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September 27, 2011

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Latest Posts from Economist's View


Fed Watch: The Bernanke of 2003

Posted: 27 Sep 2011 12:24 AM PDT

Tim Duy:

The Bernanke of 2003, by Tim Duy: Ryan Avent reminds us of a depressing point:

...Ben Bernanke seems to have forgotten everything he once knew about the crises in the 1930s and in Japan in the 1990s. America is sinking back toward recession while the global economy nears a cliff, and the Fed—by its own acknowledgment—has plenty of heavy ammunition sitting untouched on the shelf.

I recently had reason to re-read then Federal Reserve Governor Ben Bernanke's 2003 speech on Japanese monetary policy, and realized again that he eliminated virtually every objection to doing more. Concerned about a temporary inflation increase beyond the target rate? Not an problem, according to Bernanke:

A concern that one might have about price-level targeting, as opposed to more conventional inflation targeting, is that it requires a short-term inflation rate that is higher than the long-term inflation objective. Is there not some danger of inflation overshooting, so that a deflation problem is replaced with an inflation problem? No doubt this concern has some basis, and ultimately one has to make a judgment. However, on the other side of the scale, I would put the following points: first, the benefits to the real economy of a more rapid restoration of the pre-deflation price level and second, the fact that the publicly announced price-level targets would help the Bank of Japan manage public expectations and to draw the distinction between a one-time price-level correction and the BOJ's longer-run inflation objective. If this distinction can be made, the effect of the reflation program on inflation expectations and long-term nominal interest rates should be smaller than if all reflation is interpreted as a permanent increase in inflation.

Fearing the possible capital loss on the Fed's balance sheet should interest rates need to rise quickly? Bernanke offers a solution:

In short, one could make an economic case that the balance sheet of the central bank should be of marginal relevance at best to the determination of monetary policy. Rather than engage in what would probably be a heated and unproductive debate over the issue, however, I would propose instead that the Japanese government just fix the problem, thereby eliminating this concern from the BOJ's list of worries. There are many essentially costless ways to fix it. I am intrigued by a simple proposal that I understand has been suggested by the Japanese Business Federation, the Nippon Keidanren. Under this proposal the Ministry of Finance would convert the fixed interest rates of the Japanese government bonds held by the Bank of Japan into floating interest rates. This "bond conversion"--actually, a fixed-floating interest rate swap--would protect the capital position of the Bank of Japan from increases in long-term interest rates and remove much of the balance sheet risk associated with open-market operations in government securities. Moreover, the budgetary implications of this proposal would be essentially zero, since any increase in interest payments to the BOJ by the MOF arising from the bond conversion would be offset by an almost equal increase in the BOJ's payouts to the national treasury

Is the debt an impediment to additional fiscal policy? We can fix that, too:

In addition to making policymakers more reluctant to use expansionary fiscal policies in the first place, Japan's large national debt may dilute the effect of fiscal policies in those instances when they are used. For example, people may be more inclined to save rather than spend tax cuts when they know that the cuts increase future government interest costs and thus raise future tax payments for themselves or their children...If, as a result, they react to increases in government spending by reducing their own expenditure, the net stimulative effect of fiscal actions will be reduced. In short, to strengthen the effects of fiscal policy, it would be helpful to break the link between expansionary fiscal actions today and increases in the taxes that people expect to pay tomorrow.

My thesis here is that cooperation between the monetary and fiscal authorities in Japan could help solve the problems that each policymaker faces on its own. Consider for example a tax cut for households and businesses that is explicitly coupled with incremental BOJ purchases of government debt--so that the tax cut is in effect financed by money creation. Moreover, assume that the Bank of Japan has made a commitment, by announcing a price-level target, to reflate the economy, so that much or all of the increase in the money stock is viewed as permanent.

The supposed impediments to additional policy, according to Bernanke himself, are illusionary. Simply ghost stories to scare the public into thinking there are no more policy options. So why the delay? It all comes back to deflation:

In that spirit, my remarks today will be focused on opportunities for monetary policy innovation in Japan, including specifically the possibility of more-active monetary-fiscal cooperation to end deflation.

In Bernanke's view, only obvious evidence of deflation justifies the use of aggressive policy. And with downward nominal wage rigidities, the US outcome may very well be one of persistent low inflation, not outright deflation like Japan:

Earn

If average hourly wages for all employees are locked up on the downside at 1.75% y-o-y growth, I suspect outright, sustained deflation will not be likely. And without deflation, aggressive policy is unlikely. And without aggressive policy, a rapid rebound to trend is out of the question.
Bottom Line: It has got to get a lot worse before policymakers will pull out all the stops to try to make it better.

links for 2011-09-26

Posted: 26 Sep 2011 10:01 PM PDT

Macroeconomics: Evidence or Ideology

Posted: 26 Sep 2011 02:52 PM PDT

There are quite a few reactions to the interview of Robert Lucas in the WSJ, e.g. see  Noah Smith, Karl Smith, and  Paul Krugman. Antonio Fatas picks up the European angle:

Macroeconomics: Evidence or Ideology: The Wall Street Journal had a weekend interview with Robert Lucas... He is asked about the economic situation in the US and Europe. When asked about the US he talks about the cost of uncertainty about future taxes. When he is asked about Europe, he talks about the cost of high taxes. From the interview:

For the best explanation of what happened in Europe and Japan, he points to research by fellow Nobelist Ed Prescott. In Europe, governments typically commandeer 50% of GDP. The burden to pay for all this largess falls on workers in the form of high marginal tax rates, and in particular on married women who might otherwise think of going to work as second earners in their households. "The welfare state is so expensive, it just breaks the link between work effort and what you get out of it, your living standard," says Mr. Lucas. "And it's really hurting them."

No doubt that (theoretically) high taxes could discourage effort but is this statement empirically relevant? Below is a chart of marginal tax rates (as estimated by the OECD) and the female employment to population ratio for the age range (25-54) for 2010. I have chosen that particular employment to population ratio because it matches the statement in the quote above (the chart looks similar if we look at a different age range or male participation rates).

Do we see more or less effort in countries with high tax rates? Not obvious. In fact, in the sample I have selected there seems to be a positive correlation, not a negative one. Countries with strong welfare state, high taxes (both average and marginal) show higher level of efforts as measured by employment to population ratios. The US appears as a country with low taxes but also low levels of effort.

The chart above is, of course, not the final answer to the question of how taxes affect labor market outcomes but at least it gives as good argument to dispute the claim that all European problems are about high taxes.

"Beware the Wrong Lessons from Poverty and Income Data"

Posted: 26 Sep 2011 10:08 AM PDT

Jeff Madrick:

Beware the Wrong Lessons from Poverty and Income Data, by Jeff Madrick: ...The poverty data released by the Census Bureau last week may well be the straw that broke the camel's back — the camel being those deliberately blind people who can't seem to acknowledge that most Americans are doing poorly. Average Americans should not be the ones who have to shoulder the burden of balancing the budget, even if it needed balancing soon.
The poverty rate is now as high as it was during the war on poverty of the 1960s — about 15 percent. The Census also revealed that median household income went nowhere under George W. Bush and is now down to its lowest level since 1997, essentially before the Clinton boom.
Even more deplorable, the young in America have been hit hardest. Economists at Northeastern University have been showing for years how low wages are for those in their twenties, if they can find a job at all. Now they calculate that 37 percent of young families with children live in poverty — more than one in three. It was one in five when Bush came to office.
But the reason I am writing this is ... that the elderly have taken a far smaller hit than the rest. Is this going to be the new argument for reducing Social Security and Medicare benefits?
The truth is much the opposite: These findings are an argument for a stronger safety net. The reason the elderly are not doing as poorly is precisely because of Social Security, Medicare, and Medicaid. ...
So let's not use these data to claim justification for cutting back social programs for the elderly. They show that the safety net is doing what it is supposed to do, which is to protect people from the ravages of a damaged economy. What we should be doing is expanding the safety net and getting the economy to start producing good old-fashioned American-style wage gains again. Can we afford new social programs for the young? Of course we can. We are among the lowest taxed of rich nations. ...

The argument that the elderly don't need Social Security is like arguing the bars on the windows are not needed because nobody's ever broken in.

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