[N]ow the problem of implicit subsidies is far more widespread. We have in effect turned much of the financial system into government-sponsored enterprises. What to do? We could promise never to bail out financial institutions again. Yet nobody would ever believe us. And when the next financial crisis hits, our past promises would not deter us from doing what seemed expedient at the time. Alternatively, we can offset the effects of the subsidy with a tax. If well written, the new tax law would counteract the effects of the implicit subsidies from expected future bailouts.... [I]t is possible that it will be better than doing nothing at all, watching the finance industry expand excessively, and waiting for the next financial crisis and taxpayer bailout.
Textbook arbitrage in financial markets requires no capital and entails no risk. In reality, almost all arbitrage requires capital, and is typically risky. Moreover, pro- fessional arbitrage is conducted by a relatively small number of highly specialized investors using other people's capital. Such professional arbitrage has a number of interesting implications for security pricing, including the possibility that arbitrage becomes ineffective in extreme circumstances, when prices diverge far from funda- mental values. The model also suggests where anomalies in financial markets are likely to appear, and why arbitrage fails to eliminate them.
[F]iscal policy, where applied, worked extremely well in the 1930s, whether because spending from other sources was limited by uncertainty and liquidity constraints, or because with interest rates close to the zero bound there was little crowding out of private spending. Previous studies have not found an effect of fiscal policy in the 1930s, not because it was ineffectual, but because it was hardly tried (the magnitude of the fiscal impulse was small). That said, we still find it possible to pick out an effect. Our results for monetary policy are mixed, but we again find some evidence that expansionary policies were effective in stimulating activity. That modern studies (see e.g. IMF 2009) have not found equally strong effects in crisis countries, where the existence of dysfunctional banking systems and liquidity-trap-like conditions casts doubts on the potency of monetary policy, appears to reflect the fact that the typical post-1980s financial crisis did not occur in a deflationary environment like the 1930s or like that through which countries have been suffering in the last year. The role of monetary policy was to vanquish these deflationary expectations, something that was crucially important then as well as now.
If you have coverage now... there won't be many changes next year. That's by design.... Two changes will affect people with current private insurance... they won't have to worry about maxing out their lifetime medical benefits... people who are frustrated with their plans will have someone to gripe to other than their congressmen.... Medicare beneficiaries will see... the shrinking of the "donut hole," wherein Medicare covers no medical expenses between $2,700 and $6,154.... If you're a senior with moderately high health-care costs, you'll be getting some serious relief. People who've been laid off and have turned to COBRA... will be able to keep their COBRA until the state exchanges are ready, not just for the 18 months after their layoffs.... People who currently have no insurance are the ones with the biggest changes in the near future. If they've been denied coverage because of pre-existing health conditions, they'll be able to enroll in a high-risk pool... until the states get their insurance exchanges up and running in 2014.
In our view, the answer is that the current recession will not mark the end of the Great Moderation. Instead, we are experiencing a particularly severe business cycle that nonetheless pales in comparison to the volatility experienced in the 1970s... the rolling standard deviation of annualised quarterly real GDP growth over a five-year horizon with equal and geometrically declining weights for past observations. One can clearly identify the Great Moderation, associated with a reduction in volatility of approximately 50%, from the highs in the late 1970s to the lows of the 1990s. With five-year rolling measures of volatility, each of the recessions since the Great Moderation has been associated with an uptick in measured volatility, with the current recession obviously leading to a bigger rise in volatility. Nonetheless, current levels of volatility as well as expected future levels of volatility based on forecasts (as of December 2009) from Macroeconomic Advisors and the Survey of Professional Forecasters from the Philadelphia Federal Reserve remain well below levels reached in the 1970s. It is particularly apparent that the volatility has passed its peak when we use geometric discounting which downplays distant periods in general and the transitory volatility blip in 2009. Furthermore, even the most pessimistic forecasts made by professional forecasters point to levels of volatility that are simply not comparable in magnitude to levels reached in the 1970s...
[W]e combine the empirical distribution of our parameter estimates of the Taylor rule with a calibrated standard New Keynesian model and different estimates of trend inflation to infer the likelihood that the US economy was in a determinate equilibrium each period. We find that despite the substantial uncertainty about whether or not the Taylor principle was satisfied in the pre-Volcker era, the probability that the US economy was in the determinacy region in the 1970s’s is zero according to our preferred empirical specification. This reflects the combined effects of a response to inflation that was close to one, a non-existent response to output growth, relatively little interest smoothing, and, most importantly, high trend inflation over this time period. On the other hand, given the Fed’s response function since the early 1980s and the low average rate of inflation over this time period, 3%, we conclude that the probability that the US economy has been in a determinate equilibrium since the Volcker disinflation exceeds 99% according to our preferred empirical specification. Thus, we concur with the original conclusion of Clarida et al (2000). However, whereas these authors reach their conclusion primarily based on testing for the Taylor principle over each period, we argue that the switch from indeterminacy to determinacy was due to several factors, none of which would likely have sufficed on their own. For example, taking the Fed’s pre-Volcker response function and replacing any of the individual responses to macroeconomic variables with their post-1982 value would have had no effect on determinacy given the high average inflation rate in the 1970s. Instead, the most important factors causing the switch away from indeterminacy were the higher inflation response combined the decrease in the trend level of inflation.
Our paper is closely related to Cogley and Sbordone (2008). They find that controlling for trend inflation has important implications in the estimation of the New Keynesian Phillips Curve, whereas we conclude that accounting for trend inflation is necessary to properly assess the effectiveness of monetary policy in stabilizing the economy. In a sense, one may associate the end of the Great Inflation as a source of the Great Moderation...
Strengthening our financial regulatory system in ways that take the appropriate lessons from the crisis is essential for the long-tenn economic stability of our country. To this end, as you know, the Banking Committee has compiled an extensive hearing record and has begun considering specific refonn proposals. A number of your colleagues on the Committee have recently asked for the Board's views on the importance ofthe Federal Reserve's continued role in bank supervision and regulation. In response to these requests, I am enclosing for you and your colleagues a document that discusses (1) how the expertise and infonnation that the Federal Reserve develops in the making of monetary policy enable it to make a unique contribution to an effective regulatory regime, especially in the context of a more systemic approach to consolidated oversight; and (2) how active involvement in supervising the nation's banking system allows the Federal Reserve to better perfonn its critical functions as a central bank.
8) BEST NON-ECONOMICS THING I HAVE READ TODAY: Buce on Tom Campbell: What Can He Be Thinking?:
I've always had the highest possible regard for Tom Campbell ever since I met him back in the 80s. He's that rarest of the rare among politicians, a genuinely honest, hard-working serious guy, looking for real solutions to real problems. But I really can't imagine what he is thinking by jumping into the California Senator's race alongside Carly Fiorina. Is't it a given that he and she will split the sane vote and leave the lunatics in charge of the asylum. If he does, what then? I've never been particularly nuts about Boxer as a senator though I don't think she is anywhere the demon she is made out to be. And my impression is that maybe she's grown a bit in the job.
At first blush, you think I'd go for Campbell in a heartbeat. But do I really want Republicans organizing the Senate? I'm afraid that question answers itself ("no"--ed.). Put differently: I can understand why Campbell doesn't want to be a Democrat but why in heavens' name does he want to hang out with the current crop of Republicans?
9) STUPIDEST THING I HAVE READ TODAY: Elizabeth Bumiller and company. Outsourced to Dan Froomkin: Fool Me Over and Over and Over Again:
Our elite media has been repeatedly suckered into trumpeting glaringly unsupported assertions about the number of Guantanamo detainees that have "returned" to the battlefield.... [L]ast summer... New York Times Public Editor Clark Hoyt appropriately spanked reporter Elisabeth Bumiller and her editors for a top-of-the-front-page story in late May that was "seriously flawed and greatly overplayed... demonstrated again the dangers when editors run with exclusive leaked material in politically charged circumstances and fail to push back skeptically."... Bumiller's article... provided a handy talking point for former vice president Cheney later that day.... Bumiller's reporting failure also earned her an editor's note appended to her story, and a scolding op-ed.
And yet, amazingly enough, eight months later... Bumiller is at it again... chasing Bloomberg, et al.... This time it's one in five former detainees who have "engaged in, or is suspected of engaging in, terrorism or militant activity."... [I]t's not just that the Pentagon's assertions are suspicious on their face. As it happens, a series of studies directed by Seton Hall Law Professor Mark Denbeaux has been effectively picking them apart for years.... Among the other (little, inconsequential) things the Seton Hall reports have pointed out is that the Pentagon, in all the times it has leaked on the topic, has nevertheless consistently refused to provide names that would allow anyone to actually verify most of its claims. There's the issue of how they define "returning to the fight" - it apparently includes detainees speaking out publicly against their incarceration...
10) HOISTED FROM THE ARCHIVES: DeLong (March 2005): Why Oh Why Can't We Have a Better Press Corps? (Shut Up or We'll Kill Your Development Bank! Department):
The Washington Post "argues" that critics of Paul Wolfowitz as World Bank President should be quiet. Why? Because "the World Bank is necessary.... People who care about this institution and its mission -- as many of Mr. Wolfowitz's detractors do -- should think carefully before they damage it by attacking its new boss." No argument that Paul Wolfowitz is the best candidate for World Bank President. No argument that he is even a good candidate. No argument that he is either minimally qualified--in his understanding of development, in his understanding of international finance, or in his ability to manage a large bureaucracy. Pathetic. Contemptible.