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March 8, 2013

Latest Posts from Economist's View

Latest Posts from Economist's View

Posted: 19 Feb 2013 12:03 AM PST
Posted: 18 Feb 2013 12:30 PM PST
After two relatively wonky posts, let's turn to Jon Chait for a bit of (serious) fun:
Scarborough and Friends Trying to Make 'Debt Deniers' Happen, by Jonathan Chait: The deficit scold cause has suffered significant intellectual erosion... In the short run, the interest rate spike they keep insisting will happen keeps not happening. In the long run, the health-care-cost inflation that is at the root of the long-term fiscal predicament is growing markedly less dire. The case for prudent fiscal adjustment remains strong, but the case for bug-eyed, table-pounding terror is growing increasingly ridiculous.
But bug-eyed, table-pounding terror is the stock-in-trade of the fiscal scold movement. And so they are striking back by labeling anybody with a calmer view of the deficit as a "debt denier." Joe Scarborough ... has a new op-ed in Politico brandishing the epithet. ... Let's examine their case on the merits...
Analyzing the argument in a Joe Scarborough–authored op-ed is inherently challenging. (The written word in general is just a terrible medium for Scarborough, hiding his winning personality while exposing his inaptitude for analysis.) It mainly consists of using variations of "debt denier" repeatedly to describe his opponents. To his credit, Scarborough finally cites one actual economist... Unfortunately for Scarborough, the economist he cites, Alan Blinder, turns out to hold essentially the same view as Krugman. ... That Scarborough would support his claim that Krugman's view is "extreme" and "indefensible" by citing Blinder is just a total failure of reading comprehension. ...
It is the belief of the debt scolds that their issue holds such overweening importance that it can only be considered in moralistic terms. To Joe Scarborough and the whole team of anti-debt television personalities, calibrating out the ideal terms of debt reduction is like calibrating out how much to spend fighting Hitler. The fiscal scolds have so successfully inculcated their moralistic urgency about debt, so thoroughly dominated the news agenda, that millions of people like Joe Scarborough think it is self-evidently insane and evil to in any way minimize the awesome scale of the crisis. Scarborough can't really explain why Krugman is wrong, because the nub of the issue is that Krugman's way of looking at the issue simply offends him.
We do have to make adjustments in the long-run, but as Jon Chait notes, "Not only do we not need to start reducing the budget deficit this year, it would actually be harmful to do so with unemployment still high." That's the most important problem we face right now, high levels of long-term unemployment (e.g. see here for how harmful it can be to individuals). If Scarborough and friends would use their "bug-eyed, table-pounding terror" when talking about long-term unemployment, we might get somewhere on addressing this problem. But somehow the struggles of real people in the real world are less important than imaginary problems in the future that, despite dire predictions from the deficit hawks, have not materialized.
Posted: 18 Feb 2013 11:40 AM PST
Another paper to read:
Monetary Policy and Rational Asset Price Bubbles, by Jordi Galí, NBER Working Paper No. 18806, February 2013 [open link]: Abstract I examine the impact of alternative monetary policy rules on a rational asset price bubble, through the lens of an overlapping generations model with nominal rigidities. A systematic increase in interest rates in response to a growing bubble is shown to enhance the fluctuations in the latter, through its positive effect on bubble growth. The optimal monetary policy seeks to strike a balance between stabilization of the bubble and stabilization of aggregate demand. The paper's main findings call into question the theoretical foundations of the case for "leaning against the wind" monetary policies.
What's the key mechanism working against the traditional "lean against the wind" policy? That rational bubbles grow at the rate of interest, hence raising (real) interest rates makes the bubble grow faster. From the introduction:
...The role that monetary policy should play in containing ... bubbles has been the subject of a heated debate, well before the start of the recent crisis. The consensus view among most policy makers in the pre-crisis years was that central banks should focus on controlling inflation and stabilizing the output gap, and thus ignore asset price developments, unless the latter are seen as a threat to price or output stability. Asset price bubbles, it was argued, are difficult if not outright impossible to identify or measure; and even if they could be observed, the interest rate would be too blunt an instrument to deal with them, for any significant adjustment in the latter aimed at containing the bubble may cause serious "collateral damage" in the form of lower prices for assets not affected by the bubble, and a greater risk of an economic downturn.1
But that consensus view has not gone unchallenged, with many authors and policy makers arguing that the achievement of low and stable inflation is not a guarantee of financial stability and calling for central banks to pay special attention to developments in asset markets.2 Since episodes of rapid asset price inflation often lead to a financial and economic crisis, it is argued, central banks should act preemptively ... by raising interest rates sufficiently to dampen or bring to an end any episodes of speculative frenzy -- a policy often referred to as "leaning against the wind." ...
Independently of one's position in the previous debate, it is generally taken for granted (a) that monetary policy can have an impact on asset price bubbles and (b) that a tighter monetary policy, in the form of higher short-term nominal interest rates, may help disinflate such bubbles. In the present paper I argue that such an assumption is not supported by economic theory and may thus lead to misguided policy advice, at least in the case of bubbles of the rational type considered here. The reason for this can be summarized as follows: in contrast with the fundamental component of an asset price, which is given by a discounted stream of payoffs, the bubble component has no payoffs to discount. The only equilibrium requirement on its size is that the latter grow at the rate of interest, at least in expectation. As a result, any increase in the (real) rate engineered by the central bank will tend to increase the size of the bubble, even though the objective of such an intervention may have been exactly the opposite. Of course, any decline observed in the asset price in response to such a tightening of policy is perfectly consistent with the previous result, since the fundamental component will generally drop in that scenario, possibly more than offsetting the expected rise in the bubble component.
Below I formalize that basic idea... The paper's main results can be summarized as follows:
  • Monetary policy cannot affect the conditions for existence (or nonexistence) of a bubble, but it can influence its short-run behavior, including the size of its fluctuations.
  • Contrary to the conventional wisdom a stronger interest rate response to bubble fluctuations (i.e. a "leaning against the wind policy") may raise the volatility of asset prices and of their bubble component.
  • The optimal policy must strike a balance between stabilization of current aggregate demand -- which calls for a positive interest rate response to the bubble -- and stabilization of the bubble itself (and hence of future aggregate demand) which would warrant a negative interest rate response to the bubble. If the average size of the bubble is sufficiently large the latter motive will be dominant, making it optimal for the central bank to lower interest rates in the face of a growing bubble.
But before we lower interest rates in response to signs of an inflating bubble, it would be good to heed this warning from the conclusion:
Needless to say the conclusions should not be taken at face value when it comes to designing actual policies. This is so because the model may not provide an accurate representation of the challenges facing actual policy makers. In particular, it may very well be the case that actual bubbles are not of the rational type and, hence, respond to monetary policy changes in ways not captured by the theory above. In addition, the model above abstracts from many aspects of actual economies that may be highly relevant when designing monetary policy in bubbly economies, including the presence of frictions and imperfect information in financial markets. Those caveats notwithstanding, the analysis above may be useful by pointing out a potentially important missing link in the case for "leaning against the wind" policies.
Posted: 18 Feb 2013 10:44 AM PST
Richard Green:
Where's the monopsony?: President Obama, Paul Krugman and Robert Reich have all been pushing for an increase in the minimum wage. I want to agree with them, and Krugman is certainly correct that the preponderance of empirical evidence shows that the minimum wage's impact on total employment is negligible.
But the question is, why? Krugman's statement that human beings are not Manhattan apartments is true, and allows him to support the minimum wage while being appropriately skeptical of rent control, but it doesn't give a satisfactory answer as to why putting a floor on the price of labor would not create excess supply of labor.
There is in economic theory a set of circumstances, however, under which an increase in the minimum wage might raise employment. If an employer has a market largely to itself--if it has monopsony power--then it will both pay its workers less than their productivity warrants and not hire enough workers to be at the most efficient level of employment. Raising the minimum wage would then both increase pay and induce more workers into the labor market, hence increasing employment. If government could nail the minimum wage to the marginal revenue product of the least productive workers, the minimum wage could produce a first-best outcome--one where pay and employment levels were efficient.
For the argument to work, the demand for labor needn't be perfectly monopsonistic, but rather less than perfectly competitive. The fact that wages and labor productivity seem to have less and less to do with each other is evidence that the demand for labor is not competitive, but it would be nice to have further, detailed evidence of the industrial organization of labor demand.
David Card agrees with the monopsony perspective. Here is part of an interview of him (from 2006) by Douglas Clement of the Minneapolis Fed where he discusses this issue (in particular, see the part about "each employer has a tiny bit of monopoly power over his or her workforce," his comments on advocacy are also interesting):
Minimum Wage
Region: Your research on the effects of raising the minimum wage, much of which was compiled in your book with Alan Krueger, generated considerable controversy for its conclusion that raising the minimum wage would have a minor impact on employment.
Have you continued to conduct research on the impact of raising the minimum wage? And do you have an opinion about "living wage" legislation and the petition that's been circulated recently with 650 or so economists calling for an increase in the minimum wage?
Card: I haven't really done much since the mid-'90s on this topic. There are a number of reasons for that that we can go into. I think my research is mischaracterized both by people who propose raising the minimum wage and by people who are opposed to it. What we were trying to do in our research was use the minimum wage as a lever to gain more understanding of how labor markets actually work and, in particular, to address a question that we thought was quite important: To what extent does the simplest model of supply and demand actually describe how employers operate in the labor market? That model says that if an employer wants to hire another worker, he or she can hire as many people as needed at the going wage. Also, workers move freely between firms and, as a result, individual employers have no discretion in the wages that they offer.
In contrast to that highly simplified theoretical model, there is a huge literature that has evolved in labor economics over the last 25 years, arguing that individuals have to spend time looking for job opportunities and employers have to spend time finding employees. In this alternative paradigm a range of wage offers co-exist in the market at any one time. That broader theory is, I think, pretty widely accepted in most branches of economics. The same idea is used to think about product markets where two firms that sell very similar products may not charge exactly the same price. The theory explains a lot of things that don't seem to make sense, at least to me, in a simple demand and supply model.
For example, what does it mean for a firm to have a vacancy? If a firm can readily go to the market and buy a worker, there's no such thing as a vacancy, or at least not a persistent vacancy. During the early 1990s, when Alan and I were working on minimum wages, it was our perception that many low-wage employers had had vacancies for months on end. Actually many fast-food restaurants had policies that said, "Bring in a friend, get him to work for us for a week or two and we'll pay you a $100 bonus." These policies raised the question to us: Why not just increase the wage?
From the perspective of a search paradigm, these policies make sense, but they also mean that each employer has a tiny bit of monopoly power over his or her workforce. As a result, if you raise the minimum wage a little—not a huge amount, but a little—you won't necessarily cause a big employment reduction. In some cases you could get an employment increase.
I believe that that model of the labor market is correct. There are frictions in the market and some imperfect information. It doesn't mean that if we raised the minimum wage to $20 an hour we wouldn't have massive problems, if we enforced it. Realistically, of course, the U.S. is never going to enforce a draconian minimum wage, nor is one ever going to be passed. However, our results don't mean that minimum wages in other economies couldn't have some effect.
I think economists who objected to our work were upset by the thought that we were giving free rein to people who wanted to set wages everywhere at any possible level. And that wasn't at all the spirit of what we actually said. In fact, nowhere in the book or in other writing did I ever propose raising the minimum wage. I try to stay out of political arguments.
I think many people are concerned that much of the research they see is biased and has a specific agenda in mind. Some of that concern arises because of the open-ended nature of economic research. To get results, people often have to make assumptions or tweak the data a little bit here or there, and if somebody has an agenda, they can inevitably push the results in one direction or another. Given that, I think that people have a legitimate concern about researchers who are essentially conducting advocacy work. I try to stay away from advocacy of any kind, but that doesn't prevent people from being suspicious that I have an agenda of some kind.
I've subsequently stayed away from the minimum wage literature for a number of reasons. First, it cost me a lot of friends. People that I had known for many years, for instance, some of the ones I met at my first job at the University of Chicago, became very angry or disappointed. They thought that in publishing our work we were being traitors to the cause of economics as a whole.
I also thought it was a good idea to move on and let others pursue the work in this area. You don't want to get stuck in a position where you're essentially defending your old research. I certainly think it's possible that someone will come up with credible research documenting a situation where raising the minimum wage has a significant employment effect. I rather doubt we will see that right now because minimum wages are fairly low, at least in northern California where I live. My guess is that small raises in the minimum wage won't have much of an effect.
I think the monopsony power argument is correct (an argument I made in a job market paper long, long ago in trying to explain the correlation between wages and productivity).

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