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December 18, 2009

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Latest Posts from Economist's View

Paul Krugman: Pass the Bill

Posted: 18 Dec 2009 12:42 AM PST

The health care reform bill is nowhere near perfect, but it's still worth passing:

Pass the Bill, by Paul Krugman, Commentary, NY Times: A message to progressives: By all means, hang Senator Joe Lieberman in effigy. Declare that you're disappointed in and/or disgusted with President Obama. Demand a change in Senate rules that, combined with the Republican strategy of total obstructionism, are in the process of making America ungovernable.
But meanwhile, pass the health care bill.
Yes, the filibuster-imposed need to get votes from "centrist" senators has led to a bill that falls a long way short of ideal. Worse, some of those senators seem motivated largely by a desire to protect the interests of insurance companies — with the possible exception of Mr. Lieberman, who seems motivated by sheer spite.
But let's all take a deep breath, and consider just how much good this bill would do, if passed — and how much better it would be than anything that seemed possible just a few years ago. With all its flaws, the Senate health bill would be the biggest expansion of the social safety net since Medicare, greatly improving the lives of millions. Getting this bill would be much, much better than watching health care reform fail.
At its core, the bill would do two things. First,... Americans could no longer be denied health insurance because of a pre-existing condition, or have their insurance canceled when they get sick. Second, the bill would provide substantial financial aid to those who don't get insurance through their employers, as well as tax breaks for small employers that do provide insurance.
All of this would be paid for in large part with the first serious effort ever to rein in rising health care costs.
The result would be a huge increase in the availability and affordability of health insurance, with more than 30 million Americans gaining coverage, and premiums for lower-income and lower-middle-income Americans falling dramatically. That's an immense change from where we were just a few years ago: remember, not long ago the Bush administration and its allies in Congress successfully blocked even a modest expansion of health care for children.
Bear in mind also the lessons of history: social insurance programs tend to start out highly imperfect and incomplete, but get better and more comprehensive as the years go by. Thus Social Security originally had huge gaps in coverage — and a majority of African-Americans, in particular, fell through those gaps. But it was improved over time, and it's now the bedrock of retirement stability for the vast majority of Americans. ...
Whereas flawed social insurance programs have tended to get better over time, the story of health reform suggests that rejecting an imperfect deal in the hope of eventually getting something better is a recipe for getting nothing at all. Not to put too fine a point on it, America would be in much better shape today if Democrats had cut a deal on health care with Richard Nixon, or if Bill Clinton had cut a deal with moderate Republicans back when they still existed. ...
Beyond that, we need to take on the way the Senate works. The filibuster, and the need for 60 votes to end debate, aren't in the Constitution. They're a Senate tradition, and that same tradition said that the threat of filibusters should be used sparingly. Well, Republicans have already trashed the second part of the tradition: look at a list of cloture motions over time, and you'll see that since the G.O.P. lost control of Congress it has pursued obstructionism on a literally unprecedented scale. So it's time to revise the rules.
But that's for later. Right now, let's pass the bill that's on the table.

Reaching into Bank Executives' (Deep) Pocketbooks Motivates Action

Posted: 18 Dec 2009 12:06 AM PST

Daniel Gross says the threat of restrictions on how much executives can be paid has motivated banks subject to the limits to "get their houses in order":

It's Payback Time!, by Daniel Gross: One of the main criticisms of the massive bank bailouts was that the Feds didn't get sufficiently medieval on bank shareholders, including top executives who owned big chunks of stock. ... And yet, by design or dumb luck, it turns out that the government did have one powerful stick that has pushed banks and their shareholders to reform themselves sooner rather than later: the ability to regulate banks' compensation. ...
From the outset, healthy banks were eager to get out from under the TARP because they wanted to avoid discussions about appropriate levels of executive compensation. The investment banks that were capable of paying back did so in June, the month when lawyer Kenneth Feinberg was appointed as TARP's special master for executive compensation. Coincidence?
In October, Feinberg issued compensation guidelines for the companies receiving special assistance... That, and the approach of the bonus season, lit a fire under executives at the largest remaining TARP recipients. ... They cut costs, shrank their balance sheets, and raised capital from new investors.
Look what's happened in the past two weeks. First, Bank of America agreed to pay back $45 billion in TARP funds. Bank of America found that the pay restrictions were complicating the search for a new boss to replace Ken Lewis. It raised $20 billion from the public and agreed to sell $3 billion in assets. The smaller, leaner, better-capitalized bank was able to hire a new CEO on Wednesday.
Citigroup ... also sprang into action. Earlier this week, it announced it would pay back $20 billion in TARP funds... Citi raised $20.5 billion of capital, said it would give employees $1.7 billion in stock rather than cash for bonuses. Once the money was paid back to the Treasury, Citi noted, "it will no longer be deemed to be a beneficiary of ... TARP..." Translation: Ken Feinberg won't be allowed to tell us how much to pay our folks. Because of its desire to get out from under such scrutiny, Citi has aggressively cut costs (by $15 billion annually), shed assets, and vastly improved its capital position. ...
Also this week, Wells Fargo announced it would repay $25 billion in TARP funds by selling $10.4 billion of stock and selling off assets. It, too, will be a smaller, leaner, better-capitalized bank.
Among the three, that's $90 billion in repayments to the taxpayers in a week and more than $50 billion raised from the public. Of course, these offerings came at a cost. The banks essentially created new shares... They diluted existing shareholders, which is what is supposed to happen when companies suffer losses and need to raise capital. And because of these offerings, future earnings will be spread across a much larger share base. As ... much as anything else, the threat of the government having limiting bankers' compensation spurred the banks to get their houses in order.

links for 2009-12-17

Posted: 17 Dec 2009 11:02 PM PST

"On Partial Equilibrium Models of Demand and Supply"

Posted: 17 Dec 2009 01:29 PM PST

The debate (here too) over whether reducing nominal wages (in particular, the minimum wage) would generate jobs continues:

On Partial Equilibrium Models of Demand and Supply, by Rajiv Sethi: My last post on the aggregate demand effects of changes in nominal wages has attracted some attention, so I'd like to clarify a couple of things.
It was not the point of the post to claim that declines in nominal wages would lower or increase aggregate demand. The point was to argue that the simple partial equilibrium models of demand and supply that were being used by some to address the question were simply not up to the task of answering it. It was a reaction against the view -- expressed by Bryan Caplan and endorsed by Tyler Cowen -- that such effects could easily be deduced from textbook microeconomic theory. And it was a plea to move beyond partial equilibrium analysis in addressing such questions.
Tyler Cowan responded to this with yet another partial equilibrium model of supply and demand:
Graph a monopolist and shift the marginal cost curve down. Watch what happens. The first main paragraph of Sethi simply doesn't consider this mechanism but rather it assumes that changes at the margin don't matter.
That was in the comments section of Mark Thoma's blog. A similar claim now appears on his own page:
There is a simple story here.  Lower the minimum wage and firms with market power will in general hire more labor.  (Sethi's critique refuses to consider that mechanism but simply shift the MC curve and watch it happen.)
By all means, shift the MC curve and watch what happens. But please keep in mind not a single firm but a population of firms, some of which do not pay minimum wage at all. And be sure to shift the demand functions for all firms producing goods and services that minimum wage workers currently purchase. And now tell me whether it is self-evident that aggregate demand will rise in response to a decline in nominal wages.

It is not self-evident. In order to address the question it is necessary at a minimum to work with a model with multiple firms, in which the expenditure patterns from wage and capital income are properly specified, and some alternatives to immediate consumption (such as financial assets) exist. Simulate this model on a computer if you like, and watch what happens. I would be interested to know. But please don't make definitive claims about aggregate demand effects of changes in nominal wages based on an introductory textbook model that is simply incapable of carrying the weight.

Andrew Gelman is puzzled by all of this:

Lowering the minimum wage, by Andrew Gelman: Paul Krugman asks, "Would cutting the minimum wage raise employment?" The macroeconomics discussion is interesting, if over my head.

But, politically, of course nobody's going to cut the minimum wage. Can you imagine the unpopularity of a minimum wage cut during a recession? I can't imagine that all the editorial boards of all the newspapers in the country could convince a majority of Congress to vote for this one, whatever its economic merits.

Which makes me wonder why the idea is being discussed at all. Is it an attempt to shoot down a minimum wage increase that might be in the works? Krugman mentions that Serious People are proposing a minimum wage cut, but he doesn't mention who those Serious People are. I can't imagine that they're serious about thinking this might happen.

P.S. Mark Thoma links to more on the topic from Rajiv Sethi and Tyler Cowen.

P.P.S. I posted this at the sister blog to see if anyone could tell me how anyone could be considering minimum wage cuts as a serious political option. Nobody bit, but Tom Beecroft wrote that "it's a theoretical economics argument, rather than a political reality argument." That makes sense, but it still seems to me that something more is going on here than a dispute over pure theory. As a political scientist, it just seems funny for me to see people debating a policy that has no chance of being implemented. There must be something else going on here.

In the background is a more general and long-standing argument about whether falling wages is a good thing or a bad thing when an economy is in a deep recession. For example, this is Krugman back in May of this year:

Falling Wage Syndrome, by Paul Krugman, Commentary, NY Times: Wages are falling all across America. Some of the wage cuts, like the givebacks by Chrysler workers, are the price of federal aid. Others, like the tentative agreement on a salary cut here at The Times, are the result of discussions between employers and their union employees. Still others reflect the brute fact of a weak labor market: workers don't dare protest when their wages are cut, because they don't think they can find other jobs.

Whatever the specifics, however, falling wages are a symptom of a sick economy. And they're a symptom that can make the economy even sicker. ...

Not everyone believes that falling wages make an economy sicker, some people generally believe that falling wages are a necessary part of the adjustment process, and that falling wages would speed the adjustment to shocks. This group also believes that any attempt to support wages makes things worse (which is the heart of the debate where the minimum wage is concerned). Here's more from Krugman from November 2008:

Not much point in going through Amity Shlaes's latest: after having inadvertently revealed that she has no idea what Keynesian economics is, she's back on the warpath against FDR, and me. The main line of empirical argument seems to be that FDR didn't succeed in ending the Great Depression. Since that's also what my side of the debate says — fiscal expansion was too cautious, and disastrously abandoned in 1937 — I don't see what this is supposed to prove.

But I think it's worth pointing out why Ms. Shlaes thinks the New Deal was destructive of employment: namely, that it raised wages. Funny she should mention that — because the effect of wage changes on employment was the subject of a whole chapter in Keynes's General Theory.

And what Keynes had to say then is as valid as ever: under depression-type conditions, with short-term interest rates near zero, there's no reason to think that lower wages for all workers — as opposed to lower wages for a particular group of workers — would lead to higher employment. ...

Update: More from Paul Krugman: Dining room tables and minimum wages.

[In the above, I should have also added that the continuing debate over the effect that the minimum wage has on employment -- which is always spirited -- is also part of the reason this topic is receiving so much attention.]

Ben Bernanke's Final Exam

Posted: 17 Dec 2009 10:31 AM PST

Ben Bernanke answers some questions:

Sen. Vitter Presents End-of-Term Exam For Bernanke, by Sudeep Reddy, WSJ: Earlier this month, Real Time Economics presented questions from several economists for the confirmation hearing of Federal Reserve Chairman Ben Bernanke.  Many of the questions were addressed at the hearing, though not always directly. Sen. David Vitter (R., La.) submitted them in writing and received the  responses from Bernanke, along with his own other questions.  We offer them here.
The Wall Street Journal reported on some questions that different economists felt that you should answer. Let me borrow from some of those and I will credit them with their questions accordingly:
A. Anil Kashyap, University of Chicago Booth Graduate School of Business: With the unemployment rate hovering around 10%, the public seems outraged at the combination of three things: a) substantial TARP support to keep some firms alive, b) allowing these firms to pay back the TARP money quickly, c) no constraints on pay or other behavior once the money was repaid. Was it a mistake to allow b) and/or c)?
TARP capital purchase program investments were always intended to be limited in duration. Indeed, the step-up in the dividend rate over time and the reduction in TARP warrants following certain private equity raises were designed to encourage TARP recipients to replace TARP funds with private equity as soon as practical. As market conditions have improved, some institutions have been able to access new sources of capital sooner than was originally anticipated and have demonstrated through stress testing that they possess resources sufficient to maintain sound capital positions over future quarters. In light of their ability to raise private capital and meet other supervisory expectations, some companies have been allowed to repay or replace their TARP obligations. No targeted constraints have been placed on companies that have repaid TARP investments. However, these companies remain subject to the full range of supervisory requirements and rules. The Federal Reserve has taken steps to address compensation practices across all firms that we supervise, not just TARP recipients. Moreover, in response to the recent crisis, supervisors have undertaken a comprehensive review of prudential standards that will likely result in more stringent requirements for capital, liquidity, and risk management for all financial institutions, including those that participated in the TARP programs.
B. Mark Thoma, University of Oregon and blogger: What is the single, most important cause of the crisis and what s being done to prevent its reoccurrence? The proposed regulatory structure seems to take as given that large, potentially systemically important firms will exist, hence, the call for ready, on the shelf plans for the dissolution of such firms and for the authority to dissolve them. Why are large firms necessary? Would breaking them up reduce risk?
The principal cause of the financial crisis and economic slowdown was the collapse of the global credit boom and the ensuing problems at financial institutions, triggered by the end of the housing expansion in the United States and other countries. Financial institutions have been adversely affected by the financial crisis itself, as well as by the ensuing economic downturn.
This crisis did not begin with depositor runs on banks, but with investor runs on firms that financed their holdings of securities in the wholesale money markets. Much of this occurred outside of the supervisory framework currently established. An effective agenda for containing systemic risk thus requires elimination of gaps in the regulatory structure, a focus on macroprudential risks, and adjustments by all our financial regulatory agencies.
Supervisors in the United States and abroad are now actively reviewing prudential standards and supervisory approaches to incorporate the lessons of the crisis. For our part, the Federal Reserve is participating in a range of joint efforts to ensure that large, systemically critical financial institutions hold more and higher-quality capital, improve their risk-management practices, have more robust liquidity management, employ compensation structures that provide appropriate performance and risk-taking incentives, and deal fairly with consumers. On the supervisory front, we are taking steps to strengthen oversight and enforcement, particularly at the firm-wide level, and we are augmenting our traditional microprudential, or firm-specific, methods of oversight with a more macroprudential, or system-wide, approach that should help us better anticipate and mitigate broader threats to financial stability.
Although regulators can do a great deal on their own to improve financial regulation and oversight, the Congress also must act to address the extremely serious problem posed by firms perceived as "too big to fail." Legislative action is needed to create new mechanisms for oversight of the financial system as a whole. Two important elements would be to subject all systemically important financial firms to effective consolidated supervision and to establish procedures for winding down a failing, systemically critical institution to avoid seriously damaging the financial system and the economy.
Some observers have suggested that existing large firms should be split up into smaller, not-toobig- to-fail entities in order to reduce risk. While this idea may be worth considering, policymakers should also consider that size may, in some cases, confer genuine economic benefits. For example, large firms may be better able to meet the needs of global customers. Moreover, size alone is not a sufficient indicator of systemic risk and, as history shows, smaller firms can also be involved in systemic crises. Two other important indicators of systemic risk, aside from size, are the degree to which a firm is interconnected with other financial firms and markets, and the degree to which a firm provides critical financial services. An alternative to limiting size in order to reduce risk would be to implement a more effective system of macroprudential regulation. One hallmark of such a system would be comprehensive and vigorous consolidated supervision of all systemically important financial firms. Under such a system, supervisors could, for example, prohibit firms from engaging in certain activities when those firms lack the managerial capacity and risk controls to engage in such activities safely. Congress has an important role to play in the creation of a more robust system of financial regulation, by establishing a process that would allow a failing, systemically important non-bank financial institution to be wound down in an orderly fashion, without jeopardizing financial stability. Such a resolution process would be the logical complement to the process already available to the FDIC for the resolution of banks.
C. Simon Johnson, Massachusetts Institute of Technology and blogger: Andrew Haldane, head of financial stability at the Bank of England, argues that the relationship between the banking system and the government (in the U.K. and the U.S.) creates a "doom loop" in which there are repeated boom-bust-bailout cycles that tend to get cost the taxpayer more and pose greater threat to the macro economy over time. What can be done to break this loop?
The "doom loop" that Andrew Haldane describes is a consequence of the problem of moral hazard in which the existence of explicit government backstops (such as deposit insurance or liquidity facilities) or of presumed government support leads firms to take on more risk or rely on less robust funding than they would otherwise. A new regulatory structure should address this problem. In particular, a stronger financial regulatory structure would include: a consolidated supervisory framework for all financial institutions that may pose significant risk to the financial system; consideration in this framework of the risks that an entity may pose, either through its own actions or through interactions with other firms or markets, to the broader financial system; a systemic risk oversight council to identify, and coordinate responses to, emerging risks to financial stability; and a new special resolution process that would allow the government to wind down in an orderly way a failing systemically important nonbank financial institution (the disorderly failure of which would otherwise threaten the entire financial system), while also imposing losses on the firm's shareholders and creditors. The imposition of losses would reduce the costs to taxpayers should a failure occur.
D. Brad Delong, University of California at Berkeley and blogger: Why haven't you adopted a 3% per year inflation target?
The public's understanding of the Federal Reserve's commitment to price stability helps to anchor inflation expectations and enhances the effectiveness of monetary policy, thereby contributing to stability in both prices and economic activity. Indeed, the longer-run inflation expectations of households and businesses have remained very stable over recent years. The Federal Reserve has not followed the suggestion of some that it pursue a monetary policy strategy aimed at pushing up longer-run inflation expectations. In theory, such an approach could reduce real interest rates and so stimulate spending and output. However, that theoretical argument ignores the risk that such a policy could cause the public to lose confidence in the central bank's willingness to resist further upward shifts in inflation, and so undermine the effectiveness of monetary policy going forward. The anchoring of inflation expectations is a hard-won success that has been achieved over the course of three decades, and this stability cannot be taken for granted. Therefore, the Federal Reserve's policy actions as well as its communications have been aimed at keeping inflation expectations firmly anchored.

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