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November 18, 2011

Latest Posts from Economist's View

Latest Posts from Economist's View

Paul Krugman: Failure Is Good

Posted: 18 Nov 2011 01:17 AM PST

The failure to do a bad thing is a good thing:

Failure Is Good, by Paul Krugman, Commentary, NY Times: It's a bird! It's a plane! It's a complete turkey! It's the supercommittee!
By next Wednesday, the so-called supercommittee, a bipartisan group of legislators, is supposed to reach an agreement on how to reduce future deficits. Barring an evil miracle — I'll explain the evil part later — the committee will fail to meet that deadline. ...
Why was the supercommittee doomed to fail? Mainly because ... Republicans and Democrats don't just have different priorities; they live in different intellectual and moral universes.
In Democrat-world, up is up and down is down. Raising taxes increases revenue, and cutting spending while the economy is still depressed reduces employment. But in Republican-world, down is up. The way to increase revenue is to cut taxes on corporations and the wealthy, and slashing government spending is a job-creation strategy. ...
Moreover, the parties have sharply different views of what constitutes economic justice. Democrats see social insurance programs, from Social Security to food stamps, as serving the moral imperative of providing basic security to our fellow citizens and helping those in need.
Republicans have a totally different view..., they view the welfare state as immoral, a matter of forcing citizens at gunpoint to hand their money over to other people. ...
Why did anyone think this would work?
Well, maybe the idea was that the parties would compromise out of fear that there would be a political price for seeming intransigent. But this could only happen if the news media were willing to point out who is really refusing to compromise. And they aren't..., the G.O.P. pays no price for refusing to give an inch.
So the supercommittee will fail — and that's good.
For one thing, history tells us that the Republican Party would renege on its side of any deal as soon as it got the chance. ... So any deal reached now would, in practice, be nothing more than a deal to slash Social Security and Medicare, with no lasting improvement in the deficit.
Also, any deal reached now would almost surely end up worsening the economic slump. Slashing spending while the economy is depressed destroys jobs... Better to have no deal than a deal that imposes spending cuts in the next few years. ...
Eventually, one side or the other of that divide will get the kind of popular mandate it needs to resolve our long-run budget issues. Until then, attempts to strike a Grand Bargain are fundamentally destructive. If the supercommittee fails, as expected, it will be time to celebrate.

Disparities in Mortgage Lending

Posted: 18 Nov 2011 12:33 AM PST

Richard Green highlights a new report on mortgage lending:

Read CRL on Disparities in Mortgage Lending, by Richard Green: The Center for Responsible Lending's research team of Carolina Reid (who has been working tirelessly at developing data on subprime mortgages for some time now), Roberto Quercia, We Li, and Debbie Grunstein Bocian has produced Lost Ground, 2011: Disparities in Mortgage Lending and Foreclosures. They argue

(1) The nation is not even halfway through the foreclosure crisis. Among mortgages made between 2004 and 2008, 6.4 percent have ended in foreclosure, and an additional 8.3 percent are at immediate, serious risk.
(2) Foreclosure patterns are strongly linked with patterns of risky lending. The foreclosure rates are consistently worse for borrowers who received high-risk loan products that were aggressively marketed before the housing crash, such as loans with prepayment penalties, hybrid adjustable-rate mortgages (ARMs), and option ARMs. Foreclosure rates are highest in neighborhoods where these loans were concentrated.
(3)The majority of people affected by foreclosures have been white families. However, borrowers of color are more than twice as likely to lose their home as white households. These higher rates reflect the fact that African Americans and Latinos were consistently more likely to receive high-risk loan products, even after accounting for income and credit status.

It is really striking how African-Americans and Hispanics were steered into crappy loans, even controlling for income and credit history. Beyond all this, the web site accompanying the report has really nicely organized data on severely delinquent loans and loans in foreclosure by state, race, ethnicity and MSA.

Minimum Wages and Industrialization

Posted: 18 Nov 2011 12:24 AM PST

Chris Blattman:

Do minimum wages drive industrialization?, by Chris Blattman: Minimum wages kill employment, right?

Maybe not..., evidence from Indonesia's industrialization:

Big Push models suggest that local product demand can create multiple labor market equilibria: one featuring high wages, formalization, and high demand and one with low wages, informality, and low demand. I demonstrate that minimum wages may coordinate development at the high wage equilibrium.

formal employment increases and informal employment decreases in response to the minimum wage. Local product demand also increases, and this formalization occurs only in the non-tradable, industrializable industries

A new paper from Jeremy Magruder.

Links for 2011-11-18

Posted: 18 Nov 2011 12:06 AM PST

Local News: Barry Eichengreen Lecture

Posted: 17 Nov 2011 12:24 PM PST

If you are anywhere near Eugene today:

Noted expert on Europe's economy to speak on campus, UO Communications: Economist and political scientist Barry Eichengreen of the University of California, Berkeley, whose opinions have been widely sought by international media covering the European financial crisis, will deliver a lecture on the "Europe's Never-Ending Crisis" at 7:30 p.m., Thursday, Nov. 17, at the University of Oregon.

Eichengreen will address the causes of Europe's debt and financial crisis, as well as elaborate on the potential impacts on both the U.S. and world economy. The event will be held in 100 Willamette Hall, 1371 E. 13th Ave.

Admission is free, with the lecture content designed to reach a general public audience.

Contractionary Fiscal Policy is Contractionary

Posted: 17 Nov 2011 09:09 AM PST

Robert Kuttner is unhappy with the Washington Post:

Post Hoc Fallacy, by Robert Kuttner, Prospect: Wednesday's Washington Post deserves some kind of perverse award for advocacy journalism—in this case, for advocating the proposition that dire economic consequences will ensue if the congressional Super Committee fails to cut a deal for drastic deficit reduction. This is, of course, one side of an argument.
Those on the other side, including myself, have argued that austerity in a deep recession makes no economic sense...
Moreover, Social Security does not belong in this conversation, and Democrats are better off, substantively and politically, defending it against Republican proposed cuts rather than lumping it in with budget talks....
The Post has been an editorial champion of the Super Committee and austerity politics, and of the bogus claim that Social Security is partly responsible for the current deficit...
A companion piece, by Ann Kornblut, was headlined, "White House Girds for Failure." ... OMB Director Jack Lew is quoted, "I think it's important that they succeed." Again, the subtext of the piece is that the economy really needs this deal.
But the absolute corker is a companion piece by Neil Irwin and Ylan Q. Mui, with the economically absurd headline and premise, "Supercommittee could add uncertainty to holiday shopping."
The writers quote leaders of trade associations saying that the committee needs to act to restore confidence. This is Paul Krugman's famous "confidence fairy." ...
So let's get this straight. If the committee does agree to cut the budget by some $1.2 trillion, including people's Medicare, Medicaid, and Social Security, that will make them more likely to go out and shop. But if the committee fails to extract cuts—putting off budget austerity until 2013—that will make people more hesitant to spend? Where do these people study their economics? ...

The Super-Duper Job Creation Committee is, of course, nowhere to be found.

Joshua Gans: Entrepreneurship and Inequality

Posted: 17 Nov 2011 08:28 AM PST

Do you agree with this?:

Entrepreneurship and inequality, by Joshua Gans: So I was reading Felix Salmon's account of a debate here in Toronto between Paul Krugman and Larry Summers. ... I was struck by this passage.

Summers also tried to defend inequality, at least in part, by saying that "suppose the United States had 30 more people like Steve Jobs" — that, he said, would be a good thing even as it increased inequality. "So we do need to recognize that a component of this inequality is the other side of successful entrepreneurship; that is surely something we want to encourage."

Now there is nothing new in this view. It is an argument for inequality that reminds me of Ted Baxter (from the Mary Tyler Moore Show) who intended to have six children in the hope that one of them grows up to solve the population problem. The inequality version is that we accept inequality in the hopes of getting the fruits of entrepreneurship.

So no one disagrees with encouraging entrepreneurship. ... But when we link it to inequality in this way we are asking ... whether the poor (or middle class) are happy outsourcing knowledge creation and are each willing to pay a bit to see that happen.

Seen in this light, the problem of inequality is a design problem. This is something that Jean Tirole and Glen Weyl have recently investigated. They ask a related question: when is it a good idea to confer entrepreneurs with market power (as a reward)? The answer turns out to be, when the government does not know much about the nature of demand for innovative products. In this world, by exposing entrepreneurial rewards to what they can get through monopoly pricing, we screen for innovations that maximize the gap between innovative benefits and innovative costs. The implication here is that if we outsourced innovation to creative geniuses, we would do it in a way that allows them to charge high prices.

But does that carry over when there is real inequality? Let's face it, the actual products Steve Jobs produced were not priced for the poor. The best we can say is that when they were imitated the poor received some benefits (which may also be arguable). So is it really the case that poorer people would be willing to be taxed more (by government or through monopoly pricing) in order to bring out more people like Steve Jobs? Instead, the Steve Jobs argument is surely one for a lateral wealth transfer from those with wealth — innovators or not — to be more concentrated amongst those who innovate. It is inequality in talent and skill and its mismatch to wealth that drives the argument not inequality in wealth.

It takes a village to make an iPad.

Why Hasn't the Fed Lowered the Rate It Pays on Reserves?

Posted: 17 Nov 2011 07:29 AM PST

I've been wondering why the Fed hasn't lowered the interest it pays on bank reserves from its current value of .25 percent to zero. It probably wouldn't do much, but it would slightly lower the incentive for banks to hold cash rather than loaning it out, and more loans would help to spur the economy, so why not give it a try? In addition, unlike some other policies the Fed might pursue, this would be easily reversible, and it would help to convince critics that the Fed is trying everything it can think of.

Though it's buried deep within the post, the NY Fed explains the FOMC's reluctance to pursue this option. The argument is that it's possible for some interest rates to go slightly negative, and if they do it will cause various problems the Fed would rather avoid (see below). Since banks can borrow from anyone charging less than the rate they earn on reserves and arbitrage the difference away, paying interest on reserves puts a floor on interest rates.  Here's the full argument:

Why Is There a "Zero Lower Bound" on Interest Rates?, by Todd Keister, Liberty Street: Economists often talk about nominal interest rates having a "zero lower bound," meaning they should not be expected to fall below zero. While there have been episodes—both historical and recent—in which some market interest rates became negative, these episodes have been fairly isolated. In this post, I explain why negative interest rates are possible in principle, but rare in practice. Financial markets are generally designed to operate under positive interest rates, and might experience significant disruptions if rates became negative. To avoid such disruptions, policymakers tend to keep short-term interest rates above zero even when trying to loosen monetary policy in other dimensions. These policy choices are the source of the zero lower bound.

The standard description of the zero lower bound begins with the observation that the nominal interest rate offered by currency is always zero: If I hold on to a dollar bill, I'll still have one dollar tomorrow, next week, or next year. If I invest money at an interest rate of -2 percent, in contrast, one dollar of saving today would become only ninety-eight cents a year from now. Because everyone has the option to hold currency, the argument goes, no one would be willing to hold some other asset or investment that offers a negative interest rate.

This argument is only part of the story, however. Safeguarding and transacting with large quantities of currency is costly. One only needs to imagine the risk and hassle of making all transactions in cash—paying the rent or mortgage, utility bills, etc.—to appreciate the safety and convenience of a checking account. Many individuals would likely be willing to keep funds in deposit accounts even if these accounts pay a negative interest rate or charge maintenance fees that make their effective interest rate negative.

Large institutional investors are in a similar situation. They use a variety of short-term investments, such as lending funds in the "repo" (repurchase agreement) market and holding short-term Treasury bills, in much the same way individuals use checking accounts. These investments will remain attractive to large investors even at negative interest rates because of the security and convenience they offer relative to dealing in currency. Some repo rates did in fact become negative in 2003 (see this New York Fed study) and again more recently (see Bloomberg). Interest rates in the secondary market for Treasury bills have also been slightly negative recently (see Businessweek).

In other words, market interest rates can move somewhat below zero without triggering a massive switch into currency. Nevertheless, central banks typically maintain positive short-term interest rates even while using less conventional tools (such as large-scale asset purchases) to provide additional monetary stimulus.

The Federal Reserve, for example, currently pays an interest rate of 0.25 percent on the reserve balances that banks hold on deposit at the Fed. The ability to earn this interest gives banks an incentive to borrow funds in a range of markets (including the interbank market and the repo market) and thus has the effect of keeping market interest rates positive most of the time. The Federal Open Market Committee (FOMC) discussed the idea of reducing the interest on reserves (IOR) rate at its September meeting, but no action was taken. Reducing this rate would tend to lower short-term market interest rates and might push some rates below zero. The minutes from the meeting report that "many participants voiced concerns that reducing the IOR rate risked costly disruptions to money markets and to the intermediation of credit, and that the magnitude of such effects would be difficult to predict."

Similarly, the Monetary Policy Committee (MPC) of the Bank of England discussed the possibility of lowering the official Bank Rate below 0.5 percent at its September meeting, but decided against doing so. The MPC had previously expressed concern that "a sustained period of very low interest rates would impair the functioning of money markets." 

Some examples of areas where disruptions could potentially arise in U.S. financial markets are:

  • Money market mutual funds: Money market funds operate under rules that make it difficult for them to pay negative interest rates to their investors, either directly or by assessing fees. Many of these funds would likely close down if the interest rates they earn on their assets were to fall to zero or below, possibly disrupting the flow of credit to some borrowers.
  • Treasury auctions: The auction process for new U.S. Treasury securities does not currently permit participants to submit bids associated with negative interest rates. If market interest rates become negative, new Treasury securities would be issued with a zero interest rate—effectively a below-market price—and bids would be rationed if demand exceeds supply. Such rationing, which has occurred in recent auctions, would generate an incentive for auction participants to bid for more than their true demand, leading to even more rationing. This situation could generate market volatility, as unexpected changes in the amount of rationing in each auction could leave some investors holding either many more or many fewer securities than they desire.
  • Federal funds: A decrease in the IOR rate would also likely affect the federal funds market, where banks and certain other institutions lend funds to each other overnight. A lower IOR rate would give banks less incentive to borrow in this market, which would likely decrease the amount of activity. When less activity takes place, the market interest rate will be influenced more by idiosyncratic factors, making it a less reliable indicator of current conditions. This decoupling of the federal funds rate from financial conditions could complicate communications for the FOMC, which operates monetary policy in part by setting a target for this rate.

These examples demonstrate that many current institutional arrangements were not designed with near-zero or negative interest rates in mind. In principle, these arrangements—such as the rules governing mutual funds and Treasury auctions—could be changed. The implementation of a "fails charge" in 2009 for the settlement of Treasury securities (see this New York Fed study) is one example of an institutional adaptation that allows markets to function better at very low interest rates. (A similar charge is scheduled to take effect in some mortgage-related markets in February 2012.) In practice, however, such changes may take significant time to implement and could simply move disruptions to other markets.

Given the markets' limited experience with very low interest rates, it is difficult to predict with any degree of certainty how they will react to them. If the types of disruptions described above turn out to be significant, taking steps to lower short-term interest rates could actually make financial conditions tighter rather than looser and thus hinder the economic recovery. To avoid this outcome, policymakers tend to choose policies that keep market interest rates positive. In other words, the potential for negative interest rates to disrupt financial markets limits the extent to which policymakers can stimulate economic activity by lowering interest rates. This limit is known as the zero lower bound.

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