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August 7, 2012

Latest Posts from Economist's View

Latest Posts from Economist's View

Posted: 27 Jul 2012 12:24 AM PDT
We should be focused on jobs, not deficits:
Money for Nothing, by Paul Krugman, Commentary, NY Times: For years, allegedly serious people have been issuing dire warnings about the consequences of large budget deficits — deficits that are overwhelmingly the result of our ongoing economic crisis. In May 2009, Niall Ferguson of Harvard declared that the "tidal wave of debt issuance" would cause U.S. interest rates to soar. In March 2011, Erskine Bowles, the co-chairman of President Obama's ill-fated deficit commission, warned that unless action was taken on the deficit soon, "the markets will devastate us," probably within two years. And so on.
Well, I guess Mr. Bowles has a few months left. But a funny thing happened on the way to the predicted fiscal crisis: instead of soaring, U.S. borrowing costs have fallen to their lowest level in the nation's history. ...
So what is going on? The main answer is that this is what happens when you have a "deleveraging shock," in which everyone is trying to pay down debt at the same time. Household borrowing has plunged; businesses are sitting on cash because there's no reason to expand capacity when the sales aren't there... So they're buying government debt, even at very low returns, for lack of alternatives. Moreover, by making money available so cheaply, they are in effect begging governments to issue more debt.
And governments should be granting their wish, not obsessing over short-term deficits.
Obligatory caveat: yes, we have a long-run budget problem, and we should be taking steps to address that problem, mainly by reining in health care costs. But it's simply crazy to be laying off schoolteachers and canceling infrastructure projects at a time when investors are offering zero- or negative-interest financing.
You don't even have to make a Keynesian argument about jobs to see that. All you have to do is note that when money is cheap, that's a good time to invest. And both education and infrastructure are investments in America's future; we'll eventually pay a large and completely gratuitous price for the way they're being savaged.
That said, you should be a Keynesian, too. The experience of the past few years — above all, the spectacular failure of austerity policies in Europe — has been a dramatic demonstration of Keynes's basic point: slashing spending in a depressed economy depresses that economy further.
So it's time to stop paying attention to the alleged wise men who hijacked our policy discussion and made the deficit the center of conversation. They've been wrong about everything — and these days even the financial markets are telling us that we should be focused on jobs and growth.

Posted: 27 Jul 2012 12:06 AM PDT
Posted: 26 Jul 2012 12:11 PM PDT
Tim Duy:
Draghi Blinks. Maybe., by Tim Duy: Global equity marekts surged this today on the back of supportive comments from ECB President Mario Draghi. Borrowing from FT Alphaville, who borrowed from Bloomberg:
Draghi Says the Euro Is Irreversible
Draghi says ECB will do whatever needed to preserve the euro –
 Draghi Says ECB Ready to Do 'Whatever It Takes' to Preserve Euro
Draghi Says Euro-Area Much Stronger Than People Acknowledge
It looks like Draghi finally found that panic button. This is crucial, as the ECB is the only institution that can bring sufficient firepower to the table in a timely fashion. His specific reference to the disruption in policy transmission appears to be a clear signal that the ECB will resume purchases of periphery debt, presumably that of Spain and possibly Italy. The ECB will - rightly, in my opinion - justify the purchases as easing financial conditions not monetizing deficit spending.
So far, so good. But there is enough in these statements to leave me very unsettled. First, the claim that the Euro is "irreversible" should send a shiver down everyone's backs. Sounds just a little too much like "the crisis is contained to subprime" and "Spain will not need a bailout." Second, the bluster that "believe me, it will be enough" is suspect. The ECB always thinks they have done enough, but so far this has not been the case. Moreover, he is setting some pretty high expectations, and had better be prepared to meet them with something more than half-hearted bond purchases.
Also, note that despite Draghi's bluster, the rally in Spanish debt send yields just barely below the 7% mark. A step in the right direction, but also a signal that investors still worry that Spain will need a bailout despite additional ECB action.
More distressing to me was Draghi's clearly defiant tone, reminiscent of comments earlier this week from German Finance Minister Wolfgang Schäuble. The message is that Europe has done all the right things, it is financial market participants that are doing the wrong things. What we have here is a failure to communicate. European leaders believe they have made remarkable progress in the context of the political realities they face, and want credit for that expended "political capital." Financial markets are saying the the progress politicians see as "remarkable" barely moves the needle compared to what is necessary to resolve the crisis.
The classic breakup line is "it's not you, it's me." It is a classic line because everyone knows it's a lie. I suppose at least Draghi is living up to the lie, essentially saying that "it's not me, it's you." European policy makers simply will not accept what financial markets are telling them. As a consequence, Draghi doesn't act until his back is against the wall, they engage in some half-hearted program, conditions ease temporarily, and then the ECB drifts back into the woodwork, claiming they have done all they can do. Lather, rinse, repeat. Why should we believe this time is any different?
As to the claims of Euro-area strength, Isabella Kaminska has this to say:
The second thing we think is interesting is Draghi's point that the euro area is much stronger than people realise. This *we think* is very encouraging indeed. And whilst many might disagree, we actually don't think it's a bluff at all. Not only does it tie very much with Draghi's previous comments about how well Ireland is doing, it suggests Draghi feels the market may be over focusing on the wrong metrics. Or, in other words, that there may be other economic gauges that are much more reflective of what's really going on.
I don't usually disagree with the FT Alphaville staff, but I disagree on this point. I don't find it encouraging at all. I think it is exactly the kind of delusion that leads to spectacular policy failure. I can't wait for the ECB to pull out the statistics that explain exactly how we don't get it. I want to see the explanation of how this reflects the strength of the European economy:
Call me crazy, but I get a little disconcerted when unemployment rates exceed 11%. And, is it just me, or isn't the gap between the Eurozone and EU27 rates increasing, suggesting that being a member of the Eurozone is on net a negative?
And what about the lasting impact of this crisis? I get unnerved by the structural damage due to Washington's acceptance of 8+% unemployment rates in the US. That is absolutely trivial compared to Europe. Spain is at 24.6%, with a a youth unemployment rate of 52.1%. We called this a Great Depression in the 1930's, not a sign of strength. Greece was at 21.9% in March. France and Italy are in the double digit range. And the "remarkable" Ireland has an unemployment rate at 14.6%. Simply put, the mindless pursuit of fiscal consolidation is scarring a generation of workers, perhaps irrevocably. There will be a cost that offsets the benefits of the structural change European leaders seem intent on pursuing in the absence of fiscal stimulus.
Also, how much damage is being done to the European financial system? Gillian Tett reports on the fracturing of banking along national boundaries:
The bankers, however, were alarmingly precise: amid all the speculation about Grexit, they told me, banks are increasingly reordering their European exposure along national lines, in terms of asset-liability matching (ALM), just in case the region splits apart. Thus, if a bank has loans to Spanish borrowers, say, it is trying to cover these with funding from Spain, rather than from Germany. Similarly, when it comes to hedging derivatives and foreign exchange deals, or measuring their risk, Italian counterparties are treated differently from Finnish counterparties, say.
The halcyon days of banks looking on the eurozone as a single currency bloc are over; cross-border risk matters. To put it another way, while pundits engage in an abstract debate about a possible break-up, fracture has already arrived for many banks' risk management departments, at least when it comes to ALM in their eurozone books.
The way this is heading is toward a continent with limited cross-border capital flows with a fiscal policy regime that limits members ability to use fiscal policy, all under a single monetary policy. This is a recipe for long-term recession, not economic strength. And it is also a system that will become increasingly susceptible to asymmetric shocks.
Finally, note that we are well past the point where just bringing down interest rates in peripheral economies is enough to turn the ship around. The 10-year UK bond yield stands at 1.48% today. And despite low rates, the UK economy continues to struggle:
The UK's double-dip recession has deepened sharply and unexpectedly, leaving the economy smaller than it was when the coalition government took office two years ago....
...critics of Mr Osborne's austerity programme, which aims to eliminate the structural current deficit in five years, said the data showed his efforts were self-defeating.
"As we warned two years ago, David Cameron and George Osborne's ill-judged plan has turned Britain's recovery into a flatlining economy and now a deep and deepening recession," said Ed Balls, shadow chancellor for the Labour party.
In short, it's not just about interest rates.
Bottom Line: Draghi has his back up against the wall, and is now forced to step back into the crisis. A near-term positive, to be sure. It might be a longer-term positive if the ECB would commit to an open-ended purchase program based on macroeconomic objectives (sound familar?). But that is likely too much to ask, as he has yet to admit that the entire policy approach is failing the Eurozone, not just in the short-run, but in the long-run as well. Until policymakers fundamentally rethink their approach to the crisis, expect the optimisim-pessimism cycle to continue. Right now, the best case scenario I see is that the ECB will act to hold the Eurozone largely together, but at the cost of protracted recession.
Posted: 26 Jul 2012 11:15 AM PDT
Mathew Yglesias discusses a dispute about whether recovery from the recession would have been faster if we had provided more help for households, and less help for banks:
This gets us to the actual dispute. Team Tim [Geithner] would say that they're trying to create a well-capitalized banking system in order to bolster the broader economy. Team Neil [Barofsky] counters that the broader economy would be better-served by a policy that imposed steep losses on banks and instead repaired household balance sheets. Beneath all the anger and accusations and counter-accusations is a fairly wonky policy disagreement about the relative importance of household balance sheets versus the credit channel to laying the preconditions for growth.
Here's my take (from December 2010). As others have noted, we needed to help both banks and households, and it didn't have to be one or the other. But there was no need to bail out banks directly, at least not on the scale that it was done, banks could have been helped indirectly by helping households:
...recovery from these "balance sheet recessions" is notoriously slow. As households rebuild their balance sheets, resources are directed away from consumption, and the reduction in aggregate demand is a drag on the economy. It takes a long time for households to recover what is lost, and the recovery will be slow so long as this rebuilding process continues. Fiscal policy attempts to restore the lost aggregate demand, and that is important, but it does very little to directly address the household balance sheet issue.
The same cannot be said about bank balance sheets. The effect on bank balance sheets also varies with the type of recession, and a financial collapse brought about by bad loans is particularly severe. The present recession is an example of this, and policy has done a good job of preventing even worse problems from developing by rebuilding financial sector balance sheets through the bank bailout and other means.
But household balance sheets have not received as much attention. We could have helped households rebuild their balance sheets, and this would have helped banks by lowering the default rate on loans. Instead, we left households to mostly solve their problems on their own, and then helped banks when households could not repay what they owed.
When a balance sheet recession hits, one of the keys to a quick recovery is to use the federal government's balance sheet as a means of offsetting the deterioration in the private sector's financial position. But we shouldn't just focus on banks. Household balance sheet problems are every bit as severe, and in total every bit as systemically important as the balance sheet problems of banks. We'll recover faster from balance sheet recessions if we pay attention to all private sector balance sheets instead of focusing mainly on the problems of banks.
To be more concrete, the government could have given households help in the form of a voucher that could only be used to repay loans (e.g. mortgage, student loan, or credit card debt incurred prior to this program). Banks still get the money they need to stay liquid and solvent, but households get help at the same time (an alternative, and what we essentially did, is to write off the loans and foreclose, etc. on households, then give the banks money to offset the losses). There are still political problems associated with using taxpayer money to bail out people with bad credit, so how the program is designed would be important (for example, there might be less objection to helping people who are having difficulties due to job loss from the recession, but are otherwise decent credit risks), but the point is that helping banks does not require handing them money. The help can be funneled through the household sector allowing both sets of balance sheets to be rebuilt at the same time.
[Brad DeLong also comments.]
Posted: 26 Jul 2012 10:19 AM PDT
Tim Duy:
Why Europe Matters to the US, by Tim Duy: Last month I identified this error in the logic of St. Louis Federal Reserve President James Bullard:
Bullard also dismisses financial market distress as an artifact of the European crisis:
The global problems are clearly being driven by continued turmoil in Europe.
China might be a bigger driver than we realize, but I digress. Given that this is a European problem, the Fed is helpless:
A change in U.S. monetary policy at this juncture will not alter the situation in Europe.
This is one of those things that makes you shake your head in the wonder of it all. The point of further easing would not be to alter the situation in Europe - THE POINT IS TO PREVENT THE SITUATION IN EUROPE FROM WASHING UP ON US SHORES.
Via today's Wall Street Journal:
Europe's deepening economic crisis is cutting into corporate earnings, with the continent's woes threatening to exert a drag on multinational corporations around the world into next year...
...The corporate alarm bells highlight how the miserable economic conditions in much of Europe are spilling onto the global stage. With much of Europe in recession and unemployment soaring, spending is sliding on everything from big-ticket items like cars to everyday staples like yogurt...
...Companies also are growing concerned about 2013 as government austerity measures eat into sales. The Ifo Institute survey of business sentiment released on Wednesday shows business confidence in Germany, Europe's largest economy, falling to its lowest level in over two years.
And note the trend in capital goods orders:
Flat growth year-over-year. Not necessarily a recession, but a clear warning sign as well. It is starting to look like firms satisfied their pent-up demand and don't see the underlying growth that justifies further spending. And clearly Europe is only aggravating that situation.
The recent softness in manufacturing is a warning sign that usually prompts Fed easing. That might be next week, or next month - there remains considerable uncertainty on the timing of their next move. But one thing is looking more certain day by day: The Fed should have been hitting their own panic button six weeks ago when it became clear their forecasts were well off the mark.
Posted: 26 Jul 2012 10:11 AM PDT
Casey Mulligan says that trying to help the poor "had the unintended consequence of deepening-if not causing-the recession." There was a financial crisis, but that wasn't the problem according to his story, and it wasn't the decline in housing wealth. Nope, everything would have been just fine (or at least "two to three times" better) if we had just let the poor struggle like they deserved:
Redistribution, or subsidies and regulations intended to help the poor, unemployed, and financially distressed, have changed in many ways since the onset of the recent financial crisis. The unemployed, for instance, can collect benefits longer and can receive bonuses, health subsidies, and tax deductions, and millions more people have became eligible for food stamps.

Economist Casey B. Mulligan argues that while many of these changes were intended to help people endure economic events and boost the economy, they had the unintended consequence of deepening-if not causing-the recession. ... The book ... reveals the startling amount of work incentives eroded by the labyrinth of new and existing social safety net program rules, and, using prior results from labor economics and public finance, estimates that the labor market contracted two to three times more than it would have if redistribution policies had remained constant. ...
We are also told that "...Casey B. Mulligan offers ... groundbreaking interpretations..." Groundbreaking? Perhaps, but there's a reason nobody else is suggesting these things. It may be groundbreaking, but it's also a dry hole.
Moving on to another ideologue, Arthur Laffer is attempting humor as well, though he gives the appearance of being quite serious:
Jeff Horwich: ...What's so wrong about raising taxes on this small segment of wealthy Americans, and lowering them or keeping them the same for other folks?
Laffer: The problem with raising taxes on rich people -- what they call rich people -- is rich people have many options open to them that other people don't have, and you won't get the money. You know, if you could get the money from them without costs, I'd love it. But you can't.
So the problem is that the rich are just too clever for the rest of us. If we try to tax them, they'll find a way to avoid it, so why even try? But wait, aren't Republicans constantly whining that the rich are paying more taxes than they used to (while ignoring how much their incomes have risen)? How did that happen if they are so clever at avoiding such things?
Later, he also asserts that tax increases pay for themselves despite a mountain of evidence pointing in the other direction:
Laffer: Yeah, a lot of common sense. Even if you did get more money from the top 1 percent, it would be more than offset by the losses other people would not pay in taxes because these people aren't employing as many people, aren't investing as much, aren't buying as much. I mean, it's much more than just one little group.
That's nonsense, there's no evidence that raising taxes from their current rates would decrease revenues even when such secondary effects -- which are small -- are accounted for.
How do you come to such conclusions? By ignoring the data when it disagrees with you:
Horwich: Many economists will say the data is extremely inconclusive in practice as to how marginal tax changes actually affect personal and business activity. What makes you so sure?
Laffer: Because basically, these economists you talk about never worked in the real world. They're just looking at the econometrics and the data there. ...
Horwich: But am I right that I just heard you criticize economists for actually looking at the data and making their decisions based on that?
Laffer: ...I think it's really silly to look at this aggregate data and not make any judgments beyond those aggregate data.
Finally, he is asked about inequality, but he never actually answers the question of how his center could have put out such a laughable report:
Horwich: Many other economists left, right and center will point to various kinds of data that show income and wealth inequality in the U.S. are increasing, maybe the worst in many, many years. And yet, your center just put out a report claiming to debunk this narrative on income inequality. Are you saying that's not true?
Laffer: You know, this is a debate that's going to go on for years and years and years. I don't mind inequality if people are rising in incomes in all groups. I do mind equality when everyone's brought down to the lowest common denominator. You don't want to make the rich poor; you want to make the poor richer. These inequality specialists all around the place aren't proposing that. In all the quest to achieve less inequality, they are creating equality by lowering everyone. And that's silly.
He makes it sound like this is a "debate," but the debate is over for those who can be swayed be evidence. Income inequality has been rising, and tax cuts for the wealthy -- which somehow didn't produce the wonderful economy the Laffers of the world promised us -- played a big role in redirecting income to the top.

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