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August 27, 2009

Economist's View - 7 new articles

"Obama Lucky to Have Bernanke"

Brad DeLong explains why presidents are willing to reappoint Fed chairs that are members of opposing political parties:

Obama lucky to have Bernanke, by J. Bradford DeLong, Commentary, Project Syndicate: William McChesney Martin, a Democrat, was twice reappointed chairman of the ... Federal Reserve by Republican President Dwight D. Eisenhower. Paul Volcker, a Democrat, was reappointed once by the Reagan administration (but not twice: there are persistent rumors that Reagan's treasury secretary, James Baker, thought Volcker too invested in monetary stability and not in producing strong economies to elect Republicans). Alan Greenspan, a Republican, was reappointed twice by Bill Clinton. And now Barack Obama has announced his intention to renominate Republican appointee Ben Bernanke... The reason American presidents are so willing to reappoint Fed chairmen from the opposite party is closely linked to ... confidence of financial markets that the Fed will pursue non-inflationary policies. If financial markets lose that confidence - if they conclude that the Fed is too much under the president's thumb to wage the good fight against inflation, or if they conclude that the chairman does not wish to control inflation - then the economic news is almost certain to be bad. Capital flight, interest-rate spikes, declining private investment, and a collapse in the value of the dollar - all of these are likely should financial markets lose confidence in a Fed chairman. And if they occur, the chances of success for a president seeking re-election - or for a vice president seeking to succeed him - are very low. By reappointing a Fed chairman chosen by someone else, a president can appear to guarantee to financial markets that the Fed is not too much under his thumb. ... It may or may not be true, especially these days, that what is good for General Motors is good for America and vice versa, but certainly what is good economically for America is good politically for the president. It is here that Obama has lucked out. Ben Bernanke is a very good choice for Fed chairman because he is intelligent, honest, pragmatic and clear-sighted in his vision of the economy. He has already guided the Fed through two very tumultuous years with only one major mistake - the bankruptcy of Lehman Brothers.

This probably helped with Obama's willingness to reappoint Bernanke:

For years, some of his closest friends did not know that Ben S. Bernanke was a Republican. ... "If you read anything he's written, you can't figure out which political party he's associated with," said Mark L. Gertler, a professor of economics at New York University who has written more than a dozen papers with Mr. Bernanke. Mr. Gertler, who said he did not know his close friend's political affiliation until relatively recently, added: "He's not ideological. I could imagine Ben working with economists in the Clinton administration." Alan S. Blinder, a longtime colleague at Princeton who has advised numerous Democratic presidential candidates, also said he had worked alongside Mr. Bernanke for years without having any sense of his political views. "We wrote articles together and sat at the same lunch table thousands of times before I knew he was a Republican," Mr. Blinder recalled. "We never talked politics." ...


The Size of the Bush Tax Cuts vs. the Cost of Health Care Reform

Via Economix:

Trillion Dollar Health Reform, $3 Trillion in Tax Cuts, by Howard Gleckman, Tax Policy Center: It is interesting, and perhaps worth noting, that while political opposition seems to be hardening against the $1 trillion, ten-year cost of the early versions of health reform, barely a peep of concern has been raised about the $3 trillion price tag for President Obama's plan to extend most of the Bush-era tax cuts.
The message seems pretty clear: The President, congressional Democrats, and nearly all Republicans are fine with busting the budget to cut taxes for nearly everyone, notwithstanding a cumulative deficit over the next decade of $9 trillion. They are, by contrast, unwilling to spend one-third as much to provide medical insurance for those who cannot afford it. I've always felt that health reform is as much an ethical choice as an economic one. We appear to be making ours.
Yes, priorities. Tax cuts for the wealthy come before health care for the uninsured.


"Would Growth in the U.S. Debt be Inflationary?"

David Andolfatto explains why a worldwide shortage of safe, liquid assets may help the U.S. to avoid the inflationary consequences of high debt levels:

Why the Growing Level of U.S. Debt May Not be Inflationary, by David Andolfatto: History shows that high levels of government debt are frequently associated with inflation. The reason for this seems clear enough. At some point, maturing debt needs to paid back. At high enough levels of debt, rolling the debt over is no longer feasible. Cutting back government spending and raising taxes is politically difficult. The easy way out is simply to print new money. As the money supply expands, inflation results.
Let us consider the U.S. Unlike most other economies, there appears to be a huge worldwide demand for U.S. Treasuries and U.S. dollars (which can be thought of as zero-interest Treasuries). A large scale increase in the supply of these government debt instruments need not lead to a depreciation in their value if there is a correspondingly large scale increase in the worldwide demand for these objects. What is the evidence that this may be happening?
Foreigners Snap Up Treasuries Even as US Debt Keeps Rising
But why should this be so? What accounts for what appears to be an insatiable demand for US debt, especially in the wake of the recent financial crisis?
Ricardo Caballero of MIT offers some hints in a very interesting piece entitled: On the Macroeconomics of Asset Shortages. After reading this paper, I started thinking in the following way. Tell me what you think.
There is a high and growing demand for low-risk assets, both as a store of value, and as collateral objects in payment systems (e.g., repo and credit derivatives markets). This growth has exploded over the last 20 years or so; and stems from the demand from emerging economies and innovations in the financial sector. There is a worldwide "shortage" of good quality (low-risk) assets, like U.S. Treasuries (which explains their relatively low yield). Indeed, many of the innovations in the financial sector can be interpreted as the private sector's response to this shortage: the creation of "low-risk" tranches of MBSs allowing these objects to substitute for U.S. Treasuries as collateral in the rapidly expanding repo market. ... If this is more or less true, then the implication is this: The massive increase in the supply U.S. Treasury debt may very be "socially optimal" in the sense that the U.S. government is simply supplying the world with an asset that is in very high demand (which, in turn, means that the demanders obviously find some value in the existence of such an asset). To the extent that this "new demand regime" remains stable, the added supply of U.S. Treasuries will impose no financial burden on the U.S. (indeed, they make off like bandits, as the Treasuries are ultimately purchased by exporting goods and services to the U.S.).
The million dollar question, of course, is whether the high world demand for U.S. debt will persist long into the future (and whether the U.S. government will "overissue" debt beyond what is called for by this new high-demand regime). Who knows what will happen. But it appears to me that IF the U.S. government plays its cards right, it may very well enjoy its higher debt levels without the prospect of inflation. U.S. citizens will benefit (from the sales of Treasuries for goods) and the world will be grateful to hold a stable asset.
Well, maybe. But that was a big IF. What could possibly go wrong?

The future level of the debt in the U.S. is not a worry if we get effective health care reform (rising health care costs are the major source of projected future deficits). But if a debt problem does exist, I'm not sure the main risk is inflation since I expect the Fed to hold the line on debt monetization. If so, if the Fed does hold the line, then the pressure would be on government spending and taxes. If congress cannot solve the debt problem by cutting spending and/or raising taxes, the result would likely be high interest rates that crowd out private investment. In any case, what this says to me is that to the extent that this demand for safe assets exists, debt levels can be carried at a lower interest rate than otherwise, and this reduces concerns about crowding out (perhaps this is one of the reasons why long-term interest rates have remained relatively low, financial markets recognize this demand exists, believe the demand is large enough to matter, and believe it will continue for some time into the future).

"Tell me what you think."

*****

[On the relationship between debt and inflation, much of the evidence comes from developing countries. Here's one story about why debt and inflation might be related. Often a developing country will decide to run a government deficit to, say, build new roads, bridges, dams, etc. They are trying to build up the infrastructure. The idea is that the future growth that will come from this spending will allow the debt to be paid off. It's an investment in the future of the country -- borrow now, invest the money in needed infrastructure projects, and then use the resulting increase in future economic output to pay for spending (though much less noble motives for increasing debt exist as well).

How can this debt be paid for in the interim, i.e. during the time period when the projects are being built and before the expected growth is realized? The alternatives are to increase taxes, print the money, or borrow the money.

The countries can't increase taxes, these are developing countries and the tax base is insufficient. The whole point of the infrastructure projects is to begin to change that through economic growth.

If they can't tax, then can they borrow the money? Probably not domestically since, again, they are a developing country with little wealth. The necessary funds aren't available domestically. So that leaves borrowing from foreigners. Is that possible? Not if they have defaulted in the past. If they have defaulted, nobody may be willing to take the risk of lending them money, and if the money comes from international agencies such as the IMF, it may come with so many restrictions that it does no good. And even if the money can be borrowed, at some point it must be paid off, and if the promised growth does not materialize (and overly optimistic promises make this likely), investors will be unwilling to allow the debt to be rolled over. The point is that, for developing countries, supporting government spending through taxes or borrowing may not be feasible. This leaves only two choices, giving up on the spending projects, or printing money to pay for them. Printing money - and the inflationary consequences that follow - is often the choice that is made.

Developed countries are not so constrained. They have much more latitude to borrow from their own citizens or from foreigners, they have the ability to raise substantial sums through taxation, and often their infrastructure and other needs aren't as dire. In addition, they can generally count on future growth to help to pay for the borrowing. For all these reasons, developing countries aren't necessarily forced to pay for spending by printing new money and creating inflation.]


"Revisiting Popper"

Is it true that "History and society are not law-governed systems for which we might eventually hope to find exact and comprehensive theories"?:

Revisiting Popper, by Daniel Little: Karl Popper's most commonly cited contribution to philosophy and the philosophy of science is his theory of falsifiability (The Logic of Scientific Discovery, Conjectures and Refutations: The Growth of Scientific Knowledge). (Stephen Thornton has a very nice essay on Popper's philosophy in the Stanford Encyclopedia of Philosophy.) In its essence, this theory is an alternative to "confirmation theory." Contrary to positivist philosophy of science, Popper doesn't think that scientific theories can be confirmed by more and more positive empirical evidence. Instead, he argues that the logic of scientific research is a critical method in which scientists do their best to "falsify" their hypotheses and theories. And we are rationally justified in accepting theories that have been severely tested through an effort to show they are false -- rather than accepting theories for which we have accumulated a body of corroborative evidence. Basically, he argues that scientists are in the business of asking this question: what is the most unlikely consequence of this hypothesis? How can I find evidence in nature that would demonstrate that the hypothesis is false? Popper criticizes theorists like Marx and Freud who attempt to accumulate evidence that corroborates their theories (historical materialism, ego transference) and praises theorists like Einstein who honestly confront the unlikely consequences their theories appear to have (perihelion of Mars). At bottom, I think many philosophers of science have drawn their own conclusions about both falsifiability and confirmation theory: there is no recipe for measuring the empirical credibility of a given scientific theory, and there is no codifiable "inductive logic" that might replace the forms of empirical reasoning that we find throughout the history of science. Instead, we need to look in greater detail at the epistemic practices of real research communities in order to see the nuanced forms of empirical reasoning that are brought forward for the evaluation of scientific theories. Popper's student, Imre Lakatos, makes one effort at this (Methodology of Scientific Research Programmes; Criticism and the Growth of Knowledge); so does William Newton-Smith (The Rationality of Science), and much of the philosophy of science that has proceeded under the rubrics of philosophy of physics, biology, or economics is equally attentive to the specific epistemic practices of real working scientific traditions. So "falsifiability" doesn't seem to have a lot to add to a theory of scientific rationality at this point in the philosophy of science. In particular, Popper's grand critique of Marx's social science on the grounds that it is "unfalsifiable" just seems to miss the point; surely Marx, Durkheim, Weber, Simmel, or Tocqueville have important social science insights that can't be refuted by deriding them as "unfalsifiable". And Popper's impatience with Marxism makes one doubt his objectivity as a sympathetic reader of Marx's work.
Of greater interest is another celebrated idea that Popper put forward, his critique of "historicism" (Popper 1957). And unlike the theory of falsifiability, I think that there are important insights in this discussion that are even more useful today than they were in 1957, when it comes to conceptualizing the nature of the social sciences. So people who are a little dismissive of Popper may find that there are novelties here that they will find interesting. Popper characterizes historicism as "an approach to the social sciences which assumes that historical prediction is their principal aim, and which assumes that this aim is attainable by discovering the 'rhythms' or the 'patterns', the 'laws' or the 'trends' that underlie the evolution of history" (3). Historicists differ from naturalists, however, in that they believe that the laws that govern history are themselves historically changeable. So a given historical epoch has its own laws and generalizations – unlike the laws of nature that are uniform across time and space. So historicism involves combining two ideas: prediction of historical change based on a formulation of general laws or patterns; and a recognition that historical laws and patterns are themselves variable over time, in reaction to human agency. Popper's central conclusion is that large predictions of historical or social outcomes are inherently unjustifiable -- a position taken up several times here (post, post). He finds that "holistic" or "utopian" historical predictions depend upon assumptions that simply cannot be justified; instead, he prefers "piecemeal" predictions and interventions (21). What Popper calls "historicism" amounts to the aspiration that there should be a comprehensive science of society that permits prediction of whole future states of the social system, and also supports re-engineering of the social system if we choose. In other words, historicism in his description sounds quite a bit like social physics: the aspiration of finding a theory that describes and predicts the total state of society.
The kind of history with which historicists wish to identify sociology looks not only backwards to the past but also forwards to the future. It is the study of the operative forces and, above all, of the laws of social development. (45)
Popper rejects the feasibility or appropriateness of this vision of social knowledge, and he is right to do so. The social world is not amenable to this kind of general theoretical representation.
The social thinker who serves as Popper's example of this kind of holistic social theory is Karl Marx. According to Popper, Marx's Capital (Marx 1977 [1867]) is intended to be a general theory of capitalist society, providing a basis for predicting its future and its specific internal changes over time. And Marx's theory of historical materialism ("History is a history of class conflict," "History is the unfolding of the contradictions between the forces and relations of production"; (Communist Manifesto, Preface to a Contribution to Political Economy)) is Popper's central example of a holistic theory of history. And it is Marx's theory of revolution that provides a central example for Popper under the category of utopian social engineering. In The Scientific Marx I argue that Popper's representation of Marx's social science contribution is flawed; rather, Marx's ideas about capitalism take the form of an eclectic combination of sociology, economic theory, historical description, and institutional analysis. It is also true, however, that Marx writes in Capital that he is looking to identify the laws of motion of the capitalist mode of production.
Whatever the accuracy of Popper's interpretation of Marx, his more general point is certainly correct. Sociology and economics cannot provide us with general theories that permit the prediction of large historical change. Popper's critique of historicism, then, can be rephrased as a compelling critique of the model of the natural sciences as a meta-theory for the social and historical sciences. History and society are not law-governed systems for which we might eventually hope to find exact and comprehensive theories. Instead, they are the heterogeneous, plastic, and contingent compound of actions, structures, causal mechanisms, and conjunctures that elude systematization and prediction. And this conclusion brings us back to the centrality of agent-centered explanations of historical outcomes.
I chose the planetary photo above because it raises a number of complexities about theoretical systems, comprehensive models, and prediction that need sorting out. Popper observes that metaphors from astronomy have had a great deal of sway with historicists: "Modern historicists have been greatly impressed by the success of Newtonian theory, and especially by its power of forecasting the position of the planets a long time ahead" (36). The photo is of a distant planetary system in the making. The amount of debris in orbit makes it clear that it would be impossible to model and predict the behavior of this system over time; this is an n-body gravitational problem that even Newton despaired to solve. What physics does succeed in doing is identifying the processes and forces that are relevant to the evolution of this system over time -- without being able to predict its course in even gross form. This is a good example of a complex, chaotic system where prediction is impossible.


"Should We be Excited about the July New Home Sales Number?"

Richard Green:

Should we be excited about the July new home sales number?: The short answer is no. The July number was the worst July number since 1982; it just wasn't as bad as the June number, which wasn't as bad as the May number. Everybody wants to know if we have hit bottom. There are three indicators suggesting we have--and three suggesting not. The good: prices in many markets have fallen below replacement cost (which is a pretty robust fundamental in the absence of population declines). Morris Davis at Wisconsin has shown that rent to price ratios have returned to be more in line with long term ratios, and given how low mortgage rates are, this is comforting. And resale inventories in California have dropped to under 4 months. On the down side, we may have a lot of foreclosed houses coming at us in the next year. The employment picture is still atrocious. And if rents keep falling, prices will follow. I would also guess that the first-time homebuyer tax credit is time-shifting sales, rather than raising them for the long term, but we shall see. On the other hand, the nature of investor sales is actually a positive indicator: investors are buying with cash and renting out units at decent rates of return. This is very different from the borrow, buy and flip model from the earlier part of this decade. FWIW, I would assign a subjective probability of .7 that we are at bottom. On the other hand, around 2005, I assigned a .35 probability that we were about to face serious trouble.


Hope or Evidence?

I think this is a fair response to my contention that Bernanke will be effective at pushing for new regulation of the banking industry. Thinking about it more, it's probably true that it is based more on hope than on evidence:

Ben's Second Term, by Kevin Drum: What do we have to look forward to from Ben Bernanke's second term as chairman of the Fed? The New York Times asked a bunch of economists for their predictions. Here's Mark Thoma:
My worry is that as time passes, we'll forget how bad things were and the desire to impose necessary new regulation will fade. Here's where I think Mr. Bernanke's experience will be crucial. He was there at every step in the development of the Fed's response to the crisis and he will not soon forget the problems he faced (nor repeat his mistakes), making it more likely that he'll be a forceful and passionate advocate for new regulation before Congress. [Italics mine.]
Boy, do I hope this is true. But it strikes me as woefully wishful thinking. One of the reasons I opposed reappointing Bernanke is that I'd like to have someone running the Fed who's serious about reregulating the financial industry, both at a macro and a consumer level. ...

Still, I remain hopeful.

Update: Free Exchange also responds:

What will Ben Bernanke do?, Free Exchange: Kevin Drum is collecting predictions about Ben Bernanke's second term. Here's Mark Thoma, for instance:
He was there at every step in the development of the Fed's response to the crisis and he will not soon forget the problems he faced (nor repeat his mistakes), making it more likely that he'll be a forceful and passionate advocate for new regulation before Congress. ...
Now, no Fed chairman (or potential Fed chairman) can or will pre-commit themselves to specific policy actions before they're nominated (nor should we want them to, given the importance of Fed independence). At the same time, nomination is the one time that political actors get some kind of say over what they want in a Fed chairperson. It therefore seems like it might be a good idea to ask what a nominee's priorities are ahead of time. ...
In other words, it shouldn't be unclear whether Mr Bernanke is going to forcefully advocate for needed regulatory changes. And maybe it isn't unclear to the president. But there's not necessarily any reason we ought to be flying blind with respect to the chairman's views on issues that will be hugely important during his second term. ...

Update: Tim Duy emails:

Bernanke will run away from financial reform if it means the risk of exposing the Fed to enhanced GAO oversight. And maybe he should.

[End updates]

Here's Thomas Palley's view of Bernanke's reappointment. Thomas is, you will recall, a "heterodox economist" so it's not surprising that most of his criticism is directed at the profession itself rather than at Bernanke (much of which is in the full version of the article). Unfortunately, heterodox economists didn't do any better than mainstream economists at foreseeing and warning about the crisis. Thus, while I agree that new thinking and change is needed to prevent problems in the future, it's not clear that his call to open the Fed to "alternative economic views" would have done anything to help to prevent the problems we are having:

One Hand Clapping for Bernanke, by Thomas I. Palley, Commentary, Project Syndicate: President Barack Obama's nomination of Ben Bernanke to a second term as chairman of the U.S. Federal Reserve represents a sensible and pragmatic decision, but it is nothing to celebrate. Instead, it should be an occasion for reflection on the role of ideological groupthink among economists, including Bernanke, in contributing to the global economic and financial crisis. The decision to nominate Bernanke is sensible on two counts. First, the U.S. and global economies remain mired in recession. Though the crisis may be over in the sense that outright collapse has been avoided, the economy remains vulnerable. As such, it makes sense not to risk a shock to confidence that could trigger a renewed downturn. Second, Bernanke is the best among his peers. He did eventually come to understand the nature and severity of the crisis, and then took decisive steps that contributed to halting the economic freefall. That record, combined with doubts that any of his peers would have done better, means replacing him with another mainstream candidate makes little sense. These two factors justify Bernanke's reappointment, but the faintness of praise is indicative of the deeper problems that his leadership has exposed. Those problems concern the state of economics and economic policy advice. One such problem is Wall Street's implicit veto over the Fed. After all, a major reason for reappointing Bernanke is to avoid rocking financial markets. ... In effect, financial markets have established an implicit veto over much of economic policy and the people who can hold top policymaking positions, and it is time to think how we can escape that hold. A second problem concerns the state of economics. Though Bernanke may be the best in his peer group, the fact is that the economic crisis decisively proved him and his peers to have been wrong. ... Though circumstances dictate that Bernanke is the best candidate and should be reappointed, the real challenge is to ensure a thorough intellectual housecleaning at the Fed in order to open space for alternative economic views. The great danger is that reappointing Bernanke will be interpreted as a green flag for a flawed status quo. That is where public debate and Bernanke's Senate confirmation hearings enter the picture. Those hearings should be an occasion for critical examination of what went wrong, and why. If that happens, Bernanke's reappointment can serve as a trigger for constructive change rather than an endorsement of a discredited paradigm.


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