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June 5, 2010

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"State and Local Governments Continuing to Lose Jobs"

Posted: 05 Jun 2010 02:43 AM PDT

State and local governments could use more help:

State and Local Governments Continuing to Lose Jobs, Off the Charts: States and localities cut 22,000 jobs in the past month, wiping out half the month's gain in private-sector jobs... In total, state and local governments have cut 231,000 jobs, including 100,000 local education jobs, since the summer of 2008.

State-local
[click to enlarge]

This is a problem for the economy as a whole, because local businesses suffer when teachers and others don't have paychecks to spend. These new figures are further evidence that Congress needs to include aid to states in its upcoming jobs bill...

This is a no brainer, but Congress hasn't done anywhere near enough to help so far, and it is unlikely to do so now even for the "low hanging fruit". I think one of the lessons of the crisis is that we need to develop better mechanisms to prevent state and local government from magnifying the effects of crises. The balanced budget requirements that that most state and local government operate under cause them to decrease demand at a time when they should be boosting it.

It Wasn't Fannie, Freddie, or the CRA

Posted: 05 Jun 2010 02:40 AM PDT

I've written the CRA and Fannie/Freddie rebuttals so many times over the last few years, e.g. see here and here, and it just came up here, that it seems repetitive to take it up yet again. But it doesn't seem to want to go away, so one more time, with gusto:

The Sarah Palinization of the financial crisis, by Edmund L. Andrews: Of all the canards that have been offered about the financial crisis, few are more repellant than the claim that the "real cause'' of the mortgage meltdown was blacks and Hispanics.
Oh, excuse me -- did I just accuse someone of racism? Sorry. Proponents of the above actually blame the crisis on "government policy'' to boost home-ownership among low-income families, who just happened to be disproportionately non-white and immigrant. Specifically, the Community Reinvestment Act "forced'' banks to make bad loans to irresponsible borrowers, while Fannie Mae and Freddie Mac provided the financial torque by purchasing billions worth of subprime paper.
The argument has been discredited time and again, shriveling up almost as soon as it's exposed to sunlight. But it keeps coming back, mainly because the anti-government narrative gives Republicans a way to deflect allegations that de-regulation allowed Wall Street to run wild. It's the financial version of Sarah Palin's new line that "extreme environmentalists" caused the BP oil spill. ...
But far more outrageous is this working paper, which Bruce Bartlett brought to my attention, published last month by no less an authority than the World Bank. What galls me ... is that the World Bank would cloak a piece of political drivel with fixings of a serious economic analysis. Written by David G. Tarr,... the paper says Wall Street and the banks were led by the government like lambs to the slaughter. ...
But none of the devil-made-me-do-it arguments is new, and none of them is true. The Federal Reserve analyzed the Community Reinvestment Act in 2008, and emphatically concluded that it had nothing to do with the explosion of hallucinogenic mortgage lending. ...
What makes this smear so repellent is that it blames poor people – mostly minorities – for bringing on the crisis. But what makes it so maddening is that it's so demonstrably false. We have reams of evidence that banks and mortgage lenders actively targeted blacks, Hispanics and other immigrant groups for reckless loans. The lenders weren't forced. They were making a fortune.
An almost equally unforgivable lie is that Fannie and Freddie caused the subprime meltdown. ... Fannie and Freddie weren't driving the market. They were scrambling to keep up with private mortgage securitizers.
As Krugman shows, Fannie and Freddie were largely sidelined during the heyday of the subprime market, partly because they were doing penance for their prior accounting scandals. Fannie and Freddie's market share in securitizations slumped from 2004 until 2007. By contrast, the market share of private issuers soared. ... Fannie and Freddie ... pushing their private sector rivals to roll the dice. They were late to the craps table and desperately trying to make up for lost time.

Things are Different at the Zero Bound

Posted: 05 Jun 2010 02:34 AM PDT

Here's a summary of a recent exchange with Tyler Cowen and Scott Sumner:

1. Tyler Cowen says that (New) Keynesians such as DeLong, Krugman, and Thoma advocate fiscal policy, but he thinks monetary policy is a better choice.

2. I respond by saying that monetary policy suffers from time-consistency problems that fiscal policy does not have, and that's one of the reasons I prefer fiscal policy. There are ways to revive monetary policy, but they are uncertain. I then note that fiscal policy has uncertainties too, and therefore my choice is not to rely exclusively on either policy tool, instead we should pursue both types of policies.

3. Scott Sumner responds by saying fiscal policy has problems too.

4. I respond by noting that the problems he is talking about are not problems in the model I am using. They may be problems in other models, and other people are free to use those models if they think they are better, but that does not change the fact that within the class of models I am using the problems are not present.

5. Scott Sumner responds by saying he was using a different model, one he made up on the spot yesterday when writing the original post. Unfortunately, the model in the original post is buried in a large amount of text, and the point being made is not as clear as it might have been (in response to one of his complaints, it's not always the reading that's the problem).

Using a different model is fine. I've already noted that the models I have been using have their problems, and that there can be a legitimate debate over what type of model is best. But at some point you have to commit to a specific model and use it to answer your questions, one that has hopefully been carefully specified and thoroughly investigated, and that does not change daily. Full awareness of the model's weak spots and limitations should be used to qualify the answers you give, but you cannot avoid committing to a model of some sort. The policy advice I have been advocating is based upon these models and is fully consistent with them. That doesn't mean that other models won't give different answers, but those aren't the models I am using.

Now, assuming I've unearthed it correctly, let me turn to Scott's specific objection. One way to impose Scott's objection on the models I am using is to assume the Fed is a strict inflation targeter, i.e. that it never let's the price level deviate from target if there is any way at all to avoid doing so (so inflation is always zero in the model unless the zero bound for the nominal interest rate gets in the way). I base this interpretation on the following statement Scott made in a follow-up to his original post:

if people begin to believe the Fed intends to keep core inflation at 1% per year for the next 10 years, there really isn't much fiscal policy can do. 

Here's Woodford's description of what happens in this case during normal times, i.e. when the Fed pursues a strict inflation target and the interest rate is above zero:

As an example of another simple hypothesis about monetary policy, suppose that the central bank maintains a strict inflation target, regardless of the path of government purchases. (For conformity with the assumption made above about the long-run steady state, suppose that the inflation target is zero.) In the case of the Calvo model of price adjustment,... maintaining a zero inflation rate each period requires that pt = Pt each period... [U]nder this policy, aggregate output Yt will be the same function of Gt as in the case of flexible prices, and the multiplier will be given by (1.7). Again, this result does not depend on the precise details of the Calvo model of price adjustment. ...

Equation 1.7 is the multiplier in the classical model with full price adjustment, and it is necessarily less than one. So if the Fed is a strict inflation targeter and prices are sticky, the result is the same as if prices are fully flexible. Thus, under strict inflation targeting fiscal policy will not be very effective in times when the interest rate is above zero. When government spending goes up during normal times, inflation increases, and sharp increases in the real interest rate are needed to return inflation to its target value. The sharp increase in the real interest rate offsets the increase in output brought about by the increase in government spending, and this is what makes the multiplier small in this case. Under reasonable parametrizations, there "really isn't much fiscal policy can do."

[More particularly, with strict inflation targeting, the multiplier is less than one. When the Fed follows a Taylor rule instead of strict inflation targeting, the multiplier is larger, but still less than one (though not always, it could even be less than the multiplier for strict inflation targeting under some conditions). If monetary policy maintains a constant real rate instead of following a Taylor rule, the multiplier is equal to one.

This means that during normal times, sticky price models predict fiscal policy multipliers of a magnitude less than or equal to one, with the exact magnitude depending upon the rule the Fed follows, i.e. how the real interest rate responds to fiscal policy changes. These values are much like those we see from actual estimates using data from time periods when the interest rate is above the zero bound. Thus, contrary to what many people believe, estimates of multipliers less than one obtained using data from time periods where the nominal interest rate is above zero (e.g. war periods) actually support New Keynesian models.]

The results above are only applicable when the interest rate is unconstrained by the zero bound. But things change when the zero bound is a constraint (as Scott seems to acknowledge in a subsequent post). It's no longer true that fiscal policy multipliers are relatively small. In general, at the zero bound fiscal policy multipliers are greater than one, and this remains true under strict inflation targeting. Woodford explains:

Note that if, as in Eggertsson and Woodford (2003), it is assumed that the central bank pursues a strict zero inflation target as long as this is consistent with the zero lower bound, then the ... values computed here for the multipliers dYL/drL and dYL/dGL are the same under that simpler hypothesis.

The larger multiplier occurs because the increase in government spending increases inflation (more precisely it reduces the rate of deflation). If the crisis is expected to last another period with some probability, as it will in the model, then government spending is expected to persist as well and expected inflation will rise. The increase in expected inflation lowers the real interest rate when the zero bound is a constraint (even with strict inflation targeting), and the lower real interest rate generates additional economic activity.

Note that the source of the increase in expected inflation is the expected increase in government spending in the next time period. All that's required for expected inflation to rise is that fiscal policy is expected to persist another period. However, the Fed won't do anything in response to the rise in inflation expectations because under the assumptions of the model the target interest rate remains negative (and to go back to an earlier point in the discussion, the expected inflation is credible due to observable changes in fiscal policy in the present time period).

The bottom line is that despite recent claims to the contrary, when the economy is at the zero bound fiscal policy is still effective, i.e. it has a multiplier greater than one, even under strict inflation targeting.

If I've mischaracterized anyone, I'm sure I'll hear about it.

links for 2010-06-04

Posted: 04 Jun 2010 11:05 PM PDT

Stiglitz: Financial Re-Regulation and Democracy

Posted: 04 Jun 2010 03:42 PM PDT

Joe Stiglitz on financial reform legislation and the danger that the outcome will "be a sad day for democracy":

Financial Re-Regulation and Democracy, by Joseph E. Stiglitz, Commentary, Project Syndicate: It has taken ... more than three years since the beginning of the global recession brought on by the financial sector's misdeeds for the United States and Europe finally to reform financial regulation. Perhaps we should celebrate the regulatory victories in both Europe and the United States. ... But the battle – and even the victory – has left a bitter taste. ...
Banks that wreaked havoc on the global economy have resisted doing what needs to be done. Worse still, they have received support from the Fed, which ... reflects the interests of the banks that it was supposed to regulate.
This is important not just as a matter of history and accountability: much is being left up to regulators. And that leaves open the question: can we trust them? To me, the answer is an unambiguous no, which is why we need to "hard-wire" more of the regulatory framework. The usual approach – delegating responsibility to regulators to work out the details – will not suffice.
And that raises another question: whom can we trust? On complex economic matters, trust had been vested in bankers ... and in regulators... But the events of recent years have shown that bankers can make megabucks, even as they undermine the economy and impose massive losses on their own firms. Bankers have also shown themselves to be "ethically challenged." ...
We should toast the likely successes: some form of financial-product safety commission will be established; more derivative trading will move to exchanges and clearing houses...; and some of the worst mortgage practices will be restricted. Moreover, it looks likely that the outrageous fees charged for every debit transaction – a kind of tax that goes not for any public purpose but to fill the banks' coffers – will be curtailed.
But the likely failures are equally noteworthy: the problem of too-big-to-fail banks is now worse than it was before the crisis. Increased resolution authority will help, but only a little: in the last crisis, US government "blinked," failed to use the powers that it had, and needlessly bailed out shareholders and bondholders – all because it feared that doing otherwise would lead to economic trauma. As long as there are banks that are too big to fail, government will most likely "blink" again. ...
The Senate bill's provision on derivatives is a good litmus test: the Obama administration and the Fed, in opposing these restrictions, have clearly lined up on the side of big banks. If effective restrictions on the derivatives business of government-insured banks ... survive in the final version of the bill, the general interest might indeed prevail over special interests, and democratic forces over moneyed lobbyists.
But if, as most pundits predict, these restrictions are deleted, it will be a sad day for democracy – and a sadder day for prospects for meaningful financial reform.

"The Case for More Monetary Stimulus Remains"

Posted: 04 Jun 2010 12:42 PM PDT

Joseph Gagnon says further monetary ease is needed and, furthermore, it does not rely on expected future policy rates or other purely expectational effects (I've argued recently that generating such effects might be difficult to do):

Still No Exit: The Case for More Monetary Stimulus Remains Strong, by Joseph E. Gagnon: Six months ago I wrote a policy brief [pdf] in which I argued for large additional purchases of long-term bonds by the central banks of the four largest advanced economies—the United States, the euro area, Japan, and the United Kingdom—to reduce long-term interest rates. That advice remains relevant today for three of these economies. In the United Kingdom, however, policy should remain on hold pending further developments in inflation.
The European sovereign debt crisis is causing euro area and UK politicians to tighten fiscal policy faster than expected, which will weigh on economic growth, and the spillover effects also will be negative for growth in Japan and the United States. This fiscal retrenchment makes it all the more important for monetary policy to support economic recovery.
Over the past six months, forecasts of economic activity have improved noticeably in Japan, supported by exports to developing Asia. However, the improved outlook is still far below Japan's long-run sustainable economic path. Prices continue to fall in Japan so that, on balance, Japan needs monetary ease more urgently than any other economy.
Economic prospects in the euro area have been marked down from a level that was already far below potential. At the same time, core inflation fell to 0.7 percent in April,1 pointing to a dramatic undershooting of the European Central Bank's 2 percent inflation target over the next few months now that energy prices have stabilized. The need for monetary ease has greatly increased in the euro area.
Forecasts of US growth have been marked up a bit over the past six months, but this improvement is threatened by the strengthening dollar. Moreover, the Federal Reserve's latest forecast (compiled before the recent wave of bad news from Europe) continues to show unemployment far above its long-run level through the end of 2012. In addition, the news on inflation has been strikingly weak. The core consumer price index (CPI) rose only 0.9 percent in the 12 months to April and only 0.3 percent (annual rate) in the last six months. These rates are far below the Fed's desired inflation rate of around 2 percent. With both employment and inflation below desired levels over the foreseeable future, the case for more monetary ease is strong.
The United Kingdom is the exception. At 3.2 percent, the UK core inflation rate in April was higher than expected and above the Bank of England's target for headline inflation of 2 percent.2 With output still far below potential, inflation is likely to fall in coming months. Thus, the current low policy interest rate is appropriate, but the risk of a further unwelcome rise in inflation suggests that it may be prudent to wait for inflation to fall before easing policy further.
With short-term interest rates close to zero, the way to ease monetary policy now is by lowering longer-term interest rates. In a recent paper, my coauthors and I showed that Fed purchases of safe long-term bonds in 2009 lowered 10-year bond yields around 50 to 75 basis points. The latest inflation report of the Bank of England shows that similar purchases in the United Kingdom last year lowered long-term rates there, also. There is no reason to believe that such policies cannot work in the euro area and Japan. The Fed's actions last year spurred record issuance of corporate bonds in the United States, supporting business investment and employment. We need even more this year.
Notes
1. Core inflation is the 12-month change in the harmonized index of consumer prices (HICP) excluding energy and unprocessed food. Excluding volatile food and energy prices provides a better measure of where inflation is trending.

2. Core inflation is the 12-month change in the CPI excluding energy and unprocessed food. This rate includes the effect of a value-added tax increase in January that appears to have temporarily boosted inflation by at least 1 percentage point.

Let me add that even with the lags in monetary policy, today's employment report reinforces that it could be a long, long time before labor markets recover fully, so there's plenty of time for policy to have a positive effect in boosting the recovery.

The Employment Report

Posted: 04 Jun 2010 09:58 AM PDT

Today's employment report showed that employment increased by 431,000 last month, with 411,000 of those new jobs at the Census, and 20,000 new jobs in the private sector. The unemployment rate fell from 9.9% to 9.7%.

I'll just repeat what I said yesterday in response to ADP's estimate that private sector job growth would be more than twice as large as it actually was, 55,000:

Remember that we need 100,000 to 150,000 new jobs each month just just to keep up with population growth, so even if this figure is accurate we still aren't making net gains in terms of accommodating new workers. And with millions of workers still unemployed, a growth rate for jobs that simply keeps up with population growth isn't enough, jobs need to grow faster than population growth if we are going to reabsorb the unemployed into the workforce. Job growth is better than job loss, of course, but we shouldn't get too excited about this figure (see Calculated Risk as well).
[A growth rate of 20,000 jobs] still barely covers population growth -- it won't do much if anything to make inroads on the existing unemployed... Positive job growth is progress, but we shouldn't get too optimistic about labor market conditions until we are actually covering population growth and rehiring significant numbers of the unemployed. Brookings estimates the employment gap to be in the neighborhood of 11.3 million workers, but even if true number is slightly smaller than that, there are still millions and millions of unemployed workers who cannot find employment, are under employed if they do find work, or are too discouraged to even look. We need private sector job growth in the hundreds of thousands before labor markets will begin to heal, and we are nowhere near that figure yet. Hopefully we'll get there before too long, job growth in excess of 500,000 private sector jobs per month was a feature of previous recoveries, but we shouldn't assume that good times are just around the corner.

All in all, this was not the strong report I was hoping for.

See also Calculated Risk, Robert Reich, Angry Bear, Financial Times, WSJ, NYT, Washington Post, Free Exchange, Economix, and Bloomberg. [This is also posted at MoneyWatch.]

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