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October 1, 2012

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Latest Posts from Economist's View


Paul Krugman: The Optimism Cure

Posted: 24 Sep 2012 12:24 AM PDT

Mitt Romney thinks he can use his magical powers to make the economy recover "without actually doing anything":

The Optimism Cure, by Paul Krugman, Commentary, NY Times: Mitt Romney is optimistic about optimism. In fact, it's pretty much all he's got. And that fact should make you very pessimistic about his chances of leading an economic recovery. ...
Mr. Romney's five-point "economic plan" is very nearly substance-free. It vaguely suggests that he will pursue the same goals Republicans always pursue... But it offers neither specifics nor any indication why returning to George W. Bush's policies would cure a slump that began on Mr. Bush's watch.
In his Boca Raton meeting with donors, however, Mr. Romney revealed his real plan, which is to rely on magic. "My own view is," he declared, "if we win..., there will be a great deal of optimism about the future of this country. We'll see capital come back, and we'll see — without actually doing anything — we'll actually get a boost in the economy."
Are you feeling reassured? ... You should ... know that efforts to base policy on speculations about business psychology have a track record — and it's not a good one.
Back in 2010, as European nations began implementing savage austerity programs to placate bond markets, it was common for policy makers to deny that these programs would have a depressing effect... Why? Because these measures would "increase the confidence of households, firms and investors."...
I ridiculed such claims as belief in the "confidence fairy." And sure enough, austerity programs actually led to Depression-level economic downturns across much of Europe.
Yet here comes Mitt Romney, declaring, in effect, "I am the confidence fairy!"
Is he? As it happens, Mr. Romney offered a testable proposition in his Boca remarks: "If it looks like I'm going to win, the markets will be happy. If it looks like the president's going to win, the markets should not be terribly happy." How's that going? Not very well. Over the past month conventional wisdom has shifted from the view that the election could easily go either way to the view that Mr. Romney is very likely to lose; yet markets are up, not down, with major stock indexes hitting their highest levels since the economic downturn began.
It's all kind of sad. Yet the truth is that it all fits together. Mr. Romney's whole campaign has been based on the premise that he can become president simply by not being Barack Obama. Why shouldn't he believe that he can fix the economy the same way?
But will he get a chance to put that theory to the test? At the moment, I'm not optimistic.

Fed Watch: Gramm and Taylor Don't Get It

Posted: 24 Sep 2012 12:15 AM PDT

Tim Duy:

Gramm and Taylor Don't Get It, by Tim Duy: As a general rule, I stay clear of the Wall Street Journal editorial pages. I'll be honest - I just don't have the emotional energy for it anymore. But Brad DeLong forced it on all of us this weekend, drawing attention to another anti-QE article, this time penned by Phil Gramm and John Taylor.

DeLong gets to the heart of the problem. Gramm and Taylor don't seem to realize that the stock of Treasuries is the same regardless of who owns them. What GT see as higher future interest rates would simply be higher current interest rates if the Fed was not temporarily substituting some cash for bonds. DeLong summarizes:

So why are Taylor and Gramm arguing that returning interest rates in 2016 and after to what they would have been anyway is a cost to QE III? It's a zero. It's not a change. It simply does not compute.

Yet there is still room to build upon DeLong's critique. GT get off to a bad start:

That kind of monetary expansion would normally be a harbinger of inflation. However, with banks holding excess reserves rather than lending them out—and with velocity (the rate at which money turns over generating national income) at a 50-year low and falling—the inflation rate has stayed close to the Fed's 2% target..

While the Fed considered its previous rounds of easing—QE1, QE2 and Operation Twist—the argument was consistently made that the cost of such actions was low because inflation was nowhere on the horizon. The same argument is now being made as the central bank contemplates QE3 during the Federal Open Market Committee meetings on Wednesday and Thursday.

Inflation is not, however, the only cost of these unconventional monetary interventions.

Notice that they admit that inflation has remained under control, yet then proceed to claim that inflation is a cost of QE. How can inflation be both under control and a cost? It can't, of course; GT just can't admit that inflation is not a problem even after actually admitted that fact. GT continue:

As investors try to predict the timing and effect of Fed policy on financial markets and the economy, monetary policy adds to the climate of economic uncertainty and stasis already caused by current fiscal policy.

QE3 actually reduces the uncertainty about monetary policy. Rather than defining QE by arbitrary amounts and end dates, we now have a steady flow of QE tied only to improving economics conditions in the context of price stability. No more uncertainty that the Fed will pull policy support regardless of the state of the economy. More:

Since September 2008, the Fed has acquired $1.16 trillion of government securities—in fiscal year 2011 (Oct. 1, 2010-Sept. 30, 2011), the central bank bought 77% of all the additional debt issued by the Treasury. Aside from the monetary impact of these debt purchases, the Fed allowed the federal government to borrow a trillion dollars without raising the external debt of the Treasury and without having to pay net interest on that portion of the debt, since the central bank rebated the interest payments to the Treasury.

So GT do not consider the Treasury debt held by the Fed as real debt because...why? Apparently because all of the Fed's profit need to be returned to the Treasury at the end of the year. That doesn't mean it isn't real debt, issued to cover deficit spending and issued without the expectation of outright monetiziation. Moreover, private investors see the Fed's holdings as part of the aggregate Treasury debt and will set their price expectations accordingly. GT continue:

When the Fed must, in Chairman Ben Bernanke's words, begin "removing liquidity," by selling bonds, the external debt of the federal government will rise and the Treasury will then have to pay interest on that debt to the public. Selling a trillion dollars of Treasury bonds on the market—at the same time the government is running trillion-dollar annual deficits—will drive up interest rates, crowd out private-sector borrowers and impede the recovery.

This just makes my head hurt. If the Fed needs to sell their portfolio into the market, this will be because interest rates are already rising. Let's take this slowly: Currently, interest rates are at very low levels. If the economy improves, there will be upward pressure on interest rates. Yes, interest rates will rise, and supposedly "impede the recovery." Yes, this will have an impact on growth, but that is exactly what you might expect if the LM curve slopes upward (if the IS curve increases, both output and interest rates rise). And yes, the Fed will likely follow rising long term interest rates by reversing the current situation.

This should be absolutely, 100%, not a controversial subject because, surprise, surprise, the Fed reverses their policy stance in every expansion. That is a feature of monetary policy, not a defect.

Moreover, assuming the economy is operating near potential, the Fed would not be crowding out the private sector; they would only be controlling inflation. Only the fiscal authority can crowd out the private sector by not engaging in counter-cyclical policy. And if the fiscal authority does indeed not control deficit spending as needed, it would be the Fed's job to compensate to the best of their abilities.

GT continue:

In addition, Operation Twist, by shortening the average maturity date of externally held debt, will require the Treasury to borrow more money sooner when the economy recovers and interest rates start to rise. This too will drive up interest costs and the deficit.

The issue here, I think, is that the Fed is swapping out short-dated assets that they normally would have rolled over when the assets matured (assuming they wanted to hold the balance sheet constant). Thus, the Treasury needs to increase its debt issuance to the public compensate in the near term. But guess what? First, if the Fed didn't hold the debt in the first place, then the public would hold the debt with the same consequences for the Treasury at maturation. Second, the US Treasury is wisely extending the maturity of its debt; see Jim Hamilton here. Extending the maturity will help reduce the pressure to refinance short term debt and lock in low longer term interest rates. Moreover, the Treasury has time time to implement these changes; interest rates are not skyrocketing overnight.

GT make similar errors with mortgage rates:

The same problems will occur as the Fed begins to sell its holdings of mortgage-backed securities to reduce the monetary base. When the Fed bought these securities, it may have marginally reduced mortgage interest rates. Selling them during a real recovery will likely cause mortgage rates to rise.

Yes, once again in a real recovery mortgage rates will rise. Just as in the past. And guess what happens if they don't rise - then you might in fact get that inflation the authors so fear. Again, rising rates are a feature, not a defect. GT, inexplicably, continue:

Proponents of QE3 argue that while the Fed's balance sheet must be reduced at some future time, it has the tools to minimize the impact on interest rates by slowing down the pace of the sales. But the Fed's ability to act has already been compromised by its pledge to maintain low interest rates through 2014. Having to time open-market sales to minimize interest-rate increases will further limit the Fed's ability to preserve price stability.

Once again, with emphasis, it is not a commitment. Believe me, many of us would like to see a commitment to be irresponsible. This isn't it. It is a conditional forecast; if economic activity exceeds current projections, the Fed will tighten policy sooner than currently anticipated. Finally:

The Fed could raise the interest rate that it pays banks on reserves they hold in lieu of reducing its balance sheet. Where would the money come from? It has to come out of the money the Fed is currently paying the Treasury, driving up the federal budget deficit. How will taxpayers feel about subsidizing banks not to lend them money?

Yes, the profits from monetary policy accrue to the US Treasury. Yes, profits are currently unusually high. Yes, if interest rates, and along with them policy, normalizes, then those profits will fall. Will this drive up the budget deficit? Consider the bigger picture. If the economy is accelerates such that there is upward pressure on interest rates, then the deficit will be eased by the activation of automatic spending and revenue stabilizers. In other words, we will have a choice - the Fed can hold the economy down now by withdrawing monetary stimulus, which will in turn widen the deficit, or foster stronger activity which will lower the deficit in the future. The Fed's profits are of third or fourth or fifth order importance in this process.

Bottom Line: If the US economy was not operating at the zero bound, the Federal Reserve would react to improving economic conditions and tighten policy by selling Treasury securities in the process of targeting a higher Federal Funds rates. John Taylor should know this. Now, with quantitative easing, if economic conditions improve, the Fed will tighten policy by...yes, the same thing, selling Treasury securities. In either case, the Fed will only do this if interest rates are already responding to stronger activity. In this light, the Fed isn't really doing anything new. I don't think you should fear the Fed having to withdraw the stimulus. Indeed, I think you should really fear the opposite - that the economy does not lift off the zero bound before the next recession hits. If that happens, we will all be wishing the Fed had done more, and sooner.

Links for 09-24-2012

Posted: 24 Sep 2012 12:06 AM PDT

'Hard Times Come Again Once More?'

Posted: 23 Sep 2012 01:38 PM PDT

This is David Warsh on the worries about a great stagnation in our future (I remain an optimist about the future, at least when it comes to productivity. I think that, since we are part of it, it's hard to see how big of an impact the digital revolution will have on the future, or even how big of an impact it has had already. So I believe we will continue to grow robustly once our current troubles are behind us. But as digital technology advances and eliminates working class jobs -- jobs with decent pay and decent benefits -- there is a danger of an increasingly two-tiered society. For that reason, I think we are worried about the wrong thing. The big problems of the future will be about distribution, not production. We'll have plenty of stuff, but wil it be distributed in a way that allows prosperity to be widely shared?):

Hard Times Come Again Once More?, by David Warsh: I keep a couple of books on the shelf above my desk to remind me of how much things have changed over the past hundred years. One is Only Yesterday: An Informal History of the 1920s, by Frederick Lewis Allen, which first appeared in 1931. The other is The Great Leap: The Past Twenty-Five Years in America, by John Brooks, published in 1966. Some crackerjack journalist is surely working today on a similarly successful treatment of the as-yet hard-to-characterize years since 1966. In the meantime, The Good Life and Its Discontents: The American Dream in the Age of Entitlement 1945-1995, by Robert Samuelson, takes the story forward.
The really interesting question, though, has to do with what to expect in the next twenty years.
One thing that Yesterday and Leap have in common, a characteristic that in all likelihood will be shared by the book that eventually joins them, is that there are hardly any numbers in them – nothing to link together the two  epochs, or to foreshadow the future.  Measurement is the province of economists. Compelling journalism seldom has time.
Therefore I have been reading, with special interest (and a certain dread), Is US Economic Growth Over? Faltering Innovation Confronts the Six Headwinds, by Robert J. Gordon, of Northwestern University.  In fact, I read it last summer, even before it was a National Bureau of Economic Research working paper, since Gordon is a friend. It's a short report (25 pages) on an ambitious work in progress.
Beyond the Rainbow: The American Standard of Living Since the Civil War, a book version of the article, already long in preparation, will be anything but brief when it's finally done. It will, however, be the definitive survey of American living standards over the last 150 years. (Think Carmen Reinhart and Kenneth Rogoff, This Time Is Different, on the history of financial crises.) It will formulate an educated guess about the future as well.  And since that prediction has implications for anyone following the election campaign (and more than just them!), there is good reason for considering it now.
The standard assumption is that, after the disruptions of the financial crisis, and once various fiscal imbalances have been resolved (pensions, health care obligations, etc.), the United States will resume the real per capita GDP growth of around 2 percent a year that we've enjoyed since 1929.  In the immediate aftermath of the crisis, I toyed with it myself.  Technology, the growth of knowledge, will see us through.
What if it won't? ... There are two sides to Gordon's argument... [continue reading] ...

'Mitt Romney's Housing Market Plan Has to Be a Joke'

Posted: 23 Sep 2012 09:49 AM PDT

Brad DeLong points to Joe Weisenthal's response to the Romney campaign's housing plan (calling it a "plan" gives it more credit than it deserves):

Mitt Romney's Housing Market Plan Has Got to Be a Joke, by Joe Weisenthal: At this point, we have no choice but to conclude that the Mitt Romney campaign is just trolling whiny journalists who have complained about the lack of detail in his plans.

Yesterday evening (a Friday evening!) the campaign revealed a whitepaper titled Securing the American Dream and The Future of Housing Policy that's so unsubstantial, we half-suspect the timing was done so that nobody would see it amid the release of the 2011 tax documents, which came out about 20 minutes earlier. This is honestly a sentence in his whitepaper on The Future Of Housing Policy:

The Romney-Ryan plan will completely end "too-big-to-fail" by reforming the GSEs.

Romney and Ryan believe that "too-big-to-fail", which generally refers to the assumption that a collapse of a major Wall Street institution would be catastrophic to the overall economy, thus making a bailout imperative, would be solved by the reform of Fannie and Freddie. Or maybe Romney and Ryan believe that only Fannie and Freddie are too big to fail, and that the collapse of a mega-bank would be fine. Those are the only possible readings of that sentence. As for Romney and Ryan's plan to reform the GSEs, the plan is to... reform them..., basically there are no details at all. Too Big To Fail will be fixed by reforming the GSEs, and the GSEs will be fixed... somehow….

It's reasonable to think that the challenger who is trying to disrupt the status quo, actually says something that would... disrupt the status quo. Failing to provide any details or a plan during the heart of the campaign undermines the notion that he is a serious alternative.

Bonus Brad DeLong ridicule of the "plan":

"End 'Too-Big-to-Fail' by Reforming the GSEs": Are Romney and His Campaign That Pig-Ignorant?

The Romney-Ryan plan will completely end "too-big-to-fail" by reforming the GSEs. The four years since taxpayers took over Fannie Mae and Freddie Mac, spending $140 billion in the process, is too long to wait for reform. Rather than just talk about reform, a Romney-Ryan Administration will protect taxpayers from additional risk in the future by reforming Fannie Mae and Freddie Mac and provide a long-term, sustainable solution for the future of housing finance reform in our country.

That is the Romney housing white paper's section on the GSEs and "Too-Big-to-Fail".

That is not the introduction to the section.

That is the section.

That is the entire section.

I don't know which is scarier:

  1. That Romney and everybody else in his campaign think that a "white paper" on housing can cover both the GSEs and "Too-Big-to-Fail" in 85 words.

  2. That Romney and everybody else in his campaign think that if the GSEs are somehow "reformed" that that can somehow magically resolve "Too-Big-to-Fail" as well--make it so that there are no longer any problems of systemic risk associated with the potential bankruptcy of Citi, JPMC, Wells-Fargo, BoA, GS, Morgan Stanley, or any of the other systemically-important financial institutions.

People: which scares you more?...

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