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April 30, 2011

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David Andolfatto: Ron Paul's Comments on Bernanke's Press Conference

Posted: 30 Apr 2011 12:33 AM PDT

David Andolfatto continues his battle with Ron Paul and his supporters:

Ron Paul on Bernanke's Press Conference, Macromania: CNBC interview with Congressman Ron Paul yesterday (April 28, 2011); click here. The interviewer begins by quoting a statement Paul made after Bernanke's news conference:

Bernanke continues to ignore his culpability for the inflation all Americans suffer due to the Fed's relentless monetary expansion.

Let's take a look at U.S. inflation since 2008. Here it is.

The average annualized rate of inflation over this time period is a dizzying 1.6%. Note the significant deflation experienced during the economic crisis. Ah, good times. The rate of return on your money was really high back then! I can recall clearly how savers were rejoicing...praising the Fed for the deflation.

PCE inflation measures the nominal price of a basket of consumer goods. You know, the stuff people buy to maintain their material living standards. This price index was actually falling in 2010. For better or worse, the Fed interprets "price stability" as 2% inflation. This explains QE2.

PCE inflation has recently jumped up to near 5%. This jump is attributable primarily to food and energy prices. Despite what some people like to believe, the Fed does not control food and energy prices (at least, not separately from other prices). Most economists attribute these relative price changes to geopolitical events and other temporary global shocks affecting the world supply and demand for food and energy.

It seems that what Congressman Paul means by inflation (judging by this interview) is "commodity price inflation." I think he must have in mind the price of commodities like gold. ...

Recent money supply and gold price dynamics seem to support Congressman Paul's hypothesis, which he states as some sort of obvious universal truth. But if this is so, then what explains the following data?

The graph above plots the price of gold and the (base) money supply over the 20 year period September 1980 to March 2001. As you can see, the Fed created a lot of money "out of thin air" over this 20 year period. The base money supply increased by over 300%.

Imagine that you are 50 years old in September 1980. Imagine that a trusted friend of yours--oh, let's say your doctor--convinces you to put all your savings into gold. The reason he offers is that the Fed is pursuing a policy of "relentless money expansion." He warns you that the money supply is set to grow by 300% over the next 20 years. So you listen to him.

You buy gold at $673 per ounce. And then you wait. You wait until you turn 70. And then you go to withdraw your savings. You discover that the gold price in March 2001 is $263 per ounce. That's a whopping rate of return of...wait for it... -60% over 20 years. That's a minus sixty percent. ... Viva la gold standard! ...

links for 2011-04-29

Posted: 29 Apr 2011 10:04 PM PDT

"What I Learned in Econ Grad School"

Posted: 29 Apr 2011 04:32 PM PDT

Noah Smith:

What I learned in econ grad school, Noahpinion: I always find it interesting that criticisms of economics education focus more on the graduate side than the undergrad. Consider this broadside by Brad DeLong and Larry Summers...

This is interesting because, as someone who never studied econ as an undergrad (I was a physics major), I learned everything I know about macro from my grad courses. If there is an aspiring economist out there whose understanding of macro has been hurt by an overly narrow graduate curriculum, it would be me.

So, what did I learn in my first-year graduate macro course at the University of Michigan?

My first semester, business cycle theory, was taught by Chris House (the second semester was all growth theory). We spent a day covering the basic history of the field - the neoclassicals, Keynes, Friedman, Lucas and the RBC people, and finally the neo-Keynesian movement. I recall reading the Summers vs. Prescott debate but not really getting what it was about. From then on it was all DSGE. We did the Ramsey model and learned about Friedman's Permanent Income Hypothesis. We spent a lot of time on RBC. We took a big break to learn value function iteration and how to numerically solve DSGE models by fixed-point convergence. Then we did Barro's model of Ricardian Equivalence, learned a basic labor search model, briefly sketched a couple of ideas about heterogeneity, touched on menu costs, and spent a good bit of time on Q-theory and investment costs. Finally, at the very end of the semester, we squeezed in a one-week whirlwind overview of Calvo Models and the New Keynesian Phillips Curve...but we weren't tested on it.

This course would probably have given Brad DeLong the following reasons for complaint:

1. It contained very little economic history. Everything was math, mostly DSGE math.

2. It was heavily weighted toward theories driven by supply shocks; demand-based theories were given extremely short shrift.

3. The theories we learned had almost no frictions whatsoever (the two frictions we learned, labor search and menu costs, were not presented as part of a full model of the business cycle). Other than Q-theory, there was nothing whatsoever about finance (Though we did have one midterm problem, based on House's own research, involving an asset price shock! That one really stuck with me.).

At the time I took the course, I didn't yet know enough to have any of these objections. But coming as I did from a physics background, I found several things that annoyed me about the course (besides the fact that I got a B). One was that, in spite of all the mathematical precision of these theories, very few of them offered any way to calculate any economic quantity. In physics, theories are tools for turning quantitative observations into quantitative predictions. In macroeconomics, there was plenty of math, but it seemed to be used primarily as a descriptive tool for explicating ideas about how the world might work. At the end of the course, I realized that if someone asked me to tell them what unemployment would be next month, I would have no idea how to answer them.

As Richard Feynman once said about a theory he didn't like: "I don't like that they're not calculating anything. I don't like that they don't check their ideas. I don't like that for anything that disagrees with an experiment, they cook up an explanation - a fix-up to say, 'Well, it might be true.'"

That was the second problem I had with the course: it didn't discuss how we knew if these theories were right or wrong. We did learn Bob Hall's test of the PIH. That was good. But when it came to all the other theories, empirics were only briefly mentioned, if at all, and never explained in detail. When we learned RBC, we were told that the measure of its success in explaining the data was - get this - that if you tweaked the parameters just right, you could get the theory to produce economic fluctuations of about the same size as the ones we see in real life. When I heard this, I thought "You have got to be kidding me!" Actually, what I thought was a bit more...um...colorful. 

(This absurdly un-scientific approach, which goes by the euphemistic name of "moment matching," gave me my bitter and enduring hatred of Real Business Cycle theory... I keep waiting for the ghost of Francis Bacon or Isaac Newton to appear and smite Ed Prescott for putting theory ahead of measurement. It hasn't happened.)...

But all the same, I absolutely don't blame Chris House for teaching what he taught. Our curriculum was considered to be the state of the art by everyone who mattered. Without a thorough understanding of DSGE models, a macroeconomist is severely disadvantaged in today's academic job market; if he had spent that semester teaching us Kindleberger and Bagehot and Minsky, Professor House might have given us better ways how to think about history, but he would have been effectively driving us out of the macroeconomics profession.

Thus, DeLong and Summers are right to point the finger at the economics field itself. Senior professors at economics departments around the country are the ones who give the nod to job candidates steeped in neoclassical models and DSGE math. The editors of Econometrica, the American Economic Review, the Quarterly Journal of Economics, and the other top journals are the ones who publish paper after paper on these subjects, who accept "moment matching" as a standard of empirical verification, who approve of pages upon pages of math that tells "stories" instead of making quantitative predictions, etc. And the Nobel Prize committee is responsible for giving a (pseudo-)Nobel Prize to Ed Prescott for the RBC model, another to Robert Lucas for the Rational Expectations Hypothesis, and another to Friedrich Hayek for being a cranky econ blogger before it was popular. 

If you want to change economics education, it is to these people that you must appeal. The ghost of Francis Bacon, unfortunately, is not available for comment.

Did Keynes Support Having a "Central Plan"

Posted: 29 Apr 2011 04:23 PM PDT

Barkley Rosser:

Did Keynes Support Having a "Central Plan"?, EconoSpeak: That he did is charged by "Hayek" in the freshly released "Keynes versus Hayek: Round 2"... However, I ... find it disturbing that increasingly Austrians and some others have taken to charging Keynes with having supported "central planning"... Is this correct? I think that the answer is largely "no," with it certainly being that answer if one means by that command central planning of the Soviet type that Hayek criticized in his Road to Serfdom (which Keynes praised, btw, when it first came out).

I think the strongest evidence for Keynes supporting central planning comes from two sources, which I shall quote. The first comes from his 1920s essay, "The End of Laissez-Faire," which has been identified as the inspiration for the movement for indicative (non-command) planning that was seen after WW II in such countries as France, Japan, India, South Korea, and some other places, although not UK or US.

After noting that uncertainty can lead to inequality of wealth and the unemployment of labor, he states: "I believe that the cure for these things is partly to be sought in the deliberate control of the currency and of credit by a central institution, and partly in the collection and dissemination on a great scale of data relating to the business situation, including the full publicity, by law if necessary, of all business facts which it is useful to know. These measures would involve Society in exercising directive intelligence through some appropriate organ of action over many of the inner intricacies of private business, yet it would leave private initiative and enterprise unhindered." (p. 318 from Essays in Persuasion)

One can argue that Keynes is offering a hopeless contradiction when calling for this "directive intelligence," probably the closest he came anywhere to command, with his simultaneous limit on that regarding leaving "private initiative and enterprise unhindered," this latter certainly not fitting with the full-blown command socialist model at all.

Regarding the information gathering, well, of course that is now generally done in most higher income economies, and many have argued that this was the essence of the indicative planning operations carried out in many countries, when they worked at their best, as some claim was the case in France in the 1950s, when businesspeople needed some sort of external push to revive their animal spirits, to use Keynesian language, and that seeing projections of demands by others helped provide this.

The other passage that some have pointed to as possibly suggesting a central planner tendency by Keynes comes from the final chapter of the General Theory, p. 378:

"Furthermore, it seems unlikely that the influence of of banking policy on the rate of interest will be sufficient by itself to determine an optimum rate of investment. I conceive, therefore, that a somewhat comprehensive socialization of investment will prove the only means of securing an approximation to full employment; though this need not exclude all manner of compromises and of devices by which public authority will co-operate with private initiative. But beyond this no obvious case is made out for a system of State Socialism which would embrace most of the economic life of the community."

One can argue again here that Keynes is setting himself up for some sort of impossible contradiction, and Hayek may well have argued that such control of investment would lead to his road to serfdom slippery slope. However, it is clear from later passages that what Keynes had in mind was ultimately the control of the aggregate of investment rather than of its specific forms or details.

These almost certainly provide the strongest evidence for Keynes supposedly supporting there being a "central plan." But it looks at most, putting the two together, like one that involves lots of provision of information and data along with some sort of control of aggregate investment, while leaving most of the decisions up to "private initiative." This hardly constitutes a "central plan," and certainly not one of the sort that the actually existing Hayek criticized. ...

Don't Let Fiscal Policymakers Off the Hook

Posted: 29 Apr 2011 12:33 PM PDT

The recent focus on Ben Bernanke and the Fed, in particular what more could be done to help the economy and the unemployed, takes the pressure off of fiscal policymakers. But Congress also bears as much responsibility, or more in my view, for the slow recovery and the sorry state of the employment picture.

Fiscal policy was far from aggressive enough -- at best it offset declines at the state and local level leaving the net effect near zero -- yet people express surprise it wasn't able to do more. It was also too small, way too late, and it was not persistent enough. Declines in stimulus spending as the program ends are holding back economic growth at a time when fiscal policy ought to be aiding, not stalling the recovery.

Our long-run budget problem is mostly a health care cost problem, and we do need to fix this. If we address the health care cost problem, the picture improves and any worry about bond vigalantes showing up in the future mostly goes away. If we don't adress health care costs, the long-run budget remains problematic no matter what else we do. Given that reality, there is plenty of time, plenty of room, and plenty of need for more help from fiscal policy. This was always a battle that needed to be fought on multiple policy fronts, neither monetary nor fiscal policy alone, or perhaps even in combination, was going to be enough. We needed both monetary and fiscal policy to respond aggressively, and to continue to respond as long as needed, but both have fallen short and there is no sign of monetary and fiscal policymakers moving to make up lost ground.

Monetary policymakers are feeling the heat right now, at least I hope they are, but don't forget about fiscal policymakers -- they too deserve to be on the hot seat. I understand that with all the talk of austerity, the chances of more help from fiscal policy without some huge change in the outlook is next to zero. But maybe, just maybe, we can stop Congress and the president from repeating the mistakes of the past (and present in Europe) by moving to balance the budget before the economy can handle it? I'm hoping we can avoid premature austerity -- that will hurt, not help employment -- but I'm not counting on it. </rant, for now anyway>

Update: From the CBPP:

4-28-11fig1[1]

DeLong: Economics in Crisis

Posted: 29 Apr 2011 09:18 AM PDT

Brad DeLong on what is (and should be ) taught in economics programs:

Economics in Crisis, by J. Bradford DeLong, Commentary, Project Syndicate: The most interesting moment at a recent conference held in Bretton Woods, New Hampshire ... came when Financial Times columnist Martin Wolf quizzed ... Larry Summers... "[Doesn't] what has happened in the past few years," Wolf asked, "simply suggest that [academic] economists did not understand what was going on?"
Here is the most interesting part of Summers' long answer: "There is a lot in [Walter] Bagehot that is about the crisis we just went through. There is more in [Hyman] Minsky, and perhaps more still in [Charles] Kindleberger." That may sound obscure to a non-economist, but it was a devastating indictment. ... Summers then enlarged his answer to include living economists: "Eichengreen, Akerlof, Shiller, many, many others." ...
For Summers, the problem is that there is so much that is "distracting, confusing, and problem-denying in…the first year course in most PhD programs." As a result, even though "economics knows a fair amount," it "has forgotten a fair amount that is relevant, and it has been distracted by an enormous amount."
I think that Summers' judgments are fair and correct. ... "We need to change our hiring patterns," I expected to hear economics departments around the world say in the wake of the crisis.
The fact is that we need fewer efficient-markets theorists and more people who work on microstructure, limits to arbitrage, and cognitive biases. We need fewer equilibrium business-cycle theorists and more old-fashioned Keynesians and monetarists. We need more monetary historians and historians of economic thought and fewer model-builders. We need more Eichengreens, Shillers, Akerlofs, Reinharts, and Rogoffs – not to mention a Kindleberger, Minsky, or Bagehot.
Yet that is not what economics departments are saying nowadays. ...

[My response to Summers' talk was a post called Re-Kindleberger.]

April 29, 2011

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Paul Krugman: The Intimidated Fed

Posted: 29 Apr 2011 12:42 AM PDT

Why won't the Fed do more to help the unemployed?:

The Intimidated Fed, by Paul Krugman, Commentary, NY Times: Last month more than 14 million Americans were unemployed by the official definition... Millions more were stuck in part-time work because they couldn't find full-time jobs. And we're not talking about temporary hardship. Long-term unemployment, once rare in this country, has become all too normal: More than four million Americans have been out of work for a year or more. ...
It all adds up to a clear case for more action. Yet Mr. Bernanke indicated that he has done all he's likely to do. Why?
He could have argued that he lacks the ability to do more, that he and his colleagues no longer have much traction over the economy. But he didn't. On the contrary, he argued that the Fed's recent policy of buying long-term bonds, generally referred to as "quantitative easing," has been effective. So why not do more?
Mr. Bernanke's answer was deeply disheartening. He declared that further expansion might lead to higher inflation.
What you need to bear in mind here is that the Fed's own forecasts say that inflation will be below target over the next few years, so that some rise in inflation would actually be a good thing, not a reason to avoid tackling unemployment. ...
The only way to make sense of Mr. Bernanke's aversion to further action is to say that he's deathly afraid of overshooting the inflation target, while being far less worried about undershooting — even though doing too little means condemning millions of Americans to the nightmare of long-term unemployment.
What's going on here? My interpretation is that Mr. Bernanke is allowing himself to be bullied by the inflationistas: the people who keep seeing runaway inflation just around the corner and are undeterred by the fact that they keep on being wrong.
Lately the inflationistas have seized on rising oil prices as evidence in their favor, even though — as Mr. Bernanke himself pointed out — these prices have nothing to do with Fed policy. The way oil prices are coloring the discussion led the economist Tim Duy to suggest, sarcastically, that basic Fed policy is now to do nothing about unemployment "because some people in the Middle East are seeking democracy."
But I'd put it differently. I'd say that the Fed's policy is to do nothing about unemployment because Ron Paul is now the chairman of the House subcommittee on monetary policy.
So much for the Fed's independence. And so much for the future of America's increasingly desperate jobless.

links for 2011-04-28

Posted: 28 Apr 2011 10:01 PM PDT

Joe Stiglitz and Joe Gagnon Debate QEII

Posted: 28 Apr 2011 01:44 PM PDT

This comes via Mike Konczal (who has additional comments):

Mike adds:

Side note: Gagnon earlier in his talk said that "one of the biggest goals of QEI was to push down the mortgage rate to spark a refinancing boom to encourage households and enable households to reduce their expenditures and repair their balance sheets and be able to spend again. That worked not quite as well as we hoped because the administration's program for getting underwater borrowers to borrow didn't work and I think that's a true disaster that has no excuse. I have nothing but incredible, there's just, the blame the administration on not doing this is just incredible. This could have been a huge success. We got the lowest 30-year mortgage rates in history and we couldn't take advantage of them to the extent that we could. We got about a trillion dollars in refinancing when we should have gotten two or three trillion dollars in refinancing." I haven't heard this critique before and I thought it was really interesting.

Disappointing First Quarter GDP Growth

Posted: 28 Apr 2011 09:18 AM PDT

Good times just around the corner?:

U.S. Economy Slows: Gross domestic product, the value of all the goods and services produced, rose at an seasonally adjusted annual rate of 1.8% in the first quarter, the Commerce Department said Thursday in its first estimate of the economy's benchmark indicator.
The modest increase marked a significant slowdown from the economy's pace in the fourth quarter, when GDP rose by 3.1%. ...The data marked a setback for an economy still healing from a deep recession...

And, continuing a recent trend, inititial claims for unemployment insurance also increased to a level that, historically, is associated with job loss.

Brad DeLong also notes this passage from the FT:

Gross domestic product growth was also slowed by a "sharp upturn" in imports, falling exports and a steeper decline in government spending. Federal government spending sank 7.9 per cent, much faster than the 0.3 per cent decline recorded in the fourth quarter and local and state government spending fell 3.3 per cent, compared with a 2.6 per cent drop in the last three months of 2010. The pullback in government spending, particularly at the state and local level, "reflects the ongoing budget problems that will continue to be a drag on the overall economy for some time yet", Mr Ashworth said...

And he comments:

Contractionary fiscal policy is contractionary.

Yep.

[See also: Econbrowser, Free Exchange, Ezra Klein, Calculated Risk, Twenty Cent Paradigms.]

April 28, 2011

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"The Rhetoric of Closed Borders"

Posted: 28 Apr 2011 12:15 AM PDT

This attempts to answer the question "Why are there so many illegal migrants?":

The rhetoric of closed borders, by Giovanni Facchini and Cecilia Testa, Vox EU: Illegal immigration is widespread. In 2008, approximately 12 million immigrants lived unlawfully in the US, and large numbers of undocumented foreigners resided also in other advanced destination countries (Fasani 2009, Triandafyllidou 2010).

Understandably, illegal immigration has become a very prominent issue in the policy debate and a major challenge in the design of policies pursuing the control of the flows of migrants.

Let's be clear on one thing. Illegal immigration can exist only insofar as countries restrict (according to some criterion) the number of migrants that they are willing to accept. If national borders were open, there would be no notion of illegal alien as such. This leads us naturally to two questions:

  • Why do governments try to close (at least to some extent) their borders?
  • And why do they fail to keep them "closed"? 

The first point can be easily understood by considering the redistributive effects of immigration. Despite an overall welfare gain for the receiving country, the benefits of migration tend to be unevenly distributed. The crudest representation of the costs and benefits of migration for the receiving country (leaving aside the obvious important benefits for the migrants themselves) boils down to a very simple arithmetic. The downward pressure migration puts on wages means larger profits for firms' owners employing "cheaper work" and lower wages for the workforce employed in such firms.

The crux of migration policy is striking a balance between these opposing interests: the fears of the numerous individuals (often the majority) who stand out to lose from migration (Facchini and Mayda 2008), against the pressures of organized pressure groups representing the firms who benefit from foreign work. This ultimately leads to a widespread use of restrictions to the free mobility of labor in order to achieve a desired migration target.

Why are there so many illegal migrants?

The adoption of migration targets is only one aspect of migration policy. Naturally, if targets are binding, large numbers of potential migrants will not be allowed to legally enter the desired destination. Yet while some will be discouraged and decide not to emigrate, others will try to enter illegally. The large numbers of illegal migrants suggests that enforcement of migration targets is far from perfect.

But the causes of imperfect enforcement are less than obvious. "Second best" arguments would suggest that (some amount of) illegal immigration is an unavoidable consequence of constraints on policy instruments. Yet, the sheer size of illegal immigration casts some doubts on this benign view of a "constrained" welfare maximizing government. In fact, the analysis of enforcement activities reveals a striking empirical regularity: enforcement taking place at the US border is negatively correlated to the patterns of economic activity in sectors which intensively use illegal immigrants - like agriculture, construction, personal services etc. (Hanson and Spilimbergo 2001). Furthermore, governments do not seem to be guided by welfare maximization in their choice of enforcement instruments. As pointed out by Hanson (2006), they far too often resort to ineffective enforcement activities (e.g. border enforcement), even though they could use more effective ones (e.g. domestic enforcement).

Talk tough and do nothing

This evidence suggests that the number of illegal immigrants might be the result of an intentional government policy, which responds to the needs of particular economic interests, rather than of its inability to control the actual flow of foreign workers. This begs an important question. If governments deliberately avoid the enforcement of migration targets, why do they set such targets in the first place? These are daunting questions as a growing wave of anti-migration pledges is swiping the European political landscape. This emblematic statement from the recent speech by David Cameron on immigration summarizes the quandary of immigration policy:

…But there was something else we heard on the doorstep – and it was this: "We are concerned about the levels of immigration in our country . . . but we are fed up of hearing politicians talk tough but do nothing.

To understand the "talk tough but do nothing" problem we need a new framework where migration quotas and its enforcement are jointly determined. Bringing together these two important aspects of immigration policy, in recent research (Facchini and Testa 2011) we show why governments may find it optimal to set restrictive migration targets that they will deliberately not enforce.

Our analysis takes place within a second-best world, where some amount of illegal immigration is unavoidable because governments set migration quotas and enforcement with imperfect knowledge of the actual inflow of potential migrants. If such flows end up being "too large," enforcement will be insufficient to limit the number of migrants to the desired level. But policymakers face another difficult task, which can induce them to raise illegal immigration above the "second-best" level.

Governments have to reconcile opposite stances on migration coming from different fractions of the society (the gainers and losers from migration), while trying to secure re-lection for themselves. Setting restrictive migration targets and, at the same time, strategically relaxing their enforcement, may be instrumental to achieving electoral goals. The logic of political calculus is straightforward. To maximize their chances of winning elections, governments pander to the electorate by imposing "migration quotas." At the same time, exploiting their superior knowledge over the public on various aspect of policy making – from the appropriate level of funding, to the most effective forms of enforcement activities necessary to implement their migration targets – they carry out a lax policy enforcement, which de facto allows more migrants to enter in a concealed (illegal) manner. In this way, they satisfy the requests of sectors which employ foreign work, and minimize the risk of alienating the majority of the electorate, which oppose a policy openly allowing more migrants. The same logic also explains why less effective enforcement tools may be preferred to more effective ones. Once migrants have entered illegally, the incumbent government will blame the lack of policy tools (second-best argument) to explain the insufficient enforcement. The electorate are not fools, but given their limited information, they can often be deceived.

In a nutshell, governments face stark incentives: the rhetoric of closed border helps them gain in popularity among the electorate; the reality of lax enforcement (through insufficient enforcement or ineffective use of enforcement activities) responds to the interests of sectors who gain from employing foreign workers. As the mantra of closed borders is climbing high in the discourse of many European governments, whereas many sectors remain dependent on foreign work, the gap between "rhetoric" and reality can only grow bigger. Illegal immigration is largely a tale of political failure.

References

Facchini G and C Testa (2011), "The rhetoric of closed borders: quotas, lax enforcement and illegal migration", CEPR Working Paper 8245.

Facchini G and A Mayda (2008), "From individual attitudes towards migrants to migration policy outcomes: Theory and evidence", Economic Policy 56:651-713.

Fasani, F (2009), "Deporting undocumented immigrants: The role of labour demand shocks", Mimeo.

Hanson, GH and A Spilimbergo (2001), "Political economy, sectoral shocks, and border enforcement", Canadian Journal of Economics, 34:612-638.

Hanson (2006), "Illegal migration form Mexico to the US", Journal of Economic Literature, 44:869-924.

Triandafyllidou, A (ed.) (2010), Irregular Migration in Europe, Myths and Realities,  Ashgate. 

This article may be reproduced with appropriate attribution.

links for 2011-04-27

Posted: 27 Apr 2011 10:01 PM PDT

"Decoding Ben Bernanke"

Posted: 27 Apr 2011 04:05 PM PDT

Here's the video I did on Bernanke's Press Conference that I mentioned in an earlier post: Decoding Ben Bernanke:

Green Shoots and the Fed

Posted: 27 Apr 2011 02:52 PM PDT

Here are some responses to Bernanke's Press conference from The Room for Debate:

Here's mine:

The Fed's dual mandate requires it to pursue both full employment and price stability. Currently, however, the Fed is falling short on both of these goals.
Employment is far below its full employment level, and inflation is running below the Fed's preferred range of 1.5 to 2.0 percent. Inflation is expected to rise a bit in the short-run due to rising commodity prices, but the Fed says it expects commodity price increases to be transitory.
Thus, none of the Fed's forecasts show any long-run concern about inflation at all. The main question I wanted to hear Bernanke answer is, given that inflation is expected to remain low, why the Fed isn't doing more to help with the employment problem? Why not a third round of quantitative easing?
Bernanke was asked this question, but his answer was unsatisfactory. The potential benefit of further policy moves by the Fed is higher growth and lower employment. The potential cost of more quantitative easing is inflation. So the decision on whether to provide more help to labor markets comes down to a comparison of the expected employment benefits to the expected inflation cost.
Even though there is no evidence of a problem in the Fed's own projections, and the prices of long-term financial assets dependent upon future inflation show no evidence of inflation worries either, Bernanke nonetheless said that he believes the costs have risen relative to the benefits — that is, the Fed's worry about inflation is standing in the way.
But I think there is something else behind the Fed's reluctance to continue easing. The Fed first began seeing "green shoots" in April of 2009, a full two years ago. At every step since, the Fed has used the prospect of better times just around the corner as a reason to downplay the benefits of further easing.
But the growth of the green shoots has been stunted, or they have wilted away entirely. In retrospect, more aggressive action by the Fed was warranted in every instance. Perhaps this time is different — I sure hope so — but the recovery has been far too slow to be tolerable. Green shoots require more than hope, they require the nourishment, and with fiscal policy out of the picture it's up to the Fed to provide it.

Bernanke's Press Conference

Posted: 27 Apr 2011 01:17 PM PDT

I am writing up my reaction to Bernanke's press conference, and it's basically the same as this. More later. I also did a video for CBS MoneyWatch discussing the conference and I'll post that as soon as it's available (Here's a link to the video).

Update: Here's Tim Duy's reaction:

Very High Bar for QE3, by Tim Duy: My first thoughts: The FOMC statement was consistent with my expectations, while Federal Reserve Ben Bernanke sounded slightly more hawkish than I anticipated.  The latter confirms the view I took two weeks ago – near term inflation gains were not sufficient to justify altering the current policy stance, but would derail any additional increases to the balance sheet beyond June.

The FOMC statement itself was largely straightforward.  Arguably a bit of a downgrade of the economy (as CR notes, the "firmer footing" language has disappeared) and a little more talk about inflation.  The new economic projections reflected these alterations, with growth forecasts brought down to pretty much the same range when the Fed initiated QE2, while near-term headline inflation forecasts are higher.

The initial phase of Bernanke's press conference was also in line with my expectations.  He noted that the expectations for trend growth and the natural rate of unemployment were beyond the control of the Fed, while inflation was directly determined by monetary policy.  He explained the reasoning for a positive rate of inflation, explicitly pointing to the concern about deflation, defined as falling wages and prices.  This was, I believe, the last we heard about wages.

In response to the Q&A portion, he said the impending weak Q1 growth numbers are the result of transitory factors (defense spending, exports, weather), and "possibly less momentum."  The latter phrase was a bit disconcerting and should suggest a predilection toward additional asset purchases beyond June, but apparently the FOMC intends to focus on the transitory nature of the numbers.  See again my earlier piece.  When questioned about the timing of any exit, Bernanke explained the relevant factors, including the sustainability of the recovery, the strength of the labor market, the direction of inflation, and resource slack.   Not surprisingly, he gave no timeline to tightening. 

Regarding the end of QE2, he reiterated the "stock" view of the balance sheet.  Essentially, the pace of accumulation is less important than the size of the balance sheet, and there were no plans to shrink assets.  Indeed, he suggested the first step toward tightening would be to stop reinvesting assets as they mature or are redeemed.  I thought he handled the Dollar questions well – throwing it back in the lap of Treasury Secretary Timothy Geithner and claiming, rightly in my opinion, that the best thing for the Dollar over time is that the Fed pursues policies that satisfy its dual mandate.

The most interesting comments came in response to questions about whether the Fed should do more to lower unemployment and if QE2 is effective, shouldn't the program continue?  Here was a more hawkish Bernanke.  As I noted earlier, growth forecasts returned to the pre-QE2 range, which should be a red flag.  Unemployment remains high, with only moderate job creation.  Core-inflation remains low, while the impulse from commodity prices on headline inflation is expected to be temporary.  Finally, he claims that QE2 was in fact effective.  So why not do more?  Because the Fed needs "to pay attention to both sides of the mandate" and the "tradeoffs are less attractive."  Much talk by Bernanke at this point about inflation expectations, and the importance of maintaining those expectations, and not much (none, I think), about the issue (or non-issue) of wage inflation. 

Apparently the threat of headline deflation off the table, Bernanke is not inclined to pursue sustained easing despite low core inflation and high unemployment.  Again, I am not entirely surprised, except that Bernanke appear to suggest we are much closer to an inflation tipping point than I would expect.  He could have tempered these comments with a more forceful discussion of labor costs, but did not.  It seems clear these comments were intended to calm the non-existent bond market vigilantes, but is it consistent with the outlook?  Arguably, no.  For what it's worth, I think Bernanke appeared most uncomfortable during this portion of the conference. 

Bottom Line:  When I look at the revisions to the Fed's outlook and listen to Bernanke, I get the sense that the basic Fed policy is summarized as follows:  "The economic situation continues to fall short of that consistent with the dual mandate, we have the tools to address that deviation, but will take no additional action because some people in the Middle East are seeking democracy."

The FOMC Statement: No Change in Course

Posted: 27 Apr 2011 09:54 AM PDT

Here's the FOMC statement. A quick reading doesn't reveal any surprises. Rates will remain at "exceptionally low levels for the federal funds rate for an extended period," QE will continue as scheduled, and long-term expectations of inflation are stable even though prices have ticked up recently due to oil and commodity price increases. The Fed doesn't explain why, if both inflation and employment are below target levels, QE3 is out of the question. It merely states that "The Committee will regularly review the size and composition of its securities holdings in light of incoming information and is prepared to adjust those holdings as needed to best foster maximum employment and price stability." If it's prepared to do so, why not take action?: Hopefully someone will ask something along those lines at Bernanke's press conference later today. It's likely fear of inflation in the future that is holding the Fed back, but I'd like to hear the basis for those fears:

Press Release, Release Date: April 27, 2011, For immediate release: Information received since the Federal Open Market Committee met in March indicates that the economic recovery is proceeding at a moderate pace and overall conditions in the labor market are improving gradually.  Household spending and business investment in equipment and software continue to expand.  However, investment in nonresidential structures is still weak, and the housing sector continues to be depressed.  Commodity prices have risen significantly since last summer, and concerns about global supplies of crude oil have contributed to a further increase in oil prices since the Committee met in March.  Inflation has picked up in recent months, but longer-term inflation expectations have remained stable and measures of underlying inflation are still subdued.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.  The unemployment rate remains elevated, and measures of underlying inflation continue to be somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.  Increases in the prices of energy and other commodities have pushed up inflation in recent months.  The Committee expects these effects to be transitory, but it will pay close attention to the evolution of inflation and inflation expectations.  The Committee continues to anticipate a gradual return to higher levels of resource utilization in a context of price stability.
To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November.  In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and will complete purchases of $600 billion of longer-term Treasury securities by the end of the current quarter.  The Committee will regularly review the size and composition of its securities holdings in light of incoming information and is prepared to adjust those holdings as needed to best foster maximum employment and price stability.
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period. 
The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen.

Austerity Does Not Work: Contractionary Fiscal Policy is Contractionary

Posted: 27 Apr 2011 08:01 AM PDT

Austerity means less, not more:

UK, Not OK, by Paul Krugman: The bad GDP number for the UK isn't a surprise — in fact, judging from market response, investors seem to have expected something even worse. Still, if you step back and look at what has been happening, it's doubleplusungood: zero growth over the past 6 months, with every reason to be worried on the downside looking forward, as Cameron's austerity bites deeper.

Jonathan Portes gets to the nub of it:

On fiscal policy, the message is that we should listen to economists, not credit rating agencies. Most mainstream economists argued that the impact of the government's fiscal consolidation on confidence and consumer demand would be negative; so it has proved. …

In short, there is no confidence fairy... Portes hits, in particular, on a point I've tried to make a number of times, here and more recently here: right now, we're living in a world in which basic economics points to conclusions utterly at odds with what Very Serious People are supposed to believe, in which radical outsiders base their views on standard economics while orthodox types turn to heterodox, highly dubious speculations.

Econ 101, buttressed if you like by fancier New Keynesian models, says that contractionary fiscal policy is, well, contractionary. Yet much of the world of movers and shakers bought into the exotic notion that expectational effects — the confidence fairy — would make contractionary policy expansionary. And they clung to this belief even as the supposed historical evidence in favor of expansionary austerity was thoroughly debunked.

And now we're watching Econ 101 in the process of being confirmed. I wish I thought this would change anyone's mind.

For many of the Very Serious People on the austerity bandwagon, tax increases that reduce the deficit are a bad idea, they think taxes should be even lower, it's spending cuts they are after. That tells us that the true agenda is something other than reducing the deficit or calling confidence fairies to stimulate the economy. The fairies are mythical, and so is the idea that the true goal is reducing the deficit. The deficit is just the means to an end of smaller government, social insurance in particular -- that's why tax increases that reduce the deficit aren't supported -- and if a slower recovery, higher unemployemt, and more insecurity (for others of course) is the price of reaching that goal, so be it.

April 27, 2011

Latest Posts from Economist's View

Latest Posts from Economist's View


"How I Paid Only 1% of My Income in Federal Income Tax"

Posted: 27 Apr 2011 12:42 AM PDT

Eric Schoenberg doesn't have a very large tax burden given his high income, and he says it doesn't take much effort to make this happen:

How I Paid Only 1% of My Income in Federal Income Tax, by Eric Schoenberg: In 2009, the median U.S. family had an income of just under $50,000, on which they would have paid roughly $2,761 (or about 5.5%) in federal income tax. I, by contrast, enjoyed an income of $207,415 in 2009, but paid only $2,173 (or 1.0%) in income tax.

Eric.s.taxes

In a recent newspaper interview, I mentioned my absurdly low tax rate to illustrate the extent to which the tax system is biased in favor of the wealthy (my income varies widely from year to year, but is typically north of half a million dollars). My point was that with our country facing frightening budget deficits amid an ever-widening income gap between the rich and everybody else, I consider it both unwise and unfair that a former investment banker like myself pays less in taxes than working Americans with far lower incomes.

Among the dozens of emails I received in response were many from people who assumed that rich people avoid taxes through complicated strategies devised by an army of expensive advisors (many correspondents asked for the name of my accountant). But under our current tax system, the rich don't need high-priced lawyers who exploit obscure loopholes; I wasn't even trying to minimize my taxes (and, in fact, could have paid zero tax if I was). ...

Fed Watch: Quick Note on Inflation Expectations

Posted: 27 Apr 2011 12:33 AM PDT

Tim Duy:

Quick Note on Inflation Expectations, by Tim Duy: The FOMC will render judgment on the economy today, followed by the inaugural post-meeting press conference by Federal Reserve Chairman Ben Bernanke. Policy is expected to remain essentially unchanged, with the large-scale asset program continuing through June. The FOMC statement will likely be similar to the last, maybe upgrading the state of the labor market but acknowledging weak first quarter data. I am curious to what extent they have adjusted their full year GDP forecast. Any downward adjustment would be further reason to maintain the current path of policy, and it is difficult to see reason for any upward revision.

The statement will likely maintain language on commodity prices, inflation, and inflation expectations – commodity prices are likely to have only a transitory impact on core-inflation, while expectations remain stable or anchored. Rates will be kept low for "an extended period."

I am hopeful that the Chairman's press conference will be illuminating but ultimately something of a nonevent – that the general consensus on the direction of monetary policy is consistent with that of the gravitational center of the FOMC, and thus Bernanke's comments will be largely non-disruptive. Or at least it should be, as I anticipate we will learn that it was correct to heavily discount the more hawkish sounding regional bank presidents.

The Wall Street Journal focuses on the inflation expectations issue here and here. To be sure, I think the Fed is following this closely, but I think we should nuance the issue a little more carefully to account for a transmission mechanism from inflation expectations to actual inflation. I expect Bernanke would tie a discussion of inflation expectations to a discussion of labor costs. Vice Chair Janet Yellen did just that earlier this month:

In addition, the indirect effects of the commodity price surge could be amplified substantially if longer-run inflation expectations started drifting upward or if nominal wages began rising sharply as workers pressed employers to offset realized or prospective declines in their purchasing power…

…Consequently, longer-term inflation expectations became unmoored, and nominal wages and prices spiraled upward as workers sought compensation for past price increases and as firms responded to accelerating labor costs with further increases in prices….

…That said, in light of the experience of the 1970s, it is clear that we cannot be complacent about the stability of inflation expectations, and we must be prepared to take decisive action to keep these expectations stable. For example, if a continued run-up in commodity prices appeared to be sparking a wage-price spiral, then underlying inflation could begin trending upward at an unacceptable pace. Such circumstances would clearly call for policy firming to ensure that longer-term inflation expectations remain firmly anchored.

For a more immediate example of what this would look like, turn to recent stories from China like this:

China's southern economic powerhouse Shenzhen said Thursday it would raise the minimum wage by 20 percent, following a similar move by Shanghai, as China continues to battle rising inflation and a labor shortage.

Sounds clearly like an economy in which inflation expectations have become unstable, to say the least. It is difficult to see a parallel to the current US situation – we don't have a labor shortage, without which there is minimal upward pressure on wages, rendering senseless fears a wage-price spiral is imminent. I suspect Bernanke would agree with a similar line of argument, and it will be interesting if he explicitly cites unit labor costs.

Finally, the series of questions I would like asked: "What specific outcomes or goals did you expect when you initiated QE2? Have you reached those goals? If you haven't reached those goals, are you preparing for QE3? Why or why not?"

The Costs of Regulating Derivatives

Posted: 27 Apr 2011 12:24 AM PDT

Stephen Lubben of Credit Slips:

The Costs of Regulating Derivatives, by Stephen Lubben: So the outgoing chair of ISDA complains that banks will have to pass on the costs of Dodd-Frank to end users of derivatives. Undoubtedly the usual crowd -- primarily the WSJ op-ed page -- will run with this evidence of yet another hit to American competativenes coming out of Dodd-Frank.
But maybe we could stop and consider if this simply means that users of derivates will now incur the true costs of their trades, and will no longer be subsidized by the Treasury.

links for 2011-04-26

Posted: 26 Apr 2011 10:01 PM PDT

The Fed Should Have Taken More Responsibility for the Housing Bubble

Posted: 26 Apr 2011 03:15 PM PDT

As I was searching for something else, I came across this post from July 2005 that I completely forgot I had written:

The Fed Should Take More Responsibility for the Housing Bubble: I didn't find much in Greenspan's testimony over and above what has already been noted here previously.  ...
The acknowledgment that incoming data have indicated some downside risk is fairly new. ...  The uncertainties he's referring to are rising input costs, particularly labor and oil, an increase in long-term interest rates, and the potential problems that could cause in the housing market.
It's interesting to me that the Fed is not taking responsibility for the housing bubble even though monetary policy causing low interest rates had a hand in creating it.  If, in fact, low interest rates have caused a misallocation of resources towards the housing sector such that there are now risks, and there's a case to be made that it has, then the Fed should be more active and forceful in dealing with and forestalling the potential consequences.  That is, if Fed policy has enticed households to make decisions that put them at risk over the long-run, decisions they would not have made if the interest rate were at its natural level, then the Fed has a responsibility to do more than wash its hands of this sector of the economy and say its only role is to clean up after any crash that might occur. ...
Update #1:  Clarifying a bit, I am ready to believe those who say there is no significant deviation from fundamentals and hence less to worry about than if it were a true bubble (except for some areas such as coastal regions), though there are risks and it is the Fed's hand in creating those risks that I am addressing.  Nobody knows for sure how vulnerable this sector is so it is good policy to attenuate such risks to the extent possible.

My complaint is the way in which the Fed has disassociated itself from any responsibility for creating the environment that caused risks to emerge.  For example, the Fed could be more aggressive on the regulatory front in an attempt to ensure that low interest rates do not induce excessive risk taking by households, especially those living near the margin that will be most vulnerable to increases in interest rates.  It's really nice to get people into houses - I'm all for that, one hundred percent - but not if it causes financial distress and years of cleanup afterward (there's that bankruptcy bill thing as well) as households are induced to assume more risk than they can handle.

I suppose in the end we can say it's a free market and people should have known better, that they should have been more forward looking, but when prices are set below equilibrium in an attempt to stimulate the economy, market intervention to manipulate interest rates is present making the fundamentals themselves a result of policy intervention, and that has consequences. ...

Can't say I called the bubble, but I can say I called for caution and 'just in case' action.

Vouchers Won’t Solve Our Health Care Cost Problem

Posted: 26 Apr 2011 09:54 AM PDT

I have a new column that explains why a voucher system for Medicare won't work:

Vouchers Won't Solve Our Health Care Cost Problem

After explaining the problems with vouchers, the column ends with:

We know what works for health care cost control. Other countries deliver universal care at a lower cost and similar quality, and I believe that once we've tried other avenues that fail, this is where we will end up. It won't happen anytime soon, and there will be lots of false starts and dead-ends along the way –a voucher program, if pursued, is one of those dead ends. But the day will come when we realize that using successful systems in other countries as models for reform is the best way to provide universal access to health care at the lowest possible price.

More here.

The Rightward Shift in the Political Center of Gravity

Posted: 26 Apr 2011 08:28 AM PDT

Andrew Samwick:

Moderates? Republicans?, by Andrew Samwick: The way Ezra Klein tells it is largely the way I remember it, too.  Antecedents of President Obama's policies -- an individual mandate in health insurance, cap-and-trade on emissions, and some willingness to raise taxes to close deficits -- can be found in Republican policies of the George H.W. Bush era.  I supported them then and support them now, though in a way that comes from the right side of the political spectrum rather than the left.  ...

I don't find Obama's policies to be beyond compromise.  Transported to a different era, Obama would have been a Rockefeller Republican -- actively using the government's powers to try to solve public policy problems and willing to go to the voters to get more revenues to do so.

The place where I disagree with Ezra's reasoning is here:

The normal reason a party abandons its policy ideas is that those ideas fail in practice. But that's not the case here. ...

Rather, it appears that as Democrats moved to the right to pick up Republican votes, Republicans moved to the right to oppose Democratic proposals.

...The first move to the right wasn't by the Democrats.  It was by the Republicans on issues of tax policy.  More recently, this dynamic has been at work -- on issues not related to tax policy, the Republicans are moving to the right to oppose proposals that were previously part of their platform.

What's left unexplained is why movements to the right by both parties -- and these aren't marginal moves -- haven't alienated the middle of the road, swing voters that seem to make a difference in elections. I don't think I have a good answer for why. In the present case, there is some voter remorse -- Obama is far more conservative than many thought -- but I don't think that explains the larger trend.