languish past recess risks the entire goal. Speed is essential. Recall that after Bill Clinton was elected, universal health insurance looked inevitable; a year later, it was doomed. As Lyndon Johnson warned his staff after the 1964 landslide, "every day while I'm in office, I'm gonna lose votes."
Republicans don't want any bill. Blue Dog Democrats are afraid of the costs of any bill. The AMA, private insurers, and pharmaceutical companies would be delighted if universal health care died. If bills aren't passed in the House and Senate before August 7th, the fights in both chambers over the public option and money will carry over into the Fall, where they'll become more intense and more prolonged. Obama won't have a bill on his desk before the end of the end of the year. That's a death sentence for health-care reform. The gravitational pull of the mid-term elections of 2010 will frighten off Blue Dogs and delight Republicans.

However, it appears that the tension between the costly giveaways being used to get the votes needed to pass the legislation and Blue Dogs worried about the costs of the giveaways is going to delay the process past the August recess:

Obamacare Is At War With Itself Over Future Costs, by Robert Reich: Right now, Obamacare is at war with itself. Political efforts to buy off Big Pharma, private insurers, and the AMA are all pushing up long-term costs... But this is setting off alarms among Blue Dog Democrats worried about future deficits -- and their votes are critical.
Big Pharma, for example, is in line to get just what it wants. The Senate health panel's bill protects biotech companies from generic competition for 12 years after their drugs go to market, which is guaranteed to keep prices sky high. Meanwhile, legislation expected from the Senate Finance committee won't allow cheaper drugs to be imported from Canada and won't give the federal government the right to negotiate Medicare drug prices directly with pharmaceutical companies. ... No wonder Big Pharma is now running "Harry and Louise" ads -- the same couple who fifteen years ago scared Americans into thinking the Clinton plan would take away their choice of doctor -- now supportive of Obamacare.
Private insurers, for their part, have become convinced they'll make more money with a universal mandate accompanied by generous subsidies for families with earnings up to ... $80,000 ... than they might stand to lose. Although still strongly opposed to a public option, the insurance industry is lining up behind much of the legislation. The biggest surprise is the AMA, which has also now come out in favor -- but only after being assurred that Medicare reimbursements won't be cut nearly as much as doctors first feared.
But all these industry giveaways are obviously causing the healthcare tab to grow. And as these long-term costs rise, the locus of opposition to universal health care is shifting away from industry and toward Blue Dog and moderate Democrats who are increasingly worried about future deficits. My sources on the Hill tell me there aren't enough votes in the House to get either major bill through, even with a provision that would pay for it with a surcharge on the richest 1 percent of taxpayers. House members don't want to vote for a tax increase before their Senate counterparts commit to one. Yet the Senate continues to be in suspended animation because Max Baucus and his Senate Finance Committee still haven't come up with a credible way of paying for health care. In his testimony last week, Elmendorf favored limiting tax-free employer-provided health benefits, but organized labor remains strongly opposed.

Obama has less than three weeks before August recess. Chances are dimming that he can get some form of universal health care passed in both Houses before the clock runs out. The Democratic National Committee is running ads favoring passage in Blue Dog states and districts, but that won't be enough. Now is the time for the President to begin twisting arms and knocking heads. To control long-term costs, he'll also have to take away some of the goodies that have been promised to the health-industrial complex, and maybe even cross Big Labor. He also needs to come out clearly and forcefully in favor of a way to pay for the whole thing -- ideally, in my view, a surtax on the top.

Will legislation pass before the break? Will it happen at all? I expect that we will get some sort of legislation, if not before the break then after, but it will be weakened to the point where nobody is very happy with the outcome. The hope, and likely the main supporting argument for whatever legislation emerges, is that it will provide the foundation for further reform down the road, and set the stage in a way that makes that reform inevitable. But there's no guarantee that will happen.


Video: Martin Feldstein Lecture by John Taylor


Innovative Financial Shennanigans

Isn't this special?:

Cashing In, Again, on Risky Mortgages, by Peter Goodman, NYTimes: ...Jack Soussana delivered staggering numbers of mortgages to homeowners during the real estate boom, amassing a fortune. By Mr. Soussana's own account, his customers fared less happily. He specialized in the exotic mortgages that have proved most prone to sliding into foreclosure, leaving many now scrambling to save their homes.
Yet the dangers assailing Mr. Soussana's clients have yielded fresh business for him: Late last year, he and his team — ensconced in the same office where they used to broker mortgages — began working for a loan modification company [called FedMod]. For fees reaching $3,495, with most of the money collected upfront, they promised to negotiate with lenders to lower payments on the now-delinquent mortgages they and their counterparts had sprinkled liberally across Southern California. ...
Despite making promises of relief to homeowners desperate to keep their homes, FedMod and other profit making loan modification firms often fail to deliver, according to a New York Times investigation...
"Our job was to get the money in and then we're done," said Paul Pejman, a former sales agent... He recounted his experience, he said, because "I really feel bad."
"I had people calling me crying, and we were telling them, 'You can pay me or you can lose your house,' " Mr. Pejman said. "People were giving me every dime they had, opening credit cards. But I never saw one client come out of it with a successful loan modification." ...
FedMod is among dozens of similar companies that have been accused by state and federal authorities of fraudulent business practices. ... Many of the companies formerly operated as mortgage brokers... The three original partners brought in [a lawyer] to gain a crucial asset: his law license. Having a lawyer in charge enabled them to market their venture as a law firm and thus collect upfront payments under California rules. ...
Mr. Pejman, 22, ... had worked at three wholesale mortgage brokerages. Now, a trainer emphasized he was at a law center.
"Our big sales pitch was that an attorney could do a better job with your loan modification," Mr. Pejman said. "If you told them these were basically washed-up people from the mortgage industry, or just people sending in paperwork, they would say, 'Well, why bother? I might as well do this myself.' " He went on: "It was misleading to the client. Attorneys never touched those files."
Among the 700-plus full-time employees who worked for FedMod this spring, only nine were lawyers...
Mr. Pejman and his fellow agents urged homeowners to send FedMod $3,495; the agents were promised a 30 percent commission for fees they took in. ... "They basically told us, 'Do whatever you need to do,' " he said. " 'It's a sales floor. You're here to sell.' People would quote success rates and just pull them out of thin air. People would say 60 percent, 80 percent, 90 percent. ...
"I'd hear people say, 'Would you pay $1,000 to save your home? To save your marriage? Your kids' education?' " he recalled. "I'd hear people say, 'Yeah, we're the federal government.' There were a lot of corrupt people working there." ...
Each case manager was responsible for as many as 200 files at a time... "You're paying the sales agent upfront," ... "So what motivation does he have to get it closed?" ...

See, the anti-regulation types are right. A Consumer Financial Protection Agency might stifle valuable innovation like this and prevent these companies from giving consumers the value that they pay for.

I might have that backwards.


links for 2009-07-20

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