"If money isn't loosened up, this sucker could go down" - George W. Bush warned in September 2008

Thursday, December 30, 2010

Really good links - Germany and the solution for the Eurozone crisis - Krugman in 1998 - Money and Metaphysics - Deflation - Equilibrium and institutional process - Consumer confidence - Taxes and government spending

Crispin Odey - Towards a more balanced Eurozone - "The key feature of the European “now” is not government debt nor under-capitalised banks. It is Germany with an inflationary boom under way. German growth means rapid growth of imports from the eurozone worth significant percentage points on non-German eurozone GDP and a far easier path out of recession for the European periphery than is priced into bonds and equities.
        Those with long memories would argue that the German authorities will spot where all this is heading and will do what is necessary to trample on growth. But Europe and Germany have changed. Sovereign power is not what it was. The German authorities no longer have control of their own policy. <..>
        Of course, Germany will be divided in its attitude to this boom and if it were down to the authorities, interest rates would rise and the currency strengthen. But they are going to be as unable to reach the brake pedal next year, as Ireland et al were unable to reach the accelerator this year."

Tyler Cowen - Paul Krugman's predictions from 1998

Matthew Yglesias - Money and Metaphysics

Dave Altig - Probability of deflation has fallen to the levels observed prior to the economy's summer soft patch

Arnold Kling - Equilibrium vs. institutional process - "As Boettke points out, the profession is split between economists who work out the properties of equilibrium and economists who focus on institutional processes. The latter are marginalized, although they include many Nobel Laureates, including Douglass North and Elinor Ostrom.
        The focus on properties of equilibrium attracts interventionists. You point out an undesirable property of an equilibrium, and then you propose a fix. For example, Stiglitz and Rothschild pointed out that a health insurance market could collapse because of adverse selection, so it follows that government should impose a mandate to purchase health insurance.
        The focus on institutional processes attracts libertarians. You see the benefits of the forces of competition and creative destruction. You see the adverse institutional properties of government."

Tim Duy - Curiously Weak Consumer Confidence - "Consumer confidence figures appear inconsistent with actual spending patterns. That inconsistency will be resolved by either confidence rising or falling spending growth, with more or less obvious policy implications. There will be a tendency to assume the resolution will come from decelerating spending growth. To be sure, the recent trend appears unsustainable. But I also think it is worth paying attention to the more positive household spending data."

David Andolfatto - Robert Shiller's bad idea of a tax-financed increase in government spending - "Its not that I'm against increasing (components of) G. Public works projects of the sort mentioned by Shiller (building highways and improving our schools) were advocated by sensible economists long before Keynes (as evidence of this, note that public works were implemented in the Depression well before publication of the General Theory). What I have a problem with is in using some silly theory to support the notion, for example, that taxes should be raised to finance a large public capital expenditure. Shiller has been rightly celebrated for his work in the theory of finance, and on asset price bubbles in particular. But is this not a rather odd stand to take for a professor of finance?
        Now, I'm no expert in finance myself, so maybe I should be careful in what I'm about to say. But it seems to me that a large capital expenditure should be financed with debt. The debt service could be supported by toll revenue (on bridges and roads) and user fees in general, backed by the Treasury, if needed. The use of tax finance advocated by Shiller in his balanced-budget exercise implicitly assumes (among other things) lump-sum taxes. For some thought experiments, the assumption of lump-sum taxes is innocuous enough. But this is not one of those cases. Taxes are distortionary and to the extent that they are needed to support public spending, they should be spread out over time. This is a standard principle of public finance (I think). "

Monday, December 27, 2010

Really good links - Nominal GDP targeting - Shadow banking - Milton Friedman's thermostat - Origins of the national debt - QE2 and market factors

David Beckworth - The case for nominal GDP targeting - "Mark Thoma wants to hear the case for nominal GDP targeting. This approach to monetary policy requires the Fed stabilize the growth path for total current dollar spending. As an advocate of nominal GDP level targeting, I am more than happy to respond to Mark's request. I will focus my response on what I see as its three most appealing aspects: (1) it provides a simple and intuitive approach to monetary policy, (2) it focuses monetary policy on that over which it has meaningful influence, and (3) its simplicity makes it easier to implement than other popular alternatives. "

Interview with Gary Gorton - Shadow Banking; The Rise of Repo; Growth of Securitization; Information Sensitivity; The Collapse of Repo; Regulatory Reform; Creating Collateral, not Insurance; Vulnerability to Panic

Nick Rowe - Milton Friedman's Thermostat

Brad DeLong - Alexander Hamilton and the Origins of the National Debt - "Back in the early 1790s, the national debt was close to 40% of annual GDP. It was close to 40% because the first Treasury Secretary, Alexander Hamilton, thought it was a good idea to make it close to 40%. <..>
        The most important reason, however, was that Alexander Hamilton was Secretary of the Treasury in a country where the rich were at best uneasy about the revolution and independence. Of America's upper class as it stood in 1775, full half of them were gone: had fled to Britain or Canada during the Revolutionary War. Those who remained remembered that back before 1775 the British monarch had protected property, that the British army and navy had protected them against deprivations of all kinds, that it was quite clear who the police worked for. Now you have a republic with a much broader electorate. Might politicians run on a platform of soaking the rich and redistributing wealth to the poor? Thus the rich people were nervous--and at least thinking about how maybe it would be good if the British came back and ruled again.
        This was where Alexander Hamilton had his good idea. Suppose, he thought, he could set things up so that the rich owned a lot of U.S. government bonds. Then if the British returned--well, the British were not going to pay off the Revolutionary War debt of the United States of America under any circumstances. Having a national debt was a way to bind the United States rich to the country--giving them a stake in the new republic's survival. And by large it worked: the national debt was a national blessing."

John Hussman - QE2 and market factor analysis - "The key event related to QE2 wasn't its formal announcement, but was instead the Op-Ed piece that Ben Bernanke published a few days later in the Washington Post, which essentially advanced the argument that the Fed was targeting a "wealth effect" in stocks and other risky assets, in hopes of getting people to consume off of that perceived wealth. At that moment, Bernanke unleashed a speculative bubble in risky assets, and a selloff in safe ones. This has rewarded risk-seeking and punished risk-aversion, but it has also unfortunately driven the markets into an overvalued, overbought, overbullish, rising-yields condition that has historically ended in steep and abrupt losses.
        Ned Davis Research tracks a set of "factor attribution" portfolios, which measure the performance between the top 10% of stocks ranked by a given factor, and the bottom 10% of stocks as ranked by that factor. The factors are things like market beta, dividend yield, 26-week momentum, and so forth. Essentially, the these factor portfolios track the return of hypothetical portfolios that are long the top 10% and short the bottom 10% of stocks based on any given variable.
        The performance of these 133 factor portfolios over the past 13 weeks offers tremendous insight into the extent to which the Federal Reserve has encouraged speculative risk. Investors are chasing stocks with the greatest exposure to market fluctuations, commodities, credit risk, small-cap risk and volatility. Conversely, securities demonstrating reasonable valuation, stability, quality, or payout have been virtually abandoned by investors. Here is a sampling:

Market Beta
Raw Materials Beta
Commodity Sensitivity
Credit Spread Beta
Macro Economic Sensitivity
Small vs. Large Beta
Style Sensitivity
Silver Beta
Commodity Sensitivity
Sigma Risk (Volatility)
Operating Cash Flow Yield
EPS Stability
Value vs. Growth Beta
Style Sensitivity
Return on Invested Capital
Dividend Yield
10-Year T-Note Beta
Macro Economic Sensitivity
High vs. Low Quality Beta
Style Sensitivity

Saturday, December 18, 2010

Monetary policy and Minsky cycles

1. It is impossible to understand the Great Recession without invoking Minsky's cycle theory.

2. Minsky cycle creates the least damage if Minsky recession takes place in the context of stable NGDP growth. Minsky crash creates collateral damage if there is a downward deviation from the NGDP trend.

3. We observe the asymmetry of Minsky booms and Minsky crashes. Traditional monetary policy is a very powerful AD fine-tuning tool during the Minsky boom, on the other hand, monetary policy is prone to crashes and mistakes during the Minsky bust.

4. Monetary authorities usually operate some kind of peg, this peg may crash or lose credibility when the Minsky moment arrives. During the Great Depression, the dollar gold peg lost credibility, and the AD was too low until the Roosevelt devaluation. These days the Fed is operating a crawling fed funds rate peg, this peg has crashed after the bankruptcy of Lehman, and the AD was too low during the crash. During the collapse of the fed funds rate peg, we had the flight to liquidity problem, not the flight to safety problem, so the root cause of low AD was monetary, not Minskyite. The fed funds rate peg was restored in late October 2008.

5. When the monetary peg is restored, it is important that it is restored at the levels where it promotes the speedy recovery. Roosevelt repegged the dollar at the level that generated a fast recovery, on the other hand, the federal funds rate was too high when the fed funds rate peg was restored in late October 2008. Scott Sumner's NGDP expectations peg is useful in this regard. If the NGDP expectations peg crashes, most likely it will be restored at the previous NGDP trend.

6. If the neutral short term risk free interest rate drops below zero during the Minsky bust, the risk of monetary policy mistakes increases. Monetary tools that bring the neutral interest rate back into the positive territory need to be aggressively employed. There are three such tools - higher inflation targets, quantitative easing, credit easing.

7. Higher inflation targets are undesirable, as credibility of monetary policy is diminished during normal times. NGDP path targeting removes the need to change the goals of the monetary policy during the Minsky cycle.

8. Quantitative easing is powerful only until the term risk premium is lowered to zero. After that, it loses the direct effect and only signalling effect remains. The power of quantitative easing is limited, so Bernanke did not use this tool until March 2009.

9. Credit easing is the most powerful non-traditional monetary tool. Bernanke started using it in 2007. However, the extensive use of credit easing increases the risk of Fed's insolvency, it also creates various legal, technical and political problems. Credit easing programs were not expanded to the extent needed to stabilize AD. Bernanke has indicated that additional fiscal stimulus is needed to increase AD.

10. Measures that increase the use of credit easing would be helpful. Larger Fed's capital base could reduce the risk of Fed's insolvency. Development of broad short term credit market indexes could help us design credit easing programs that are not discriminatory and thus more attractive politically.

11. NGDP path pegging is the policy that could prevent the collateral damage caused by the Minsky crash. NGDP path peg gives us a speedy recovery when monetary policy temporarily loses credibility. NGDP path provides a good focal point for the coordination of monetary and fiscal policies when the zero interest rate constraint is binding.

Thursday, December 16, 2010

Really good links - Optimism about US recovery - Bailout - What is money? - Mankiw is a New Keynesian

Nick Rowe - Optimism about US recovery - "What matters is the gap between what the market believes will happen and what the market believes the Fed believes will happen. I think we have just such a gap right now. The market believes the Fed is too pessimistic. That creates an upside cumulative process. That's what makes me optimistic."

Tyler Cowen - Bailout and inequality - "In short, there is an unholy dynamic of short-term trading and investing, backed up by bailouts and risk reduction from the government and the Federal Reserve. This is not good. “Going short on volatility” is a dangerous strategy from a social point of view. For one thing, in so-called normal times, the finance sector attracts a big chunk of the smartest, most hard-working and most talented individuals. That represents a huge human capital opportunity cost to society and the economy at large. But more immediate and more important, it means that banks take far too many risks and go way out on a limb, often in correlated fashion. When their bets turn sour, as they did in 2007–09, everyone else pays the price.
        And it’s not just the taxpayer cost of the bailout that stings. The financial disruption ends up throwing a lot of people out of work down the economic food chain, often for long periods. Furthermore, the Federal Reserve System has recapitalized major U.S. banks by paying interest on bank reserves and by keeping an unusually high interest rate spread, which allows banks to borrow short from Treasury at near-zero rates and invest in other higher-yielding assets and earn back lots of money rather quickly. In essence, we’re allowing banks to earn their way back by arbitraging interest rate spreads against the U.S. government. This is rarely called a bailout and it doesn’t count as a normal budget item, but it is a bailout nonetheless. This type of implicit bailout brings high social costs by slowing down economic recovery (the interest rate spreads require tight monetary policy) and by redistributing income from the Treasury to the major banks. <..>
        The upshot of all this for our purposes is that the “going short on volatility” strategy increases income inequality. In normal years the financial sector is flush with cash and high earnings. In implosion years a lot of the losses are borne by other sectors of society. In other words, financial crisis begets income inequality. Despite being conceptually distinct phenomena, the political economy of income inequality is, in part, the political economy of finance<..>
        Another root cause of growing inequality is that the modern world, by so limiting our downside risk, makes extreme risk-taking all too comfortable and easy. More risk-taking will mean more inequality, sooner or later, because winners always emerge from risk-taking. Yet bankers who take bad risks (provided those risks are legal) simply do not end up with bad outcomes in any absolute sense. They still have millions in the bank, lots of human capital and plenty of social status. We’re not going to bring back torture, trial by ordeal or debtors’ prisons, nor should we. Yet the threat of impoverishment and disgrace no longer looms the way it once did, so we no longer can constrain excess financial risk-taking. It’s too soft and cushy a world."

Paul Krugman - What is money? - "Surely we don’t mean to identify money with pieces of green paper bearing portraits of dead presidents. Even Milton Friedman rejected that, more than half a century ago. For one thing, a lot of those pieces of green paper are pretty much inert — sitting outside the United States, in the hoards of drug dealers and such. For another, checking accounts are clearly a close substitute for cash in hand.
        Friedman and Schwartz dealt with this by proposing broader aggregates –M1, which adds checking accounts, and M2, which adds a broader range of deposits. And circa 1960 you could argue that those aggregates were good enough.
        But now we have a large shadow banking system, in which things like repo serve much the same function as deposits; M3 used to capture some of that, but the Fed discontinued it, in part I think because it wasn’t clear which repo belonged there, and data on repo not involving primary dealers is scattered. Whatever.
        The truth is that these days — with credit cards, electronic money, repo, and more all serving the purpose of medium of exchange — it’s not clear that any single number deserves to be called “the” money supply. Intellectually, this isn’t a problem; nor is there necessarily a problem maintaining monetary policy even if there isn’t any single thing you’re willing to call money."

JTapp - Textbook politics - " I had been using the Mankiw Principles of Macro text for the 2 years I’d been at my current position and decided to adopt his Micro this year in order to bring some symmetry and take advantage of his Aplia sets, etc. But I share Micro with other professors who would also be required to adopt it. One lodged a complaint when a Google search revealed Mankiw is a “New Keynesian,” which immediately raised a flag b/c anything with “Keynes” in it is problematic. Nevermind that the department, including this professor, had been using other New Keynesians, including Mishkin, for years in other classes and I’d been using Mankiw’s macro for years and adopted Ball in the M&B class– Micro was a step to far.
        He had our department chair (a marketing professor) take it home to check for subversive material. One of Mankiw’s 10 Principles of Economics being “government can sometimes improve market outcomes” was a red flag. In the end we adopted it b/c they trusted my judgment. In higher education, EVERYTHING is political, maybe worse than proper academia. (I sent the story to Mankiw who found it amusing, he commented that just working at Harvard made him a socialist to many.)"

Wednesday, December 8, 2010

Really good links - Global AD - Austrian theory - Germany - A sentence to ponder

Bill Gross - Global aggregate demand - "The global economy is suffering from a lack of aggregate demand. In simple English that means that consumers are not buying enough things and that companies are not hiring enough people because of it. Growth slows down, especially in developed as opposed to developing countries, and the steel mills of Allentown, USA and Sheffield, England close down.
        This shortfall of global demand is a nearly impossible concept to grasp amongst politicians and their citizenry. Don’t people always want to buy more things and isn’t demand theoretically insatiable? They do, and it is. Yet economic growth is a delicate dance between production and finance and when a nation’s or a family’s credit card gets maxed out, then demand/spending slows measurably. We are witnessing these commonsensical repercussions across the entire continent of Europe today and to a lesser extent in the United States.
        Developing nations and their consumers want to buy things too. And while their economies are growing fast, their overall size is not yet sufficient to pull along the economies of Europe, Japan and the U.S. Their financial systems are still maturing and reminiscent of a spindly-legged baby giraffe, having lots of upward potential, but still striving for balance after a series of missteps, the most recent of which was the trio of the 1997–98 Asian crisis, the 1998 Russian default and the 2001 Argentine default. And so their policies are oriented towards export to debt-laden developed nations instead of internal consumption, leaving a gaping hole in global aggregate demand. China is a locomotive to be sure, but it cannot pull the global economy uphill on the basis of mercantilistic exports alone. It needs to develop many more of its own shopping malls and that will take years, if not decades."

Steve Randy Waldman - Austrian hangover theory - "Austrian-ish “hangover theory” claims, plausibly, that if for some reason the economy has been geared to production that was feasible and highly valued in previous periods, but which now is no longer feasible or highly valued, there will be a slump in production. It wisely asks us to consider not only the prosperity we measure today, but the sustainability of that prosperity going forward. I am not “Austrian”, and have no interest in defending specific claims regarding the roundaboutness of activity or the role of central banks in causing bursts of quasiprosperity. But as Brad DeLong wisely reminds us, it is good to be somewhat catholic in our evaluation of macroeconomic schools, and to take what is useful from each. I consider myself Keynesian at least as much as I am Austrian, but I recognize good and not-so-good offshoots of both schools. (Austrian and Keynesian ideas are more complementary than most people acknowledge. The Austrians focus on unsustainable arrangements of real capital, while the Keynesians focus on unsustainable arrangements with respect to money, debt, savings, and income. I think both approaches are fruitful.)<..>
        At an individual level the correlation between past consumption and recent unemployment is obviously negative. The people who have sinned are not by and large the people being punished. Some people overconsumed relative to their income, and some people invested poorly. Those who overconsumed have mostly faced consequences for their misbehavior — they are either deeply in debt, or they have endured foreclosure or bankruptcy. But the people who invested absurdly, especially “savers” who lent money but permitted themselves ignorance and indifference to how their wealth would be mismanaged, have not suffered the costs of their recklessness. Instead, they have been almost entirely bailed out. It is lenders and investors more than any other group who determine the patterns of our macroeconomy. There are always people willing to overconsume or gamble on foolish enterprises. We do and must rely upon those with resources to steward to ensure those resources are used wisely. They did not, and their recklessness has brought us to catastrophe. But rather than condemn them for negligence and permit their claims to be appropriately devalued, we applaud them for “prudence” and let government action be bound by commitments to sustain their destructive and ridiculous claims. You don’t counter that sort of villainy with technocratic arguments about liquidity traps. You point out that the motherfuckers who are calling themselves prudent, who are blocking both writedowns and government action that might risk inflation, are hypocrites and thieves. You state clearly that their claims are illegitimate and will be written down one way or another, unless we can generate sufficient growth to ratify them ex post, which would require claimants to behave less like indignant creditors and more like constructive equityholders. It is not technocratic economists who will win the day and pull us out of our cul-de-sac, but angry Irishmen and Spaniards who challenge, on moral terms, the right of German bankers to impose vast deadweight costs on current activity because they lent greedily into what might easily have been recognized as a property and credit bubble."

Daniel Pfaendler - German view - "What we should not forget though is that a) just as the peripheral countries were profiting from very low real yields during the past decade amid the German economic malaise, Germany suffered from too high real yields amid the periphery's boom which rendered its economic weakness even worse and most importantly b) if Germany would not have done the corporate restructuring/budget consolidation/structural reforms, the German economy would be in a much worse shape at present."

Michael - A sentence to ponder - "Most people are libertarian with regards to their own lives and people they like, statist with regards to people they don't know, and positively fascist about people they dislike, stereotype, or don't understand."

Payroll tax holiday and the credit channel

Bryan Caplan says Obama has botched the payroll tax holiday:

"If you cut a tax on employers, this reduces labor costs, increases the quantity of labor demanded, and reduces surplus labor. If you cut a tax on employees, in contrast, this increases worker compensation, increases the quantity of labor supplied, and increases surplus labor.

In both cases, admittedly, a tax cut might directly increase demand and, with nominal wage rigidity, increase employment. But when you cut taxes on employers, the incentive effect and the fiscal effect work in the same direction. When you cut taxes on employees, the incentive effect and the fiscal effect work in opposite directions.

That's why Obama's proposed payroll tax holiday botches an idea of truly Singaporean cleverness. Instead of giving the tax cut to employers, where it would do the maximum good, or splitting it evenly, where it would do intermediate good, he's giving all of it to employees, where it does the minimum good"

I have an alternative interpretation. It is true that if you cut a tax on employees, you do very little to directly correct the labor market imbalances. However, the poor functioning of the labor market was caused by the insufficiently stimulative monetary policy that is constrained by the zero bound on interest rates. The zero interest rate bound creates the most damage to those economic agents who have the weakest balance sheets. And these days the household balance sheets are the weakest. Weak household balance sheets are pushing the optimal fed funds rate down to the negative levels. If you cut a tax on employees, you relax the credit constraints on household balance sheets, and the day when the zero interest rate bound is no longer constraining Bernanke will arrive sooner.

In late 2008 - early 2009 balance sheets of non-financial corporations were very weak, so Bryan Caplan's logic would have worked then very well. But today Obama's payroll tax holiday is the solution that will have the most powerful effect.

Sunday, December 5, 2010

Ireland - Greece - Fiscal vs. monetary policy - Eurozone - Overconsumption and recessions

Barry Eichengreen - Ireland - "The Irish “program” solves exactly nothing – it simply kicks the can down the road. A public debt that will now top out at around 130 per cent of GDP has not been reduced by a single cent. The interest payments that the Irish sovereign will have to make have not been reduced by a single cent, given the rate of 5.8% on the international loan. After a couple of years, not just interest but also principal is supposed to begin to be repaid. Ireland will be transferring nearly 10 per cent of its national income as reparations to the bondholders, year after painful year.
        This is not politically sustainable, as anyone who remembers Germany’s own experience with World War I reparations should know. A populist backlash is inevitable. <..>
        For internal devaluation to work, therefore, the value of debts, expressed in euros, has to be reduced. This would have been particularly easy in the Irish case. A bright red line could have been drawn between the third of the government debt that guarantees the obligations of the banks, on the one hand, and the rest of the government’s debt, on the other. The third representing the debts of the Irish banking system could have been restructured. Bondholders could have been offered 20 cents on the euro, assuming that the Irish banks still have some residual economic value."

John Dizard - Greece - "The Greeks and their advisers are already much further along in their thinking than euro-officialdom. They realise that reaching a “successful” conclusion of the three-year adjustment process agreed with the euro leaders would be a disaster for their balance sheet. As Greek bonds mature over that period, they are paid off in large part with new borrowings from Europe and the IMF, as well as with Greek banks’ discounting bond purchases with the ECB. That means Greece is exchanging outstanding debt that is legally and logistically easy to restructure on favourable terms with debt that is difficult or impossible to restructure. It’s as if they were borrowing from a Mafia loan shark to repay an advance from their grandmother."

Narayana Kocherlakota - Fiscal policy vs. Monetary policy - "I believe that QE is a move in the right direction. However, as I have discussed on earlier occasions, I also think there are good reasons to suspect that the ultimate effects of any amount of QE are likely to be relatively modest. That’s why I would have greatly preferred for the committee to have been able to cut its target rate rather than using QE. The problem is that its target rate is already essentially at zero, and so it was not possible to cut the target rate any further.
        Given this constraint on monetary policy, I believe it is important to ask if it is possible to synthesize the effects of a one-year interest rate cut of, say, 100 basis points using fiscal policy tools. In his current and past work, Minneapolis Fed staff researcher Juan Pablo Nicolini and his co-authors have answered this question in the affirmative. Their key insight is that there is a broad equivalence between monetary and fiscal policy. They argue that the essence of an FOMC interest rate cut is that it makes current consumption cheaper relative to future consumption. With that in mind, the fiscal authorities can use the time path of consumption taxes to accomplish this same change in relative prices.
        In the remainder of my remarks, I’ll illustrate this insight by describing one particular fiscal policy plan that is equivalent to a 100-basis-point cut by the Fed. The proposal has three parts. The first part is a permanent consumption tax of 100 basis points, instituted with a one-year delay. The second part is a permanent decrease in labor income taxes of 100 basis points, also instituted with a one-year delay. The third part is an investment tax credit undertaken in 2011. The Nicolini et al. results demonstrate that, in a wide class of economic models, the effects of this three-part plan would be equivalent to the effects of a 100-basis-point interest rate cut."

Tyler Cowen - Eurozone - "Fiscal union was, is, and will remain a fantasy. The best the eurozone could have done was to abolish national banking systems and have a truly European banking market. It's too late for even that, though."

Karl Smith - Overconsumption theory of recessions

The Money Demand