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September 30, 2011

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Paul Krugman: Phony Fear Factor

Posted: 30 Sep 2011 12:33 AM PDT

"Republican assertions about what ails the economy are pure fantasy":

Phony Fear Factor, by Paul Krugman, Commentary, NY Times: ...Listen to just about any speech by a Republican presidential hopeful, and you'll hear assertions that the Obama administration is responsible for weak job growth. How so? The answer, repeated again and again, is that businesses are afraid to expand and create jobs because they fear costly regulations and higher taxes. Nor are politicians the only people saying this. Conservative economists repeat the claim in op-ed articles, and Federal Reserve officials repeat it to justify their opposition to even modest efforts to aid the economy.
The first thing you need to know, then, is that there's no evidence supporting this claim and a lot of evidence showing that it's false ... as a new paper by Lawrence Mishel of the Economic Policy Institute documents at length...
So Republican assertions about what ails the economy are pure fantasy, at odds with all the evidence. Should we be surprised?
At one level, of course not. Politicians who always cater to wealthy business interests say that economic recovery requires catering to wealthy business interests. Who could have imagined it?
Yet it seems to me that there is something different about the current state of economic discussion. Political parties have often coalesced around dubious economic ideas — remember the Laffer curve? — but I can't think of a time when a party's economic doctrine has been so completely divorced from reality. And I'm also struck by the extent to which Republican-leaning economists — who have to know better — have been willing to lend their credibility to the party's official delusions.
Partly, no doubt, this reflects the party's broader slide into its own insular intellectual universe. Large segments of the G.O.P. reject climate science and even the theory of evolution, so why expect evidence to matter for the party's economic views?
And it also, of course, reflects the political need of the right to make everything bad in America President Obama's fault. Never mind the fact that the housing bubble, the debt explosion and the financial crisis took place on the watch of a conservative, free-market-praising president; it's that Democrat in the White House now who gets the blame.
But good politics can be very bad policy. The truth is that we're in this mess because we had too little regulation, not too much. And now one of our two major parties is determined to double down on the mistakes that caused the disaster.

links for 2011-09-29

Posted: 30 Sep 2011 12:06 AM PDT

"The Moral Question"

Posted: 29 Sep 2011 08:19 PM PDT

Robert Reich:

The Moral Question, by Robert Reich: We dodged another shut-down bullet, but only until November 18. That's when the next temporary bill to keep the government going runs out. House Republicans want more budget cuts as their price for another stopgap spending bill.
Among other items, Republicans are demanding major cuts in a nutrition program for low-income women and children. The appropriation bill the House passed June 16 would deny benefits to more than 700,000 eligible low-income women and young children next year.
What kind of country are we living in? ... We're in the worst economy since the Great Depression – with lower-income families and kids are bearing the worst of it – and what are Republicans doing? Cutting programs Americans desperately need to get through it.
Medicaid is also under assault. Congressional Republicans want to reduce the federal contribution to Medicaid by $771 billion over next decade and shift more costs to states and low-income Americans.
It gets worse. Most federal programs to help children and lower-income families are in the so-called "non-defense discretionary" category of the federal budget. The congressional super-committee charged with coming up with $1.5 trillion of cuts ... will almost certainly take a big whack at this category because it's the easiest to cut. Unlike entitlements, these programs depend on yearly appropriations. ...
It gets even worse. Drastic cuts are already underway at the state and local levels. ...  So far this year, 23 states have reduced education spending. ... Local family services are being cut or terminated. Tens of thousands of social workers have been laid off. Cities and counties are reducing or eliminating their contributions to Head Start...
All this would be bad enough if the economy were functioning normally. For these cuts to happen now is morally indefensible.
Yet Republicans won't consider increasing taxes on the rich to pay for what's needed – even though the wealthiest members of our society are richer than ever, taking home a bigger slice of total income and wealth than in seventy-five years, and paying the lowest tax rates in three decades. ...
When Republicans recently charged the President with promoting "class warfare," he answered it was "just math." But it's more than math. It's a matter of morality. Republicans have posed the deepest moral question of any society: whether we're all in it together. Their answer is we're not.
President Obama should proclaim, loudly and clearly, we are.

Plosser: Recent Stimulus Will Hurt the Fed's Credibility

Posted: 29 Sep 2011 11:07 AM PDT

Federal Reserve Bank of Philadelphia President Charles Plosser voted against Operation Twist -- the recent attempt for the Fed to help the economy -- because:

"The actions taken in August and September tend to undermine the Fed's credibility by giving the impression that we think such policies can have a major impact on the speed of the recovery. It is my assessment that they will not," ... "We should not take certain actions simply because we can."
"If we act as if the Fed has the ability to solve all our economic problems, the credibility of the institution is undermined," Plosser said. "The loss of that credibility and confidence could be costly to the economy because it will make it much harder for the Fed to implement effective monetary policy in the future," he said.

He certainly isn't acting like "the Fed has the ability to solve all our economic problems," (and two other Fed officials dissented along with him). In addition, the Fed officials who voted for this action have been careful to say this won't, in fact, solve all of our problems. They've said it can help modestly, and given the state of the economy even modest help is vary valuable, but they have not implied this will suddenly and magically fix our problems. So I really don't see how this action undermines credibility. Fed officials have been clear this is no magic bullet, but they think it could help some and things are so bad -- and the threat of inflation so low -- that they feel compelled to try.

But from Plosser's point of view, the Fed can't do much at all at this point, and the fear of inflation down the road trumps concerns about unemployment now. Plus, the Fed can't do anything about unemployment anyway:

"I am skeptical that this will do much to spur businesses to hire or consumers to spend, given the ongoing structural adjustments occurring in the economy and the uncertainties posed by the fiscal challenges both here and abroad," Plosser said. Meanwhile, "we should be cautious and vigilant that our previous accommodative policies do not translate into a steady rise in inflation over the medium term even while the unemployment rate remains elevated."

He is saying that unemployment is largely structural ("given the ongoing structural adjustments") even though it's clear that a large part of it is cyclical, and that uncertainty over fiscal policy is holding the economy back even though bond yields show no sign of this whatsoever. Thus, in his view the structural problems combined with uncertainty are holding back employment, and there's nothing the Fed can do about it.

Is he worried about inflation in the near term? No:

with many commodity prices now leveling off or falling, and inflation expectations relatively stable, inflation will moderate in the near-term

And why should we trust his forecasts in any case? He keeps seeing green shoots that aren't there:

"I was expecting GDP growth in 2011 to be 3% to 3.5%. Now, I expect GDP growth to be less than 2% in 2011, but to gradually accelerate to around 3% in 2012." He added "I do not believe the current data signal that we are on the precipice of a so-called double-dip recession."

So he keeps expecting growth that never comes, and uses those expectations along with the excuse that it's structural/uncertainty forestall policy action. What if his forecast for 3% growth in 2012 is as wrong as his previous forecast, and what if there is a double-dip? What if the unemployment problem is largely cyclical like most analysts say? What if, as many have concluded, uncertainty is not the problem? Is he really so certain about his forecasts and views about what's holding the economy back given his track record? With near term inflation falling, why not at least try to do more? Why should inflation risk trump the risk of continued sluggish growth (which in and of itself alleviates inflation concerns if it happens)? Is somewhat higher inflation down the road -- if it even happens -- really more worrisome than a period of elevated unemployment?

And why should this action produce inflation in any case? Operation Twist doesn't change the size of the Fed's balance sheet, it changes the average duration of the assets the Fed holds. If the balance sheet doesn't expand how, exactly, does that create inflation pressure to any significant degree? If there's no inflation pressure, what is the real concern? It appears to be the credibility argument and the fact that unemployment can't be helped -- it's structural/uncertainty -- but as noted above the structural/uncertainty claim is easy to rebut, and the concerns over credibility ring hollow. So he might at least consider the possibility that he has this wrong.

For me, one of the most frustrating thing about policy over the last several years is the continued insistence from some Fed officials that good times are just around the corner so any action they take will be inflationary. They have been wrong again and again, yet the optimism about future growth -- green shoots -- remains. Like Paul Krugman, I have been warning about a slow recovery since at least 2008, and warning about seeing green shoots that aren't there for almost as long, and it's disappointing to see policymakers continue to use the promise of good times just ahead -- especially policymakers who have been wrong again and again -- along with the easily refuted claim that the problem is all uncertainty and structural issues as an excuse to stand against doing more to try to help the unemployed (however modestly).

A Free Lunch for America

Posted: 29 Sep 2011 09:36 AM PDT

Brad DeLong explains how to get A Free Lunch for America.

September 29, 2011

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Interview with Daron Acemoglu

Posted: 29 Sep 2011 12:24 AM PDT

This is part of a much, much longer interview of Daron Acemoglu:

Interview with Daron Acemoglu, by Douglas Clement, The Region, FRB Minneapolis: ... Job Markets Region: You've done a great deal of research on labor market imperfections, looking at search frictions and asymmetric information, as well as important work on directed job search, matching efficiency and the impact of unemployment insurance. What's your sense of the impact those factors are having on the current U.S. job market?
Acemoglu: I pondered exactly that question over the last few years. Who hasn't, I suppose? [Laughs.] And I guess I have a two-layered answer. I tend to think that there are serious structural problems with the U.S. labor market that will keep the economy down more and more over the next decade. They're related to the fact that our workforce, especially the male half, hasn't really made an adjustment to the new technologies and types of skills that are required.
Labor market imperfections play a role in that, in the sense that I think most people are not sufficiently informed about the sort of skills that they will require. ... U.S. workers who don't have college degrees are not going to be able to get good-paying manufacturing jobs. ...
Region: Some contend that labor market factors like these have raised the structural rate of unemployment.
Acemoglu: Right, yes. I was just getting to that idea in fact. I would probably agree with the statement that these factors have raised the structural rate. But I don't agree—and I think it's hard to agree—with the statement that what we are seeing right now in the U.S. labor market is just structural unemployment. It seems quite clear that the sudden increase in and the composition of joblessness points out that this unemployment experience is really related to the downturn in economic activity. I think it also highlights that at some level, despite decades of very productive work, we economists haven't really made as much progress in understanding cyclical unemployment as we thought.
At some level, this wasn't so much of an embarrassment for us because the United States previously had relatively low unemployment, so most labor economists in the United States didn't really worry about unemployment, and most macroeconomists worried much more about employment than unemployment. Even when search models have been successful in thinking about some conceptual issues, I don't think they have been really that useful for thinking about why is it that we have these long periods of unemployment?
I think we probably need sort of a paradigm shift there, to combine some of the elements of the search model, perhaps, with some other ingredients in order to understand these things. ...
"Top Inequality" & Political Processes
Region: Earlier this year, at the American Economic Association meeting, you said that top inequality (the top 99th percentile) and the financial crisis itself might be due to "the peculiar political processes that have been under way in the United States over the last 25 years."
Can you elaborate on what you meant?
Acemoglu: Yes, sure. I think it's useful to put that into perspective, because that was commenting on a well-known thesis, that's become even better known over the last year or so, proposed by Raghu Rajan at the University of Chicago. And Raghu is a leading financial economist and has written many insightful pieces, including a wonderful book called Fault Lines. ...
I sympathize with 80 percent of the book greatly. But the 20 percent that has perhaps received the most attention, including by Raghu himself, I think, in his presentations, is about this new thesis ... that the root of the crisis was a regulatory response to the rising inequality experienced in the United States. I think this 20 percent is less compelling.
And the story goes like this: Inequality has been rising in the United States, and I think by that he was referring not to the top 1 percent inequality, but inequality between the bottom quarter and top quarter, or middle and the top quarter. It's been rising for exogenous reasons, for reasons unrelated to finance or to banking regulations and so on. This rise in inequality generated demand for appeasing the bottom of the distribution, and the political process responded by giving them cake instead of bread, so to speak—by giving them housing. And it did so by encouraging the GSEs [government-sponsored enterprises such as Fannie Mae and Freddie Mac] to give lower-income people unsustainably cheap credit or subprime lending and mortgages.
Region: Creating the "ownership society."
Acemoglu: Exactly: the "ownership society." And the house of cards that was created came tumbling down. That would be my summary of the 20 percent of Raghu's book that he emphasizes a lot and is the part that I disagree with.
So when I made that comment about top inequality and the crisis being due to the political process, it followed other remarks I made to explain why, in my opinion, this thesis doesn't hold water.
Why not? First, I think evidence that the demand for redistribution from the bottom was strongest in the 2000s is nonexistent. If anything, it was stronger in the 1980s, which was a time when the bottom of the income distribution was falling and, in fact, there was a stronger labor movement to demand such changes. If you look at the 2000s, the bottom of the income distribution is doing well, actually, for the reasons that we just talked about. In fact, the middle is not doing all that badly either in the 2000s, relative to what was going on before. So the 2000s seem to be a particularly peculiar time for people to make those demands.
Second, I actually see no evidence, qualitative or quantitative, that even if people at the bottom did make such demands, the political system would respond to it. Over time, the U.S. political system seems to have become much less responsive to what's being demanded by the bottom.
And third, I didn't see any evidence that GSEs really played such an important role in this whole thing. They were relatively late arrivals into the subprime scene, which the private sector had fought very hard to carve out away from the GSEs and had successfully done so. Then the GSEs came in because they thought this was a profitable opportunity.
Region: So the demand timing was wrong, the political response wasn't really there and the institutional details weren't quite right either.
Acemoglu: Yes, the details of the institutional process just don't seem to work out. Now, for all of this, we don't have conclusive evidence, but existing evidence doesn't seem to support the thesis.
And at the end, I said that if there was going to be any link between inequality and the financial crisis, I would have put it another way, which is that the financial crisis and the inequality of the top 1 percent, which has a heavy overrepresentation from the financial sector, has been an outcome of the political processes that have removed all of the regulations in finance, and so created the platform for 40 percent of U.S. corporate profits to be in the financial sector—which is just an amazing number. That is where financial sector profits stood at the time.
Region: Really, 40 percent? Wow.
Acemoglu: Exactly, wow. ... They were amazingly overrepresented in the top 0.1 percent of the income distribution. And the thing is that this was underpinned by a political process, in the sense that it was an outcome of this lack of regulation and the way that we have allowed the laws to be changed for things such as subprime, and the relationship between investment banking and regular banking. And those things also played a major role, obviously, in the run-up to the financial crisis.
So it could well be that a political process that responded not to the bottom of the income distribution, but to the lobbying, financial and expertise power of the very top of the income distribution might have been responsible for these two processes. ...

links for 2011-09-29

Posted: 28 Sep 2011 10:08 PM PDT

Ben Bernanke and the Washington Consensus

Posted: 28 Sep 2011 06:30 PM PDT

A few quick and somewhat scattered comments on Bernanke's speech today:

Ben Bernanke and the Washington Consensus

September 28, 2011

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"Wages and Recovery"

Posted: 28 Sep 2011 12:15 AM PDT

Laurence Kotlikoff misrepresents the views of Paul Krugman and Jamie Galbraith:

Five Prescriptions to Heal Economy's Ills, by Laurence Kotlikoff, Bloomberg: Desperate times call for creative measures. We're in desperate times, but we've had little creative thinking from the Obama administration on how to fix the economy. ... I see five things policy makers can do to get the economy going. ...
4. Get prices and wages unstuck.
Some prices and wages are set too high, thereby damping demand for output and for the workers needed to produce it. This is the standard sticky wage and price explanation for our economic malaise offered by Keynesian economists such as Paul Krugman and James Galbraith. I think there are fewer markets suffering from this problem than Krugman and Galbraith do, but there are enough such markets to make the case for government intervention. Indeed, the president should put these economists in charge of identifying the markets suffering from this problem and helping their participants set market-clearing prices and wages.
One example is the market for construction workers. A 1931 law called the Davis-Bacon Act effectively requires contractors using federal money to pay union wages. If the act were suspended or repealed, federal spending on much-needed infrastructure projects could create a lot more jobs.  

In comments, Jamie Galbraith corrects the record:

...I have never written, argued or believed that unemployment can be cured by cutting wages. Nor does that position have anything to do with Keynes, who wrote The General Theory to debunk this view. Keynes favored stable money wages, writing: "it is fortunate that the workers, though unconsciously, are instinctively more reasonable economists than the classical school, inasmuch as they resist reductions of money wages..."
It seems likely that Professor Kotlikoff has never read Keynes either.

Here's Paul Krugman's dismissal of this idea: Wages and recovery.

Fed Watch: Opinions and Rumors

Posted: 28 Sep 2011 12:06 AM PDT

Tim Duy:

Opinions and Rumors, by Tim Duy: Federal Reserve President Richard Fisher today attempted to defend his ongoing policy dissent. He gives plenty of material to work with, beginning with his version of research ahead of an FOMC meeting:

Before every FOMC meeting, I survey a select group of 30 or so private business and banking operators, imparting no information about monetary policy but listening carefully to their perspectives on developments in the economy as seen at the ground level. For weeks leading up to the meeting, there was speculation in the financial markets and in the press that an Operation Twist was being contemplated. I received an earful of opinions on these rumors.

A big red flag right away. He claims to listen to survey contacts on the state of the economy, but does he tell us what they said about the economy? No, of course not. Instead, he emphasizes that he heard a lot of opinions about rumors. Pay very close attention to what Fisher is saying. He is saying he does not attempt to make policy on the basis of economic fact. He believes policy should be made on the basis of random speculation. I guess it is too much work to look beyond that random speculation. He continues:

What I gleaned from those conversations was as follows:

Embarking on an Operation Twist would provide an even greater incentive for the average citizen with savings to further hoard those savings for fear that the FOMC would be signaling the economy is in worse shape than they thought.

The economy is in worst shape than the FOMC believed just months ago. Is it Fisher's contention that the Fed's best policy is to attempt to hide this fact? Apparently so – good luck establishing a credible monetary policy when the stated intent is to lie about the actual state of the economy.

They might view an Operation Twist as setting the stage for a new round of monetary accommodation―a QE3, if you will. Such a program was considered redundant by business operators given their surplus of undeployed cash holdings and bankers' already plentiful excess reserves.

Actually, apparently market participants came to exactly the opposite conclusion and, realizing the path to QE3 was longer than initially believed, bid down long-term inflation expectations. More:

In addition, such a program might frighten consumers by further driving down the yields they earn on their savings and/or lead to long-term inflation that would erode the value of those savings;

I don't know how you drive yields down any further, as the average savings account is paying nearly zero percent. And the second sentence doesn't follow from the first – if rates are near zero, it is only because the environment is decidedly non-inflationary. See the point above. Again, the lack of significant action on the part of the Federal Reserve is dragging down inflation expectations and real interest rates. Only in Fisher's fantasy land is the opposite happening. More objections:

The earning power of banks, both large and small, would come under additional pressure by suppressing the spread between what they can earn by lending at longer-term tenors and what they pay on the shorter-term deposits they take in;

I think this point gets overplayed. The prime-lending rate has been locked up at 3.25% since the beginning of 2009. The spread between the prime lending rate and short-term deposit rates:

Fisher1

Sure enough spread between the two has hovered around 300bp since 1990, holding true to the rule of thumb that the prime rate is 300bp plus the fed funds rate. Another example - the 24 month personal loan rate was 12.41% in 2006 when 1 month CD rates were 5%. Now the same loan rate is 11.47%, for a much wider spread. Same story with credit card rates, which have only come down a fraction of the amount of short rates. All of which makes me doubt this concern that Fed policy is deterring lending activity by crushing yields on Treasury debt (although I can see where it erodes the earnings on any Treasury debt held by the banking sector). Indeed, the opposite is occurring. Lending activity is on the rise for at least one segment of the market:

Fisher2

Apparently someone is lending money, although admittedly the consumer market is more challenging. If anything, the necessity of the banking community to earn a spread places a lower limit on lending rates, which explains the 3.25% prime rate which in turn would limit the uptake of loans (and justifies the use of higher inflation expectations to bring down real rates).

The ability to lend, however, is not only determined by the rate spread, but also by the demand from credit-worthy borrowers – and that demand has been sorely lacking as households deleverage. See also this note from the Wall Street Journal suggesting Operation Twist was a subsidy for banks. A final point is that looking through FDIC reports, the net interest margin has hovered within 25bp of 3.5% for the last decade. In 2Q11 it was 3.61% and in 2Q05 it was 3.49%. True enough, a few basis point lower spread is meaningful. But what is more important at this point is to see even higher loan growth to profit on that margin. And that is what the Fed is trying to induce. If the Fed allows the economy to slow and loan demand to falter, a slightly higher margin might not be sufficient to prop up earnings, not to mention the impact of additional loan-loss provisions that would come into play. In short, lots of dynamics on this issue. More from Fisher:

Pension funds would have to reassess their potential returns, with the consequence that public and private direct-benefit plans would have to set aside greater reserves that might otherwise have gone to investments stimulating job creation

Yes, low interest rates place an additional burden on pension funds, just as low rates squeeze the returns for savers. But is it the Fed driving rates lower, or is the Fed just following the economy. I think it is more the latter than the former. If the Fed was actually pursuing an aggressive monetary policy, the economy would firm and long rates rise. The problem is that, contrary to the belief at Constitution Ave., the Fed's commitment to supporting economic activity is only half-hearted. And does Fisher really believe everything would be better if the Fed hiked rates by 200bp? Would pension funds really be better off if we knocked 25% off of equity valuations? More:

Expanding the holdings of the Fed's book of longer-term debt would likely compound the complexity of future policy decisions. Perversely, the stronger the economy, the greater the losses the Fed would incur as interest rates rise in response and the prices of those longer-term holdings depreciate. The political incentive to hold rates down might then become stronger precisely when we want to initiate tighter monetary policy. This concern, of course, would be a good news/bad news issue: The good news is that it would stem from a stronger economy; the bad is that might hurt our maneuverability and, in doing so, might undermine confidence in the Fed to conduct policy independently.

This concern over the Fed's balance sheet is way overblown. First, San Francisco Federal Reserve economist Glenn Rudebusch addressed this issue earlier this year, concluding that:

Such interest rate risk appears modest, especially relative to the Fed's policy objectives of full employment and price stability

Second, then Governor Ben Bernanke already dismissed this concern in 2003, and noted very clearly it would be a mistake to allow such concerns to prevent the central bank from acting. The Fed should simply reach an agreement with Treasury to take this concern off the table entirely, otherwise Fisher and his ilk will just continue to use it as an excuse to justify inaction. And, quite frankly, rather than basing policy on "opinions on these rumors," wouldn't a real policymaker attempt to explain why such opinions are unfounded? He continues:

One other factor gave me pause and that was, and remains, the moral hazard of being too accommodative. For years, I have been arguing that monetary policy cannot solve the problem of substandard economic performance unless it is complemented by fiscal policy and regulatory reform that encourages the private sector to put to work the affordable and abundant liquidity we are able to create as the nation's monetary authority.

The argument here is that the Fed is enabling a dysfunctional fiscal process by attempting to aid the economy. In other words, according to Fisher, the Fed needs to let the economy collapse to prove a point about fiscal policy. That sounds great around the coffee table, but in reality, such wanton disregard for economic welfare only promises to leave behind a mountain of collateral damage.

Finally, Fisher channels former Federal Reserve Chairman Paul Volker:

Paul Volcker, who has the scars on his back from his Herculean effort to rein in inflation in the 1980s, wrote of this in the New York Times on Sept. 18. He reminded us that once unleashed, inflation combines with stagnation to make stagflation, the most painful of all combinations for the poor, for workers, for job seekers, for bond and stock holders and for businesses trying to navigate the economy.

I addressed this last week. Ultimately, for all his antics, this is what Fisher is about - hard money. He might claim that:

…while I remain on constant watch for signs of inflationary impulses, I believe the most urgent issue is job creation and the reduction of the scourge of unemployment.

but in reality he sees nothing but economic apocalypse in 3% inflation. He cannot wrap his mind around one simple fact – the 1970's began with 2.5% unemployment. We are currently facing unemployment above 9%. Apples and oranges. But Fisher is simply too intellectually lazy to attempt to differentiate between apples and oranges. For him, policy begins and ends with a single idea: Hard money is just morally good. And he will base policy on any "opinions on these rumors" that sound like they support his ideological conviction.

links for 2011-09-28

Posted: 28 Sep 2011 12:01 AM PDT

"The Importance of Economic History"

Posted: 27 Sep 2011 06:48 PM PDT

Kevin O'Rourke:

The importance of economic history, by Kevin O'Rourke: Paul Krugman is upset about some pretty fanciful accounts of what supposedly happened during the Great Depression, and I don't blame him. He also wonders whether economics is a progressive science (I am using the word 'science' in its German sense). Well, one of the things that philosophers of science have argued about in the past is whether, when you have a paradigm shift, you end up losing knowledge, and it's pretty clear what has happened in this instance. ... [F]or example, I have been reliably informed that a well-known department stopped teaching its undergraduates IS-LM just before the crisis hit in 2008. And the result is that you had people seriously peddling the line that austerity would be expansionary in the wake of the biggest downturn since the 1930s — and these claims were influential in Europe, it seems clear, in the fateful spring and summer of 2010.

One lesson is that it is one thing to play counter-intuitive intellectual parlour games in order to get tenure at a fancy university, but another thing entirely to say something about the real world. For that you need a little common sense.

Another lesson is that economists need at least some training in economic history. No-one with the slightest feeling for historical reality could believe that the Great Depression was due to supply side forces, for example. I observe that Krugman, along with such luminaries as Maurice Obstfeld and Ken Rogoff, did his graduate work in MIT, and I surmise (without having any inside knowledge on the matter) that all three were exposed to Charlie Kindleberger and Peter Temin. They are all distinguished theorists, but also have a historical sensitivity, and this makes them better economists — if your definition of a good economist includes the ability to say sensible things about our very messy real world.

One of the most important things that a bit of history gives you is a sense of the importance of context. A model will work very well in some technological or institutional contexts, but not in others. For example, the Reverend Malthus devised a model that did a pretty decent job of describing the world up to the point that he started writing, but which soon became essentially irrelevant in the century that followed, at least in the richer countries of the world. (He had an economist's sense of timing.) Sometimes the world is well-described by Keynesian models, and sometimes it is not. And so on.

If the only thing that economic history did was protect us from one-size-fits-all merchants, it would still be worth the price of admission.

[I'd have to agree with his points about the use of models, and about the value of economic history.]

"Should Social Security Be Progressive?"

Posted: 27 Sep 2011 10:08 AM PDT

I worry about this too, i.e. that the more progressive Social Security becomes (and hence the more income redistribution that is part of the system), the less political support it will have:

Should Social Security Be Progressive?, by James Kwak: ...Should Social Security be more progressive than it already is? The most common ways liberals want to make it more progressive are (a) eliminating the cap on taxable earnings altogether and (b) reducing benefits for high earners. For part of my brain the automatic answer is "yes," but I think there is a reasonable argument for leaving things roughly the way they are.
First, there's a straight-up political argument. Social Security is popular because people feel like they earn their benefits. If people thought it was a covert redistribution program, then the high earners would definitely be against it, and most of the middle class probably would be too because of the American allergy to welfare. In fact, there are certainly people who think it is "pure welfare", like the author of the post I criticized last time around. But it isn't..., the retirement program on its own is only modestly progressive. The really progressive parts of the program are disability insurance and survivors' benefits. The fact is that there isn't that much redistribution based solely on income level; most of the "redistribution" is based on disability or having your spouse die young, which feels more like insurance than welfare. It turns out that most Americans' instincts are right: Social Security isn't a welfare program. ...
Now some people ... say that Social Security should be more progressive. But I'm not so sure. Conceptually speaking, I think of Social Security as contributory pension system run by the federal government along with an insurance component to protect people against various risks—disability, early death of your working spouse, bad luck that prevents you from saving enough for retirement, living too long, etc. ... I think of this governmental function as different from the welfare function—the one that ensures that everyone person has the basic means of subsistence. (Wait, we don't have that in this country? Well, we should.) And that's precisely what the founders of Social Security thought; they saw it as an alternative to noncontributory old-age assistance programs, which is what the conservatives preferred. ...
So to me, it makes the most sense to have (a) a contributory pension/insurance scheme that compensates participants for losses (e.g., disability) but is not mainly about redistribution; (b) a real welfare system for the poor; and (c) a progressive tax system to fund the rest of the government. And I worry that if you make (a) too much like (b) or (c) it will become unpopular and die a slow death. But I'm open to being convinced otherwise.

I view Social Security fundamentally as a social insurance program, not welfare, and as noted above I think that's important for its political support. But if it comes down to a choice between raising the income cap or cutting benefits for middle and lower class households, I favor raising the cap. (I favor this over means testing benefits -- if we stop sending checks to part of the population, that will erode support much faster than increasing the income cap. Most people would hardly notice an increase in the cap, but they'd notice if the checks stopped. And I certainly favor this option over raising the retirement age.)

How the GOP Assault on the Fed Could Backfire

Posted: 27 Sep 2011 08:46 AM PDT

I have a new column on the need for Federal Reserve independence:

How the GOP Assault on the Fed Could Backfire

I expect disagreement on this one. The emphasis is on the long-run, but I wish I would have had the space to talk more about the short-run, i.e. that the Fed could be more aggressive in the short-run and allow inflation to rise temporarily without abandoning its commitment to long-run price stability. That's implied by the statement that "I don't think the voice of the unemployed is adequately represented in monetary policy decisions," but it may not be clear. I also wish I would have had the space to talk about why a return to the gold standard -- which is behind some of the attacks on the Fed -- is a bad idea.

September 27, 2011

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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.