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October 18, 2012

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Latest Posts from Economist's View


Paul Krugman: Truth About Jobs

Posted: 08 Oct 2012 12:24 AM PDT

Good news for Obama in the form of polls, employment reports -- whatever -- drives the right crazy:

Truth About Jobs, by Paul Krugman, Commentary, NY Times: If anyone had doubts about the madness that has spread through a large part of the American political spectrum, the reaction to Friday's better-than expected report from the Bureau of Labor Statistics should have settled the issue. For the immediate response of many on the right — and we're not just talking fringe figures — was to cry conspiracy. ...
It was nonsense, of course. Job numbers are prepared by professional civil servants, at an agency that currently has no political appointees. ... Furthermore, the methods the bureau uses are public...
Some background: the monthly employment report is based on two surveys. One asks a random sample of employers how many people are on their payroll. The other asks a random sample of households whether their members are working or looking for work. And if you look at the trend over the past year or so, both surveys suggest a labor market that is gradually on the mend ... The eye-popping number from Friday's report was a sudden drop in the unemployment rate to 7.8 percent from 8.1 percent, but ... you shouldn't put too much emphasis on one month's number. The more important point is that unemployment has been on a sustained downward trend. ...
None of this should be taken to imply that the situation is good, or to deny that we should be doing better — a shortfall largely due to the scorched-earth tactics of Republicans, who have blocked any and all efforts to accelerate the pace of recovery. (If the American Jobs Act, proposed by the Obama administration last year, had been passed, the unemployment rate would probably be below 7 percent.) The U.S. economy is still far short of where it should be, and the job market has a long way to go before it makes up the ground lost in the Great Recession. But the employment data do suggest an economy that is slowly healing...
And that's the truth that the right can't handle. The furor over Friday's report revealed a political movement that is rooting for American failure, so obsessed with taking down Mr. Obama that good news for the nation's long-suffering workers drives its members into a blind rage. It also revealed a movement that lives in an intellectual bubble, dealing with uncomfortable reality — whether that reality involves polls or economic data — not just by denying the facts, but by spinning wild conspiracy theories.
It is, quite simply, frightening to think that a movement this deranged wields so much political power.

What Really Happened

Posted: 08 Oct 2012 12:21 AM PDT

This is from David Warsh (note that, despite Dodd-Frank and other regulatory measures instituted since the financial crises,we are still susceptible to the shadow bank run problems described below):

What Really Happened - Economic Principals: ...the best economics book on the fall calendar ... (to be published next month) is a slender account about the circumstances that led to that near meltdown in September 2008, and an explanation of why they were not apparent until the last moment. Misunderstanding Financial Crises: Why We Don't See Them Coming (Oxford University Press), by Gary Gorton, of Yale University's School of Management ... can be viewed as an answer to the question famously posed to their advisers, in slightly different ways, by both George W. Bush and Queen Elizabeth: why was there no warning of a calamity that was warded off only at such great expense? The answer is that, lulled by nearly 75 years without one, economists had become convinced that banking panics had become a thing of the past. The book is probably better understood as the successor to Charles P. Kindleberger's 1977 classic, since updated many times, Manias, Panics, and Crashes: A History of Financial Crises. This time, I think, the message won't be brushed aside.

Not that building the near-certainty of periodic crises back into economics' analytic framework will be easy. Gorton is an economic historian by training, and the economists with whom he collaborates mostly have monetary, financial or organizational backgrounds. This means they are up against macroeconomics, one of the most powerful guilds in ... virtually all of macro, from Edward Prescott on the right to Olivier Blanchard on the left, in the form of models of that describe economies in terms of dynamic stochastic general equilibrium (DSGE). More on that in a moment.

But Gorton, 61, possesses several advantages that Kindleberger (1910-2003) did not. He is an expert on banking, for one thing. (Kindleberger specialized in the international monetary system.) He's mathematically adroit, for another, a quant. Most significantly, he is an insider, the economist whose models and product concepts were at the heart of insurance giant AIG's Financial Products unit, whose undoing amid a stampede of competing claims was one of the central events of the crisis. As such, he had a front row seat.

Gorton's case is ostensibly simple. Where there are banking systems, he says, there will be periodic runs on them, episodes in which everyone tries to turn his claim into cash at the same time. He sets out the pattern this way:

  • Crises have happened throughout the history of market economies.
  • They are about demands for cash in exchange for bank debt — debt which takes many different forms, not just retail deposits.
  • The demands for cash are on such a scale – often the whole banking system is run on – that it is not possible to meet those demands, because the assets of the banking system cannot be sold en masse without their prices plummeting.
  • Crises are sudden, unpredictable events, although the level of fragility may be observable.
  • Crises, when they occur, may be contained, panics halted, but only at enormous cost.
  • Preventing depression means saving the banks and bankers. As Treasury Secretary Timothy Geithner put it: "what feels just and fair is the opposite of what's required for a just and fair outcome."

The problem is that, starting in the 1970s, many economists convinced themselves that bank runs were something they no longer had to worry about, or even think about. They thought because the measures implemented during the Great Depression – deposit insurance, careful segregation of banks by line of business, and close supervision – had ushered in what Gorton calls "the quiet period." Between 1934 and 2007 there were no financial crises in the United States. (Expensive as it was, the savings and loan debacle of the late 1980s and early '90s, doesn't meet the definition of a crisis. Some 750 of around 3,200 institutions failed, in slow motion, over a period of several years, but there was no run on any of them, because depositors expected that the government would make them whole.)

It was in these years that new models began taking over macroeconomics. These new models are said to be dynamic, because in them things change over time; stochastic, because the system is seen to respond to periodic shocks, factors whose origins economists don't try to explain as part of their system, at least not yet; and general equilibrium, because everything in them is interdependent: a change in one thing causes changes in everything else. Best of all, such models are set to rest on supposedly secure microfoundations, meaning the unit of analysis is the individual or firm. One trouble was that no one had succeeded in building banking or transactions technology into such a model (though some economists had begun to try). Another was that the behavioral aspects of those microfoundations were anything but secure.

It turns out the villain in the DSGE approach is the S term, for stochastic processes, meaning a view of the economy as probabilistic system ... as opposed to a deterministic one... It is ... when economists begin to speak of shocks that matters become hazy. Shocks of various sorts have been familiar to economists ever since the 1930s, when the Ukrainian statistician Eugen Slutsky introduced the idea of sudden and unexpected concatenations of random events as perhaps a better way of thinking about the sources of business cycles than the prevailing view of too-good-a-time-at-the punch-bowl as the underlying mechanism.

But it was only after 1983, when Edward Prescott and Finn Kydland introduced a stylized model with which shocks of various sorts might be employed to explain business fluctuations, that the stochastic approach took over macroeconomics. The pair subsequently won a Nobel Prize, for this and other work. (All this is explained with a reasonable degree of clarity in an article the two wrote for the Federal Reserve Bank of Minneapolis in 1990, Business Cycles: Real Facts and a Monetary Myth). Where there had been only supply shocks and demand shocks before, now there were various real shocks, unexpected and unpredictable changes in technologies, say, or preferences for work and leisure, that might explain different economic outcomes that were observed. Before long, there were even "rare economic disaster" shocks that could explain the equity premium and other perennial mysteries.

That the world economy received a "shock" when US government policy reversed itself in September 2008 and permitted Lehman Brothers to fail: what kind of an explanation is that? Meanwhile, the shadow banking industry, a vast collection of financial intermediaries that included money market funds, investment banks, insurance companies and hedge funds, had grown to cycle and recycle (at some sort of rate of interest) the enormous sums of money that accrued as the world globalized. Finally, there was uncertainty, doubt, fear, and then panic. These institutions began running on each other. No depositors standing on sidewalks – only traders staring dumbfounded at comport screens.

Only a theory beats another theory, of course. And the theory of financial crises has a long, long way to go before it is expressed in carefully-reasoned models and mapped into the rest of what we think we know about the behavior of the world economy. Gorton's book is full of intriguing insights, including a critique of President's Obama response to the crisis, and glimpses of a pair of reforms that might have put the banking system back on its feet much more quickly had they been widely briefed and better understood: federally charter a new kind of narrowly-funded bank required to purchase any and all securitized assets; and regulate repo (the interest-bearing repurchase agreements through which financial giants created the shadow banking system), to the extent that there would be limits on how much non-banks could issue (a proposal recently defeated at the Securities and Exchange Commission after massive lobbying by the money-market funds).

There is going to be a long slow reception to Misunderstanding Financial Crises. Let's see how it rolls out. I'll return to the topic frequently in the coming months.

Links for 10-08-2012

Posted: 08 Oct 2012 12:03 AM PDT

'The Progress is Real'

Posted: 07 Oct 2012 09:57 AM PDT

Paul Krugman has another post arguing that, contrary to Romney's assertions, "the progress is real":

The Payroll Data: Another quick note, this time on what the payroll data say. Again, you want to focus on somewhat longer-term trends, not monthly numbers. Over the past year the employer survey says that we've added 1.8 million jobs, or 150,000 a month ... And this number is likely to be revised up.
This is substantially more than the number of jobs we need to keep up with population growth, which is currently something like 90,000 a month. ...
So the two survey are saying the same thing: job growth fast enough to make gradual progress on the employment front. Not fast enough; it will take years to restore full employment, and we should, um, end this depression now. But the progress is real.

I think the 90,000 estimate is a bit low, 125,000 is probably closer (e.g. see here). So while I agree we are making progress, I also agree it's far too slow -- perhaps even slower than Krugman's estimates. The question is why, and two answers come to mind. First, as Krugman explains here, recoveries from financial crashes tend to take awhile:

However, as he also explains, this is far from the slowest recovery we've seen -- "it's way better than Bush's recovery." We started with a huge problem, the initial stimulus along with the efforts at the Fed stopped it from being an even bigger problem -- the no-stimulus at all outcome would have been far worse -- but more needed to be done.

That brings up the second point. Republicans in Congress have blocked efforts to implement fiscal policy measures over and above the initial stimulus effort (and they would have blocked the Fed as well if they had the power to do so). An aggressive infrastructure construction effort would, for example, buttress monetary policy and speed the recovery, and it would also provide benefits (including higher future growth) that exceed costs, but Republicans are not going to let that happen. This is like hiding half of the medicine a patient needs for recovery based upon medical quackery, and then asking why the doctor is doing such a lousy job.

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