Hoisted from the Archives from Four Years Ago:
Nevertheless, Jeremy Siegel and Jeremy Schwartz think that we are in a bond bubble:
Hoisted from the Archives from Four Years Ago:
Nevertheless, Jeremy Siegel and Jeremy Schwartz think that we are in a bond bubble:
A correspondent reminds me of this from a couple of years ago, that I now hoist from the archives:
Hoisted from the Archives:
Why oh why can't we have a better press corps?
This is really embarrassing, New York Times: really, really embarrassing:
The first joke comes in Casey Mulligan's first paragraph: the Fed does not lend money to banks on an overnight basis at the Federal Funds Rate. The Fed lends money to banks at an interest rate called the Discount Rate. The Federal Funds rate is the rate at which banks lend their Federal Funds--the deposits they have at the Federal Reserve--to each other. That's why it is called the Federal Funds rate.
The second joke comes in the second paragraph. Hansen and Singleton (1983) is 'new research'?
The third joke is the entire third paragraph: since the long government bond rate is made up of the sum of (a) an average of present and future short-term rates and (b) term and risk premia, if Federal Reserve policy affects short rates then--unless you want to throw every single vestige of efficient markets overboard and argue that there are huge profit opportunities left on the table by financiers in the bond market--Federal Reserve policy affects long rates as well. Note the use of the weasel word 'largely'.
The New York Times badly needs to clean house here.
There are lots of economists who would love to write for the New York Times for free, and who know the difference between the Federal Funds Rate and the Discount Rate:
Yes, I am happy that I am able to postpone reading further in chapter 11 of David Graeber's Debt: My First 5000 Mistakes for another week...
Amity Shlaes: What triggered Krugman’s pulling some kind of imagined rank on Asness was that Asness, along with me and others, signed a letter a few years ago suggesting that Fed policy might be off, and that inflation might result. Well, inflation hasn’t come on a big scale, apparently. Or not yet. Still, a lot of us remain comfortable with that letter, since we figure someone in the world ought always to warn about the possibility of inflation. Even if what the Fed is doing is not inflationary, the arbitrary fashion in which our central bank responds to markets betrays a lack of concern about inflation. And that behavior by monetary authorities is enough to make markets expect inflation in future...
I will react by asking, to the air, one and only one four-part question:
Consider whether one should line up with Amity Shlaes--along with William Kristol, Niall Ferguson, James Grant, David Malpass, Dan Señor, and the rest of that motley company--against Ben Bernanke. Suppose that one has no special expertise on the issue. Suppose that Ben Bernanke has studied that issue for his entire adult life.
Wouldn't anybody with a functioning neural network greater than that of a moderately-intelligent cephalopod recognize that such a lining-up was an intellectual strategy with a large negative prospective α?
Wouldn't--after the intellectual strategy's large negative-α returns have been realized--anybody with a functioning neural network equal to that of a moderately-intelligent cephalopod recognize that it was time to perform a Bayesian updating on one's beliefs, rather than doubling down and claiming that: it's not over--the inflationary pressures are building minute-by-minute?
Wouldn't--when thinking about how to double-down on one's negative-α intellectual strategy, and placing even more of one's mental and reputational chips on the claim that expanding and keeping the Federal Reserve's balance sheet beyond $1.5T generates excessive and dangerous risks of inflation, and that any such expansion ought to be stopped and reversed--anybody with a functioning neural network even less than that of a moderately-intelligent cephalopod recognize that phrasing one's doubling-down in the voice of John Belushi on a very bad day would be unwise, would be likely to call forth mockery and scorn on the same rhetorical level that one had chosen, and would make one a figure of fun and merriment?
And, when the readily-predictable tit-for-tat responses at the rhetorical level one chose do in predictable and due course manage to arrive, that to respond by whinging and sniveling and feeling offense would be unwarranted--would demonstrate only that whatever functioning neural network one does have was not fully connected to reality?
Responding to Krugman is as productive as smacking a skunk with a tennis racket.... Let's not be fooled by chicanery (silly Paul, you are no Rabbit).... An honest Paul Krugman (we will use this term again below but this is something called a "counter-factual").... Also remember, much like when the Germans bombed Pearl Harbor, nothing is over yet. The Fed has not undone its extraordinary loose monetary policy and is just now stopping its direct QE purchases.... Paul, and others, should by now know the folly of declaring victory too early....
This isn't a screed where I claim to have invented my own consumption basket showing inflation is rising at 25% per annum - though some of those screeds are interesting.... We have indeed observed tremendous inflation in asset prices.... If one counts asset inflation it seems we've indeed had tremendous inflation.... Where effects did show up, it actually caused rather a lot of inflation....
Mostly Paul is wrong, and twisting the facts, and doing so as rudely and crassly as possible, yet again. The rest of the JV team of Keynesians who have also jumped on board are doing the same thing, just with more class and less entertainment value than the master.... Paul will continue to be mostly wrong, mostly dishonest about it, incredibly rude, and in a crass class by himself (admittedly I attempt these heights sometimes but sadly fall far short). That is a prediction I'm willing to make over any horizon, offering considerable odds, and with no sneaky forecasts of merely 'heightened risks'. Any takers?
Over at Equitable Growth: I am very happy to be here this morning to introduce the Oregon Economic Forum's Keynote Speaker, Doug Elliott of the Brookings Institution, and to set the stage for his talk.
To do that, let me ask all of you to cast yourselves back to 2006, to the end of Alan Greenspan's long tenure as Chair of the Federal Reserve, and to the days of what was then called the "Great Moderation". During Greenspan's term starting in 1987 the unemployment rate had never gone above 7.8% and it had gotten as low as 3.8%. The attainment of low unemployment under Greenspan did not signal any forthcoming inflationary spiral: The peak 12-mo PCE price index core inflation rate during Greenspan's tenure was 4.7%. The peak inflation rate that followed that 3.8% unemployment rate was 2.4%. Inflation had not been above 2.5% since December 1993. READ MOAR
If Cliff Asness was going to write the passage below, has there ever been a worse week for him to write it?
I mean "it's not over! The enormous pent-up inflation from the Fed's QE programs is out there bubbling under the surface!! Short Treasuries massively now!!!" has not been a winning rhetorical strategy for quite a while, and to double down on it this week does make you look like quite an idiot...
Paul Krugman lived up to his lifelong motto of 'stay classy'... lesser lights of the Keynesian firmament have also jumped in (collectivists, of course, excel at sharing a meme). Responding to Krugman is as productive as smacking a skunk with a tennis racket.... Paul's screeds.... I'll put our collective record up against Krugman's (and the Krug-Tone back-up dancers) any day of the week and twice on days he publishes... chicanery (silly Paul, you are no Rabbit)... never-uncertain-but-usually-wrong like Paul... malpractice... honest Paul Krugman (we will use this term again below but this is something called a "counter-factual")... former economists turned partisan pundits....
Much like when the Germans bombed Pearl Harbor, nothing is over yet. The Fed has not undone its extraordinary loose monetary policy and is just now stopping its direct QE purchases...
It was perfectly normal--well, not strikingly abnormal--for Cliff Asness to have taken a look at the speed at which the monetary base was increasing in 2009 and thinking that such policies, unless reversed, were likely to lead to a burst of inflation. Wrong, but not strikingly abnormal.
It was perfectly normal--well, not strikingly abnormal--for Cliff Asness to have taken a look at the speed at which the national debt was increasing in 2009 and thinking that such policies, unless reversed, were likely to lead to high Treasury real interest rates. Wrong, but not strikingly abnormal.
In order to avoid such predictions you had to:
For large increases in the monetary base not to make the likely future one of high inflation, and for large increases in the national debt not to make the likely future one of high Treasury real interest rates--well, something weird had to be going on.
But, as Krugman, Woodford, Eggertssen, Hicks, Keynes, etc. had noted, were warning, and were correct in warning back in 2009-2010, something weird was going on.
Because of how the economy had gotten itself wedged, the risk that extraordinary monetary easing would lead to an inflationary spiral was extremely low. Because of how the economy had gotten itself wedged, the risk that large government debt issuance would lead to exploding real interest rtes on government debt was extremely low. Only people who really did not understand what was going on would think that 2010 was a time to stress, highlight, obsess over, and freak out about INFLATION! DEBT! when the real risks to freak out about were DEPRESSION!! UNEMPLOYMENT!!!
But when something weird is going on, to get things badly wrong is normal--well, not that abnormal.
What is not normal--what is really abnormal--is to be a dead-ender.
What is not normal is to claim that your analysis back in 2010 that quantitative easing was generating major risks of inflation was dead-on.
What is not normal is to adopt the mental pose that your version of classical austerian economics cannot fail--that it can only be failed by an uncooperative and misbehaving world.
What is not normal is, after 4 1/2 years, in a week, a month, a six-month period in which market expectations of long-run future inflation continue on a downward trajectory, to refuse to mark your beliefs to market and demand that the market mark its beliefs to you. To still refuse to bring your mind into agreement with reality and demand that reality bring itself into agreement with your mind. To still refuse to say: "my intellectual adversaries back in 2010 had a definite point" and to say only: "IT'S NOT OVER YET!!!!"
...with an unprecedented level of loose monetary policy... created a risk of serious inflation....Paul Krugman lived up to his lifelong motto of "stay classy" with a piece on the subject entitled Knaves, Fools, and Quantitative Easing. Some lesser lights of the Keynesian firmament have also jumped in.... Responding to Krugman is as productive as smacking a skunk with a tennis racket. But, sometimes, like many unpleasant tasks, it's necessary....
We did not make a prediction.... We warned of a risk....
UPDATE: Cliff Asness states that I misinterpreted his column: that he did not intend for his:
I'm amazed that a Paul Krugman can look at 15+ years of the earth not warming and feel his beliefs [on global warming] need no modification...
to be a right-wingnut dog-whistle claim that global warming from human activity had stopped and was unlikely to resume.
@delong: .@Cimmerian999 Suggest you replace “the earth not warming” with “surface atmosphere temperatures not exceeding extraordinary spike of 1998”
.@Cimmerian999: .@delong Yes, in a paragraph meant to be funny (lost on you and Jesse obviously) that would work much better.
...can look at 15+ years of the earth not warming and feel his beliefs need no modification or explanation...
What next, Cliff? ShadowStats? Queen Elizabeth a secret lizard-person? Moon landing faked?
Over at Equitable Growth: I note the publication of the IMF World Economic Outlook and its chapter 3 calling for North Atlantic economies to borrow more and spend it on infrastructure because, right, now in today's exceptional circumstances, it is--as Larry Summers and I pointed out in 2012--a policy that is self-financing does not increase but rather reduces the relative burden of the national debt.
It is thus time for Larry and me--and everyone else who has been doing the arithmetic--to take a big victory lap.
We have had no effect on policy in the North Atlantic in the past 2 1/2 years. But we were (and are) right. And it is important to register that--both so that our intellectual adversaries rethink their models and thus their positions, and so that the North Atlantic economic policymakers can do better next time. And next time is, come to think of it, right now: interest rates on the debts of reserve currency-issuing sovereigns are no higher, infrastructure gaps are larger, and output gaps are at least as large as they were 2 1/2 years ago. It's not too late to do the right thing, people!
...for countries with infrastructure needs, the combination of low interest rates and mediocre growth mean that it’s time for an investment push. What’s at stake: For countries with infrastructure needs, the combination of low interest rates and mediocre growth mean that it’s time for an investment push. While Brad DeLong and Lawrence Summers already laid out the theoretical case in a 2012 Brookings paper, the empirical case was laid out this week in Chapter 3 of the latest IMF World Economic Outlook.
Lawrence Summers writes that in a time of economic shortfall and inadequate public investment, there is for once a free lunch – a way for governments to strengthen both the economy and their own financial positions. Greg Mankiw writes that the free-lunch view is certainly theoretically possible (just like self-financing tax cuts), but we should be skeptical about whether it can occur in practice (just like self-financing tax cuts).
Abiad and al. write on the IMF blog that the evolution of the stock of public capital suggests rising inadequacies in infrastructure provision. Public capital has declined significantly as a share of output over the past three decades in both advanced and developing countries. In advanced economies, public investment was scaled back from about 4 percent of GDP in the 1980s to 3 percent of GDP at present (maintenance spending has also fallen, especially since the financial crisis).
This makes a very strong case for sharply increasing public investment in a depressed economy
Paul Krugman writes that this is disinvestment madness. Real interest rates are extremely low, indicating that the private sector sees very little opportunity cost in using funds for public investment. There has been a lot of slack in the labor market, so that many of the workers one would employ in public investment would otherwise have been idle--so very little opportunity cost there either. This makes a very strong case for sharply increasing public investment in a depressed economy; a case that doesn’t rely on claims that there is a large multiplier, although there’s every reason to believe that this is also true.
The authors of the WEO’s chapter 3 write that in contrast to the large body of literature that has focused on estimating the long term elasticity of output to public and infrastructure capital using a production function approach, the IMF analysis adopts a novel empirical strategy that allows estimation of both the short- and medium-term effects of public investment on a range of macroeconomic variables. Specifically, it isolates shocks to public investment that can plausibly be deemed exogenous by following the approach of smooth transition VARs of Auerbach and Gorodnichenko (2012, 2013), where the shocks are identified as the difference between forecast and actual investment. In the WEO chapter, the forecasts of investment spending are those reported in the fall issue of the OECD’s Economic Outlook for the same year.
The positive effects of increased public infrastructure investment are particularly strong when public investment is undertaken during periods of economic slack and monetary policy accommodation
The authors of the WEO’s chapter 3 write that a problem in the identification of public investment shocks is that they may be endogenous to output growth surprises. But the public investment innovations identified are only weakly correlated (about –0.11) with output growth surprises. Another possible problem in identifying public investment shocks is a potential systematic bias in the forecasts concerning economic variables other than public investment, with the result that the forecast errors for public investment are correlated with those for other macroeconomic variables. To address this concern, the measure of public investment shocks has been regressed on the forecast errors of other components of government spending, private investment, and private consumption.
Abiad and al. write on the IMF blog that the benefits depend on a number of factors. The authors find that the positive effects of increased public infrastructure investment are particularly strong when public investment is undertaken during periods of economic slack and monetary policy accommodation, where additional public investment spending is not wasted and is allocated to projects with high rates of return and when it is financed by issuing debt has larger output effects than when it is financed by raising taxes or cutting other spending.
Mario Monti writes that while a simplistic stability pact may have been the right choice when the euro was in its infancy, Europe can no longer afford to stick with such a rudimentary instrument. By failing to recognize the proper role of public investment, it has pushed governments to stop building infrastructure just when they should have built more. What is needed is not the flexibility to deviate from the rules, but rules that are economically and morally rigorous. The new Commission should announce a proposal for updating the rules on fiscal discipline, to reflect the role of productive public investment. The commission would then enforce the existing stability pact while allowing for the favorable treatment of public investment within the limits set out in 2013.
Europe needs mechanisms for carrying out self-financing infrastructure projects outside existing budget caps
Lawrence Summers writes that Europe needs mechanisms for carrying out self-financing infrastructure projects outside existing budget caps. This may be possible through the expansion of the European Investment Bank or more use of capital budget concepts in implementing fiscal reviews.
...That is, an IMF study suggests that the expansionary effects are sufficiently large that debt-financed infrastructure spending could reduce the debt-GDP ratio over time. Certainly this outcome is theoretically possible (just like self-financing tax cuts), but you can count me as skeptical about how often it will occur in practice (just like self-financing tax cuts). The human tendency for wishful thinking and the desire to avoid hard tradeoffs are so common that it is dangerous for a prominent institution like the IMF to encourage free-lunch thinking."
The Laffer Curve proposition holds true--tax-rate cuts are self-financing--if, defining α to be the elasticity of production with respect to the net-of-tax rate:
τ > 1/(1+α)
τ = 1/(1+α)
then tax revenue is at its maximum. If:
τ < 1/(1+α)
then the Laffer Curve proposition fails, and tax-rate cuts are not self-financing.
Arguments that the Laffer Curve proposition fails--that tax-rate cuts reduce revenue--are invariably arguments, with various bells and whistles added on, that the economy's parameter α is in the range from 0.25 to 1, depending, and thus that the critical tax rate τ at which the Laffer Curve proposition becomes true is between 50% and 80%, and thus above the current tax rate t.
Arguments that infrastructure investment is not self-financing should, similarly, invariably be arguments, with bells and whistles, that the net revenue raised ρt--the product of ρ, the comprehensive net rate of return on and thus the income produced by a dollar of infrastructure investment, multiplied by the current tax rate t--is less than the real rate of interest r at which the government must borrow to finance its infrastructure investment:
ρt < r
In a world where the real rate at which the U.S. Treasury can borrow for ten years is 0.3%/year and in which the tax rate t is about 30%, infrastructure investment fails to be self-financing only when the comprehensive rate of return is less than 1%/year.
Now you can make that argument that properly-understood the comprehensive rate of return is less than 1%/year. Indeed, Ludger Schuknecht made such arguments last Saturday. He did so eloquently and thoughtfully in the deep windowless basements of the Marriott Marquis Hotel in Washington DC at a panel I was on.
But Mankiw doesn't make that argument.
And because he doesn't, he doesn't let his readers see that there is a huge and asymmetric difference between:
my argument that tax-rate cuts are not (usually) self financing, which at a tax rate t=30% requires only that α < 2.33; and:
his argument that infrastructure investment is not self-financing, which at a tax rate t=30% requires that ρ < 1%/year.
To argue that α < 2.33 is very easy. To argue that ρ < 1%/year is very hard. So how does Mankiw pretend to his readers that the two arguments are equivalent? By offering his readers no numbers at all.
The data of economics comes in quantities. We can count things. We should count things. Please step up the level at which you play this game, guys...
"Secular stagnation" is a misleading phrase. It was coined by Alvin Hanson in the 1930s to describe a fear that an exhaustion of technological opportunities in a world monetary system that still possessed a nominal anchor to gold would generate a sub-zero full-employment Wicksellian natural rate of interest. But we don't have an exhaustion of technological opportunities. We don't have a monetary system with a nominal anchor to gold.
What we do have are rates of inflation in the DMs that expose us to severe downside macroeconomic risks, and a lack of risk tolerance and risk-bearing capacity in the United States that keep even the lowest of attainable safe interest rates from producing high enough equity and capital valuations to make it profitable to boost investment enough to push DM economies to anything like full employment.
There have not yet been any convincing stories of how a trend growth drop would have emerged in the absence of the investment shortfall, the labor skills atrophy, and the other channels of "hysteresis" that have been in operation since 2008.
The only major supply shock in the past decade has been a positive one: the unexpected emergence of new hydrocarbon-extraction technologies like tracking. We could have a large adverse hydrocarbon-supply shock from political turmoil at the borders of Muscovy. But we have not yet.
What to expect from interest rates? They will, of course, fluctuate. The modal scenario I see in the United States is one in which the Federal Reserve begins raising interest rates too early--a la Sweden at the start of this decade--and then has to return to the ZLB in a year or two as the economy weakens. The optimistic scenario is that that of the smooth glide-path to the normalized, Goldilocks economy. The pessimistic scenario is another adverse shock hits demand while the Federal Reserve is still too close to the ZLB to effectively respond, and political gridlock gives the United States another lost decade.
What to expect from interest rates? They will, of course, fluctuate. The modal scenario I see in the Eurozone is one of continued waves of crisis as Eurozone breakup fears cause spikes in interest rates in the European periphery, as the ECB then does enough to calm markets but not enough to generate recovery, that Germany makes covert fiscal transfers to keep the pain low enough to keep the Eurozone together--and winds up spending much much more than if it had bit the bullet back in 2000. In that scenario German growth over the medium term remains at best adequate as the chronic Eurozone crisis both diminishes confidence and keeps German exports competitive.
The pessimistic scenario is one of Eurozone breakup--with German interest rates even lower than they are, and peripheral European interest rates high with redoubled risk premium. The optimistic scenario is that somehow, some way, the Confidence Fairy appears and the Eurozone has a smooth glide-path to a normalized, Goldilocks economy.
The source of the chronic crisis is a shortage of aggregate demand coupled with deep structural woes that originated in the decision by German banks to loan massive amounts to the Eurozone periphery. Those loans pushed costs in the Eurozone periphery up to levels that are in strong disequilibrium in the absence of continued capital outflows from Germany.
Since the chronic crisis had a German origin--in the lending decisions of German banks--it is only appropriate that it have a German solution--adjustment via German fiscal expansion and via the implicit real debt writedowns generated by moderate German inflation should be part of the solution.
Back in 1829, the young British economist John Stuart Mill was the first to argue that while in a market monetary economy there would usually be enough spending to employ everyone who could be profitably employed at the wages they demanded, this was not always the case. If and when the economy lacked enough cash and cash-like assets to make households, businesses, and savers as a group happy with their holdings of means of payment and potential collateral, then there would be a "general glut"--an excess demand of cash and collateral--and an excess supply of labor and currently-produced goods and services: what we call a depression.
The provision of those cash and cash-like assets has to be the business of the national or currency-area government--if not of a super-continental monetary and financial hegemon--because no private entity has the power to make its liabilities legal tender and thus the ability to guarantee their acceptance in transactions and as collateral.
The ECB is tasked with this Millian objective of providing the eurozone economy with the means of payment and stores of value--cash and potential collateral--that the economy needs. The ECB is failing.
Fourth quarter-to-fourth quarter real GDP growth in the eurozone in 2013 was 0.5%. Fourth quarter-to-fourth quarter real GDP growth in the eurozone in 2013 looks to be 0.4%. December-to-December inflation in the eurozone in 2013 was 0.9%. December-to-December inflation in the eurozone in 2014 looks to be 0.0%. The ECB's annual inflation target is 1.75%. Given the potential for catchup in the European periphery to higher productivity standards, that can only be attained via nominal eurozone GDP growth of 4%-5%/year. The 1.4% nominal GDP growth we saw in 2013 and the 0.4% nominal GDP growth it appears we will see in 2014 tell us that the ECB has fallen further behind the curve than it was at the end of 2012: 7.2%-points further behind the curve than it was then.
One possibility is that the ECB is failing because it cannot do so, for every time it creates a reserve deposit it does so by withdrawing A high-quality liquid asset from the private market place, and so to first-order leaves the stock of cash plus potential collateral unchanged. Perhaps the ECB cannot carry out its million objective without engaging in what would be regarded as fiscal policy.
Another possibility is the ECB is failing because financial Germany believes that the ECB's target must be not a 1.75%/year inflation target for the eurozone, but a 1.5%/year or less inflation target for Germany--and that Mario Draghi is not powerful enough to overrule financial Germany in the corridors of power in the ECB and hence cannot do whatever it takes.
In this context, I am reminded of Ludger Schuknecht's exchange with Martin Wolf back in 2012, in which Schuknecht said, among others things: "Mr Wolf’s solution... is risk transfer via eurobonds... and demand stimulation via cheaper money and less fiscal consolidation in Germany. But the public and markets have been led to believe in short-term measures for far too long...." "expansionary policies and weak fiscal positions... created the current problems..." "fiscal consolidation and structural reforms... have invariably succeeded wherever they have been implemented..." "any decision to disregard the rules or introduce ill-suited tools such as eurobonds could undermine... confidence..." "Germany must not undermine its role as an anchor of stability via inappropriate and ineffective fiscal stimuli..." "German and European interests are indeed very much aligned and they are reflected in the jointly agreed strategy...": the policies that the eurozone has undertaken over the past 2.5 years were, to his eyes back in 2012, already dangerously radical and already pushing the utmost of the envelope that Germany could allow. Yet now we clearly need more...
Daniel Davies: The World Is Squared--Episode 3: The Greek Calends--A Disquisition on the Nature of Debt: "What is debt?...
...It’s a promise to pay back a specific amount of money at a specific time. Why is it so popular--why do people always seem to end up getting into it? Why, for example, don’t people make more equity investments, buying a share of someone else’s profits and sharing their risks in the way in which Islamic banking is meant to operate?
Over at Equitable Growth: As I continue to try to worry--without great success--the question of just where the increases in financial instability produced by the prolonged period of past and expected future extremely low interest rates and by quantitative easing comes from...
Two sources of risk:
To recap my thinking before now:
Over at Equitable Growth: Larry Elliott: IMF warns period of ultra-low interest rates poses fresh financial crisis threat: "The Washington-based IMF said...
...that... the risks to stability... c[o]me from the... shadow banking system... hedge funds, money market funds and investment banks that do not take deposits from the public. José Viñals, the IMF’s financial counsellor, said:
Policymakers are facing a new global imbalance: not enough economic risk-taking in support of growth, but increasing excesses in financial risk-taking posing stability challenges.... Risks are shifting to the shadow banking system in the form of rising market and liquidity risks. If left unaddressed, these risks could compromise global financial stability.
The stability report said low interest rates were “critical” in supporting the economy because they encouraged consumers to spend, and businesses to hire and invest. But it noted that loose monetary policies also prompted investment in high-yield but risky assets and for investors to take bigger bets. One concern is that much of the high-risk investment has taken place in emerging markets, leaving them vulnerable to rising US interest rates.... The IMF said there was a trade-off between the upside economic benefits of low interest rates and the money creation process known as quantitative easing and the downside financial stability risks... developments in high-yielding corporate bonds were “worrisome”, that share prices in some western countries were high by historical norms, and that there were pockets of real estate over-valuation...
I have come to the conclusion that those who say that quantitative easing has increased systemic financial-market risks have simply not thought hard enough about what quantitative easing is. In quantitative easing the central bank takes duration risk off of the private sector's balance sheet and onto the governments, that is, the taxpayers'. The ratio of risk to be borne to private-sector risk-bearing capacity falls. The presumption is that this makes financial markets less, not more, vulnerable to systemic risk. You could tell some kind of complex contrarian story with demand and supply curves that slope in non-obvious ways. But none of those who say that quantitative easing increases systemic risk make such arguments--and if they understood quantitative easing properly, they would understand that they need to and feel impelled to do so.
The argument that ultra-low interest rates and the anticipated continuation of ultra-low interest rates for a considerable time period raises systemic financial risks is less mired in the, well, mire. But it, too, is not obvious. An economy sinks into depression when households, savers, and businesses in aggregate believe that they are short of the assets they need to hold to ensure liquidity--that after subtracting off assets they are holding as savings vehicles they do not have enough cash and enough safe nominal assets that could be pledged to immediately raise cash. As a result, the aggregate of households, savers, and businesses try to cut their spending below their income in order to build up their liquid cash and safe collateral balances; but since my income is nothing more than your spending, they fail and so production, income, and spending fall until the private sector finds itself so poor that it no longer seeks to build up its liquid cash and safe collateral balances.
In such a situation the government, by trading its cash and its safe collateral liabilities for risky financial assets and four currently-produced goods and services both:
creates more of what the private sector wants to hold, and so reduces or eliminates the gap between current and desired holdings of liquid cash and safe collateral.
lowers interest rates and so increases the value of the future relative to the present, providing a direct financial incentive both to spend now on the creation of long-duration real assets and to spend now out of what are now more valuable anticipations of future income.
On the one hand, higher asset valuations and higher levels of production and income greatly reduce the risks associated with financial assets backed by real wealth of one form or another. On the other hand, the tilting of the intertemporal relative price structure greatly increases the incentive to create long-duration financial assets--which will inherently be speculative, and some of which will partake to some degree of the unhedged out-of-the-money put or even the Ponzi nature. Which of these effects will be larger? For small reductions in interest rates, the first-order effect on the value of existing collateral assets in making finance safer will outweigh the second-order creation of new long-duration assets in making finance riskier. To the extent that prudential regulation is effective--or even exists--the range over which reductions in interest rates will improve stability is larger. To the extent that the economy is already flush with long-duration financial assets--which it is--the range over which reductions in interest rates will improve stability is larger.
The first-class study of this I know finds no evidence of the IMF's contention that policies of ultra-low interest rates have laid the foundations for increased risks of systemic financial instability in the United States. Outside the United States? Yes, times of low interest rates in the core are times of opportunity--cheap financing is available to finance economic development--but also times of danger--are their financial markets robust enough to control and manage the hot-money fluctuations?--in the periphery. But how much weight does the argument that prudential policy in the periphery may go wrong have in militating against policies that--correctly--aim at appropriate internal balance in the core?
I am now more inclined to view worries that ultra-low interest rate and quantitative easing policies raise risks of future financial instability as the last-gasp argument of the austerians--as one more attempt to find an argument, any argument, to justify universal bankruptcy and the war on the Keynesian Mammon of Unrighteousness.
Over at Equitable Growth: I think Mohamed El-Erian makes two analytical errors:
He argues that a faster American recovery requires that the private sector "decouple even more from Washington" and undertake "longer-term investments... [to] unleash underused resources and expand longer-term potential... [at the] scale and scope... need[ed] to validate the current level of excessive risk-taking by financial markets lest that, in itself, becomes a consequential headwind to economic growth and stability..." This morning's earnings yield is 5.1%. This morning's 5-year TIPS yield is 0.1%. That five percentage-point spread does not suggest a financial market in which demand for risky assets has outrun supply and pushed risky-asset valuations to levels that are inviting a crash and subsequent financial crisis triggered by the potential bankruptcy of institutions with normal equity cushions. And are there an unusually large number of institutions right now with normal or subnormal equity cushions whose business model is to sell unhedged out-of-the-money puts on a large scale, pocket their winnings until the strategy goes bust, and then declare bankruptcy and walk away? I'm watching. I don't see any concentration of such institutions...
El-Erian assumes that Washington can do nothing. That is not true. Washington may do nothing--it probably well do nothing. But it could do a lot. FHFA head Mel Watt has the power to offer every homeowner in America a refi at conforming-loan rates with an equity-option kicker attached to mortgages that do not have the 20% equity cushion or exceed appropriate conforming-loan limits. Federal Reserve head Janet Yellen has the power to do a Paul Volcker and undertake a regime change to the Federal Reserve's operating procedures and so alter the expected and actual future path of nominal GDP. Either or both of those could powerfully jumpstart the economy over the next two years. The FHFA and Federal Reserve regime change options should be on the table. El-Erian should not overlook them...
Mohamed El-Erian: US midterm elections offer limited prospect for economic change: "The main question is not whether the midterms will change the gridlock in Washington...
...that undermines economic growth, accentuates inequalities, and holds back prosperity; it is whether companies and individuals can decouple even more forcefully from yet another 'do-little' Congress.... There is little chance of change in the polarisation and dysfunction paralysing Congress.... The fiscal stance would not be altered to provide for higher and better balanced aggregate demand; supply responsiveness would not be enhanced by stepped-up investments in infrastructure, education, labour market strengthening and other areas that improve productivity; medium-term operational uncertainty would not be reduced by greater clarity on corporate tax reform; and damaging debt overhangs would not be lifted.... For stock markets to continue to prosper, the private sector would have to decouple even more from Washington.... It would require much bigger emphasis on longer-term investments in areas that, notwithstanding the continued shortfalls in Congress, unleash underused resources and expand longer-term potential. And the scale and scope would need to validate the current level of excessive risk-taking by financial markets lest that, in itself, becomes a consequential headwind to economic growth and stability...
Now that's more like it, internet!
You all are going to have to wait at least a week more for my to continue my death-march close reading of chapter 11 of David Graeber's Debt: The First 5000 Mistakes--a chapter which I think whose bankruptcy goes well beyond chapter 11 into chapter 7.
For today we have Paul Krugman:
Paul Krugman: Bill Grosses, Idealized and Actually Existing: "Brad DeLong tries at some length to rationalize Bill Gross’s insistence in 2011 that interest rates were about to spike...
...But while it’s nice to be charitable, to attempt to put the best face on someone else’s arguments, it’s also important to look at the argument someone was actually making. And the reasoning of Gross and others was much cruder and a lot more foolish than Brad acknowledges.... Gross wasn’t arguing that rates would rise sharply once people understood that the economy would normalize.... He was arguing that rates were being suppressed right now by the Fed’s purchases of Treasuries, and would spike as soon as those purchases ended.... Not only did it ignore the fundamental reasons rates tended to stay low in a deleveraging world, not only did it overestimate the impact of QE, but it also assumed that the rate of Fed purchases--the flow of QE--was what mattered, when sensible people argued that the stock of assets the Fed held mattered. I wrote all about this at the time. If you find it hard to believe that such a smart guy could make such a poor argument, well, that’s the world we’re living in.
Needless to say, he has good reason:
Paul Krugman Plays Ming the Merciless: Gross Gone: "I don’t know anything about what’s been going on internally at Pimco...
I just read the same stories as everyone else. I have, however, written a lot about Pimco’s macroeconomic analysis (which drove its bond-investment decisions). The interesting thing is the Pimco was initially a bond bull, based on the correct understanding that deficits don’t crowd out lending when the economy is in a liquidity trap; but it then went off the rails, with Bill Gross insisting that rates would spike when the Fed ended QE2. I tried to explain why this was wrong, and got a lot of flak from people insisting that the great Gross knew more than any ivory-tower academic. But I knew what I was talking about!
Joshua Brown: “Do we need to fire PIMCO?”: "In February of 2011, [Bill] Gross loudly proclaimed...
[that] Pimco Total Return had taken its allocation to US Treasury bonds down to zero. As recently as the previous December, Pimco Total Return had been carrying as much as 22 percent of its AUM in Treasurys.... Gross compounded the move by being extremely vocal about his rationale--he went so far as to call Treasury bonds a 'robbery' of investors given their ultra-low interest rates and the potential for inflation. He talked about the need for investors to 'exorcise' US bonds from their portfolios, as though the asset class itself was demonic. He called investors in Treasury bonds 'frogs being cooked alive in a pot'. The rhetoric was every bit as bold as the fund’s positioning. It’s really hard to pound the table like this and then be flexible in the aftermath...
So I was updating my basic stock-index return-predictability lecture, and moving the files for it into R, and I made an unwise data transformation in annualizing the monthly return on the stock index:
YRETURN <- MRETURN^12
LNYRETURN <- 12*log(MRETURN,exp(1))
And I got into a surprising amount of trouble...
...from which I was rescued by the bootstrap. Take a look, if you care:
[that] PIMCO Total Return had taken its allocation to US Treasury bonds down to zero. As recently as the previous December, PIMCO Total Return had been carrying as much as 22 percent of its AUM in Treasurys.... Gross compounded the move by being extremely vocal about his rationale--he went so far as to call Treasury bonds a 'robbery' of investors given their ultra-low interest rates and the potential for inflation. He talked about the need for investors to 'exorcise' US bonds from their portfolios, as though the asset class itself was demonic. He called investors in Treasury bonds 'frogs being cooked alive in a pot'. The rhetoric was every bit as bold as the fund’s positioning. It’s really hard to pound the table like this and then be flexible in the aftermath...
Yes, Bill Gross's judgment in February 2011 that U.S. Treasuries were overbought has been an absolute disaster for PIMCO's Total Return Fund vis-a-vis the market portfolio: READ MOAR
New Economist writes:
New Economist: Has Barro solved the equity premium puzzle? : A new paper by Robert Barro to this year's Minnesota Workshop in Macroeconomic Theory attempts to answer the puzzle: Rare Events and the Equity Premium (PDF). Barro's paper builds upon a 1988 JME article by Thomas Rietz entitled "The equity premium: A solution" (sorry, no PDF available), which argued that the premium could be explained by infrequent but very large falls in consumption (i.e. wars, depressions or disasters), if the intertemporal elasticity of substitution of consumption is low.
Hyman Minsky: Minsky on the IS-LM obfuscation: "The glib assumption made by Professor Hicks...
...in his exposition of Keynes’s contribution that there is a simple, negatively sloped function, reflecting the productivity of increments to the stock of capital, that relates investment to the interest rate is a caricature of Keynes’s theory of investment... which relates the pace of investment not only to prospective yields but also to ongoing financial behavior.... The conclusion to our argument is that the missing step in the standard Keynesian theory was the explicit consideration of capitalist finance within a cyclical and speculative context... then the full power of the revolutionary insights and the alternative frame of analysis that Keynes developed becomes evident.... The greatness of The General Theory was that Keynes visualized [the imperfections of the monetary-financial system] as systematic rather than accidental or perhaps incidental attributes of capitalism.... Only a theory that was explicitly cyclical and overtly financial was capable of being useful... READ MOAR
J. Bradford DeLong
Professor of Economics, U.C. Berkeley
Research Associate, NBER
September 30, 2009
A Little Background
About a year and a half ago—in the days after the forced merger of Bear Stearns into J.P. MorganChase, say—there was a near consensus of economists that an additional dose of expansionary fiscal policy was unlikely to be necessary. The Congress had passed a first round of tax cut-based stimulus, the impact of which in the summer of 2008 is clearly visible in disposable personal income and perhaps visible in the tracks of estimated monthly real GDP. The near-consensus belief back then, however, was that that was the only expansionary discretionary fiscal policy move that was appropriate. READ MOAR
Over at Equitable Growth: The extremely-sharp Jérémie Cohen-Setton has a roundup:
Jérémie Cohen-Setton: Blogs review: The bond market conundrum redux: "Are we seeing a new version of the Greenspan 2005 conundrum?...
Fed tapering was widely expected to push up US yields. Instead, US yields have fallen since the beginning of the year.... A successful explanation of this new conundrum cannot just rely on a flight to safety... it also needs to rationalize why 5-year... and 10-year yield[s] have diverged.... READ MOAR
It is kinda scary that I only knew what seven out of these fifteen were:
Over at Equitable Growth: Nick Rowe begs for North Atlantic central banks to do what he (and I) regard as their proper job, and whimpers:
Nick Rowe: Money, Prices, and Coordination Failures "The more interesting cases are...
...where a non-monetary coordination failure has spillover effects, and causes a monetary coordination failure. A worsening of asymmetric information problems in financial markets, which is a coordination problem in its own right, also causes an increased demand for money and a monetary coordination problem. Should we say that the problem in financial markets is the "root cause" of the recession, and one that should be addressed directly, if possible, by something other than monetary policy? No. Monetary policy should take the world as it is, warts and all, and do what it can do. And what it can do is eliminate that excess demand for money, even if it cannot eliminate that original problem that initially caused the excess demand for money. It does not matter, for the monetary authority, whether that increased demand for money was caused by some natural event like the weather, which nobody can change, or whether it was caused by some other problem, which the fiscal authority can and should fix. READ MOAR
Moving the (corrected) calculations for last weekend's http://delong.typepad.com/sdj/2014/08/under-what-circumstances-should-you-worry-that-the-stock-market-is-too-high-the-honest-broker-for-the-week-of-august-16.html and http://delong.typepad.com/sdj/2014/08/under-what-circumstances-should-you-worry-that-the-stock-market-is-too-high-the-honest-broker-for-the-week-of-august-16.html over to R, as only people who really, really, really want to make bad mistakes do things in the un-debuggable Excel (or Numbers)...
Import data from http://delong.typepad.com/20140824_Shiller_Data.csv...
Over at Equitable Growth: The Setup:
Let's start with Paul Krugman, who made me aware of this ebook by writing:
Paul Krugman: All About Zero: "Way back in 2008 I (and many others) argued...
...that the financial crisis had pushed us into a liquidity trap... in which the Fed and its counterparts elsewhere couldn’t restore full employment even by reducing short-term interest rates all the way to zero.... In practice the zero lower bound has huge adverse effects on policy effectiveness... [and] drastically changes the rules... [as] virtue becomes vice and prudence is folly. We want less saving, higher expected inflation, and more.... Liquidity-trap analysis has been overwhelmingly successful in its predictions: massive deficits didn’t drive up interest rates, enormous increases in the monetary base didn’t cause inflation, and fiscal austerity was associated with large declines in output and employment.... READ MOAR
From Josh Brown and Jeff Macke: Clash of the Financial Pundits:
Josh Brown and Jeff Macke: Chapter 7: The Man Who Moved Markets: ￼"'There are clear lines separating those who swear by him and those who swear at him.' —LOUIS RUKEYSER ON JOE GRANVILLE...
...It is late in the evening on January 6, 1981, and telephones all over the country are starting to ring. Thirty employees of a Florida-based stock market newsletter business are making out-going calls to deliver a very simple, yet ominous, message to a few thousand subscribers across the nation:
This is a Granville Early Warning. Sell everything. Market top has been reached. Go short on stocks having sharpest advances since April. Click.
Early the next morning, just after the opening bell of trade rings on the New York Stock Exchange, the market gaps lower and sell orders continue to flood into the trading floor. The Dow drops a total of 24 points that day, or 2.5 percent, on historic volume of more than 93 million shares traded, more than double the daily average. The Dow then proceeds to drop another 1.5 percent the next day; a five-week sell-off is soon under way. Traders and business news reporters are pointing toward Joe Granville to explain the sudden, sharp drop in the stock market, and Granville is more than happy to be pointed at.
UPDATE: As Noah Smith politely points out, I did a no-no in being so lazy as to take averages of monthly returns to be "close enough" to cumulative compounded returns. Fixing that requires some edits, which I have made:
...is hovering at a worrisome level.... Above 25, a level that has been surpassed... in only... the years clustered around 1929, 1999 and 2007. Major market drops followed those peaks.... We should recognize that we are in an unusual period, and that it’s time to ask some serious questions about it...
The first question I think we should ask is: how damaging in the long run to investor portfolios were the major market drops that followed the 1929, 1999, and 2007 CAPE peaks? The CAPE is the current price of the S&P index divided by a ten-year trailing moving average of its earnings: the CAPE looks back ten years to try to get an estimate of what normal earnings are and how stock prices deviate from them. Let's look ahead and calculate ten-year forward earnings to get a sense of what signals the CAPE sends for those of us interested in stocks for the long run.
Over at Equitable Growth: The extremely sharp and hard-working Neil Irwin has a nice piece that gives his answer:
Neil Irwin: Why Is the Economy Still Weak? Blame These Five Sectors: "The economy keeps underperforming...
...producing around $800 billion a year less in goods and services than it would if the economy were at full health, and as a result millions of people aren’t working who would be if conditions were better. But why?... To get at an answer, we needed a more basic question: What would the economy look like right now if it were fully healthy, and how is the actual reality... different?... A handful of sectors, including housing, government spending and spending on durable goods, are at fault for the continuing underperformance of the American economy.... Six of 11 sectors we analyzed are doing fine... consumer spending on services... spending on nondurable goods... Business spending on intellectual property.... READ MOAR
Over at Equitable Growth: I have been waiting to post this until now when there are only twelve months before the end date of my bet with Noah Smith on whether inflation would break 5% over any twelve-month period without a high-pressure labor market. I took the "no". He took the "yes" and did so, from my perspective, irrationally--he only took 50-1, while he should have demanded odds an order of magnitude greater. That the final twelve-month window of our bet is now running means it is time to set out my thoughts on the trahison des clercs of so much of the academic economics profession over the past seven years. READ MOAR
Over at Equitable Growth: I have said this before. But I seem to need to say it again...
The very intelligent and thoughtful David Beckworth, Simon Wren-Lewis, and Nick Rowe are agreeing on New Keynesian-Market Monetarist monetary-fiscal convergence. Underpinning all of their analyses there seems to me to be the assumption that all aggregate demand shortfalls spring from the same deep market failures. And I think that that is wrong.
Simon Wren-Lewis writes:
I really like David Beckworth’s Insurance proposal against ‘incompetent’ monetary policy. Here it is: 1) Target the level of nominal GDP (NGDP). 2) "The Fed and Treasury... agree... should a liquidity trap emerge anyhow... quickly work together to implement a helicopter drop...." Market Monetarists and New Keynesians [do not] suddenly agree about everything... for David this is an insurance against incompetence by the central bank, whereas Keynesians... view hitting the ZLB as unavoidable if the shock is big enough. However this difference is not critical... READ MOAR
Over at Equitable Growth: I have always understood expected-utility decision theory to be normative, not positive: it is how people ought to behave if they want to achieve their goals in risky environments, not how people do behave. One of the chief purposes of teaching expected-utility decision theory is in fact to make people aware that they really should be risk neutral over small gambles where they do know the probabilities--that they will be happier and achieve more of their goals in the long run if they in fact do so. READ MOAR
Over at Department of "WTF?!" Chris House on Traditional Macroeconomic Models and the Great Recession,: Someone Who Remembers 1997-8 writes in comments:
I was more struck by this:
Chris House: Traditional Macroeconomic Models and the Great Recession:
Macroeconomists were caught completely off-guard by the financial crisis. None of the models we were accustomed to use provided insights or policy recommendations.... Neither the New Keynesian model nor its paleo-Keynesian antecedent feature a meaningful role for financial market failures. As a result, the policy response to the crisis was largely improvised. This is not to say that the improvised policy actions were bad. Improvisation guided by Ben Bernanke was about as good as we could hope for. Nevertheless, for the most part, the models we were accustomed to use to deal with business cycle fluctuations were simply incapable of making sense of what was going on.... While I typically do not grant much credence to heterodox economists, in this instance Professor Wray’s diagnosis is completely correct...
Has Chris House:
never heard of Walter Bagehot, Hyman Minsky, or Charlie Kindleberger?
not think that they were macroeconomists?
unaware of the debates and discussions and modeling exercises carried out around the 1997-98 East Asian financial crisis and the 1994-5 Mexican crisis?
unaware of all the credit-channel work on the Great Depression?
It is a great mystery...
Over at Equitable Growth: Paul Krugman admonishes me for thinking I should try to work out what model underlies the Bank for International Settlements' 84th Annual Report. It is, he says, not so much a macroeconomic model or an analytical framework. Rather, he says, it is a mood: the rhetorical stance of austerity a outrance:
Paul Krugman: Liquidationism in the 21st Century: "The BIS position... [is] that of 1930s liquidationists like Schumpeter...
...who warned against any 'artificial stimulus' that might leave the 'work of depressions undone'. And in 2010-2011 it had an intellectually coherent--actually wrong, but coherent--story... that mass unemployment was the result of structural mismatch... [and] easy money would lead to a rapid rise in inflation.... it didn’t happen. So... it... look[ed] for new justifications for the same [policy] prescriptions... playing up the supposed damage low rates do to financial stability.... That over-indebtedness on the part of part of the private sector is exerting a persistent drag on the economy... is a reasonable story.... But the BIS... doesn’t understand that model... as if they were equivalent to... real structural problems... [which] makes a compelling case for... fiscal deficits to support demand while the private sector gets its balance sheets in order, for monetary policy to support the fiscal policy, for a rise in inflation targets both to encourage whoever isn’t debt-constrained to spend more and to erode the real value of the debt. The BIS, however, wants governments as well as households to retrench... and--in a clear sign that it isn’t being coherent--it includes a box declaring that deflation isn’t so bad, after all. Irving Fisher wept....
Are the BIS’s methods unsound? I don’t see any method at all. Instead, I see an attitude, looking for justification... READ MOAR
Claudio Borio (2012): The Financial Cycle and Macroeconomics: What Have We Learnt? "[']The financial cycle[']... denote[s] self-reinforcing interactions between perceptions of value and risk...
...attitudes towards risk and financing constraints, which translate into booms followed by busts... [that] amplify economic fluctuations and possibly lead to serious financial distress and economic dislocations.... Equity prices can be a distraction.... Interest rates, volatilities, risk premia, default rates, non-performing loans, and so on.... Combining credit and property prices appears to be the most parsimonious way to capture the core features....
Over at Equitable Growth: I confess that I do not understand the recent BIS Annual Report. I have tried--I have tried very hard--to wrap my mind around just what the BIS position is. But I have failed.
So let me try to lay out how I see it--where I think we are, and what I think the three live macroeconomic-policy positions are:
First, where we are:
We had in the late-1990s a high-pressure full-employment low-inflation tight-fiscal equilibrium. It was, however, unsustainable: based on exaggerated beliefs not about the utility but the profitability of companies based on the high-tech computer and communications technologies of the 1990s. When expectations adjusted to the reality of profitability, the high investment part of the 1990s boom went away, and the economy fell into the minor recession of the early 2000s. READ MOAR:
Inaugural Michel Camdessus Central Banking Lecture on Financial Stability’, at the IMF
CHRISTINE LAGARDE: Oh, my goodness. Madam Chairman, you have impressed us enormously with a rich, dense, very informative and very candid read — your read of the current situation and how monetary and macroprudential — monetary policy and macroprudential tools could be used in sequence, in parallel, in different circumstances. And I would like to, maybe following the Stradivarius analogy of Michel, to stay loyal to (our man ?) today, what would you say? Would you say that macroprudential tools are second fiddle to the main Stradivarius of monetary policy? Or would you say that, depending on circumstances, macroprudential tools become the premier violon and have to deal with the issues as a first line of defense?
Robert Peston: Peston's Picks: Merrill's Mess: All weekend, wave after wave of schadenfreude has been crashing on the head of Stan O’Neal...
...the chairman of Merrill Lynch. After Merrill announced those colossal losses on inventories of sub-prime loans reprocessed into noxious collateralised debt obligations, O’Neal could not survive.
The point is that Merrill’s historic strengths have been as an agent, a broker, not a risk-taker. So its veterans launched into the “I-told-you-so” dance when “new Merrill” came a cropper from putting its capital at risk in the manufacture of securities out of loans to US homeowners with poor credit histories.
A Note: Prolegomenon to Any Useful Discussion of Modern American Finance (Brad DeLong's Grasping Reality...): 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.
Over at Equitable Growth: In relatively short order after John Paulson and company figured out how to sell mortgage finance short--howto collect the money from selling MBS to addled investors without having to first finance the construction of five-bedroom houses with swimming pools in the desert between Los Angeles and Albuquerque--the housing bubble reached its peak.
It seems at least plausible that if Paulson and company had been in business in 2004 the bad bets of MBS buyers would have gone into the pockets of short sellers rather than being wasted financing the construction of houses people really do not want to live it. And it seems at least plausible that if the supply of MBS had not been limited by housing construction, the price peaks would have been lower, the losses when MBS prices returned to fundamentals would have been less, and that even with all of the portfolio and risk-management dysfunction in the too-big-to-fail money-center banks and all the regulatory dysfunction at the Federal Reserve the bubble collapse would not have taken down our too-big-to-fail money-center banks, and we would not be in our current mess. READ MOAR
Over at Equitable Growth: In the 1970s and 1980s CEOs received about three times the average earnings of the top 0.1%-ile and about 45 times the earnings of the average worker. Today CEOs receive about 5 tuies the earnings of the top 0.1%-ile and about 300 times the earnings of the average worker. I am now convinced that there is an extra, corporate-control and finance-driven story to CEO pay that does not apply to the earnings of the top 0.1%-ile in general. What might it be? A self-reinforcing iron oligarchy of effective control rights redirecting cash flows in which CEOs, board members, and financiers all of whom form a social network in which it is impolite not to treat each other as well as possible seems inadequate as an explanation, but that seems to be what we have... READ MOAR
Mishel and Davis:
...it stemmed from a financial shock. Housing prices stopped going up, and then Lehman Brothers fell, triggering paralysis in the credit markets. This spilled onto Main Street, and the effects still linger in terms of elevated unemployment and sluggish economic growth. But this history of the recession can’t be right, say... Amir Sufi... and Atif Mian.... Consumer purchases dropped sharply well before the September 2008 Lehman bankruptcy, and most deeply in places where home prices fell the most.... Steeper declines in net worth... led to far sharper reductions in consumer spending, and bigger job losses. But even those with no debt suffer when fire-sale foreclosures drop home prices, and lower overall demand spreads out across the country.... The normal channels of fiscal and monetary policy have difficulty dealing with highly leveraged household balance sheets. House of Debt correlates these features of recessions, and really targets debt as the core problem, arguing that it needs to be restructured during crises and prevented during better times.... READ MOAR
To quote Robert Benchley, “Having a dog teaches a boy fidelity, perseverance, and to turn around three times before lying down.” Such are the shortcomings of experience. Nevertheless, it’s a good idea to review past mistakes before committing new ones. So let’s take a quick look at the last 25 years.
Lawrence H. Summers: The Inequality Puzzle: "His policy recommendations are unworldly....
Success in combating inequality will require addressing the myriad devices that enable those with great wealth to avoid paying income and estate taxes.... If, as I believe, envy is a much less important reason for concern than lost opportunity, great emphasis should shift to policies that promote bottom-up growth. At a moment when secular stagnation is a real risk, such policies may include substantially increased public investment and better training for young people and retraining for displaced workers, as well as measures to reduce barriers to private investment in spheres like energy production, where substantial job creation is possible. Look at Kennedy airport... if a moment when the United States can borrow at lower than 3 percent in a currency we print ourselves, and when the unemployment rate for construction workers hovers above 10 percent, is not the right moment to do it, when will that moment come? READ MOAR
Over at the WCEG Equitablog: Yet again? Yet again! It cannot be healthy for me to keep worrying this over and over again. But I do. The question of how we got into this Obama Stagnation--this situation in which US real GDP is 8% below its pre-2008 trend, with no signs of it ever reapproaching that trend--continues to bother me.
I continue to worry it for two big reasons:
It is the lowest-hanging fruit for equitable growth here in America. If you want to grow the economy in a way that shrinks income disparities, rebalancing the macroeconomy and returning to the old 1990s full-employment high-pressure economy is by far the easiest way to do the most good.
It is, I think, by far my greatest career analytical failure. I used to think that my greatest analytical failure was not seeing that NAFTA would generate a demand by Mexico's wealthy for assets in the U.S. that would swamp the demand it would create by America's corporations for factories in Mexico. Thus I did not see that NAFTA would weaken rather than strengthen the peso. But this is a bigger analytical howler. If you had asked me back in 2007 what the chances were that we would be here today, I would have given you all probably 100-to-1, and certainly 20-to-1 against--and I would have been willing to bet a substantial portion of my net worth on that position. And I would have been taken to the cleaners. READ MOAR
Atif Mian and Amir Sufi: Tim Geithner Is Wrong: "We published our post over at WaPo’s WonkBlog...
...one of our favorite sites.... As a quick follow up, here is a quote from a research paper by Richard Disney and others:
However, we do find a strong asymmetry in the response for households in “negative equity”—households in negative equity experiencing a surprise gain exhibit a consumption response five times stronger than households that had initially positive equity values in their housing stock.”
Again, the MPC estimate that Geithner uses is absurdly small, outside of the range that most economists use...."
Felix Salmon: Tim Geithner as Unreliable Narrator: "Geithner makes simple declarations...
...which are easily fact-checked. So let’s turn to pages 79-81, where Geithner is covering his early tenure as the president of the New York Fed....
In my very first public speech at the New York Fed in March 2004, I tried to push back against complacency, telling a room full of bankers that the wonders of the new financial world would not necessarily prevent catastrophic failures of major institutions, and should not inspire delusions of safety on Wall Street. I even cited my favorite theorist on financial irrationality, the leading promoter of the idea that periodic financial crises are practically inevitable.
“These improvements are unlikely to have brought an end to what Charles Kindleberger called ‘manias and panics,’ ” I said. “It is important that those of you who run financial institutions build in a sufficient cushion against adversity.” …
This is Geithner at his most prescient and heroic. He enters a hidebound wood-paneled institution where coffee is brought to his desk on a silver tray while briefings involved precious little discussion or debate; and in his very first speech he... speak[s] truth to entrenched financial power... 'push[es] back against complacency' and warn[s] against the rise of the shadow banking system....
But here’s the thing: we can read the speech....
Emanuel Derman: "Speech at Commencement 2014 to Berkeley MSE Grads: March 21, 2014...
...It’s truly a great pleasure for me to be at the University of California at Berkeley today. Not quite 50 years ago, when I was an undergraduate studying physics in Cape Town, I began applying to go to the United States for graduate school. It seemed to be the right thing to do if you were serious about your field.
So I applied to three schools: Columbia, because I knew someone in Cape Town who had just gone there, and because it was in New York City; Caltech, because Feynman was there and had recently been awarded the Nobel prize and also published the stylish and insightful Feynman lectures on physics, though I didn’t understand at the time what he had actually accomplished; and Berkeley, because it was in the news for the start of the revolts against arbitrary authority on campus. I read the other day that year is the 50th anniversary of the Berkeley Free Speech Movement that seem to me to have kicked off the Sixties. For those of you who are too young to remember that, whichI suppose is all of you graduating today and maybe much of the faculty too, take a look — it’ll make interesting reading.
Over at the WCEG:
The frustrating thing about Geithner's Stress Test is that he doesn't explain why he took the housing policy positions he did when he did, and why he made the housing personnel decisions he did when he did. Instead, he appears to jump from claim to incompatible claim about his housing policy...
Thus we are left with Glenn Hubbard's reaction to the housing policy discussion in Stress Test:
About housing... I must say I split my side in laughter because Tim Geithner personally and actively opposed mortgage refinancing.... And now he’s claiming this would be a great idea...
And David Dayen's reaction to the housing policy discussion in Stress Test:
The guy who handed hundreds of billions of dollars over to banks with basically no strings attached [was] suddenly worried about fairness when homeowners get a break on their mortgage payments.... Even as he says in the book “I wish we had expanded our housing programs earlier,” he completely contradicts that to Andrew Ross Sorkin, saying [that his own] statement is “unicorny”...
And Amir Sufi and Atif Mian's reaction to the housing policy discussion in Stress Test:
Multiplying $700 billion by 0.18 gives us a spending boost to the economy in 2009 of $126 billion, which is 1.3% of PCE, 10 times larger than the estimate Secretary Geithner asserted in his book. So Mr. Geithner is off by an order of magnitude... READ MOAR