## Department of "Hah!!": Child-Rearing Edition

Chris Blattman:

Further rightward shifts in my future?: In response to my nanny-driven Republicanism post, Peter Berck comments:

It is being a parent that will drive you rightwards. Keeps lots of rice paper around so you can eat words like “our children will go to public schools.”"

Sigh. I can already see that capitulation coming. Right after “my child will not watch TV”…

Well, we sent our children to public schools (until college, that is) and none of us watched TV until the youngest child was highly literate…

It can be done!

## One Possible Set of Readings and Topics for Economics 24-1: The Financial Crisis and the Little Depression of 2007-2012

Yes, I know that this is about four times as much as freshmen in a freshman seminar can be expected to absorb. But where to cut?

F4-5:30, Evans Hall 597. J. Bradford DeLong delong@econ.berkeley.edu 925.708.0467

Aug. 26: Panics: Kindleberger, Manias, Panics, and Crashes

Sep. 2: Bubbles: Galbraith, The Great Crash

Sep. 9: NO CLASS

Sep. 16: General Gluts: Bagehot, Lombard Street http://tinyurl.com/dl20110612b; Minsky, "The Financial Instability Hypothesis" http://tinyurl.com/dl20110612f.

Sep. 23: NO CLASS

Sep. 30: The Great Moderation: Greenspan, The Age of Turbulence; Bernanke, "The Great Moderation" http://tinyurl.com/dl20110612g; Blinder and Reis, "Economic Performance in the Greenspan Era: The Evolution of Events and Ideas" http://tinyurl.com/dl20110612j; Rajan, "Financial Markets, Fragility, and Central Banking" http://tinyurl.com/dl20110612i plus discussions at http://www.kansascityfed.org/publicat/sympos/2005/pdf/GD5_2005.pdf http://www.kansascityfed.org/publicat/sympos/2005/pdf/Shin2005.pdf and http://www.kansascityfed.org/publicat/sympos/2005/pdf/Kohn2005.pdf

Oct 7: Mortgages and Derivatives: Nocera and MacLean, All the Devils Are Here

Oct.14: NO CLASS

Oct. 21: Bank Runs: Gorton, Slapped by the Invisible Hand; Shleifer and Vishny, "Fire Sales in Finance and Macroeconomics"

Oct. 28: The Financial Collapse: Paulson, On the Brink; Cecchetti, "Crisis and Responses: The Federal Reserve in the Early Stages of the Financial Crisis"

Nov. 4: The Recession: Robert Hall, "Why Does the Economy Fall to Pieces After a Financial Crisis?"; Mill, "Of the Influence of Consumption on Production" http://tinyurl.com/dl20110612a; Krugman, selections from The Conscience of a Liberal http://krugman.blogs.nytimes.edu

Nov. 11: NO CLASS

Nov. 18: Policies: Suskind, Confidence Men; Viner, "Mr. Keynes on the Causes of Unemployment" http://tinyurl.com/dl20110612e

Nov. 25: NO CLASS

Dec. 2: Politics and Sovereigns: Reinhart and Rogoff, This Time It's Different

Dec. 9: Lunch

## Department of "Huh?!"

The first rule of policymaking is that you get all the players whose cooperation is needed to implement policies into a room together:

Obama to meet with Bernanke as markets continue to fluctuate: by Sam Youngman: President Obama is scheduled to meet with Federal Reserve Chairman Ben Bernanke on Wednesday afternoon at the White House. Obama will also meet separately with Treasury Secretary Timothy Geithner, White House press secretary Jay Carney said...

## Interpreting the Aftermath of the S&P Ratings Downgrade: Commute/Time Thoughts

The week following the S&P ratings downgrade of the USA was a week of remarkable volatility, of a marked strengthening of the long-term US treasury bond, and of a steep decline in US equity values. That is not what we expect to follow a sovereign ratings downgrade--at least not one that carries new information or transmits information to a wider audience.

A sovereign ratings downgrade should see the sovereign's currency weaken, should see its bonds weaken, and should see equity values denominated in the sovereign's currency rise.

That is not what happened.

What is going on?

A couple of possibilities:

The first possibility is that S&P's ratings are completely without influence. After the decade of the 2000 you would have to be an idiot to rely on S and P, and while there are idiots there is a limit to their idiocy. The US macro situation and the European debt crisis are the drivers of market price movements. S&P is simply the dog running in front of the parade that thinks it is leading it.

Second, perhaps there is a disjunction between the people who have the money and the people who manage the money. Perhaps the people who have the money think that the downgrade increases risk and that they want to get risk off of their portfolios. Thus they pull their money out of the hands of managers with an appetite for risk and give it to managers with an appetite for conserving value. If so, each individual manager could respond to the ratings downgrade in the normal way, but the composition effect from the changing amount of money in the hands of different types of managers overwhelms the normal response.

The third possibility is that the market is treating this not as an economic but rather a political intervention: an intervention against full employment and reflation, an intervention for austerity and deflation, and an intervention that will succeed in pushing policy in a destructive direction and raise the chances that the lost half decade of the Lesser Depression will turn into a lost decade or two.

All three of these are consistent with the pattern of asset price movements we have seen: collapsing equities, rising debt, slight weakening in the currency.

But, above all, note that the one story not consistent with the data is the one you see on the teevee: "investors panic because of US government debt". That story would see falling stocks, a sharply falling currency, and falling bond prices.

## Jon Chait: Drew Westen's Nonsense

Jon Chait does not like cultural students:

Drew Westen's Nonsense: There are some strong criticisms to be made of the Obama administration from the left, especially concerning Obama's passive response to the debt ceiling hostage crisis, and his frightening willingness to give away the store to John Boehner. I've made many of these criticisms myself. But Drew Westen's lengthy, attention-grabbing Sunday New York Times op-ed is not a strong criticism. It's a parody of liberal fantasizing.

Westen is a figure... [who] sell[s] liberals on an irresistible delusion. The delusion rests on the assumption that the timidity of their leaders is the only thing preventing their side from enjoying total victory.... It is unusually fixated on the power of words.... Westen's op-ed rests upon a model of American politics in which the president in the not only the most important figure, but his most powerful weapon is rhetoric.... Westen locates Obama's inexplicable failure to properly use his storytelling power in some deep-rooted aversion to conflict. He fails to explain why every president of the postwar era has compromised, reversed, or endured the total failure of his domestic agenda....

Obama took office at the cusp of a massive worldwide financial crisis that was bound to inflict severe damage on himself and his party. That he faced such difficult circumstances does not absolve him of blame for any failures. It sets the bar lower, but the bar still exists. How should we judge Obama against it? I would argue that both the legislative record of 2009-2010 and Obama's personal popularity level exceed the expectation level -- facing worse economic conditions than the last two Democratic presidents at a similar juncture, Obama is far more popular than Jimmy Carter and nearly as popular as Bill Clinton, and vastly more accomplished than both put together....

The most inexcusable factual errors in Westen's essay have been documented by Andrew Sprung, who points out some of the occasions Obama has used exactly the kind of rhetoric Westen accuses him of refusing to deploy. Westen is apparently unaware, to take one example, that Obama repeatedly and passionately argued for universal coverage. The fact of his unawareness is the most devastating rejoinder to his entire rhetoric-centered worldview. If even a professional follower of political rhetoric like Westen never realized basic, repeated themes of Obama's speeches and remarks, how could presidential rhetoric -- sorry, "storytelling" -- be anywhere near as important as he claims? The clear reality is that Americans pay hardly any attention to what presidents say, and what little they take in, they forget almost immediately. Even Drew Westen.

## Department of "Huh?!": Equity Premium Edition

The thoughtful and intelligent Frances Woolley writes:

Worthwhile Canadian Initiative: Does the equity premium still exist? And, if not, so what?: The equity premium can be observed over certain time periods. For example, during the 1950s stocks outperformed bonds by 19 percent. But I've never understood why there should be a large premium on equities. Supposedly the equity premium compensates shareholders for the risks that they bear. But large institutional investors are able to hold a highly diversified portfolio, so variance in the performance of individual stocks should have little effect on their overall rate of return…. [I]t's not as if bonds are risk-free, anyways. Bond issuers go bankrupt and default. Inflation happens. Interest rates go up and down.

It seems to me equally plausible that the equity premium was an artifact of the Great Depression, when the Dow Jones lost 89 percent of its value over a three year period. The gradual recovery of those losses during the 1950s, 60s and 70s could explain the equity premium observed in the data. Alternatively, perhaps new technology and the emergence of large institutional investors in the 1970s, 1980s and 1990s allowed people to figure out how to diversify portfolios and manage risks, creating an increased demand for stocks, running up the value of equities. But now we're in a new equilibrium, with a much smaller, or non-existent equity premium.

The twelve-month trailing earnings yield for the S&P 500 write now is 9%--that's 2.5% of dividends and 6.5% of retained earnings. The interest rate on U.S. Treasury ten-year TIPS right now is -0.13%. Unless you think that the profits of the S&P are going to take a big dive in real terms or that the earnings yield is going to go way up in the next ten years or that companies will take their retained earnings and use them extraordinarily unproductively, it looks to me like right now we have a ten-year equity premium vis-a-vis TIPS of 9.13%. For the seven-year TIP the rate is -0.74%.

It has to be a very high expected value bet to find clients and get them short TIPS and long the S&P 500, ignore the portfolio for seven years, and then take a look at what you got.

To which the Wall Street response is: "Yeah, it would be. But the only client who will give you their money for seven years without any chance of asking it back is named 'Pharaoh'. And the only money-manager he trusts is 'Joseph ben Jacob'."

## S&P's Ratings Are Statistically Uninformative

Since the New York Times has disconnected my online login from my print edition, I can't link to anything at the New York Times. But James Kwak reads Nate Silver:

S&P Ratings Destroy Information: Nate Silver has the best article I’ve seen yet on S&P’s sovereign debt ratings, and the summary is that it isn’t pretty….

• Debt-to-GDP ratio alone is a better predictor of default risk than an S&P rating (meaning that the rating subtracts information provided by the debt-to-GDP ratio).
• S&P ratings have almost no correlation with future default risk.
• S&P rates European countries higher than other countries, all other things being equal—and look where that got us.
• S&P ratings are serially correlated, which means they incorporate new information especially slowly.

Hopefully this will be one more nail in the coffin of regulations that incorporate NRSRO ratings.

## Ta-Nehisi Coates Goes to Gettysburg: The Unmasterable Burden of the Past Department

Grant at Appomattox Courthouse:

U.S. Grant: My own feelings… were sad and depressed. I felt like anything rather than rejoicing at the downfall of a foe who had fought so long and valiantly, and had suffered so much for a cause, though that cause was, I believe, one of the worst for which a people ever fought, and one for which there was the least excuse…

I think that is the answer to the questions Ta-Nehisi Coates is asking at Gettysburg:

A Quick Word On Gettysburg: Beyond my own ignorance of the Civil War, there's also the way Gettysburg exists in the American narrative. I think the frequent invocation of this Faulkner quote, though perhaps not the quote itself, sum up the problem:

For every Southern boy fourteen years old, not once but whenever he wants it, there is the instant when it's still not yet two o'clock on that July afternoon in 1863, the brigades are in position behind the rail fence, the guns are laid and ready in the woods and the furled flags are already loosened to break out and Pickett himself with his long oiled ringlets and his hat in one hand probably and his sword in the other looking up the hill waiting for Longstreet to give the word and it's all in the balance, it hasn't happened yet, it hasn't even begun yet, it not only hasn't begun yet but there is still time for it not to begin against that position and those circumstances which made more men than Garnett and Kemper and Armistead and Wilcox look grave yet it's going to begin, we all know that, we have come too far with too much at stake and that moment doesn't need even a fourteen-year-old boy to think This time. Maybe this time with all this much to lose than all this much to gain: Pennsylvania, Maryland, the world, the golden dome of Washington itself to crown with desperate and unbelievable victory the desperate gamble, the cast made two years ago.

No one, in Shelby Foote fashion, should ever earnestly offer up this quote. People who do sound foolish. It's fawning invocation of this quote is almost always racist, and perhaps even sexist…. Racism, in this country, is inevitably tied to sexual violence notions of family and gender. It's inescapable.)

Those Southern boys are all boys, and they are all white. And having tackled Pennsylvania, Maryland, and the world they would have plunged the whole of it into a regime built on black slavery. Their dream is the continued prosecution of a two and half century old war against black people. The dream of the Confederate cause, is the dream of the Ku Klux Klan. There is not a whit of daylight in between. To think otherwise is to think that the battle-flag re-emerged in the South in 1962, the year George Wallace won in Alabama, by mere coincidence.

I can't go much further, because I risk giving up my article. But the point I'm driving at it's very tough to consider Gettysburg, as its commonly rendered in the American imagination, when you're black. And yet in point of fact, perhaps more than any other battlefield in the country, the folks at Gettysburg have done a really good job in making clear that the war was about slavery…. You really couldn't watch it and think the Civil War was about anything else…

The crux of the issue, I think, is that even in a democracy--especially in a democracy perhaps, for democracies tend to be naive about power--people trust their leaders, and loyalty and trust are virtues along with courage and a willingness to be the sharp end of the spear when the needs of the many require it. The fact that the leaders were evil men and the culture in which the boys--and even the officers--were raised was an evil culture does not completely erase the fact that on June 3, 1863 five thousand young Virginian men risked and lost everything in the sincere belief that the future of Virginia required that they do deeds of violence that day.

As Senator Webb (D-VA) said:

James Webb: our leaders should carry next to their breasts, and contemplate every time they face a crisis... echo in their consciences, from the power of a million graves. It is simply this: You hold our soldiers' lives in sacred trust. When a citizen has sworn to obey you, and follow your judgment, and walk onto a battlefield to defend the interests you define as worthy of his blood, do not abuse that awesome power through careless policy, unclear objectives, or inflexible leadership…

And as President von Weizsacker of Germany said:

Richard von Weizsacker: We need and we have the strength to look truth straight in the eye–without embellishment and without distortion.... The greater honesty we show in commemorating this day, the freer we are to face the consequences with due responsibility.... The vast majority of today's [German] population… cannot profess a guilt of their own for crimes that they did not commit…. But their forefathers have left them a grave legacy. All of us, whether guilty or not, whether old or young, must accept the past. We are all affected by its consequences and liable for it...

## Time for QE III, IV, V, and VI

Duncan Black:

Eschaton: WHEEEEEEEEEEEEEEEEEE: I wonder if any serious investor could actually explain what new information "the market" has which could explain why DJIA should be worth 11% less than it was 2 weeks ago. Down 3.3% today so far, which maybe we could explain on the S&P downgrade except for the fact that Treasury prices (yields) are way up (down).

## Matthew Yglesias Visits the Sewer That Is National Review

Somebody please get the firehouse to clean him off

John Derbyshire Wants To ‘Let Britain Burn’: It’s been a while now since I’ve read a good old fashioned insane John Derbyshire post.... It’s one thing if you want to call “deracinated moral universalism” a “sick” principle. But it’s very strange to combine this with table-pounding about Christianity. I’m no Christian, personally, but deracinated moral universalism is one of Christianity’s best and most worthy contributions to human thought. I, for example, am not British nor am I descended from British people. But despite the lack of ties of blood, it seems to me that it’s sad if British people get hurt or killed or have their property damaged in rioting. You can see that as being because we’re all God’s children and equal in His eyes, or as a non-theological statement of human equality. In either case, I think it would be very sad for the country to burn.

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

## Treasury Real Interest Rates Now Negative Out to Ten Years...

If this isn't a market prediction of a double-dip and a lost decade (or more), I don't know what would be. At least Hoover was undertaking interventions in financial markets--and not just blathering about how cutting spending was the way to call the Confidence Fairy...

## Time to Recess-Appoint Joe Gagnon to the Federal Reserve Board...

Joe Gagnon:

Stop Sticking Our Heads in the Sand! A Plan for Action on Jobs: Despite the claim that last week’s jobs numbers were “better than expected,” they were in fact an abysmal indictment of US economic policy over the past two years. The unemployment rate has remained near or above 9 percent for 28 consecutive months, a policy failure not seen since the Great Depression of the 1930s…. Many actions that would be helpful—extension and enlargement of the payroll tax cut, extension of unemployment benefits, extension of aid to the states, and a substantial and accelerated infrastructure program—require Congressional approval. I have no insights as to how to get such actions approved….

I propose aggressive actions that can be taken by the Obama Administration and the Federal Reserve without a single vote in Congress… the same actions I proposed nearly two years ago but that were never adopted. The stakes are higher now….

First and foremost, the Federal Reserve should announce an additional $2 trillion of asset purchases….$2 trillion of [quantitative easing] monetary stimulus is not comparable to $2 trillion of fiscal stimulus. In my previous proposal, I estimated that this policy would boost US GDP by an amount comparable to$500 to $800 billion in fiscal stimulus. However, monetary easing reduces rather than increases our national debt. An additional step the Federal Reserve should take is to stop paying interest on reserves…. [T]he Administration should use its control of Fannie Mae and Freddie Mac to force them to invite all homeowners whose mortgages are already guaranteed by Fannie and Freddie, and who are not delinquent in their mortgage payments, to refinance their current mortgage balance…. Lowering mortgage interest payments on underwater loans would be the best way to prevent future defaults that would harm Fannie, Freddie, the holders of second liens, and US taxpayers. It is a win-win for all…. [T]he Administration needs to acknowledge that the strong dollar policy… is defunct and opt to embrace moderate further dollar depreciation…. Naysayers will argue that this strategy is a recipe for runaway inflation. Indeed, they have been saying that for nearly three years… ## Change of Subject: Ronald Reagan on Medicare, circa 1961. Prescient rhetoric or familiar alarmist claptrap? Ronald Reagan: Medicare = Socialism: nbsp;There are many ways in which our government has invaded the precincts of private citizens, method of earning a living; our government is in business to the extent of owning more than 19,000 businesses covering 47 different lines of activity. This amounts to a fifth of the total industrial capacity of the United States. But at the moment I would like to talk about another way because this threat is with us, and at the moment, is more imminent. One of the traditional methods of imposing statism or socialism on a people has been by way of medicine. It’s very easy to disguise a medical program as a humanitarian project, most people are a little reluctant to oppose anything that suggests medical care for people who possibly can’t afford it. Now, the American people, if you put it to them about socialized medicine and gave them a chance to choose, would unhesitatingly vote against it. We had an example of this. Under the Truman administration it was proposed that we have a compulsory health insurance program for all people in the United States, and, of course, the American people unhesitatingly rejected this. So with the American people on record as not wanting socialized medicine, Congressman Ferrand introduced the Ferrand bill. This was the idea that all people of Social Security age, should be brought under a program of compulsory health insurance. Now this would not only be our senior citizens, this would be the dependents and those that are disabled, this would be young people if they are dependents of someone eligible for social security. Now , Congressman Ferrand, brought the program out on that idea out , on just for that particular group of people. But Congressman Ferrand was subscribing to this foot-in-the door philosophy, because he said, “If we can only break through and get our foot inside the door, then we can expand the program after that. Walter Ruther said, “It’s no secret that the United Automobile Workers is officially on record of backing a program of national health insurance. And by national health insurance, he meant socialized medicine for every American. Well, let us see what the socialists themselves have to say about it. They say once the Ferrand bill is passed this nation will be provided with a mechanism for socialized medicine capable of indefinite expansion in every direction until it includes the entire population. Now we can’t say we haven’t been warned. Now Congressman Ferrand is no longer a Congressman of the United States government. He has been replaced, not in his particular assignment, but in his backing of such a bill by Congressman King of California. It is presented in the idea of a great emergency that millions of our senior citizens are unable to provide needed medical care. But this ignores that fact that in the last decade, 127 million of our citizens, in just 10 years, have come under the protection of some form of privately owned medical or hospital insurance. Now the advocates of this bill when you try to oppose it challenge you on an emotional basis. They say, "What would you do? Throw these poor people out to die with no medical attention?” That’s ridiculous and of course no one is advocating it. As a matter of fact, in the last session of Congress a bill was adopted known as the Kerr/Mills bill. Now without even allowing this bill to be tried to see if it works, they have introduced this King bill, which is really the Ferrand bill. What is the Kerr/Mills bill? It is a frank recognition of the medical need or problem of the senior citizens I have mentioned and it has provided from the federal government, money to the states and the local communities that can be used at the discretion of the state to help those people who need it. Now what reason could the other people have for backing a bill which says we insist on compulsory health insurance for senior citizens on a basis of age alone regardless of whether they are worth millions of dollars, whether they have an income, whether they are protected by their own insurance, whether they have savings. I think we can be excused for believing that as ex-congressman Ferrand said, this was simply an excuse to bring about what they wanted all the time -- socialized medicine. James Madison in 1788 speaking to the Virginia convention said, “Since the general civilization of mankind, I believe there are more instances of the abridgement of the freedom of the people by gradual and silent encroachments of those in power than by violent and sudden usurpations.” They want to attach this bill to Social Security and they say here is a great insurance program; now instituted, now working. Let’s take a look at Social Security itself. Again, very few of us disagree with the original premise that there should be some form of savings that would keep destitution from following unemployment by reason of death, disability or old age. And to this end, Social Security was adopted, but it was never intended to supplant private savings, private insurance, pension programs of unions and industries. Now in our country under our free-enterprise system we have seen medicine reach the greatest heights that it has in any country in the world. Today, the relationship between patient and doctor in this country is something to be envied any place. The privacy, the care that is given to a person, the right to chose a doctor, the right to go from one doctor to the other. But let’s also look from the other side. The freedom the doctor uses. A doctor would be reluctant to say this. Well, like you, I am only a patient, so I can say it in his behalf. The doctor begins to lose freedoms, it’s like telling a lie. One leads to another. First you decide the doctor can have so many patients. They are equally divided among the various doctors by the government, but then the doctors are equally divided geographically, so a doctor decides he wants to practice in one town and the government has to say to him he can’t live in that town, they already have enough doctors. You have to go some place else. And from here it is only a short step to dictating where he will go. This is a freedom that I wonder if any of us has a right to take from any human being. I know how I’d feel if you my fellow citizens, decided that to be an actor I had to be a government employee and work in a national theater. Take it into your own occupation or that of your husband. All of us can see what happens once you establish the precedent that the government can determine a man’s working place and his working methods, determine his employment. From here it's a short step to all the rest of socialism, to determining his pay and pretty soon your son won’t decide when he’s in school where he will go or what he will do for a living. He will wait for the government to tell him where he will go to work and what he will do. In this country of ours, took place the greatest revolution that has ever taken place in the world’s history; the only true revolution. Every other revolution simply exchanged one set of rulers for another. But here, for the first time in all the thousands of years of man’s relations to man, a little group of men, the founding fathers, for the first time, established the idea that you and I had within ourselves the God given right and ability to determine our own destiny. This freedom was built into our government with safeguards. We talk democracy today, and strangely, we let democracy begin to assume the aspect of majority rule is all that is needed. The “majority rule” is a fine aspect of democracy provided there are guarantees written in to our government concerning the rights of the individual and of the minorities. What can we do about this? Well, you and I can do a great deal. We can write to our congressmen and to our senators. We can say right now that we want no further encroachment on these individual liberties and freedoms. And at the moment, the key issue is, we do not want socialized medicine. In Washington today, 40 thousand letters, less than 100 per congressman are evidence of a trend in public thinking. Representative Hallock of Indiana has said, “When the American people wants something from Congress, regardless of its political complexion, if they make their wants known, Congress does what the people want." So write, and if this man writes back to you and tells you that he too is for free enterprise, that we have these great services and so forth, that must be performed by government, don’t let him get away with it. Show that you have not been convinced. Write a letter right back and tell him that you believe government economy and fiscal responsibility, that you know governments don’t tax to get the money they need; governments will always find a need for the money they get and that you demand the continuation of our free enterprise system. You and I can do this. The only way we can do it is by writing to our congressmen even we believe that he's on our side to begin with. Write to strengthen his hand. Give him the ability to stand before his colleagues in Congress and say that he has heard from my constituents and this is what they want. Write those letters now call your friends and them to write. If you don’t, this program I promise you, will pass just as surely as the sun will come up tomorrow and behind it will come other federal programs that will invade every area of freedom as we have known it in this country until one day as Normal Thomas said we will wake to find that we have socialism, and if you don’t do this and I don’t do this, one of these days we are going to spend our sunset years telling our children and our children’s children, what it once was like in America when men were free. ## Economic Impact of the Recovery Act Menzie Chinn: Econbrowser: Assessing the Stimulus and Its Aftermath: Or, on reading those who can do math, and those who can’t (i.e., yet more from Heritage). The CEA released its most recent assessment of the impact of the ARRA. Some popular accounts, from the Heritage Foundation, from the Weekly Standard, and from Ted Nugent, argue that those estimates of output and employment effects are outlandish. They also cite incredibly high cost-per-job figures. Here are some thoughts on the those arguments.... The CEA model approach (which incorporates using multipliers) is bracketed by the CBO low and high estimated effects. The CEA model approach yields a counterfactual GDP in 2011Q1 that is virtually indistinguishable from the private sector forecasts.... [I]t is somewhat surprising to see the ridicule heaped upon the CEA estimates, implying that they are outlandish.... CEA estimates are in line with private sector estimates indicating a substantial impact on GDP. What is truly hysterically funny (and demonstrates the innumeracy so typical of so much writing these days) is the following assertion: ... The council reports that, using "mainstream estimates of economic multipliers for the effects of fiscal stimulus" (which it describes as a "natural way to estimate the effects of" the legislation), the "stimulus" has added or saved just under 2.4 million jobs — whether private or public -- at a cost (to date) of$666 billion. That’s a cost to taxpayers of $278,000 per job. This seemed like a familiar argument, and then I realized Casey Mulligan performed a similarly (incorrect) calculation two years ago, which involved a similar stock-flow mismatch calculation.... Suppose in 2015, when almost all funds are expended, only one job was still being supported. Then using their preferred methodology would indicate each job cost$787 billion....

It’s also important to recall that around a third of the ARRA was tax related. Had more been devoted to infrastructure investment and transfers to the states, as I’d suggested [1], then the cost-per-worker-year would have been lower. It was only at the insistence of Republicans that a larger share of the stimulus was devoted to tax cuts. (By the way, where are all those critics who argued the recession would be too brief for infrastructure spending to matter?).

## I Must Say, If S&P's David Beers Had Set Out to Humiliate HImself...

…he could not have done better than choosing last Friday to downgrade U.S Treasury bonds:

Perhaps Obama should use his control of the Treasury Department, and its control of Fannie Mae and Freddie Mac, to implement a jobs-and-growth agenda based on fixing the housing market?

It's not as though Europe is going to be the locomotive of the world economy anytime soon, is it?

And it's not as though there are many signs that general non-construction corporate investment is depressed, are there?

## At the Economist's Economics by Invitation: We Need Different Cossacks Round II

Too few American officials recognise the need to boost demand: THE financial crisis is what went wrong with the American economy.

As Richard Koo would say—as he has said over and over and over again—the US economy looks as one would expect an economy to look in the aftermath of a financial crisis.

Households think—correctly—that they have too much risky debt and that they are too poor for the sum of household spending and business investment to add up to enough demand to attain full employment. Open-market operations don't help: they have no effect on household or business assets because they are simply swapping one zero-yield government asset for another. The risky debt that companies could issue does not sell in terms that make companies happy to expand investment—how can it when households already feel overextended and will only buy risky assets at an attractive price? The economy will recover only as rapidly as households rebuild their balance sheets and so become confident, spending more on the one hand and financing risky business investment on the other—and that can take a long time.

Credit-worthy governments acting aggressively could greatly speed recovery from such a balance-sheet recession. The economy has not too much debt but rather too much risky debt: safe debt right now sells at unbelievably high prices. Credit-worthy governments can boost demand directly by borrowing and spending. Credit-worthy governments can boost demand indirectly by taking on tail risk—either via guarantees or swaps of its debt for risky debt—on terms that make it attractive for businesses to borrow and invest. Aggressive central banks can shift expected inflation upward and thus make households fear holding risky debt and equity less because they gear dollar devaluation more.

The US government could undertake all of these strategies for dealing with a balance-sheet recession, and I am highly confident that at least one would work.

But it won't.

In the late spring of 2009, Barack Obama had five economic policy principals: Tim Geithner, who thought Obama had done enough to boost demand and needed to turn to long-run deficit reduction; Ben Bernanke, who thought that the Fed had done enough to boost demand and that the administration needed to turn to deficit reduction; Peter Orszag, who thought the administration needed to turn to deficit reduction immediately and could also use that process to pass (small) further stimulus; Larry Summers, who thought that long-run deficit reduction could wait until the recovery was well-established and that the administration needed to push for more demand stimulus; and Christina Romer, who thought that long-run deficit reduction should wait until the recovery was well-established and that the administration needed to push for much more demand stimulus.

Now Romer, Summers, and Orszag are gone. Their successors—Goolsbee, Sperling, and Lew—are extraordinary capable civil servants but are not nearly as loud policy voices and lack the substantive issue knowledge of their predecessors. The two who are left, Geithner and Bernanke, are the two who did not see the world as it was in mid-2009. And they do not seem to have recalibrated their beliefs about how the world works—they still think that they were right in mid-2009, or should have been right, or something.

I fear that they still do not see the situation as it really is.

And I do not see anyone in the American government serving as a counterbalance."

(Via .)

## Ryan Avent on the Federal Reserve's Refusal to Follow Its Instructions from Congress

Ryan Avent:

Monetary policy: The mandate problem: Yesterday's policy announcement is a real puzzler if one assumes that the Fed is interested at all in full employment or macroeconomic stability. It makes perfect sense once one realises that the Fed is solely and entirely interested in price stability. When the Fed initiated QE2, it wasn't responding to high unemployment, which had been high for months on end. It was responding to a sustained drop in inflation expectations. A Fed interested in macroeconomic stability would not have allowed QE2 to end in June, as nominal growth was still below trend and unemployment remained high. But a Fed focused solely on price stability couldn't help but get nervous about upward movement in core inflation. And yesterday's policy announcement was far too timid to push nominal GDP growth back to trend. It was, however, perfectly tailored to arrest the sudden, precipitous decline in inflation expectations….

I think there's a good chance that future economists will look back on the choice to stick with price stability as the central bank's goal as a strange and counterproductive norm, in much the same way current economists marvel at the disastrous central bank policies of the past. For now, America seems to be stuck with a Fed that's content to keep the American economy bumping along in statis, falling ever farther behind potential growth, so long as inflation stays nicely contained between 1% and 2%. It will fall to some future Ben Bernanke to apologise for present mistakes.

Treasury's John Bellows reported that S&P's projections of the American debt trajectory were off by $2 trillion in 2021--were at 93% of GDP in 2021 under the Alternative Fiscal Scenario as opposed to the (correct) 85% of GDP in 2021. In spite of that, S&P made remarkably few changes to its explanation of why it had downgraded the U.S. from AAA to AA+. Perhaps the most disturbing thing in S&P's explanation--to me at least--is the removal of all numbers from the "Overview" section. Rating agencies exist not to watch politicians on the TV and opine but rather to crunch numbers that others cannot easily crunch. But that requires that you actually crunch numbers, and explain how your number crunching leads to the conclusions that you reach… I have tried to redline the S&P explanation: Download S&P's AA+ Downgrade Letter ## How Should Obama Answer the Stock Market's Wake-Up Call? We-Need-Different-Cossacks Department At least Bloomberg has taken down the "how long will the bull market last?" advertisement from the top of its S&P 500 screen… Stock market down 17% in two and half weeks while the bond market has reduced the yield on the Ten-Year Treasury from 3% to 2.35%, and break-even five-year inflation has fallen from 2.1% to 1.7%. I think that is a very loud wake-up call for Mr. Obama--that it is long past time for him to stop talking about how surrendering to Republicans on long-run spending priorities will bring the confidence fairy who will then gift us with a strong recovery and start actually doing his job. Back in the summer of 2009, Barack Obama had five economic policy principals on the Treasury Bench: • Tim Geithner, who thought that the administration and the Fed had done enough to stabilize the economy, that we were on track for a rapid recovery, and that the principal economic policy problems were going to be dealing with the long-run budget. • Ben Bernanke, who thought that the administration and the Fed had done enough to stabilize the economy, that we were on track for a rapid recovery, and that the principal economic policy problems were going to be avoiding an unwanted uptick in inflation and dealing with the long-run budget. • Peter Orszag, who thought that the economy probably needed some (relatively small) additional fiscal, banking, and monetary stimulus to boost demand, but that the path to getting to that stimulus was to make it part of a package with policies to deal with the long-run budget. • Larry Summers, who thought that the economy probably would need some additional fiscal, monetary, and banking-side stimulus--if only as insurance--and that dealing with the long-run budget could wait until the recovery was well-established (although in an ideal world Washington would be able to do more than one thing at a time and so it would not have to wait). • Christy Romer, who thought that the economy probably needed (much) more additional fiscal, monetary, and banking-side stimulus--especially as insurance should things break badly--and that dealing with the long-run budget crisis probably should wait until the recovery was well-established: that the key point was "no 1937s!" Opposite the Treasury Bench was the Right Opposition, with its guiding principle: never mind everything we have said in the past, whatever Obama proposes we reject. And over in the corner was the Left Opposition, represented by: • Paul Krugman, who thought not quite "we are all going to die!" but rather that without five-alarm stimulus the risks were very high of a jobless recovery stemming from a combination of labor-market changes that had eliminated the temporary layoff and so the economy's ability to rapidly bounce-back on the labor side and of the fact that a financial-crisis solvency and safety squeeze was different from a monetary liquidity squeeze along the lines argued by Koo, Reinhart, Rogoff, and before them Bagehot, Minsky, and Kindleberger. And that Christy Romer was a wild-eyed optimist. At the time I was, IIRC, somewhere between Christy and Larry--thinking that the risks of a jobless recovery were there and certainly demanded action as insurance, but that nobody wanted to see 1937 again, and that even without the cooperation of Congress the administration and the Federal Reserve had powerful tools and could and would stabilize aggregate demand. The key, after all, is to get people to spend. Three things could keep people from spending: 1. A shortage of liquidity--and the Fed had and would continue to keep there from being any shortage of liquidity. 2. A shortage of savings vehicles--but that did not seem to be the case as the bonds of even good companies were not selling for the high prices you would have then expected to see. 3. A shortage of safety or an excess of risk in their portfolios--both on the debit and the credit side. The first of these had been solved by the Fed. The second of these was not an issue. And the Fed and the Treasury had mighty tools to solve the third. The Fed via quantitative easing could take as much risk as it wanted to onto its balance sheet and replace the risky assets it bought with safe assets that the private sector wanted to hold--the Fed could push its balance sheet up from$2 trillion to $3,$4, $5, or even$6 trillion if needed. The Treasury could use its HAMP money to grease the refinancing of troubled mortgages. If HAMP wasn't enough the Treasury owned Fannie and Freddie: they could borrow at nearly the Treasury rate and refinance every house in the nation if necessary in order to get mortgage risk off of banks' books where it constrained lending and off of households' obligations where it constrained spending. The Treasury could use additional TARP money as the grease via the PPIP to take tail risk onto its books and so transform risky into safe assets. The Fed could take the TALF program and use it as a wrapper to make the long-run infrastructure projects we needed to undertake sources of the safe assets the private sector wanted to hold.

Even with a Congress gridlocked and neutralized, the Fed and the executive had enough power through their ownership of Fannie and Freddie, through the Federal Reserve act, and through the TARP to do everything necessary to guarantee a strong recovery.

But the problem I did not see in the summer of 2009 was that the stimulus skeptics were the operational managers of the government, while the stimulus advocates were staff without line responsibilities.

Hence nothing happened.

And Peter, Larry, and Christy left.

And their successors--Jack, Gene, and Austen--are very smart men and dedicated civil servants, but they lack the strong substance-matter knowledge and aggressive policy views of their predecessors.

So the only strong policy views in the administration's internal debate mix right now are those of people who were wrong in the summer of 2009.

And when I talk to their staffs, the message I hear is not "we were wrong about how the world works, and are rethinking the issues from the ground up to figure out what to do" but instead "we were unlucky: our policies were good". Never mind that Richard Koo or Carmen Reinhart or Ken Rogoff or indeed all of us who have ever taught the Great Depression in Europe foresaw the rerun of 1931s Credit-Anstalt crisis that is now playing at the European cinema. If I were as unkind as Jon Walker, I would say that I am reminded of the old Scooby-Doo TV series, in which at the end the villain always says: "My plan was perfect, perfect! I would have gotten away with it if not for those meddling PIIGS!"

Three years ago I would have said--I did say--that Ben Bernanke was among the best available candidates for Fed chair and that Tim Geithner was among the best available candidates for Assistant to the President for Economic Policy.

Today I think they both suffer from the sunk-costs problem.

In order to properly respond to the situation today they need to forget everything they thought they knew about the world in the summer of 2009 and look at the situation with fresh eyes. I don't think they have done that. i don't think they can do that. And yet theirs seem to be the only strong policy voices from people with deep substance-matter expertise that Obama hears

If you were to ask me what thing--aside from the complete and immediate collapse of the Republican Party and the resignation of all of its legislators from both houses of the Congress: if the previous fifteen years had not taught me that Republican politicians have nothing useful to contribute to national governance the last three years would certainly have done so--would most give me confidence that America would surmount this current economic crisis, it would be personnel changes to put qualified people who saw the world as it was in the summer of 2009 into the key economic jobs:

• Laura Tyson or someone like her to Treasury Secretary (recess-appointed, acting, whatever).
• Larry Summers or someone like him to Fed Chair (recess-appointed, acting, whatever).
• Alan Blinder or someone like him to CEA Chair (recess-appointed, acting, whatever)
• Christy Romer or someone like her to Assistant to the President for Economic Policy.

## What Does the Market Fear? It Fears a Double Dip

Paul Krugman:

It's a Growth Scare: FTalphaville has been saying this all day, and it’s right. The action in the markets looks nothing like worries about US solvency; it looks exactly like what you expect to see when markets suddenly realize that the economy’s growth prospects look terrible. One more note: inflation expectations are plunging. Truly, our public discourse has been entirely about problems we don’t have, at the expense of dealing with the problems we do have.

## Peter Orszag Calls for More Stimulus

Peter Orszag calls for more economic stimulus in the form of a big push to boost government infrastructure spending and for a big payroll tax holiday:

Four Ways Congress Can Upgrade Our Credit Rating: The U.S. economy will face a hard slog for an extended period; the political system is polarized; and, under current policies, the budget deficit will remain intractably large…. What bold actions are legislatively feasible?…

End all the 2001/2003 tax cuts when they expire at the end of 2012…. [W]e shouldn’t extend any of the tax cuts past 2012 unless every cent is offset through other measures…. [B]eyond the coming decade… [t]he most important driver of our long-term deficit is the cost of health care. The Affordable Care Act provides tools that can help contain cost growth; they should be used aggressively…. Congress should try to reform Social Security now. The economist Peter Diamond and I have put forward one variant of a progressive reform plan…

[T]riple the existing 2 percent payroll tax holiday and extend it for as long as unemployment remains elevated….

Third, we must learn to live with structural gridlock and polarization by preventing legislative inertia from always leading to inaction. We need more mechanisms like the budget-balancing trigger that is pulled if the supercommittee fails, more entities like the Independent Payment Advisory Board whose recommendations for slowing Medicare costs take effect if Congress doesn’t act, and more automatic stabilizers…. [T]he Senate should amend its rules to require only 50 votes for any deficit-reducing legislation (not just changes made through the so-called reconciliation process) and a threshold even higher than 60 votes (perhaps something more like 75) for any deficit-increasing legislation unless it is an emergency response to a recession….

[W]e need to invest more in roads, bridges, railroads and the like, and the best way to do this would be to scrap the present pork-barrel system and create a new infrastructure bank…

I don't think this is enough to restore the economy to near-full employment over the next several years. We need to use the Fed, FANNIE and FREDDIE to take risk onto the government's balance sheet as well…

## Liveblogging World War II: August 7, 1941

Senator Burton Wheeler says that it is time to investigate whether the foreign-born Jews of Hollywood are using the movies they make to shape American public opinion...

David Gordon:

David Gordon: America First: the Anti-War Movement, Charles Lindbergh and the Second World War, 1940 - 1941: Burton Wheeler... announced in August of 1941 that he would investigate “interventionists” in the motion picture industry.  Most studio heads, he would soon be surprised to learn, were Jews.[79]  Gerald Nye, who accused Hollywood of attempting to “drug the reason of the American people,“ and “rouse war fever,“ was particularly hostile to Warner Brothers.[80]  Wheeler questioned why so many foreign born were allowed to shape American opinion, causing Roosevelt to observe that the Bible, too, had been written “by mostly foreign-born and Jewish people.” But the industry knew how to fight back.  It retained Wendell Willkie, the Republican party’s 1940 presidential candidate, as counsel.  He soon ridiculed the Committee into silence.[81]

## Liveblogging World War II: August 7, 1941

Joseph Stalin appoints himself "Generalissimo" of the Red Army.

## The Rating Agency Clown Show

S&P claims that their $2 trillion baseline error is "not material." John Belliows watches them put on their rubber noses and throw the custard pies at each other: In a document provided to Treasury on Friday afternoon, Standard and Poor’s (S&P) presented a judgment about the credit rating of the U.S. that was based on a$2 trillion mistake. After Treasury pointed out this error – a basic math error of significant consequence – S&P still chose to proceed with their flawed judgment by simply changing their principal rationale for their credit rating decision from an economic one to a political one.

S&P has said their decision to downgrade the U.S. was based in part on the fact that the Budget Control Act, which will reduce projected deficits by more than $2 trillion over the next 10 years, fell short of their$4 trillion expectation for deficit reduction. Clearly, in that context, S&P considers a $2 trillion change to projected deficits to be very significant. Yet, although S&P’s math error understated the deficit reduction in the Budget Control Act by$2 trillion, they found this same sum insignificant in this instance.

In fact, S&P’s $2 trillion mistake led to a very misleading picture of debt sustainability – the foundation for their initial judgment. This mistake undermined the economic justification for S&P’s credit rating decision. Yet after acknowledging their mistake, S&P simply removed a prominent discussion of the economic justification from their document. In their initial, incorrect estimates, S&P projected that the debt as a share of GDP would rise rapidly through the middle of the decade, and they cited this as a primary reason for a downgrade. In S&P’s corrected estimates – which lowered S&P’s projection of future deficits by$2 trillion over 10 years and lowered S&P’s estimate of debt as a share of GDP in 2021 by 8 percentage points - public debt is much more stable.

The error came about because S&P took the amount of deficit reduction CBO calculated from the Budget Control Act and applied it to the wrong starting point, or “baseline.”...

## Wall Street Journal Total Fail

Why oh why can't we have a better press corps? And it is not just the WSJ editorial page.

Krugman and Glasner read the WSJ editorial page so we don't have to:

Prattle and Prejudice: Via Mark Thoma, David Glasner marvels at an utterly incoherent op-ed by David Malpass in the WSJ. The fact that the Journal even invites Malpass to write says volumes: this is, after all, the guy who insisted that American savings were plenty high because of all those capital gains on housing.

But what’s really interesting, as Glasner notes, is the incoherence. And this is an issue that goes beyond the woeful Malpass; it pervades the WSJ in general, and is broadly visible in much conservative economic writing, including the academic side.

Think of it this way: there was a time when you could say that the right had a model of how the economy worked. A silly model, yes, since it depended on implausibly large effects of marginal tax rates on incentives. Still, supply-side economics had a point of sorts.

But can you discern any model in what Malpass wrote, or for that matter in almost anything on the WSJ editorial page? I can’t. All I see is a bunch of prejudices, strung together with some vaguely economistic-sounding phrases, something like someone talking gibberish that sort of sounds like Swedish. In the world according to the WSJ, low taxes are good (unless the people involved are low income lucky duckies), regulation bad, low inflation good, low interest rates bad, strong dollar good — and don’t ask why.

The thing is, however, that more or less the same thing, at a subtler level, is going on among famous Republican economists. Read what Robert Barro is saying lately, or Robert Lucas, and try to find any commonality between their explanations of the current slump and what they have been saying about business cycles these past 30 years. I can’t....

[W] e’re not having a debate between opposing models; we’re having a conflict in which one side has a model that has been working, while the other side has prejudices, and makes stuff up to justify those prejudices.

## You Know, If You Had Told Me a Year Ago That on August 5, 2011 S&P Would Downgrade the U.S, and the 10-Yr Treasury Would Yield 2.5%...

... I would have laughed at you. I would have said that while there were possible futures in which each of those things happened, they were disjoint futures.

Diamond and Saez:

The bottom line is that uncertain future earnings opportunities argue against zero taxation of capital income, as do savings preference heterogeneity, limited distinctions between capital and labor incomes, and borrowing constraints. It is true that these arguments are based on life-cycle analyses, and that the empirical literature finds that the life-cycle approach, while helpful, is limited in its success in explaining savings behavior. The belief that many people do not save enough for their own retirements often leads to calls for policies to encourage savings, particularly retirement savings. The most widely used method is some form of forced saving through mandatory contributions to a retirement systems. This can also be complemented with a combination of taxing capital income and having tax-favored retirement savings (including some subsidies) targeted to those liable to save too little.

## The New Forecasting Consensus for the Second Half of the Year

Real GDP growth at 2.5%. Unemployment slowly drifting up. The employment-to-population ratio slowly drifting down.

Suppose we end 2011 with a 9.3% unemployment rate and a 57.9% employment-to-population ratio. Anything on the horizon to make growth in 2012 liook faster?

## Mohammed El-Erian Joins the Sect of Economists More Pessimistic than I Am

MEE: >Debt deal darkens fragile US economic outlook: Those responsible for America’s multi-month debt ceiling debacle deserve, at best, an “incomplete”. They could even merit a “fail” grade if both the process and outcome inflict the type of damage to America and the global system that I suspect they will. It is discouraging that several months of disruptive political bickering and posturing failed to deliver a well-defined medium-term fiscal reform effort. Instead, the legislation signed into law by President Barack Obama on Tuesday is terribly unbalanced in design, lacks proper operational details and leaves key issues to at least one more round of political brinkmanship. This incomplete endeavour could be dismissed as business as usual in Washington except for one important consideration: it materially darkens an already fragile outlook for economic growth and job creation.... >Naturally, other countries are both stunned and worried. America’s mishaps will amplify their own policy challenges, mostly importantly in Europe where severe dislocations are again evident in financial markets. With such evidence of dysfunctional economic governance in the US, some countries are also worried about America’s ability to perform its critical role as the anchor of the global financial system. Since there is no other country to assume this role, a weaker core translates into greater fragility for the system as a whole and, therefore, a higher risk of gradual fragmentation. >Some of you may think that I am being too harsh or overly pessimistic. After all, enormous effort and time went into crafting a delicate compromise agreement that succeeded in averting a technical debt default. But effort cannot, and should not, be judged independently of outcome. Here, the analysis is unambiguous in my mind: other than eliminating default risk emanating from a self-manufactured crisis, there is nothing good about America’s debt ceiling debacle.

## Liveblogging World War II: August 5, 1941

Army Group Center captures more than 300,000 Soviet prisoners in the Smolensk pocket.

## Duncan Black Reminds Us That Governments Have Eliminated Half a Million Public Sector Jobs since July 2009...

Profoundly stupid. Stupid. Stupid. Stupid. Stupid. Stupid. Stupid. Stupid. STUPID!!

When financial markets are desperate for the safe financial assets created when a credit-worthy government hires people and borrows to pay them, when the unemployed are desperate for jobs, and when lots of useful things the government can make and do are left unmade and undone...

## Hoisted from Comments: Uh-Oh...

In comments:

howard said... prof, i'm writing at 7:47 a.m. pacific time, and i'd say, offhand, you shouldn't be trying tp predict daily moves by mr. market...

Uh-oh. It is moving day, but I had better go look...

UPDATE: -1.929% VALUE: 1,176.920 USD at 8:57 am pdt. Not that bad.

## August Jobs Report Objectively Bad, But No Market Crash Expected Today

Duncan Black:

Eschaton: Please Don't Tell Them To Do The Math: twitter machine tells me Obama is going to speak about jobs at 11am. They already have the numbers...

Now that is a bad sign...

UPDATE: An objectively bad number--job growth too slow to even begin to raise the employment-to-population ratio--but not bad enough to guarantee a bad day at the dog track. The headline item I note is that the employment-to-population ratio is now at 58.1%, down from 58.5% in March and below its previous 58.2% trough of December 2009. July 1983--a time when American feminism was only halfway born--was the last time we saw an employment-to-population ratio this low:

U.S. economy gained 117,000 jobs in July - MarketWatch: The U.S. economy added 117,000 jobs in July and an even larger 154,000 in the private sector while the unemployment rate fell to 9.1% from 9.2%, partly because 193,000 people dropped out of the labor force, according to the latest government data. Job gains in May and June were also revised up by a combined 56,000…

And the BLS website appears to have crashed…

## Noah Smith: Identifying the Causes of Recessions

NOah Smith:

Noahpinion: Supply-side vs. demand-side recessions: Does output falter because people don't want to buy as much stuff, or because we become unable to make as much stuff as we used to? This is a debate that has gripped the macroeconomics profession for many decades. Which is kind of surprising to me, because it is so obvious that demand shocks are the culprit.

The reason is prices. If recessions are caused by negative supply shocks, then we should see falling output accompanied by rising prices (inflation). If recessions are caused by negative demand shocks, we should see falling output accompanied by falling prices (disinflation or deflation)….

In all of the recent recessions, faltering output has been accompanied by lower, or even negative, inflation. This means that demand shocks must have been the culprit. If "uncertainty about government policy" were really the cause of the recession, as many conservatives claim, then we would have seen prices rise - as companies grew less willing to make the stuff that people wanted, stuff would become more scarce, and people would bid up the prices (dipping into their savings to do so). I.e, we would have seen inflation. But we didn't see inflation. So it seems that the stories that conservatives tell about the recession - "policy uncertainty," "recalculation," or even a "negative shock to financial technology" - are not true. The stories that everyone else tells about the recession - "a flight to quality," "increased demand for safe assets," etc. - look much more like what basic introductory macroeconomics would predict….

The basic point here is about the dangers of doing what Larry Summers calls "price-free analysis". If you ignore prices, it is possible to convince yourself that recessions are caused by technology getting worse, or by people taking a spontaneous vacation, or by Barack Obama being a scary socialist. If you pay attention to prices - as all economists should - it becomes harder to believe in these things.

So the question is: Do conservative-leaning economists push these stories because they believe that we live in a world that is vastly more complicated than anything that can be described in Econ 102? Or is it just because they choose to ignore Econ 102 completely?

## Start the Helicopters II: Paul Krugman

PK:

The Wrong Worries: In case you had any doubts, Thursday’s more than 500-point plunge in the Dow Jones industrial average and the drop in interest rates to near-record lows confirmed it: The economy isn’t recovering, and Washington has been worrying about the wrong things. It’s not just that the threat of a double-dip recession has become very real. It’s now impossible to deny the obvious, which is that we are not now and have never been on the road to recovery.

For two years, officials at the Federal Reserve, international organizations and, sad to say, within the Obama administration have insisted that the economy was on the mend. Every setback was attributed to temporary factors — It’s the Greeks! It’s the tsunami! — that would soon fade away. And the focus of policy turned from jobs and growth to the supposedly urgent issue of deficit reduction.

But the economy wasn’t on the mend….

[A]t no point has growth looked remotely adequate given the depth of the initial plunge. In particular, when employment falls as much as it did from 2007 to 2009, you need a lot of job growth to make up the lost ground. And that just hasn’t happened.

Consider one crucial measure, the ratio of employment to population. In June 2007, around 63 percent of adults were employed. In June 2009, the official end of the recession, that number was down to 59.4. As of June 2011, two years into the alleged recovery, the number was: 58.2…. [T]hey reflect a truly terrible reality. Not only are vast numbers of Americans unemployed or underemployed, for the first time since the Great Depression many American workers are facing the prospect of very-long-term — maybe permanent — unemployment. Among other things, the rise in long-term unemployment will reduce future government revenues, so we’re not even acting sensibly in purely fiscal terms. But, more important, it’s a human catastrophe.

And why should we be surprised at this catastrophe? Where was growth supposed to come from?…

To turn this disaster around, a lot of people are going to have to admit, to themselves at least, that they’ve been wrong and need to change their priorities, right away…. Republicans won’t stop screaming about the deficit because they weren’t sincere in the first place: Their deficit hawkery was a club with which to beat their political opponents, nothing more — as became obvious whenever any rise in taxes on the rich was suggested. And they’re not going to give up that club.

But the policy disaster of the past two years wasn’t just the result of G.O.P. obstructionism, which wouldn’t have been so effective if the policy elite — including at least some senior figures in the Obama administration — hadn’t agreed that deficit reduction, not job creation, should be our main priority. Nor should we let Ben Bernanke and his colleagues off the hook….

Well, it’s time for all that to stop….

Earlier this week, the word was that the Obama administration would “pivot” to jobs now that the debt ceiling has been raised. But what that pivot would mean, as far as I can tell, was proposing some minor measures that would be more symbolic than substantive. And, at this point, that kind of proposal would just make President Obama look ridiculous.

The point is that it’s now time — long past time — to get serious about the real crisis the economy faces. The Fed needs to stop making excuses, while the president needs to come up with real job-creation proposals. And if Republicans block those proposals, he needs to make a Harry Truman-style campaign against the do-nothing G.O.P.

This might or might not work. But we already know what isn’t working: the economic policy of the past two years — and the millions of Americans who should have jobs, but don’t.

## Tim Duy on How the Fed Needs to Start the Helicopters

Tim Duy:

That. Was. Unpleasant: The rapidity with which confidence can shift is nothing short of a wonder of nature. I am not sure there was any terribly new news today. The evidence the US economy is weakening has been mounting for weeks. That equities had not sold off yet was something of a testament to the underlying profit situation.

But now fear grips financial market participants as the rush to cash or cash equivalents accelerated. A rush to judgment on the US economy?…

The slow learning curve on Constitution Ave. argues against action next week. The reality of the world argued for action last month. Go figure….

Bottom Line:  The market nosedive does not yet guarantee Fed action in the near future.  History has shown the Fed tends to react with a lag.  They should have learned better by now, but if they had learned anything, they would not have pushed forward with hawkish rhetoric earlier this year. Arguably, they will hold firm, let the markets think they are out of the game and further bid down implied inflation expectations, and then, once the damage is done, up the level of stimulus.  Terrible way to run an economy, I know. Still, it would be remiss to declare anything is certain before the employment report is released.  A downside surprise could promt the Fed into more rapid action.  I am now entirely speechless on the European situation – with Trichet's ongoing hawkish stance, it has truly devolved into one of those slow-motion train wrecks that one only sees in the movies.

## Yet Another Atlantic Monthly Fail...

Clive Crook:

Time for QE3, and Then Some: The global beating shares just took had many causes, no doubt. Still disgusted by the US debt-ceiling fiasco, I am apt to give that masterclass in malice and incompetence more of the blame than it really deserves: the talk in markets today was more about signs of stalling growth in the US and mounting anxieties over Europe than about US fiscal impotence…

But the talk in markets today was not more about signs, it was all about signs of stalling growth in the U.S. and mounting anxieties over Europe.

I heard precisely zero people say: "the U.S. government's debt is out of control!" But I heard a huge number of people say: "Treasuries are the only thing I can be confident will hold their value to maturity."

You know: it is really odd. If people took the debt-ceiling deal to be a sign of U.S. fiscal impotence, they would have sold both their holdings of U.S. stocks and their holdings of Treasury bonds and moved into other asset classes, and stock prices would have fallen and Treasury bond interest rates would have risen. People didn't. Interest rates didn't. Stock prices did fall, but because of stalling growth.

When people get more scared about a country's long-run fiscal solvency, its stock and bond prices move in the same direction. If they don't move in the same direction, it's not about a market fear of a country's long-run fiscal solvency.

This isn't rocket science.

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

## Buy Equities, Huskies, Buy!!

At an index value of 1200 the S&P 500 has a trailing twelve-month price-index ratio of 16--an earnings yield of 6.25% and a dividend yield of 2.5%.

Buy seven-year inflation-indexed Treasuries and hold them to maturity and in 2018 you are down 1.4%.

Buy the S&P 500, reinvest the dividends, and assume that retained earnings get transformed into value with a 20% haircut, and in seven years you are up 47% plus or minus whatever the real change in the relative valuation of corporate America is over the next seven years.

Not that I would recommend a portfolio with a beta of greater than two, mind you--things could get very sticky over the next three years. And the fact that U.S. equities look to be a buy now doesn't mean that they won't be even more of a buy in a year--although the fact that the Bernanke anti-deflation put does operate at some level puts limits on how low we can go.

But I can't see many scenario in which the S&P 500 declines in relative value by enough to outweigh that 47% bump from the real earnings that the S&P 500 companies will make over the next seven years.

It's very strange to finally be more optimistic than the market...

## Duncan Black Reports from the Dog Track

Dow down 512 points. Haven't had such an exciting day at the dog track for awhile.

## I Must Say I Do Think It Is Time to Start Minting the Platinum Coins...

100,000 of them, worth $10 million each. Billionaires will want to hold some to be cool. Multi-millionaires will want to hold some so that people think that they are billionaires. Use the proceeds to buy back a lot of long-term debt: that's$1 trillion of quantitative easing by the Treasury right there. And if the Fed sterilizes the duration component, that is a massive money stock increase.

Easy to undertake. Intus vires. Gets headlines. Effective. On a large enough scale to matter...

## No, Gillian Tett Is Not More Optimistic Now than I Am...

GT:

Eurozone crisis resembles US turmoil in 2008 - FT.com: "the manner in which this eurozone story is playing out feels unnervingly similar to the pattern behind the American financial turmoil of late 2008. Ponder some of these parallels:

1. When Greece first started to wobble, many policymakers – and some investors – tried to downplay it because Greece is so small relative to global markets…. Similarly, Lehman Brothers and Bear Stearns… were also small….

2. Similarly, when the troubles erupted, eurozone policymakers initially assumed that the problem was a liquidity, not solvency issue…. It has proved no more successful in the eurozone than it was in the US: though each new announcement produces a modicum of relief, investors keep baying for a more comprehensive solution.

3. This has now forced some eurozone leaders to move to a new phase and admit something they long denied: namely that Greek debt will need to be restructured and not everybody will always be bailed out…. As shocks go, this is perhaps comparable with the US government’s decision to put Fannie and Freddie into conservatorship in the summer of 2008….

4. Unsurprisingly, this is stoking a contagious sense of fear…. [G]etting a sense of a bank’s real “whole country” exposure is tough, since banks stopped measuring their risks this way in recent decades.

5. As this fear spreads, another ghost of 2008 returns: short-term funding risks…. Short-term funding could yet dry up, as it did for dollar-structured investment vehicles in 2007, and Bear Stearns and Lehman Brothers in 2008. Particularly since the unpredictable actions of credit rating agencies are – once again – fuelling market fears.

So will this now be followed, as it was in 2008, will a full-scale financial meltdown? Will panic spread when investors suddenly stumble on some overlooked interconnection risks?…Will that turn a sticky summer into a turbulent autumn? And then produce a wintry “real economy” hit? I fervently hope not. But nobody can deny that there is a rising sense of déjà vu, to use a phrase from France, the core of the eurozone. The Gods of Finance might chuckle. Then weep.

## Indeed, All of a Sudden I Seem to Be More Optimistic than Anybody...

…except, that is, for White House spokesman Jay Carney and Treasury Secretary Tim Geithner, who see no chance of a double dip.

But this is unusual: to have only two people more optimistic than me--that hasn't been the case for at least three years…