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December 1, 2011

Latest Posts from Economist's View

Latest Posts from Economist's View

Kenneth Arrow: Economics and Inequality

Posted: 01 Dec 2011 12:33 AM PST

I've written recently on several occasions about the mal-distribution of income over the last several decades, i.e. the fact that wages have lagged behind increases in labor productivity. Why has this happened? Kenneth Arrow explains how the fact that "the bulk of the gains from increased productivity went to a small group of upper-income recipients" is related to market failure in the finance industry, in particular the presence of asymmetric information (he also highlights additional explanations for rising inequality such as the "steady attack on the use of the tax system as a means of equalizing income"):

Economics and Inequality, by Kenneth Arrow , Boston Review: The specific problems of the current United States economy—the drastic increase in unemployment and sluggish increase in output—overlay a tendency of much longer duration, a drastic and rapid increase in the inequality of income. ... Profits from the finance sector, which historically have been about 10 percent of all profits, have risen to an extraordinary 40 percent. ...
The notion of a well-running market is applicable to manufactured goods; different items are produced to be alike and can be evaluated by consumers. But the products of ... finance ... are ... complex. The consumer cannot seriously evaluate them—a situation that economists call "asymmetric information."
This casts light on the claim that the problem is one of personal ethics, of "greed." After all, the search for improvement in technology, and consequently in the general standards of living, is motivated by greed. When the market system works properly, greed is tempered by competition. Hence, most of the gains from innovation and good service cannot be retained by the providers.
But in situations of asymmetric information, the forces of competition are weakened. The individual .. client of a financial firm does not have access to all the relevant information. Indeed, when the information is sufficiently complex, it may be impossible to provide adequate information.
In these circumstances, the concept of "greed" becomes more relevant. There arises an obligation to present the relevant information as fully as possible, an obligation that has been violated in the financial industry. ... A proper sense of responsibility has to be enforced by legislation... There has been some erosion in the law, for example under the Clinton administration, and in enforcement. The Dodd-Frank law is a step in the right direction, but the influence of the financial industry watered it down and created unnecessary complications.
It is, of course, not superfluous to argue that steepening the income tax progression, removing a number of blatant loopholes, such as the special treatment of capital gains, and reducing the exemption level for estates would add considerably to post-tax equality.

Is Anything Better Yet?

Posted: 01 Dec 2011 12:24 AM PST

 Tim Duy:

Is Anything Better Yet?, by Tim Duy: I think the world's central banks just validated my pessimism - the Eurozone financial system is falling apart. Will this be enough to put the pieces back together? Paul Krugman is doubtful:

I am, I have to say, somewhat mystified. Of course the Fed will make dollar liquidity available to other central banks as needed; that was never in question, because Bernanke doesn't want to be the man who destroyed the world to save a few pennies. And reducing the interest rate on those loans seems to me to make virtually no difference; it was a trivial charge anyway.

Indeed, the only surprise here is that it took this long for somebody to push the panic button. Actually, there was another surprise - the dissent of Richmond Fed President Jeffrey Lacker to the increased swap lines. From Reuters:

"I dissented on the vote because I opposed the temporary swap arrangements to support Federal Reserve lending in foreign currencies," Lacker said in an emailed statement.

"Such lending amounts to fiscal policy, which I believe is the responsibility of the U.S. Treasury. The Federal Reserve has provided and can continue to provide sufficient dollar liquidity through purchases of U.S. Treasury securities," he said.

This is misguided. The Fed is responsible for protecting the US financial sector, and needs to do so, when possible, even if the threat is eminating from overseas. US banks may not be in need of dollar liquidity, but their foreign counterparties might be - and failure to provide it would more rapidly turn a European problem into a US problem.

Equity markets took the bait and ran with it. Perhaps, as Krugman suggests, market participants see this as a precursor for more to come. To be sure, the European Central Bank is almost sure to cut rates further, as well as extend liquidity facilities. But this, as well as eventual quantitative easing, are already anticipated. And if this is the final cure, why did Treasuries hold the line? Yields on the ten-year bond where up only 7bp today - not exactly a signal that investors are vastly increasing their appetite for risk.

That said, I admit to being mystified by the compulsions of equity traders. I reiterate my observation that equity prices held their ground and then some in 2007, even as the Fed was beginning a rate cut cycle that would eventually take them to zero. There is no reason to expect a different story now. In fact, the data flow on this side of the Atlantic is, quite frankly, not bad at all - see Ryan Avent's rundown. I don't really expect equities would be hit hard unless it became evident the US would not decouple from the rest of the globe. And although I am somewhat pessimistic on that point, I also admit the jury is still out.

And how exactly is the rest of the globe? Not good. Not good at all. Eurostat confirmed the unemployment rate in the Eurozone continues to rise and now stands at 10.3% in October, although with vast differences accross countries. Austria is at the bottom with 4.1%, Spain at the top with 22.8%. Notice Germany's unemployment rate continues to drop, from 5.7% to 5.5% in October. No wonder the German public resists more forceful crisis responses. Crisis? What crisis?

If you thought unemployment rates are high now, remember that we are only in the initial stages of this recession. It will get worse.

I call attention again to Portugal (unemployment 12.9% in October, up from 12.3% a year ago). The austerity parade marches forward. From the Washington Post:

Portugal's Parliament gave its blessing Wednesday to the country's severest austerity measures in almost 30 years as it scrambles to free itself from a ruinous debt crisis and help relieve pressure on the wider eurozone.

Lawmakers approved the government's spending plans for next year, including a new round of tax hikes and pay and welfare cuts that will further crunch living standards amid a deepening recession and record unemployment....

...Finance Minister Vitor Gaspar told lawmakers the cuts are needed "to restore the confidence of the Portuguese people, the markets and our international partners." The budget will help "put (Portugal) back on the path to sustainable development," he said.

How fast is confidence being restored? While most of Europe was getting relief from today's central bank action in the form of lower interest rates, yields continued to back up in Portugal, rising 42bp on the ten-year to 14.5%, extending last week's rating cut induced rise. Doesn't sound like much confidence to me. What it sounds more like is "private sector involvement."

On a completely difference topic, Eurostat also released obesity statistics. Italy looks to be doing something right.

On the other side of the world, we see that where European manufacturing goes, so too does China's. From Bloomberg:

China's manufacturing recorded the weakest performance since the global recession eased in 2009, underscoring the case for monetary stimulus as Europe's crisis weighs on the world's second-largest economy.

A purchasing managers' index compiled by the China Federation of Logistics and Purchasing slid to 49 in November, lower than all but two of 18 forecasts in a Bloomberg News survey. Readings below 50 signal a contraction. Separate reports showed slowing retail sales and an industrial slump in Australia, which relies on China as its biggest export customer.

No wonder Chinese policymakers are stepping on the gas.

Bottom Line: Central banks took a step in the right direction. But nothing in Europe is close to be solved by that action. We are still closer to the beginning of this mess than the end.

Links for 2011-12-01

Posted: 01 Dec 2011 12:06 AM PST

Did the Fed Go Far Enough?

Posted: 30 Nov 2011 04:29 PM PST

More comments at the NY Times Room for Debate on today's announcement that monetary authorities are taking steps to increase the availability of dollar loans to foreign banks in the hopes of avoiding a Lehman-like crisis. The question we were asked is:

Should the Fed be more aggressive in dealing with Europe's financial crisis? What are the risks of its involvement?

Here are our responses:

[Additional comments here.]

DeLong: The 70% Solution

Posted: 30 Nov 2011 09:55 AM PST

Busy morning -- quick one between meetings:

The 70% Solution, by J. Bradford DeLong, Commentary, Project Syndicate: Via a circuitous Internet chain – Paul Krugman of Princeton University quoting Mark Thoma of the University of Oregon reading the Journal of Economic Perspectives – I got a copy of an article written by Emmanuel Saez, whose office is 50 feet from mine, on the same corridor, and the Nobel laureate economist Peter Diamond. Saez and Diamond argue that the right marginal tax rate for North Atlantic societies to impose on their richest citizens is 70%.

It is an arresting assertion, given the tax-cut mania that has prevailed in these societies for the past 30 years, but Diamond and Saez's logic is clear. The superrich command and control so many resources that they are effectively satiated: increasing or decreasing how much wealth they have has no effect on their happiness. So, no matter how large a weight we place on their happiness relative to the happiness of others – whether we regard them as praiseworthy captains of industry who merit their high positions, or as parasitic thieves – we simply cannot do anything to affect it by raising or lowering their tax rates.

The unavoidable implication of this argument is that when we calculate what the tax rate for the superrich will be, we should not consider the effect of changing their tax rate on their happiness, for we know that it is zero. Rather, the key question must be the effect of changing their tax rate on the well-being of the rest of us.

From this simple chain of logic follows the conclusion that we have a moral obligation to tax our superrich at the peak of the Laffer Curve... [continue reading]...

The Fed's Move to Help Europe

Posted: 30 Nov 2011 09:55 AM PST

I did a short Q&A for CBS News on the news that central banks around the world are taking steps to make it cheaper for foreign banks to borrow dollars:

Will the Fed's move to help Europe hurt the U.S.?

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