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August 1, 2010

Latest Posts from Economist's View

Latest Posts from Economist's View


Shiller: Use Government Policy to Directly Create Jobs

Posted: 01 Aug 2010 12:42 AM PDT

The ideas expressed below have been discussed around here for some time, and Atrios (among others) has been making similar points (e.g. put people to work painting roofs white). So it's nice to see Robert Shiller helping to deliver the message. Too bad Congress refuses to hear it:

What Would Roosevelt Do?, by Robert J. Shiller, Commentary, NY Times: Across the United States, thousands of federally financed stimulus projects are under way, aimed at bolstering the economy and putting people to work. The results so far have not been spectacular.
Why not? There's nothing wrong with the idea of fiscal stimulus itself. We need more stimulus, not less — but we need to focus much more on actually putting people to work.
Two friends of mine, both economists, came upon a stimulus project ... highway ... sign that read "Putting America to Work: Project Funded by the American Recovery and Reinvestment Act" and prominently featured a picture of a worker digging with a shovel. Out on the road, there was plenty of equipment, including a gigantic asphalt paver, dump trucks, rollers and service vehicles. But there wasn't a single laborer with a shovel. That project employed capital, certainly, but not many human beings.
Like many such stimulus projects, it could be justified if you accept the idea that gross domestic product, not jobs, is central — a misconception...
So here's a proposal: Why not use government policy to directly create jobs — labor-intensive service jobs in fields like education, public health and safety, urban infrastructure maintenance, youth programs, elder care, conservation, arts and letters, and scientific research?
Would this be an effective use of resources? From the standpoint of economic theory, government expenditures in such areas often provide benefits that are not being produced by the market economy. ...
President Franklin D. Roosevelt's New Deal, though no more than partly successful, was much more focused on job creation than our current economic stimulus has been. It seems that the New Deal was also more successful at inspiring the American public.
Consider one of the most applauded of Roosevelt's programs, the Civilian Conservation Corps, from 1933 to 1942. ... The C.C.C. emphasized labor-intensive projects... Congress has recently set plans for tripling the size of AmeriCorps, the modern counterpart of the C.C.C.... At its peak, the C.C.C. employed 500,000 young men. Under current plans, AmeriCorps would top out at 250,000 people in 2017, even though the nation now is two and a half times larger. We ought to be bolder.
Big new programs to create jobs need not be expensive. Suppose the cost of hiring a single employee were as high as $30,000 a year, several times typical AmeriCorps living allowances. Hiring a million people would cost $30 billion a year. That's only 4 percent of the entire federal stimulus program... Why don't we just do it?

Fed Watch: More on Disinflation

Posted: 01 Aug 2010 12:24 AM PDT

Tim Duy:

More on Disinflation, by Tim Duy: Paul Krugman pulls together three charts to illustrate the link between high unemployment and disinflation in two major disinflationary episodes, 1974-1977 (Series 1 in chart below) and 1980-1986 (Series 2). He then tracks the pattern of the current cycle (Series 3), which suggests that the combination of high unemployment and past disinflationary responses to such unemployment is very likely deflationary. Krugman asks:

How can you look at this record and not conclude that deflation is a very real risk? I have no idea where the complacency of many at the Fed comes from.

An explanation for the Fed's complacency can be found by plotting all three episodes on the same chart:

I believe when monetary policymakers look at this chart, they ask a different question: Why has the disinflationary response been so muted in this cycle? It would have been reasonable to conclude that unemployment rates at this magnitude should have long ago pushed the US economy into deflationary territory. What is the Fed's explanation for the relatively tame disinflation? Krugman already has the answer:

All of this was to be understood in terms of a Phillips curve in which actual inflation at any point in time depends both on the unemployment rate and on expected inflation….

Fed officials will say that inflation expectations are currently well anchored. Indeed, the early 1980's experienced a period of rapid disinflationary expectations:

Note that expectations by this measure are stable. What about financial market expectations? The difference between 5 year Treasuries and 5 year TIPS fell slightly in recent months, but nothing like the clear taste of deflationary expectations at the end of 2008:

But are stable inflation expectations written in stone? Krugman concludes the above sentence with:

...and expected inflation gradually adjusts in the light of experience.

The implication is that the Fed should not get too complacent as persistently high unemployment will eventually erode those expectations.

Now - just thinking out loud - suppose downward rigidity of nominal wages, with workers unwilling to accept nominal wages declines. Does this support positive - albeit low - inflation expectations? Which thus prevents deflationary expectations from forming…which is good, but prevents the Fed from further action despite high unemployment rates? And the lack of action that increases structural unemployment, ensuring NAIRU increases? Something else to chew on...

links for 2010-07-31

Posted: 31 Jul 2010 11:01 PM PDT

"Some Observations Regarding Interest on Reserves"

Posted: 31 Jul 2010 08:46 AM PDT

Does paying interest on reserves discourage lending? Are there good reasons to pay interest on reserves?:

Some Observations Regarding Interest on Reserves, by David Altig: One of the livelier discussions following Federal Reserve Chairman Ben Bernanke's testimony to Congress on monetary policy has revolved around the issue of the payment of interest on bank reserves. Here, for what it's worth, are a few reactions to questions raised by that discussion: ...

What is the opportunity cost of not lending?

...[C]ertainly the real issue about the IOR policy concerns the presumed incentive for banks to sit on excess reserves rather than putting those reserves into use by creating loans. This, from Bruce Bartlett, is fairly representative of the view that IOR is, at least in part, to blame for the slow pace of credit expansion in the United States:

"… As I pointed out in my column last week, banks have more than $1 trillion of excess reserves—money that the Fed has created that banks could lend immediately but are just sitting on. It's the economic equivalent of stuffing cash under one's mattress.

"Economists are divided on why banks are not lending, but increasingly are focusing on a Fed policy of paying interest on reserves—a policy that began, interestingly enough, on October 9, 2008, at almost exactly the moment when the financial crisis became acute."

OK, but the spread that really matters in the bank lending decision is surely the difference between the return on depositing excess reserves with the Fed versus the return on making loans. In fairness, it does appear that this spread dropped when the IOR was raised from its implicit prior setting of zero…

073010b
(enlarge)

… but it's also pretty clear that this development largely reflects a general fall in market yields post-October 2008 as much is it does the increase in IOR rate...

And here's another thought: As of now, the IOR policy applies to all reserves, required or excess. Consider the textbook example of a bank that creates a loan. In the simple example, a bank creates a loan asset on its book by creating a checking account for a customer, which is the corresponding liability. It needs reserves to absorb this new liability, of course, so the process of creating a loan converts excess reserves into required reserves. But if the Fed pays the same rate on both required and excess reserves, the bank will have lost nothing in terms of what it collects from the Fed for its reserve deposits. In this simple case, the IOR plays no role in determining the opportunity cost of extending credit.

Of course, the funds created in making a loan may leave the originating bank. Though reserves don't leave the banking system as a whole, they may certainly flow away from an individual institution. So things may not be as nice and neat as my simple example.  But at worst, that just brings the question back to the original point: Is the 25 basis point return paid by the central bank creating a significant incentive for banks to sit on reserves rather than lend them out to consumers or businesses? At least some observers are skeptical:

"Barclays Capital's Joseph Abate…noted much of the money that constitutes this giant pile of reserves is 'precautionary liquidity.' If banks didn't get interest from the Fed they would shift those funds into short-term, low-risk markets such as the repo, Treasury bill and agency discount note markets, where the funds are readily accessible in case of need. Put another way, Abate doesn't see this money getting tied up in bank loans or the other activities that would help increase credit, in turn boosting overall economic momentum."

And:

Are there good reasons for paying interest on reserves?

Even if we concede that there is some gain from eliminating or cutting the IOR rate, what of the costs? Tim Duy, quoting the Wall Street Journal, makes note (as does Steve Williamson) of the following comment from the Chairman:

"… Lowering the interest rate it pays on excess reserve—now at 0.25%—could create trouble in money markets, he said.

" 'The rationale for not going all the way to zero has been that we want the short-term money markets, like the federal funds market, to continue to function in a reasonable way,' he said.

" 'Because if rates go to zero, there will be no incentive for buying and selling federal funds—overnight money in the banking system—and if that market shuts down … it'll be more difficult to manage short-term interest rates when the Federal Reserve begins to tighten policy at some point in the future.' "

Professor Duy interprets this as aversion to the possibility that "the failure to meet expectations would be the real cost to the Federal Reserve," but I would have taken the words for exactly what they seem to say—that the skills and infrastructure required to maintain a functioning federal funds rate might atrophy if cutting the rate to zero brings activity in the market to a trickle. And ... to the extent that federal funds targeting is a desirable part of the picture, it sure will be helpful if a federal funds market exists.

Even if you don't buy that argument—and the point is debatable—it is useful to recall that the IOR policy has long been promoted on efficiency grounds. There is this argument for example, from a New York Fed article published just as the IOR policy was introduced:

"… reserve balances are used to make interbank payments; thus, they serve as the final form of settlement for a vast array of transactions. The quantity of reserves needed for payment purposes typically far exceeds the quantity consistent with the central bank's desired interest rate. As a result, central banks must perform a balancing act, drastically increasing the supply of reserves during the day for payment purposes through the provision of daylight reserves (also called daylight credit) and then shrinking the supply back at the end of the day to be consistent with the desired market interest rate.

"… it is important to understand the tension between the daylight and overnight need for reserves and the potential problems that may arise. One concern is that central banks typically provide daylight reserves by lending directly to banks, which may expose the central bank to substantial credit risk. Such lending may also generate moral hazard problems and exacerbate the too-big-to-fail problem, whereby regulators would be reluctant to close a financially troubled bank."

Put more simply, one broad justification for an IOR policy is precisely that it induces banks to hold quantities of excess reserves that are large enough to mitigate the need for central banks to extend the credit necessary to keep the payments system running efficiently. And, of course, mitigating those needs also means mitigating the attendant risks.

That is not to say that these risks or efficiency costs unambiguously dominate other considerations—for a much deeper discussion I refer you to a recent piece by Tom Sargent. But they should not be lost in the conversation.

(Not sure this is it, but I was wondering where Brad DeLong found the new Sargent paper.)

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