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August 20, 2010

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Latest Posts from Economist's View


Paul Krugman: Appeasing the Bond Gods

Posted: 20 Aug 2010 12:23 AM PDT

Can "the minds of the policy elite" be deprogrammed? Let's hope so:

Appeasing the Bond Gods, by Paul Krugman, Commentary, NY Times: As I look at what passes for responsible economic policy these days, there's an analogy that keeps passing through my mind. I know it's over the top, but here it is anyway: the policy elite — central bankers, finance ministers, politicians who pose as defenders of fiscal virtue — are acting like the priests of some ancient cult, demanding that we engage in human sacrifices to appease the anger of invisible gods.
Hey, I told you it was over the top. But bear with me for a minute.
Late last year the conventional wisdom on economic policy took a hard right turn. Even though the world's major economies had barely begun to recover,... creating jobs was no longer on the agenda. Instead, we were told, governments had to turn all their attention to reducing budget deficits.
Skeptics pointed out that slashing spending in a depressed economy does little to improve long-run budget prospects, and may actually make them worse by depressing economic growth. But the apostles of austerity — sometimes referred to as "austerians" — brushed aside all attempts to do the math...: immediate spending cuts were needed to ward off the "bond vigilantes," investors who would pull the plug on spendthrift governments,... precipitating a crisis. Look at Greece, they said.
The skeptics countered that Greece is a special case, trapped by its use of the euro... The interest rates paid by major nations with their own currencies ... showed no sign that the bond vigilantes were about to attack, or even that they existed.
Just you wait, said the austerians: the bond vigilantes may be invisible, but they must be feared all the same.
This was a strange argument even a few months ago, when the U.S. government could borrow for 10 years at less than 4 percent interest. We were being told that it was necessary to give up on job creation, to inflict suffering on millions of workers, in order to satisfy demands that investors were not, in fact, actually making, but which austerians claimed they would make in the future.
But ... recently ... it has become clear that investors aren't worried about deficits; they're worried about stagnation and deflation. And they've been signaling that concern by driving interest rates on the debt ... lower, not higher. ...
So how do austerians deal with the reality of interest rates that are plunging, not soaring? The latest fashion is to declare that there's a bubble in the bond market: investors aren't really concerned about economic weakness; they're just getting carried away. It's hard to convey the sheer audacity of this argument: first we were told that we must ignore economic fundamentals and instead obey the dictates of financial markets; now we're being told to ignore what those markets are actually saying because they're confused.
You see, then, why I find myself thinking in terms of strange and savage cults, demanding human sacrifices to appease unseen forces. ...
It seems almost superfluous, given all that, to mention the final insult: many of the most vocal austerians are, of course, hypocrites. Notice, in particular, how suddenly Republicans lost interest in the budget deficit when they were challenged about the cost of retaining tax cuts for the wealthy. But that won't stop them from continuing to pose as deficit hawks whenever anyone proposes doing something to help the unemployed.
So here's the question I find myself asking: What will it take to break the hold of this cruel cult on the minds of the policy elite? When, if ever, will we get back to the job of rebuilding the economy?

"Public Debt and National Income"

Posted: 20 Aug 2010 12:10 AM PDT

Earlier today a colleague, Peter Lambert, gave me a book containing the first 8 volumes of a series called "Postwar Economic Studies." The volumes, which as Peter says are "more like extended pamphlets," were published individually between August 1945 and November 1947 and then assembled into this collection.

I haven't read much of the book yet, but this part sounds familiar (it's from the third volume, "Public Finance and Full Employment," and this article is by Evsey D. Domar, published in December, 1945):

Public Debt and National Income, by Evsey D. Domar, Division of Research and Statistics, Board of Governors: On November 30, 1945 the Federal debt reached 265 billion dollars, a magnitude without precedent in the history of this country. With the present interest rate structure, it involves an annual service charge of more than 5 billion dollars, an amount exceeded by only two peacetime Federal budgets until 1934.[1] It is quite understandable that a debt of this magnitude should cause considerable apprehension, and that a policy of repaying at least a part of it should be advocated so often.
DEBT AS AN INSTRUMENT OF FISCAL POLICY
It is true that our economy would be better off without so large a debt. But this does not mean that our position can be always improved by reducing the debt. The difficulty lies in the fact that the various components of our economy are interdependent, so that it is impossible to change one without affecting the others. In particular, the debt problem is more complex and difficult than it appears on the surface because changes in the debt exercise a powerful effect on the size of the national income. ...
Debt and Fiscal Policy. ...Now that the war is over, our economic policy should be directed toward achieving a high and stable level of employment and a growing national income. But there is increasing agreement among economists and others that stability will not maintain itself automatically, and that active Government intervention will be needed to eliminate the swings between prosperity and depression which characterized our economy in the past..., a  deficit will probably be required to prevent a slump. Similarly when inflation threatens, a budget surplus should be accumulated and a part of the debt repaid. But trying to repay the debt ... when considerable unemployment already exists ... makes little sense: income will suffer a greater proportional decline than the debt, and debt "burden" of the economy will actually rise.
If times of low business activity are sufficiently compensated by years of high private expenditures, Government deficits incurred during the former periods-will be balanced by surpluses created during the latter. Roughly speaking, the debt will then fluctuate around the same average level; over a period of time (without wars) its magnitude will not rise. But what if this will not be the case? What if in spite of all our efforts it will be impossible to accumulate sufficient surpluses to offset the deficits -- what kind of a debt problem shall we have to face then?
Secular Expansion of the Debt. ...Government borrowing ... is not synonymous with "make-work projects." There are many fields, such as urban redevelopment, public health and education, development of our resources, scientific research, and many others, in which Government expenditures are extremely useful, aside from employment aspects. That they create jobs and raise national income is so much the better. I believe that our actual experience during this war has well demonstrated that with sufficient Government expenditures national income can be raised to the highest level permitted by our productive capacity. This is now recognized by many competent authorities, including some opponents of Government borrowing. The latter object to the pursuit of such a policy on other grounds. From a political point of view, they argue, continuous Government borrowing will involve increasing regimentation and eventually destroy our democratic institutions; and from an economic point of view, it will lead to an ever mounting debt which, among other things, will necessitate higher and higher taxes with their well-known depressive effects.
The political aspects of Government borrowing are not discussed in this paper. In passing one can briefly remark that even in our most prosperous years, such as 1929, our cities were blighted by slums; that large areas of our country, particularly in the Southeast, have never had anything even approaching a satisfactory minimum standard of health and education, and that finally private business has-not been able to prevent the waste of our natural resources. Democracy will hardly be endangered by projects such as the TVA which, moreover, create numerous opportunities for private investment; or by healthier cities and better schools. As we can learn from the experience of other countries, it is chronic depression and unemployment that endanger democracy. ...

links for 2010-08-19

Posted: 19 Aug 2010 11:02 PM PDT

Stiglitz: Needed: a New Economic Paradigm

Posted: 19 Aug 2010 05:01 PM PDT

Joseph Stiglitz says adding bells and whistles to the current vintage of macroeconomic models will not fix what is wrong with them, "Nothing less than a paradigm shift will do":

Needed: a new economic paradigm, by By Joseph Stiglitz, Comentary, Financial Times: The blame game continues over who is responsible for the worst recession since the Great Depression – the financiers who did such a bad job of managing risk or the regulators who failed to stop them. But the economics profession bears more than a little culpability. It provided the models that gave comfort to regulators that markets could be self-regulated; that they were efficient and self-correcting. The efficient markets hypothesis ... ruled the day. Today, not only is our economy in a shambles but so too is the economic paradigm that predominated in the years before the crisis – or at least it should be.
It is hard for non-economists to understand how peculiar the predominant macroeconomic models were. Many assumed demand had to equal supply – and that meant there could be no unemployment. (Right now a lot of people are just enjoying an extra dose of leisure; why they are unhappy is a matter for psychiatry, not economics.) Many used "representative agent models" – all individuals were assumed to be identical, and this meant there could be no meaningful financial markets (who would be lending money to whom?). Information asymmetries, the cornerstone of modern economics, also had no place: they could arise only if individuals suffered from acute schizophrenia, an assumption incompatible with another of the favored assumptions, full rationality.
Bad models lead to bad policy: central banks, for instance, focused on the small economic inefficiencies arising from inflation, to the exclusion of the far, far greater inefficiencies arising from dysfunctional financial markets and asset price bubbles. After all, their models said that financial markets were always efficient. Remarkably, standard macroeconomic models did not even incorporate adequate analyses of banks...: even a cursory look at the perverse incentives confronting banks and their managers would have predicted short-sighted behavior with excessive risk-taking. ...
Fortunately, while much of the mainstream focused on these flawed models, numerous researchers were engaged in developing alternative approaches. ... With a few exceptions, most central banks paid little attention to systemic risk and the risks posed by credit interlinkages. Years before the crisis, a few researchers focused on these issues, including the possibility of the bankruptcy cascades that were to play out in such an important way in the crisis. This is an example of the importance of modeling carefully complex interactions among economic agents (households, companies, banks) – interactions that cannot be studied in models in which everyone is assumed to be the same. Even the sacrosanct assumption of rationality has been attacked: there are systemic deviations from rationality and consequences for macroeconomic behavior that need to be explored.
Changing paradigms is not easy. Too many have invested too much in the wrong models. Like the Ptolemaic attempts to preserve earth-centric views of the universe, there will be heroic efforts to add complexities and refinements to the standard paradigm. The resulting models will be an improvement and policies based on them may do better, but they too are likely to fail. Nothing less than a paradigm shift will do.

But a new paradigm, I believe, is within our grasp... What is at stake, of course, is more than just the credibility of the economics profession or that of the policymakers who rely on their ideas: it is the stability and prosperity of our economies.

"For Cost Control, Vouchers and Medicare Don't Mix"

Posted: 19 Aug 2010 01:22 PM PDT

Are vouchers the key to controlling Medicare costs? Apparently not:

For Cost Control, Vouchers and Medicare Don't Mix, by Austin Frakt: With the ambition of reducing the federal debt, Congressman Paul Ryan has offered a proposal to convert Medicare to a voucher-based program. ... In principle, such a system could reduce federal Medicare costs... The history of Medicare and its politics suggest it is unlikely to work out that way.

About Ryan's plan, economist Paul Krugman wrote in the New York Times, "[W]e already know, from experience with the Medicare Advantage program, that a voucher system would have higher, not lower, costs than our current system." Krugman is correct...

What's going on? Why is the market-based Advantage voucher system not helping to control Medicare costs? The answer is that health care cost control is tough, technically and politically. ... By adding another private-sector layer to the program--health insurers--the Advantage program invites a third source of political pressure. Rent-seeking by providers and insurers, as well as the power of the beneficiary constituency, align in their encouragement of higher Advantage payments. Congress, apparently, is willing to yield to that encouragement.

So, it's really no surprise that Advantage plans have not, to date, been part of a Medicare cost control solution. Congress has not consistently been willing to say no to the combination of powerful interests that advocate for higher payments to private plans. Given the track record, it is also not unreasonable to conclude the mandatory voucher program Ryan advocates wouldn't save money either. As Krugman suggests, it could even be worse because in time 100% of beneficiaries would be enrolled in vouchers, not the 24 percent that are enrolled today.

The politics of Medicare are such that Ryan's idea, paying for care entirely through private plans, costs more. That's not due to a market failure, but a political one. Congress likes to spend money; insurers, providers and beneficiaries like to receive it. Congress spends even more when it can satisfy those interests under the guise of a seemingly pro-market, pro-competitive program. ...

Initial Claims for Unemployment Insurance Increase to 500,000

Posted: 19 Aug 2010 09:16 AM PDT

This is not very good news. Initial claims for unemployment insurance took a turn for the worse and climbed back to 500,000, the highest level since late in 2009:

In the week ending Aug. 14, the advance figure for seasonally adjusted initial claims was 500,000, an increase of 12,000 from the previous week's revised figure of 488,000. The 4-week moving average was 482,500, an increase of 8,000 from the previous week's revised average of 474,500.

Claims have been moving sideways for several months and are at the highest level since late in 2009:

initial-claims-un
Initial Claims for Unemployment Insurance: 4-Week Average

I have a few brief comments on this latest piece of bad labor market news at MoneyWatch.

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