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March 12, 2010

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Latest Posts from Economist's View

"Fed Vacancies and the Monetary Challenge"

Posted: 12 Mar 2010 12:30 PM PST

Having made the same points, I have no choice but to agree:

Fed Vacancies and the Monetary Challenge, by Alan S. Blinder, Commentary, WSJ: ...Federal Reserve Vice Chairman Donald Kohn's recent announcement that he will retire in June will bring the Federal Reserve Board down to four members—unless the Obama administration gets some new members in place by then. Recent history is not propitious. While the law states that the board has seven governors, vacancies have become the norm in recent decades. ... Let's hope Mr. Obama breaks that pattern—soon.
Why? Because ... Chairman Ben Bernanke and his four (soon to be three) colleagues, along with the presidents of the 12 district Reserve Banks, face two enormously complex and consequential sets of decisions. One has to do with the Fed's exit from its hyper-expansionary monetary policies—a process that is just beginning. The other pertains to the post-crisis regulatory system—provided Congress keeps the Fed in that business.
Each of these two areas is replete with hazards and numerous questions... And in each, mistakes can be quite consequential. As the Fed grapples with its many difficult decisions..., it would be nice if the estimable Mr. Bernanke were supported by a full, talented team. ...
That said, the Fed is formulating exit plans... Doing so adroitly will require both consummate technical skills and good seat-of-the-pants judgments. Yet, remarkably, once Vice Chairman Kohn retires, the Federal Reserve Board will be down to just one ... trained economist. That member, of course, is a very talented guy named Bernanke. But not even Derek Jeter carries the Yankees alone.
So it is imperative that President Obama appoint two distinguished and knowledgeable economists to the board as soon as possible. Such talent is often found in academia..., but that is not the only source. In selecting nominees, the president should be mindful ... that ... the Federal Open Market Committee ... is, on average, pretty hawkish. Mr. Obama will, I believe, want to create more balance.
The Fed's second big task will be creating and adapting to the new financial regulatory system. The ... Fed must be prepared for either of two challenging contingencies. If a major financial-reform bill passes, the Fed will likely have to reorganize itself and, in concert with other agencies, write scores of rules and regulations to implement the new regulatory framework. The other possibility is that no legislation passes. Since maintaining the regulatory status quo ante is unthinkable, the Fed and other agencies would then have to think through and promulgate dozens of regulatory changes that fall within their existing authority...
In either case, the Fed has a major regulatory job ahead of it. Economics will be useful here, too. But ... economists who would be most helpful on monetary policy will probably have little expertise on financial regulation. So President Obama would be wise to use one of his three nominations for someone deeply experienced in banking or financial regulation. Having three vacancies ... gives the president the luxury of being able to hire a diversified portfolio of talented people.
One last but important point: Confirmations of Federal Reserve governors have not traditionally been political events. ... Fed nominees are rarely highly political people. That's a tradition that both parties should cherish and nurture. ... Senate Republicans should refrain from turning his nominations into a political circus. Well, a man can hope, can't he?

It looks like there may finally be some action on this issue:

Report: Yellen to Fed vice-chair, by Tracy Alloway, FT Alphaville: Janet Yellen, president of the Federal Reserve Bank San Francisco, has been chosen by US president Barack Obama to replace Donald Kohn as vice chairman of the central bank, Bloomberg reports, citing two people with knowledge of nomination process. The selection is "pending completion of vetting by the Obama administration," Bloomberg said.

Brad DeLong says "A very good person for the job. Not, however, a good move as far as strengthening the FOMC is concerned..." I also think Yellen is a very good choice, and if the new president at the SF Fed is chosen wisely, the FOMC will be improved over its present composition.

Paul Krugman: Health Reform Myths

Posted: 12 Mar 2010 12:36 AM PST

Don't believe the "three big myths" about health care reform:

Health Reform Myths, by Paul Krugman, Commentary, NY Times: Health reform is back from the dead. Many Democrats have realized that their electoral prospects will be better if they can point to a real accomplishment. Polling on reform — which was never as negative as portrayed — shows signs of improving. And I've been really impressed by the passion and energy of this guy Barack Obama. Where was he last year?
But reform still has to run a gantlet of misinformation and outright lies. So let me address three big myths about the proposed reform...
The first of these myths, which has been all over the airwaves lately, is the claim that President Obama is proposing a government takeover of one-sixth of the economy, the share of G.D.P. currently spent on health.
Well,.... Medicare, Medicaid, and other government programs already pay for almost half of American health care, while private insurance pays for barely more than a third (the rest is mostly out-of-pocket expenses). And the great bulk of that private insurance is provided via employee plans, which are both subsidized with tax exemptions and tightly regulated.
The only part of health care in which there isn't already a lot of federal intervention is the market in which individuals who can't get employment-based coverage buy their own insurance. And that market ... is a disaster — no coverage for people with pre-existing medical conditions, coverage dropped when you get sick, and huge premium increases in the middle of an economic crisis. It's this sector, plus the plight of Americans with no insurance at all, that reform aims to fix. What's wrong with that?
The second myth is that the proposed reform does nothing to control costs. To support this claim, critics point to reports by the Medicare actuary... The actuary's assessment of the Senate bill ... finds that it would raise total health care spending by less than 1 percent, while extending coverage to 34 million Americans... That's a large expansion in coverage at an essentially trivial cost.
And it gets better ... further into the future: the Congressional Budget Office has just concluded, in a new report, that the arithmetic of reform will look better in its second decade than it did in its first.
Furthermore, there's good reason to believe that all such estimates are too pessimistic. ... Realistically, health reform is likely to do much better at controlling costs than any of the official projections suggest.
Which brings me to the third myth: that health reform is fiscally irresponsible. How can people say this given Congressional Budget Office predictions — which, as I've already argued, are probably too pessimistic — that reform would actually reduce the deficit? Critics argue that ... when cost control actually starts to bite on Medicare,... Congress will back down.
But this isn't an argument against Obamacare, it's a declaration that we can't control Medicare costs no matter what. And it also flies in the face of history: contrary to legend, past efforts to limit Medicare spending have in fact "stuck"...
So what's the reality of the proposed reform? Compared with the Platonic ideal of reform, Obamacare comes up short. If the votes were there, I would much prefer to see Medicare for all.
For a real piece of passable legislation, however, it looks very good. It wouldn't transform our health care system; in fact, Americans whose jobs come with health coverage would see little effect. But it would make a huge difference to the less fortunate among us, even as it would do more to control costs than anything we've done before.
This is a reasonable, responsible plan. Don't let anyone tell you otherwise.

links for 2010-03-11

Posted: 11 Mar 2010 11:02 PM PST

"On Asymmetry, Reflexivity and Sovereign Default"

Posted: 11 Mar 2010 02:00 PM PST

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Rajiv Sethi draws a connection between reflexivity theory, risk/reward asymmetry, and the question of whether naked credit default swaps should be restricted:

On Asymmetry, Reflexivity and Sovereign Default, by Rajiv Sethi: One of the most rewarding aspects of blogging is that it gives me the opportunity learn from those who read and comment on the ideas expressed here. ...Macroeconomic Resilience ... left a couple of very helpful comments in response to my recent post on credit default swaps.

MR pointed out that the idea of multiple self-fulfilling default probabilities plays a key role in George Soros' theory of reflexivity, and linked to an article in which Soros interpreted the Lehman bankruptcy in precisely these terms. In fact, it is a combination of reflexivity and a particular kind of risk/reward asymmetry that gives rise to what Soros calls self-validating bear raids:...[long Soros quote]...

Soros' point about risk/reward asymmetry directly answers one objection to curtailing purchases of naked credit default swaps, namely that such contracts "provide identical leverage both to the optimistic and the pessimistic side of the transaction." Leverage may be considerable on both sides of the contract but this does not mean that market clearing prices reflect optimistic and pessimistic beliefs in equal measure, because the spreads at which sellers are willing to enter the contract must offer them adequate compensation for the significant downside risk that they face.

MR does not consider reflexivity to be a routine problem in credit markets, arguing that "only when the entity is in a state of low resilience that markets are sufficiently reflexive to push it over the edge." This is also David Merkel's view of the matter:

... if a company or government has a strong balance sheet, and has a lot of cash or borrowing power, there is nothing that speculators can do to harm you. You have the upper hand. But, if you have a weak balance sheet, I am sorry, you are subject to the whims of the market, including those that like to prey on weak entities. Even without derivatives, that is a tough place to be.

But what causes a balance sheet to become weak? In the case of sovereign states, it could be widespread tax avoidance and excessive spending relative to revenues, as has been alleged in the case of Greece. But it could also be a significant decline in economic activity that reduces the tax base and triggers automatic stabilizers. This is how Paul Krugman interprets the experience of Spain, which had a budget surplus three years ago, but "is running huge deficits now [as] a consequence, not a cause, of the crisis: revenue has plunged, and the government has spent some money trying to alleviate unemployment."

Any attempt to raise taxes or cut spending in this environment could make it even harder for the country to meet its near term debt obligations. ... As a result, raising tax rates or trimming expenditures (such as unemployment benefits) in the face of severe deficiencies in aggregate demand can worsen rather than improve its balance sheet position.

Under such circumstances, it is terribly important to determine whether the looming threat of default is simply one of several possible equilibrium paths. As Felix acknowledged in his response to my post, it is true in principle that "a company or country can find it easy to repay debt when spreads are low, thereby justifying the low spreads, while finding it hard to repay debt when spreads are high, justifying the high spreads." Default under these conditions would be terribly wasteful, and I can see no reason why attempts to avoid it should not be pursued vigorously.

Paul Krugman also discusses "the possibility of multiple equilibria in sovereign solvency."

Is This the Best Congress Can Do for the Unemployed?

Posted: 11 Mar 2010 10:02 AM PST

Why are they calling this a jobs bill? There are hardly any job creation measures in it:

Jobless claims bill OK'd by Senate, by Tami Luhby, The Senate on Wednesday approved ... by a 62-36 vote ... the latest job creation effort to go before lawmakers, though it contains virtually no new initiatives to boost employment. Its price tag has wavered between $140 billion and $150 billion, which is partially offset. Its next stop is the House, where a quick passage is anything but assured. ...
Lawmakers have come under pressure from both the White House and unemployed Americans to do more to spur hiring. But after many speeches, officials have enacted little to help the nearly 15 million looking for work. ...
The bill passed Wednesday would push back the deadline to file for extended jobless benefits and the federal subsidy for COBRA health insurance until Dec. 31. ...
The measure would also extend dozens of tax provisions -- including allowing teachers to deduct education expenses and providing businesses a research and development credit -- that expired at the end of last year. ...
It would also temporarily halt a 21% reduction in Medicare physician reimbursement rates. And it would send another $25 billion to the states to help them fund their Medicaid programs for another six months.
The bill also extends two Recovery Act provisions for small businesses. It provides $354 million to continue funding the increased Small Business Administration guarantee and fee waiver through year's end.
Next up is a $15 billion bill that would:
--Exempt employers from Social Security payroll taxes on new hires who were unemployed.
--Fund highway and transit programs through 2010.
--Extend a tax break for business that spend money on capital investments, such as equipment purchases.
--Expand the use of the Build America Bonds program, which helps states and municipalities fund capital construction projects. ...

Even if every measure that has been proposed passes, it won't have much of an impact on jobs. Congress ought to be embarrassed by this effort, it's not even close to what is needed, but come election time, I have no doubt that they'll brag about how they stepped up to the plate in a time of need. What they won't tell you is that they struck out -- looking -- and lost the game.

[Dual posted at MoneyWatch]

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