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July 15, 2015

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Posted: 15 Jul 2015 12:06 AM PDT

Who Should Pay for Recessions?

Posted: 14 Jul 2015 02:52 PM PDT

I have a new column:

Who Should Pay for Recessions?: Over the last several hundred years, financial panics have repeatedly caused severe economic turmoil. For example, there were financial panics every 10 to 20 years in the late 1700s, 1800s, and early 1900s, many of which resulted in severe recessions. 
To combat this instability, new rules and regulations were imposed on the financial sector after the Great Recession, and for approximately 50 years this seemed to be very successful. The bank panics that had caused so much trouble appeared to be over. But in recent years there has been a return of financial instability in the relatively unregulated shadow banking system, and a "Great Recession" associated with a financial meltdown. 
The conclusion seems obvious. No matter what we do in terms of regulating the financial sector, the risk of a financial collapse and subsequent recession is always present. Given this, a question to ask is who should pay the costs of the inevitable meltdown? That is, when the financial sector gets into trouble, as it surely will at some point in the future, who should shoulder the burden? ...

Fed Watch: More Mediocrity

Posted: 14 Jul 2015 02:47 PM PDT

Tim Duy:

More Mediocrity, by Tim Duy: Federal Reserve Chair Janet Yellen will be playing a game of mixed messages with Congress tomorrow as she explains why she believes a rate hike approaches in spite of lackluster data. Today's data didn't help. The June retail sales report was a disappointment, slipping from May levels with generally soft internals in addition to downward revisions to previous months. Consequently, core spending growth is decelerating on a year-over-year basis to 2013 rates:

RETAIL071415

Maintaining the 2014 growth bump has been something of a challenge, to be sure.The report triggered downgrades to the second quarter growth forecast as it offset upward revisions attributable to last week's new estimates of federal spending and inventories:

Gdpnow-forecast-evolution-3

More mediocre growth - stuck in that 2.5 percent range which is a touch higher than the Fed's longer-run central tendency of 2.0-2.3 percent. And therein lies the key to understanding the Fed's repeated calls that 2015 is the year for the first rate hike. I think they are concluding 2014 was sufficient to largely close the output gap, as evidenced by falling unemployment and other measures of labor underutilization. San Francisco Federal Reserve President John Williams even believes that optimally, US growth needs to DECELERATE in 2016:
Looking towards next year, what we really want to see is an economy that's growing at a steady pace of around 2 percent. If jobs and growth kept the same pace as last year, we would seriously overshoot our mark. I want to see continued improvement, but it's not surprising, and it's actually desirable, that the pace is slowing.

With the output gap closing, Fed policymakers believe they need to begin reducing financial accommodation. They are not sufficiently sure of that hypothesis to begin hiking at anything more than a modest pace, but are sufficiently sure to comfortably declare that the first rate hike is upon us. Hence, Boston Federal Reserve President Eric Rosengren can say things to Reuters like:

"If we do continue to get improvement in labor markets, if we do become reasonably confident that we're moving back to 2-percent inflation, it may be appropriate as early as September," he said of raising rates from near zero. "I don't think we have seen that evidence yet but we still have a couple months of data to see whether it's more strongly confirmed."
Rosengren has long advocated for more monetary accommodation than most of his colleagues at the central bank, which has kept interest rates at rock bottom to boost the recovery. With wages showing early signs of a pick-up and U.S. unemployment down to 5.3 percent, he set a high bar for delaying a hike.
Only if labor markets unexpectedly weaken, if core inflation starts to drop off, or if the wage gains dissipated, "those would be the things that would make me want to pause and wait and see whether there is further evidence," he said.
And Federal Reserve Chair Janet Yellen says:
My own outlook for the economy and inflation is broadly consistent with the central tendency of the projections submitted by FOMC participants at the time of our June meeting. Based on my outlook, I expect that it will be appropriate at some point later this year to take the first step to raise the federal funds rate and thus begin normalizing monetary policy.
Whereas Cleveland Federal Reserve President is somewhat more aggressive in an interview with the Financial Times:
Loretta Mester, president of the Federal Reserve Bank of Cleveland, said the case for "emergency" levels of interest rates was now gone given that the economy was "fundamentally sound", as she signalled that she would support two increases in short-term rates this year.
To be sure, it is all data dependent. More solid wage growth would do the trick, I think, to draw the Fed to September. Without that wage growth acceleration, I suspect the more dovish side of the FOMC will pull the Fed toward December. No reason to rush given the lackluster numbers we are seeing. But one senses greater impatience on the more hawkish side of the FOMC. They will argue like Mester that the general consistency of underlying growth, steady improvement in labor utilization, and proximity to mandates signals it is time to leave behind the policies of the financial crisis.
Bottom Line: The basic theme is that the economy is that, in the Fed's eyes, the economy is sufficiently stable to justify a rate hike, but lacks any reason to rush that hike or the pace of subsequent hikes. That message I expect to hear tomorrow. In her appearance before the House Financial Services Committee, Yellen will reiterate the basic points of Friday's speech, maintaining faith that 2015 will be the year for the first rate hike since 2006. Heavy caveats, however, about data dependence. She may get asked directly about September. If so, she will not rule out September. She will instead say maybe September, maybe later. But more interesting might be the questioning surrounding the Fed's perceived intransigence; Congress is looking for more of that transparency the Fed is always bragging about.

'Faithocrats'

Posted: 14 Jul 2015 09:01 AM PDT

Paul Krugman:

One of the ideas floating around in the aftermath of the sack of Athens has been that of, in effect, deposing Syriza from outside and installing a "technocratic" government. It wouldn't be the first time in this dismal saga, and I won't be surprised if it happens, for a few months anyway.
But let me note, as I have before, that what Europe calls technocrats aren't people who know how the world works; they're people who subscribe to the approved fantasies, and never change their minds no matter how badly wrong things go. Despite the overwhelming evidence that austerity has exactly the dire effects basic textbook macro says it will, they cling to belief in the confidence fairy. Despite a striking lack of evidence that "structural reform" delivers much of a growth boost, especially in an economy suffering from a huge output gap, they continue to present structural reform — mainly in the form of disempowering workers — as a sovereign remedy for all ills. Despite a clear record of past failure, they continue to push for asset sales as a supposed answer to debt overhang.
In short, what Europe usually means by a "technocrat" is a Very Serious Person, someone distinguished by his faith in received orthodoxy no matter the evidence. ...

'Needed: More Government, More Government Debt, Less Worry'

Posted: 14 Jul 2015 09:00 AM PDT

Brad DeLong (the full post is much, much longer):

Needed: More Government, More Government Debt, Less Worry: **Introduction**
Olivier Blanchard, when he parachuted me into this panel, asked me to "be provocative".
So let me provoke:...
It makes sense to distinguish the medium from the short term only if the North Atlantic economies will relatively soon enter a régime in which the economy is not at the zero lower bound on safe nominal interest rates. The medium term is at a horizon at which monetary policy can adequately handle all of the demand-stabilization role. ...
As I see it, there are three major medium-run questions that then remain...:
* What is the proper size of the 21st-century public sector?
* What is the proper level of the 21st-century public debt for growth and prosperity?
* What are the systemic risks caused by government debt, and what adjustment to the proper level of 21st-century public debt is advisable because of systemic risk considerations?
To me at least, the answer to the first question–what is the proper size of the 21st-century public sector?–appears very clear.
The optimal size of the 21st-century public sector will be significantly larger than the optimal size of the 20th-century public sector. Changes in technology and social organization are moving us away from a "Smithian" economy, one in which the presumption is that the free market or the Pigovian-adjusted market does well, to one that requires more economic activity to be regulated by differently-tuned social and economic arrangements (see DeLong and Froomkin (2000)). One such is the government. Thus there should be more public sector and less private sector in the 21st-century than there was in the 20th.
Similarly, the answer to the second question appears clear, to me at least.
The proper level of the 21st century public debt should be significantly higher than typical debt levels we have seen in the 20th century ... *unless interest rates in the 21st century reverse the pattern we have seen in the 20th century, and mount to levels greater than economic growth rates*.
This consideration is strengthened by observing that the North Atlantic economies have now moved into a régime in which the opposite has taken place. Real interest rates on government debt are not higher but even lower relative to growth rates than they have been in the past century. Financial market participants now appear to expect this now ultra-low interest-rate régime to continue indefinitely (see Summers (2014)).
The answer to the third question–what are the systemic risks caused by government debt?–is much more murky. ...
The question ... is:... How much more likely does higher debt make it that interest rates will spike in the absence of fundamental reasons? How much would they spike? What would government policy be in response to such a spike? And what would be the effect on the economy?
The answer thus hinges on:
* the risk of a large sudden upward shift in the willingness to hold government debt, even absent substantial fundamental news.
* the ability of governments to deal with such a risk that threatens to push economies far enough up the Laffer curve to turn a sustainable into an unsustainable debt.
I believe the risk in such a panicked flight from an otherwise sustainable debt is small. I hold, along with Rinehart and Rogoff (2013), that the government's legal tools to finance its debt via financial repression are very powerful, Thus I think this consideration has little weight. I believe that little adjustment to one's view of the proper level of 21st-century public debt of *reserve currency-issuing sovereigns with exorbitant privilege* is called for because of systemic risk considerations.
But my belief here is fragile. And my comprehension of the issues is inadequate.
Let me expand on these three answers...

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