Really great links - Greece - Interest rates and housing bubble - China - Healthcare deficit

Ambrose Evans-Pritchard - Europe has left Greece hanging in the wind - "“So they want Greece to reach the point of bankruptcy before they help us?” asked Greek opposition leader Antonis Samaras
Greece is worse off than before. It cannot decide when to invoke the mechanism. It has given up its right as an IMF member to go to the fund when it wants, leaving it prisoner to Europe's deflation dictates. "The IMF would be a lot softer than Europe," said Ken Rogoff, the fund's former chief economist."

Bill Woolsey - Credit boom 2003? - "In conclusion, nominal expenditure was too low during the period of the supposed credit boom. On other other hand, that does not necessarily imply that interest rates were not too low. It is certainly possible that excessively low short term interest rates were one of the many factors resulting in excessive increases in home prices. So the Fed's approach to monetary policy could be a contributing cause of the speculative bubble in home prices. And that speculative bubble certainly resulted in a misallocation of resources that can only now be gradually corrected by shifting labor to more productive avenues and producing new capital goods.
Worse, the end of the speculative bubble, and the losses of the financial firms that had lent into that bubble, were the key trigger for the disastrous drop in nominal expenditure in late 2008. And now, the absence of a clear commitment to returning nominal expenditure to its previous growth path is resulting in even more severe difficulties with production and employment. A policy approach of gradual decreases in short term interest rates, and further, dealing with the zero bound by promising to keep short term interest rates low for an extended period of time, not only is again not getting nominal expenditure back to its trend growth path, it might also be responsible for a future speculative bubble."

Interfluidity - China - "Remember, economic capital has nothing to do with money. Supplying capital is nothing more or less than assuming the burden of economic risks. Where do you think China’s ever-expanding capital base comes from, when it has been the world’s largest exporter of financial capital? China’s citizens assume great risk, in the form of below-world-market wages and social safety benefits, in exchange for the promise of a wealthier and more powerful nation. To some degree that capital is extracted involuntarily, but China’s government has had remarkable success at maintaining legitimacy and the consent of the governed despite the extraordinary costs citizens have borne in the service of an uncertain future. So far, citizens have seen consistent returns on their investment: the big question is how China fares in a persistent “bear market”, when it comes to seem as though much of their sacrifice has been wasted or stolen."

Scott Sumner - Healthcare math - "Let me get this straight. We’ve been told for many years by economists of all political stripes that Medicare and Medicaid were on a tragectory to bust the budget, and something would eventually have to be done. Of course in the past when Congress promised to cut Medicare, they generally reneged on their promises. But let’s give DeLong the benefit of the doubt, the commission in the bill really does have more teeth than usual. But does that make DeLong’s argument correct? I don’t see how. If Medicare was projected to bust the budget in future decades, then doesn’t it stand to reason that we already needed to cut Medicare and use the money for deficit reduction? But Obama is basically saying; “we propose to have future governments do what everyone knows has to be done at some point anyway, but instead of having the Medicare cuts used for deficit reduction, we propose they be used to increase medical spending in other areas, such as subsidies for health insurance.” Someone please explain to me how that makes this deficit neutral."

Really great links - crying ‘Fire! Fire!’ in Noah’s flood - run on the shadow financial system - anti-anti-communism - progress

Brad DeLong - "We sit here in the midst of 10% unemployment in the USA, of fiscal policy that is crippled in some countries by (legitimate) fears that more deficit spending will trigger government debt crises and crippled in others by confusion between short-term cyclical and long term structural deficits, of banking policy crippled by the public populist reaction against more bailouts for the bankers, and of monetary policy crippled by a strange and sinister mindset among central bankers that fears inflation even as rates of wage increase continue to drop—people who are, as R.G. Hawtrey said of their predecessors in the Great Depression, “crying ‘Fire! Fire!’ in Noah’s flood.”"

David Beckworth - "Deposit Insurance" for the Shadow Banking System - "Like deposit holders during the Great Depression, repo holders in this crisis wanted their money back and could get it by (1) forcing the shadow banks to take a haircut on the collateral used in repos or (2) not renewing the repos . As a result, repo markets began freezing up and threatened the shadow banking system. Since the shadow banking system is a conduit for funding the traditional banking system, financial intermediation in general became threatened (See Gorton for more details). The official response to this banking panic was for the Federal Reserve to create liquidity programs to effectively unthaw the repo market. Like deposit insurance in the 1930s, this government intervention stopped the run on the shadow banking system. Now that these liquidity facilities have been tested and shown to work, there is an expectation they will be used again if needed. And like the deposit insurance for the traditional banking system, this modern form of "deposit insurance" for the shadow banking system is bound to create moral hazard problems that will ultimately lead to more government regulation. These are interesting parallels.
 The emergence of the shadow banking system, therefore, not only has implications for the correct measure of the money supply, but also for what will be the new moral hazard and government regulation of the financial system."

Scott Sumner - "One thing I have noticed about progressives is that while they pay lip service to having rejected communism, their real passion is for anti-anti-communism. They seem more outraged that a few Hollywood screenwriters lost their jobs in anti-communist witch hunts decades ago, than they do that policies advocated by those screenwriters, such as “to each according to their needs,” led to the starvation of tens of millions of people. One thing I have noticed about conservatives is that while they pay lip service to opposing racism, their real passion is for anti-anti-racism. They seem more outraged about a white firefighter who was passed over for a promotion then they do for all of the tragic history of African Americans (and Native Americans.)
Just so that I won’t be misunderstood, I want to be clear about one thing. I do not believe that most modern progressives secretly favor communism, nor do I believe that most modern conservatives secretly favor Jim Crow laws. I think both groups have absorbed at least some of the lessons of the 20th century. Both have been somewhat enlightened. But as long as each side continues to talk the way they do, then progressives will continue to suspect that conservatives are secret racists, and conservatives will continue to think that progressives are secret Marxists.
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Where is the conservative outrage over 100,000s of black Americans who are in prison for drug law violations, whereas conservatives like Rush Limbaugh go to places like the Betty Ford clinic, not jail."

Brad DeLong - industrial revolution - "Some say it was an agricultural revolution that allowed transfer of a large chunk of the labor force into making things. But eleventh-century China had had a bigger and earlier agricultural revolution than eighteenth-century Britain had.
Some say it was the European conquest of the Americas. But what was shipped back from America across the Atlantic to Europe and what was paid for in imports from Asia with American products was never real wealth but was instead sterile gold, sterile silver, some empty calories (in the form of sugar), and some psychoactive chemicals—coffee, tea, chocolate, and nicotine.
Some say it was the commercial revolution and the rise of the middle class. But in 1776 Adam Smith and a little later David Ricardo were looking forward to a future for Britain in which it became a lot more like China—a full country with high agricultural productivity per acre and a well-developed division of labor but a very poor and low-wage peasantry and working class ruled by very rich landlords."

Donald Kohn - don't blame me for the crisis, blame science instead. And price level path targeting doesn't work, because third grade math problems will leave people perplexed

Fed vice chairman Donald Kohn thinks that the end of Great Moderation was caused by bad science:

"More study leading to a better understanding of the linkage between central bank actions and expectation formation should improve the ability of central banks to achieve society's inflation and output objectives more effectively under a variety of circumstances, including in a severe negative shock of the type we recently experienced."

In the earlier part of his speech it becomes clear that the problem is not with the linkage between central bank actions and expectations, but with central banks themselves:

"Given the severity of the downturn, it became clear that lowering short-term policy rates alone would not be sufficient."

If the key problem is central banks that were asleep at the wheel, should central banks correct their driving mistakes? According to Kohn, no, because third grade maths are two complicated:

"Another approach to this problem is for central banks to target a gradually rising price level rather than a constant inflation rate. Imagine a plot of the consumer price index (CPI) from today onward increasing 2 percent each year. Central banks would commit to adjusting policy to keep the CPI near that line.

The advantage of this approach, in theory at least, is that when a negative shock drives prices below the target level, people will automatically expect the central bank to increase inflation for a while to get back to trend. In principle, that expectation would lower real interest rates without the central bank changing its inflation commitment, even if nominal interest rates were pinned at zero. It could also make it easier for people to make long-term economic decisions because they could anticipate that inflation misses would be reversed over time, reducing uncertainty about the future price level.
While I appreciate the elegance of this price-level-targeting idea, I have serious doubts that it would work in practice. Central to the idea is that the Federal Reserve would be committing to hit a price level that was growing at a constant rate from a fixed point in the past. The specific inflation rate that could be expected in the future would change over time, depending on the inflation that had been realized up to that point. You could know what inflation rate to expect only if you knew both the current consumer price index and the Fed's target for the index in the future. In addition, the inflation rate that you could expect would be different for different horizons. Moreover, central banks are able to control inflation only with a considerable lag and even then only imprecisely, so the process of hitting a target would likely involve frequent overshooting and correction and consequently frequently shifting inflation objectives.

Contrast this approach with the communications required of central banks when targeting a specific inflation rate. For example, central banks targeting a 2 percent inflation rate typically put that target prominently on their webpage. If those banks were instead targeting a price level growing at 2 percent, their webpages would have to provide a table of inflation rate targets for a variety of horizons, and the targets would change each month. I fear that rather than anchoring people's expectations about prices, it could leave them perplexed."

Really great links - Textbook models and extra reserves - Calibrating the quantitative easing - China bubble - Krugman vs. Krugman

Donald Kohn - Textbook models and extra reserves - "A second issue involves the effect of the large volume of reserves created as we buy assets. The Federal Reserve has funded its purchases by crediting the accounts that banks hold with us. Those deposits are called "reserve balances" and are part of bank reserves. In our explanations of our actions, we have concentrated, as I have just done, on the effects on the prices of the assets we have been purchasing and the spillover to the prices of related assets. The huge quantity of bank reserves that were created has been seen largely as a byproduct of the purchases that would be unlikely to have a significant independent effect on financial markets and the economy. This view is not consistent with the simple models in many textbooks or the monetarist tradition in monetary policy, which emphasizes a line of causation from reserves to the money supply to economic activity and inflation. Other central banks and some of my colleagues on the Federal Open Market Committee (FOMC) have emphasized this channel in their discussions of the effect of policy at the zero lower bound. According to these types of theories, extra reserves should induce banks to diversify into additional lending and purchases of securities, reducing the cost of borrowing for households and businesses, and so should spark an increase in the money supply and spending. To date, that channel does not seem to have been effective; interest rates on bank loans relative to the usual benchmarks have continued to rise, the quantity of bank loans is still falling rapidly, and money supply growth has been subdued. Banks' behavior appears more consistent with the standard Keynesian model of the liquidity trap, in which demand for reserves becomes perfectly elastic when short-term interest rates approach zero. But portfolio behavior of banks will shift as the economy and confidence recover, and we will need to watch and study this channel carefully."

Donald Kohn - Quantifying the quantitative easing - "However, the economic effects of purchasing large volumes of longer-term assets, and the accompanying expansion of the reserve base in the banking system, are much less well understood. So my second homework assignment for monetary policymakers and other interested economists is to study the effects of such balance sheet expansion; better understanding will help our successors if, unfortunately, they should find themselves in a similar position, and it will help us as we unwind the unusual actions we took.
One question involves the direct effects of the large-scale asset purchases themselves. The theory behind the Federal Reserve's actions was fairly clear: Arbitrage between short- and long-term markets is not perfect even when markets are functioning smoothly; and arbitrage is especially impaired during panics when investors are putting an unusually large premium on the liquidity and safety of short-term instruments. In these circumstances, reducing the supply of long-term debt pushes up the prices of the securities, lowering their yields.
But by how much? Uncertainty about the likely effect complicated our calibration of the purchases, and the symmetrical uncertainty about the effects of unwinding the actions--of reducing our portfolio--will be a factor in our decisions about the timing and sequencing of steps to return the portfolio to a more normal level and composition. Good studies of these sorts of actions are sparse. Currently, we are relying in large part on studies that examine how much interest rates dropped when purchases were announced in the United States or abroad. But such event studies may not be an ideal means to predict the consequences of reducing our portfolio, in part because the economic and financial environment will be very different, and also because event studies do not measure effects that develop or reverse over time. We are also uncertain about how, exactly, the purchases put downward pressure on interest rates. My presumption has been that the effect comes mainly from the total amount we purchase relative to the total stock of debt outstanding. However, others have argued that the market effect derives importantly from the flow of our purchases relative to the amount of new issuance in the market. Some evidence for the primacy of the stock channel has accumulated recently, as the prices of mortgage-backed securities appear to have changed little as the flow of our purchases has trended down."

Willem Buiter - "A bubble is a manifestation of out-of-control or over-the-top economic success; you find bubbles in countries with strong fundamentals. In no major country are the fundamentals stronger, the structural change more dazzling or the policy authorities less experienced at managing a market economy than in China. We recognize that experience and familiarity with the modus operandi of a financial market economy are no guarantor of good policy. Even highly experienced monetary policymakers and financial regulators, heading institutions with a track record of decades, like the current and previous Federal Reserve Chairmen, failed to identify and prevent excessive credit growth and asset bubbles, and may indeed have contributed through their regulatory and monetary policy actions (or inaction) to the financial boom, bubble and bust that severely damaged the financial system of the US. Even so, the fact that those in charge of monetary, financial and credit management in China are operating in terra incognita increases the risk of policy errors."

Greg Mankiw - Krugman vs. Krugman - "In my view, a default on U.S. government debt is less likely than another scenario, suggested by Paul Krugman:

How will the train wreck play itself out?...my prediction is that politicians will eventually be tempted to resolve the crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt. And as that temptation becomes obvious, interest rates will soar. It won't happen right away....But unless we slide into Japanese-style deflation, there are much higher interest rates in our future.
I think that the main thing keeping long-term interest rates low right now is cognitive dissonance. Even though the business community is starting to get scared — the ultra-establishment Committee for Economic Development now warns that "a fiscal crisis threatens our future standard of living" — investors still can't believe that the leaders of the United States are acting like the rulers of a banana republic. But I've done the math, and reached my own conclusions.

Actually, Paul wrote that in 2003, and we know now that his prediction of higher inflation did not come to pass"

Really great links - left-wing support for nominal GDP targeting - China bubble

Liberal think-tank supports NGDP targeting, the idea associated in the blogosphere with the right-winger Scott Sumner - Centre Forum - start targeting nominal GDP until the output gap is closed - "The markets need to know that the Bank will not rest until the economy is growing fast enough to close the output gap. So CentreForum’s first recommendation is for the Bank explicitly to target high growth in nominal GDP (NGDP) for the next five years.
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Finally, the political economy of central bank independence provides another reason to support NGDP targeting. The Bank needs to maintain popular support if it is to manage long term price expectations. A persistent failure to return the economy to growth may pose a larger risk to Bank independence than a change in targeting methodology. If the economy stays weak and the output gap remains unclosed, the government’s fiscal problems may well get worse, and fears of a truly inflationary solution to the crisis will grow. As former MPC member Sir John Gieve said in February 2009: “The Bank and MPC need to convince [the general public] that the policy we are pursuing is the best way of restoring growth and full employment without reawakening inflation”."

Edward Chancellor - China's Red Flags (free reg. required) - "In fact, bubbles can be identifi ed ex ante, as the economists like to say. There also exists an interesting, if rather neglected, body of research on leading indicators of fi nancial distress. A few years ago, many of these indicators were pointing to rising economic vulnerability in the United States and other parts of the globe. Today, those red fl ags are fl ying around Wall Street’s current darling, The People’s Republic of China."

Really great links - EU - China - Austrian vs Minsky story

Ambrose Evans-Pritchard - Has Germany just killed the dream of a European superstate? - "Let me be clear. I do not blame Greece, Ireland, Italy, or Spain for what has happened. No central bank could have tried more heroically than the Banco d’España to counter the effects of negative real interest rates, but the macro-policy error of monetary union washed over its efforts."

Nick Rowe - ""Blame China" is not necessarily the lesson to be drawn here. It is quite understandable that some countries might legitimately want or need to accumulate international reserves. "Blame the international reserve system" seems a more appropriate lesson.
For example, if China allowed the US to accumulate yuan, the US Fed could hold yuan reserves, just as China holds dollar reserves. Then, if China wanted to increase its dollar reserves but the US didn't want to increase its liabilities to China, then China could accumulate dollars, and the US Fed could accumulate an equal value of yuan.
Perhaps, if we want to blame China for something, we should not blame it for buying dollars. We should blame it for not allowing the US to buy yuan."

Arnold Kling - Austrian vs Minsky story - "In the Austrian view, misleading signals are created by low interest rates set by the central bank. In the Minsky view, misleading signals are endogenous to the financial process. I think that the Minsky story has merit."

Really great links - Greenspan on Lehman - Mankiw on Greenspan - Greenspan on bubbles - Mankiw on health bill - Brad DeLong on housing bubble

Alan Greenspan - "Financial crises are characterized by a progressive inability to float, first long term debt and eventually short term, and overnight, debt as well. Future uncertainty and therefore risk is always greater than near term risk, and hence risk spreads always increases with the maturity of a financial instrument. The depth of financial crisis is properly measured by the degree of collapse in the availability of short term credit.
The evaporation of the global supply of short term credits within hours or days of the Lehman failure is, I believe, without historical precedent. A run on money market mutual funds, heretofore perceived to be close to riskless, was underway within hours of the Lehman announcement of default."

Greg Mankiw - Comments on Alan Greenspan's "The Crisis" - "The issue I am wrestling with is whether this maturity transformation is a crucial feature of a successful financial system. The resulting maturity mismatch seems to be a central element of banking panics and financial crises. The open question in my mind is what value it has and whether the benefits of our current highly leveraged financial system exceed the all-too-obvious costs.
To put the point most broadly: The Modigliani-Miller theorem says leverage and capital structure are irrelevant, while undoubtedly many bankers would claim they are central to the process of financial intermediation. A compelling question on the research agenda is to figure out who is right, and why."

Alan Greenspan - "Some bubbles burst without severe economic consequences, the dotcom boom and the rapid run-up of stock prices in the spring of 1987, for example. Others burst with severe deflationary consequences. That class of bubbles, as Reinhart and Rogoff data demonstrate,20 appears to be a function of the degree of debt leverage in the financial sector, particularly when the maturity of debt is less than the maturity of the assets it funds.
I very much doubt that in September 2008, had financial assets been funded predominately by equity instead of debt, that the deflation of asset prices would have fostered a default contagion much beyond that of the dotcom boom. It is instructive in this regard that no hedge fund has defaulted on debt throughout the current crisis, despite very large losses that often forced fund liquidation."

Greg Mankiw - CBO scoring of the health bill - "Recall that the bill raises taxes substantially. Some of these tax hikes are the explicit tax increases on capital income to pay for the insurance subsidies. Some of these tax hikes are the implicit marginal rate increases from the phase-out of the insurance subsidies as a person's income rises. Both of these would be expected to reduce GDP growth.

Indeed, to be very wonkish about it, these tax changes could have especially large GDP effects. Some people like to argue that taxes have small GDP effects because income and substitution effects offset each other. But if you give someone a subsidy and then phase it out, both the income and substitution effects work in the direction of reducing work effort."

Brad DeLong - Interest Rates and the Housing Bubble - "Suppose that John Taylor is right: that prudent macroeconomic policy would have had the Federal Reserve begin to raise interest rates not in the middle of 2004 but in the middle of 2003, and raise them back to boom-time levels not in two years but in one year, like so:
What would have been the direct effect of such an alternative short-term interest rate path on housing prices?"