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August 16, 2010

Latest Posts from Economist's View

Latest Posts from Economist's View

Paul Krugman: Attacking Social Security

Posted: 16 Aug 2010 12:39 AM PDT

The unnecessary and misguided war over Social Security is heating up once again:

Attacking Social Security, by Paul Krugman, Commentary, NY Times: Social Security turned 75 last week. It should have been a joyous occasion, a time to celebrate a program that has brought dignity and decency to the lives of older Americans.
But the program is under attack, with some Democrats as well as nearly all Republicans joining the assault. Rumor has it that President Obama's deficit commission may call for deep benefit cuts, in particular a sharp rise in the retirement age.
Social Security's attackers claim that they're concerned about the program's financial future. But their math doesn't add up, and their hostility isn't really about dollars and cents. Instead, it's about ideology and posturing. And underneath it all is ignorance of or indifference to the realities of life for many Americans.
About that math: ...The program won't have to turn to Congress for help or cut benefits until or unless the trust fund is exhausted, which the program's actuaries don't expect to happen until 2037 — and there's a significant chance, according to their estimates, that that day will never come.
Meanwhile, an aging population will eventually (over the ... next 20 years) cause the cost of paying Social Security benefits to rise from its current 4.8 percent of G.D.P. to about 6 percent of G.D.P. To give you some perspective, that's a significantly smaller increase than the rise in defense spending since 2001, which Washington certainly didn't consider a crisis, or even a reason to rethink some of the Bush tax cuts.
So where do claims of crisis come from? To a large extent they ... rely on an exercise in three-card monte in which the surpluses Social Security has been running for a quarter-century don't count — because hey, the program doesn't have any independent existence; it's just part of the general federal budget — while future Social Security deficits are unacceptable — because hey, the program has to stand on its own.
It would be easy to dismiss this..., except ... many influential people — including Alan Simpson, co-chairman of the president's deficit commission — are peddling this nonsense.
And having invented a crisis,... Social Security's attackers ... don't propose cutting benefits to current retirees; invariably the plan is, instead, to cut benefits many years in the future. ... In order to avoid the possibility of future benefit cuts, we must cut future benefits. O.K.
What's really going on here? Conservatives hate Social Security for ideological reasons: its success undermines their claim that government is always the problem, never the solution. But they receive crucial support from Washington insiders, for whom a declared willingness to cut Social Security has long served as a badge of fiscal seriousness, never mind the arithmetic.
And neither wing of the anti-Social-Security coalition seems to know or care about the hardship its favorite proposals would cause.
The currently fashionable idea of raising the retirement age even more... — it has already gone from 65 to 66, it's scheduled to rise to 67, but now some are proposing that it go to 70 — is usually justified with assertions that life expectancy has risen... But that's only true for affluent...— the people who need Social Security least. ...
America is becoming an increasingly unequal society — and the growing disparities extend to matters of life and death. Life expectancy at age 65 has risen a lot at the top of the income distribution, but much less for lower-income workers. And remember, the retirement age is already scheduled to rise under current law.
So let's beat back this unnecessary, unfair and — let's not mince words — cruel attack on working Americans. Big cuts in Social Security should not be on the table.

Fed Watch: A Bleak View

Posted: 16 Aug 2010 12:15 AM PDT

Tim Duy:

A Bleak View, by Tim Duy: Deferring to the faltering economy, the Federal Reserve stepped up its policy efforts last week. Barely. Almost imperceptibly. Indeed, it is almost as if the Fed could muster nothing better than throwing a bone to its critics. Will they throw more bones in the coming months? In this environment, I suspect the Fed will continue to do more than I expect, but less than is necessary.

The few data releases since the FOMC meeting have not been particularly encouraging. The trade deficit expanded, implying a downward revision to the Q2 GDP numbers. Initial unemployment claims continue to hover at levels consistent with weak job growth. University of Michigan consumer sentiment ticked up, but signals that households remain under severe pressure. Retail sales edged up in July, reinforcing the long standing trend of this recovery - an inability to grow fast enough to reestablish the previous trend:

One can argue that the previous trend was unsustainable, driven on the back of a clearly faulted debt-fueled asset bubble dynamic. But even accepting that hypothesis, that spending was critical to ensuring full employment. If consumers fall back, some other sector needs to step up to the plate. Otherwise, the economy will continue to limp along a suboptimal growth path.

Will FOMC members continue to accept that path? Acceptance is dependent on the inflation outlook. And on that point, the July CPI release, which revealed a slight increase in core inflation, leaves me unsettled. Given downward nominal wage rigidities, it is not that difficult to imagine an economy stuck significantly below potential output, but with just enough price pressures to sustain a slightly positive inflation rate. Absent a substantial output decline, would the Fed be inclined to significantly expand quantitative easing in the face of low, but positive, inflation, combined with positive inflation expectations? Apparently no, as this is a description of the current situation. More of the same is likely to produce little drips of monetary easing here and there, but it is difficult to see, for example, a commitment to purchase $200 billion of Treasuries each quarter until unemployment stands at 7%.

Is dramatic action necessary? I believe so, which, ironically, brings me to last Friday's speech by arch-hawk Kansas City Federal Reserve President Thomas Hoenig. Hoenig is stepping up his public criticism of the FOMC, lambasting his colleagues for setting the stage for another financial crisis. In short, Hoenig sees parallels to the deflation scare of 2003, which prompted the Fed to lower rates to 1%. Shortly thereafter, economic activity accelerated on the back of the housing bubble. We all know how that story ended. In Hoenig's view, this was essentially a repeat of the experience of the late 90's equity bubble and subsequent collapse. Hoenig concludes that it is important to break the cycle; he suggests dropping the "extended period" language, moving the Federal Funds rate to 1%, pausing, and then make a final move to 2%. He does not view this as tight policy, but instead accommodative yet firmer policy. Tough love.

Hoenig's story of policy induced bubbles is certainly not new. Indeed, the fluctuations in household net worth appear to be intimately related to the business cycle since 1995:

We tend to view these asset bubbles as "bad," but I think this pattern also poses an interesting question. If you remove the asset bubbles, what is left? It sure looks like nothing more than an economy stuck in a subpar equilibrium. Perhaps rather than diverting capital from productive investments, capital flowed into asset bubbles due to a lack of investment opportunities. It is not so far fetched; we know that firms are sitting on nearly two trillion dollars of cash yielding low returns.

In other words, were the asset bubbles critical to maintaining full employment? And if so, how can we reflate the economy in their absence? Hoenig believes we will restructure the economy over time, but his story is woefully incomplete:

… then how might GDP and important components perform? Let me start with consumption, which for decades amounted to about 63 percent of GDP. During the boom it rose to 70 percent. It seems reasonable that the consumer will most likely return toward more historical levels relative to GDP and then grow in line with income. If so, the consumer will contribute to growth but is unlikely to intensify its contribution to previously unsustainable levels….

…While businesses need to rebalance as well, they are essential to the strength of the recovery. Fortunately, they are in the early stages of doing just that. Profits are improving and corporate balance sheets for the nonfinancial sector are strengthening and are increasingly able to support investment growth as confidence in the economy rebuilds. Also, although credit supply and demand may be an issue impeding the recovery to some extent, a shortage of monetary stimulus is not the issue. There is enormous liquidity in the market, and it can be accessed as conditions improve.

Finally, the federal government needs to rebalance its balance sheet as well. Federal and state budget pressures are enormous, and uncertain tax programs surely are a risk to the recovery. This adds harmful uncertainty upon both businesses and consumers. However, while these burdens are a drag on our outlook, they are not new to the U.S. and, by themselves, should not bring our economy down unless they go unaddressed.

It appears Hoenig believes both consumer and government spending are set to become less important to the growth mix. Yet, he also believes in such an environment, firms will continue to invest in new capital as confidence grows. But how are we to expect that firms will have any confidence in the absence of a strong consumer outlook or a government backstop? Indeed, the strains of such a dynamic emerge already. From Bloomberg:

Weaker-than-forecast sales at Cisco Systems Inc. and International Business Machines Corp. may signal a slowdown in the corporate spending that has led the U.S. recovery.

"It's been business investment, particularly technology, that's been in the driver's seat," said Stuart Hoffman, chief economist at PNC Financial Services in Pittsburgh. Should equipment spending slow significantly, "unless something else picks up the pace, it means the outlook for the economy is going to be that much dimmer."

Note too that he conspicuously offers no mention of the external sector - perhaps no surprise given that an external impetus has been noticeably absent during this recovery. Simply put, if we take consumer, government, and external spending off the table, I don't see any path that leads to Hoenig's promised land.

Nor do I see a path to the promised land in the current stance of monetary policy. Nor do I see a path in what I suspect is the likely path - drips of easing here and there. Moreover, given the propensity of firms to offshore productive capacity, I am wary that even aggressive easing will stimulate investment activity. I think the latest trade release clearly show that stronger domestic demand is likely to get translated straight into imports. The same goes for consumer spending - the recession has ravaged credit ratings, leaving the pool of potential borrowers shriveled. And even if we can induce households to buy more flat screen TV's, such stimulus is more of a economic boost for the Port of Long Beach than anything else.

So, increasingly I worry the most effective policy paths are less than palatable for policymakers. And I can't say that I am particularly comfortable with said paths as well. But, at the risk of oversimplifying channels of monetary transmission, if future quantitative easing is to work, I suspect it needs to flow through one of two channels. The first is the via an explosion of net worth. In other words, a fresh asset bubble. I don't think this will happen spontaneously. Via financial reform, policymakers are in the process of injecting enough glue into the financial markets to keep asset bubbles at bay, at least for the time being. The other channel is via a sharp decline in the value of the Dollar. Undoubtedly, this would stimulate export and import-competing sectors (I tend to think the latter is actually the most important). The rest of the world, however, would be likely to lean against such a decline.

This is a depressing outlook, as it suggests that even aggressive monetary easing might not be enough unless such easing can be induced to work along one of two channels policymakers will resist. Indeed, I think it would be most effective if the Fed could eliminate the middleman of Treasury purchases. Accumulate equities to drive up net worth and thus sustain consumer spending, enough of which would be spent on nontradables (the beauty of the housing bubble, by the way) that the stimulative effect would remain in the US. This option, however, is not legally available to the Fed. But the Fed could accumulate foreign sovereign debt, thereby inducing a decline in the value of the Dollar. Alas, that option might as well be illegal as well, and it will never happen. It would be seen as a.) stepping on Treasury's turf, b.) risking retaliatory devaluations, and c.) setting the stage for an actual currency crisis.

Bottom Line: The Fed took a baby step forward last week. It is natural to interpret that step as a signal that more easing is coming. On the surface, however, such an interpretation is premature. If the economy continues to produce more of the same - steady growth with minimal inflation - policymakers are likely to keep additional policy responses to a minimum, more as an effort to placate critics than to affect meaningful changes to the economic path. Such meaningful policy might simply be a bridge too far for policymakers, especially if the asset bubbles during the past two business cycles were key to generating full employment. In such a framework, the Fed would either need to accept, and even support, a fresh asset bubble or a sharp decline in the value of the Dollar. Neither option looks acceptable at this time.

Update: Tim, who is on a camping trip, emails an update (he wrote the post before he left):

One could argue that government backed debt is the latest bubble supported by the Fed. But, in the context of the ongoing disruptions in lending channels, at least relative to what is necessary to hold the economy near potential, it is not a particularly effective bubble, absent a more committed fiscal complement.

links for 2010-08-15

Posted: 15 Aug 2010 11:03 PM PDT

Parking Spaces: What is the Free-Market Equilibrium?

Posted: 15 Aug 2010 03:33 PM PDT

In response to Robin Hanson, I think Arnold Kling makes some good points about why government intervention in parking may be necessary to resolve externality problems. Arnold doesn't say that government intervention is necessary, and he would likely resist that interpretation, a Coasian bargaining solution is the outcome in his scenario. But the usual sorts of considerations, i.e. transactions costs, unclear property rights regarding street parking in front of residences -- some people, for example, use cones and other devices to save parking spots -- and other barriers may prevent the Coasian bargaining outcome. (Robin Hanson doesn't like what I wrote either, though, again, I was trying to make a general point about equity versus efficiency and probably should have chosen another example besides parking near the ocean to make that point):

Parking Spaces: What is the Free-Market Equilibrium?, by Arnold Kling: Robin Hanson writes,

I didn't see Tyler favoring forcing prices above marginal cost, just opposing laws requiring excess supply.
So, there are two issues.

a. How much land should be devoted to parking spaces?
b. Given the answer to (a), what should be the price for parking?

I argue that for (b) the answer is often zero. A higher price would simply result in unused parking places, which does not increase welfare. Robin is falling back on issue (a), and here the thinking is that the state provides, either directly or through regulation, more parking spaces than are optimal.

Suppose there were no state provision of parking places. What would the equilibrium look like? Some possibilities:

1. You get Berlin, where the public transit is highly efficient and lots of people ride bicycles, even in the rain.

2. Individual housing developments and businesses undersupply parking. The thinking is that if parking runs out in front of your business, your customers will use the parking spaces in front of the business next door. This leads to stores putting up warning signs that say, "unless you patronize my store, your car will be towed." Neighborhoods put up signs that say, "unless you have a residential permit, your car will be towed." This imposes all sorts of enforcement costs as well as inefficient use of space. The warning signs often deter people from parking in places where they impose no cost at that particular time.

3. Land use responds, but not toward the Berlin scenario. On the contrary, businesses relocate farther away from cities, to locations where parking is cheap to supply and you don't get into fights with other businesses about towing rules. Housing developments are built without street parking but instead with large driveways--in effect, each household requires its own oversized parking lot to accommodate its peak demand . As a result of these sorts of adaptations, it takes more parking places to accommodate the same number of cars.

4. After a lot of Coasian bargaining, businesses agree to each provide a minimum number of parking places and housing developers agree to provide streets wide enough to allow parking.

The point is, you don't necessarily get (1). And you might get (4).

Identity and Interests

Posted: 15 Aug 2010 01:37 PM PDT

I don't have anything useful to say about this, but I'm hoping you will, so I'll refrain from the usual space fillers that don't say anything (such as what I just wrote and am writing). This is from Kevin Quinn:

Identity and Interests, by Kevin Quinn: I believe that the "economic way of thinking," as the textbooks have it, destroys the world we have in common, because that world is a world constructed in a normative, not a natural, space and rationality, as economists understand it, is inconsistent with, indeed makes nonsense of, the notion of normative authority. In effect, this point was made 30 years ago by Amartya Sen in "Rational Fools," where he argued that while the economic conception of rationality can make sense of "sympathy," - preference structures that made the utility of others part of the agent's objective function - it cannot make sense of what Sen called "commitment," which he defined as "counter-preferential choice." The idea that we sometimes sacrifice something - lower our utility - to do what is right is absolutely inconsistent with rational choice. I don't doubt that there are people who are well described as rational choosers - and more of them, unfortunately, than there would be had rational choice theory never been invented - but they are damaged humans, sociopaths.

The history of attempts to make sense of normative authority without giving up utility maximization is sad and pathetic and I will not rehearse it here. (The crudest is the attempt to make values a species of meta- or second-order preferences; the problem is that this approach cannot explain why their "second-orderness" gives them any more authority than the first-order preferences they are about.)

At one time, influenced by Mark Sagoff and early Bowles and Gintis, I thought that a reasonable way of "assimilating" the normative, taming it, in effect, was to distinguish between our concern with pursuing our interests and our concern with our identities, with the latter concern giving rise to commitment and making sense of normativity. So I refrain from doing something that would serve my interests because I am (we are) not the sort of person (people) who would do such a thing. This sort of thing is perfectly compatible with utility maximization, as the Akerlof/Krainton papers have shown, and therefore perfectly inconsistent with Senian commitment.

Here is the deeper problem with using "identity" to make sense of commitment: the criteria of identity are, if identity is to underpin the normative, themselves normative, not natural. My commitment to honest inquiry is tied to my identity as a "scientist," say- but scientists understood as honest inquirers, not scientists per se -many of whom are not honest. So appeal to identity to make sense of normative authority is, or can be, question-begging.

The normative, I submit, is irreducible. Hic rosa, hic salta!

I had to look up "Hic rosa, hic salta!" I think it means, essentially, "put up or shut up," but it's still not completely clear to me and that may not be right. Anyone? Update: Via email, see here too.

At EconoSpeak, Peter Dorman comments:

Interesting post, Kevin. There is an empirical side to normative behavior that is more or less tractable. This is about explaining why one norm is chosen over another, and, in some cases, why behavioral discontinuity (the indicator of a norm) exists. I've been interested in risk norms for some time.

But you are interested in the question of why individuals accept the authority of externally-given norms, which is different. I suspect this is (at least) two different problems. One is how individuals constitute themselves, perhaps fictitiously, as a "we" instead of an "I". That is an identity problem, but not exactly the same one you describe. (It is invoked at times by Sagoff, but not with much precision.) The other is the willful abandonment of personal authority -- simply giving over one's choice to an external institution or dictate. Sometimes they are hard to distinguish.

I'm less worried than I used to be about figuring this stuff out. There are sociologists, social psychologists, anthropologists and now neuropsychologists to do that job. I think it's enough for economists to just import their findings, as long as we don't try to squeeze it through the filter of utility theory.

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