1) Robert Solow: Hedging America:
It is nice that Cassidy is able to use the story of the financial crisis to exemplify some of the systematic sources of egregious market failure. But there is a deeper, or at least prior, question that he does not take up. Is all this financial activity socially useful, even in the absence of breakdown? It is worth a moment’s thought. Cassidy quotes Alan Greenspan:
Recent regulatory reform coupled with innovative technologies has spawned rapidly growing markets for, among other products, asset-backed securities, collateral loan obligations, and credit derivative default swaps. These increasingly complex financial instruments have contributed, especially over the recent stressful period, to the development of a far more flexible, efficient, and hence resilient financial system than existed just a quarter-century ago.
Flexible maybe, resilient apparently not, but how about efficient? How much do all those exotic securities, and the institutions that create them, buy them, and sell them, actually contribute to the “real” economy that provides us with goods and services, now and for the future? The main social purpose of the financial system--banks, securities markets, lending institutions, and the rest--is to allocate society’s pool of accumulated savings, its capital, to the most productive available uses.... We would be much poorer without a functioning financial system.... If anyone who wanted to start a business--a software company, a biotechnology laboratory, a retail store--had to do so with his or her already saved-up wealth and the help of relatives, many good ideas would go unrealized....
But those needs were being taken care of a quarter-century ago, and well before that. The real question, to which Greenspan gave such a confident and grandiose answer, is whether anything much was added to the system’s ability to allocate capital efficiently by the advent of naked CDSs and CDOs and the rest of the alphabet...
2) Doug Elmendorf: How Reducing Payroll Taxes Can Encourage Employment:
Today CBO released a letter... about policies that could be adopted to increase employment... a policy option to reduce employers’ payroll taxes for firms that increase their payroll, and how different design elements of this type of policy might affect its impact on employment. In CBO’s January 2010 publication, Policies for Increasing Economic Growth and Employment in 2010 and 2011, the agency analyzed the effects on employment of several policy options, including giving employers a one-year, nonrefundable credit against their payroll tax liability for increasing their payrolls in 2010 from their 2009 levels.... CBO estimated that, through its effects on wages, prices, and profits, the policy would add 8 to 18 cumulative years of full-time-equivalent employment in 2010 and 2011 per million dollars of total budgetary cost, measured in terms of lost revenues. Thus, the budgetary cost of increasing employment by one full-time person for one year would probably be between $56,000 and $125,000. Although such a policy would have economic benefits in the short run, it would also add to already large projected budget deficits. Unless offsetting actions were taken to reverse the accumulation of additional government debt, future incomes would tend to be lower than they otherwise would have been....
Capping the size of the tax cut for individual firms would decrease the employment effect; Restricting eligibility to small firms would decrease the employment effect; Limiting the eligible wage base would not change the employment effect, but would alter the types of employment fostered by the policy; Basing the tax cuts on the total payroll in 2010 for new hires rather than on the net change in a firm’s payroll from 2009 to 2010 would have a similar effect on employment; Offering larger tax cuts in economically depressed areas would probably not significantly alter the effect on employment; Raising awareness of the tax change would increase the employment effect; and Increasing the complexity of the tax change would reduce the employment effect.
3) dsquared: Zombie ideas walk again:
I like this concept of “low volatility, interrupted by occasional periods of high volatility”. I think I will call it “volatility”.
4) Paul Krugman: Percents And Sensibility:
Brad DeLong makes a very good point: "If you believe that the Fed kept the fed funds rate 2% below its proper Taylor-rule value for 3 years, that has a 6% impact on the price of a long-duration asset like housing. Even with a lot of positive-feedback trading built in, that’s not enough to create a big bubble. And it wasn’t the bubble’s collapse that caused the current depression–2000-2001 saw a bigger bubble collapse, and no depression."
This is actually a very broad problem with all accounts of the crisis that try to exonerate the private sector and place the blame on the government and/or the Fed: none of the proposed evil deeds of policy makers were remotely large enough to cause problems of this magnitude unless markets vastly overreacted. That is, you have to start by assuming wildly dysfunctional financial markets before you can blame the government for the crisis; and if markets are that dysfunctional, who needs the government to create a mess? This logic applies... to all attempts to explain the crisis in terms of excessively low Fed funds rates for a few years.... to John Cochrane’s story that financial markets are efficient, but were terrorized by George W. Bush’s scary speech.... John Taylor’s basically similar claim that policy uncertainty in the couple of weeks after Lehman fell did it... claims that the Community Reinvestment Act and/or Fannie Freddie somehow led to massive bubbles in high-end housing and commercial real estate. Put it this way: if our financial system is so high-strung, so manic-depressive, that low rates for a few years can inflate a monstrous bubble, while a few discouraging words from high officials can send them into a tailspin*, this doesn’t make the case that policy must walk on eggshells, forgoing any attempt to fight prolonged unemployment. Instead, it makes the case for much, much stronger financial regulation.
5) Paul Samuelson: Rational Irrationality:
“I applaud the fact that Robert Lucas received the Nobel Prize last year. I thought it was overdue,” Samuelson said. In terms of economic theory, he went on, the rational expectations approach was very significant, but its practical importance was negligible. “The rational expectations paradigm of analysis had nothing to contribute to the Reagan administration, where it would have been welcome, or, indeed, to the Federal Reserve Board’s outside committee of academic consultants, which I used to attend. There was usually one rational expectations man at each meeting, but it was rarely the same one twice. In terms of practical analysis, they had nothing to teach us.” “What is real”—of the rational expectations approach—“is that you can’t fool all of the people all of the time,” Samuelson said, but the suggestion that changes in monetary policy don’t impact the economy, at least in the short-term, was plainly wrong. “That is the Achilles heel of the Lucas vision.” Equally troubling, Samuelson went on, were later elaborations of the rational expectations approach, particularly the “real business cycle” theory, which posited that the economy at large was in a continuous state of equilibrium, and that economic outcomes, including mass joblessness, were a product of voluntary choices. “If somebody says, as Friedrich Hayek said when one in four Germans were unemployed, that people are out of work because they are choosing to consume leisure, that, to my mind, is a ridiculous real-business cycle theory”...
6) Christina Romer (December 29, 2009): Making job creation a priority:
President Obama has laid out a series of steps that should be at the heart of our continuing efforts to accelerate job growth, rebuild our economy for the long term, and bring American families relief during these difficult times. These proposals are an important steppingstone in our efforts to fix the economy - but they are only a part of our strategy. There is no single piece of legislation that will solve our problems. Our nation faces double-digit unemployment. Far too many Americans still are struggling to make ends meet.
But to understand where we need to go, it's important to look back at where we started. On the first days after the president was elected, our economy was rolling toward the edge of a cliff with ever-increasing momentum.... [W]e took unprecedented - and often unpopular - action to stave off a total economic collapse. We worked with Congress to pass the American Recovery and Reinvestment Act... saved more than a million jobs and begun to lay the foundation for lasting recovery. We took these steps out of necessity. Today, our economy is growing for the first time in more than a year. Last month, employment was nearly stable and the unemployment rate dropped slightly.
But we understand that talking about what we've accomplished may mean little to someone who is still out of a job. That's why President Obama outlined plans earlier this month to accelerate private-sector job creation.... First... the president's plan encourages investment by small businesses and improves their access to capital by proposing a one-year elimination of the tax on capital gains from new investments in small businesses. We're also calling for the extension of Recovery Act provisions to give small businesses tax incentives to invest in new equipment and other types of capital goods. We will work with Congress to create a tax cut for small businesses that hire new workers. And we will eliminate fees and increase loan guarantees for small businesses that borrow through the Small Business Administration.
Second... we will create new incentives for consumers who invest in energy-efficient retrofits... expand Recovery Act programs to leverage private investment in energy efficiency....
Finally, the president is calling for investments in a wide range of infrastructure....
These are important steps, but there is still so much work that remains. President Obama hears about the struggles the American people are facing every day. He will not rest until every American who wants a job has one.
7) HISTORICAL DOCUMENT OF THE DAY: The dissent of Mr. Justice "Please Mr. President, Don't Put Another K-ke on the Court" McReynolds from the Switch in Time That Saved Nine--the Supreme Court's unexplained 1937 reversal of itself between Shechter Poultry and Carter Coal on th one hand and Jones and Laughlin Steel on the other: LABOR BOARD V. FRIEDMAN-HARRY MARKS CLOTHING CO., 301 U. S. 58 (1937) -- US Supreme Court Cases from Justia & Oyez:
MR. JUSTICE McREYNOLDS delivered the following dissenting opinion.
MR. JUSTICE VAN DEVANTER, MR. JUSTICE SUTHERLAND, MR. JUSTICE BUTLER, and I are unable to agree with the decisions just announced.
We conclude that these causes were rightly decided by the three Circuit Courts of Appeals, and that their judgments should be affirmed. The opinions there given without dissent are terse, well considered, and sound. They disclose the meaning ascribed by experienced judges to what this Court has often declared, and are set out below in full.
Considering the far-reaching import of these decisions, the departure from what we understand has been consistently ruled here, and the extraordinary power confirmed to a Board of three, [Footnote 1] the obligation to present our views becomes plain.
The Court, as we think, departs from well established principles followed in Schechter Poultry Corp. v. United States, 295 U. S. 495 (May, 1935), and Carter v. Carter Coal Co., 298 U. S. 238 (May, 1936). Upon the authority of those decisions, the Circuit Courts of Appeals of the Fifth, Sixth, and Second Circuits in the causes now before us have held the power of Congress under the commerce clause does not extend to relations between employers and their employees engaged in manufacture, and therefore the Act conferred upon the National Labor Relations Board no authority in respect of matters covered by the questioned orders. In Foster Bros. Mfg. Co. v. Labor Board, 85 F.2d 984, the Circuit Court of Appeals, Fourth Circuit, held the act inapplicable to manufacture, and expressed the view that, if so extended, it would be invalid. Six District Courts, on the authority of Schechter's and Carter's cases, have held that the Board has no authority to regulate relations between employers and employees engaged in local production. [Footnote a] No decision or judicial opinion to the contrary has been cited, and we find none. Every consideration brought forward to uphold the act before us was applicable to support the acts held unconstitutional in causes decided within two years. And the lower courts rightly deemed them controlling...
8) BEST NON-ECONOMICS THING I HAVE READ TODAY: Justin Fox: What to do about those danged bank lobbyists:
Those who would address the financial problems of the past few years with better laws and regulations (a group of which I am a member) have a big problem when the rulemakers are captured not just by the industry they regulate but the dodgiest parts of that industry. So what do we do about this?
Get out of the regulating business. This is the libertarian solution, and while it reeks a bit of libertopianism, there is a basic truth behind it: The less affected by regulation and/or government spending an industry is, the less it spends on campaign contributions and lobbying, as a general rule.
Shine a light on what's going on so the public interest can trump private interests. This does work sometimes. And the increased attention paid to the House Financial Services and Senate Banking committees over the past couple of years has made life more difficult for financial industry lobbyists (at least, that's what people in the financial industry say). Because the Republican Congressional leadership has decided its most promising political strategy for the first two years of the Obama Administration is to be against everything, though, it's hard to put together majorities without including goodies for the most bought-and-paid-for Democrats...
9) STUPIDEST THING I HAVE READ TODAY: Niall Ferguson: An Empire at Risk:
[I]f the United States succumbs to a fiscal crisis, as an increasing number of economic experts fear it may, then the entire balance of global economic power could shift.... [T]he president's... indecision about the deficit could matter much more for the country's long-term national security. Call the United States what you like—superpower, hegemon, or empire—but its ability to manage its finances is closely tied to its ability to remain the predominant global military power. Here's why.
The disciples of John Maynard Keynes argue that increasing the federal debt by roughly a third was necessary to avoid Depression 2.0. Well, maybe, though some would say the benefits of fiscal stimulus have been oversold and that the magic multiplier (which is supposed to transform $1 of government spending into a lot more than $1 of aggregate demand) is trivially small... let's consider the cost of this muted stimulus... there is no end in sight to the borrowing binge.... [C]alculate the net present value of the unfunded liabilities of the Social Security and Medicare systems. One recent estimate puts them at about $104 trillion, 10 times the stated federal debt. No sweat, reply the Keynesians. We can easily finance $1 trillion a year of new government debt...
[which "Keynesians" is he talking about? He never says--because they are the ones who exist only in his fevered brain...]
10) HOISTED FROM THE ARCHIVES: DeLong and Summers (1996): Is Increased Price Flexibility Stabilizing?
This paper uses Taylor's model of overlapping contracts to show that increased wage and price flexibility can easily be destabilizing. This result arises because of the Mundell effect. While lower prices increase output [conditional on nominal demand], the expectation of falling prices decreases [demand and so decreases] output. Simulations based on realistic parameter values suggest that increases in price flexibility might well increase the cyclical variability of output in the United States.
