When will the market rebel against the deadlock?

by on July 28, 2011 at 5:00 am in Economics, Uncategorized | Permalink

There is a mother and a daughter, and the mother wants the daughter to clean her room.  Cleaning the room doesn’t take long, but it does involve the daughter getting out of bed at some positive cost.

The mother can come and threaten to beat the daughter with a broomstick.  That will induce a rapid-enough cleaning (or a good enough start), but the mother would prefer to achieve the end of a clean room without such drastic measures.  That said, the mother will wield the broomstick if that is the only means of getting the room cleaned.  The daughter has a slight preference not to be threatened with the broomstick, ceteris paribus.

Time passes and for a while nothing happens.  What is the equilibrium?

By construction of the example, I’ve ruled out “the mother comes with the broomstick right away” and “the daughter cleans up the room right away.”  So it cannot be common knowledge who will yield first; if it were common knowledge, the cleaning with or without broomstick threat already would have occurred.

The daughter is Congress.  The mother is an anthromorphized set of bond and equity markets.

Under EMH, the next move of “the mother: is generally unpredictable, including by the daughter.  And if the daughter cannot predict her mother’s behavior, what should the mother infer about the daughter’s future behavior?

Does common knowledge arrive?  Does a trembling hand eventually force an outcome?  Which variable is affected by the mere passage of time?  Does it depend on differential discount rates?

There are other ways to think about this.

1 as3005 July 28, 2011 at 6:01 am

Your little model should have an important extension. There are actually two daughters (i.e. Republicans and Democrats). They don’t like each other very much and neither minds a little beating if the other is hit harder.Their subgame is a game of chicken. Both try to avoid the cleaning, while hoping the other will do it. And in case neither gives in and the mother starts the beating, both can hope it is the other daughter who suffers more.

2 Bill July 28, 2011 at 9:07 am

Thumbs up. Very good. I would just add that we all live in this house, so that there is a third party, the public, that also pays a cost.

3 Jim July 28, 2011 at 10:04 am

“there is a third party, the public, that also pays a cost.”

That’s putting it a little mildly.

I would say the public lives in the house, pays each daughter $2000 per month allowance money to keep the room clean (plus the cellphone bills, free clothes, and they get Porsches when they turn 18), while the mother is a multi-millionaire who charges us exorbitant rent, and the room is not just messy but rat- and disease-infested on the far end where our children have to sleep.

Yeah, that’s about right.

4 allan July 28, 2011 at 11:46 am

Actually there is a third daughter: Cinderella, the American people. The step-mother is the bond dealer. This time, however, magic is not going to save Cinderella.

5 blah July 28, 2011 at 2:05 pm

True, but who needs magic when you have the Tea Party?

6 Eddie July 28, 2011 at 12:30 pm



7 T. Shaw July 28, 2011 at 12:46 pm

This crisis: the missing element is the mother. There is no adult in the equation. There are politicians (I would say “corrupt politicians” but I would repeat myself) and idealogues.

In the end, the people of the USA will lose: big time.

8 foosion July 28, 2011 at 6:20 am

The market believes that if the market plummets, govt will fix the problem and the market will soar or at least return to pre-plummet levels. No single market participant wants to sell, because that means missing the consequent rise.

9 Silas Barta July 28, 2011 at 12:01 pm

Now what would *possibly* possess them to believe such a thing? Not because of past policies that Tyler_Cowen pimped (bailouts, TARP) … surely!

10 Popeye July 28, 2011 at 2:06 pm

This is totally incoherent, the market only moves when someone is selling (to someone else who is buying). It’s not a magical carpet ride that goes up and down independently of participants buying and selling.

11 rettals July 28, 2011 at 6:21 am

Speaking as a mother and house wife, I would not say it is the same, but it does hold similarities to prisoners dilemma and non-zero sum game theory.
Possible Pay-off matrix:
beat not_beat
not_clean 1,1 5,0
clean 0,5 3,3

If the mother has a random strategy then the best move for the daughter is to never clean her room because the mother is detached from the daughters actions, there is no point in trying to please her mother if she’s possibly going to be beaten anyway.

12 rettals July 28, 2011 at 6:31 am

Actually I think the game of chicken provides a better pay-off structure:
not_beat beat
clean 0,0 -1,1
not_clean 1,-1 -10,-10

Same principle, but looks more scary, huge losses etc.

13 Matt Young July 28, 2011 at 6:42 am

The market considers Federal multipliers less than one, as does the House of representatives. So we have a situation in which Federal lenders and borrows agree on less federal business. This is not a sudden discovery, the market has been aware of low multipliers for quite some time. Why would hysteria associated with the discovery of low multiplier federal spending, especially when all parties planned for the event?

So, the only threat is if we hyperinflate.

14 Hondo69 July 28, 2011 at 6:45 am

The market has already factored in a certain amount of turbulence for the eventual downgrade in bond rating for the US. As the downgrade nears the market will drop some and on that day a larger drop. But these market makers plan well into the future and are already looking 2-3 years down the road.

For example, George Soros began buying billions in gold a few years back because he could see the future. Top financial players went long on stocks when the government plainly stated they were going to prop up the market some time back. Stocks were avoided that cater to the American middle class because they’ve already written this group off as lost.

So the daughter might think in terms of tomorrow or maybe even the next election cycle while the mother is miles ahead, thinking years down the road.

15 joshua the postlibertarian July 28, 2011 at 6:52 am

Don’t forget the part where the mother is fidgety and is always playing with the broomstick in her hand. A 24-7 webcam focused on the broomstick allows for unceasing inane commentary about whether or not the latest millimeter twinge in the mother’s hand means the broomstick is about to strike.

16 Rahul July 28, 2011 at 8:19 am

Nice. And next Marginal Revolution blogs deep insights into the mothers heart and character based on how she wields that broom!

17 E. Barandiaran July 28, 2011 at 6:55 am

Tyler, sorry but you have chosen the wrong model to analyze the conflict between Republicans and Democrats. The conflict is not about reaching a consensus (a common knowledge) caused by a conflict about facts. It is part of a conflict about values with each party attempting to impose its values. I suggest you to use the model developed by D. Gershenson and H. Grossman in “Civil Conflict: Ended or Never Ending?”, Jo. of Conflict Resolution, Dec. 2000.

Although their model focuses on two parties employing mercenary armies to contest political dominance, you may extend it to two parties employing mercenary media to contest it. I define media broadly enough to include anyone employed to destroy the other party’s reputation and therefore diminish the probability of being elected or re-elected in a forthcoming election. In addition to the conflicts of values and interests underlying the struggle for political dominance, the model highlights how important the technology of the mercenary armies/media is. Since we are talking about political parties conditioned by electoral cycles, every four years the dominant group may change.

Indeed, as all models, it simplifies the conflict but it focuses on some critical variables. And it is a challenging intellectual exercise to apply it to this conflict. Look at Figure 3 of their paper and ask yourself under waht conditions the conflict will end by one party imposing its positions or will never end (meaning that it will end when a shock changes significantly one of the underlying assumptions).

Good luck. And hurry up because the debt ceiling battle is just a battle in a long war and I still believe it will be over by the end of next week. And there will be other battles before November 2012. The war may end in November 2012 with one party achieving political dominance, but I doubt. Be ready for a long war, over several electoral cycles. The pie will not increase large enough to end the U.S. conflict of values with economic incentives to the parties (the pie’s relative stagnation has nothing to do with your TGS hypothesis; it’s a consequence of the growth of the welfare state and especially of the great shock to the world market economy in the past 25 years).

18 Rich Berger July 28, 2011 at 9:25 am

I agree, especially with the last paragraph. It is also clear that the Democrats do not want this to be an issue in the 2012 elections (hence their recent demand that this issue be taken off the table until 2013). I think they realize that it is a loser for them. They want to lock in the welfare state as it is and it is expected to grow with the addition of Obamacare and make increased taxes the only option 5-10 years from now.

The Democrats have been using their Mediscare tactics intensively since the early 1990’s and have blocked solutions that might have been more gradual before the beneficiary class expands enormously. Also, the Republicans have been bamboozled multiple times in a tax/cuts tradeoff (in 1982 and 1990) and with the phantom cuts in last spring’s budget deal. Tyler’s example ignores all these specific details and thus is not very useful.

19 Bill July 28, 2011 at 5:59 pm

First, have you thought that maybe they knew they were being fooled and the fool was you.

Second, we’ll probabably have something like a commission reporting back with a bill for an up or down vote before Christmas. Be careful. This may force you to have a tax increase. Think of it as a base closing phenomena: you have very conservative republicans, but also republicans who won’t be able to take the heat for medicare or ss cuts–you can create a majority for an up or down bill from democrats and scared republicans once the real public options, get exposed or discussed. the commission will probably be something along the lines of what Obama and Boehner were discussing.

Third, removing this from the electorate before 2012 races begin in the summer removes an issue from debate; it doesn’t create one for debate.

20 Andrew' July 28, 2011 at 9:56 am

E. Barandiaran,

What is your model for this? My personal mental model is friction against velocity of money mostly from policy. I accept the competition from globalization and there is nothing we can do about economic integration and wouldn’t want to if we could.

21 Jay July 28, 2011 at 6:55 am

I would not use any rational expectations theory to predict Congress’ actions. Congress includes people as stupid as Maxine Waters.

22 Effective July 28, 2011 at 6:59 am

…method to clean up the rooms by the daughter. but your little model of childhood education and their probabilities of decision-making has nothing in common with the market. in this case, there is a “yes i do” or “no i won’t” situation, starting from 1 person. Such thinking reduces the market (or the congress) to rational decisions by one player…this is definitely the blind spot in your nice methaphor

23 Jay July 28, 2011 at 7:18 am

OT: Delong is lucky he can censor people that prove him wrong and a following of ignorant people that will not realize he is wrong. My guess is Delong does not know US Treasury notes make coupon payments.


*censored comment below
Right now the benchmark 10-yr UST is a 3.125 coupon bond maturing 5/15/2021, priced at 101+7/32 with a yield to maturity of 2.98%. You can make a risk-free profit shorting this security under Delong’s condition X = 3 even though Delong claims otherwise. How?

Short $100 par and receive $101.22 today. Buy rolling 3-month T-bills the rest of the way.
In 6 months (I’m ignoring the first period accrual adjustment) pay $1.56 coupon earn $0 interest. Ending balance $99.66.
In 6 more months pay $1.56 coupon earn $0 interest. Ending balance $98.10.
In 6 more months pay $1.56 coupon earn $0 interest. Ending balance $96.54.
In 6 more months pay $1.56 coupon earn $0 interest. Ending balance $94.98.
In 6 more months pay $1.56 coupon earn $0 interest. Ending balance $93.42.
In 6 more months pay $1.56 coupon earn $0 interest. Ending balance $91.86.

*3 years later now the 3-mo T-bill jumps to 5%.
In 6 more months pay $1.56 coupon earn $2.30 interest. Ending balance $92.60.
In 6 more months pay $1.56 coupon earn $2.32 interest. Ending balance $93.36.
In 6 more months pay $1.56 coupon earn $2.33 interest. Ending balance $94.13.
In 6 more months pay $1.56 coupon earn $2.35 interest. Ending balance $94.92.
In 6 more months pay $1.56 coupon earn $2.37 interest. Ending balance $95.73.
In 6 more months pay $1.56 coupon earn $2.39 interest. Ending balance $96.56.
In 6 more months pay $1.56 coupon earn $2.41 interest. Ending balance $97.41.
In 6 more months pay $1.56 coupon earn $2.44 interest. Ending balance $98.29.
In 6 more months pay $1.56 coupon earn $2.46 interest. Ending balance $99.19.
In 6 more months pay $1.56 coupon earn $2.48 interest. Ending balance $100.11.
In 6 more months pay $1.56 coupon earn $2.50 interest. Ending balance $101.05.
In 6 more months pay $1.56 coupon earn $2.53 interest. Ending balance $102.02.
In 6 more months pay $1.56 coupon earn $2.55 interest. Ending balance $103.01.
In 6 more months pay $1.56 coupon earn $2.58 interest. Ending balance $104.03.
Pay back $100 par. Final balance (risk-free profit assuming Delong interest rate forecast) of $4.03 per $100 par.

24 TallDave July 28, 2011 at 7:28 am

Why would the markets care about the debt-limit deadlock? Revenues are several times interest paymenrts. Even if this dragged on for another ten years we wouldn’t default.

25 Pseu July 28, 2011 at 7:46 am

Since we’re on metaphors.

The economy is a person running headlong towards a cliff.

Actually, the runner is well over the edge of the cliff, but there’s a cartoon-like series of slapped together planks extending over the abyss that he is now running on. Said runner is getting perilously close to the end of the most recent plank.

The “raise the debt ceiling now!” folks are saying “Hey! We need to slap another plank on the end here toot sweet or the economy’s going to fall off the edge!”

Meanwhile the tea-party-type folks are saying “Hey! How about he stops running that direction! Or at least slows the eff down a bit!”

And the raisers reply “There’s no time to talk about that now! He’s going to fall! Help us put up another plank and we’ll consider your risky ‘stop running off the cliff’ plan later… maybe.”

26 rpl July 28, 2011 at 8:15 am

You know, this story would be a lot more compelling if the people who passed the budgets with massive deficits and the people who are now screaming, “Enough! We have to get control of the deficit,” weren’t exactly the same people, viz., the US Congress. The only thing more baffling than the fact that the deficit hawks chose to make their stand on the debt ceiling rather than on the annual appropriations bills is the fact that so many people seem to think that this little drama has something to do with deficits and spending, rather than crass political maneuvering. Truly, we have met the enemy, and he is us.

27 Popeye July 28, 2011 at 7:59 pm


28 joshua the postlibertarian July 28, 2011 at 9:22 am

In my analogy we are not off a cliff but climbing a mountain, and even though we’re really far up it’s still not very steep but we have no idea when the mountain stops.


29 Pseu July 28, 2011 at 8:35 am

Some – many – Congresscritters are self-promoting hypocrites, yes. This is news? It would be nice if the other, non-elected people who yell “enough!” were listened to – by officials of either party – at times other than crises.

30 E. Barandiaran July 28, 2011 at 8:51 am

Games that fraudulent clowns play. This is Jen Rubin’s latest post in WP:

White House shenanigans on the Boehner debt plan
By Jennifer Rubin
Politico reports that Senate Minority Leader Mitch McConnell (R-Ky.) is in negotiations with Vice President Joe Biden on a debt-ceiling deal. McConnell’s communications director Don Stewart e-mailed me to deny the story. “This headline and assertion about Sen. McConnell is inaccurate. While they do talk from time to time, they are not in talks. They’re not negotiating. They’re not working on a new bill or any new amendment. Sen. McConnell has been crystal clear that he supports the speaker’s bill.”

Since this story obviously didn’t come from McConnell’s office one can infer that the White House, once again, or someone acting on its behalf is desperately trying to interject itself into the process. Plainly we have not been “stalemated,” as the president claimed on Monday night. The Congress, specifically the House, has been doing its job.

As McConnell said on Wednesday, “The fact is, Republicans have offered the only proposal at this point that attempts to get at the root of the problem — and which actually has a chance of getting to the president’s desk. That’s why we’ll continue to press for the legislation Speaker Boehner has proposed.”

It is July 28; the Senate hasn’t voted on any debt-ceiling bill. When last we left things Minority Leader Harry Reid (D-Nev.) was trying to recalculate his bill after the Congressional Budget Office revealed there were less savings than promised. The White House has never sent a debt-ceiling bill to Congress and rejected a bipartisan attempt to resolve the issue last Sunday. It is folly to think there is any alternative but the Boehner bill for now. So all the White House can hope for is to claim credit. Now that’ll be some trick.

By Jennifer Rubin | 08:15 AM ET, 07/28/2011

Categories: Morning Bits

31 Bill July 28, 2011 at 8:52 am

The next move is to by the rating agency is downgrade because you have a child, and not an adult, playing this game.

32 Bill July 28, 2011 at 8:53 am

Rewrite to correct transposition: The next move by the rating agency is to downgrade because you have a child, not an adult, playing this game.

33 E. Barandiaran July 28, 2011 at 8:57 am

In the meantime, Tyler’s beloved Ezra Klein is desperate for a consolation prize. From his latest Bloomberg’s column

Democrats are going to lose this one. Whatever deal emerges to raise the debt ceiling, we can be pretty sure it won’t include revenue, it won’t include stimulus, and it will let Republicans pocket a trillion dollars or more in cuts without offering anything to Democrats in return.
It’s difficult to see how it could end otherwise. Virtually no Democrats are willing to go past Aug. 2 without raising the debt ceiling. Plenty of Republicans are prepared to blow through the deadline. That’s not a dynamic that lends itself to a deal. That’s a dynamic that lends itself to a ransom.
Yet Democrats will have their turn. On Dec. 31, 2012, three weeks before the end of President Barack Obama’s current term in office, the Bush tax cuts expire. Income tax rates will return to their Clinton-era levels. That amounts to a $3.6 trillion tax increase over 10 years, three or four times the $800 billion to $1.2 trillion in revenue increases that Obama and Speaker John Boehner were kicking around. And all Democrats need to do to secure that deal is — nothing.

You can read the column here

34 Zach July 28, 2011 at 9:19 am

As a Democrat, I don’t see that as losing on revenues. The worst-case scenario for me would be a deal that locks in Bush-cut rates for longer or locks them in with some small amount of increased revenues from accelerated depreciation or whatever. I think Democrats win if whether or not we should let any of the cuts expire is a 2012 election issue — we did in 2008 even if there wasn’t political will to let it happen. If Democrats don’t do well in 2012, we’ll have the Bush cuts’ expiration as a bargaining chip in the 2012 lame duck session through 2013. Of course, Republicans have shown they’re actually willing to proceed in the Senate with a mere 50 votes on issues where doing so is within the rules.

Whatever law ends up raising the debt ceiling, the GOP will have one or more additional opportunities to take the country hostage and I expect that further marginal rate extensions will be part of their demands — the continuing resolution for spending ends in September, Boehner’s plan requires another debt ceiling vote of some sort, etc.

35 tom July 28, 2011 at 11:39 am

“GOP will have one or more additional opportunities to take the country hostage ”

Kind of like taking a suicidal person hostage until they are back on their meds.

36 Zach July 28, 2011 at 9:13 am

The total stock market index dropped over 2% yesterday; that’s a few hundred billion dollars in American market capitalization; about a trillion in global losses if that’s reflected in global equities. I don’t see how we’ll have another ~6% daily drop as we did following the TARP vote unless something happens that’s very much like the TARP vote — a vote that’s expected to pass, but fails because whips were overly confident about getting votes.

37 E. Barandiaran July 28, 2011 at 9:14 am

And this is how the “debt ceiling” comedy will unfold today

The House kicks off an exhaustive day of debate and votes over the bill Thursday morning. The first big hurdle is a procedural vote on what’s known as the “rule” — if that fails, Boehner’s bill cannot even be called up for debate.

If it clears, the House may not get to a final vote on the measure until Thursday evening.

Ideally, Boehner wants the House to approve the bill and virtually force the Senate to follow suit.

Enjoy it.

38 TallDave July 28, 2011 at 10:04 am

The WH has to be looking at post-debt-limit prioritization and realizing it’s a political nightmare. It is Dem constituencies (esp. federal and state employees) who will be hit harder in any prioritization scheme and they will all be shrieking demands to be paid first.

I think when it comes down to it the Dems will grit their collective teeth and pass the Boehner bill.

39 Bill July 28, 2011 at 4:48 pm

E., You are trying too much to be political with this idea of last minute forcing.

Here is a counter-scenario: the House bill goes to the Senate; it fails to pass; there is a majority of the Senate in favor of the Reid bill, and Senate Republicans fillibuster the Reid bill.

Tell me: Does it look good for the Senate minority to be fillibustering when the clock is about to expire and when there are 50 votes to pass?

40 dave July 28, 2011 at 9:17 am

If this were an actual issue the 10 year would be 5%+. It isn’t. Stop worrying.

41 TallDave July 28, 2011 at 9:59 am

That so many people resist this logic is a continuing source of amazement to me. Megan McArdle, who is normally quite level-headed and perspicacious, seems to the think the answer is that the bond markets are stupid for not panicking. Yet it’s trivially obvious there is no reason for the U.S. to default given the difference between revenues and interest payments.

At the end of the day I have almost infinitely more confidence in the financiers’ understanding of the political process than in the politicians’ understanding of the financial process.

42 anonymous July 28, 2011 at 10:37 am

Excerpts from the abstract of “Political risk and the international bond market between the 1848 revolution and the outbreak of the First World War” by Niall Ferguson (The Economic History Review
Volume 59, Issue 1, pages 70–112, February 2006):

… In particular, I ask why the outbreak of the First World War, an event traditionally seen as having been heralded by a series of international crises, was not apparently anticipated by investors. […] However, even this structural change cannot explain why the London market was so slow to appreciate the risk of war in 1914. To investors, the First World War truly came as a bolt from the blue.

You might want to dial down your “infinite confidence” a notch or two.

43 TallDave July 28, 2011 at 12:55 pm

Certainly we were all a lot stupider then, but I’ll still take the financiers of 1914 over the politicians of 1914 — remember, this was the era when Communism got started.

But if you think the markets are wrong, now is the perfect time to take a massive short position on Treasuries.

44 anonymous July 28, 2011 at 1:57 pm

You’re missing the broader point: the London bond markets of 1914 (the largest in the world at the time) got it wrong. Badly wrong. If you were relying back then on market indexes and prices as a predictor of whether an unimaginable and unprecedented disaster was imminent, you would have had little or no warning.

You are pointing to low rates for long-term bonds as though that were all the proof that’s needed of clear skies ahead. That does not follow.

45 TallDave July 28, 2011 at 8:58 pm

That would be highly relevant if the transmission of information hadn’t undergone any major advances since 1914, or we were worried about a German chancellor invading Poland.

Again, if skies aren’t clear ahead, why is no one betting that way?

I’ll tell you why: the markets know there is virtually no chance of default because revenues are many times interest payments and Obama is not insane enough to deprioritize interest payments.

46 TallDave July 28, 2011 at 11:08 pm

Or a Kaiser invading France if you like.

At any rate I believe the 1914 London bond markets are something between a hundred and a thousand times smaller than the 2011 U.S. bond market.

47 anonymous July 29, 2011 at 11:58 am

Again, if skies aren’t clear ahead, why is no one betting that way?

1. In 1914, bond markets said “everything is OK”
2. Actually, everything was very, very, very not OK. An era ended.
3. In 2011, bond markets say “everything is OK”
4. You: If something was wrong, why aren’t markets telling us so?

Believe what you wish, and place your bets accordingly. I have. (And I’m not short Treasuries, that’s premature). Whoever’s right will make money. That’s capitalism. Good luck to you, sir.

48 TallDave July 29, 2011 at 12:42 pm

in 1914, a relatively tiny bond market did not predict the complex unfolding of geopolitical events that led to WW I.
in 2011, a much much larger and more sophisticated bond market is seeing no good reason to think we will default based on things like the fact revenues greatly exceed expectations and we have over half a trillion in liquid assets.

Best of luck to you as well sir.

49 Scott F July 28, 2011 at 9:36 am

The real problem with your analogy is that the daughter is not the one being hit with the broom, it is her little brother. She might have to listen to his screams but in the end she thinks she can just pull the blanket over her head.

Congress will NOT be punished by the markets. They may lose some of their investments but you can bet they have been hedging lately. Each side figures they can weather the storm and come out in 2012 the winners. They care about themselves and their power, not the state of the markets. That’s why some of these proposed bills are mainly about landing blame of the other side.

50 rjs July 28, 2011 at 10:08 am
51 Bill July 28, 2011 at 10:08 am

Simon Johnson nails it in the NYT Economix section today:

“In contrast, the United States has a simple fiscal problem – as I discussed in my testimony to the House Ways and Means Committee this week. Government debt surged from 2008, not because of Greek-style profligacy but rather because of an Irish-style banking disaster. When credit collapses, so does revenue. As the economy recovers, revenue comes back.

The single most interesting point about today’s debt ceiling debate is that over the 10-year forecast horizon that frames for the entire discussion, by any conventional definition no fiscal problem exists. In 2021, the United States is likely to have a small primary surplus at the federal level – meaning that the budget, before interest payments, will no longer be in deficit. (James Kwak elaborates on this point on Baseline Scenario, the blog we run together.)

The really bad budget numbers for the United States come after 2021, but these are not the focus of anyone’s current proposals on Capitol Hill. Compared with other countries, the increase in health-care spending from 2010 to 2030 is most troublesome and what will ruin us (see Statistical Table 9 in the International Monetary Fund’s Spring 2011 Fiscal Monitor; or, if you prefer a single picture that cuts to the chase, look at where the United States falls in Figure 1 on page 9 of the I.M.F.’s recent report on how to handle “fiscal consolidation” in the Group of 20 developed economies.)

The debate in Washington is both heated and off course, because no one is grappling with the difficult issue of how to control health-care costs. The Tea Party enthusiasts are intent on near-term government spending cuts as a condition of supporting any increase in the debt ceiling.”

52 Bill July 28, 2011 at 10:16 am

I mistakenly did not include Johnson’s conclusion:

“If this version of a libertarian tax revolt carries the day, the resulting fiscal contraction will slow the economy and fewer jobs will be created. It does nothing directly to address the looming budget issues beyond 2021.

In the near term, the Europeans have the bigger problem – and this will only be compounded by slower growth in the United States (home to about one-quarter of the world economy). Over the longer haul, it remains to be seen when and how politicians in the United States will take up the real budget issues.

So far, the evidence is not encouraging.”

53 Andrew' July 28, 2011 at 11:29 am

Where does he get the idea this is a libertarian tax revolt?

Even if he is right about his contraction prediction, it is not the Tea Party that is requiring a disorderly cut in spending.

We are here because we got here. If it’s too soon, when would you like to revisit this issue? Debt 100% of GDP? 110%? 120%? We are flexible, just name a time.

54 E. Barandiaran July 28, 2011 at 11:37 am

A few days ago the IMF published the last Article IV Consultation Report on the U.S. Economy and in the first page it summarizes the key issues. The first one refers to fiscal policy and says:

Fiscal policy. Consolidation needs to proceed as debt dynamics are unsustainable and
losing fiscal credibility would be extremely damaging. However, the pace and
composition of adjustment should be attuned to the cycle. A politically-backed
medium-term framework that raises revenues and addresses long-term expenditure
pressures should be the cornerstone of fiscal stabilization. The official deficit reduction
proposals could be too front-loaded given the cyclical weakness and, at the same time,
insufficient to stabilize the debt by mid-decade.

Apparently, during his short-term position at the IMF, Simon Johnson learnt little about fiscal sustainability and fiscal adjustment. He was there at a period marked by inside meditation about what they had done wrong in past decades and by how to downsize the organization. Although I have always been critical of this Article IV Consultation reports, I know that if the official report on the U.S. economy says that “Consolidation needs to proceed as debt dynamics are unsustainable and losing fiscal credibility would be extremely damaging” (first sentence of the first key issue), then the IMF staff will be thinking that the prospects are really bad. Unsustainable debt dynamics means the prospect of a serious, Argentine-type fiscal crisis, and consolidation means fiscal adjustment.

Bill, don’t be blind to your own blindness (read http://www.freakonomics.com/2011/07/27/blind-to-our-own-blindness-wisdom-from-danny-kahneman/ )

55 E. Barandiaran July 28, 2011 at 11:42 am

The IMF Report can be downloaded at

56 Bill July 28, 2011 at 4:13 pm

From the report you cited:

‘Consolidation needs to proceed as debt dynamics are unsustainable and
losing fiscal credibility would be extremely damaging. However, the pace and
composition of adjustment should be attuned to the cycle. A politically-backed
medium-term framework that raises revenues and addresses long-term expenditure
pressures should be the cornerstone of fiscal stabilization. The official deficit reduction
proposals could be too front-loaded given the cyclical weakness and, at the same time,
insufficient to stabilize the debt by mid-decade.’

Was it the raising revenue cite you were talking about, or the need to adjust based on the business cycle.
Neither seems to support your statement.

And, by the way, the IMF chief just said in a statement:

“The head of the International Monetary Fund says failure to raise the U.S. borrowing limit could damage the global economy.

In a speech in New York, Christine Lagarde calls on U.S. political leaders to show the same “political courage” that European leaders demonstrated last week, when they agreed on several new measures to address Greece’s debt crisis.

President Barack Obama and Republican lawmakers are at an impasse in negotiations to raise the nation’s $14.3 trillion borrowing limit. The federal government is at risk of defaulting on its debt after Aug. 2 if an agreement isn’t reached by then.

Lagarde says a default or downgrade of U.S. debt “would be a very, very, very serious event not just for the United States but for the global economy at large.”

57 Bill July 28, 2011 at 11:44 am

E., I don’t know how any ad hominem attack at Prof. Johnson advances any discussion.

58 Andrew' July 28, 2011 at 11:55 am

I actually agree with him, Bill, not that that means anything.

But at some point the problem has to be addressed in a time we call “The Present.”

It is unfortunate the current debt ceiling opportunity is so short, don’t waste the crises you have, not the crises you don’t have.

59 Andrew' July 28, 2011 at 12:00 pm

By “Him” I mean Johnson, on the part about long-term problems versus short-term and that if lines of business are disrupted there could be a contraction, not the part that this is just a ho-hum cycle.

Of course I agree with E. Barandiaran by definition.

60 anonymous July 28, 2011 at 10:25 am

Just a stick?

Once upon a time — seems like a lifetime ago — a secretary of the Treasury confidently spoke of brandishing a bazooka to overawe the markets. A few weeks later Freddie and Fannie imploded, and the rest is (all too recent) history.

Turnabout is fair play. Forget the stick. Here’s to Mr. Market showing up with a bazooka, backed up by a posse of villagers armed with torches and pitchforks. And maybe we can anthopormorphowhatchamacallit the metaphorical daughter into actual members of Congress, while we’re at it.

61 R Richard Schweitzer July 28, 2011 at 10:51 am

There is a lot else going on in the “mother’s” life.

What is (are) the “daughter’s” motivation(s)?

62 Kevin July 28, 2011 at 11:13 am

There may not be an equilibrium a la Bond, Goldstein, and Prescott 2010 Review of Financial Studies.

If the market is trying to figure out what politicians do, and politicians are informing their actions based on what the market does…then politicians will react swiftly to a rapid fall in prices, which will make the fall unjustified. It’s hard for this to be an equilibrium, so who knows what can be learned from prices

63 Andrew' July 28, 2011 at 11:13 am

I’m bangin’ the daughter. And the mother.

It’s tense.

64 allan July 28, 2011 at 12:00 pm

The story of the mother and daughter reveals more than Mr. Cowen knows. The mother is the bond dealer, the parent, the one with authority, the one with the right to physically abuse the daughter. The daughter, the American people (a democracy) is the subordinate, the one who takes orders, the one who must submit to abuse.

Exactly who is in charge in this situation. The American people or the bond dealer?

65 anonymous July 28, 2011 at 1:42 pm

Read it again. The “daughter” in this story is Congress.

If you conflate “Congress” with “the American people”, you’re part of the problem.

Maybe in the next episode of this exciting saga, we can introduce the American people as the “father”, who shows up with an even bigger stick.

66 allan July 28, 2011 at 6:54 pm

Ah….America is not a democracy?

67 mulp July 28, 2011 at 2:11 pm

Speaking for the conservatives I’ve read in the past few weeks, Tyler Cowen as an inexperienced arrogant elitists with zero experience and not a hint of leadership who is posturing for future gain (probably a book deal) by drawing a parallel between Congress persons and children, ensuring those in Congress will never trust him.

Instead of parent-child you should have used the snake-rat cause in a flood (or whatever that story is) and drawn the analogy between the snake biting the rat before they reach safety and they both drown…. Oh, wait, that would be worse because you would be comparing the factions in Congress to rats and snakes….

Maybe the prisoners’ dilemma… Nope, now you are calling those in Congress crooks and liars….

Maybe one should dig into the bible, but only the Abrahamic tradition to avoid offending Jews and Muslims, but use the King James to appeal to the secular as classic literature. Or Shakespeare, or the Odyssey,…

Those who drafted the US Constitution did know the classics and faced with these conflicts in deadlock compromised by writing a Constitution which sets up the conditions for deadlock we are experiencing today.

To those who claim Parliamentary systems don’t have this problem, I point to the highly functional and decisive Iraqi government….

The problem is a complete lack of consensus on the role of government.

The “market” talking heads have been attacking government, blaming it for the bad economy, and calling for the government to do less, but at the same are demanding government end uncertainty by decisively acting to solve problems the private sector can’t.

We the People are attacking our agent for We the People for both acting for We the People and failing to act for We the People, which really indicates that We the People are split and fighting over who of We the People get to control the other We the People.

We have gone in my lifetime from probably 90% of use with common cause to maybe three groups (certainly more than two) with common cause pitted against each other. The two previous times with such division would be the American Revolution and the Civil War.

68 E. Barandiaran July 28, 2011 at 2:27 pm

With House’s approval of the Boehner bill secured, you can entertain with the White House’s response

Next Debt Pinch Could Play Grinch?
Are Republicans being the Grinches who are about to steal Christmas?

Senior White House officials suggested on Thursday morning that Speaker John A. Boehner’s bill to extend the debt ceiling would ruin the 2011 holiday season.

“Happy Holidays America: Boehner plan would have the debt ceiling all over again during the holiday season, which is critical for the economy,” Dan Pfeiffer, the White House communications director, said in a Twitter message Thursday morning.

Jay Carney, the White House press secretary, repeated the criticism, telling reporters that extending the debt ceiling for a few months, as Mr. Boehner’s bill does, would “require all of us to go through all of this before the end of the year.”

Mr. Carney argued that the objection was not about ruining vacations. He said that repeating the debt-ceiling fight would depress the Christmas buying season, one of the most important times of the year for the economy.

Aides to Mr. Boehner dismissed the criticism, saying the legislation would extend the debt ceiling into January, beyond the holiday season.

But White House advisers apparently think that another extended debate leading up to January deadline would not be good for holiday cheer.

“The debt ceiling debate would ruin Christmas,” David Plouffe, a White House senior adviser, said on MSNBC’s “Morning Joe” program on Thursday.

69 duncan July 28, 2011 at 2:53 pm

I have a daughter and in this scenario I would withhold a positive until the room was clean. I would also say that I would help her with the cleaning to speed up her job. I guess this would be reducing the negative slightly in exchange for taking part. In practice: ” when the room is clean, we can read some books. Would you like me to help you with this job and we can do together” This seems to work well

Strangly bond market is not withholding a positive on inflicting a negative. The long end of the curve looks like it almost welcomes a default, which maybe would force long term fiscal cuts. The bond market is guessing it would still get payed off while other wait in line.

70 Former Beltway Wonk July 28, 2011 at 3:41 pm

A poor metaphor on several dimensions. One of them being, “the market” is a large and very competitive group of people who have a wide variety of opinions about what should happen Congress, not some monolithic mother who wants some particular political outcome. Second, the “threat” of a “market plummet” is a figment of the fevered Beltway imagination, not of Wall Street, and people not caught up in the D.C. hysteria know this. There are other other ways the metaphor falls down but those are the two big ones.

P.S. Treasuries continue to trade at 2.95% (10 year note), within the right-around-3% range they’ve been trading at for several weeks.

71 Bill July 28, 2011 at 5:09 pm

I think we should have a new form of hostage taking to resolve the debt crisis.

What I propose is that we selectively execute (I’m sorry, remove) the names of Congresspersons on federal buildings.

Afterall, of the 55 bills passed by the House this year,” fourteen of the 55 bills signed into law since January were for the naming of federal buildings.” http://www.thesunnews.com/2011/07/10/2267685/what-has-congress-accomplished.html#ixzz1TR6l8Bv4

So, the McConnel Federal Courthouse gets renamed if a budget bill does not pass; the Shelby Interdisciplinary Biomedical Research building and other Shelby buildings get renamed. Hell, we can even threaten to rename the biggest federal building of all, the Reagan building, if things get tough.

I figure that if you can’t do your job, you shouldn’t have a building named after you.

72 Saliency July 29, 2011 at 9:43 am

The normal solution is that the mother will signal her future actions. Actors try to communicate when deadlock occurs.

The problem with Congress and the market is that they are not a single entity able to create a credible signal.

73 SkepticProf July 29, 2011 at 3:29 pm

In the game as posed, I believe that, as time goes by without any action, it becomes increasingly (rather than less) certain that the room will get cleaned before the stick is brought to bear.

The daughter, if she desires to postpone getting out of bed, can choose a pure threshhold strategy of when to get up — trading off a little more sleep vs. a chance of getting the stick. If she has decreasing marginal value for sleep and the probability density does not decrease too fast, she will decide to clean her room strictly before the deadline — but for the mother to claim “the stick is coming at time X” is just cheap talk, since every instant the mother chooses to put it off a little further and thereby increase her expected utility (by the probabilty that the room will be cleaned, without requiring the punishment, in the next instant.) This time inconsistency by the mother places more and more probability weight on the punishment coming at (or at least towards) the end of the period, which is exactly the condition that needs to be true for there to be an interior solution for the daughter.

I think it’s safe to say that, in the debt case, the probability of punishment is not decreasing as we approach the deadline.

Thus, I confidently predict that the crisis will be resolved (and not just epsilon before the end) but after lots and lots of waiting, which after all) is in the interest of both the mother and the daughter. We will only very rarely see a situation in which the stick is brought to bear (a low-probability outcome, given the daughter’s optimal choice of timing) before the room is cleaned up. If this is a mixed-strategy equilbrium, it’s nearly certain that we observe that “time passes” without anything “happening,” even though each side places a small probability of acting early.

74 Bill July 29, 2011 at 4:40 pm

Ah, but there is reputation effect of the mother’s behaviour that hasn’t been taken into consideration.

Maybe we need a crisis to avert the next one so that this game isn’t played again.

No one played this game since Newt went down in flames 15 years ago.

We just have short memories, so we should replay news clips whenever we think of this as a strategy and remind republicans what happened to them in the next election cycle.

75 i comment late August 18, 2011 at 3:40 pm

So, the daughter cleaned the room and then got beat a week later.

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