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July 22, 2010

Latest Posts from Economist's View

Latest Posts from Economist's View

"Time for a Monetary Boost"

Posted: 22 Jul 2010 12:42 AM PDT

More on the Fed's wait and see approach to doing more to try to help the economy recover:

Time for a Monetary Boost, by Joseph E. Gagnon: In his testimony to the Congress this week, Fed Chairman Ben Bernanke left the door open to further monetary stimulus but made it clear that such action is not imminent. ...
The Federal Reserve's own forecast shows that it will take at least three or four years for employment to return to its long-run sustainable level. This extended period of high unemployment represents a massive waste of productive labor and untold personal suffering of unemployed workers. The Fed should be aiming to get us back on track within two years. And the urgency of Fed action is all the more important because Congress has refused to provide more stimulus.
In addition, it is now apparent that deflation is a more serious risk for the US economy than inflation. The latest data show overall declines in consumer and producer prices..., core inflation has trended well below the 2-percent level that ... the Fed has adopted as its goal.
Clearly, the case for monetary stimulus is strong. But what form should it take? ... Three actions, in particular, would be helpful at this time.
First, the Fed should lower the interest rate it pays on bank reserves to zero. This is a small step, as the current rate is only 0.25 percent, but there is no reason to pay banks more than the rate paid by the closest substitute, short-term Treasury bills. Three-month Treasury bills currently yield 0.15 percent, and that rate, too, should be brought down to zero.
Second, the Fed should bring down the rates on longer-term Treasury securities by targeting the interest rate on 3-year Treasury notes at 0.25 percent and aggressively purchasing such securities whenever their yield exceeds the target. That is a 65-basis point reduction from the current rate of 0.90 percent. This step would ... reduce a wide range of private borrowing rates, encouraging business investment, supporting the housing market, and boosting exports through a weaker dollar. Moreover, pushing down yields on short- to medium-term Treasury securities is precisely the strategy for fighting deflation recommended by Ben Bernanke in 2002.
Finally, the Fed could bolster the stimulative effects of these actions by establishing a full-allotment lending facility to enable banks to borrow (with high-quality collateral) at terms of up to 24 months at a fixed interest rate of 0.25 percent.
These measures are all within the Federal Reserve's established powers. They pose essentially no risk to the Fed's balance sheet. They would reduce unemployment roughly as much as a 2-year $600 billion fiscal package and yet they would actually reduce the federal budget deficit. And they can be reversed quickly should the balance of risks shift from deflation to inflation.
Given the unsatisfactory outlook for unemployment and inflation and the lack of action by Congress, that is the right medicine for the US economy now.

As I've said before, there are reasons to worry that this won't provide enough of a boost, these policies provide incentives that may or may not be acted upon and that's why I've emphasized fiscal policy. But additional fiscal policy isn't going to happen unless there is a significant downturn in economic conditions, so this is our best hope.

Receding Glaciers of the Greater Himalaya

Posted: 22 Jul 2010 12:33 AM PDT

[I was going to post this yesterday, but Brad's post disappeared while I was doing this, so I decided to wait. It's back now. I should have also noted that Brad's post has excerpts from David Leonhardt's Overcome by Heat and Inertia discussing the options and prospects for climate change legislation.]

Brad DeLong shows changes in the Qori Kalis Glacier, Quelccaya Ice Cap, Peru between 1978 and 2002. Here's another example:


Kyetrak Glacier in Tibet in 1921 and 2009

Here are two more:


West Rongbuk Glacier, Northern Slope of Mt. Everest, in 1921 and 2008


East Rongbuk Glacier, Northern Slope of Mt. Everest, in 1921 and 2008

And for even more, see the interactive, comparative photography, and video links here.

Am I Being Unfair to the Fed, or is the Fed Being Unfair to Those Who Need Its Help?

Posted: 22 Jul 2010 12:24 AM PDT

Robin Harding at the Financial Times blog Money-Supply says I'm being unfair:

Why the Fed's options are still under review, by Robin Harding: In his testimony today Ben Bernanke said that the Fed has not yet decided on its leading option in the event that it has to ease policy further. Mark Thoma asks, why?

After all this time, and after all the calls for the Fed to do more, they don't even know what the leading options are? Bernanke says they are prepared to do more if conditions warrant it, but if there was a sudden disruption in financial markets tomorrow, they wouldn't even know which policy option to prefer. I expected better than this from Bernanke and the rest of the Fed.

I don't think that's fair. I think the Fed knows exactly what it would do if there was a sudden disruption in financial markets tomorrow: liquidity programs like those we saw during the crisis and then probably asset purchases if they didn't work.

I think the Fed is still pondering for a few reasons. First, the best response would depend on the conditions at the time, e.g. asset purchases will deliver better results if markets are stressed and the effect of communications will depend on the yield curve.

Second, the FOMC is quite split about the effectiveness of asset purchases, how much they distort markets, and the risks to the Fed's credibility. Those debates are reasonable enough. It's hard to expect a consensus to form unless it has to, because the Fed has decided to act (whether it should already be acting is a separate debate).

Third, I think the Fed is keen to keep revisiting all possible options, including those it has decided against in the past. That seems healthy enough to me.

I'll accept that the Fed may know what it would do if financial markets have a sudden breakdown tomorrow, but I'm not sure they know "exactly" what to do. That requires that they've worked out the uncertainties that plagued them the first time they faced a sudden financial crisis, and I don't think we know for sure that they have. But the point is that what the Fed needs to do in the case of a sudden financial disruption is different from what it needs to do to give a boost to an economy struggling to recover, and that they can know one without knowing the other. That's fair. But isn't it also fair to expect the Fed to be prepared for both?

So I don't accept that the Fed should not know what its best option is for dealing with the situation as it exists today. The first rationale for this given above, that the best response is state dependent (i.e. that it will depend upon the conditions at the time), is not an excuse for waiting to figure out what to do. If the Fed faces different possible future outcomes, then it should develop state contingent policy responses, i.e. it should know what it will do under all of the future scenarios it can imagine. It's a mistake to wait until you know what the conditions are before starting to figure out what to do. Instead, there should be a plan that says what the best response is to a variety of potential future states of the economy. A black swan could always appear and that would require policy to be developed on the fly, but the response to most potential future economic conditions should already be known.

The second objection, that the Fed is split, is not a very compelling excuse either. Policy splits are common, nothing new there. Take a vote or institute a process for resolving this. Better to get the disputes resolved now than trying to resolve them in the middle of a crisis when quick action is needed. The third excuse is that the Fed may discover a better policy as it revisits its options. The Fed should revisit its options, no disagreement there, and if a better option presents itself later, the Fed should certainly adopt it. But how does that stop the Fed from making the best choice given what it knows right now? There's always the possibility of finding a better solution in the future, and the Fed shouldn't stop trying to improve, but it should also know what the best options are given present conditions. Being able to say what they'd do if they had to act today doesn't seem to be too much to ask.

So the answer I expected from Bernanke was something like, "while we continue to try to fine-tune and improve policy, as always, we are fully prepared to react to a wide variety of future conditions, and could act today if we thought we needed to do so."

What this really says, to me anyway, is that the Fed does not believe conditions are bad enough right now, or can possibly get bad enough in the near future, to make the Fed feel the need to be ready to act. It also says that six months ago, or however long it takes to figure this out, they were convinced that the economy would not need more help today, so there was no need to be ready. But how did they know then that they wouldn't want to act today? Members of the Fed think they have plenty of time yet to weigh their options carefully, and in the unlikely event things really do get worse, measurably worse than they are now, then they'll figure out what to do. But, apparently there's no rush.

That they haven't even felt the need to be ready to react to conditions like we are seeing today -- unemployment staying persistently high, deflation month after month, and so on, conditions worse than the Fed expected six months ago -- is the disappointing part. The main problem I have with the Fed's position is that they haven't told us what they are so worried about if they do act now. Is it inflation? Even after recent data showing deflation? Is it credibility? The Fed has an obligation to address both inflation and unemployment, and it's a mistake to base their credibility on just one component of its dual mandate. The Fed is losing credibility with the public daily, and its not because of worries over inflation. They've tossed out a variety of possibilities regarding the things they are worried about, but the specifics have been lacking.

What, exactly is the cost if they do act now? Until the Fed has a good answer to that question, and so far I haven't heard it, I will continue to wonder not only why they aren't ready to act now, which is bad enough, but why they haven't tried to do more to help an economy that is clearly struggling. We're in danger of a lost decade or worse, and the Fed is not responding adequately to that threat.

links for 2010-07-21

Posted: 21 Jul 2010 11:02 PM PDT

Why are the Fed's Options Still under Review?

Posted: 21 Jul 2010 01:44 PM PDT

I'm in a bit of a rush, but I want to note this from Ben Bernanke:

Bernanke's comments to Congress are largely as expected, but some may be a bit taken aback by his comments on shrinking the balance sheet, which doesn't suggest much central bank appetite to provide additional stimulus to a troubled economy. ...
In the testimony, Sen. Shelby asks Bernanke what everyone wants to know: what more can the Fed do for the economy, if needed. Bernanke replies that the Fed has options from lowering the interest on reserves rate, to language changes in the FOMC outlook, to balance sheet tweaks.
He notes current policy is "already quite stimulative" and adds "we do still have options, but they are not going to be conventional options."
Bernanke says any additional action is still under review, saying "we have not come to the point where we can tell you precisely what the leading options are."

After all this time, and after all the calls for the Fed to do more, they don't even know what the leading options are? Bernanke says they are prepared to do more if conditions warrant it, but if there was a sudden disruption in financial markets tomorrow, they wouldn't even know which policy option to prefer. I expected better than this from Bernanke and the rest of the Fed.

The we could do more but aren't ready to do so just yet line from Bernanke is also puzzling. With unemployment as high as it is and with the projections for a very slow recovery -- if we can avoid a double dip -- why doesn't the Fed do more now? Why hasn't it done more already? That question has never been answered to my satisfaction.   [dual posted]

Master's Forum on the Dodd-Frank Financial Reform Bill

Posted: 21 Jul 2010 12:34 PM PDT

This is mostly to let those of you who might be interested know about the Conglomerate Blog's Master's Forum on the Dodd-Fran financial reform bill. Here are a few examples taken from recent posts in the long series of posts on this topic. (These are lawyers, so much of it is from a legal perspective. Also, I don't necessarily agree with everything that is said in the examples below or in the discussions more generally):

Dodd-Frank Forum: I Give It a B, by Brett McDonnell: Erik asks us how we would grade the Act as a whole, and whether we would have voted for it. I seem to be more of a supporter than most posters here: I would certainly have voted in favor, and I give it a solid B. Unlike Renee, I think there is a big picture story which helps identify the core provisions. After decades of deregulation, our financial system has become unstable as players loaded up on leverage and untested innovations, leaving the system vulnerable to episodes of panics and deleveraging which can bring down the entire economy. There are two complementary stories of leverage and systemic risk. The too big to fail story focuses on financial giants whose failure would rapidly spread to dozens of other connected firms. The shadow banking story focuses on the ways that markets like repo, commercial paper, and money market funds resemble banks, with short-term debts financing long-term assets, and hence become subject to runs. A major side story is the housing market, where the main bubble that led to the panic occurred. There, securitization and abusive credit products helped create the dubious debts which eventually ignited the system.

The core provisions for addressing system instability are Titles I and II. We addressed the banking system in the 30s with 3 main elements: deposit insurance, FDIC resolution authority, and increased banking supervision. There's no explicit insurance in Dodd-Frank, but the bailouts suggest that the federal government stands ready to prop up a failing financial system. Title II replicates something close to FDIC resolution authority for a broader range of financial institutions. One element of Title II that I really like is its push to punish the officers of failed companies, through firing and restitution. That may go a decent way to mitigate the moral hazard caused by the bailouts. Title I extends supervision, including regulation of leverage, to a broader range of companies. It should at least cover the too-big-to-fail companies. It doesn't break them up, but it does direct regulators to impose heavier burdens on those companies, and gives them the power to break them up if they believe doing so is needed for financial stability. ... Title IV (hedge fund advisers) should at least give regulators more information about what is happening in many companies within the shadow banking system. Title VII address another important source of financial instability, swaps with their counterparty risks that create doubts throughout the system. The creation of derivative clearinghouses is likely a good idea, although it creates its own risks, and as always the devil is in the details.

Dodd-Frank also addresses the problems in the housing market. Title X creates the Bureau of Consumer Financial Protection. ...

Those core provisions strike me as serious attempts to address the main problems that the crisis has revealed. There was even more moaning about the banking and securities acts of the 30s, but they created a regulatory framework that helped bring the longest period of financial stability in American history. ... We have a vast, unstable financial system which no one really understands in anything like the depth required to adequately regulate it, and yet unregulated it is likely to drive us into a Second Great Depression one of these days (and there's no good reason to think that the First Great Depression is as bad as it can get). There are no good alternatives available. Given all that, I think Dodd-Frank is quite a reasonable stab at an impossible task. ...

By contrast:

Dodd-Frank Forum: "I'll Have the Meatless Entrée, Please", by Kim Krawiec: The administration and lawmakers are busy congratulating themselves on the "historic" Dodd-Frank legislation, the "toughest financial reform" since the Great Depression. Sure . . . if historic is synonymous with long, costly, needlessly complex, and likely to have little impact on systemic risk, moral hazard, or the financial market opacity that exacerbated the financial crisis.

Not all of the bill's provisions are bad, of course, and some may even be good (though much will depend on implementation). And there is little doubt that the legislation will significantly change the regulatory landscape and business operations of every financial institution and many commercial companies doing business in this country.

But I join the chorus of those who believe that the bill largely fails to address the root causes of the financial crisis and the financial system weaknesses exposed by it; grants discretionary authority to regulators to perform acts already within their existing powers, such as identifying systemic risks (which they did not use before the last crisis, and are not likely to use before the next one); punts the bulk of meaningful issues to regulators; and fails to address at all items that should have been at the top of Congress' reform list (such as the credit rating agencies and Fannie and Freddie). ...

Here's another example:

Dodd-Frank: Only You Can Prevent Ponzi Schemes, by Christine Hurt: So, in the interview portion of our financial reform pageant, Erik asked me as a follow up to my Dodd-Frank & Madoff post:
Christine: What grade would you give to the Dodd-Frank provisions designed to make sure the SEC doesn't drop the ball with future Madoffs? ...

I hate to say this, but I think Ponzi schemes are inevitable..., con artists will always be there to offer you unbelievable returns. Regulating against human nature is impossible. We have murder laws, but we'll always have murder. So, the question is can any regulation help the SEC spot the Ponzi scheme before people lose money.

First, Ponzi schemes aren't really illegal until someone doesn't get their money back. Perhaps the schemes (like Madoff's) where he claims to make an investment and then doesn't do anything at all could be prosecuted prior to its collapse, but it would be hard to do. Or, if someone holds himself out as something he isn't -- broker, investment adviser, etc. or offer an unregistered security. Sometimes the SEC finds an ongoing scheme and in investigating, gets the target to obstruct justice or make a false statement, but usually someone has to lose money and complain about it first. So, pretty much someone has to lose money before we can step in and prosecute. So, it's hard to write any new SEC procedures that will prevent at least some loss. ...

Madoff was ... able to continue for a long time because he was an insider and human nature made the SEC investigators not suspect him. Most garden variety Ponzi schemes are by industry outsiders, and the SEC is very good about prosecuting those low-hanging fruits. Will regulation make SEC individuals rise above human nature? No, but now experience will educate investigators to look out for insiders as well as outsiders. ...

Ponzi schemes will always pop up as long as their are people who want to make high returns in a quick period of time. Human nature makes the victims look past red flags, particularly with affinity fraud. Regulation can't really do much about that.

One more:

Dodd-Frank Forum: Who Benefits from the New Resolution Authority?, by Michelle Harner: Like many, I am skeptical that the Dodd-Frank Act accomplishes much of anything. It does provide nice photo ops and plenty of ammunition (on both sides of the political spectrum) for the mid-term elections. It also reminds us of the lobbyists' ability to influence legislation (see, e.g., Gordon's post here and reference to auto dealer exemption here). But does it fix all, or even some, of what contributed to the financial crisis?

Given the number of contributing factors and the breadth of the legislation, I am just going to say a few words about one piece of this puzzle—the resolution authority granted the federal government under the Act. ...

As a last example:

Dodd-Frank Forum: What Ever Happened to Criminal Sanctions?, by Lisa Fairfax: I ask the question not because I believe they are warranted, but rather because we have been discussing comparisons between this new Act and Sarbanes-Oxley and those comparisons got me thinking about one striking difference between the two acts in terms of the emphasis on criminal sanctions. With Sarbanes-Oxley, there was a lot of discussion about the need for personal accountability, which ultimately translated into a push for increased liability for corporate executives, and hence provisions imposing enhanced criminal penalties related to various frauds, including sanctions for executives' false certification of financial reports. This time, such a push has not been a central focus of reform efforts. In fact, even though this new Act uses the term "accountability," it does not even have the same connotation as it did under Sarbanes-Oxley. Which raises the question, why not? Here are some possibilities. ...

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