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August 28, 2009

Economist's View - 6 new articles

Bernanke and Regulation of the Financial Sector

Economics of Contempt says I gave in too easily:

Bernanke's Reappointment, by Economics of Contempt: Bernanke's reappointment seems to be the topic of the day, so I suppose I'll weigh in as well. I think Bernanke absolutely deserves a second term. He reacted early and aggressively when strains in the funding markets first appeared back in the fall of 2007, after the two Bear Stearns hedge funds failed and the ABCP market shut down, and he's kept his foot on the gas ever since. Everyone seems to be praising Bernanke for his "creativity" in responding to the financial crisis. While the Fed's various liquidity facilities have indeed been creative, they were almost certainly designed by the New York Fed's markets desk, not Bernanke. What Bernanke deserves credit for is his willingness to use these new and decidedly non-traditional facilities without hesitation. Like Paul Krugman said, a different Fed chairman might well have balked at these new facilities. Bernanke's willingness to approve the AMLF—the most creative of the new lending facilities—probably saved the entire prime money market fund sector, which was experiencing a full-blown bank run. (The Fed pumped $122 billion into money market funds in the first 7 days of the AMLF—and bear in mind that only money funds that were experiencing specified redemption pressures were even eligible for the AMLF in the first place.) People who, like Kevin Drum, oppose Bernanke based on his regulatory views, simply haven't been paying attention. Drum claims that Bernanke "inherited and then perpetuated weak regulation of consumer loan products, something that aggravated the housing bubble." It's true that Bernanke inherited weak regulation of mortgages, but it's simply not true that he perpetuated that weak regulation. That sounds more like what Drum thinks Bernanke probably did (if he had to guess, and without looking at the record). In reality, the Fed adopted new regulations on subprime mortgages over a year ago, and there was nothing "light touch" about them. The Fed started the process of adopting new regulations on subprime mortgages way back in 2006, and the explicit focus from the beginning was on curbing the abuses of 2004/2005. But a Fed chairman can't just wave his magic wand and have new regulations appear in Federal Register—the rulemaking process takes time. And when it comes to something like Reg Z, which is both controversial and complex, it often takes even longer than normal. Bernanke can't be blamed for sweeping the regulatory effort under the rug either. He devoted the bulk of his semiannual Humphrey-Hawkins testimony—the most high-profile testimony a Fed chairman gives—to the need for more regulation of subprime mortgages in July 2007. (He made the case for subprime mortgage regulation again a few months later, in even longer testimony.) The Board of Governors approved the final rule in July 2008. Mark Thoma, who previously argued that Bernanke will be an effective regulator, actually concedes Drum's point, saying that his argument is probably "based more on hope than on evidence." Don't give up so easily, Professor Thoma! If anything, Thoma's argument is the one based on evidence, while Drum's seems to be based on a flawed memory. [Read Barry Ritholz's post on disingenuous Bernanke bashing as well.]

Did Hetrodox Economists Get it Right?

After feeling like I overstated the case, I invited Barkley Rosser (or anyone else) to respond to my claim that "heterodox economists did not do a better job of "calling" the recent crashes and crises than did mainstream or conventional economists." I don't think the list below of people who called the crisis is particularly well defined, e.g. how do you leave off people like Raghuram Rajan, should Krugman be on it, and so forth, and the definition of what it means to have called it can be questioned. But I was the one who first invoked the list (I got it from Steven Keen's site), and I agree that the list as formulated is slanted toward non-conventional economists. I also agree with Barkley's response to my invitation to respond:

I do not think this is going to be easy to determine. It involves not only identifying "who called it," (preferably publicly) and who did not, as well as this sticky wicket of "who is heterodox" and who is not (having just pointed out that it is unclear whether I count or not, and I called a lot of it, and there is question about whether Dean Baker is heterodox, who certainly called a lot of it and very early).
What certainly is clear that the clearly orthodox, and here I would say those who accepted (and many still accept) rational expectations and some sort of equilibrium associated with that, have been very wrong, with basically none of them "calling it." ...

Here's the counterargument:

Did Heterodox Economists Do Better At "Calling It" Than Mainstream Ones?, by Barkley Rosser: In a posting and comments yesterday, Mark Thoma at economists view, , argued that heterodox economists did not do a better job of "calling" the recent crashes and crises than did mainstream or conventional economists. Of course, part of the issue here involves both who one counts as "calling it," and also how one labels economists. In the comments, a list provided by Steve Keen of 11 who "called it," was invoked, with Thoma, at least, claiming that it did not show any preponderance of the heterodox. The list is as follows:
Dean Baker,US Wynne Godley, UK Fred Harrison, UK Michael Hudson, US Eric Janszen, US Stephen Keen, Australia Jakob Brochner Madsen and Jens Kjaer Sorenson, Denmark Kurt Richebacher, US Nouriel Roubini, US Peter Schiff, US Robert Shiller, US.
Keen categorizes these as follows in a private communication with me: 5 as Post Keynesian (Baker, Godley, Hudson, Keen, Sorenson), 2 as Austrian (Richebacher, Schiff), 2 as "from neoclassical backgrounds," but "mavericks" (Roubini, Shiller), one sort of a combination of Austrian and Post Keynesian (Janszen), and one unclear (Harrison). This looks about right to me to the extent I know about these people, although I note that Thoma claims that Baker is not "heterodox." I have not asked Dean, and he may not wish to comment, although he was once-upon-a-time a co-blogger on the predecessor to this blog, maxspeak, prior to starting his own punchy blog, Beat the Press. About four of these people I know nothing about. I also note that there are quite a few others who can make the claim of having "called it" (I like to include myself in that gang, at least to some degree), and I also know that some of those are conventional, more or less, such as Andrew Lo of MIT, although he is now pushing a non-conventional theory about evolutionary financial dynamics. In any case, I think that the heterodox have the edge here, even if it is not clear what constitutes being in that category.

"Beware Authoritative 'Inside Washington' Sources"

Robert Reich says incremental reform of health care won't work, and he gives an example to illustrate why incremental reform isn't always the best way to proceed:

Beware Authoritative "Inside Washington" Sources Who Say The Public Option is Dead, by Robert Reich: ...Years ago, as the story goes, Britain's Parliament faced a difficult choice. On the European continent drivers use the right lanes, while the English remained on the left. But tunnels and fast ferries were bringing cars and drivers back and forth ever more frequently. Liberals in Parliament thought it time to change lanes. Conservatives resisted; after all, Brits had been driving on the left since William the Conquerer's chariot. Parliament's compromise was to move from the left to right lanes -- but incrementally, on a voluntary basis. Truckers first.
But his main point is to be careful of reports of authoritative voices saying that "the public option is dead, that the President won't be able to get a comprehensive health care bill, and that the White House and congressional leadership already know the best they'll be able to do now is move incrementally":
Washington, D.C. is an echo chamber in which anyone who sounds authoritative repeats the conventional authoritative wisdom about the "consensus" of inside opinion, which they've heard from someone else who sounds equally authoritative, who of course has heard it from another authoritative source. Follow the trail to its start and you often find an obscure congressional or White House staffer who has seen some half-assed poll number or briefing memo, but seeking to feel important hypes it a media personality or lobbyist who, desperate to sound authoritative, pronounces it as truth. In any other place on the planet it would be called rumor, gossip, or drivel. In our nation's capital it's called "inside information." The process would be harmless except that it creates self-fulfilling prophesies. Since most of our elected representatives would rather not stick their necks out lest they lose their heads, they tend to rush toward whatever consensus seems to be emerging -- which, of course, is based on authoritative reports about the emerging consensus. In the last few days authoritative sources have repeatedly told me that the public option is dead, that the President won't be able to get a comprehensive health care bill, and that the White House and congressional leadership already know the best they'll be able to do now is move incrementally... The rightwing media fearmongers and demagogues have won. Don't believe it. The other thing about Washington is how quickly conventional authoritative wisdom changes, especially when the public is still in flux over some large matter. Rightwing fearmongers and demagogues thrive only to the extent the mainstream media believes they're thriving. Although polls continue to show that while most Americans like the health care they're getting, they also dislike their insurance companies, worry that they or their families will be denied coverage, and are anxious about the increasing co-payments, deductibles, and premiums they're facing. Most are still eager for reform. In addition, we've come to the point where health-care incrementalism won't work. [explains why, and also explains the need for a public option]... When you go through the logic, it starts to look a lot like comprehensive reform. ... So forget the authoritative sources. Mobilize and organize. We can get comprehensive, meaningful health care reform if we push hard enough. And we must.

Health Care Reform and Entreprenuership

I've also argued that if we don't reform health care, people who think they will be able to keep their current health coverage will find out otherwise, and that health care reform will have a positive effect on entrepreneurship:

Fixing Health Care Is Good for Business, by Gary Locke, Commentary, WSJ: ...There has been a lot of talk about the 47 million Americans who do not have health insurance. But health-care reform is just as important to the majority of Americans who have health insurance now. Absent reform, the price of an average family's insurance will nearly double over the next decade—to $25,000 from $13,000.
No less troubling are the stories I hear from CEOs, entrepreneurs and workers. Rising health-care costs are crushing American companies—particularly small businesses that are the source of much of our economic vitality. ...
The pernicious price of runaway health-care costs also has a dampening effect on entrepreneurship.
How many aspiring owners of businesses are locked in jobs they don't like for fear that striking out on their own would cause them to lose their health insurance? The Small Business Majority, a national advocacy group, estimates there are as many as 1.6 million. ...
The bills working through Congress are moving in the right direction... We must keep moving forward. ...
Because insurance costs are obscured by the employer based system that we rely upon for much of our health insurance, most people don't realize how much they pay for insurance now, let alone the costs they will face in the future. This lack of transparency about the actual insurance costs faced by a typical family creates unnecessary confusion and fear. When, for example, people hear that reform means they might have to pay, say, $8,000 for insurance coverage, they balk at the figure even though it actually saves money and would result in their receiving higher wages (research suggests that the total wage plus insurance bill that firms pay is relatively stable so that a fall in the cost of insurance translates into higher wages). And even if people know how much the insurance costs, the belief may be that the employer is actually paying for the insurance, or at least a significant portion of it, but that is not what research on the incidence of the insurance costs suggests.

Paul Krugman: Till Debt Does Its Part

Should you be worried about the national debt, or the politicians in charge of it?:

Till Debt Does Its Part, by Paul Krugman, Commentary, NY Times: So new budget projections show a cumulative deficit of $9 trillion over the next decade. According to many commentators, that's a terrifying number, requiring drastic action — in particular, of course, canceling efforts to boost the economy and calling off health care reform.
The truth is more complicated and less frightening. Right now deficits are actually helping the economy. In fact, deficits here and in other major economies saved the world from a much deeper slump. The longer-term outlook is worrying, but it's not catastrophic.
The only real reason for concern is political. The United States can deal with its debts if politicians of both parties are, in the end, willing to show at least a bit of maturity. Need I say more?
Let's start with the effects of this year's deficit. ... Consider what would have happened if the U.S. government and its counterparts around the world had tried to balance their budgets as they did in the early 1930s. It's a scary thought. If governments had raised taxes or slashed spending in the face of the slump, if they had refused to rescue distressed financial institutions, we could all too easily have seen a full replay of the Great Depression.
As I said, deficits saved the world.
In fact,... the ... White House forecast shows a nation stuck in purgatory for a prolonged period, with high unemployment persisting for years. If that's at all correct — and I fear that it will be — we should be doing more, not less, to support the economy.
But what about all that debt we're incurring? That's a bad thing, but it's important to have some perspective. ...
Here's one way to look at it: We're looking at a rise in the debt/G.D.P. ratio of about 40 percentage points. The real interest on that additional debt (you want to subtract off inflation) will probably be around 1 percent of G.D.P., or 5 percent of federal revenue. That doesn't sound like an overwhelming burden.
Now, this assumes that the U.S. government's credit will remain good so that it's able to borrow at relatively low interest rates. So far, that's still true. Despite the prospect of big deficits, the government is able to borrow money long-term at ... less than 3.5 percent, which is low by historical standards. People making bets with real money don't seem to be worried about U.S. solvency. ...
So is there anything to worry about? Yes, but the dangers are political, not economic.
As I've said, those 10-year projections aren't as bad as you may have heard. Over the really long term, however, the U.S. government will have big problems unless it makes some major changes. In particular, it has to rein in the growth of Medicare and Medicaid spending.
That shouldn't be hard in the context of overall health care reform. After all, America spends far more on health care than other advanced countries, without better results, so we should be able to make our system more cost-efficient.
But that won't happen, of course, if even the most modest attempts to improve the system are successfully demagogued — by conservatives! — as efforts to "pull the plug on grandma."
So don't fret about this year's deficit; we actually need to run up federal debt right now and need to keep doing it until the economy is on a solid path to recovery. And the extra debt should be manageable. If we face a potential problem, it's not because the economy can't handle the extra debt. Instead, it's the politics, stupid.
Update: A response to Jim Hamilton:
The burden of debt. by Paul Krugman: I respect Jim Hamilton a lot, so I take his criticism seriously — and he raises questions that others raise too about my relatively sanguine assessment of the debt situation. Yet I think that he and others are quite wrong, on several counts.
First off: the assertion that the post-World War II debt was sui generis, that it offers no guidance on what we can afford. It's true that right after the war it was possible to get a drastic reduction in spending easily, since we didn't have to fight the Axis any more. But let's take a slightly later start date: in 1950, federal debt in the hands of the public was 80 percent of GDP, which is in the ballpark of what we're looking at for 2019. By 1960 it was down to 46 percent — and I haven't heard that anyone considered America a debt-crippled nation when JFK took office.
So how was that possible? Was it through drastic cuts in defense spending? On the contrary: we're talking about the height of the Cold War (with a hot war in Korea along the way), and federal spending actually rose as a share of GDP. So yes, it wasn't entitlement programs, but it wasn't exactly discretionary either.
How, then, did America pay down its debt? Actually, it didn't: federal debt rose from $219 billion in 1950 to $237 billion in 1960. But the economy grew, so the ratio of debt to GDP fell, and everything worked out fiscally.
Which brings me to a question a number of people have raised: maybe we can pay the interest, but what about repaying the principal? Jim gets scary numbers about the debt burden by assuming that we'll have to pay off the debt in 10 years. But why would we have to do that? Again, the lesson of the 1950s — or, if you like, the lesson of Belgium and Italy, which brought their debt-GDP ratios down from early 90s levels — is that you need to stabilize debt, not pay it off; economic growth will do the rest. In fact, I'd argue, all you really need to do is stabilize debt in real terms.
So where Jim Hamilton has us paying $1 trillion a year to service $9 trillion in debt, I have us paying $225 billion — 2.5% real interest on that sum.
Now, how does that compare with the tax base? Hamilton rather mysteriously compares debt service only with current personal income taxes. If we use the overall tax take, and talk about what that tax take will be a decade from now, things look much less severe.
So: in 2008, with revenues already depressed by the recession and housing bust, the federal government took in $2.5 trillion in revenues. If we assume 2.5% real growth* and 2% inflation, by 2019 that would rise to $4 trillion. So debt service costs due to the next decade's deficits would be less than 6 percent of revenue under current law.
So, to review: to make the debt look scary, you have to dismiss the post-World -War II experience, even though it turns out that the 50s offer a quite good lesson; assume that in the future the federal government will have to amortize debt over a quite short period, even though it never had to in the past; compare this inflated debt burden with a narrow piece of the federal tax base; and ignore the likely growth in the tax base over the next decade.
I'm not convinced.
*Contrary to what some think, we'd actually expect growth over the next decade to be somewhat above trend, as the economy picks up some of the current slack. That's what the historical record tells us actually happens.

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