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March 24, 2014

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Paul Krugman: Wealth Over Work

Posted: 24 Mar 2014 12:24 AM PDT

The drift toward oligarchy:

Wealth Over Work, by Paul Krugman, Commentary, NY Times: ..."Capital in the Twenty-First Century," the magnum opus of the French economist Thomas Piketty,... does more than document the growing concentration of income in the hands of a small economic elite. He also makes a powerful case that we're on the way back to "patrimonial capitalism," in which the commanding heights of the economy are dominated not just by wealth, but also by inherited wealth, in which birth matters more than effort and talent.

To be sure, Mr. Piketty concedes that we aren't there yet. ... But six of the 10 wealthiest Americans are already heirs rather than self-made entrepreneurs... As Mr. Piketty notes, "the risk of a drift toward oligarchy is real and gives little reason for optimism."

Indeed. And if you want to feel even less optimistic,... America's nascent oligarchy may not yet be fully formed — but one of our two main political parties already seems committed to defending the oligarchy's interests.

Despite the frantic efforts of some Republicans to pretend otherwise, most people realize that today's G.O.P. favors the interests of the rich over those of ordinary families. I suspect, however, that fewer people realize the extent to which the party favors returns on wealth over wages and salaries. And the dominance of income from capital, which can be inherited, over wages — the dominance of wealth over work — is what patrimonial capitalism is all about.

To see what I'm talking about, start with ... Representative Paul Ryan's "road map" — calling for the elimination of taxes on interest, dividends, capital gains and estates. Under this plan, someone living solely off inherited wealth would have owed no federal taxes at all. ...

Why is this happening? Well, bear in mind that both Koch brothers are numbered among the 10 wealthiest Americans, and so are four Walmart heirs. Great wealth buys great political influence — and not just through campaign contributions. Many conservatives live inside an intellectual bubble of think tanks and captive media that is ultimately financed by a handful of megadonors. Not surprisingly, those inside the bubble tend to assume, instinctively, that what is good for oligarchs is good for America.

As I've already suggested, the results can sometimes seem comical. The important point to remember, however, is that the people inside the bubble have a lot of power, which they wield on behalf of their patrons. And the drift toward oligarchy continues.

Fed Watch: Post-FOMC Fedspeak

Posted: 24 Mar 2014 12:15 AM PDT

Tim Duy:

Post-FOMC Fedspeak, by Tim Duy: Some thoughts on post-FOMC activity as we head into Monday.

First, I did not cover Federal Reserve Chair Janet Yellen's definition of a "considerable period" as six months in my review of the FOMC statement. I did not highlight the issue because when I went back to the tape, it looked clear to me that the bulk of the bond market response came at the release of the statement and projections. To be sure, the equity market stumbled, but here I completely agree with Felix Salmon:

But here's the thing: the market didn't freak out....last Thursday, for instance, the yield fell by a good 10bp when John Kerry made noises about imposing sanctions on Russia. And overall, the yield has stayed comfortably in a range between 2.6% and 2.8%.

What's more, the big FOMC-related move in the 10-year bond yield happened immediately at 2pm, when the statement was released. Yellen's "gaffe" caused barely a wobble.

So why does everybody think that Yellen blundered? The answer is simple: they were looking at the stock market (which doesn't matter), rather than the bond market (which does). Stocks fell, briefly; not a lot, and not for long, but enough that people noticed.

It is the bond market response that is important, and that response was pre-Yellen. It is not entirely clear that the six months timeline was new information. Or, at least, it wasn't to St. Louis Federal Reserve President James Bullard:

"That wasn't very different from what we had heard from financial markets, so I think she's just repeating that at that time period," Bullard said at a roundtable at the Brookings Institution. Bullard doesn't vote on policy this year.

Second, the more important issue appears to be the interest rate projections, the now infamous dot chart. In her press conference, Yellen attempted to deny the projections contained much useful information in her testimony:

But more generally, I think that one should not look to the dot-plot, so to speak, as the primary way in which the committee wants to or is speaking about policies to the public at large. The FOMC statement is the device that the committee as a policy-making group uses to express its – its opinions. And we have expressed a number of opinions about the likely path of rates.

Dallas Federal Reserve President Richard Fisher went further. Via Bloomberg:

Fisher suggested investors were placing too much emphasis on the change in forecasts, which the Fed illustrates as dots plotted on a chart.

There is a "fixation if not a fetish on the dots," he said at the London School of Economics. The change in forecasts by Fed officials came before this week's meeting, he said.

"Somehow, this was read as a massive shift," Fisher said. "These are our best guesses."

The Fed wants markets to focus on the distance between the bulk of the dots and participants view of normal. Back to Yellen:

Looking further out, let's say if you look at toward the end of 2016, when most participants are projecting that the employment situation, that the unemployment rate will be close to their notions of mandate-consistent or longer-run normal levels. What you see -- I think if you look, this time if you gaze at the picture from December or September, which is the first year that we showed those dot-plots for the end of 2016, is the massive points that are notably below what the participants believed is the normal longer-run level for nominal shortterm rates. And the committee today for the first time endorsed that as a committee view.

That said, it is clear the dots moved:

So I think that's significant. I think that's what we should be paying attention to. And I would simply warn you that these dots -- these dots are going to move up and down over time, a little bit this way or that. The dots moved down a little bit in December relative to September. And they moved up ever so slightly. I really don't think it's appropriate to read very much into it.

What should we take away from all of this? Well, first of all, I think it is absolutely ludicrous that the Fed is trying to claim the dots have no value. Seriously, can they work any harder to raise the act of bungling their communications strategy to an art form? If the dots have no value, then why force feed this information to market participants in the first place?

Second, yes, the dots do not represent the FOMC consensus. The statement represents the consensus. But the consensus is vague about what defines a "considerable period" or "accommodative" policy. Each individual participant has their own definition of these terms, and the dots thus provide value by quantifying the vagueness of the consensus. That is the real problem here - as a group, the Fed wants qualitative discretionary policy, and the dots provide quantifiable guidance. If they want qualitative discretionary policy, they need to pull all the numbers from their communications.

Third, Yellen needs to accept responsibility for mangling communications. She has been pushing her optimal control story for a long, long time. In the process, she has convinced market participants on the importance of the forward projections of economic variables. Yet now forward projections are meaningless?

Fourth, the dots undeniably moved forward and steeper, which means individual outlooks on the definitions of "considerable period" or "accommodative" did in fact change in meaningful ways. I am surprised, however, that this was not anticipated by market participants given the rapid decline in the unemployment rate. Along any given given Fed objective function, one would expect that a more rapid decrease in unemployment would move forward and steepen the interest rate trajectory, even if just by 25 or 50pb.

Why, why, why should Federal Reserve participants be permitted to change their outlooks but the Fed believes financial market participants are not allowed to follow suit?

Perhaps it is that while - and I believe this - the Fed's reaction function did not change, I suspect there is a very good chance that market participants expected it to change in a more dovish direction. This follows directly again from Yellen's optimal control story. How many analysts were expecting a September lift-off on the basis of her charts? How many expected Yellen push for a more dovish reaction function? I think you need to throw any analysis that explicitly allowed for above target inflation out the window - and that includes the optimal control framework.

In my opinion, some financial market participants are resisting abandoning their dovish interpretation of Fed policy. For instance, Jan Hatzius of Goldman Sachs continues to hold to its 2016 rate hike call. Via the Wall Street Journal:

"Rate hikes are far off," wrote Jan Hatzius, Goldman's chief Fed watcher, in a note to clients late Thursday. "Our central forecast for the first hike remains early 2016, although the risks now tilt in the direction of a slightly earlier move."

Recall, however, Goldman's view from November:

According to an analysis from Jan Hatzius, chief economist at Goldman Sachs, the two Fed papers actually would imply an earlier reduction of QE than planned—perhaps as soon as December—while the zero-bound interest rates could remain in place until 2017 and kept below normal into "the early 2020s."

Why? Because of extensions of the optimal control framework.

"The studies suggest that some of the most senior Fed staffers see strong arguments for a significantly greater amount of monetary stimulus than implied by either a Taylor rule or the current 6.5 percent/2.5 percent threshold guidance," Hatzius wrote. "Given the structure of the Federal Reserve Board, we believe it is likely that the most senior officials—in particular, Ben Bernanke and (Chair-elect) Janet Yellen—agree with the basic thrust of the analysis."

And more from Hatzius from Bill McBride at Calculated Risk:

It is hard to overstate the importance of two new Fed staff studies that will be presented at the IMF's annual research conference on November 7-8. The lead author for the first study is William English, who is the director of the Monetary Affairs division and the Secretary and Economist of the FOMC. The lead author for the second study is David Wilcox, who is the director of the Research and Statistics division and the Economist of the FOMC. The fact that the two most senior Board staffers in the areas of monetary policy analysis and domestic macroeconomics have simultaneously published detailed research papers on central issues of the economic and monetary policy outlook is highly unusual and noteworthy in its own right. But the content and implications of these papers are even more striking.

...[O]ur initial assessment is that they considerably increase the probability that the FOMC will reduce its 6.5% unemployment threshold for the first hike in the federal funds rate, either coincident with the first tapering of its QE program or before.
...
[O]ur central case is now that the FOMC will reduce the threshold from 6.5% to 6% at the March 2014 FOMC meeting, alongside the first tapering of QE; however, a move as early as the December 2013 meeting is possible, and if so, this might also increase the probability of an earlier tapering of QE.

In comparison to these expectations, the Fed is downright hawkish despite no change to their reaction function. The point is that, in my opinion, reality is starting to set in and financial market participants are walking back on their caricaturization of Yellen and the most dovish of all doves.

Bottom Line: The Fed is pushing back on the dots because they don't want quantitative guidance, and they forgot they were giving it. Expectations that Yellen will push for a more dovish reaction function are being disappointed. Note that the interest rates forecasts are just that - forecasts. They will evolve in one direction or the other in response to incoming data. But incoming data on unemployment undeniably pushes in the direction of an earlier liftoff and, subsequently, a steeper trajectory for rates. If they want to lean against those expectations, the Fed does need to change its reaction function, but to a more dovish one. That, I think, is not the direction of policy at this point.

Links for 3-24-14

Posted: 24 Mar 2014 12:06 AM PDT

'Secular Stagnation and Wealth Inequality'

Posted: 23 Mar 2014 11:11 AM PDT

Atif Mian and Amir Sufi:

Secular Stagnation and Wealth Inequality, by Atif Mian and Amir Sufi: Alvin Hansen introduced the notion of "secular stagnation" in the 1930s. Hansen's hypothesis has been brought back to life by Larry Summers...
A brief summary of the hypothesis goes something like this: A normally functioning economy would lower interest rates in the face of low current demand for goods and services... A lower interest rate helps boost demand.
But what if ... real interest rates need to be very negative to boost demand, but prevailing interest rates are around zero, then we will have too much savings in risk-free assets — what Paul Krugman has called the liquidity trap. In such a situation, the economy becomes demand-constrained.
The liquidity trap helps explain why recessions can be so severe. But the Summers argument goes further. He is arguing that we may be stuck in a long-run equilibrium where real interest rates need to be negative to generate adequate demand. Without negative real interest rates, we are doomed to economic stagnation. ...
In our view, what is missing from the secular stagnation story is the crucial role of the highly unequal wealth distribution. Who exactly is saving too much? It certainly isn't the bottom 80% of the wealth distribution! We have already shown that the bottom 80% of the wealth distribution holds almost no financial assets.
Further, when the wealthy save in the financial system, some of that saving ends up in the hands of lower wealth households when they get a mortgage or auto loan. But when lower wealth households get financing, it is almost always done through debt contracts. This introduces some potential problems. Debt fuels asset booms when the economy is expanding, and debt contracts force the borrower to bear the losses of a decline in economic activity.
Both of these features of debt have important implications for the secular stagnation hypothesis. We will continue on this theme in future posts.

On Greg Mankiw's 'Do No Harm'

Posted: 23 Mar 2014 09:29 AM PDT

A rebuttal to Greg Mankiw's claim that the government should not interfere in voluntary exchanges. This is from Rakesh Vohra at Theory of the Leisure Class:

Do No Harm & Minimum Wage: In the March 23rd edition of the NY Times Mankiw proposes a 'do no harm' test for policy makers:

…when people have voluntarily agreed upon an economic arrangement to their mutual benefit, that arrangement should be respected.

There is a qualifier for negative externalities, and he goes on to say:

As a result, when a policy is complex , hard to evaluate and disruptive of private transactions, there is good reason to be skeptical of it.

Minimum wage legislation is offered as an example of a policy that fails the do no harm test. ...

There is an immediate 'heart strings' argument against the test, because indentured servitude passes the 'do no harm' test. ... I want to focus instead on two other aspects of the 'do no harm' principle contained in the words 'voluntarily'and 'benefit'. What is voluntary and benefit compared to what? ...

When parties negotiate to their mutual benefit, it is to their benefit relative to the status quo. When the status quo presents one agent an outside option that is untenable, say starvation, is bargaining voluntary, even if the other agent is not directly threatening starvation? The difficulty with the `do no harm' principle in policy matters is the assumption that the status quo does less harm than a change in it would. This is not clear to me at all. Let me illustrate this...

Assuming a perfectly competitive market, imposing a minimum wage constraint above the equilibrium wage would reduce total welfare. What if the labor market were not perfectly competitive? In particular, suppose it was a monopsony employer constrained to offer the same wage to everyone employed. Then, imposing a minimum wage above the monopsonist's optimal wage would increase total welfare.

[There is also an example based upon differences in patience that I left out.]

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