Olivier Blanchard.... "Higher average inflation, and thus higher nominal interest rates to start with, would have made it possible to cut interest rates more, thereby probably reducing the drop in output and the deterioration of fiscal positions."... I’m not that surprised that Olivier should think that; I am, however, somewhat surprised that the IMF is letting him say that under its auspices. In any case, I very much agree. I would add, however, that there’s another case for a higher inflation rate — an argument made most forcefully by Akerlof, Dickens, and Perry (pdf). It goes like this: even in the long run, it’s really, really hard to cut nominal wages. Yet when you have very low inflation, getting relative wages right would require that a significant number of workers take wage cuts. So having a somewhat higher inflation rate would lead to lower unemployment, not just temporarily, but on a sustained basis. Or to put it a bit differently, the long-run Phillips curve isn’t vertical at very low inflation rates.
I think this is especially important in the European context. As I’ve been writing in a number of posts, the period 2000-2008 saw a huge divergence in price levels between the capital-inflow nations of the European periphery and the European core.... Almost surely, that divergence now has to be reduced. Yet with a low overall inflation rate for the eurozone, that means large-scale deflation in the overvalued economies if convergence is to happen any time in, say, the next 5-10 years. (Actually, in Eurospeak I think this is cohesion rather than convergence, but never mind). The task would be a lot easier if the eurozone had 4 percent inflation instead of 2. So yes, let’s have modestly higher inflation. Alas, Ben Bernanke — at least when speaking publicly — doesn’t agree. And I can only imagine what Trichet would say.
State legislatures are looking a combined budget gaps worth more than the size of the House jobs legislation, and senators busy themselves stripping aid to states from their bill. Mr Krugman has written that what the euro zone needs is tighter fiscal integration to offset the burdens imposed by a uniform monetary policy. But if America is any indication, tighter fiscal integration doesn't mean a thing if the people running the show at the federal level are short-sighted, provincial, and apt to choose grandstanding over good policy.
There has been a lot of impassioned debate over the efficient markets hypothesis recently, but some of the disagreement has been semantic rather than substantive, based on a failure to distinguish clearly between informational efficiency and allocative efficiency. Roughly speaking, informational efficiency states that active management strategies that seek to identify mispriced securities cannot succeed systematically.... Allocative efficiency requires more... is satisfied when the price of an asset accurately reflects the (appropriately discounted) stream of earnings.... If markets fail to satisfy this latter condition, then resource allocation decisions (such as residential construction or even career choices) that are based on price signals can result in significant economic inefficiencies. Some of the earliest and most influential work on market efficiency was based on the (often implicit) assumption that informational efficiency implied allocative efficiency. Consider, for instance, the following passage from Eugene Fama's 1965 paper on random walks in stock market prices....
The assumption of the fundamental analysis approach is that at any point in time an individual security has an intrinsic value... which depends on the earning potential of the security. The earning potential of the security depends in turn on such fundamental factors as quality of management, outlook for the industry and the economy, etc.... In an efficient market, competition among the many intelligent participants leads to a situation where, at any point in time, actual prices of individual securities already reflect the effects of information based both on events that have already occurred and on events which, as of now, the market expects to take place in the future. In other words, in an efficient market at any point in time the actual price of a security will be a good estimate of its intrinsic value.
Or consider the opening paragraph of his enormously influential 1970 review of the theory and evidence for market efficiency:
The primary role of the capital market is allocation of ownership of the economy's capital stock. In general terms, the ideal is a market in which prices provide accurate signals for resource allocation: that is, a market in which firms can make production-investment decisions, and investors can choose among the securities that represent ownership of firms' activities under the assumption that security prices at any time “fully reflect” all available information. A market in which prices always “fully reflect” available information is called “efficient.”
The above passage is quoted by Justin Fox, who argues that proponents of the hypothesis have recently been defining efficiency down:
That leaves us with an efficient market hypothesis that merely claims, as John Cochrane puts it, that "nobody can tell where markets are going." This is an okay theory, and one that has held up reasonably well—although there are well-documented exceptions such as the value and momentum effects.
The most effective recent criticisms of the efficient markets hypothesis have not focused on these exceptions or anomalies, which for the most part are quite minor and impermanent. The critics concede that informational efficiency is a reasonable approximation, at least with respect to short-term price forecasts, but deny that prices consistently provide "accurate signals for resource allocation."
After reading John Taylor and John Cochrane's analyses Lehman's failure, I'm beginning to understand how it's possible for economists to say that "we're still arguing about the causes of the Great Depression." It's generally hard to come to an agreement when one side simply lies, or refuses to acknowledge undeniable facts.... Let's start with Cochrane's claim that there wasn't a secondary wave of failures after Lehman's bankrtupcy. First of all, that's not even true. Plenty of hedge funds failed as a result of Lehman-related losses. However, since they were generally structured as LLPs, they went into pre-defined liquidation procedures rather than filing for bankruptcy. But that doesn't make those failures any less real. Second, Cochrane, like Taylor, inexplicably ignores the fact that Lehman's biggest counterparties — the other dealers — were virtually all bailed out by their governments.
Next, let's take Cochrane's bizarre attempt to minimize the importance of the obvious knock-on effects from Lehman's bankruptcy — namely, the problems at Lehman's European broker-dealer (LBIE), and the run on the money markets. Contrary to Cochrane's assertion, it wasn't just "repos in the United Kingdom" that were affected by LBIE's failure. In addition to the 140,000 failed trades, over $40bn in prime brokerage client funds and assets were frozen by LBIE's administrator. That's $40bn that was suddenly and unexpectedly unavailable to hedge funds — and when you consider that hedge funds use their prime brokers to lever up, that end result is that LBIE's failure caused hundreds of billions in liquidity to suddenly vanish from the markets. It also caused other hedge funds to pull their money out of their prime brokerage accounts at Morgan Stanley and Goldman (the two biggest prime brokers), since they were now scared that they wouldn't be able to access their funds if either of the prime brokers failed....
And there was absolutely nothing minor about the run on the money markets.... As to why the run on the money markets would cause people to stop lending to banks like Citigroup, there are several reasons. The biggest reason the run on the money markets affected Citi's (and other banks') wholesale funding was that to meet the massive redemptions, money funds all drew down their backup lines of credit with banks at the same time. Institutional investors knew this, and started to pull back aggressively from the big banks in the wholesale funding markets. And then there were all the asset firesales by money funds.... Cochrane's claim that these two problems were "easy to fix" further demonstrates how detached from reality he is. The vast majority of the prime brokerage client assets frozen by LBIE's administrator still haven't been returned yet. Not only was that problem not "easy to fix," but it still hasn't been fixed yet! Also, the money market funds never borrowed from the Fed. I know the structures of the Fed's various financing facilities are a bit complicated, but Cochrane is supposed to be a professor of finance at a prestigious business school, is he not?)
Finally, there's Cochrane's point that "[m]ost of Lehman's operations were up and running in days under new owners." Well, yes, Barclays did buy Lehman's core US units, and Nomura bought some of Lehman's Asian and European units — minus those pesky liabilities, of course! I'm not sure Cochrane knows this, but in a bankruptcy, the debtor's liabilities tend to be kinda-sorta important in determining how large an effect the bankruptcy has on non-debtors...
In public, Adobe claims to “support” HTML5. On the private W3C mailing list, though, they’ve placed an objection to prevent the current spec from being published. My understanding is that Adobe is trying to block the API spec for the canvas element. The canvas element hasn’t gotten as much attention as the video element, but clearly, 2D graphics in canvas is competitive with Flash, and it appears that Adobe’s plan is to sabotage it via W3C politics.
6) GRAPH OF THE DAY: Bond Spreads:
7) BEST NON-ECONOMICS THING I HAVE READ TODAY: Mark Graham: Rereading Christopher Moore's Bloodsucking Fiends: A Love Story:
The week of Valentine’s Day is an ideal time for a love story. Christopher Moore’s third vampire novel, Bite Me: A Love Story, isn’t due out for another month, so this seemed an ideal time to reread Bloodsucking Fiends: A Love Story, the first book in the series. Although Bloodsucking Fiends, released in 1995, was preceded by Practical Demon Keeping and Coyote Blue, it was this hilarious vampire love story that began to establish the former disc jockey, waiter and grocery store shelf stocker as a cult icon, and eventual New York Times best-selling author.
Twenty-six-year-old Jody Stroud has just gotten off work at her menial job in an insurance company in San Francisco. She is dragged into an alley, bitten in the throat and forced to drink from her attacker’s arm, then drained of blood and left under a dumpster. When Jody awakens the following night, she discovers she has the strength to toss the dumpster off her and that the hand that has been left in the sunlight is badly burned. It doesn’t take too long for her to discover that she has joined the ranks of the undead. She has a thirst for blood and she will remain exactly as she is for eternity. She will never be able to lose that last five pounds she was intending to diet away. Nineteen-year-old Tommy Flood has left the Midwest, adopted the pen name C. Thomas Flood (the C doesn’t stand for anything, but sounds great for a writer), and nursed his dying Volvo to San Francisco where he hopes to become an author. The fact that the Volvo goes up in flames is probably a symbol for something, but you will have to decide what.... In order to pay the rent, Tommy hires on with the night crew at a local Safeway where he proves his prowess at frozen turkey bowling (not yet a Winter Olympic sport, but not totally dissimilar to curling).
As Jody begins to get used to being a vampire, she discovers her need for a man, someone who can operate during the day, who can get her car out of the impound lot, who can find an apartment with a bedroom with no windows, in general, someone who can run errands. Her current boyfriend is a jerk who is already two-timing her. It’s time to find a Renfield...
8) STUPIDEST THING I HAVE NOT READ TODAY: The New York Times headline writers, as observed by RoberWaldmann:
[T}his New York Times headline is... uhm... very...
Climate-Change Debate Is Heating Up in Deep Freeze
The article by John Broder clearly explains that the debate is between climate scientists on one side vs politicians and media personalities on the other. Every single scientist quoted in the article notes that, to the extent that the recent blizzard on the mid Atlantic US provides evidence on global warming it supports standard models of human caused warming. As far as I can tell from the article, all such models imply increased precipitation on the area. The article contains a brief reference to global warming skeptics which clearly refers to the very very few actual climate scientists who are skeptics. However, Broder doesn't have a quote from an actual climate scientist who doesn't think that, to the very limited extent it provides any evidence, the blizzard weakens the skeptics case. Among scientists there is a difference of emphasis between those who note that the blizzard supports the standard models and those who note that a few days weather provides almost no evidence on climate change. In effect all scientists quoted agree that the blizzard provides evidence in support of standard models but, being only a few days weather on one region, only a little. This view is supported by citations of predictions of higher precipitation made before the blizzard. There really couldn't be a stronger case that the blizzard is not evidence in favor of global warming skepticism.
A reasonable headline would be "All interviewed scientists agree that Inhofe is full of it" or "standard global warming models predicted increased snow" or something. Instead, the disagreement must be presented as a debate in which headline skimmers are not informed that one side in the debate consists of people with no expertise making claims inconsistent with all published evidence...
9) DELONG SMACKDOWN WATCH OF THE DAY: Professionally administered by Brian Weatherson:
rad DeLong has two posts up defending Richard Layard's defence of Benthamism against criticism from Fontana Labs and Will Wilkinson. I think Brad is misinterpreting Bentham, so while his defence might be a defence of something interesting (say, preference utilitarianism) it isn't much of a defence of Bentham.... The problem with interpreting [Bentham] is that "advantage, pleasure, good, or happiness" do not really come to the same thing. At the very least, it is clear that advantage and pleasure do not come to the same thing, and which (if either) of these good and happiness are is part of what's at dispute. But for interpreting Bentham, it's very important to realise that he did view them as the same thing.... What matters for [Brad] is "what people would choose for themselves", i.e. preferences, and preference satisfaction isn't a kind of experience. If people choose different kinds of experiences, or even things that don't maximise their own chances for good experiences (as when people take life-endangering jobs so as to provide goods for their children) they are getting what they choose, but not maximising utility as Bentham saw it. In principle my preferences can be satisfied by things that happen after I die, even if I don't get any extra experiences after I die, in which case we certainly couldn't identify preference satisfaction with any kind of experience. As I said, I don't want to get into the pros or cons of the moral view Brad is espousing here. I just want to make an historical point, that it's a mistake to think Bentham viewed preferences rather than experiences as the core of utilitarianism. It was a great advance over Bentham (I think) when later philosophers made this move...
10) HOISTED FROM THE ARCHIVES: A Rich Baker Special (June 2002):
Jem (serious): "The Americans didn't land on the Moon - it was all a hoax."
Rich: "Dude, you're so naive. America doesn't exist: it's really a soundstage in the south of France..."