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October 2011

Yet Another Note on Benefits of Nominal GDP Targeting

At lunch today Christina Romer reminded me of--or rather drove into my thick head a point that I had missed during the seminar, even though he was standing only six feet in front of me at the time--Ivan Werning's point that level nominal GDP targeting is a good policy in a liquidity trap not just or not primarily because it promises future inflation but also and (for his parameter values) primarily because it promises a future boom. In the IS-LM framework with the long-term real interest rate on the vertical axis, the liquidity trap maintains itself both because the LM curve is shifted upwards (because fear of deflation raises the expected real returns to holding cash) and because the IS curve has been shifted to the left (because fear of continued depression makes business calculate that investment is unprofitable). Raising expected inflation can unlock only the first half of the trap. Level nominal GDP targeting can unlock both halves.

Ivan Werning: Managing a Liquidity Trap: Monetary and Fiscal Policy: As first argued by Krugman (1998), optimal monetary policy can improve on this dire outcome by committing to future policy in a way that affects current expectations favor- ably. In particular, I show that, it is optimal to promote future inflation and stimulate a boom in output. I establish that optimal inflation may be positive throughout the episode, so that deflation is completely avoided. Thus, the absence of deflation, far from being at odds with a liquidity trap, actually may be evidence of an optimal response to such a situ- ation. I show that output starts below its efficient level, but rises above it towards the end of the trap. Indeed, the boom in output is larger than that stimulated by the inflationary promise.

There are a number of ways monetary policy can promote inflation and stimulate output. Monetary easing does not necessarily imply a low equilibrium interest rate path. Indeed, as in most monetary models, the nominal interest rate path does not uniquely determine an equilibrium. Indeed, an interest rate of zero during the trap that becomes positive immediately after the trap is consistent with positive inflation and output after the trap. I show, however, that the optimal policy with commitment involves keeping the interest rate down at zero longer. The continuous time formulation helps here because it avoids time aggregation issues that may otherwise obscure the result.

Some of my results echo findings from prior work based on simulations for a Poisson specification of the natural rate of interest. Christiano et al. (2011) reports that, when the central bank follows a Taylor rule, price stickiness increases the decline in output during a liquidity trap. Eggertsson and Woodford (2003), Jung et al. (2005) and Adam and Billi (2006) find that the optimal interest rate path may keep it at zero after the natural rate of interest becomes positive. To the best of my knowledge this paper provides the first formal results explaining these findings for inflation, output and interest rates. An implication of my result is that the interest rate should jump discretely upon exit- ing the zero bound—a property that can only be appreciated in continuous time. Thus, even when fundamentals vary continuously, optimal policy calls for a discontinuous interest rate path…

Level nominal GDP targeting also has very nice properties in an economy buffeted by either positive or negative commodity-price supply shocks. The principal case in which it appears inferior to inflation targeting is one in which the economy is subject to shocks to the persistent rate of productivity growth.


Twitterstorm delong: October 31, 2011

  • RT @afrakt: Gruber: "Mitt Romney is the single person most responsible for health care reform in this country" -

  • @AndyHarless @interfluidity Jon Corzine thought he had non-nested private information from his personal conversations with Mario Draghi...

  • Yet More Halloween Blogging: "I Find Your Lack of Faith… Disturbing…" Edition: RT @TimHarford: Best pumpkin-carving ever. RT @jamescrabtree: The destruction of Alderaan, with pumpkins.

  • RT @dceiver: So, you woke up this morning and thought, "I'm in Canada. Let's see...GOT IT: gonna steal a tractor-trailer. Yep. This'll w ...

  • Rachel Zimmermann: "A Sneak Peek at Jon Gruber's ‘Health Reform: The Comic Book’"

  • RT @felixsalmon: .@timharford with a great column on Malthus’s ghost as the world hits Population 7B

  • RT @Eris: When you think about it, the Bat Signal was probably the first cloud-based push notification.

  • RT @hillhealthwatch: CBO confirms CLASS repeal wouldn't affect deficit

  • RT @caleb_crain: At @parisreview, I consider "In Time," a new sci-fi film starring Justin Timberlake as the Labor Theory of Value

  • RT @hblodget: In other words, terrible idiotic bets RT @crampell: MF Global: Good Bets, Bad Timing?:

  • RT @starkehealth: New health #data shows Massachusetts most insured state, Texas least #uninsured via @governing

  • Mike Konczal: The Beveridge Curve

Hoisted from Comments on Comments Hoisted from Comments: Informationally-Inefficient Markets Edition

I think Robert means: "as Sandy Grossman and Joe Stiglitz proved when they were in nursery school"…

Robert Waldmann:

Hoisted from Comments: Information Externalities from Visible Trades: You are kind to Andy Harless. Yes his argument is worthy of attention. It isn't something which is ideally ignored entirely. However, as you proved when you were in junior high (maybe high school) such trades require irrationality. It isn't enough for different agents to have different information (as you know this is a mathematical result).

It is necessary for some agent to be overconfident. This is usually modelled by including agents which trade based on no information so their confidence should be zero. But it is quite general.

So the position is that we can learn about the world by observing irrational people. This is not an absurd claim. However, the case that the outcome is better than the outcome without such trades is based on the assumption that the traders are rational. This is absurd. It is also the state of research….

I can certainly write down a model in which such trade is socially useful (this is a special case of my claim that, for any result you want, I can write down a model to give you that result -- this is a challenge which has been open for years)…. The way to get an example of good trade is to get a model in which agents get private information about the mean of a variable and third parties care only about the mean:

Agents last three periods:

  • In the first they invest in a safe asset and a risky asset.
  • They consume in period 3.
  • Agents have CARA utility.
  • Some agents get no information and are rational.
  • Other agents get a signal and are irrationally optimistic: agent i gets a signal equal to the 2nd period value of the risky asset plus epsilon_i, and epsilon_i is normal with mean zero and independent across agents.

So far we have an equilibrium with no trading…. But now assume that agent i misperceives the variance of i to be half what it really is, and correctly perceives the variance of epsilon_j for all j other than i. In this case, informed agents demand the risky asset proportional to i. Then the market closes.

This means that in period 2 agents know exactly what the risky asset will pay in period 3. in period 2 agents can convert safe to risky asset and back with a quadratic adjustment cost.

In this model, trade based on asymmetric information and subjective overconfidence is good….

[Alternatively] the risky asset can pay high with probability p or low with probability 1-p. One agent guesses and is sure that his guess is right. He is trusted by the others so he borrows and invests allllll the money in the risky asset if he is sure it will pay high. So horrible things happen with probability 1-p….

The point is: if everyone is rational than [irrational information-revealing trades] can't happen. The argument that [when such trades] happen [they] must be good because everyone is rational[--that] is schizo finance.

Quote of the Day: October 31, 2011

"In sum, there were many varieties of Progressivism and Progressives. They held in common, however, a conviction that society should be fair to its members (white native-born ones, anyway), and that governments had to represent “the people” and to regulate “the interests.” It went without saying that there was such a thing as “society.” The progressive “big four”—Bryan, Theodore Roosevelt, La Follette, and Wilson—and the many less visible Progressives for all their differences shared a belief in society, a common good, and social justice, and that society could be changed into a better place."

--Walter Nugent, "Progressivism: A Very Short Introduction"

Hoisted from Comments: Information Externalities from Visible Trades

Andrew Harless says that the rest of us want there to be gamblers in financial markets who trade in public:

A Note: Prolegomenon to Any Useful Discussion of Modern American Finance: I'm not sure whether there are a whole lot of trades I don't like. A typical trade (perhaps) is between two intelligent, rational, well-informed investors, each with their own set of private information. Necessarily, one set of private information will turn out ex post to have been better than the other, but both pieces may be good in an absolute sense, and neither side would be willing to reveal its information to the public except as implied motivation for the trade.

Even if it is mostly zero-sum (and if we ignore time and risk preferences, etc.), trading is useful as a way to get market participants to disclose (admittedly in extremely vague form) their private information. If we see movement in a price, we have new information about the value of the asset, which we wouldn't have had if there weren't a bunch of agents out there trying to take advantage of one another.

When a trade is motivated by moving money across time--savers and builders--or by getting decision-makers skin in the game--principals and agents--or by hedging risk--principals and agents--in general both sides of the trade will be happy both ex ante and ex post. As Andrew says, when a trade is motivated by disagreement, one side of the trade must be unhappy ex post. That means that the side that has the lower-quality information ought to be happy ex ante. So in order for the trade to go, not only must one side be wrong in its information, but both sides must think they have the better information and at least one of them must be wrong in that also.

Andrew is making a somewhat subtle argument that even though a disagreement-driven trade cannot be Pareto-optimal for the two parties ex post and hence cannot be Pareto-optimal ex ante, it is still good from a social-welfare point of view because of the informational externalities arising as gamblers are motivated to discover useful information and then partially reveal it through their trade patterns.

This is correct. The question is: how big are these informational externalities, and how much of a gambling propensity would we then want to see in the market?

Yet More Preliminary Throat-Clearing on How to Think About Financial Markets

First, financial markets are a place where savers and builders, diversifiers and insurers, and principals and agents coming together to make win-win deal. Second, financial markets are also a place where con artists and marks, savers and procrastinators, and gamblers and houses meet to make deals that are ex-ante losers for at least one of the parties. And, third and last, financial markets are a place where herd animals and positive-feedbackers on the one hand and those who do not grasp the benefits of diversification on the other hand degrade the ability of savers and builders, principals and agents, and diversifiers and insurers to make their ex-ante win-win deals.

We would like to have a financial market that maximizes the freedom of the first of these three groups of participants, and minimizes the impact and influence of the second and third of these three groups...

Yes, Megan McArdle Is Wrong Once Again: Health Care Reform Predictive Analysis Blogging

Read beyond the first two paragraphs, Megan, please!

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

McKinsey Quarterly, June 2011:

How US health care reform will affect employee benefits: The shift away from employer-provided health insurance will be vastly greater than expected and will make sense for many companies and lower-income workers alike...

McKinsey, June 20, 2011:

US employer healthcare survey | McKinsey & Company: In February 2011, McKinsey & Company commissioned a survey of 1,329 U.S. private sector employers to measure their attitudes about healthcare reform. The opinion survey was paid for entirely by McKinsey as part of its routine, proprietary research.

We stand by the integrity and methodology of the survey.  

The survey was not intended as a predictive economic analysis of the impact of the Affordable Care Act. Rather, it captured the attitudes of employers and provided an understanding of the factors that could influence decision making related to employee health benefits.

As such, our survey results are not comparable to the healthcare research and analysis conducted by others such as the Congressional Budget Office, RAND and the Urban Institute. Each of those studies employed economic modeling, not opinion surveys, and focused on the impact of healthcare reform on individuals, not employer attitudes.

Comparing the McKinsey survey to economic estimates, such as the CBO’s, is comparing apples to oranges. While the McKinsey Quarterly article about the survey cited CBO estimates, any comparison is not apt. We understand how the language in the article [How US health care reform will affect employee benefits] could lead the reader to think the research was a prediction, but it is not...

For the McKinsey Quarterly to write "The shift away from employer-provided health insurance will be vastly greater than expected" by CBO and others is for the McKinsey Quarterly to make a predictive economic analysis.

For McKinsey to then say that that the claim is not a prediction--and that it "understand[s] how the language in the article [How US health care reform will affect employee benefits] could lead the reader to think the research was a prediction" is a repudiation of the article's lead.

And here we have Megan McArdle:

Did McKinsey Repudiate their Employer Health Care Survey?: As I scrolled through the RSS reader this morning, my attention was grabbed by this guest-post on Jonathan Cohn's blog.  The author is Jonathan Gruber…. [O]ne claim rather jumped out at me:

Claim #3: The ACA Will Lead to a Large Erosion of Employer-Sponsored Insurance

To make this claim the committee leans on a report from McKinsey so flawed that the firm itself ultimately repudiated it…

I found this rather startling.  I thought I had followed the debate over the McKinsey survey (which showed large numbers of employers saying they'd drop their coverage after ObamaCare went into effect) rather closely, and I didn't remember them repudiating it.  I asked the Official Blog Spouse, who had also followed the debate rather closely.  He had seen the same article, and been puzzled by the same thing…. [Gruber's links] didn't show McKinsey repudiating the survey.  Rather, they referenced Brian Beutler's story in which several anonymous McKinsey employees of uncertain seniority or involvement in healthcare and/or HR projects, bashing the study…. McKinsey has about 9,000 employees around the world.  I am sure more than three of them were unhappy that the company had released a report critical of ObamaCare, since hundreds of them donated a total of $207,296 to Obama in the 2008 campaign cycle.  But this hardly proves anything, especially since at least one of these insiders was clearly not very well plugged in:  ten days later, McKinsey released their survey materials.  And they were hardly "damaging"….

So where was the repudiation?  Googling "McKinsey repudiates health care survey" turns up only this:

In February 2011, McKinsey & Company commissioned a survey of 1,329 U.S. private sector employers to measure their attitudes about healthcare reform. The opinion survey was paid for entirely by McKinsey as part of its routine, proprietary research.

We stand by the integrity and methodology of the survey…

Unless both the Official Blog Spouse and I are misremembering--entirely possible, of course--this seems like a very strange way to characterize the study.  Saying that a firm has repudiated something is a strong factual claim with a fairly narrow meaning…

The repudiation--it comes in paragraph 5 of the document from which McArdle quotes paragraphs 1 and 2.

The sentence, "We understand how the language in the article [How US health care reform will affect employee benefits] could lead the reader to think the research was a prediction, but it is not", is a repudiation of the prediction in the study's lead that: "The shift away from employer-provided health insurance will be vastly greater than expected."

The ECB’s Battle Against Central Banking

We are live at Project Syndicate:

As I sat down to put the final touches on this column, I found that Paul de Grauwe had written the opening of it much better than I had:

Paul de Grauwe: When [the ECB] announced its programme of government bond buying, it made it known to the financial markets that it thoroughly dislikes it... [that it] was not fully committed... that it would stop the programme... that the stabilisation of the price of government bonds would only be temporary....

There is no sillier way to implement a bond purchase programme than the ECB way. By making it clear from the beginning that it does not trust its own programme, the ECB guaranteed its failure. By signalling that it distrusted the bonds it was buying, it also signalled to investors that they should distrust these too....

The people sitting around the table in Frankfurt continue to believe that financial stability is not part of their core business, and, to use the words of Trichet, that there is only one needle on the Frankfurt compass and that is inflation.... The result of this failure of the ECB to be a lender of last resort has been that a surrogate institution, the EFSF/ESM, had to be created that everybody knows will be ineffective. It has insufficient firepower and has an unworkable governance structure...

Indeed. From my perspective, the astonishing thing about the spectacle that the ECB is making of itself--its current claim that its proper mission is price stability and only price stability, not financial stability, certainly not being a lender of last resort, and certainly certainly no concern for the welfare of the workers and businesses that make up the economy--is its extraordinary divorce from the history of the central-banking tradition. Modern central banking has its start in the collapse of the British canal boom of the early 1820s, in the financial crisis and recession of 1825-6, and in the first time a central bank--the Bank of England--intervened in the interests of financial stability as the irrational overexuberance of the boom turned into the extravagant overpessimism of the bust.

As Walter Bagehot in his Lombard Street quoted Jeremiah Harman of the Court of the Bank of England, in the 1825-6 crisis:

We lent... by every possible means and in modes we had never adopted before; we took in stock on security, we purchased exchequer bills, we made advances on exchequer bills, we not only discounted outright, but we made advances on the deposit of bills or exchange to an immense amount, in short, by every possible means consistent with the safety of the Bank, and we were not on some cases over-nice. Seeing the dreadful state in which the public were, we rendered every assistance in our power...

The charter of the Bank of England did not give it the legal authority to undertake such lender-of-last-resort financial stability operations. But the Bank undertook them anyway.

Half a generation later Britain’s Parliament discussed whether the modifications of the Bank’s charter should give it explicit power to conduct lender-of-last-resort operations. The answer Parliament reached was “no”: granting explicit power would undermine confidence in price stability, for already there was “difficulty restrain[ing] over-issue, depreciation, and fraud”; and granting explicit lender-of-last-resort powers to the Bank of England would mean that the “millennium of the paper-mongers would be at hand”. But the leaders of Parliament also believed that the absence of power to act as a lender-of-last-resort would not keep the Bank of England from doing so when dire necessity so commanded. As the then First Lord of the Treasury Sir Robert Peel wrote: “If it be necessary to assume a grave responsibility”--to exceed the limits that the Bank of England’s charter places upon it and act--”I dare say men will be willing to assume such a responsibility.”

Our current politico-economic institutions are built upon the wager that a decentralized monetary industrial market economy provides a superior social planning, coordination, and allocation mechanism to any other that we have yet had the wit to devise. But from the moment the Industrial Revolution was born part of our system has been a central law-giving authority that preserves trust that contracts will be fulfilled and promises kept--and the lender-of-last-resort role is part of that function.

That is what the ECB is now throwing away.

Department of "Huh?!": What Is Bill Gross Saying? Edition

I know what Robert Barro's or Narayana Kocherlakota's or Robert Lucas's model of the world is--and it is pretty clear to me that their models are wrong, for they have been greatly surprised by reality over the past four years in lots of ways that people in the Bagehot-Minsky-Kindleberger or Keynes-Hicks-Tobin traditions have not been surprised.

And I know that William H. Gross of PIMCO is very smart, and very good at this. But I cannot figure out what his model of how the world works is:

William H. Gross: PIMCO | Investment Outlook - Pennies from Heaven: [T]he investment question du jour should be “can you solve a debt crisis with more debt?”… Policymakers have been striving to answer it in the affirmative ever since Lehman 2008 with an assorted array of bazookas and popguns: 0% interest rates, sequential QEs with a twist, and of course now the EU grand plan… write-offs for Greece, bank recapitalizations for Euroland depositories and the leveraging of their rather unique “EFSF” which requires 17 separate votes each and every time an amendment is required. What a way to run a railroad…. Not being one to cast pearls before swine or little Euroland PIGS for that matter, I would tentatively agree with one huge qualifier:

As long as these policies generate growth….

The lack of growth, as explained in prior Outlooks over the past few years, is structural as opposed to cyclical, and therefore relatively immune to interest rate or consumption stimulative fiscal policies. 1) Globalization, 2) technological innovation, and 3) an aging global demographic have all combined to dampen policy adjustment post Lehman and will inexorably continue to work their black magic going forward. To defeat this misunderstood structural voodoo, countries would have to mint pennies by the billions, pretend to lose them, and then incredibly find them strewn all across their city streets like some global Easter egg hunt. Not gonna happen.

The situation, of course, is compounded now by high debt levels and government spending that always used to restart capitalism’s private engine…. [S]overeign debt at 80-90% of GDP acts as a barrier to growth… debt service and interest rate spreads start to rise at these debt levels, a greater and greater percentage of a nation’s output must necessarily be diverted to creditors who in turn become leery of reinvesting in a slowing economy….

Halting the downward maelstrom is what current monetary policy is attempting to accomplish. With fiscal policy in most developed countries incredibly restrictive instead of stimulative, central banks have assumed the helm on their own – but it has been a long and relatively futile watch. Structural growth problems in developed economies cannot be solved by a magic penny or a magic trillion dollar bill….

My original question – “Can you solve a debt crisis by creating more debt?” – must continue to be answered in the negative, because that debt – low yielding as it is – is not creating growth…. The Rogoff/Reinhart biblical parallel of seven years of fat followed by seven years of lean is not likely to be disproven in this cycle. The only missing input to the equation would seem to be how many years of fat did we actually experience? More than seven, I would suggest…

If nominal GDP growth had just jumped from 4%/year to 7%/year and if the consequence had been the real growth had gone from 2.5 to 3.0%/year while core inflation had gone from 1.5% to 4.0%/year and nominal ten-year Treasury rates had gone from 2.5 to 6.0%/year, I would say that the market had spoken: thet too much (risky) debt could not be cured by issuing lots more (safe) debt. But if that is happening at all, it is happening in some alternative universe: not here, not now.

Here and now the principal immediate disease of the economy continues to be (in Wicksellian terms) that the natural rate of interest is lower than the market rate and is in fact less than zero, (in monetarist terms) that nominal GDP is too low and is expected to grow too slowly given the current level of wages and prices, (in Bagehot-Minsky-Kindleberger-Reinhart-Rogoff-Koo terms) that the risk tolerance of the market is too low given the still-extraordinary level of leverge, (in Bernanke-Gertler-Hubbard terms) that a wave of moral hazard and adverse selection has overwhelmed and broken the credit channel. All of these diagnoses are not quite identical, but the overlap between them is enormous. And they all admit of the same cure: Jubilee. A reduction in risky debt and its replacement in portfolios by an increase in safe debt. This can be accomplished through either guarantees of risky debt by the credit-worthy, by explicit write-downs and refis, or by the I-word.

Oh, there are other more chronic diseases of the American and the world economy: globalization one wrong, overfinancialization, overhealthcareadministrationization, rising inequality, financialunderregulationization, et cetera--and some of these played a role in setting up the current crisis. But you don't have to fix a tire through the puncture. And we shouldn't believe that we must.

A Comment on "A Prolegomenon to Any Useful Analysis of Modern Finance"

A correspondent berates me, correctly, for not having enough balls in the air at once. I had ten: savers, borrowers, diversifiers, insurers, principals, agents, gamblers, houses, marks, and con artists. He says:

You need to:

  • Divide borrowers into those who are borrowing because they have something useful to do with the money and those who are borrowing because they short-sightedly think it is a way of avoiding rather than merely delaying the unpleasant conversation with the spouse or the board: call them "entrepreneurs" and "procrastinators".

  • point out that a great many of the savers are impatient where they need to be patient.

  • point out that a great many of the savers are much more risk-averse because they are not diversifiers or do not understand the benefits they derive from diversification--and that they need to be and to understand such.

  • point out the macroeconomic risks caused by herd animals and positive-feedbackers.

In addition to diminishing the numbers of the gamblers, the houses, the marks, and the con artists, we also need to diminish the numbers of the procrastinators, the herd animals, and the positive-feedbackers, and convince the savers not only to be diversifiers but to take account of the benefits of diversification in their planning.

So I need to divide borrowers into entrepreneurs and procrastinators--that's 11--and add undiversified savers, herd animals, and positive-feedbackers to my list: that's 14 different kinds in my bestiary.

A Note: Prolegomenon to Any Useful Discussion of Modern American Finance

In a standard economic transaction, it is no mystery where the value to both sides comes from. When I buy a double espresso from Café Nefeli for $2.25, the coffee is more valuabe to me then $2.25 is. Were I to consider only the experience and not worry about fairness consideration--that is, if I did not worry about thinking that I was turning into a chump--I would pay $5.00 for a double espresso (if Café Nefeli were the only possible place I could get one and if that is what they charged) and count myself happy. And sometimes $10.00.

Similarly, for Café Nefeli the beans, the water, the grinding, the serving, the financing, and the rent, fully amortized, add up no more than $1.50 a cup. Any price between $1.50 and $5.00 a cup (and sometimes $10.00!) leaves both of us better off and happier--them with more generalized purchasing power, and me with caffeine coursing through my arteries.

Financial transactions, however, are different. In normal economic life we are trading commodities we personally value less for commodities we personally value more, we are trading away generalized purchasing power--money--for commodities we value highly, or we are trading away commodities we value little for generalized purchasing power--money--we value more. The sources of the gains from trade are obvious.

But in finance neither side is getting useful commodities. Instead, both sides are trading away claims to a pile of money and getting claims to a different pile of money in return. So how is it that me selling this pile of cash I have to you for that pile of cash that you currently own can be a good idea for both of us? Doesn't one of the piles have to be bigger? And isn't the person who trades the bigger for the smaller pile losing?

Almost, but not quite.

There are three ways in which a financial transaction can be a good deal for both sides.

First, people have different time preferences: I have money now that I do not want to spend on some useful commodity until sometime in the future, while you may have no money now and need some but anticipate being flush in the future; then we both benefit if I lend you the money--at interest. Second, risks distributed and diversified are risks dissipated, and so even though the average customer pays money into the insurance system insurance is still a valuable thing to buy because the insurance company pays you when you really need the cash. Third, economies work best when benefits and losses run with decsion-making: those whose actions create or destroy value pay attention when they have "skin in the game", and financial transactions are a good way to make sure they have that "skin in the game".

Those three sources of value for both sides in financial transactions are powerful.

They motivate net investments and drawdowns, insurance and diversification, and the creation of equity interests for managers, partners, homeowners, and others.

They drive perhaps 1/1000 of the transactions we see on financial markets each day.

All the other transactions are driven by two different factors:

First, in some transactions one or both sides are simply swept up in the excitement of the game. Second, in many transactions one or both sides has simply gotten the odds wrong, and they do not understand what they are doing.

Many economists these days talk about trade in financial assets as being motivated by "disagreement": I think I can make money by doing X, you think you can make money by doing Y, because we disagree about how the world works both X and Y are compatible, and so we trade and we both go away happy--until time passes, uncertainty is resolved, and I learn that you were right and I was an idiot.

"Disagreement"does not, however, capture what is going on.

Sokrates famously said that even though he was completely ignorant he was nevertheless the wisest man in Athens, because he knew that he was completely ignorant. Similarly, If I am completely ignorant about any financial asset, I nevertheless know one very very important thing: I know--unless saving or dissaving, insurance or diversification, or skin in the game considerations apply--that you cannot possibly know less than I do, and the fact that you think this is a good price for you to sell to me is a powerful reason for me to conclude that it is a bad price for me to buy at. When economists say that a financial transaction is motivated by "disagreement", what they mean is that there is not in fact value being created for both sides, and that the more ignorant party is being conned--perhaps by their counterparty, but most likely by themselves.

Overwhelmingly, this last factor is necessary to drive the vast majority of trades we see in modern financial markets. Look at any trade, and the odds are that on one side you will find people who know less than their counterparty and yet have not asked themselves the obvious question: "if this is a good price at which to buy, why are these people who know more than I do about the situation selling?"

If you don't start thinking about finance in this way--don't start by classifying those who trade into savers, borrowers, risk-bearers, risk-shedders, principals, agents, gamblers, and marks--you do not, I think, have any chance of conducting a serious analyses of modern finance.

A serious analysis has to start by dividing transactions into those we like and those we do not like. We like diversification and insurance. We like saving, investing, and repayment. We like transactions that give decisionmakers skin in the game.

The business of originating and greasing such saving, diversification, and incentive transactions is an extremely valuable contribution to society. We want to make sure that everybody knows the value of saving, diversification, and incentive transactions and that the costs of and barriers to them are as low as possible.

But there are also the--more numerous--transactions we do not like.

We do not like transactions motivated by the thrill of the game. The professionals in Las Vegas sell you the thrill of the gamble in a much more entertaining form and at a much lower price than your investment advisers and investment counterparties do. And there is no societal value at all created at all by selling somebody something for more than you know it is worth. Finance as casino and finance as confidence game should not play a major role in any financial system. We want to minimize such transactions.

And if your business model is not just to profit from the gamblers and marks, but to dissipate society's resources by inducing additional gamblers and marks to enter finance and play with higher stakes at games in which you are the house or have the aces up your sleeve--then it would be better for all the rest of us if we could figure out a way to transfer you from the financial sector to some activity with a higher societal value added. Perhaps we could use more unicycle riders to entertain commuters waiting for their express busses...

Liveblogging World War II: October 31, 1941: The Torpedoing of the U.S.S. Reuben James

U.S.S. Reuben James sunk October 31, 1941 « Millard Fillmore's Bathtub:

October 31 is also the anniversary of the sinking of the World War I era Clemson-class, four-stack destroyer, U.S.S. Reuben James, by a German U-boat. Woody Guthrie memorialized the sad event in the song, Reuben James, recorded by the Almanac Singers with Pete Seeger (see also here, and here), and later a hit for the Kingston Trio.  The Reuben James was sunk on October 31, 1941 — over a month before the Japanese attack on Pearl Harbor. Details via Wikipedia (just to make you school librarians nervous):

USS Reuben James (DD-245), a post-World War I four-stack Clemson-class destroyer, was the first United States Navy ship sunk by hostile action in World War II and the first named for Boatswain’s Mate Reuben James (c.1776–1838), who distinguished himself fighting in the Barbary Wars.

This history figures into the current presidential campaign in a small way:  One of the internet hoax letters complaining about Barack Obama claims that the U.S. entered World War II against Germany although the Germans had not fired a single round against the U.S.  The 115 dead from the crew of 160 aboard the James testify to the inaccuracy of that claim, wholly apart from the treaty of mutual defense Germany and Japan were parties to, which required encouraged Germany to declare war upon any nation that went to war with Japan (see comments from Rocky, below).  After the U.S. declaration of war on Japan, Germany declared war on the U.S., creating a state of war with Germany.

This history also reminds us that many Americans were loathe to enter World War II at all.  By October 1941, Japan had been occupying parts of China for ten years, and the Rape of Nanking was four years old.  The Battle of the Atlantic was in full swing, and the Battle of Britain was a year in the past, after a year of almost-nightly bombardment of England by Germany.  Despite these assaults on friends and allies of the U.S., and the losses of U.S. ships and merchant marines, the U.S. had remained officially neutral.

Many Americans on the left thought the sinking of the Reuben James to be the sort of wake-up call that would push Germany-favoring Americans to reconsider, and people undecided to side with Britain.  The political use of the incident didn’t have much time to work.  Five weeks later Japan attacked Pearl Harbor, and by the end of 1941, the U.S. was at war with the Axis Powers.

Twitterstorm delong: October 30, 2011

  • A Volcker Moment Indeed (Slightly Wonkish)

  • RT @pkedrosky: Words cannot express the nuttiness of this Richard Stallman email offering to speak.

  • Washington Post Discards All Journalistic Standards In Attack on Social Security | Beat the Press

  • RT @jeffhauser: Dean Baker is a national treasure, just like Social Security, and Pete Peterson ought to stop messing with either.

  • Econbrowser: Home Affordable Refinance Program

  • Econbrowser: CBO on Income Inequality, and Interpreting OWS

  • RT @thinkprogress: Dear @CatoInstitute: No, we will not link to your study that "proves" income inequality is not getting worse. #sorry ...

  • RT @pandagon: Final Arkham City review: Brilliant story, not that interested in the obsessive collecting after. 9/10.

  • RT @Mobute: We call them New Yorkers or Canadians. MT @michaelkruse: more invasive species make their home in #Florida than anywhere els ...

  • The Radioactive Wolves of Chernobyl

  • RT @EconOfContempt: The Beltway Republicans' crush on Paul Ryan is just sad now. He reads! He thinks! Journalists respect him! Amazing! ...

Paul Krugman on the European Feedback Cycle of Doom


European Doom Loop: Dean [Baker] is completely right about the macro doom loop the Europeans have created for themselves, in which the ECB’s refusal to provide either the lender of last resort facility or the monetary expansion the eurozone needs is creating a vicious circle of self-reinforcing austerity. Dick Baldwin got at this very well last week, although he was excessively optimistic about how long the fix would last; it was two days, not six months. And was anyone else struck by Sarkozy’s declaration last week that since French growth was going to be slower than expected, it would be necessary to tighten the budget further? France may still have a AAA rating, but at the margin it’s behaving like a debt crisis country, with fiscal policy reinforcing a downturn rather than fighting it.

I’d still like to imagine that next week Mario Draghi, newly installed as ECB president, will suddenly reveal himself as a supporter of quantitative easing and a 4 percent inflation target, not to mention open-ended lending to crisis countries. And all this would be perfectly sensible — much more so than the way the ECB is actually behaving. But it’s not going to happen.

My Respect for Wolfgang Schäuble Rises Substantially

Quentin Peel and Gerrit Wiesmann:

Schäuble calls for EU lead on Tobin tax: Wolfgang Schäuble, Germany’s finance minister, wants the European Union to take the global lead in introducing a financial transaction tax to curb speculative trading, along with tougher regulation of big banks and the “shadow” banking sector, such as hedge funds.

If the UK blocked agreement on such a tax in the full EU, he said in an interview with the Financial Times, the eurozone should press ahead on its own.

Speaking just days before the G20 summit of global economies in Cannes, Mr Schäuble spelt out his conviction that failure to reach agreement on tougher financial regulation by the full G20 should not stop Europe acting alone…

Memo to Google

Re: voice transcriptiiins. Somebody calling from Amherst is much more likely to be saying "Amherst" than "Atlantis".

That is all.

Hoisted from Comments: The Armadillos of Castle Dracula

ME: What is the significance of the armadillos underfoot at Castle Dracula?


The armadillos are a sign of status. According to folklore, vampires are obliged to sleep in contact with the soil of their native land. Unfortunately, grave earth tends to attract worms, burrowing insects and other invertebrates. While Dracula may be Lord of the Undead, he is no more comfortable waking up with his nose full of beetle larvae than any living person would be.

As it happens, these are exactly the sort of vermin that comprise the armadillo's specialized diet. An armadillo's keen sense of smell can detect invertebrates buried up to a foot deep in the ground. Moreover, armadillos have a much reduced, anteater-like dentition; so there is no danger of the vampire being inadvertently gnawed on as the armadillo sweeps the crypt clean of worms and maggots. It's a marvelous example of symbiosis, or would be if both participants were technically alive.

In the past, only the wealthiest of vampire nobility could afford to transport armadillos from the New World to eastern Europe. Vampire peasants were sadly accustomed to rising from the grave each night with all their available orifices infested by earthworms and millipedes. This is yet another reason why vampire peasants have been historically eschewed by romantic fiction.

Quote of the Day: October 30, 2011

"Because the value of a currency was tied, by law, to a specific quantity of gold and because the amount of currency that could be issued was tied to the quantity of gold reserves, governments had to live within their means, and when strapped for cash, could not manipulate the value of the currency. Inflation therefore remained low. Joining the gold standard became a “badge of honor,” a signal that each subscribing government had pledged itself to a stable currency and orthodox financial policies. By 1914, fifty-nine countries had bound their currencies to gold."

--Liaquat Ahamed, "Lords of Finance: The Bankers Who Broke the World"    

Josef Stalin Liveblogs World War II: October 30, 1941

Josef Stalin to Franklin Roosevelt:

The American Ambassador, Mr. Steinhardt, through Mr. Vyshinski, presented to me on November 2, 1941, an aide-mémoire containing the contents of your message, the exact text of which I have not yet received.

First of all I would like to express my sincere thanks for your appreciative remarks regarding the expeditious manner in which the conference was handled. Your assurance that the decisions of the conference will be carried out to the limit is deeply appreciated by the Soviet Government.

Your decision, Mr. President, to grant to the Soviet Union a loan in the amount of one billion dollars subject to no interest charges and for the purpose of paying for armaments and raw materials for the Soviet Union is accepted with sincere gratitude by the Soviet Government as unusually substantial aid in its difficult and great struggle against our common enemy, bloodthirsty Hitlerism.

I agree completely, on behalf of the Government of the Soviet Union, with the conditions which you outlined for this loan to the Soviet Union, namely, that payments for this loan to the Soviet Union, namely that payments on the loan shall begin five years after the end of the war and shall be completed during the following ten-year period.

The Government of the U.S.S.R. stands ready to expedite in every possible way the supplying of available raw materials and goods required by the United States.

I am heartily in accord with your proposal, Mr. President, that we establish direct personal contact whenever circumstances warrant.

Nominal GDP Targeting: Is It Simply the Re-animation of Dead Tissue?

This morning Christina Romer sang her aria in the "Time to Level-Target Nominal GDP" opera, calling for the Federal Reserve to announce that it was going to push nominal GDP back to its pre-2009 track.

Would this work? Would this generate a rapid real recovery in employment and production without unleashing an uncontrollable inflationary spiral?

Steve Randy Waldmann says it may not:

interfluidity » Expectations can be frustrated: I think an NGDP path target is superior in nearly every respect to an inflation target, and so would represent a clear improvement over current practice. But… I do not believe that central banks can sustainably track their target… given the set of tools…. I think we need to add direct-to-household “helicopter drops” to our menu of instruments….

Self-fulfilling expectations lie at the heart of the market monetarist theory. A depression occurs when people come to believe that income will be scarce relative to prior expectations and debts. They nervously scale back expenditures and hoard cash, fulfilling their expectations of income scarcity. However, if everybody could suddenly be made to believe that income would be plentiful, everyone would spend freely and fulfill the expectations of plenty…. [T]o switch between the two scenarios, all that is required is persuasion…. As long as we all keep the faith, our faith will be rewarded. This is not a religion, but a Nash equilibrium.

If the market monetarists’ theory of depressions is correct, then their position is correct. They are famously vague and prickly on the question of what instruments or “concrete steps” central banks will use to achieve their objective. That is because it doesn’t matter one bit, as long as those instruments are persuasive. Whether police wield pistols or tanks or tear gas or nightsticks to keep the peace really doesn’t matter, as long as their choice is sufficiently intimidating….

I have a Minsky/Mankiw theory of depressions. The economy is divided into two kinds of people, spenders and savers…. Variation in aggregate expenditure is due mostly to changes in the behavior of the spenders. Savers spend at a relatively constant rate and save the rest. Spenders spend whatever they can earn or borrow…. [A] central bank that targets something — NGDP, inflation, whatever — doesn’t regulate behavior via expectations. Instead, the central bank regulates access to credit and wages…. When the economy is below potential, the central bank reduces interest rates and relaxes credit standards, encouraging spenders to borrow and leaving them with higher wages net of interest payments….

If my theory is right, absent significant structural change, attempting to restore demand merely by shocking expectations would be like trying to defibrillate a corpse….

I am all for targeting an NGDP path. I think it’s a great idea, and have more nice things to say about it. I hope the market monetarists are right…. But if we adopt an NGDP target and are serious about it, there is significant risk that we will be committing to chronic intervention. The market monetarists owe us a more serious conversation than they’ve offered so far about how monetary policy would be conducted if resetting expectations turns out not to be enough. Would the interventions they propose be fair, if pursued cumulatively over many years? Would they be wise? Would they help resolve the structural problems that have rendered it so difficult to sustain demand, or would they exacerbate those problems?

I agree: money printing-financed fiscal expansion in the service of nominal GDP targeting is by far the better policy.

Christina Romer agrees with this point, but hopes that the Federal Reserve can demonstrate that it is serious and so get the economy to jump from the bad equilibrium to the good one.

That is why her op-ed said that the Fed should not just announce this policy of nominal GDP targeting but also start buying bonds for cash, promise that it was going to keep interest rates lower for longer, and sell dollars to foreigners to push the value of the dollar down--and credibly promise it was going to keep doing all these things until nominal GDP was back to its pre-2009 track.

Others go further. Gauti Eggertsson and Michael Woodford [1] believe that right now even buying huge amounts of bonds for cash wouldn't do much if anything to boost the economy. To translate from the Formal Economese: Eggertsson and Woodford are saying that as long as people believe that the Federal Reserve will follow its normal Taylor-rule interest rate policies after the crisis is over and as long as people believe that the government's total debt path will be the same in the long run, buying bonds today does not change the equilibrium configuration [today] of the economy. There is then nothing the Federal Reserve can do to boost the economy right now if its promises are not believed. If there are two equilibria, Eggertsson and Woodford imply, having the Fed buy bonds does not give the economy any reason to jump from the bad one to the good one.

Paul Krugman says that shifting to nominal GDP targeting will be important only to the extent that it makes the Federal Reserve's promises that more bond purchases now mean lower interest rates and higher levels of government debt even in the long run more credible:

A Volcker Moment Indeed : NGDP is a much better target than M1, which (it turns out) is subject to wide swings in velocity. And the Fed’s goals [today], if frankly stated, wouldn’t be nearly as politically explosive as what it was doing in 1979-82. Still, NGDP is arguably mainly a relatively palatable way to state a strategy that’s ultimately about something else.

As I see it — and as I suspect many people at the Fed see it — the basic point is that to gain traction in a liquidity trap you must either engage in huge quantitative easing, raise the expected rate of inflation, or both. Yet saying this is very hard; people treat expansion of the Fed’s balance sheet as horrible money-printing, and as for the virtues of inflation, well, wear your body armor.

But say that we need to reverse the obvious shortfall in nominal GDP, and you’ve found a more acceptable way to justify huge quantitative easing and a de facto higher inflation target.

Don’t call it a deception, call it a communications strategy. And as I said, I’m for it.

I would say that I think Christy Romer has the best argument here. It seems to me that Eggertsson's and Woodford's argument is incomplete. To the extent that taxpayers are different from bondholders--and they are--portfolio-balance effects are real. Sufficiently large quantitative easing would make those portfolio-balance effects large enough to destroy the bad equilibrium--and then the economy would quickly transit to the good one. That is what Krugman means by "huge quantitative easing".

And, of course, once expectations coordinate on the good equilibrium, you don't need to do any quantitative easing at all--rather the reverse: the Fed will have to shrink its balance sheet relatively quickly in order to maintain a good and non-inflationary equilibrium.

[1] Eggertsson and Woodford: The Zero Bound on Interest Rates and Optimal Monetary Policy:

A Neutrality Proposition for Open-Market Operation…. [W]e suppose that the central bank's operating target for the short-term nominal interest rate [i] is determined by a feedback rule in the spirit of the Taylor rule… that the central bank supplies the quantity of base money that happens to be demanded at the interest rate given by this formula…. Under those conditions in which the value of [i] is zero, the policy commitment… [imposes] only a lower bound on the monetary base…. [W]e may ask whether it matters whether a greater or a smaller quantity of base money is supplied. We assume that the central bank's policy in this regard is specified by a base-supply rule… [with a] multiplicative factor ψ…. The use of quantitative easing as a policy tool can then be represented by a choice of a function ψ that is greater than 1 under some circumstances….

PROPOSITION. The set of paths for the variables {p*, P, Y, i, q, D} that are consistent with the existence of a rational expectations equilibrium is independent of the specification of [ψ]….

The reason for this is fairly simple. The set of restrictions… implied by our model can be written in a form that does not involve the… functions… ῳm, ῳf, ψ… and the result is established.

Discussion: The above proposition implies that neither the extent to which quantitative easing is employed when the zero bound binds, nor the nature of the assets that the central bank may purchase through open-market operations, has any effect on whether a deflationary price-level path represents a rational expectations equilibrium…. [E]xpansions of the monetary base [do not] represent an additional tool of policy, independent of the specification of the rule for adjusting short-term nominal interest rates. If the commitments of policymakers regarding the rule by which interest rates will be set, on the one hand, and the rule by which total private sector claims on the govemment will be allowed to grow, on the other, are fully credible, then it is only the choice of those commitments that matters. Other aspects of policy should matter in practice only insofar as they help to signal the nature of these policy commitments….

It might be suspected that an important omission is our neglect of portfolio-balance effects…. No such effects arise in our model…. The classic theoretical analysis of portfolio balance effects assumes a representative investor with mean-variance preferences. This has the implication that if the supply of assets that pay off disproportionately in certain states of the world is increased (so that the extent to which the representative investor's portfolio pays off in those states must also increase), the relative marginal valuation of income in those particular states is reduced, resulting in a lower relative price for the assets that pay off in those states. But in our general-equilibrium asset pricing model, there is no such effect. The marginal utility to the representative household of additional income in a given state of the world depends on the household's consumption in that state…. And changes in the composition of the securities in the hands of the public do not change the state-contingent consumption of the representative household.  [L]eaving aside the question of whether a clear theoretical foundation exists for the existence of portfolio balance effects, there is not a great deal of empirical support for quantitatively significant effects….

[I]t is more important to note that our irrelevance proposition depends on an assumption that interest rate policy is specified in a way that implies that these open-market operations have no consequences for interest rate policy, either immediately (which is trivial, because it would not be possible for them to lower current interest rates, which is the only effect that would be desired), or at any subsequent date. We have also specified fiscal policy in a way that implies that the contemplated open-market operations have no effect on the path of total government liabilities D either, whether immediately or at any later date. Although we think these definitions make sense, as a way of isolating the pure effects of open-market purchases of assets by the central bank from either interest rate policy on the one hand or fiscal policy on the other, those who recommend monetary expansion by the central bank may intend for this to have consequences of one or both of these other sorts…

Hey Hey, Ho Ho: Nominal GDP Level Targeting Is Ready to Go

Christina Romer speaks sooth to Ben Bernanke:

Ben Bernanke Needs a Volcker Moment: Volcker… believed that… backing up his commitment to lower inflation with a new policy framework… would break people’s inflationary expectations…. Bernanke needs to steal a page from the Volcker playbook…. [H]e needs to set a new policy framework — in this case, to begin targeting the path of nominal gross domestic product…. The Fed would start from some normal year — like 2007 — and say that nominal G.D.P. should have grown at 4 1/2 percent annually since then, and should keep growing at that pace. Because of the recession and the unusually low inflation in 2009 and 2010, nominal G.D.P. today is about 10 percent below that path. Adopting nominal G.D.P. targeting commits the Fed to eliminating this gap….

By pledging to do whatever it takes to return nominal G.D.P. to its pre-crisis trajectory, the Fed could improve confidence and expectations of future growth….

Even if we went through a time of slightly elevated inflation, the Fed shouldn’t lose credibility as a guardian of price stability. That’s because once the economy returned to the target path, Fed policy — a commitment to ensuring nominal G.D.P. growth of 4 1/2 percent — would restrain inflation….

The Fed would need to take additional steps. These might include further quantitative easing, more forceful promises about short-term interest rates, and perhaps moves to lower the exchange rate…

Note that if the Federal Reserve did commit to returning nominal GDP to its pre-2007 growth path within the next three years, it would be aiming for 8%-9% per year of nominal GDP growth--which would carry with it a (temporary) inflation rate of 3%-4% per year. If Ben Bernanke did not have buy-in for such a (temporary) inflation rate from a solid majority on the FOMC, he should not undertake the proposed policy. Note that if the Federal Reserve did commit to returning nominal GDP to its pre-2007 growth path within the next three years, it might well have to buy more than $2 trillion of long-term dollar-denominated securities in the next several months (or it might find that it might need to sell up to $800 billion of its current bond holdings: we really don't know). If Ben Bernanke did not have buy-in for such a tremendous expansion of the Federal Reserve balance sheet from a solid majority on the FOMC, he should not undertake the proposed policy. Note that if the Federal Reserve did commit to returning nominal GDP to its pre-2007 growth path within the next three years, the dollar might well fall by 10% or more more-or-less immediately. If Ben Bernanke did not have buy-in for such a large move in the dollar from a solid majority on the FOMC, he should not undertake the proposed policy.

Those are the only three possible reasons I can think of for not announcing on Monday that level targeting of the nominal GDP growth path is now Federal Reserve policy, and that the quantitative easing asset purchases that may be needed to support that policy will start immediately at the rate of $50 billion a day.

Christy Romer's Pro-Nominal GDP Targeting Op-Ed Is Now Live

Mark Thoma informs us:

Christina Romer: "Dear Ben: It’s Time for Your Volcker Moment": Christina Romer tells Ben Bernanke that we need "aggressive actions," including adopting a nominal GDP target, to "help to heal the economy"

Dear Ben: It’s Time for Your Volcker Moment

No disagreement here about the need for more forceful monetary policy actions. We could use more help from fiscal policy too.

Twitterstorm delong: October 29, 2011

  • Finished reading Models.Behaving.Badly by Emanuel Derman #Kindle

  • Finished reading Brain Bugs: How the Brain's Flaws Shape Our Lives by Dean Buonomano

  • Finished reading Fractions: The First Half of The Fall Revolution by Ken MacLeod #Kindle

  • The Street Light: Worrying Signs

  • Paul Krugman: Denial In Depth

  • RT @EmanuelDerman: A Look Ahead: Are Cozy Ties Muzzling S&P on MF Global Downgrade?

  • RT @greg_ip: As @NYTimeskrugman noted, here is Chris Sims on central banks as lender of last resort to government. Excellent.

  • Superhero Rubric

  • RT @HansRosling: 1968 women got 1.87 adult daughters. Ehrlich called it population bomb. Now women get 1.07 daughters, 92% of way to pop ...

  • Larry Kramer: Watch Out Media Companies, Here Comes The Real Google

Quote of the Day: October 29, 2011

"Uncertainty is not a statement about the limits of measurement, it’s a statement about the limits of reality. Asking for the precise position and momentum of a particle doesn’t even make sense, because those quantities do not exist."

--Chad Orzel, How to Teach Physics to Your Dog

Winston Churchill Lliveblogs World War II: October 29, 1941

Winston Churchill Speaking at Harrow:

Almost a year has passed since I came down here at your Head Master's kind invitation in order to cheer myself and cheer the hearts of a few of my friends by singing some of our own songs.

The ten months that have passed have seen very terrible catastrophic events in the world--ups and downs, misfortunes-- but can anyone sitting here this afternoon, this October afternoon, not feel deeply thankful for what has happened in the time that has passed and for the very great improvement in the position of our country and of our home?

Why, when I was here last time we were quite alone, desperately alone, and we had been so for five or six months. We were poorly armed. We are not so poorly armed today; but then we were very poorly armed. We had the unmeasured menace of the enemy and their air attack still beating upon us, and you yourselves had had experience of this attack; and I expect you are beginning to feel impatient that there has been this long lull with nothing particular turning up!

But we must learn to be equally good at what is short and sharp and what is long and tough. It is generally said that the British are often better at the last. They do not expect to move from crisis to crisis; they do not always expect that each day will bring up some noble chance of war; but when they very slowly make up their minds that the thing has to be done and the job put through and finished, then, even if it takes months - if it takes years - they do it.

Another lesson I think we may take, just throwing our minds back to our meeting here ten months ago and now, is that appearances are often very deceptive, and as Kipling well says, we must « with Triumph and Disaster. And treat those two impostors just the same.»

You cannot tell from appearances how things will go. Sometimes imagination makes things out far worse than they are; yet without imagination not much can be done. Those people who are imaginative see many more dangers than perhaps exist; certainly many more than will happen; but then they must also pray to be given that extra courage to carry this far-reaching imagination.

But for everyone, surely, what we have gone through in this period--I am addressing myself to the School--surely from this period of ten months, this is the lesson:

Never give in. Never give in. Never, never, never, never--in nothing, great or small, large or petty--never give in, except to convictions of honor and good sense. Never yield to force. Never yield to the apparently overwhelming might of the enemy.

We stood all alone a year ago, and to many countries it seemed that our account was closed, we were finished. All this tradition of ours, our songs, our School history, this part of the history of this country, were gone and finished and liquidated.

Very different is the mood today. Britain, other nations thought, had drawn a sponge across her slate. But instead our country stood in the gap. There was no flinching and no thought of giving in; and by what seemed almost a miracle to those outside these Islands, though we ourselves never doubted it, we now find ourselves in a position where I say that we can be sure that we have only to persevere to conquer.

You sang here a verse of a School Song: you sang that extra verse written in my honor, which I was very greatly complimented by and which you have repeated today. But there is one word in it I want to alter - I wanted to do so last year, but I did not venture to. It is the line: «Not less we praise in darker days.»

I have obtained the Head Master's permission to alter darker to sterner. «Not less we praise in sterner days.»

Do not let us speak of darker days: let us speak rather of sterner days. These are not dark days; these are great days--the greatest days our country has ever lived; and we must all thank God that we have been allowed, each of us according to our stations, to play a part in making these days memorable in the history of our race.

Twitterstorm delong: October 28, 2011

*RealTime Economic Issues Watch | How Much Refinancing?

  • Jed Rakoff puts the SEC on notice | Felix Salmon

  • iPhone 4S Battery Life Sucks? Try Disabling Location Services

  • The Rise of Coffee—And Personal Productivity | ThinkProgress

  • Democrats Offer Significant Concessions — Center on Budget and Policy Priorities

  • RT @daveweigel: Ralph Nader's campaign to primary Obama sputters; won't have a candidate for NH, deadline in 78 minutes.

  • RT @nickconfessore: RT @greenhousenyt: Survey: 68% of millionaires back tax hikes for those w/ >$1 million in income

  • Gagnon’s $2 trillion plan for Fed MBS buys | MacroScope

  • Women win equal right to British throne

  • Mark Hosenball: Dealings with Gaddafi son embarrass LSE

  • RT @TPM: Report: Bank of America scaling back debit card fees

  • RT @libsechumanist: @EricBoehlert And imagine how the recovery would be going if the #GOP actually WANTED a good economy.

  • Dahlia Lithwick: Occupy the No-Spin Zone

  • Ms. Rand, Meet Singapore. Mr. Hayek, Meet Norway. - BusinessWeek

  • How Occupy Wall Street Cost Me My Job

There Is No Point in Trying to Negotiate Any "Grand Budget Compromise"

Robert Greenstein, Richard Kogan and Paul N. Van de Water write:

Center on Budget and Policy Priorities: The new deficit-reduction plan from a majority of Democrats on the congressional Joint Select Committee on Deficit Reduction (the "supercommittee") marks a dramatic departure from traditional Democratic positions — and actually stands well to the right of plans by the co-chairs of the bipartisan Bowles-Simpson commission and the Senate's "Gang of Six," and even further to the right of the plan by the bipartisan Rivlin-Domenici commission. The Democratic plan contains substantially smaller revenue increases than those bipartisan proposals while, for example, containing significantly deeper cuts in Medicare and Medicaid than the Bowles-Simpson plan. The Democratic plan features a substantially higher ratio of spending cuts to revenue increases than any of the bipartisan plans…

You can't negotiate without a negotiating partner. When the Democrats get--reliable--majorities in both houses, they can impose a long-run government budget solution. Until then there is no point in trying until Republican legislators are willing to come to the table.

That is not rocket science. That is kindergarten tiddlywinks.

7 Billion

BBC: What's your number?: >When you were born, you were the: 3,037,348,163rd person alive on Earth, and the 76,687,107,007th person to have lived since history began. How about looking beyond the narrow humancentric? How about apes? Mammals? Chordata? Living beings?

Yes, the Economy Does Have a Sectoral Problem: In the Housing Finance Sector

Ryan Avent:

America's economy: The obstacle | The Economist: As a share of the economy, residential investment during the peak of the housing boom was high, but not remarkably so…. During the bust, by contrast, investment as a share of the economy has hit striking historical lows…. There is, at the moment, a remarkable shortfall in residential investment, far greater in magnitude than the excess in building during the boom. And that shortfall is directly related to the disappointing nature of recent GDP and employment growth.

At a dinner last night, I heard Alan Greenspan correctly diagnose this ailment in the economy, then go on to offer an extremely puzzling explanation for it: policy uncertainty. That seems off to me. I think there are two key factors generating the failure of the residential investment sector to enjoy a recovery. One is the dismal outlook for demand growth, which has had a particularly relevant impact on household formation (there are lots of people doubling and tripling up at the moment). And another is the failure to get mortgage markets working again: despite rising rents and rock-bottom interest rates, mortgage lending remains at very low levels….

It would seem that there is substantial pent-up housing demand, and if policies become more supportive of growth generally and mortgage lending, then a bounce-back in residential investment could help America make up a fair amount of economic ground in a short period of time…. The country may have had too many housing units at one point during the boom, particularly in certain outlying areas in especially bubbly markets. Whatever national excess there was has vanished. Once growth triggers a rise in household formation, housing demand will soar, and if the government can't clear up the lending channel, rents will begin soaring too.

Twitterstorm delong: October 27, 2011

  • RT @mawrgan: Manhattan is insane right now. People are getting out of cabs to join the march. Protesters have taken Broadway for #Occupy ...

  • RT @JeffSharlet: I missed this: MSNBC anchor said "In Oakland, police fired tear gas to calm down the crowd." I have some w/ milk & cook ...

  • RT @xeni: But my gripe isn't with individual reporters or hosts; rather, the fact that no networks are there now, live, when Major Shit ...

  • Wolfgang Munchau: Half measures and wishful thinking do not a solution make

  • What do Rick Perry and pro sports teams have in common? | Matt Rognlie

  • the understatement: Android Orphans: Visualizing a Sad History of Support

  • Economist's View: Charlatans and Cranks

  • EMU summit leaves €1,000 billion to be raised | Gavyn Davies

  • The big questions raised by anti-capitalist protests -

  • Earth: Population 7 Billion

  • RT @brianbeutler: Jefferson Starfish #lessexcitingbandnames

  • RT @daveweigel: I'm excited RT @Adrastosno: @daveweigel Better Than Weigel #lessexcitingbandnames

  • RT @daveweigel: Working in Dupont circle has definitely colored my views on drum circles. I'm pro-ejecting them into the heart of the sun.

  • RT @jamisonfoser: Ever notice that nobody ever explains why it's important to employ Pat Buchanan? They just hope you'll forget about it.

  • RT @thinkprogress: "I stand with Scott Olsen. I am the 99%." #ows

  • RT @Atrios: phew. the stock market is back. we can go back to ignoring all the unemployed again about 3 hours ago from web RT @ModeledBehavior: Are There Too Many Homes in America, Ctd

  • RT @markos: Fox poll says Fox News is failing: Most Americans not scared of Obama's reelection

  • RT @ddayen: April budget cuts which were back-loaded and supposedly not all that bad actually cost 370,000 jobs, per CAP

A Note: Components of Autonomous Spending

FRED Graph  St Louis Fed 2

The longer I stare at figures like this, the more impressed I am with how well Say's Law worked between the peak of the housing boom in the third quarter of 2005 and the start of the recession in the first quarter of 2008.

Housing construction (and government purchases) sit down. Exports, equipment investment, and nonresidential construction stand up. Even as of 2008:III, the sum of the components of autonomous spending was only 0.7% of potential GDP lower than trend.

It is in the next three quarters to 2009:II that the autonomous spending shortfall grows swiftly to -5.6% of GDP.

This makes me suspicious of accounts of the Lesser Depression that rely on the loss of household wealth in the collapse of the housing bubble as a big explanation. At the very least, such explanations need to be supplemented by an account of why the damage done by real-estate losses' effects on household balance sheets was not linear. It also makes me even more suspicious of "Austrian" accounts. For the first three years after the peak of the housing bubble, redeploying labor out of housing construction imposes no requirement that other sectors shrink: rather the reverse: they grow.

Microsoft Excel

FRED Graph  St Louis Fed 1

Quote of the Day: October 27, 2011

"If the European Civil War is to end with France and Italy abusing their momentary victorious power to destroy Germany and Austria-Hungary now prostrate, they invite their own destruction also, being so deeply and inextricably intertwined with their victims by hidden psychic and economic bonds."

--John Maynard Keynes: The Economic Consequences of the Peace

Monetary Policy In A Storm

Matthew Yglesias ponders why we are here:

Monetary Policy In A Storm: David Leonhardt channels the economics blogosphere in a great Sunday Review column on monetary policy:

But you would also find a sizable group of economists who thought the Fed could and should do far more than it was doing. This group, known as doves, tilts liberal, though it includes conservatives as well. If anything, it can probably claim a larger number of big-name economists — J. Bradford DeLong, Paul Krugman (an Op-Ed columnist for The New York Times), Christina D. Romer, Scott Sumner and Mark Thoma, among others — than the camp that believes the Fed has done too much.

You would never know this, however, from listening to the public debate among Federal Reserve officials. That debate is much narrower…

Tragically, the growing media awareness of this school of thought seems to have come far too late to save us from the disasters of the past 18 months and the bleak situation I expect to play out over the next 18. But I do believe that ideas have consequences. At a crucial moment in the winter of 2008-2009 and then for most of the subsequent year there just weren’t enough people outside specialist communities who grasped the importance of these issues. Everyone—whether or not they’re constitutional lawyers by trade—understands that the Supreme Court exists, that its actions are important, that authority to nominate people to fill vacancies on its bench is one of the President’s most important powers, that lots of things hinge on filling those seats with the right people, etc. The Federal Reserve simply wasn’t on the radar, President Obama meekly reappointed a conservative Republican to the most important economic policy job in the country, vacancies sat unfilled, hard money cranks dominated the public debate, and poor macro performance started to drag down progressive policy across the board. We have to do better.

A Note on the U.S. Comparative Advantage in the Sale of "Political Risk Insurance"

The 4% of GDP trade deficit that we have on average run over the past decade is best viewed as yet another shift of the US economy into the insurance industry: in this case, a shift inro the "industry" of providing political risk insurance.

Poor-country governments desperately need economic growth for two reasons: first, to enhance the welfare of their people; second, to keep the heads of the rulers from winding up being carried through the streets on pikes. But the only reliable way we know him for a poor country to become richer is for it to grab some markets by exporting low and relatively simple manufactured goods to the rich industrial core. That requires a low value look for the domestic currency. And that requires that the government manipulate the currency by buying large amounts of dollars at prices that it knows damned well it will not be able to match when it comes time to sell its accumulation of dollar-denominated assets.

Developing country governments, especially in Asia, think that this political risk insurance policy is well worth buying.

That is about half of the past decade's trade deficit

The other half is the sale of political risk insurance not to poor-country governments but to rich people in poor countries. If the balloon goes up, if the revolution commences, and if the upper class of a poor country has to make a run for it in the Learjet or the rubber boat, it is then much better for them to arrive on the other side with a large securities account of dollar-denominated money at Citigroup or J.P. Morgan Chase than to arrive as penniless refugees. That in large part explains the extraordinary demand by the emerging rich of much of the rest of the world for dollar denominated assets.

That is the other half of our past decade's trade deficit.

Now from one perspective the sale of political risk insurance is a very lucrative business to be in indeed. The People's Bank of China pays eight renminbi for each dollar that it buys, and yet when it will come time to sell those dollars it will get only four renminbi in return. $30 billion at four renminbi per dollar profit means 120 billion renminbi a month in value to the United States from its trade deficit with China alone. That is $180 billion a year of value from the sale of political risk insurance to Greater China alone.

The question, however, is whether this American specialization in finance and in the sale of political risk insurance is truly intelligent. Are these the "industries" of the future? Or is this rather a path that leads to a dimmer future for middle-class America?

More Bad Macro Outcomes

Slow economic growth continues to put upward pressure on unemployment:

Non-residential investment grew at a 16.3 percent annual rate in the third quarter, accounting for 1.54 percentage points of the 2.5 percent GDP growth in the quarter. Consumption growth was weak at 2.4 percent, but considerably better than the 0.7 percent rate reported for second quarter...

Note the strength of nonresidential investment--exactly what we would not see if business "uncertainty" about regulatory policy were holding back the recovery.

Twitterstorm delong: October 26, 2011

  • Transcript of "Lost Decades: The Making of America's Debt Crisis and the Long Recovery"

  • RT @davidmwessel: Well put. Some distrib issues too @djheakin: Most impt aspect of flat tax: the base Most talked about: one rate Least ...

  • RT @brianbeutler: RT @MichaelSLinden @RepPaulRyan is wrong RE US income mobility. Most Eur countries (incl France, Sweden, Denmark) have ...

  • Wild-Eyed Theorists In Pinstripes -

  • Advice for Obama: The Press and the Republicans Will Call You a Liberal, So You Might as Well Be a Liberal

  • RT @TheStalwart: RT @ComfortablySmug: Euro Summit 14: The Wrath of Hu

  • RT @TheStalwart: RT @LorcanRK: Euro Summit 14: The Italian Job

  • RT @drgrist: Paul Ryan laments "politics of division," divides America into "makers and takers."

  • RT @drgrist: Oakland cop deliberately throws flash grenade into group trying to help wounded protestor:

  • RT @joshtpm: Watching the painful spectacle of Wolf Blitzer finding out on live TV that Rick Perry's had a bad month or so about 5 hours ago from web

  • RT @crampell: Life Without Stimulus: comparing the US economy, which passed stimulus, to UK economy, which didn't about 5 hours ago from web

  • RT @mattyglesias: The super committee is deadlocked? And over taxes? #shocked

  • Transcript of "Lost Decades: The Making of America's Debt Crisis and the Long Recovery"

  • RT @mattyglesias: Paul Ryan on equality of opportunity -- a fool acting foolish:

  • RT @Nouriel: Berlusconi will do asset sales of 5bn euros a year to reduce a debt of 2 trillion euros. That will impress the markets...

  • RT @dangillmor: BoingBoing's #occupyoakland is comprehensive. plainly a police overreaction (at best)

  • Washington Post Illustrates Oakland Police Brutality With Cop Petting Kitty

  • Royal Society journal archive made permanently free to access | Royal Society ☑ Royal Society journal archive made permanently free to access | Royal Society

  • Harold Pollack on Paul Starr: Sisyphus Gets to the Top

  • RT @BetseyStevenson: This is good news--even if Congress is melting down, the Fed seems to be holding onto its sanity.

Martin Sullivan: The U.S.-U.K. Comparison

Tax com Life Without Stimulus

Martin Sullivan: Life Without Stimulus: In the United Kingdom the government is led by Conservative Prime Minister David Cameron. His government… boldly enacted an economic program that cut spending and raised taxes. The chart… shows the results and compares it to the U.S. experience. After three and a half years, U.S. GDP is just about returning to the pre-recession peak. That's awful. But it s far better than the U.K…

Advice for Obama: The Press and the Republicans Will Call You a Liberal, So You Might as Well Be a Liberal

This is especially true because by and large liberal policies are good policies. To pursue sub-par policies and abandon policies that are good for the nation because you think your political viability is enhanced by being a hippie-punching non-liberal simply does not work. It simply does not work on the terrain of politics, for you are going to be classified as a liberal no matter what. And it simply does not work on the terrain of policy.

Duncan Black explains:

Eschaton: Unforced Errors: The Republicans shit the bed and I get that it is indeed difficult to unshit it, but the thing to remember is that every Democratic president is, no matter how they portray themselves, the representative of liberalism and their policies, and policy outcomes become liberal policy outcomes. Whether it's JFK's Brahmin Bolshevism, LBJ's Stonewall Stalinism, that peanut farmer from the Georgian Soviet Socialist Republic, Slick Willie's Hillbilly Marxism, or, of course, the current Kenyan Muslim Socialism, they all represent The Left because, well, they run the damn country and they're nominally of The Left. I tend to think the hippies get it mostly right, and while none of these people are actually hippies, given the way they're portrayed they ultimately do represent them.

Battle of Seattle vs. Occupy Wall Street

Matthew Yglesias:

Yglesias | ThinkProgress: It seemed to me both then and now that the big problem with the global justice movement of [the 1990s]... that the movement’s analysis was mistaken. The late 1990s were a very prosperous time for America. And the analysis that the spread of global capitalism to what we used to call “the third world” would be immiserating for those countries was wrong. China has not been immiserated. Nor has India. Nor has Brazil. Nor has Turkey. Africa’s just wrapped up a very solid decade. It’s true, as Dani Rodrik will tell you, that none of the development success stories (except maybe Chile) has come from a carbon copy implementation of the full Washington Consensus. But it’s even more true that none of the development success stories have come from developing a radical alternative to participation in a globalized market economy.

By contrast, the main analytic points of Occupy Wall Street and its offshoots are correct. Policymakers promised us broadly shared prosperity and macroeconomic stability. We didn’t get the former, and now we can see that we didn’t get the latter either. Having failed to deliver prosperity or stability, the global elite pivoted to the claim that owing to the lack of past prosperity it would be irresponsible to return us to macroeconomic stability without first cutting pensions. It’s crap, and people shouldn’t stand for it.

And in America, at least, it’s already working. Conservative politicians are expressly talking about inequality, and the Obama administration has gone back to talking about aggregate demand instead of grand bargains. There’s more to life than being right, but being right helps a lot. And that’s the main difference here.

Wild-Eyed Theorists In Pinstripes -

Paul Krugman is thinking like I am thinking about the radicalism of the Grandees of Europe, and especially of the ECB:

Wild-Eyed Theorists In Pinstripes: [W]e have a couple of centuries’ experience with central banking, and that experience clearly shows that the lender of last resort function is crucial. The Federal Reserve basically was created after America had to rely on J.P. Morgan to fill that role in the panic of 1907, and it was recognized that one couldn’t always count on having a J.P. Morgan on hand when you needed one…. Yet we have some people in Frankfurt who are apparently dedicated to the proposition that they can be Europe’s central bank without performing that function… a radical theory at odds with evidence and experience. And it’s a theory that could kill the euro….

The crisis we’re in is not something unprecedented. It’s a close cousin to the Great Depression — milder, but recognizably the same sort of thing. And we understand — or used to understand — how the Depression happened, and what to do…. So how is it that policy is so confused and lost? I’ve been arguing for a while that much of the economics profession has lost its way…. But it’s not just economists…. On Monday night… Chris Sims… pointed out that central banks have always had a wider mandate than simply guaranteeing price stability…. And there are good, well-understood reasons for this wider mandate. Yet the creators of the euro essentially threw away hard-won wisdom…. The result of all this is that the supposedly sober, serious people are actually radicals insisting that we can make the economy work in ways that it has never worked in the past — hence the embrace of magical thinking on expansionary austerity and the power of structural reform. Meanwhile, the irresponsible bearded professors are actually the custodians of traditional wisdom…

John Cassidy:

Rational Irrationality: I was on Leonard Lopate’s WNYC radio show… Leonard asked me an interesting question: Has the financial crisis and Great Recession produced any big new economic ideas? My immediate response was that it hasn’t…. But I do think that some important ideas have been discovered—or, rather, rediscovered. Here are six….

  1. Finance matters…. [M]any economists somehow managed to forget it. Two who didn’t were Hyman Minsky and Wynne Godley….

  2. Credit busts are different from ordinary recessions…. Carmen Reinhart and Ken Rogoff’s historical survey, “This Time is Different: Eight Centuries of Financial Folly”…. Irving Fisher’s famous essay from 1933….

  3. Positive feedback and multiple equilibria have to be taken seriously….

  4. Especially in financial markets, self-regarding rational behavior isn’t necessarily socially optimal….

  5. Monetary policy doesn’t always work very well. This lesson should have been relearned in Japan. One person who did relearn it was Paul Krugman. This essay of his from 1998 explains how economies can get stuck in a “liquidity trap,” and is still worth reading, as his book “The Return of Depression Economics,” an updated version of which was reissued in 2008.

  6. Fiscal stimulus programs don’t provide a panacea for deep recessions, but the alternatives—do-nothing policies or austerity—are much worse. If you doubt this, I would suggest you look at what is happening in Greece and the United Kingdom…

Mark Thoma comments:

Economist's View: Important Ideas Have Been Discovered—or, Rather, Rediscovered: I'll add one more: Before the crisis Alan Greenspan assured us that there wasn't a housing bubble, and even if there was, and it popped, the Fed could contain its effects and clean up afterward. Nothing to worry about. That was wrong…. The Fed needs better ways to identify bubbles. Because of the belief that bubbles could be contained and easily mopped up, little effort was made to find ways to identify bubbles as they were inflating. Now that we know how much damage bubbles can do -- something we should have known already -- we need to put effort into finding reliable indications of bubbles, and then take action to stop them from doing severe damage.

Another: In this type of recession, saving banks is not enough to restore the economy. It's critical to help households too.