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August 7, 2012

Latest Posts from Economist's View

Latest Posts from Economist's View

Posted: 12 Jun 2012 12:20 AM PDT
Gramm-Hubbard: So Many Misconceptions, So Little Time: Glenn Hubbard appears to be getting drunk on GOP Kool-Aid again with an assist from Phil Gramm. As they try to argue that Mitt Romney will be the saving grace for our economy, they also contrast the current recession/recovery with what happened in the early 1980's making so many ridiculous arguments, it is hard to keep track. But let's start with their explanation for the most recent recession:
The more recent recession resulted from excessive government intervention to increase homeownership by expanding subprime housing loans, on which substantial leverage was built. The resulting wave of defaults damaged the base of the banking system.
Two points here. The first is that Glenn served as economic advisor to that President who kept bragging about rising home ownership. Secondly, the problem was more too little government regulation of the banking system – not excessive regulation. But that line of reasoning is not nearly as bizarre as the following:
The superior job creation and income growth following the 1981-82 recession are all the more striking as they occurred against the backdrop of restrictive monetary policy … By reducing domestic discretionary spending, setting out a three-year program to reduce tax rates, and alleviating the regulatory burden, Reagan sought to make it profitable to invest in America again. He clearly succeeded. President Obama's polices would, by contrast, make permanent a significant surge in federal spending and raise marginal tax rates on earnings and entrepreneurial returns.
Paul Krugman partially addresses my problem with this aspect of Gramm-Hubbard:
Because recessions like those of 1990-91, 2001, and 2007-2009 have very different origins from recessions like 1974-75 or the double-dip recession of 1979-82. The old recessions were more or less deliberately created by the Fed via tight money to control inflation, which meant that you had a V-shaped recovery once the Fed decided that we had suffered enough and loosened the reins.
Gramm-Hubbard admitted earlier that it was Volcker's tight monetary policies that lead to the double-dip recession of 1979-82. One would think these two economists understand our macroeconomic history enough to realize the Volcker reversed his monetary restraint. One would also hope that they understood – as most economists do – that Reagan's fiscal stimulus wasn't necessary and ended up leading to less investment not more. Paul's point is that under the current liquidity trap situation, we need fiscal stimulus to restore full employment. Gramm-Hubbard also paint current U.S. fiscal policy as being very expansionary, which is not even remotely true. They also play the card that our current woes could be cured by less regulation. President Reagan did preside over the deregulation of the banking sector but note early in the Gramm-Hubbard op-ed their recognition of the savings-and-loan crisis. They blame the Volcker FED for this crisis but most economists blame what John Kareken dubbed putting the cart before the horse. Luigi Zingales appears to now support Glass-Steagall because of concerns similar to those that Kareken had with the financial deregulation during the early 1980's. Somehow – all of this seems to have been missed by Phil Gramm and Glenn Hubbard.
Posted: 12 Jun 2012 12:06 AM PDT
Posted: 11 Jun 2012 04:54 PM PDT
Does inequality cause slower growth and instability?:
Inequality, the crash and the crisis: Part 1 "The defining issue of our times", OECD Insights: Today we publish the first of three articles on inequality and the crisis by Stewart Lansley, visiting fellow at The Townsend Centre for International Poverty Research, Bristol University and the author of The Cost of Inequality: Why Economic Equality is Essential for Recovery... He was one of the speakers at the 2012 OECD Forum session: How Is Inequality Holding Us Back?
Does inequality trigger economic instability? A few years ago this was a issue that did not register on the political Richter scale. Nor did it attract much attention amongst professional economists. As James Galbraith ... has put it, those few working in inequality research were in an economics "backwater". ...
There is one key reason for this lack of interest. For the last thirty years, the economic orthodoxy has been that inequality is a necessary condition for economic success. We can have greater equality or faster growth but not both. That orthodoxy emerged out of the global crisis of the 1970s when, it was claimed, the move towards more equal societies in the immediate post-war decades had gone too far and had led to economic sclerosis. What was needed to put economies back on an upward and sustainable path was a stiff dose of inequality.
Since the late 1970s that theory – for theory it was – has been put to the test in a real life experiment in both the US and the UK, and more latterly in a number of rich countries. ...
Not only has the rise in inequality failed to deliver on faster growth, history shows a clear association between inequality and instability. The great crashes of 1929 and 2008 and the deep-seated recessions that followed were both preceded by sharp rises in inequality. In contrast, the most prolonged period of economic success and stability in recent history – from 1950 to the early 1970s – was one in which inequality fell across the rich world and especially in the UK and the US.
Of course, association is one thing, causation is another. In part 2, we will look at the reasons why the link may run from inequality to crisis, at why economies that allow a small minority to colonize an increasing share of the economic cake hike the level of economic risk and the likelihood of implosion.
I'll be interested to see the evidence in part 2. There does seem to be an association between inequality and crises, but causality has been much harder to establish. It's easy to think of stories where this could happen, e.g. inequality leads to political power which spurs deregulation and causes a crisis. But it's just as easy to think of stories where a third factor causes both inequality and instability, and the evidence has not been sharp enough to allow us to choose one particular story over the others.
Posted: 11 Jun 2012 09:40 AM PDT
Tim Duy:
A Bigger Bailout Awaits, by Tim Duy: The half-life of European bailouts is getting shorter and shorter, which should come as no surprise in these kinds of repeated games. The announced Spanish bank bailout triggered some early euphoria in financial markets which at the moment is quickly fading. Why? I suspect that market participants fear the bank bailout is simply a precursor to a much bigger bailout of Spanish government debt, a bailout that will involve some sizable private sector involvement.
One of the most telling stories is this from the FT:
Spain's Treasury on Monday vowed to continue as normal with sovereign bond auctions, arguing that the eurozone's weekend agreement on a €100bn bailout for Spanish banks would underpin the country's debt market.
Spain desperately needs to be able to finance at lower bond yields - the fiscal situation simply is not sustainable at interest rates currently north of 6%. They can't close deficits fast enough at those yields. Moreover, the ECB for all intents and purposes is out of the game. Not only do they feel honor bound to avoid anything that looks like the direct financing of national deficits, but they have likely run out of patience. Recall ECB President Mario Draghi's comments in May:
In a damning indictment of Spain's handling of the problems at Bankia, its third largest lender, ECB president Mario Draghi said national supervisors had repeatedly underestimated the amount a rescue would cost. He also cited the rescue of Dexia, the Franco-Belgian lender, as an example.
"There is a first assessment, then a second, a third, a fourth," Mr Draghi said. "This is the worst possible way of doing things. Everyone ends up doing the right thing, but at the highest cost."
One also wonders what kind of fiscal deterioration is being hidden from the general public. Or other EU officials for that matter.
Apparently, the hope was that by channeling the bailout funds to Spain's Fund for Orderly Reconstruction, it would appear as if Spain itself is not paying for the bailout. The lack of a "program" with IMF involvement was added to further create the illusion that this was not a sovereign bailout, and was instead some type of EuroTARP. Thus, a potential liability would be avoided and Spanish bond yields would fall accordingly. In essence, the bank bailout was a last-ditch gamble on the part of the Spanish government to avoid a general government bailout. (For further reading, FT Alphaville has a nice series of posts trying to understand the details of the bailout. See here, here, and here).
The trouble is that market participants started to poke holes in this ruse, realizing that the bailout is just sovereign debt by another name, and debt that most likely would be senior to existing bondholders. There was some initial confusion over this point, although it seems that Germany wants the funds to coming from the soon-to-be-launched ESM, in which case the debt will be senior. It really doesn't matter, though. FT Alphaville hits the nail on the head:
But we'll close by noting even 'pari passu' EFSF debt (or ESM debt which might subsequently absorb EFSF pari passu status) has shown signs of de facto seniority in Greece. EFSF loans to Greece were rescheduled before bondholders, but when it came to the PSI, the EFSF did not take write-downs in common with bondholders.
I think that no matter how many smoke and mirrors the Europeans try to put into the place, they can't cover up the fact that the Spanish government owns this bailout. Market participants came to this conclusion as well and sent Spanish yield higher:
Which means that as of roughly 9am on the West Coast, Spain's gamble has failed. And that pushes Spain once step closer to a real bailout of sovereign debt, and the mess - private sector involvement, Troika monitoring, etc - that comes with it.

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