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August 12, 2015

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Posted: 12 Aug 2015 12:33 AM PDT
Bruce Bartlett:
Will Donald Trump Crack-up the Republican/Tea Party Alliance?: ... It appeared that Trump was the favored candidate of Fox News before the debate... Trump was clearly shocked by the sharpness of the questions at the debate...
With Trump and Fox now on opposite sides and the Republican establishment eager to quash his threat to run next year as a third party candidate, which would virtually guarantee a Democratic victory, conservatives began to choose sides. Erick Erickson, a paid Fox contributor who runs the politically powerful RedState website, publicly disinvited Trump to an Atlanta gathering at which most other Republican candidates appeared.
Of particular interest, I think, is that two of talk radio's most powerful voices, Rush Limbaugh and Mark Levin, quickly came to Trump's defense. I suspect this was as much a market-driven decision as an honest personal one – talk radio has long catered to the more downscale, less educated wing of conservatism, where most Trump supporters dwell. Whatever else one thinks of Limbaugh and Levin, they are enormously useful allies in the sort of fight Trump is waging.
It is too soon to know whether Trump is in this for the long haul, but I would not underestimate his ego or willingness to spend freely from his vast fortune to secure the Republican nomination. Early signs are that his support remains firm in post-debate polls and he is still leading the pack. If the Republican field stays divided, preventing consolidation around the strongest non-Trump candidate, one cannot dismiss his chances of success.
Of more importance to me is that if the forces for and against Trump play out as they have so far, with Fox and Tea Party leaders siding with the GOP establishment while talk radio and large numbers of the Tea Party grassroots are committed to Trump, we may see the crackup of the Republican coalition that controls Congress, many state legislatures and governorships. The Tea Party will go down in history as just another populist movement that lacked staying power and Donald Trump will be its William Jennings Bryan.
Paul Krugman:
Tea and Trumpism: Memo to pollsters: while I'm having as much fun as everyone else watching the unsinkable Donald defy predictions of his assured collapse, what I really want to see at this point is a profile of his supporters. What characteristics predispose someone to like this guy, as opposed to accepting the establishment candidates? ...
OK, here's my guess: they look a lot like Tea Party supporters. And we do know a fair bit about that group.
First of all, Tea Party supporters are for the most part not working-class, at least in the senses that group is often defined. They're relatively affluent, and not especially lacking in college degrees.
So what is distinctive about them? Alan Abramowitz:
While conservatism is by far the strongest predictor of support for the Tea Party movement, racial hostility also has a significant impact on support.
So maybe Trump's base is angry, fairly affluent white racists — sort of like The Donald himself, only not as rich? And maybe they're not being hoodwinked? ...
Again, this is just guesswork until we have a real profile of typical Trump supporter. But for what it's worth, I think the Trump phenomenon is much more grounded in fundamentals than the commentariat yet grasps.
Posted: 12 Aug 2015 12:24 AM PDT
Brad DeLong:
Worst Fed Forecaster: It is quite an accomplishment to both be (a) the worst economic forecaster among your peers, and yet (b) engage in no public reflection and discussion of how and why you got the past wrong, and how you are changing your model of the economy in order to get it less wrong when you forecast in the future.
Charles Plosser has managed that accomplishment.
Those close to him in the WSJ rankings of Fed forecasting success--Bullard, Lacker, Kocherlakota, Williams, and Bernanke--have all discussed, sometimes at great length, what they got wrong, why they think they got it wrong, and what they think they have learned. Not Charles Plosser--at least, nowhere that I have seen. I have not even found any recognition by Charles Plosser that every single year he was President of the Federal Reserve Bank of Philadelphia he did get it wrong, did misjudge the economy, and was recommending monetary policies that would be unduly and inappropriately restrictive. None.
Posted: 12 Aug 2015 12:15 AM PDT
Tim Taylor:
The Aftermath of LIBOR and Penny-Shaving Attacks: Anyone remember the LIBOR scandal from back in spring 2008? A trader for UBS Group and Citigroup named Tom Hayes was just sentenced by a British court to 14 years imprisonment for his role as a ringleader of the scandal. Darrell Duffie and Jeremy C. Stein discuss both the scandal and--perhaps more interesting to those of us who bleed economics--the economic function of financial market benchmarks in  "Reforming LIBOR and Other Financial Market Benchmarks," in the Spring 2015 issue of the Journal of Economic Perspectives. (All JEP articles back to the first issue in 1987 are freely available online courtesy of the American Economic Association. Full disclosure: I've worked as Managing Editor of the JEP since that first issue.)
For those who have blotted the episode from their memories, LIBOR stands for London Interbank Offered Rate. It's the interest rate at which big international banks borrow overnight from each other. A main use of LIBOR in financial markets was as a "benchmark" for adjustable interest rates. For example, if you are a potential borrower or lender worried about the risk that interest rates might shift, you might be able to agree on a loan where the interest rate was, say, the LIBOR rate plus 4%. Duffie and Stein point out that using LIBOR as a benchmark interest rate for international loans dates back to 1969, when "a consortium of London-based banks led by Manufacturers Hanover introduced LIBOR in order to entice international borrowers such as the Shah of Iran to borrow from them."
Two key details set the state for the LIBOR fraud. The first detail is that after LIBOR became well-established as a basis for interest rates on loans, the finance industry began to use LIBOR as the basis for lots of more complex financial transactions: for example, "exchange-traded eurodollar futures and options available from Chicago Mercantile Exchange Group, and over-the-counter derivatives including caps, floors, and swaptions (that is, an option to engage in a swap contract)." I won't plow through an explanation of those terms here. The key takeaway is that the benchmark LIBOR interest rate wasn't just linked to about $17 trillion in US dollar loans. It was also linked to $106 trillion in interest rate swap agreements, and tens of trillions more in interest rate options and futures, as well as cross-currency swaps. As a result, if you had some information on how LIBOR was likely to change on a day-to-day basis--even if the change was a seemingly tiny amount that didn't much matter to borrowers or lenders--you could make a substantial amount of money in these more complex financial markets.
The second detail involves how LIBOR was actually calculated. Banks did not actually submit data on the costs of borrowing; indeed, someone at a bank responded to a survey each day with an estimate of what it would cost that bank to borrow--even though on a given day many of these banks weren't actually borrowing from other banks. In addition, during the financial crisis as it erupted in 2007 and 2008, no bank wanted to admit that it would have been charged a higher interest rate if it wanted to borrow, because financial market would be quick to infer that such bank might be in a shaky financial position.
So on one side, LIBOR is a key financial benchmark that affects literally tens of trillions of dollars of continuously traded and complicated financial instruments.  On the other side, you have this key benchmark being determined by a survey of the opinions of fairly junior bank officers who have some incentive to shade the numbers. The British court found that Tom Hayes led a group of traders who sent messages to the bankers who responded to the LIBOR survey, requesting that the LIBOR rate be jerked a little higher one day, or pushed a little lower another day. Again, those who were just using the LIBOR rate as a benchmark for loans probably wouldn't even notice these fluctuations. But traders who knew in advance how the LIBOR was going to twitch up and down could make big money in the options and futures markets.
What's the solution here? Duffie and Stein point out that financial benchmarks like LIBOR are extremely useful in financial markets. However, you need to design the benchmark with some care. For example, instead of using a survey of bank officers, it makes a lot more sense to use an actual market-determined interest rate for a benchmark. Moreover, the LIBOR rate is based on banks borrowing from banks, and so it will reflect risk in the banking sector. For certain kinds of lending and borrowing, it's not clear that you would want your interest rate to rise and fall with changes in the riskiness of the banking sector. Thus, they discuss the virtues of benchmark rates that are market-determined and not linked to the banking sector--like the interest rate for short-term borrowing by the US government. (They also discuss the merits of using some other less well-known  benchmark interest rates, like the Treasury general collateral repurchase rate or the  overnight index swap rate, fo those who want such details.)
More broadly, it seems to me that the LIBOR scandal is the actual real-life version of what seems to be an urban legend plot: the story of how a fraudster finds a way to program the computers of a bank or financial institution so that a tiny amount of certain transaction is siphoned off into a different account (for examples, see the 1983 movie Superman III, or the 1999 movie Office Space). The problem with these "penny-shaving" or "salami-slicing" attacks in real life is that if you steal a little bit from a large number of transactions, it's quite possible that no individual party will notice. But if you take a few million dollars out of a financial institution, the accountants are going to notice!
In the LIBOR scandal, however, the fraud happened by knowing about tiny little changes in LIBOR a day in advance. Those who lost out from not knowing these changes in advance had no way of knowing that they were being cheated. In a similar scandal from earlier this year, Citicorp, JPMorgan, Barclays, Royal Bank of Scotland and UBS pled guilty to felony charges for their actions in foreign exchange markets. Again, these are very large markets, and so small acts of dishonesty can add up to large amounts. As the US. Department of Justice described it:
"According to plea agreements to be filed in the District of Connecticut, between December 2007 and January 2013, euro-dollar traders at Citicorp, JPMorgan, Barclays and RBS – self-described members of "The Cartel" – used an exclusive electronic chat room and coded language to manipulate benchmark exchange rates. Those rates are set through, among other ways, two major daily "fixes," the 1:15 p.m. European Central Bank fix and the 4:00 p.m. World Markets/Reuters fix. Third parties collect trading data at these times to calculate and publish a daily "fix rate," which in turn is used to price orders for many large customers. "The Cartel" traders coordinated their trading of U.S. dollars and euros to manipulate the benchmark rates set at the 1:15 p.m. and 4:00 p.m. fixes in an effort to increase their profits.

As detailed in the plea agreements, these traders also used their exclusive electronic chats to manipulate the euro-dollar exchange rate in other ways. Members of "The Cartel" manipulated the euro-dollar exchange rate by agreeing to withhold bids or offers for euros or dollars to avoid moving the exchange rate in a direction adverse to open positions held by co-conspirators. By agreeing not to buy or sell at certain times, the traders protected each other's trading positions by withholding supply of or demand for currency and suppressing competition in the FX market."
A trader at Barclay's reportedly wrote in the group's electronic chat room: "If you aint cheating, you aint trying," Clearly, situations where relatively small groups of people can cause relatively small and almost imperceptible  tweaks in values that affect a very large market are ripe for manipulation. 
Posted: 12 Aug 2015 12:06 AM PDT
Posted: 11 Aug 2015 08:35 AM PDT
My editor suggested that I might want to write about an article in New Scientist, After the crash, can biologists fix economics?, so I did:
Macroeconomics: The Roads Not Yet Taken: Anyone who is even vaguely familiar with economics knows that modern macroeconomic models did not fare well before and during the Great Recession. For example, when the recession hit many of us reached into the policy response toolkit provided by modern macro models and came up mostly empty.
The problem was that modern models were built to explain periods of mild economic fluctuations, a period known as the Great Moderation, and while the models provided very good policy advice in that setting they had little to offer in response to major economic downturns. That changed to some extent as the recession dragged on and modern models were quickly amended to incorporate important missing elements, but even then the policy advice was far from satisfactory and mostly echoed what we already knew from the "old-fashioned" Keynesian model. (The Keynesian model was built to answer the important policy questions that come with major economic downturns, so it is not surprising that amended modern models reached many of the same conclusions.)
How can we fix modern models? ...

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