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August 13, 2010

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Paul Krugman: Paralysis at the Fed

Posted: 13 Aug 2010 12:42 AM PDT

Fiscal policymakers deserve their share of the blame for not responding adequately to the crisis, and I blame them first foremost, but monetary authorities have not responded adequately either. Disappointingly, and to the disadvantage of those hoping to find employment sooner rather than later, the Fed hasn't even taken the steps that Bernanke urged Japan to take when it faced similar circumstances:

Paralysis at the Fed, by Paul Krugman, Commentary, NY Times: Ten years ago, one of America's leading economists delivered a stinging critique of the Bank of Japan, Japan's equivalent of the Federal Reserve, titled "Japanese Monetary Policy: A Case of Self-Induced Paralysis?" With only a few changes in wording, the critique applies to the Fed today.
At the time, the Bank of Japan faced a situation broadly similar to that facing the Fed now. The economy was deeply depressed and showed few signs of improvement, and one might have expected the bank to take forceful action. But short-term interest rates — the usual tool of monetary policy — were near zero and could go no lower. And the Bank of Japan used that fact as an excuse to do no more.
That was malfeasance, declared the eminent U.S. economist: "Far from being powerless, the Bank of Japan could achieve a great deal if it were willing to abandon its excessive caution and its defensive response to criticism." He rebuked officials hiding "behind minor institutional or technical difficulties in order to avoid taking action."
Who was that tough-talking economist? Ben Bernanke... So why is the Bernanke Fed being just as passive now as the Bank of Japan was a decade ago? ...
What could the Fed be doing? Back when, Mr. Bernanke suggested, among other things, that the Bank of Japan could get traction by buying large quantities of "nonstandard" assets... The Fed actually put that idea into practice during the most acute phase of the financial crisis, acquiring, in particular, large amounts of mortgage-backed securities. However, it stopped those purchases in March. ...
Back in 2000, Mr. Bernanke also suggested that the Bank of Japan could ... make private-sector borrowing more attractive by announcing that it would keep interest rates low until deflation had given way to 3 percent or 4 percent inflation — an idea originally suggested by yours truly. ... But as chairman of the Fed, Mr. Bernanke has explicitly rejected any such move.
What's going on here? Has Mr. Bernanke been intellectually assimilated by the Fed Borg? I prefer to believe that he's being political, unwilling to engage in open confrontation with other Fed officials — especially those regional Fed presidents who fear inflation, even with deflation the clear and present danger, and are evidently unmoved by the plight of the unemployed.
And in fairness to Mr. Bernanke, discord among senior officials also makes it difficult for policy to change expectations: it would be hard to credibly commit to higher inflation if this commitment were constantly being undercut by speeches out of the Richmond or Dallas Feds. In fact, I'd argue that loose talk by some Fed officials is already having a negative economic impact. But while Mr. Bernanke doesn't have the authority to stop that loose talk, he could make it clear that it doesn't represent overall Fed policy.
Last, but not least, policy is suffering from an act of neglect by President Obama, who waited until his 16th month in office before offering a full slate of nominees to fill vacancies on the Federal Reserve Board. If he had filled those slots quickly — his nominees still aren't in place — the Fed might be less passive.
But whatever the reasons, the fact is that the Fed — which is required by statute to promote "maximum employment" — isn't doing its job. Instead, like the rest of Washington, it's inventing reasons to dither in the face of mass unemployment. And while the Fed sits there in its self-inflicted paralysis, millions of Americans are losing their jobs, their homes and their hopes for the future.

This Isn't Funny Anymore

Posted: 13 Aug 2010 12:33 AM PDT


Remember this? (I removed the warning that was on the original.) In addition to the reasons Krugman cites in his column, I sure hope that fear of the nickname "Helicopter Ben" isn't part of the Bernanke Fed's reluctance to pursue more aggressive policy.

links for 2010-08-12

Posted: 12 Aug 2010 11:03 PM PDT

Who Benefits the Most from Extending Middle-Class Tax Cuts?

Posted: 12 Aug 2010 03:23 PM PDT

Suppose that the tax cuts are allowed to expire for those making over $250,000, but not for households with incomes lower than that. How would the benefits from extending the tax cuts only for incomes of $250,000 or less be distributed? It turns out that the wealthy do pretty well:

Who Benefits the Most from Extending Middle-Class Tax Cuts?

It's not as good as they'd do if all tax cuts were extended, but the wealthy still gain the most.

"It is Such a Silly Analysis"

Posted: 12 Aug 2010 11:58 AM PDT

Tim Duy reacts to Casey Mulligan's claim that teenage employment statistics during the summer pose a problem for the Keynesian view of the world:

Summer Employment All About Demand, by Tim Duy: Casey Mulligan offers a chart of the nonseasonally adjusted teenage employment data as proof that aggregate demand effects are not the dominate factor behind low employment. It is such a silly analysis that the instinct is to immediately dismiss it without comment. I see, however, that Greg Mankiw has anointed the Mulligan analysis as an important piece of evidence:

Casey points out that there is a regular surge in teenage employment during the summer months because more teenagers are available to work (that is, the supply of their labor has increased). That is no surprise: It is normal supply and demand in action. But if aggregate demand were the main constraint on employment, this increase in supply should not translate into higher employment during deep recessions such as this one. But it does!

It really makes one understand why the public often dismisses academics as out of touch in their ivory towers. One has to imagine that neither Mulligan nor Mankiw ever held a real summer job. Nor, apparently, have they looked at any other nonseasonally adjusted data. Nor do they appear to have much understanding of the basic ebb and flow of US economic activity over the course of the year.

Mulligan and Mankiw both look at the seasonal increase in teenage employment during the summer and conclude that of course this should not happen in a period of weak aggregate demand. Therefore, the hiring must be driven by the sudden influx in teenage employment during the summer. It seems to entirely escape them that aggregate demand has a very predictable season pattern - a seasonal pattern that exists in a recession or expansion.

These seasonal patterns in demand activity are not new. Indeed, I imagine that if the data existed, we would see the pattern has remained virtually unchanged since the dawn of human existence, as least in parts of the world where seasonal weather patterns govern economic life. Indeed, it is the reason we have an influx of teenage labor in the summer. It is a throwback to the days of America's agricultural past, when the DEMAND for additional labor in the summer months necessitated closing schools for the summer.

Are these seasonal patterns still evident? Turn to the NSA retail data series:


As sure as the sun rises each day and winter turns to spring, sales spike at the end of the year as the holiday season approaches, collapse at the beginning of the year, rise in the summer, and then decline in the fall.

You can set your clock to this trend. Every retail analyst knows this trend. Every teenager who has ever held a summer job knows this trend. And a huge swath of data follows similar trends, albeit usually without the pronounced end of year impact. Building activity, waste disposal, tourism, you name it, it has a seasonal demand pattern. I only have to look out my ivory tower to see it - stuff grows faster in the summer, and the city hires crews of teenagers to cut it back. The pool down the road is open and staffed by teenage lifeguards only in the summer. Not because the lifeguards are available, but because there is no demand for an outdoor pool most of the year in Eugene.

Aggregate employment data has always followed this trend:


Recession or expansion, the demand for labor increases in the summer and winter, following the patterns of demand. In the summer, some of this demand is satisfied by a seasonal rise in teenage labor supply. This isn't exactly brain surgery.

Mulligan and Mankiw have not found any smoking gun that refutes Keynesianism. They do unwittingly reveal that they don't really understand how to use nonseasonally adjusted data. But, more importantly, they reveals a remarkable ignorance of - and, presumably, lack of appreciation - for the ebb and flow of economic life in America. It is almost like not understanding basic elements of your own culture.

More Reinhart and Rogoff

Posted: 12 Aug 2010 11:29 AM PDT

Peter Dorman comments on the debate over the usefulness and validity of the Reinhart and Rogoff results concerning debt levels and economic growth:

Reinhart and Rogoff: There's No There There, by Peter Dorman: Here's the core problem with Reinhart and Rogoff's claim that public debt levels above 90% of GDP cause reduced growth: it's all correlation and no mechanism. It epitomizes the worst aspects of empirical economics, searching tirelessly for statistical regularities, but not the mechanisms that might underlie them. Because economic contexts are highly diverse, often singular, it's the processes at work, not generalizations about outcomes, that economics has the power to elucidate.

Sorry to be so abstract.

The R&R dataset, as the authors proudly explain, encompasses 44 countries over two centuries. We've got Finland, Spain, Japan and the US, Thailand, Mexico and Colombia. We've got the aftermath of the American Revolution against England and WWII, banking crises under the gold standard, the third world debt crisis of 1982. It's all there in one hopper, ready to be crunched. I would convert to Rosicrucianism before I would embrace the belief that a single statistical relationship captures all these places and times.

Paul Krugman has highlighted two cases in particular, the US demobilization following WWII and the Japanese lost decades (still lost). Yes, he says, there is a correlation between public debt and slow growth, but in the US episode it's spurious (war gave us the debt, demobilization the slow growth), and in Japan the causation runs from slow growth to high debt.

Just scanning the R&R list, I see lots of countries that have battled external deficits, a condition that weakens growth and puts governments in the position of running deficits in order to delay adjustment. And what about price shocks that cripple countries with a narrow export base or particular import dependencies? The R&R list is thick with these cases too. Given these interrelationships, it is revealing that, under "Debt and growth causality", R&R consider only "Growth-to-debt" and "Debt-to-growth", without the vast third category of "joint causation by other factors".

Which gets us back to mechanisms. What are the forces, economic, political or otherwise, that cause runups of public debt? Under what circumstances does debt feed back to these other factors? What mechanisms govern the expansion and contraction of fiscal space? These are the kinds of things we need to know.

R&R have it backwards: they are looking for broad generalizations that might be identified over large samples but have uncertain application to any particular case. A better kind of economics would be one that identified processes that, while they generate diverse outcomes with no discernible central tendency over large samples, can be applied precisely to individual cases.

Like, for instance, ours.

Very few people are saying that there is nothing to worry about in the long-run. There are some who say this, but they are rare. The vast majority of observers agree that we will need to address the debt problem, which is mostly a health care cost problem, at some point.

The question is whether we need to take action today while the economy is still struggling, or whether it would be best to wait until the economy is on more solid ground before beginning to cut back on government spending and/or raise taxes.

The case is far from air tight, but even if you accept that Reinhart and Rogoff have made the case that there is a connection between high debt levels and growth in the long-run, that doesn't necessarily imply that we need to take immediate action to fix the problem. I don't see anything in the analysis above that implies the debt problem must be addressed starting yesterday or we will be forever saddled with lower growth (particularly since bond markets show no evidence of worry over this problem). But I do know about cases where governments did, in fact, begin to tighten too soon, the 1937/38 experience for example, and the result was lower economic growth, precisely what the deficit hawks are worried about.

As I've said before, I've been hesitant to address the long-run debt problem because it is too easily misinterpreted as a call for austerity today rather than during better times or times of excess. The time will come to address this problem, and when it does I will be one of the ones pushing hard for health care reform and other policies that can put the budget on a more sustainable long-run course. But that time is not here yet, and trying to fix the debt problem too soon stands a good chance of making things worse, not better, by prolonging the recession.

For some, the time to reduce the deficit will never be right (it will kill jobs!), and we have a history of failing to pay the bills incurred during bad times once things do improve. But the answer to that problem, a problem that is largely the result of a poisonous political atmosphere in Congress, is not premature austerity and a prolonged recession.

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