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December 2010

Jay Alan of the California Office of Emergency Services Tries to Speak Metaphorically, and Fails


Kelly Zito:

Blustery storms heading to Northern California: the federal weather agency is holding regular briefings with state and local authorities to plan for any major snafus.

"These storms are on our radar," said Jay Alan, spokesman for the California Office of Emergency Services. "When the weather folks say we might have significant storms like this, we pay attention."

The problem with Jay's statement is that these storms really are on our radar.

Here they are, on our radar:

Lafayette, CA Satellite Radar -

More on the Four Stupidest Economists Alive of 2010: Thomas, Hennessy, Holtz-Eakin, and Wallison

Richard Green tells us to look at Peter Wallison vs. Peter Wallison. Perter Wallison says that the GSEs ought to have been lending a lot more to the relatively high-risk low- and moderate-income homebuyers of America. By contrast, Peter Wallison says that the origin of the financial crisis was the government's unconscionable use of the GSEs as instruments of social policy to make lower-quality loans to high-risk low- and moderate-income homebuyers.

Peter Wallison, 2006:

The GSEs are not doing the job they should for low-income homebuyers: [T]he GSEs’ record in providing assistance for homebuyers of low and moderate income has not been good. The Department of Housing and Urban Development has long had regulations intended to focus Fannie and Freddie on low-income or affordable housing. HUD secretaries have set goals, but these have had little effect in helping ensure the GSEs meet the housing needs of the underserved.... [T]he GSEs were doing less than conventional lenders in helping the underserved.... Fannie and Freddie should do a much better job of providing affordable home financing to a neglected portion of the mortgage market...

Peter Wallision, 2010:

Primr: Government... was following a social policy in addition to an investment policy.... [D]uring the bubble’s expansion, the largest investors in the mortgage market, the government-sponsored enterprises (GSEs)—Fannie Mae and Freddie Mac—were instruments of U.S. government housing policy.... Subsidizing mortgages through the GSEs was a particularly politically expedient way to increase the homeownership rate.... During the inflation of the housing bubble, the GSEs lowered their standards and began investing in subprime and Alt-A mortgages... guaranteeing ever-riskier loans... MBS backed by subprime and Alt-A mortgages.... [T]he government supported the financing of high-risk mortgages... subsidized and, in some cases, mandated the extension of credit to high-risk borrowers, propagating risks for financial firms, the mortgage market, taxpayers, and ultimately the financial system...

Are All European Policymakers Insane?

Matthew Yglesias:

Yglesias » The Latvian Catastrophe: Klaus Regling, chief executive of the European Financial Stability Facility, wants you to know that monetary union without fiscal integration is workable after all and he offers, as an example, Latvia:

Latvia which has a currency pegged to the euro, testifies to the success of this policy. Contrary to commentators who predicted disaster for Latvia early last year unless it gave up its hard peg – in line with advice from the commission – it did not devalue its exchange rate. A real effective devaluation was achieved through severe cuts in nominal income. Today its economy is growing again. Those outside “experts”, who always seem to know what is good for Europe, should take note.

So to be clear about this, the Latvian economy suffered a 4.2 percent contraction in 2008. By way of comparison, in the horrible year of 2009 the US economy contracted 2.44 percent. So that was a very bad recession, much worse than the American recession. At this point, so called “outside ‘experts’” predicted disaster for Latvia in early 2009 unless it devalued its exchange rate. Latvia declined to devalue and its GDP shrunk 18 percent! That’s the disaster right there. Overall GDP growth for 2010 is forecast to be slightly negative again. So, yes, Latvia has returned the growth. But the toll was terrifyingly high.

As ever, there were some “real” shocks involved in this. Some loss in Latvian living standards was inevitable and unavoidable. But the unemployment rate in Latvia is nearly 20 percent. That means a great many able-bodied adults are simply not working, not producing any goods and services for market consumption. That represents a vast loss of living standards that could have been largely avoided in a floating exchange rate regime.

To suggest that this is some kind of success story that illustrates the underlying workability of the system is horrifying.

Bethany McLean on This Year's Winners of the Stupidest Economists Alive Contest

Bethany McLean:

Why won't the GOP's financial-crisis report follow the money?: [O]n Dec. 15, defecting Republicans—former Calif. Rep. Bill Thomas; Keith Hennessey, who served on President Bush's National Economic Council; Douglas Holtz-Eakin, the former head of the Congressional Budget Office; and Peter Wallison, a fellow at the conservative American Enterprise Institute... released what they describe as their "preliminary findings and conclusions." This "primer" (in a blog, Wallison denied that it was either a "report" or a "response") put blame just where many Republicans would like to see it: on the government's push for homeownership. "There were three important ways that the government pushed investors toward investing in mortgage debt," the authors write.

First, the regulatory capital requirements associated with mortgage debt were lower than for other investments. Second, the government encouraged the private market to extend credit to previously underserved borrowers through a combination of legislation, regulation and moral suasion. Third, and most important, during the bubble's expansion, the largest investors in the mortgage market … Fannie Mae and Freddie Mac, were instruments of U.S. government housing policy.

As a result of government-established affordable-housing goals starting in 1993, the authors argue, Fannie and Freddie had to "invest in mortgages of increasingly lower quality and higher risk to the taxpayer." This narrative... is shockingly incomplete... a ludicrous distortion.... [T]he government did lower the regulatory capital requirements... in the face of fierce lobbying from the private sector.... Countrywide and Ameriquest didn't make mortgages—and Wall Street firms didn't package those mortgages and sell them off to investors—because the government was holding a gun to their heads.... As for the implication that subprime lending began with Fannie and Freddie and resulted from the government's affordable housing goals, that's simply false....

For most of the 1990s, Fannie's and Freddie's affordable-housing goals required them to buy a certain percentage of mortgages made to families with a median income level. That was hardly onerous or risky, and anyway Fannie executives, who were far more preoccupied with return to shareholders, used to joke about the ways they neutered the affordable-housing rules....

The GOP report—oops, primer—provides a calculatedly incomplete account of how bad mortgages found their way onto the balance sheets of financial firms. There's an interesting dissection of the kinds of risk that banks took—but no mention of the reason they took those risks.... As for the ways the risky mortgages were packaged into supposedly safe securities, all readers get is a whitewash.... [No] mention of the Street's failure to investigate the underlying mortgages, despite its promises to investors that it was doing so. Oh, and here's the line about the credit-rating agencies like Moody's and Standard and Poor's, which made fortunes by stamping triple-A ratings on bundles of bad mortgages:

The credit rating agencies made many of the same mistakes as mortgage investors, and ratings on MBS proved to be severely inflated.

Er, the mortgage investors were relying on the credit-rating agencies to do their job by assessing risk accurately. Anyone with even a rudimentary understanding of the 2008 crisis knows that. But apparently it never came up in those "hundreds of interviews" financed by taxpayer dollars....

[T]he explanation—that in essence, what happened to Wall Street was simply a "run on a bank"—ignores the active role Wall Street itself played in causing the run. If you sell hundreds of billions of dollars in bad securities to investors, and then those investors start to realize that you also own some of those same securities, well, there might just be a run. And a justified one at that...

Repeat A Lie Enough Times . . .

Barry Ritholtz:

Repeat A Lie Enough Times . . . | The Big Picture: All last year, I kept getting emails from people asking me: “Why do you keep hammering  on these issues?  Why do you beat up on the eejits who push the Fannie Freddie CRA meme? Its dead, everyone knows its nonsense.” Except, not so much. That 4 members of the FCIC could push such as discredited meme reflects a broader strategy of Agnotology. Even Gretchen Morgenson, of that liberal media outlet NYTimes, began her column on Sunday with this sentence:

DECIDING what to do with Fannie Mae and Freddie Mac, the taxpayer-owned mortgage giants that helped set the financial crisis in motion, will be a huge job for Congress next year.

That single sentence is a huge victory for the reality challenged.

Dani Rodrik on the Planned Trial of His Father-in-Law, Cetin Dogan

Dani Rodrik:

Dani Rodrik's weblog: A weird, weird trial: The most significant court case in Turkey in at least five decades is about to start. Nearly two hundred retired and active-duty officers will be on trial for having plotted back in 2003 to destabilize the country through violent acts (including the bombing of mosques and the downing of a Turkish fighter jet) and to overthrow the AKP government. Defendant no. 1 in this trial, and the alleged leader of the coup plot, is my father-in-law, Cetin Dogan.

The tragedy is that this is as much a show trial as the one that took place on the tiny Yassiada island almost exactly 50 years ago. Then, the roles were reversed. A military junta (that time, a real one) had deposed the elected government and placed the president, prime minister, and cabinet ministers on trial on trumped up charges.

True to form, history is repeating itself as a farce. The evidence behind the current case, a trove of documents on CDs delivered to a newspaper by a “secret informer,” consists of blatant forgeries. These documents are allegedly secret military plans from 2003 detailing the coup preparations. Yet they contain anachronisms that leave no doubt that they were prepared in late 2008 at the earliest... references to entities -- firms, NGOs, military installations, hospitals – by names that they had yet to acquire. It’s as if a text pretending to be from 1970 referred to Diana Spencer as Princess of Wales—a title which she acquired only in 1981—or mentioned her car crash decades later. To any but the most jaundiced eye it is obvious that the incriminating documents have been authored not by the military officers on trial, but by others many years later....

[T]he case says much about Turkey at present, not any of it pretty. The AKP government has fanned the flames against the defendants and exploited the case for political purposes. The pro-government media have disgraced themselves by publishing a steady stream of disinformation on the case (just check out Today’s Zaman for a good dose of it on a daily basis). Many leading members of the Turkish liberal intelligentsia have chosen to disregard the fabricated evidence lest their cherished narrative of a democratic government putting an end to “military tutelage” get tarnished.

As for the once-powerful military establishment, it stands so weakened by its own history of coups and meddling in politics, that it has been totally incapable of putting up a credible storyline.... [T]his trial... will say a lot about where Turkey is headed...

Buce on the Stupidest Economists Alive


Underbelly: The Blogger has Questions: They say the Devil has nine questions. Barry Ritholtz has ten; he poses them to the four guys [Peter Wallison, Keith Hennessey, Bill Thomas and Douglas Holtz-Eakin] who didn't finish their term paper:

  1. From 2001 to 2003, Alan Greenspan took rates down to levels not seen in almost half a century, then kept them there for an unprecedentedly long period. What was the impact of ultra low interest rates on Housing, credit, the bond markets, and derivatives?

  2. How significant were the Ratings Agencies (S&P, Moodys and Fitch) to the collapse? What did their AAA ratings on junk derivatives affect? What about their being paid directly by underwriters for these ratings?

  3. The Commodities Futures Modernization Act of 2000 removed all Derivatives from all oversight, including reserve requirements, exchange listings, and disclosures. What effect did the CFMA have on firms such as AIG, Bear, Lehman, Citi, Bank of America?

  4. Prior to 2004, Investment Houses were limited to 12-to-1 leverage by the SEC’s net capitalization rule. In 2004, the 5 largest investment banks asked for, and received, a full exemption from leverage restrictions (known as the Bear Stearns exemption) These five firms all jacked up their leverage. What impact did this increased leverage have on the crisis?

  5. For seven decades, Glass Steagall separated FDIC insured depository banks from riskier investment houses. Prior to the repeal of Glass Steagall in 1998, the market had regular crashes that did not spill over into the real economy: 1966, 1970, 1974, and most telling of all, 1987. What impact did the repeal of Glass Steagall have on the banking system during the 2008-09 crash?

  6. NonBank Lenders: Most of the sub-prime mortgages were made by unregulated non-bank lenders. They had a ”Lend to securitize” business model, and they sold enormous amounts of subprime loans to Wall Street for this purpose. Primarily located in California, they were also unregulated by both the Federal Reserve and the California State legislator. What was the impact of these firms?

  7. These firms abdicated traditional  lending standards. They pushed option arms, interest only loans, and negative amortization mortgages, all of which defaulted in huge numbers. Was non-bank sub prime lending a major factor in the crisis?

  8. The entire world had a simultaneous global housing boom and bust. US legislation such as the CRA or Fannie & Freddie only covered US housing and lenders.  How did this cause a worldwide boom and bust — even bigger than that in the US ?

  9. Prior to the 2004, many States had Anti-Predatory Lending (APL) laws on their books (and lower defaults and foreclosure rates). In 2004, the Office of the Comptroller of the Currency (OCC) Federally Preempted state laws regulating mortgage credit and national banks. What was the impact of this OCC Federal Preemption ?

  10. Corporate Structure: None of the Wall Street partnerships got into trouble, only the publicly traded iBanks. Partnerships have full personal liability for their losses. What was the impact of this lack of personal liability of senior management on Wall Street risk management?

Comment:  Some of these come close to being purely rhetorical in the sense that (I suspect) Barry feels he knows the answer, and that the answer is damning to the culprits.  For every one of them, I suspect somebody over at the American Enterprise Institute will be ready with a memo showing that it was a total non-issue and oh look!  There's Barney Frank!  Even given AEIs risible record of "research," still a number of these do represent real issues on which I'd love to have a better sense of who is right.  Example: repeal of Glass Steagall is part of the standard mantra.  Yet wouldn't I be right that the worst afflicted banks (Bear Stearns, Lehman) are the ones least diversified, the ones that took least advantage of Glass Steagall repeal?  Can we document that Federal preemption really changed anything?

I know, that's not really his point--his point being to try to shame four guys who seem to have no sense of shame, and who pass on, as an "investigation report," a set of AEI talking points that they could have drafted before the commission was ever appointed.

Quotes to Live For...

Paul Kedrosky writes:

Three Quotes to Live By: Phil Libin of the excellent Evernote has a cute idea in this video discussion with Jason Calacanis. He says everyone should have three quotes around which they aim to structure their lives, quotes that one day they'd like to say, in the right context. Here are his:

  • Set the controls for the heart of the sun.
  • Fire the explosive bolts.
  • This week I'm working out of the Tokyo office.

So far he's one for three. Wonder what mine are. Or yours. [-]

14 yo · 2 hours ago:

  • I am absolutely certain I'm on the right side of this trade.
  • Well boys, it appears that we've bought too much champagne.
  • Mr. President, you are The Man.

Britain: This Time Is Not Different

Adam Posen:

Inflation and Monetary Policy: T]he persistently above target CPI inflation the UK economy is experiencing is almost entirely due to the combination of the depreciation of Sterling prior to January 2009 and the increase in VAT in January 2010. As a committee, our forecast underestimated the size and particularly the persistence of these inflationary effects, and I accept my share of responsibility for that mistake. The lesson we need to take therefore is to update our estimates of transmission from external shocks going forward. That said, annual inflation in the UK as measured in the CPIY series, which excludes the price effect of indirect taxes, has been below target throughout this calendar year. Thus, if we allow for even just some exchange rate pressure upwards on prices over this period as well, underlying UK inflation has stayed well below target. Recognizing that fact has to be the starting point for our forecast.

This is not to dismiss the harmful impact of the past months of higher inflation on the vast majority of British citizens. British households do suffer.... What British households have suffered in this regard over the last year, however, is a decline in their purchasing power due to one-time factors that is neither amenable to reversal through monetary policy nor going to feed a more general rise in prices and wages. The MPC would only make things worse by making policy looking in the rear-view mirror, trying to make up for past mistakes, especially given the fact that the underlying trend inflation rate is below target....

Moreover, both the MPC and the British public should maintain some perspective on the size of our inflation forecast error given the magnitude of the shocks to which the UK economy has been subjected. That is not an excuse, but a reality check. I think both the Bank of England and the public gained an exaggerated confidence over the NICE decade of 1997-2007 about just how finely the MPC could both forecast and control inflation.... Given an appropriate degree of humility about our ability to forecast inflation, and the right mindset to keep looking forward by learning from past errors (rather than doing harm by trying to make up for them), how should we make our inflation forecast? To me, the right way to think about it is to consider what has happened to the UK and other similar economies when they have been in post-financial crisis situations like the one we are in now. As an already classic recent book (Reinhart and Rogoff (2010)) reminds us, economic policymakers as well as investors get into trouble when they arrogantly say “this time is different.” If anything, part of the reason the UK and other western economies got into the difficulties we have been in is because many of us assumed this time was different during the mid-2000s boom....

I would rather look at several cases, or even better try to draw conclusions statistically from a large sample, and try to take into account the specific conditions of the UK economy at present, than to just leap to conclusions from our current indicators or from comparison with one or two prior UK recessions... the last couple of UK recessions... came about due to monetary tightening, not as the result of a financial crisis, [and so]may be more different in nature from today‟s situation than other economies' post financial crisis experiences.... [I]f one plots the course of our current recovery versus that of the UK from recession in 1992 and that of Japan from its initial recession in 1993, one can discern no significant divergence between them.... [W]e all know what terrible things happened to Japan after 1993, and both credit and fiscal developments in the UK today look a lot more like Japan then than the UK at the same time.

Can't Anybody in the White House Play This Game?

A paragraph from Ezra Klein this morning struck me as yet more evidence that the staff in the Obama White House are simply not professionals, and do not understand the game.

Ezra Klein:

Orszag and Citigroup: It's difficult to overstate how much bad will has developed between Orszag and the White House he used to serve. Some of that comes from perceived disloyalty in Orszag's public statements -- like his first New York Times column, which called for a short-term extension of all the tax cuts when the White House was arguing for the permanent extension of most of the cuts and the expiration of the cuts for the rich...

Look: Peter Orszag believes--as do I--that the most basic principles of good governance mandate that the American government have a long-term plan in place to match its long-term projected expenditures with its long-term projected revenues. Peter Orszag believes--as do I--that requiring that every policy initiative be paid-for in the long-term so that it does not increase the projected debt, say, ten years out into the future is the minimum low bar that policy should be able to clear.

Barack Obama has not taken Peter Orszag's advice: he has not proposed only initiatives that are paid-for in the long-term. He has not pledged to veto bills that raise the projected debt ten years hence.

Peter Orszag is no longer in the government.

Does he now have a duty to tell those who read his New York Times columns the same things that he told Obama when he was in government?

Or does he have a duty to tell lies to his readers about what he thinks good policy is in order to advance the interests of an administration that he is no longer part of?

I would say he has the first duty.

The White House staff has no warrant to expect that ex-officials will say things that the administration regards as convenient after they leave government when they are different than what the ex-officials said at NEC meetings.

The assumption that Peter would rests, I think, on a lack of understanding that he really believes in the policies he advocates--that his primary loyalty is and always has been to the policies and not to any one or any group of politicians. It is, I think, very dangerous to have such a White House staff.

Deficit Hawks and Deficit Frauds

Ezra Klein:

Ezra Klein - Deficit hawks vs. deficit frauds: The deficit frauds are the folks who use deficits for short-term political gain: This year, they've mainly been Republicans who opposed unemployment benefits because they'd add $56 billion to the deficit but demanded tax cuts that would add $4 trillion to the deficit. And they've been empowered not by Peterson's money or even the climate in Washington, but by the fact that people get very anxious about the deficit when the economy slows, as it's a number that they think helps explain the economic problems even as it mainly tracks them, and because a misplaced analogy to the European debt crises has made our deficit look scarier than it actually is.

The Drive to Construct a Better Financial Regulatory System Is Over

Mark Thoma:

Economist's View: How Will the GOP Regulate Wall Street?: Regulation is rarely flawless when it is first imposed. Adjustments are needed to make sure that the intent of the original legislation is carried out, and to plug any new holes that are discovered. However, any new regulatory initiatives will face a tough hurdle -- a Republican chairman of the House Financial Services Committee and Republican control of the House.

In fact, the battle will be to stop current regulatory initiatives from being watered down or eliminated. Democratic control of the Senate and White House should be able to prevent this from happening, and the outcome is likely to be a standoff. However, a standoff can still lead to watered down or ineffective legislation. Since there won't be any way to fix regulatory problems that emerge over time as the industry evolves and attempts to evade existing restrictions, or to fix new problems that are discovered, gridlock will work in favor of the banks.

And he sends us to Andrew Leonard:

Rarely do you see a politician quite this honest: Last Wednesday, just hours after securing the position of chairman of the House Financial Services Committee, Spencer Bachus, R-Ala., told the Birmingham News that:

in Washington, the view is that the banks are to be regulated, and my view is that Washington and the regulators are there to serve the banks.

In the very next paragraph, the newspaper reported that Bachus:

later clarified his comment to say that regulators should set the parameters in which banks operate but not micromanage them."

But the damage was already done.... The candor of Bachus' initial statement is eyebrow-raising, no doubt about it, but the fuss and bother over his revelation is a little bit disingenuous.... Together with his fellow Alabaman Republican, Sen. Richard Shelby, the powerful ranking member of the Senate Banking Committee, he's part of a dynamic duo of market fundamentalist crusaders who will likely set the tone for how banking reform and regulatory oversight aimed at Wall Street are implemented for the next two years. Immediately after the midterm elections were over, and long before his confirmation as chairman, Bachus got quickly to work on his anti-regulation agenda. The day after the election, in fact, Bachus sent a letter to the Financial Stability Oversight Council, that, as I wrote last month, was written as if dictated by bank lobbyists....

Let's recap: Who hates the Volcker rule the most? The banks. Who is most annoyed by the Consumer Financial Protection Agency? The banks. Whose agenda is Spencer Bachus already serving to the best of his ability? The banks'....

The most famous Alabaman to influence how Washington regulated Wall Street was probably Henry Steagall, whose name resonates through history from its inclusion as part of the name of the Glass-Steagall Act that separated investment and commercial banking for the better part of 60 years. Both Bachus and Shelby voted to repeal Glass-Steagall, and both of them have worked hard to make sure that the spirit of regulation birthed in the Great Depression, and revivified by the Great Recession, dies stillborn. Henry Steagall was no flaming liberal, but it is hard to imagine he'd be too pleased by today's Alabama agenda.

Fiscal Policy and American Governance

As I have said often, one of Barack Obama's first moves as president should have been to announce that he would veto any bill that did not reduce the projected national debt in 2020--that that was the best way to set up the pool table to get us to policies that provide for short-term stimulative deficit spending to promote recovery and long-term budget balance to promote fiscal sanity. Obama, instead, prefers to talk about how the government must tighten its belt via discretionary spending caps and federal salary freezes in the short term while permanently extending tax reductions without regard to PAYGO for the long term.

The only saving grace is that he is not nearly as bad as his Republican counterparts.

Simon Johnson on the lack of grownups in American government:

Voodoo Economics Revisited: Democratic and Republican leaders in Washington are suddenly falling over themselves to agree on the need for major tax cuts – affecting not just middle-class Americans, but also very rich people (both living and when they die). Does this sudden outbreak of the long-desired bipartisan consensus indicate that a new, stronger America is just around the corner? Unfortunately, the opposite is true. What we are seeing is agreement across the aisle on a very dangerous approach to public finance: a continuation and extension of what President George H.W. Bush memorably called “voodoo economics.” Its consequences are about to catch up with America, and the world.

Bush was competing with Ronald Reagan for the Republican nomination in 1980. Reagan suggested that tax cuts would pay for themselves, i.e., actually raise revenue – a notion that became known as “supply side” economics. There’s nothing wrong with worrying about the disincentive effect of higher taxes, but the extreme version put forward by Reagan did not really apply to the United States. When you cut taxes, you get lower revenue, which means a bigger budget deficit. To be sure, no serious people are claiming the full Reagan effect today.... But there is a broader Reagan-type reasoning at work here....

Experience with fiscal policy over the past few decades is clear. It is worth stimulating the economy with discretionary fiscal policy only occasionally – specifically, when not doing so would be calamitous. Thus, it made sense to pursue a fiscal stimulus of some kind in early 2009.... [But today] a further fiscal stimulus may prove counterproductive, with the extra spending counterbalanced by the negative effect on the housing market of higher interest rates....

A year from now, what kind of economy will the US have? Any short-term “fiscal stimulus” effect will have worn off, unemployment will still be high, and there will no doubt be politicians clamoring for more tax cuts. The budget deficit will likely be in the range of 8-10% of GDP, even if growth comes back to some extent. And the bond markets will be much more nervous....

Some people expected Paul Ryan, a rising star within the Republican Party who will become Chairman of the House budget committee in the next Congress, to provide a fiscally responsible anchor to the next round of the deficit debate in the US. Writing in The Financial Times in early November, Ryan suggested, “America is eager for an adult conversation on the threat of debt.” But all indications are that he is just as childishly reckless on fiscal policy as most of his Republican colleagues since Ronald Reagan.

Unfortunately, there is no sign yet that the Democratic leadership is ready for a mature conversation about fiscal consolidation, either. Both parties’ leaders will get there – but only when dragged, kicking and screaming, by the financial markets.

On Tibor Moricz's "From Bar to Bar"

Gwyneth Jones:

What they say about From Bar to Bar interviews: From Bar to Bar is a fascinating and novel idea for the cyberspace interview: don’t change a word of the material the interviewee provided, but set your imagination free and change everything else! It’s an effect of lighting, decor and staging, provided (as, essentially, in all virtual worlds) by the word alone. Any writer (or any arts professional) who volunteers can be certain of gaining new insight into their own work, and seeing themselves in a new light, in the glittering refractions of the Bar to Bar hall of mirrors.

The Republican Party Has Always Been at War with Eurasia

Paul Krugman:

Orwell and the Financial Crisis: Barry Ritholtz catches AEI purging mention of deregulation from Peter Wallison’s bio. Wallison is co-director of AEI’s financial deregulation project; but he’s also one of the Gang of Four demanding that the Financial Crisis Inquiry Commission not so much as mention deregulation in its report. So Wallison’s history as an advocate of the policy that shall not be named must be expunged, I guess.

If this sounds familiar, it should. The same thing happened with Social Security privatization. There was a long effort by conservative groups to promote privatization, a term they themselves devised. Cato had a Project on Social Security Privatization. But then, when it turned out that the term polled badly, they began rewriting old records in an attempt to cover up the fact that they had ever talked about it.

As Brad DeLong says, I’ll stop calling these people Orwellian when they stop using Nineteen Eighty-Four as an operations manual.

Update: I wonder if Ezra Klein is serious when he asks whose interests are served by this. The right has always understood that the perceptions game is a long game, that you have to rewrite history on a sustained basis to shape the assumptions that govern politics. Work at it steadily, and you have even a liberal Democratic president believing that Social Security only covered widows and orphans at first, that Medicare started small, and that the Clinton-era productivity boom began under Reagan. So of course they’re working hard, right now, to expunge deregulation and shadow banking from the story of the 2008 crisis.

RomneyCare Reduces Uncertainty

David Leonhardt:

David Leonhardt: On the most basic level, the law will ensure that people can get health insurance, and thus medical care, even if they are not insured by their employer or their spouse’s employer. Today, many can’t. The people who try to buy policies in the individual market are disproportionately those who have reason to think they or their children will need medical care. Healthy people, on the other hand, often go without coverage — until they think they need it. So insurance companies charge sky-high prices for individual policies, to cover the high average costs of care. The new law takes two steps to solve the problem. First, it prohibits insurers from denying coverage or charging more because of a person’s health. Second, the law requires individuals to have insurance, spreading the costs of care among the sick and the healthy....

[T]he law is quite moderate. It is more conservative than President Bill Clinton’s 1993 plan or President Richard Nixon’s 1974 plan (in which the federal government would have covered anyone who wasn’t insured through an employer). It’s much more conservative than expanding Medicare to cover everyone. It is clearly one of the least radical ways for the United States to end its status as the only rich country with millions and millions of uninsured. But the law depends to a significant degree on the mandate. Without it, some healthy people will wait to buy coverage until they get sick — which, of course, is not an insurance system at all. It’s free-riding.

Without the mandate, the cost of insurance in the individual market would rise, perhaps sharply, because some healthy people would not be paying their share. Just look at Massachusetts. In 1996, it barred insurers from setting rates based on a person’s health but did not mandate that individuals sign up for insurance. Premiums then spiked. Since the state added a mandate in 2006, more people have signed up, and premiums have dropped an average of 40 percent.

It’s easy to look at the current debate and see an unavoidable trade-off between this country’s two economic traditions — risk-taking and security. But I don’t think that’s quite right. I think it is ultimately as misplaced as those worries about Social Security and Medicare equaling Bolshevism.

Guaranteeing people a decent retirement and decent health care does more than smooth out the rough edges of capitalism. Those guarantees give people the freedom to take risks. If you know that professional failure won’t leave you penniless and won’t prevent your child from receiving needed medical care, you can leave the comfort of a large corporation and take a chance on your own idea. You can take a shot at becoming the next great American entrepreneur.

Good News on Health Reform: The Massachusetts Individual Mandate Does Not Appear to Be Melting Down...


Austin Frakt:

Massachusetts coverage update | The Incidental Economist: The Massachusetts Division of Health Care Finance and Policy (MA DHCFP) has released the results of its 2010 household insurance survey. It’s very good news, and to tie it into current news, it continues to show the value of an individual mandate.

[N]ot only does Massachusetts continue to have the highest health insurance coverage rate in the nation, but that our state has seen gains even through an economic recession.

This year, more than 98 percent of Massachusetts residents have health insurance. These results are astonishing.

Some of the most exciting news is related to children and elderly adults, as the survey found that virtually all Massachusetts children have health insurance (99.8 percent) and nearly all elderly adults are covered (99.6 percent).

The survey, conducted by the independent Urban Institute on behalf of the Division, indicates that coverage is very strong for Massachusetts residents at all income levels, ranging from 96 percent for those with family income under 300 percent of the federal poverty level to over 99 percent of those with income above 500 percent of the federal poverty level.

Problem 4 on the Fall 2010 U.C. Berkeley Econ 1 Final...


The answer--or, at least, what I think the answer is (yes, it is cruel and unusual to ask fresh-men and -women and sophomores to do all all 8 parts in 2:30 for each part):

Let me tell you what I thought the answers to problem 4 were...

(4) Suppose that the number of espresso drinks demanded and supplied in the university city of Tall Stick are given by the equations:

Qd= 20,000 - 2000P

Qs= -10,000 + 8000P   (a) What is the market equilibrium price?

ANSWER: 30,000 = 10000P. P = $3/drink.

(b) What is the market equilibrium quantity?

ANSWER: 20000 - 2000(3) = Q. 14000 drinks

(c) What is the producer surplus?

ANSWER: The lowest-cost producer has a cost of $1.25. The highest-cost producer has a cost of $3. The average cost for producers is thus $2.12 1/2. A price of $3 gives average producer surplus of $0.87 1/2 per drink. Multiply by 14000 drinks and get $12,250

(d) What is the consumer surplus?

ANSWER: The highest-value consumer has a value of $10. The lowest-value consumer has a value of $3. The average value for consumers is thus $6.50. There are thus $3.50 of consumer surplus per drink. Multiply by 14000 drinks and get $49000.

(e) Suppose that the university students of Crony Capitalism University in Tall Stick, hyped up on caffeine, begin trashing the town and the city of Tall Stick imposes a $1 per drink graffiti clean-up tax on espresso drinks. What is the new market equilibrium price?

ANSWER: We now have 20000 - 2000(P+1) = -10000 + 8000P. 10000P = 28000. P = $2.80. (P to consumers is now $3.80)

(d) Suppose that the university students of Crony Capitalism University in Tall Stick, hyped up on caffeine, begin trashing the town and the city of Tall Stick imposes a $1 per drink graffiti clean-up tax on espresso drinks. What is the new market equilibrium quantity?

ANSWER: -10000 + 8000(2.80) = 12,400 drinks

(g) Suppose that the university students of Crony Capitalism University in Tall Stick, hyped up on caffeine, begin trashing the town and the city of Tall Stick imposes a $1 per drink graffiti clean-up tax on espresso drinks. What is the new total surplus assuming that $1 of government revenue has the same social value as $1 of consumer or producer surplus?

ANSWER: An extra-credit answer points out that we do not know whether the $1/drink tax is the right Pigouvian tax or not, and then goes on to solve the problem making some assumption about what graffiti-damage-per-drink is. An answer that gets full credit assumes that $1 per drink is the right Pigouvian tax, in which case we have:

Producer surplus: 12400 x (2.80 - 1/2 x (2.80 + 1.25)) = 9610
Consumer surplus: 12400 x (1/2 x (3.80 + 10) - 3.80)) = 38440
Graffiti damage: -12400
Value of cleanup: 12400

Total: 48050

(h) In (g), what must be the value of each $1 spent by the city of Tall Stick on graffiti cleanup for the decision to impose the $1 per drink tax and then spend all the revenue on graffiti cleanup to raise social welfare? 

ANSWER: Once again, an extra-credit answer points out that we do not know whether the $1/drink tax is the right Pigouvian tax or not, and then goes on to solve the problem making some assumption about what graffiti-damage-per-drink is. An answer that gets full credit assumes that $1 per drink is the right Pigouvian tax, in which case we have:

Surplus with tax: 48050 + (b-1)(government revenue), where b is the value of $1 spent on graffiti cleanup

Surplus without tax: 49000+12250-14000 = 47250

48050 + (b-1)(revenue) = 47250
800 = (1-b)12400
1-b = 800/12400
1-b = .06129
b = 0.9355

So as long as $1 of cleanup does at least $0.9355 worth of graffiti removal, the tax is a good idea (although not necessarily the best idea).

We Have a Winner in the Stupidest Economist Alive Competition: Keith Hennessey, Douglas Holtz-Eakin, Bill Thomas, and Peter Wallison


Shame on them. Hennessey and Holtz-Eakin were economists--once.

Mike Konczal:

Keith Hennessey, Douglas Holtz-Eakin vote to remove phrases “Shadow Banking”, “Interconnectedness”, “Deregulation” from FCIC Report: So the Financial Crisis Inquiry Commission (FCIC), the bipartisan panel created to study and issue a report on the financial crisis, imploded. The four Republican appointees – Peter Wallison, Keith Hennessey, Bill Thomas and Douglas Holtz-Eakin – have decided to go it alone and issue their own report Wednesday. Politico, and the Wall Street Journal have more. This will no doubt play into a “Democrats say one thing, Republicans say another thing, who can really tell?” narrative, but what is leaking out of the Republican worldview on the financial crisis is disturbing. Shahien Nasiripour, Financial Crisis Panel In Turmoil As Republicans Defect; Plan To Blame Government For Crisis, catches this gem:

During a private commission meeting last week, all four Republicans voted in favor of banning the phrases “Wall Street” and “shadow banking” and the words “interconnection” and “deregulation” from the panel’s final report, according to a person familiar with the matter and confirmed by Brooksley E. Born, one of the six commissioners who voted against the proposal.

“I think a number of us had really pulled for” bipartisan consensus, said Born, a Democratic commissioner who famously tried to regulate certain derivatives as head of the Commodity Futures Trading Commission. “But this action by the Republicans indicates they have decided to go their own way.”... Hennessey and Holtz-Eakin, for example, have missed about half of the commission’s meetings since [early August], according to a person familiar with the panel’s activities.

Oh. My. God.

I did an interview for the Atlantic Business section about the shadow banking system with Perry Mehrling last year, who has now written a fantastic book about the subject, The New Lombard Street.... Banks have well known problems, and one thing we’ve learned from the crisis is that you can provide maturity transformation – function just like a bank, have bank runs just like a bank – without hanging a sign with the words “bank” on your storefront. How to deal with this, how to fully understand it even, is crucial to understanding the crisis and the way forward.  Here’s Gillian Tett covering a fascinating (and detailed) report by the Federal Reserve Bank of New York Staff Reports titled “Shadow Banking.” Every person I know interested in this topic is reading it, trying to understand the complicated nature of the topic;  evidently that GOP would think this report shouldn’t be covered because of its name is really disturbing.

Even if you think this narrative is overplayed it needs to be discussed and examined. That they would vote to not even use the words says all you need to know...

Nouriel Roubini on Our Fiscal Follies


We need to loosen fiscal policy now and tighten fiscal policy later. That really does not look to be what we will do.

Nouriel Roubini:

Fiscal Follies by Nouriel Roubini: In the US, we have the worst of all possible worlds. On one hand, stimulus had become a dirty word – even within the Obama administration – well before the Republicans’ mid-term election victory ruled out another round altogether. On the other hand, medium-term consolidation will be all but impossible in America’s current atmosphere of hyper-partisanship, with Republicans blocking any tax increase and Democrats resisting reforms of entitlement spending. Nor is there any pressure from bond markets to concentrate the minds of policymakers.

In the periphery of the eurozone, the problem is the opposite: bond vigilantes are demanding that Greece, Ireland, Portugal, Spain, and Italy front-load fiscal consolidation or watch their borrowing costs go through the roof.... Markets don’t care that front-loaded fiscal consolidation is exacerbating recession and thus making the goal of reducing debt and deficits as a share of GDP near-impossible to achieve.

To avoid a persistent and destructive recession, the fiscal and structural reforms imposed by the bond vigilantes should be accompanied by other euro-zone policies that restore growth and prevent vicious debt dynamics. The European Central Bank should ease monetary policy in order to weaken the value of the euro and bootstrap the periphery’s growth. And Germany should cut taxes temporarily – rather than raising taxes, as planned – in order to increase disposable income and stimulate German demand for the periphery’s goods and services.

Alas, neither of the two biggest players in the euro zone is pursuing policies consistent with restoring sustained growth in the euro zone’s periphery. The ECB’s monetary policy is too tight; and Germany is front-loading fiscal austerity. Thus, the periphery is destined to a destructive deflationary and recessionary adjustment that will exacerbate the risks of recession, insolvency, eventual defaults and, possibly, exit from the euro.

In the United Kingdom, the new government gave several reasons for front-loading fiscal consolidation. The bond vigilantes might have woken up if early austerity was not implemented; the deficit was very large and the public sector bloated; and it is always politically easier to implement tough measures early in an administration, when popular support is still high and the next election is far off.... [T]he government could well end up with no plan B in case plan A – massively front-loaded austerity – leads to a double-dip recession...

We Are Lucky to Have Shirley Sherrod Among Us


Kathy Politt:

Comment is free | For courage and grace under truly nonsensical fire, Shirley Sherrod, former Georgia state director of rural development for the US Department of Agriculture, is my hero of the year.

On 19 July, rightwing blogger Andrew Breitbart released video excerpts of a speech Sherrod, who is black, had given atan NAACP event in March, in which she supposedly boasted that she had dragged her feet in helping a white farmer. Within moments the story went viral – and vicious – throughout the conservative media; Ben Jealous, head of the organisation, tweeted his disapproval of Sherrod; by the end of the day, agriculture secretary Tom Vilsack had fired her.

In fact, the excerpts completely misrepresented the speech in which Sherrod movingly described feelings she had had to overcome (and did overcome) when in 1986 a white farmer, Roger Spooner, had come to her for help saving his farm. Given that Sherrod's father had been murdered when she was 17 years old by a white person who was never prosecuted and that a cross had soon after been burned in front of the family home, perhaps she had a lot to get over. The next day, the now very elderly Roger and Eloise Spooner stepped forward to defend Sherrod for having saved their land. Obama called and Vilsack offered to give her back her job. Sherrod declined.

The real Shirley Sherrod has been a well-known civil rights activist in Georgia since the late 60s. What does it say about the US that a hack like Breitbart can destroy a decades-long career in one day? That the head of the nation's premier civil rights organisation is so ignorant of the history of his own movement? That the administration of the first black president is so fearful of the rightwing media that it didn't even take a day to think it over before jumping on their absurd bandwagon?

In a just world, Vilsack would have been fired and Sherrod would be sitting at his desk. In this world, she has the satisfaction that, of all the people involved in this sordid tale, she and those ancient white farmers kept their heads, their dignity and their historical memory intact.

Bond Markets Show a Welcome Decline in Fear and Panic

FRED Graph - St. Louis Fed.jpg

Martin Wolf:

Why rising rates are good news: Terrified by irresponsible fiscal and monetary policies, the bond market vigilantes are out in force. So rose the cry, as rates on government bonds jumped last week. Alas for the panic-mongers, this glib story is nonsense. What is happening is a move towards normalisation. That is excellent news. Policy is working. That does not mean it could not be improved. But what is astonishing is not how high nominal and real interest rates have become, but how low they remain. They are likely to rise substantially if and when less abnormal conditions arrive.

What has happened? Between November 30 and December 13 2010, the yield on 10-year US government bonds jumped by 0.49 percentage points.... Are these jumps significant? No. In the case of the US, rates are back where they were in June 2010, before the marked fall in optimism about economic prospects....

To understand what is going on, we need to distinguish the role of shifts in real interest rates from that of shifts in inflation expectations. Fortunately, inflation-indexed bonds allow us to do just that. In the US, the recent rise in nominal rates is explained almost entirely by the rise in the real rate, not by a rise in implied inflation expectations. To be precise, the rise in real rates turns out to explain 76 per cent of the jump from November 30 2010 and 83 per cent of the jump from November 4 2010.... Do these jumps in long-term interest rates mean that the Fed’s quantitative easing programme has failed? Absolutely not. The Fed’s aim is to make rates lower than they would otherwise be and so raise economic growth and eliminate any threat of deflation. Rates are still remarkably low. They are rising because of a jump in real rates that almost certainly reflects improved prospects for growth. I would imagine that the Fed is pleased with the picture it sees before it....

Are long-term interest rates likely to rise still further? Definitely....

In all, what has happened in bond markets is encouraging. Rates are rising, as depression psychology dwindles. With luck, the recovery is going to take hold. Hurrah!

Scott Sumner Plumps for Nominal GDP Targeting--of a Sort


It is a very interesting article. The first half of it is the best conservative argument for nominal GDP targeting that I have ever seen. Then the going gets somewhat weird, for it is a somewhat strange form of nominal GDP targeting he ultimately calls for...

The start of his essay:

Money Rules: Once the devastating costs of deflation are acknowledged, one can no longer imagine an earlier age when the dollar was “as good as gold.” A gold standard stabilizes the price of one good, gold itself, at the cost of allowing instability in the overall price level.... Nor can we avoid the pitfalls of previous gold-standard regimes by getting government out of the picture. If governments did not hold gold reserves for monetary purposes, the value of gold would be even more closely tied to fluctuations in the industrial demand for the metal. In recent years, almost all metals prices have become highly unstable, as rapid industrialization in Asia has pushed up their prices relative to those of other goods. Fixing the nominal price of gold will not lead to price stability.

For better or worse, conservatives need to acknowledge that we live in a fiat-money world, and we need to figure out a way of managing paper money... we can’t dodge the hard questions of macroeconomics and blithely assert that we oppose the Fed’s “meddling” in the economy. There is no laissez faire in fiat money. If the Fed holds the money supply constant, it will be changing the interest rate and the price level. And if it holds interest rates constant, it loses control over the price level and money supply. As a result, many economists now favor some sort of inflation-targeting regime.... But inflation targeting has several defects that in my view make nominal income (or GDP) stabilization a better goal.

One well-known argument against inflation targeting is that there are times when price-level fluctuations are desirable... during a productivity boom, it might be better to have a mild deflation in order to prevent labor markets from overheating. Conversely, a negative supply shock ought to make inflation rise: We don’t want to force all non-energy prices to fall to make up for an oil embargo.

Most of the problems that are believed to flow from an unstable price level actually result from nominal-income instability... Borrowers almost always have trouble repaying debts when nominal income comes in much lower than was expected when the debts were contracted. Some people overlook this problem because they focus on the most spectacular debt problems.... But those cases are merely the tip of the iceberg; the sort of systemic debt problem now faced by the Western world goes far beyond these isolated cases, and can be explained only by the fall in nominal income.

Would my proposal for NGDP targeting merely bail out reckless borrowers? No; I am asking the Fed to provide a stable policy environment for the negotiation of wage and debt contracts. Right now, a sudden fall in NGDP growth tends to lead to mass unemployment, lower profits, and sharply higher debt defaults. An unexpectedly large increase in NGDP would cause problems of its own when the stimulative effects wore off. In fact, it is our current policy that is unfair....

If the Fed decides to target NGDP, it will need to choose an optimal growth rate.... There are two NGDP target paths that might be politically acceptable... 3 percent... 5 percent.... The Fed clearly thought that 5 percent nominal growth was fine during the Great Moderation, but the near-zero nominal growth over the past few years has had a disastrous impact, much worse than it would have, had it been expected and factored into wage and debt contracts negotiated in earlier years...

Then, however, things in the essay do get somewhat weird, for it is a somewhat strange form of nominal GDP targeting he ultimately calls for.

It is not that the Federal Reserve buys and sells bonds (government and perhaps private) for cash in order to try to get the money stock and other variables to levels that lead its forecasters to predict that nominal GDP will grow at, say, 5% per year.

Instead, Scott writes that:

[t]he Fed would simply define the dollar as a given fraction of 12- or 24-month forward nominal GDP, and make dollars convertible into futures contracts at the target price.... The public, not policymakers in Washington, would determine the level of the money supply and interest rates most consistent with a stable economy...

As I understand Scott's proposal, it is this: Nominal GDP in the fourth quarter of 2007 was $14.291 trillion. A 5% growth rate from that base would give us a value of $17.455 trillion for the fourth quarter of 2011. Add on another 3% for the average short-term nominal interest rate we would like to see, and we have $18.153 trillion. Therefore the Federal Reserve would, today, announce that it stands ready to buy and sell dollar deposits to qualified customers at a price of $1 = 1/18,155,000,000,000 of 2011Q4 GDP.

If investors thought that nominal GDP in the fourth quarter of 2011 was likely to be lower than $18.15 trillion, they would take the Fed up on its offer: demand the cash now, pay off the contract in a year by then paying 1/18,155,000,000,000 of 2011Q4 GDP, and (hopefully, if they were right) make money--thus the money stock would increase. If investors thought that nominal GDP in the fourth quarter of 2011 was likely to be greater than $18.155 trillion, they would take the Fed up on its offer: give cash to the Fed now, collect the contract in a year by receiving 1/18,155,000,000,000 of 2011Q4 GDP, and (hopefully, if they were right) make money--thus the money stock would fall.

If nominal GDP were expected to fall, the Federal Reserve would be shoveling money out the door at negative expected nominal interest rates. If his scheme were applied today it would be quantitative easing on a pan-galactic scale, as everybody would run to the Fed with bonds to use as collateral for their promises to pay the expected futures contract in a year in exchange for the cash now.

The Federal Reserve would then become truly the lender of not just last but first resort. Why would anybody borrow on the private market even at 0% per year when they could borrow from the Fed at -3%/year? Savers would simply hold cash rather than try to match the terms that the Fed was offering borrowers. Borrowing firms would borrow from the Fed exclusively. The Fed would thus create a wedge between the minimum nominal interest rate that savers would accept (zero, determined by the alternative of stuffing cash in your mattress) and the nominal interest rate open to borrowers.

I see how this would solve a monetarist downturn--a shortage of liquid cash money projected to lead to nominal GDP below its target. Once arbitrage had kicked in there would be no shortage of cash money.

I see how this would solve a Keynesian downturn--a shortage of savings vehicles that means that balancing savings and investment at full employment requires a nominal interest rate of -3%, which the zero-bound keeps you from getting to. The Fed would lend to all comers at a nominal interest rate of -3%.

I cannot quite see how this would solve a Minskyite downturn--a flight to quality because of a collapse in the market's risk tolerance and a shortage of safe assets. But perhaps this is because I am a bear of too little brain to figure it out during the Econ 1 final when the GSIs are glowering at me because I am supposed to be outlining the answers for the essay questions...

Scott goes on, anticipating that implementation of his proposal would bring the New Jerusalem: "And the building of the wall of it was of jasper: and the city was pure gold, like unto clear glass. And the foundations of the wall of the city were garnished with all manner of precious stones. The first foundation was jasper; the second, sapphire; the third, a chalcedony; the fourth, an emerald; 20: The fifth, sardonyx; the sixth, sardius; the seventh, chrysolite; the eighth, beryl; the ninth, a topaz; the tenth, a chrysoprasus; the eleventh, a jacinth; the twelfth, an amethyst":

This sort of policy regime addresses many of the liberal arguments for big government. Right now conservatives don’t have good counterarguments to Paul Krugman’s insistence that all the laws of economics go out the window when we are in a “depression.” Classical economics assumes full employment; how credible are classical arguments against federal job-creation schemes when unemployment is 9.8 percent? Yes, government intervention doesn’t even work very well when there is economic slack. But with NGDP futures targeting, there is no respectable argument for fiscal stimulus, as the money supply would already be set at the level expected to produce the desired level of future nominal spending.

In a world of NGDP futures targeting, liberals would no longer be able to mock those who invoke Say’s Law (supply creates its own demand). It would be transparently obvious that any auto demand created by a bailout of GM would be at the expense of less demand in some other sector of the economy. Nor would the Washington elites be able to intimidate people into bailing out the big banks by pointing to the specter of an economic depression. Banks would fail, but the money supply would adjust so that expected future nominal spending continued to remain on target. Creative destruction could do what it’s supposed to do, with jobs lost in declining industries being offset by jobs gained in creative new enterprises.

There are two types of conservatism. One is pessimistic, resentful, dismissive of any claims of progress in governance. It relies on nostalgia for a mythical golden age, before big government ruined everything. It is scornful of intellectual inquiry into new policy approaches. Nominal GDP futures targeting is part of an optimistic, forward-looking conservatism; it is progressive in the best sense of the term. It is based on time-tested conservative principles, such as the fact that markets can set prices and quantities better than government can, but also builds on the serious academic work of scholars such as Milton Friedman, who understood the devastating effects of a serious plunge in nominal output. There’s no going back, but we can build a monetary regime that undercuts the liberal arguments for big government while providing an economic environment where capitalism can flourish.

I am somewhat skeptical. It seems to me that sensible fiscal policy might be better than mega-TARP helicopter drops to bankers under some circumstances. And people even quarrel over the construction of the New Jerusalem. Wikipedia:

Revelation lacks a list of the names of the Twelve Apostles, and does not describe which name is inscribed on which foundation stone, or if all of the names are inscribed on all of the foundation stones, so that aspect of the arrangement is open to speculation. The layout of the precious stones is contested. All of the precious stones could adorn each foundation stone, either in layers or mixed together some other way, or just one unique type of stone could adorn each separate foundation stone...

Yes, of Course Nick Clegg Should Blow Up Britain's Conservative Government and Send Miliband to Kiss the Queen's Hands. Why Do You Ask?


Nick Clegg is on the road to winning the contest to be the worst British politician since Ramsey MacDonald.

Philip Stephens:

Britain’s coalition badly needs a Plan B: The uproar over higher education funding has exposed what was always going to be the coalition’s weak point. Nick Clegg’s Liberal Democrats – the junior partner – have found themselves serving as the lightning rod for public anger at policies framed by David Cameron’s Conservatives. The steep rise in student tuition fees was a Conservative choice. You would not think so from the public furore. Mr Cameron, who has a habit of putting himself above the fray at awkward moments, has artfully left Mr Clegg to absorb the opprobrium. Voters could be forgiven for thinking that the Lib Dem leader had been the architect of a policy that he and his party had roundly denounced during the election campaign.... There will be other collisions. The coalition agreement promised Mr Clegg’s Lib Dems an end to top-down reorganisations of the health service. Yet Andrew Lansley, the Tory health secretary, is now pushing through the most radical shake-up since the inception of the NHS....

It is the economy that will make the political weather during the first half of 2011... things will be grim.... It is hard to see where the growth will come from. Value added tax is set to rise in January. The Bank of England’s suspension, in effect, of its 2 per cent inflation target will see a further squeeze on household incomes as prices outpace wages. Swingeing spending cuts will see the public sector shed programmes and jobs ahead of the new financial year.

The government’s answer is that exports and investment will do the trick. The very radicalism of its planned fiscal retrenchment will persuade business that better times are around the corner.

Not everyone is so confident. A confidential paper circulating in Downing Street suggests the government should consider in advance if not a fully worked up “Plan B” then at least a series of possible stimulus measures.... [M]ore quantitative easing by the Bank... lend directly to business through buying commercial as well as government bonds... accelerate spending in infrastructure.... Tax cuts would be another option....

The fundamentalists... may be proved right. As in the 1930s, they have the Bank governor on their side, though that is hardly a recommendation. I have not come across many practical economists who share their confidence....

The government really should have a Plan B. Mr Clegg might consider whether he also needs a Plan C.

Nick Rowe on Why the Austrian Theory of the Business Cycle Is Arrant Nonesense


As Milton Friedman once said, Friedrich von Hayek was a great economist, but his contributions definitely did not lie in business cycle theory.

Nick Rowe:

Worthwhile Canadian Initiative: Money, Barter, and Recalculation: The [economic] calculation problem doesn't solve itself. It takes people to solve it. The price system helps them solve it. Monetary exchange helps them solve it. But it isn't easy to solve.... And if technology, resources, and preferences are changing as well, people have to keep re-solving it. That's what I take to be the [economic] re-calculation problem.

But that re-calculation is happening all the time. What's it got to do with recessions?

The answer, as Nick says very well, is "absolutely nothing":

Sure, sometimes a really big real shock comes... and it takes a lot more re-calculation than it normally does.... [A] financial crisis isn't... a change in the underlying tastes, technology, and resources.... But... it too would require a re-calculation. And maybe output would fall while we are trying to figure out how to re-solve the economic problem. Maybe even employment would fall too:

Hang on guys, don't commit to doing anything quite yet, while I try and figure out where you should best be working now that everything's changed...

But I just can't buy it as a full story of recessions. It's the general glut thing that's missing. Stuff gets easier to buy in a recession, and stuff gets harder to sell.... What makes a recession a recession, and something more than a bad harvest, or a re-calculation, is that most goods, and most labour, gets harder to sell and easier to buy. And I really want to call that an excess demand for money. Because it is money we are selling stuff for, and it is money we are buying stuff with. And... I've also got a theory... which says that an excess demand for money will cause a drop in output and employment, and an excess supply of goods and labour...

Why Oh Why Can't We Have a Better Press Corps? (Sewell Chan of the New York Times Edition)


That Thomas Hoenig has consistently overestimated the impact of Fed policy on the inflation rate throughout his tenure at the Kansas City Fed does not mean that he is wrong today. But it is something that a reporter like Sewell Chan needs to put his article. Chan's failure to do so breaks his contract with his readers:

Hoenig, Contrarian at the Fed, Keeps Wary Eye on History: As the lone dissenter on the Federal Reserve committee that sets interest rates, Mr. Hoenig, the president of the Federal Reserve Bank of Kansas City, has been a persistent skeptic of just about everything the Fed’s chairman, Ben S. Bernanke, has done to try to stimulate the flagging recovery. Mr. Hoenig’s latest, loudest objections, aimed at the Fed’s risky $600 billion infusion into the markets to reinvigorate the economy, have made him a champion of the Fed’s critics in Congress, on Wall Street and among business leaders, who, like Mr. Hoenig, fear that the central bank is risking runaway inflation, asset bubbles and a weakened dollar.... To him, Mr. Bernanke’s plan is “a dangerous gamble” and “a bargain with the devil,” strong words that have rankled some officials of the Fed, where dissent is tolerated but not celebrated....

Why oh why can't we have a better press corps?

What Does an Unmanaged Macroeconomy Look Like?

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In some very nice musings about Lawrence Summers's farewell address, Greg Ip commits one misstep when he writes that:

What will scholars’ verdict of Mr Summers’ contribution be?... The pessimistic view... macroeconomic activism failed because its success in the decades before the crisis sowed the seeds of ever more risk-taking and complacency...

It is certainly possible that the relative macroeconomic calm of what we used to call the "Great Moderation" from 1985-2005 played a material role in setting the stage for our current volatility and distress. But in the larger sweep of history, even our current volatility and distress has been quite effectively handled and managed--at least compared to what went on back before the U.S. government and the Federal Reserve took on the mission to attempt and handle and manage the macroeconomy.

We can see this if we take a look back and ask the question: what does an economy without effective macroeconomic regulation look like?

We do not have all that many examples. Britain's Bank of England started regulating the macroeconomy in response to the industrial business cycle back in 1825. The Bank of France was not far behind. Almost as soon as a country had a capital-intensive industrial sector capable of generating a modern business cycle, it had a central bank to stabilize its macroeconomy.

The U.S. was an exception. It lost its proto-central bank to Andrew Jackson in the 1830s. It did not acquire a central bank until 1913--and the central bank had no clue what to do in a recession after the death of Benjamin Strong in 1928. The pre-World War II U.S. was as close to an economy without effective macroeconomic regulation as we have--and even there we have occasional monetary and banking policy conducted by the pickup central banks that were the House of Morgan in 1907 and the Belmont-Morgan syndicate in 1895. It was the passage of the Employment Act of 1946 that marked the start of systematic stabilization policy in the United States.

And, at least from the perspective of the metric that is the non-farm unemployment rate--the agricultural sector does not have an industrial business cycle, after all--there is no evidence that macroeconomic management has not been vastly better than the alternative.

Greg Ip:

American economic policy: The legacy of Larry Summerst: FOR two years the Obama Administration’s economic policy has been caricatured from the right as an invasive expansion of government and from the left as a cowardly capitulation to Wall Street free market fundamentalism. How can it be both things at once? It helps to understand the philosophy of the man who most embodies that policy, Larry Summers, who today delivered perhaps his final public speech as Barack Obama’s National Economic Council director. The "Summers Doctrine" fuses microeconomic laissez faire with macroeconomic activism. Markets should allocate capital, labour and ideas without interference, but sometimes markets go haywire, and must be counteracted forcefully by government.

The most liberal economists concede the intrinsic superiority of markets in allocating real economic resources but many make an exception for financial markets. Mr Summers doesn’t, and that’s what critics from the left most hold against him. In his tenure in the Clinton Administration he championed the repeal of  Glass-Steagall and blocked Brooksley Born’s efforts to regulate over-the-counter derivatives. Mr Summers holds regulators in low esteem.... He brought this view with him to the White House, battling efforts on the Hill and inside the Administration to nationalise banks, corral bankers’ pay, or curb derivatives and trading activity.

Yet Mr Summers’ mistrust of government is not the same as a trust in markets.... Mr Summers supplemented his academic appreciation of markets’ limitations with real-world experience in the Clinton Administration. The Mexican and east Asian financial crises demonstrated to horrific effect how markets could rapidly go from complacency to panic. Mr Summers sums up the lesson with a line he attributes to former Mexican president Ernesto Zedillo: “Markets overreact—and that means policy has to overreact.” Crises call for the financial equivalent of the “Powell Doctrine”: the application of overwhelming monetary force so that market participants have no doubt about the ability and will of policymakers. Austrian economists fret that this simply sows moral hazard; to Mr Summers, this was precisely the point: with the government providing insurance against catastrophe, investors could take more risks, generating more innovation, more growth, and more welfare....

When Mr Summers reflected on his two years in the White House in today’s speech....

Scholars … will continue to debate just how close the American financial system and economy came to all-out collapse in the six months between September of 2008 and April of 2009… Had it not been for President Obama’s willingness to support a sufficiently aggressive response … I have little doubt that we would be looking at a vastly different world today.

He framed the recent tax deal Mr Obama negotiated with Republicans the same way. Excluding the extension of expiring tax provisions, it contains about $280 billion of new stimulus. Only by the standards of the last few years is that less than overwhelming. Mr Summers went on:

It is right and necessary for government to counteract private sector deleveraging. … Even with our deficits, the amount of extra debt is less than the amount of reduced borrowing in the private sector… the recent tax agreement … averts what could have been a serious collapse in purchasing power and adds far more fiscal support than most observers thought politically possible.

What will scholars’ verdict of Mr Summers’ contribution be?... The optimistic view is that the economy is now in a sustained, though restrained, recovery that will prove Mr Summers right. The pessimistic view takes two paths. One follows Ireland, a country that applied more Powell doctrine than it could afford; by guaranteeing all its banks’ liabilities it has undermined the solvency of the sovereign. This seems unlikely. The other follows Japan into a trap of stagflation and deflation, one that Mr Summers is unwilling to dismiss: “The risks of deflation or stagnation in the United States exceed the risks of uncontrolled growth or high inflation.” If that is indeed America's fate, we may conclude that macroeconomic activism failed because its success in the decades before the crisis sowed the seeds of ever more risk-taking and complacency...

There Are at Most 13 Deficit Hawks in the Senate

A deficit hawk is somebody willing to vote against bills that increase the national debt--that do not contain within themselves provisions to recapture revenue and cut spending that lead to a reduction in the projected national debt within, say, ten years.

There are at most 13 deficit hawks in today's U.S. Senate:

Bipartisan support as tax deal advances in Senate: By James Politi in Washington: The deal struck by the White House and Republican leaders to prevent the expiry of Bush-era tax cuts advanced with overwhelming bipartisan support in its first vote in the Senate, building momentum in favour of the legislation.

The agreement would extend income tax rates for two years and unemployment benefits for 13 months, while cutting the payroll tax by 2 percentage points. It would deliver an extra $200bn in fiscal stimulus to the economy compared with economists’ expectations and bolster growth in 2011, but it would add to the US debt burden.

The margin in the procedural vote to end debate, known as “cloture”, was comfortable. By the evening, at least 82 of 100 senators had voted in favour of the deal, with 13 against. The vote paves the way for final passage by the Senate as soon as Tuesday and makes it harder for House of Representatives members to oppose it this week...

Lawrence H. Summers: Farewell Address at the Economic Policy Institute


Larry Summers:

It's a pleasure to be here at EPI this morning.

For 25 years, your distinctive and important voice has helped underscore in our national debate the central importance of economic policies that support a growing, striving, proud American middle class. It is by what happens to the middle class that our economic policies have to be judged. Success for the middle class means:

  • A better life for our citizens
  • Upholding the 250 year American tradition of children whose lives are better than their parents'
  • And central to America's continuation as a role model for the world.

I want to say a brief word about what we have done over the past two years to strengthen the economic position of the middle class, and then turn to what I see as the great challenges that we face in the years ahead if the American economy is to work for all our people.

Just as scholars continue to debate how close we came to nuclear conflict during the Cuban missile crisis, they will continue to debate just how close the American financial system and economy came to all-out collapse in the six months between September of 2008 and April of 2009. What we do know is:

  • That during that time the stock market fell more sharply than in the six months after Black Tuesday in 1929
  • That global trade declined more rapidly than in the first year of the Great Depression
  • And that the economy was not self equilibrating and that a variety of vicious cycles were pulling it down even deeper, at a rate of 700,000 jobs a month at the worst of it.

Had it not been for President Obama's willingness to support a sufficiently aggressive response – from the late stage of the presidential campaign to his first days and months in office – I have little doubt that we would be looking at a vastly different world today. His stalwart advocacy of efforts to support the economy through the Recovery Act, to rescue the financial system, to ensure the health of key industries, and to maintain stability in the global system halted the vicious cycles in less time and at less cost than virtually anyone thought possible.

Yet, while the economy may be out of the intensive care unit, the patient now faces the long road of not just recovering from previous affliction but beginning to address chronic ailments. The slow process of recovery has caused some to conclude that perhaps we have entered a new and weakened normal state of affairs – a state in which we must lower our sights, lower our aspirations, and not be able to pass on to the next generation the kinds of dramatic improvement in American economic potential that were passed down to us.

President Obama rejects this view, and so should the rest of us. With the right approach, we can and we will resurrect, rebuild and renew the American economy. To do this, we need to do two profoundly important things in the years ahead.  Both are necessary, neither is sufficient.

First, we must generate forward momentum in the economy to fully recover from the Great Recession, and second, we must put in the place a framework that assures that our growth, productivity and living standards remain an example to a rapidly changing world.

First, we must do everything we can to ensure that this recovery is as rapid as possible. Without rapid recovery, every other one of our goals will be compromised. In the absence of recovery, there is no prospect of reducing medium-term budget deficits while simultaneously increasing investments in our human capital, without which we will not compete successfully with the rest of the world or grow living standards for the middle class, and above all, putting the 8 million Americans who should have jobs back to work.

What is holding our economy back?

  • When unemployment has been above 9% for 19 straight months,
  • When the job vacancy rate is at near record low levels,
  • When 8 million houses and countless square feet of office and retail space sit empty,
  • When capacity utilization in the nation's factories and on its railways and highways is nearly as low as it has been in any period since the Second World War,
  • There cannot be any question that the constraint on our economy now and for the next several years will be lack of demand.

I am under no illusion that increased demand alone is sufficient to restore America's economic health, but it is an unquestionably necessary component of a full recovery. Unfortunately, the approaches we have become used to over the last fifty years for supporting demand in a market economy are not open to us today. Base interest rates cannot fall below their current level of zero. And, in the face of excess capacity and excess debt, it is not clear that, even if they were possible, falling interest rates would be effective in convincing consumers and businesses to spend more.

We need non-traditional approaches.

Take exports. It is always the case that when we export more successfully we are more prosperous.  But when the economy is demand-constrained as it is now, increases in exports have a more potent effect because with excess capacity more exporting does not mean less of anything else. That is why agreements like the one we recently concluded with Korea are important, as is the breadth of the support it has received. It is also why the President has set a goal of doubling our exports over the next five years and pointing to ways we can do so:

  • Enforcing our trade agreements,
  • Relaxing export controls,
  • Standing up diplomatically for American producers,
  • And insisting in global fora on the rebalancing of the global economy.

Promoting exports, though, will not be enough to assure adequate demand.

In the decade prior to the current downturn, the American household and business sectors, if you added them together, spent close to two percent of GDP more than they earned.  They were net borrowers.  As a consequence of the developments of recent years, this situation has changed dramatically. Private spending now falls nearly 6 percent short of private sector income.  That means to private sector has swung in its deficit by about 7.5 percent from about a two percent deficit to a little less than a six percent surplus.  That swing, all of which means less demand, is one of the reasons we are suffering the aftermath of the worst recession in 50 years.

It is right and necessary for government to counteract private sector deleveraging. Even with all the fiscal measures of the last several years, total borrowing in the American economy has failed to grow for the last 2 years.  That is the first two year period since the Second World War when total borrowing in the U.S. economy has not increased. Let me be clear: Even with our deficits, the amount of extra debt is less than the amount of reduced borrowing in the private sector.  Increased federal borrowing has offset, but only partially, deleveraging in the private sector. This is why the recent tax agreement concluded between the President and congressional leaders is so important.  It averts what could have been a serious collapse in purchasing power and adds far more fiscal support than most observers thought politically possible through:

  • An extension of unemployment insurance,
  • A payroll tax holiday,
  • Refundable tax credits and business expensing.

That's why independent estimates of job creation over the next year or two are being revised up by 1.5 million or more.

These measures not only support jobs but also our medium-term goal of deficit reduction. By retiming allowances, business expensing actually raises revenue collections after 2013. Accelerating recovery, the additional effect of these measures, is the best form of deficit reduction.  Indeed, a one percent increment to GDP in 2013 or any year afterward reduces the deficit by more than $40 billion.

To be sure, this legislation is a compromise. The President strongly opposed continuation of the high-income tax cuts and especially opposed the estate tax relief that benefits only 6,400 of the country's least needy families. These concessions were the price exacted by the Congressional minority for the fiscal support that will provide a significant impetus to the economy. But be clear that compromises that were necessary with a weak economy in 2010 should be inconceivable as recovery accelerates in 2012.

Now the extraordinary gap that I referenced a moment ago has opened up between private saving and private investment.  The tax compromise will help, but it is not enough. At a time when real interest rates even over 30 years are less than 2 percent, at a time when construction unemployment is nearly 20 percent, and at a time when building material costs are depressed, what better time to invest in renewing and upgrading our nation's infrastructure – working off a backlog of deferred maintenance and insufficient investment? A substantial, sustained effort to rebuild America should be at the top of Washington's priority next year.

These measures, taken together, will accelerate recovery.  Accelerating recovery and increasing demand will mean more workers with jobs, more employers in a position to provide training, more capital investment in capacity for the future, more revenues for state and local governments to make the investments that are crucial for them. Without increased demand we are not in a position to pursue our longer-term objectives.

In a demand constrained economy like the one we have today and will have for several years, economics is turned topsy-turvy. As Keynes pointed out in his celebrated Paradox of Thrift, individual efforts to save more lead to less total saving.  More educated workers get jobs but with demand constraints those job opportunities come at the expense of their less educated neighbors.  With demand constraints, increases in productivity may act to exacerbate deflationary pressures and increases in efficiency may result in more unemployment rather than more output. That is why we have to drive recovery and remove the demand constraint on the economy.

At the same time, it is essential that we recognize that fiscal and monetary policy or increases in demand never made a society prosperous, fair, or strong. We need to renew the American economy for a century that will be very different from its predecessor. A key lesson that management strategists have distilled for businesses is this: you don't succeed by producing exactly the same thing that other people are producing in the same way just at a lower cost. You succeed, by establishing your own uniqueness and excellence. Think of the distinctiveness of products like Google's search engine; the iPad or a Harley-Davidson. Think of the distinctive way that Southwest or Nucor or even Walmart deliver their products and services. The United States has led the global economy by building on its unique capacities. By building on our distinctive strengths, we can continue to lead in the next century.

There is no going back to the past.  Technology is accelerating productivity in mass production to the point where even China has seen manufacturing employment decline by more than ten million jobs over the most recent decade for which data is available. We are moving towards a knowledge and service economy.

Another inescapable truth is that the world is shrinking.  When I worked in Jakarta just 30 years ago I tried to follow the Red Sox.  When the Red Sox played on Tuesday night, I learned how they did on Friday because I had to wait until the Herald Tribune arrived days later. It is a different: a smaller world. What does it mean to adapt to this? Just as the American North prospered even as the southern part of the United States caught up, even as we drew strength in the generation after World War II as Europe and Japan's economies converged towards our own, we will need to find ways to prosper as the emerging markets of the world take their place on the global stage.

What should our approach be? Some suggest that we have no alternative but to compete with the world on price even if it means striving to win races to the bottom.

  • They would have workers sacrifice wages, benefits, and bargaining rights to hold onto their jobs.
  • They would slash taxes on businesses even as their profits rise in order to lure them to stay in the United States.
  • They would shred social safety nets in the name of self-reliance.

Such Social Darwinism was bad morality and bad economics in the 19th century and it is no better in the 21st.

Consider this: The flatness of the world notwithstanding, by far the largest part of the activities Americans engage in and the goods they buy remain quite local.  It is health care and retail services, recreation and education, haircuts and insurance policies, hotels and houses and I could go on. Moreover, where we compete with other countries, our strength is collective.  Few of us can hope to succeed as individuals in a global economy where any particular task or skill can be purchased at very low prices in much of Asia and beyond.  Rather, our strength must come from establishing uniqueness, establishing that which is difficult to replicate, that which comes from more collective action. Any idea or machine or even individual capacity can be transplanted.  Far harder to transplant, imitate, or emulate are our great institutions – the national laboratories and the national parks and the national highway system, great universities and great cities and great technology clusters, a diverse culture, deep capital markets, and a tremendous ethic.

Where competition is concerned, the lesson for us as a nation is the same as the lesson for business: far better to compete by innovating, leading, and competing on strength, than by standing still, and reducing prices.  Let me highlight what I see in this regard as the three essential priorities for the years ahead.  President Clinton used to say that in a world where ideas can move, capital can move, a nation's distinctive strength lay in its people.  Our biggest failing as a nation over the last 50 years has been with respect to education.  We were once the envy of the world; now we struggle to get into the top half of OECD nations.  The Duke of Wellington famously observed that the Battle of Waterloo had been won on the playing fields of Eton, and I would suggest that in this less elitist age, the battle for America's future will be won or lost in its public schools.  For too long we have been caught in a sterile debate between those who believe in more accountability and those who see the need for more resources.  In truth, no one who has seen the conditions in our urban schools can deny the need for more resources, and no one who believes in incentives can deny the need for more accountability.  Through Race to the Top the Administration has sought to reform elementary and secondary education both by providing resources and by increasing accountability.  These kinds of efforts will need to be magnified in the future.

Even as we strengthen elementary and secondary education, we must also expand higher education opportunities.  The US used to lead the world in the share of young people who became college graduates.  It is no longer in the top ten.  Worse yet, over the last generation, income gaps in this land of equal opportunity in college attendance have actually widened, as a consequence of both issues of affordability and, I would submit, issues of subtle discrimination.  To take just one example, I would suggest to you that the least diverse classrooms in American are in the SAT prep schools that help some, but not all, students raise their admissions test scores.  This is why the Administration has made major new investments to expand educational opportunities.  Since taking office, the Administration has funded an unprecedented doubling of the Pell Grant program, which will help more than 8 million of low income students attend college, at the same time as winning enactment of the American Opportunity Tax Credit.

Let me pause on this for just a second: in less tumultuous times I would suggest to that the largest increase in federal support for college attendance by students from low and middle income backgrounds would be recognized as a signal, defining accomplishment.  It is a signal of the magnitude of the issues we have contended with that this has not earned the attention it deserves.  Education is closely linked with a second major priority for the years ahead: innovation, the other central pillar of economic growth.  Here we have had for a very long time in the United States a distinctive ecology which is the reason we are the leading economy in the world.

On the one hand, we have recognized, venerated, and acted on the observation that it is individualists – the Edisons, the Fords, the Gates and Zuckerbergs – who, with a uniquely anti-bureaucratic temperament, who would not dream of a filing a grant application, who drive an enormous amount of the economy's progress.  We have maintained a culture where it is still true today that with all our financial system's failings, and they are many, we are the only country in the world where you can raise your first hundred million without owning a tie if you have a sufficiently good idea.  And that is a great strength of our economy.

But at the same time as maintaining a culture that supports the entrepreneur, that salutes the rebel, that allows people to establish themselves as major figures in business without even bothering to complete a college degree – at the same time as having support for the individual, we also recognize that fundamental innovation and progress will not happen without the public sector playing its essential role.  There would be no internet without DARPA.  No car industry without highways.  No pharmaceutical revolution with the NIH.  Maintaining and increasing our American capacity for innovation thus requires both fundamental support for entrepreneurial innovation and for the key foundations of science and technology.  That's why we have to make it easier to patent a new idea or innovation; make it easier for entrepreneurs and small businesses to raise capital; make it easier for the most promising minds and the most promising entrepreneurs to come to this country from around the world.  But we must also take the steps that will not happen without satisfactory public action, to invest in energy efficiency, and the renewable energy technologies of the future.

If we are able to maintain what is distinctive about the United States, a simultaneous capacity for strong public actions and for great entrepreneurs to emerge in the years ahead, we will be in a much stronger position to assure our leadership.

The third and final thing we must do is renew the public compact between the present and the future. Budget deficits are a tax on our future, unless used to finance productive investments. I am not one who sees financial collapse on the imminent horizon.  Indeed, I believe that at this point the risks of deflation or stagnation in the United States exceed the risks of uncontrolled growth or high inflation.  But unless we change our course, we are at risk of a profound demoralization of government.

At one level this means a decay of essential public functions and a loss of our national self-confidence. At a deeper level, we risk a vicious cycle in which an inadequately resourced government performs badly leading to further demands that it be cut back, exacerbating performance problems, deepening the backlash, and creating a vicious cycle. That is why while recovery is our first priority, it is essential that we establish long-run parity between revenues and expenditures.

Now this is a more complex matter than is often supposed.  One of the more important and less well-known ideas to come out of the economics profession over the last generation or so is the phenomenon known as Baumol's Disease. In certain areas, rapid productivity growth is possible.  In other areas it is much more difficult. It always has and always will take 8 teachers to teach 96 students for one hour in classes of twelve. Productivity improvement simply is not possible in the way that it is in other activities. Similar phenomena apply to almost anything that involves direct human interaction. Nursing care is another example.

Moynihan's Corollary to Baumol's Disease is the observation that there is a tendency in activities in which Baumol's disease is most pronounced to migrate to or be located in the public sector.  To take just one example, every five years the share of GDP devoted to government spending on health care goes up by 1 percentage point. As we contemplate our long-run fiscal future we must contemplate this reality rather than to suppose that there is some past static pattern of expenditures of revenues and expenditure that can be maintained indefinitely.

That is why Bowles-Simpson so important.

That is why President Obama committed to health care cost reduction in the context of the recently enacted health care legislation

If ever there was an area where President Kennedy's doctrine applies – that “man's problems were made by man, that therefore they can be solved by man” – it is to the budget deficit. The United States improved its structural deficit by nearly 4 percentage points of GDP between 1993 and 2000. Greece and Ireland are being called on to make fiscal adjustments in the range of 10 percent of GDP. Once our temporary fiscal support expires, we need an improvement only in the 2 to 3 percent of GDP range to begin the process of putting our debt on a declining path relative to our income.

President Obama has already taken several important steps in this direction: a multi-year freeze in spending outside national security, a serious effort to root out wasteful outdated spending in every area, particularly defense. A particularly welcome feature of the recent commission report is its bipartisan recognition of the idea that tax expenditures are just like expenditures, and need to be held to the same standard of efficiency, fairness, and tough tests on government intrusion into the economy.

They say that markets climb walls of worry.  So it is with our nation.  America's history, in a certain sense, has been one of self-denying prophecy – a history of alarm and concern, but alarm and concern averted by decisive actions to assure our prosperity. As one former CIA director warned of our largest competitor, that industrial growth rates of eight or nine percent per year for a decade would dangerously narrow the gap between our two countries. That was Allen Dulles in 1959 referring to the Soviet Union. And when the Soviet Union collapsed instead, the Harvard Business Review of 1990 proclaimed in every issue – every issue – in one way or another that the Cold War was over, and that Germany and Japan had won. Now we hear the same thing with respect to China.

Predictions of America's decline are as old as the republic.  But they perform a crucial function in driving the kind of renewal that is required of each generation of Americans. I submit to you that as long as we're worried about the future, the future will be better. We have our challenges.  But we also have the most flexible, dynamic, entrepreneurial society the world has ever seen.  If we can make the right choices, our best days as competitors and prosperous citizens still lie ahead.

Life in the Great Recession


Jim Hamilton of UCSD:

Econbrowser: Extending unemployment benefits: >Here I make two quick observations on the policies being discussed.

The first point has been widely noted, but it bears repeating since I keep hearing comments from people who seem to be unaware of it. When you hear that current unemployment benefits can in some cases be collected for up to 99 weeks, and that Congress is discussing an extension of this program, it is perhaps natural to think this means that some people might be eligible for longer than 99 weeks. But this is not the case. Instead what is being discussed is whether the current limits will be kept in place for another two years or whether the limits will be decreased immediately.

The second point to which I'd like to call attention has also been around awhile, but is appropriately still being discussed (e.g., Calculated Risk, Washington Post). The source appears to be these observations made by Wal-Mart CEO Bill Simon in September:

And you need not go further than one of our stores on midnight at the end of the month. And it's real interesting to watch, about 11 p.m., customers start to come in and shop, fill their grocery basket with basic items, baby formula, milk, bread, eggs, and continue to shop and mill about the store until midnight, when electronic--government electronic benefits cards get activated and then the checkout starts and occurs. And our sales for those first few hours on the first of the month are substantially and significantly higher.

And if you really think about it, the only reason somebody gets out in the middle of the night and buys baby formula is that they need it, and they've been waiting for it. Otherwise, we are open 24 hours — come at 5 a.m., come at 7 a.m., come at 10 a.m. But if you are there at midnight, you are there for a reason.

One thing you might take away from such accounts is that the spending multiplier out of compensation for the unemployed is pretty high.

But this story makes it hard for me to say no to the folks waiting in line at midnight for other reasons.

Christopher Hitchens on Henry Kissinger


Nixon and Kissinger. Worse than we imagined, even though we knew that they were worse than we imagined.


The Nixon tapes remind us what a vile creature Henry Kissinger is: [T]he latest revelations from the Nixon Library might perhaps turn the scale [against Kissinger] at last.... Chatting eagerly with his famously racist and foul-mouthed boss in March 1973, following an appeal from Golda Meir to press Moscow to allow the emigration of Soviet Jewry, Kissinger is heard on the tapes to say:

The emigration of Jews from the Soviet Union is not an objective of American foreign policy. And if they put Jews into gas chambers in the Soviet Union, it is not an American concern. Maybe a humanitarian concern.

(One has to love that uneasy afterthought...)

In the past, Kissinger has defended his role as enabler to Nixon's psychopathic bigotry, saying that he acted as a restraining influence on his boss by playing along and making soothing remarks. This can now go straight into the lavatory pan, along with his other hysterical lies. Obsessed as he was with the Jews, Nixon never came close to saying that he'd be indifferent to a replay of Auschwitz. For this, Kissinger deserves sole recognition....

I wonder how long the official spokesmen of American Jewry are going to keep so quiet. Nothing remotely as revolting as this was ever uttered by Jesse Jackson or even Mel Gibson, to name only two famous targets of the wrath of the Anti-Defamation League. Where is the outrage? Is Kissinger—normally beseeched for comments on subjects about which he knows little or nothing—going to be able to sit out requests from the media that he clarify this statement? Does he get to keep his op-ed perch in reputable newspapers with nothing said? Will the publishers of his mendacious and purloined memoirs continue to give him expensive lunches as if nothing has happened?

After I published my book calling for his indictment, many of Kissinger's apologists said that, rough though his methods might have been, they were at least directed at defeating Communism.... that Kissinger did many favors for the heirs of Stalin and Mao: telling President Gerald Ford not to invite Alexander Solzhenitsyn to the White House, for example, and making lavish excuses for the massacre in Tiananmen Square. He is that rare and foul beast, a man whose record shows sympathy for communism and fascism...

Department of "Huh?!" (London Economist Edition)


The Economist notes that the problems of the hyper-Keynesian emerging markets are the problems of full employment and prosperity, while the problems of anti-Keynesian Europe are the much worse problems of the edge of depression:

The world economy: Three-way split: [T]he performance of the world economy in 2011 depends on what happens in three places: the big emerging markets, the euro area and America.... These big three are heading in very different directions, with very different growth prospects and contradictory policy choices....

Begin with the big emerging markets, by far the biggest contributors to global growth this year. From Shenzhen to São Paulo these economies have been on a tear. Spare capacity has been used up. Where it can, foreign capital is pouring in. Isolated worries about asset bubbles have been replaced by a fear of broader overheating.... [M]onetary conditions are still extraordinarily loose....

The euro area is another obvious source of stress, this time financial as well as macroeconomic. In the short term growth will surely slow, if only because of government spending cuts. In core countries, notably Germany, this fiscal consolidation is voluntary, even masochistic. The embattled economies on the periphery, such as Ireland, Portugal and Greece, have less choice and a grim future.... [T]he financial consequences of a shift to a world where a euro-area country can go bust are only just becoming clear.... The euro zone’s political leaders, alas, are a fractious and underwhelming lot. An even bigger mess seems all but certain in 2011...

But is their bottom line that America should emulate emerging markets and--with nominal GDP 10% below trend and unemployment kissing 10%--plump for more immediate economic stimulus? No:

America’s economy, too, will shift, but in a different direction. Unlike Europe’s, America’s macroeconomic policy mix has just moved decisively away from austerity.... America is injecting itself with another dose of stimulus steroids just when Europe is checking into rehab and enduring cold turkey.

The result of this could be that American output grows by as much as 4% next year. That is nicely above trend and enough to reduce unemployment, although not quickly. But America’s politicians are taking a risk, too. Even though their country’s long-term budget outlook is famously dire, Mr Obama and the Republicans did not even try to find an agreement on medium-term fiscal consolidation this week. Various proposals to fix the deficit look set to gather dust (see article). Bondholders, who have been very forgiving of the printer of the world’s chief reserve currency, greeted the tax deal by selling Treasuries. Some investors, no doubt, see faster growth on the way; but a growing number are worried about the size of America’s fiscal hole. If those worries take hold, the United States could even see a bond-market bust in 2011...

Tacitus: The Death of the Emperor Galba


Publius Cornelius Tacitus, History I:41, 49:

Viso comminus armatorum agmine vexillarius comitatae Galbam cohortis (Atilium Vergilionem fuisse tradunt) dereptam Galbae imaginem solo adflixit: eo signo manifesta in Othonem omnium militum studia, desertum fuga populi forum, destricta adversus dubitantis tela. iuxta Curtii lacum trepidatione ferentium Galba proiectus e sella ac provolutus est. extremam eius vocem, ut cuique odium aut admiratio fuit, varie prodidere. alii suppliciter interrogasse quid mali meruisset, paucos dies exolvendo donativo deprecatum: plures obtulise ultro percussoribus iugulum: agerent ac ferirent, si ita [e] re publica videretur. non interfuit occidentium quid diceret. de percussore non satis constat: quidam Terentium evocatum, alii Laecanium; crebrior fama tradidit Camurium quintae decimae legionis militem impresso gladio iugulum eius hausisse. ceteri crura brachiaque (nam pectus tegebatur) foede laniavere; pleraque vulnera feritate et saevitia trunco iam corpori adiecta...


Galbae corpus diu neglectum et licentia tenebrarum plurimis ludibriis vexatum dispensator Argius e prioribus servis humili sepultura in privatis eius hortis contexit. caput per lixas calonesque suffixum laceratumque ante Patrobii tumulum (libertus in Neronis punitus a Galba fuerat) postera demum die repertum et cremato iam corpori admixtum est. hunc exitum habuit Servius Galba, tribus et septuaginta annis quinque principes prospera fortuna emensus et alieno imperio felicior quam suo. vetus in familia nobilitas, magnae opes: ipsi medium ingenium, magis extra vitia quam cum virtutibus. famae nec incuriosus nec venditator; pecuniae alienae non adpetens, suae parcus, publicae avarus; amicorum libertorumque, ubi in bonos incidisset, sine reprehensione patiens, si mali forent, usque ad culpam ignarus. sed claritas natalium et metus temporum obtentui, ut, quod segnitia erat, sapientia vocaretur. dum vigebat aetas militari laude apud Germanas floruit. pro consule Africam moderate, iam senior citeriorem Hispaniam pari iustitia continuit, maior privato visus dum privatus fuit, et omnium consensu capax imperii nisi imperasset.

As this armed band approached, the standard-bearer of Galba's escorting cohort (said to have been Atilius Vergilio) tore Galba's insignia off and threw it underfoot. The sentiment of the troops turned out to be for Otho. The populace fled the drawn weapons in the Forum. Near the lake of Curtius, Galba's frightened litter bearers dropped him to the ground. His last words have been differently reported. Those who hated him have said that he asked pitifully what he had done wrong and begged for a few more days to pay his soldiers the bonus he had promised. Those who admired him--and it is the more general account--have said that he offered his neck to his killers and told them to strike quickly if they thought killing him would be good for the country.

Those who killed him did not care what he said.

Nothing is certain about the man who actually killed Galba. Some have said that he was called Terentius, others Lecanius, but the most reliable report is that one Camurius of the 15th legion, cut his throat by stomping down on his sword. The other soldiers disgraced and mutilated his arms and legs--his breast was still protected by armor--and were so savage and ferocious that they managed to inflict a number of wounds on the headless trunk.


Galba's corpse was neglected for quite a while. Darkness gave permission for the body to suffer a host of insults, until finally his slave-steward Argius gave the body a modest grave in Galba's gardens. Galba's head, which Otho's camp-followers had desecrated and stuck on a pike, went missing until the next day when it was found in front of the then put with Galba's cremated body.

Such was the end of Servius Galb. In his seventy-three years he had lived prosperously through five Emperors. He had been luckier when ruled by others than when he ruled. His family boasted of its noble lineage. His wealth was great. His character was average--he was rather free from vices than distinguished by virtues. He neither ignored fame nor did he vainly grasp for it. He did not covet other people's money. He was parsimonious with his own money. He was avaricious with the government's money.

His tolerance for his freedmen and friends would not have been blameworthy had he surrounded himself with more worthy followers. But since his followers were worthless his blindness was criminal. His noble birth and the perilous times made him look wise when he was only lazy. While in the prime of his life he was an effective commander in Germany and proconsul in Africa. When old he showed the same administrative competence in Eastern Spain.

While he was a subordinate he seemed a supreme commander. And all would have agreed that he was fit to be an Emperor if only he had never been one.

The Becker-Murphy Theory of Rational Addiction

Andrew Gelman writes:

Rational addiction: Ole Rogeberg sends in this:

and writes:

No idea if this is amusing to non-economists, but I tried my hand at the xtranormal-trend. It's an attempt to spoof the many standard "incantations" I've encountered over the years from economists who don't want to agree that rational addiction theory lacks justification for some of the claims it makes. More specifically, the claims that the theory can be used to conduct welfare analysis of alternative policies.

Mike Konczal on the Moderate Republican Stimulus That Is McConnell-Obama

Moderate GOP Stimulus_ Re-examining the Who Got What Tax Deal Chart. « Rortybomb.jpg

I don't think it is moderate Republican--a moderate Republican stimulus has a bunch of infrastructure spending in it that this thing does not, and a moderate Republican stimulus has a debt-limit increase, and a moderate Republican stimulus has stand-by spending caps and tax increases as of 2015 if the deficit is still high.


Moderate GOP Stimulus: Re-examining the Who Got What Tax Deal Chart. « Rortybomb: There is no continuation of the Temporary Assistance for Needy Families Emergency Fund (TANF EF) from the stimulus bill in the tax cut compromise. Regular TANF was created as part of the Clinton-era welfare reform to get people off welfare by getting them back to work. This approach becomes problematic when unemployment is high through faults of monetary and fiscal policy, rather that people choosing not to work.  In a Great Recession TANF runs out of both money and conceptual scope very quickly.  So this Emergency Fund, at the low cost of five billion dollars distributed to states allowed locals on the ground to expand and continue TANF to meet the needs of fighting poverty and putting people to work in the Great Recession.... Who really got what in this deal?.... I want to argue the chart should look like this....

[T]he Child Tax Credit. From the Republican Pledge To America (pdf), the Republicans both take credit for the creation of the child tax credit and note the damage that will happen if it isn’t extended (“During the 1990s, a Republican Congress enacted pro-family policies such as marriage penalty relief and the child tax credit. Unless action is taken, a $3.8 trillion tax hike will go into effect on January 1, 2011 that will unravel these policies”).... [T]his is a “got” for the GOP.

The second is more interesting:  Should the payroll tax cut be a “get” for the Republican Party?... [If] you want to know what the GOP wants to get the economy jump-started, ask them, by all accounts these kinds of payroll taxes are what the GOP wanted. From (h/t Jed Lewison at DailyKos):

Q: So the only reason that the payroll tax holiday will provide more stimulus is because it’s twice as large. Making Work Pay was capped. Why didn’t you preserve Making Work Pay? Is it because, as the President said some months ago, it’s just a kind of invisible tax cut and didn’t provide any political benefit for the White House?

MR. SUMMERS: No, it came out of the process of compromise with the Republicans who were more attracted to the payroll tax holiday concept, and that was a proposal that, as had been coming out of here, we had been giving considerable thought to in the context of the President’s budget.

Weakest Stimulus And that isn’t a mistake.  This takes the weakest part of the stimulus, tax cuts, makes it weaker and puts it in front of the stimulus package. According to Mark Zandi’s estimates it has a weaker multipler than the anemic Making Work Pay tax credit.... It turns away from the idea of investing in public goods and infrastructure spending, laying out the groundwork of the 21st century economy, and instead mails checks to people. That’s the GOP response to any problem – tax cuts! – and now it is branded the Democratic stimulus response.... Viewed through this lens, this is the Moderate Republican Stimulus Package 2.0.   I wonder how it is going to work.

All I can say is that I really hope Greg Mankiw is right about the high marginal propensity to spend out of tax cuts...

Department of Things I Never Thought I Would See: Dani Rodrik Bails on the Euro...



Thinking the Unthinkable in Europe by Dani Rodrik - Project Syndicate: When Greece was bailed out by a joint eurozone-IMF rescue package back in May, it was clear that the deal had bought only a temporary respite. Now the other shoe has dropped. With Ireland’s troubles threatening to spill over to Portugal, Spain, and even Italy, it is time to rethink the viability of Europe’s currency union. These words do not come easily, as I am no Euroskeptic.... I believed that monetary union made perfect sense in the context of a broader European project that emphasized – as it still does – political institution-building alongside economic integration. Europe’s bad luck was to be hit with the worst financial crisis since the 1930’s while still only halfway through its integration process. The eurozone was too integrated for cross-border spillovers not to cause mayhem in national economies, but not integrated enough to have the institutional capacity needed to manage the crisis.

Consider what happens when banks in Texas, Florida, or California make bad lending decisions.... If the banks are merely illiquid, the Federal Reserve in Washington is ready to act as a lender of last resort. If they are judged to be insolvent, they are allowed to fail or are taken over by federal authorities.... Similarly, in case of bankruptcy, federal laws and courts readily adjudicate claims... private debt is not socialized by state governments (but by the federal government, if at all), and does not threaten public finances at the state level. State governments in turn have no legal power to abrogate debt contracts vis-à-vis out-of-state creditors, and no incentive to do so (given the help they get from the federal government). So, even in the throes of a financial crisis, banks and non-financial firms can continue to borrow if their balance sheets are sound, uncontaminated by the “sovereign risk” of their state government. 

Meanwhile, the federal government makes up for a good chunk of the drop in state incomes by transfers or reduced taxes....

So the real problem in Europe is not that Spain or Ireland has borrowed a lot, or that too much Spanish and Irish debt sits on banks balance sheets elsewhere in Europe. After all, who cares about Florida’s current-account deficit – or even knows what it amounts to? No, the real problem is that Europe has not created the union-wide institutions that an integrated financial market requires.

This reflects the absence of adequate political institutions at the center. The European Union has taught us valuable lessons over the last few decades: first, that financial integration requires eliminating volatility among national currencies; next, that eradicating exchange-rate risk requires doing away with national currencies altogether; and now, that monetary union is impossible, among democracies, without political union. It should have been expected that the political side of the equation would take time to fall into place. It is easy to blame European politicians for lack of leadership. But let us not underestimate the magnitude of the task that European governments took on... the closest analogue to it is America’s own historical experience with building a federal republic. As the long American struggle for “states’ rights” – and indeed the Civil War – shows, creating a political union out of a collection of self-governing entities is hardly a smooth or speedy process....

[I]t may now be too late for the eurozone. Ireland and the southern European countries must reduce their debt burden and sharply enhance their economies’ competitiveness. It is hard to see how they can achieve both aims while remaining in the eurozone. The Greek and Irish bailouts are only temporary palliatives: they do nothing to curtail indebtedness, and they have not stopped contagion. Moreover, the fiscal austerity they prescribe delays economic recovery. The idea that structural and labor-market reforms can deliver quick growth is nothing but a mirage. So the need for debt restructuring is an unavoidable reality.

Even if the Germans and other creditors acquiesce in a restructuring – not from 2013 on, as German Chancellor Angel Merkel has asked for, but now – there is the further problem of restoring competitiveness. This problem is shared by all deficit countries, but is acute in Southern Europe. Membership in the same monetary zone as Germany will condemn these countries to years of deflation, high unemployment, and domestic political turmoil. An exit from the eurozone may be at this point the only realistic option for recovery.

A breakup of the eurozone may not doom it forever. Countries can rejoin, and do so credibly, when the fiscal, regulatory, and political prerequisites are in place. For the moment, the eurozone may well have reached the point where an amicable divorce is a better option than years of economic decline and political acrimony.

Today Steve Horwitz Enters This Year's Stupidest Economist Alive Contest


Entry submitted by Karl Smith:

Working For the Weekend: There are so many things wrong with this Steve Horowitz post its hard to know where to begin.... Matt Yglesias does an excellent job responding to the claim that we should focus on increasing production not consumption.

People talk about demand during downturns because in a downturn you have an unusually large number of unemployed people. That’s people producing nothing who the year before were producing something. If there were more demand, they’d produce something.... [Y]ou can find lots of examples of countries with lower unemployment rates... that are nonetheless poorer than the United States.... [W]hen you’re not in a downturn, the only way for a country to improve its living standards is to actually get better at producing stuff.... Productive capacity matters—a lot. But when lots of people who want jobs aren’t doing hobs, you’ve got a different problem. A failure to mobilize the productive people you already have...

There is a certain “click” when a concept becomes more than a set of principles or equations but is imbedded into your fundamental understanding of reality. You can see that business cycle macro has “clicked” in what Yglesias writes.

I... want to address another claim that Horwitz makes:

The great irony is that leftists frequently argue that capitalism equals “consumerism.”... [W]e are charged with providing the ideological cover that justifies the consumerism they see as deadening lives and wasting resources. What the leftist critics miss is that economists never saw consumption as the driving force of economic growth and prosperity until the Keynesian criticisms of free markets became ascendant...

So, first off, obviously the desire to consume is the beating heart of all economies. Remember

It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest...

[T]hat “own interest”... is their interest in consuming... using resources to satisfy their wants and needs.... Investment – which is perfectly good Keynesian demand by the way – is using the resources of the universe to create tools that will allow me to make even more stuff in the future. However, I don’t just do this for the hell of it. I hope that one day this investment will lead to a world of even greater consumption. Consumption is still the ultimate goal. Nor does consumption equate with “consumerism”.... [T]aking time off to spend with your kids is consumption.... [I]nvestment... allow[s] us to have more [consumption] in the future. I might not see my kids for two weeks while I build a machine that automatically grades papers for me. I forewent consumption, spending time with my kids, for investment, building a machine. However, once the machine is built I can spend even more time with my kids as the machine does my work for me. That’s the essence of economic growth....

The desire to provide the things we want for our loved ones and community - the desire to consume - is the entire point of the economic exercise and the ultimate source of all of our motivations. Consumption doesn’t mean consumerism. Walks in the park are perfectly good consumption. As is flying kites with your grandkids...

I Think John Cochrane Is Very Confused...


John Cochrane says that unemployment today is not high because something went very wrong in financial markets but because of the "real, microeconomic, tax, and regulatory barriers to growth":

Sense and nonsense in the quantitative easing debate: Unemployment is not high because the maturity structure of government debt is too long, thank you, nor from any lack of “liquidity” in a banking system that is sitting on a trillion dollars of cash. It’s time to focus on the real, microeconomic, tax, and regulatory barriers to growth, not a policy that creates a lot of noise but no real effect...

When asked why unemployment was so much lower back in 2007--when we had the same real, microeconomic, tax, and regulatory barriers to growth that we do now--he has no answer.

But he does double down:

[A] slow, steady, and widely expected deflation... [is] much better [than even 2% inflation] in the long run. The financial system is much healthier with bundles of cash lying around, at no interest cost (as happens under deflation), than if everyone is engineering clever, but ultimately fragile, cash management schemes...

The utility-of-liquidity theoretical argument that underlies claims that the optimal rate of price change is deflation fast enough to drive the nominal interest rate on Treasury bills to zero is very incomplete, because money is not just a medium of exchange but also a store of safe value and a unit of account. The worth of the theoretical argument is such that it will get you a decaf Americano at Strada--if you also chip in $1.75.

We need to go to the data.

The major economy currently attempting a "slow, steady, and widely expected deflation" is called "Japan." The last major economy before that to attempt one was the United Kingdom between 1924 and 1931, a time that its central bank head Montagu Norman described as time "under the harrow."

The era of "slow, steady, and widely expected deflation" before that was 1865-1896 under the classical gold standard--an era that appears to have been marked by relatively large and long-lasting business-cycle downturns and that was definitely marked by higher real interest rates than normal that one presumes discouraged at least some socially-valuable investment.

Physicist Chad Orzel Comes Perilously Close to WInning the Internet...


It's twue! It's twue!:

Literary Interlude: Bearded Mentor Figures in the Literature of the Fantastic : Uncertain Principles: It's time now to talk about two of the greatest mentor figures in the literature of the fantastic. You know their stories well, I'm sure, but the parallels between them are eerie:

  • Both are gruff but kindly mentor figures who provide crucial guidance for the young and naive protagonist of the story as he moves out into a scary world to complete an important quest.
  • Both fall into a chasm while battling a fearsome monster to allow the protagonist time to flee.
  • Both return from their apparent death when least expected, just in time to save the day. *Both have awesomely impressive beards.

I am speaking, of course, of Gandalf from J. R. R. Tolkien's The Lord of the Rings, and Yukon Cornelius from the animated tv special Rudolf the Red-Nosed Reindeer

Liveblogging World War II: December 13, 1940

Robert Paxton: Vichy France: Old Guard and New Order:

On the afternoon of Friday, December 13, 1940, Pierre Laval, home from the second round of military talks on Africa with General Warlimont, presided over a routine cabinet meeting. A few hours later, a surprise meeting of the whole Council of Ministers was called by Marshal Petain. The Marshal asked each member of the government to write out a letter of resignation. Then he accepted those of Pierre Laval and Georges Ripert, minister of education. In the meantime, Laval's floors of the Hotel du Parc were occupied by special security forces.... Laval was... placed under house arrest. Communications with Paris were cut off. This was the most Byzantine of all the many Vichy changes of cabinet, the only one accomplished by the threat of force....

Yet Another One from Nick Rowe


"Illiquid" and "insolvent" are not clearly distinguished:

Nick Rowe: Worthwhile Canadian Initiative: Sovereign insolvency and illiquidity: If a country has a debt/GDP ratio of 100%, and is paying 9% interest, and nominal GDP is not rising, then it's got a solvency problem. It needs to run a budget surplus of 9% of GDP just to stop the debt/GDP ratio rising further. And that is very hard to do.

But why would a country ever be paying 9% interest and have 0% nominal GDP growth? By David Beckworth's simple, crude, but nevertheless useful measure of the tightness of monetary policy -- the gap between nominal interest rates and expected nominal GDP growth rate -- a gap of 9 percentage points is very tight monetary policy. No country that had control over its own monetary policy would set monetary policy that tight (OK, unless its population were falling exogenously at around 9% per year, or if it were a purely temporary measure to reduce entrenched inflation).

Countries like the UK, US, Japan, have large debts and deficits. But they control their own monetary policy, and none of them have monetary policy anywhere near that tight. If they did set monetary policy that tight, they too would have a solvency crisis.

Ireland has a solvency crisis, but only because it has a liquidity crisis. Ireland does not control its own monetary policy. Money is the most liquid of all assets.

If monetary policy were less tight, so the gap between nominal interest rates and nominal GDP growth were 1%, a country with a 100% debt/GDP ratio would only need a budget surplus of 1% of GDP to prevent the debt/GDP ratio from rising. That's doable. That country is solvent.

Why Was Europe So Cold in the Hottest November on Record?

Joe Romm sends us to: NASA’s James Hansen, Reto Ruedy, Makiko Sato and Ken Lo, “2010 — Global Temperature and Europe’s Frigid Air”:

This is the warmest January-November in the GISS analysis, which covers 131 years. However, it is only a few hundredths of a degree warmer than 2005, so it is possible that the final GISS results for the full year will find 2010 and 2005 to have the same temperature within the margin of error.... November 2010 surface temperature anomalies based only on surface air measurements at meteorological stations and Antarctic research stations... to allow extreme temperature anomalies to be apparent. Northern Europe had negative anomalies of more than 4°C, while the Hudson Bay region of Canada had monthly mean anomalies greater than +10°C. The extreme warmth in Northeast Canada is undoubtedly related to the fact that Hudson Bay was practically ice free. In the past, including the GISS base period 1951-1980, Hudson Bay was largely ice-covered in November.... Sea ice insulates the atmosphere from ocean water warmth, allowing surface air to achieve temperatures much lower than that of the ocean. It is for this reason that some of the largest positive temperature anomalies on the planet occur in the Arctic Ocean as sea ice area has decreased in recent years.

The cold anomaly in Northern Europe in November has continued and strengthened in the first half of December.... [I]s it possible that reduced Arctic sea ice is affecting weather patterns?... The fixed location of the Hudson-Baffin heat source could plausibly affect weather patterns, in a deterministic way — Europe being half a Rossby wavelength downstream, thus producing a cold European anomaly in the trans-Atlantic seesaw. Several ideas about possible effects of the loss of Arctic sea ice on weather patterns are discussed in papers referenced by Overland, Wang and Walsh. However... the few years just prior to 2009-2010, with low Arctic sea ice, did not produce cold winters in Europe. The cold winter of 2009-2010 was associated with the most extreme Arctic Oscillation in the period of record.... 7 of the last 10 European winters were warmer than the 1951-1980 average winter, and 10 of the past 10 summers were warmer than climatology. The average warming of European winters is at least as large as the average warming of summers, but it is less noticeable because of the much greater variability in winter.

Sunday Morning Monetary Theology


Nick Rowe asks me three questions in his Worthwhile Canadian Initiative: If cows were money (a response to Brad DeLong):

Nick: If cows were money, an increased demand for milk would cause a recession. People would stop spending their cows to buy goods and services, because if you spend your cows you don't have as much milk. Was the recession caused by an excess demand for milk, or an excess demand for money?

Me: If the Federal Cow Reserve conducted expansionary monetary policy by selling cows in exchange for promises to deliver milk, then its open market operations in cows would have no stimulative effect on the economy: the cows it sold would not enter the circulating medium but would instead be kept in reserve to replace the milk that the Federal Reserve had bought. Since open-market operations that boost the money stock are ineffective, it is clear that the recession was not caused by an excess demand for money but by an excess demand for milk.

Nick: If gold bars were money, an increased demand for bling would cause a recession. People would stop spending their gold bars to buy goods and services, because if you spend your gold bars you don't have as much bling. Was the recession caused by an excess demand for bling, or an excess demand for money?

Me: If the Federal Jewelry Reserve conducted expansionary monetary policy by selling gold in exchange for other forms of bling, then its open market operations in gold would have no stimulative effect on the economy: the gold it sold would not enter the circulating medium but would instead be used as bling replace the bling that the Federal Reserve had bought. Since open-market operations that boost the money stock are ineffective, it is clear that the recession was not caused by an excess demand for money but by an excess demand for bling.

Nick: If dollars were money, an increased demand for savings would cause a recession. People would stop spending their dollars to buy goods and services, because if you spend your dollars you don't have as much savings. Was the recession caused by an excess demand for savings, or an excess demand for money?

Me: If the Federal Reserve conducted expansionary monetary policy by selling dollars in exchange for other savings vehicles like bonds, then its open market operations in dollars and bonds would have no stimulative effect on the economy: the dollars it sold would not enter the circulating medium but would instead be used as savings vehicles to replace the bonds that the Federal Reserve had bought. Since open-market operations that boost the money stock are ineffective, it is clear that the recession was not caused by an excess demand for money but by an excess demand for savings vehicles.

Now that that is clear, let me say that Nick's post is very good. He goes on:

It has almost come down to a semantic dispute.... [W]e are arguing about the referential opacity of demand functions. If I demand milk, can I be said to demand the medium of exchange, if, as a contingent fact, the medium of exchange just happens to provide milk, and I want the medium of exchange only for its milk?

But it matters. Because the way you frame the cause of the recession may influence where you look for a cure.

If you say that the recession is caused by an excess demand for milk, you start looking for ways to either increase the supply of milk or reduce the demand. Can the government breed some goats, and increase the supply of milk that way? But if you see the recession as being caused by an excess demand for cows, you also start to think of other solutions. Perhaps the government could tax ownership of cows? Even, as a last ditch policy, make the cows stop giving milk? If you think of the recession as being caused by a shortage of milk, then taxing cows, or making the cows stop giving milk, look like totally daft solutions. They wouldn't cure the shortage of milk. But they would cure the recession. With a tax on cows, or if cows stopped giving milk, people would start spending their cows again.

But I also see the point of looking at it from Brad's perspective. An open market operation of cows for goats, where the government imports cows, uses them buy goats, and exports the goats, may not work. The total supply of milk is the same, and if cow's milk and goat's milk are perfect substitutes, people have no additional incentive to get rid of their cows to buy the goods and services that are in excess supply. If, at the margin, the demand for cows is a demand for milk only, the demand for cows will increase one-for-one with the increased supply of cows, if that increased supply of cows is the result of an open market purchase of goats. But why did the demand for cow's milk increase in the first place? Was it that all the goats went dry? Or might the increased demand for milk be a consequence of the recession, and so a consequence of the excess demand for cows? "I had better hang on to my cows, because I won't be able to sell my labour to buy milk in this recession!"

I don't know whether Brad is right about the shortage of other safe savings vehicles being the cause of the increased demand for money qua second best savings vehicle. But, even if he is wrong, this is something that might happen.... [C]orrectly diagnosing the proximate cause of the recession as an excess demand for the good that happens to be the medium of exchange, even if that excess demand is not a demand for that good qua medium of exchange, lets us start thinking about radical solutions.

And we need to start thinking about radical solutions, because as history teaches us, and as this recession reminds us (and judging by the Eurozone we are going to be reminded again) stuff happens. Things go wrong. Safe assets become unsafe. Goats stop giving milk. And we need a monetary system that is robust in the face of human stuff-ups. A shortage of milk is a problem, but it didn't ought to cause a recession too. A shortage of safe assets is a problem, but it didn't ought to cause a recession too. And if it didn't cause an excess demand for the medium of exchange, as a contingent side-effect, it wouldn't cause a recession to compound the original problem. And it's just because those side-effects are contingent, and don't follow of necessity, that I insist on my way of framing the problem. A shortage of safe assets may cause an excess demand for money. An excess demand for money will cause a recession. We can break that first link in the causal chain, because it's only a contingent link. The second link follows of metaphysical necessity, unless we switch to barter.

What's the solution that could prevent an excess demand for the medium of exchange, and so prevent general gluts? Silvio Gessell? Barter on Ebay? Funny money systems where you can't hold a positive balance? God only knows. But we ought to start thinking about it. Quasi-monetarism (which is really Keynesianism too, if you are the sort of Keynesian that recognises that Keynesian economics doesn't make any sense in a barter economy) can be a radical approach.

The one thing this left out, I think, is that "money" becomes a first-rate savings vehicle and store of safe value only when nominal interest rates hit their zero lower bound.

Actually, it left out something else: in comments to Nick, Andrew Harless starts musing about money not just as a medium of exchange and a store of value but a unit of account...