Month: March 2010

Why aggregate demand stimulation becomes less effective as a recession continues

Megan McArdle raises some doubts about the idea of a four percent inflation target, as has been suggested by Olivier Blanchard and others.  I would stress the point that the optimal inflation target falls as a recession proceeds.  Whatever you think of four percent inflation in absolute terms (I have favored two percent, though not four), it would have done much more good a year or two ago than it can do today.

There is an asymmetry between layoffs and rehires.  If an economy starts heading into recession, robust aggregate demand may limit the number of layoffs.  But once those workers are laid off, robust aggregate demand won't necessarily lead to their rehiring.  The employer already has figured out how to do without those workers and the production process has "moved on," so to speak.  Few employers are looking to recreate the status quo ex ante.

Even a shock which was originally one hundred percent "nominal" becomes increasingly "real" as time proceeds.  The laid-off workers have to find new and different jobs, which often means cross-sectoral adjustments.  Laid-off workers become frustrated, lazier, less healthy, and so on — hysteresis – which also makes for required real adjustments, since now they are less productive.

As time passes in the recession, nominal wages also adjust to some extent, perhaps in a painful manner, but that too limits the value of inflation or reflation.

Repeat after me: "Even a shock which was originally one hundred percent "nominal" becomes increasingly "real" as time proceeds."  Again, that means the case for significantly higher inflation — whether strong or weak in absolute terms — becomes weaker every day. 

Auction markets in everything

Daniel Lippman sends me notice of the following:

The Exchange Bar & Grill, set amid the bustling shops and pubs of the Grammercy Park neighborhood, is replete with a ticker tape flashing menu prices in red lettering as demand forces them to fluctuate.

Customers can move prices for all beverages and bar snacks such as hot wings ($7 for 6 pieces) or fried calamari ($9). The prices will fluctuate in $.25 cent increments, but will most likely plateau at a $2 change in either direction.

A glass of Guinness starts at $6 but could be pushed to a high of $8 or a low of $4, depending on popularity.

So if one drink is in heavy demand, its price will rise, causing the cost of other equivalent drinks to drop. A rush on a particular beer would increase its price, and cause other beers to drop.

It is, of course, a marketing gimmick.  Daniel also sends along a link on the new idea of eco-sex.

Review copies waiting in my pile

1. Acting White: The Ironic Legacy of Desegregation, by Stuart Buck.

2. Prophet of Innovation: Joseph Schumpeter and Creation Destruction, by Thomas McCraw, new in paperback.  I loved this book, you can Google back to my previous reviews.

3. Anthony de Jasay, Political Philosophy, Clearly: Essays on Freedom and Fairness, Property and Equalities.  This one is a Liberty Fund edition.

4. The Great Reset: How New Ways of Working and Living Drive Post-Crash Prosperity, by Richard Florida.

5. 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, by Simon Johnson; a public choice analysis of the unholy alliance between finance and politics.

6. Holy Warriors: A Modern History of the Crusades, by Jonathan Phillips.

There are others, too.  All of these appear to have merits.

Can the Canadian banking model work for the U.S.?

No, and Simon Johnson explains why.  Excerpt:

Proposing a Canadian-type model to create stability in the U.S. is, to be blunt, nonsense.  We would need to merge our banks into even fewer banking giants, and then re-inflate Fannie Mae and Freddie Mac to guarantee some of the riskiest parts of the bank’s portfolios.  With our handful of new “hyper megabanks”, we’d have to count on our political system to prevent our banks from going wild; Canada may be able to do this (in our view, the jury is still out), but what are the odds this would work in Washington?  This would require an enormous leap of faith in our regulatory system immediately after it managed to fail repeatedly and spectacularly over thirty years (see 13 Bankers, out next week, for the awful details).  Who can be confident our powerful corporate lobbies, hired politicians, and captured regulators can become so Canadian so soon?

There is much more at the link, recommended.

From the comments

Steve S writes:

Steve Entin at the National Center for Policy Analysis has written on the very issue of the subsidies vs the tax exclusion. His conclusion:

Adding the subsidies for premiums and cost sharing, the family getting the health exchange policy would receive a total subsidy of $17,400, while the family receiving employer-based insurance would receive a total subsidy of $4,143.

That is a huge differential. The whole piece is here: http://www.ncpa.org/pdfs/Health-Insurance-Exchange-Subsidies-Create-Inequities.pdf

File under "Not a political equilibrium."

FCPA as embargo

It turns out Andrew Spalding has a paper on the topic.  Here is the abstract:

Although the purpose of international anti-bribery legislation, particularly the U.S. Foreign Corrupt Practices Act, is to deter bribery, empirical evidence demonstrates a more problematic effect: in countries where bribery is perceived to be relatively common, the present enforcement regime goes beyond deterring bribery and actually deters investment. Drawing on literature from political science and economics, this article argues that anti-bribery legislation, as presently enforced, functions as de facto economic sanctions. A detailed analysis of the history of FCPA enforcement shows that these sanctions have most often occurred in emerging markets, where historic opportunities for economic and social development otherwise exist and where public policy should encourage investment. This effect is contrary to the purpose of the FCPA which, as the legislative history shows, is to build economic and political alliances by promoting ethical overseas investment.

These perverse and unanticipated consequences create two policy problems. First, the sanctions literature suggests that the resulting foreign direct investment void may be filled by capital-rich countries that are not committed to effectively enforcing anti-bribery measures. This dynamic can be observed, for example, in China's aggressive investment in Africa, Latin America, and Central Asia, and creates myriad ethical, economic, and foreign policy problems. Second, by enforcing these laws without regard to their sanctioning effects, developed nations are unwittingly sacrificing poverty reduction opportunities to combat bribery. The paper concludes with various proposed reforms to the text and enforcement of international anti-bribery legislation that would further the goal of deterring bribery without deterring investment.

Here is my previous post on the FCPA and Haiti.

*The Future History of the Arctic*

I loved this book, which is written by Charles Emmerson.  Here is one short bit:

Despite the prominence of the colors of Norway on Svalbard — and the firm insistence from any government representative that Svalbard is an integral part of the kingdom of Norway — there are reminders that the archipelago is both something more and something less than that.  Russians and Ukrainians live here, some in Longyearbyen, though most are at the Russian settlement at Barentsburg.  The girls at the supermarket checkout counter speak Thai.  Somewhere in town is an Iranian who came here six years ago and, under the terms of the Spitsbergen Treaty, was able to settle here.  If he were to return south to the Norwegian mainland, he would almost definitely be forced to leave the country, his asylum claims having been refused.  Import duties are nonexistent on Svalbard: Cuban cigars cost less in Longyearbyen, at 78 degrees North, than they do in Oslo, three hours' flight to the south.

Here is Wikipedia on Svalbard

This book covers why and how Greenland might become independent, what kind of presence in the Arctic Canada can realistically expect to have, the changing historical fortunes of Vladivostock, what the Law of the Sea really means, and why Norway manages its fossil fuel revenues so well, among other matters.  The Future History of the Arctic has fun and useful information on just about every page.

Norway

Views I toy with but do not (yet?) hold

Financial panics and economic crises are nearly inevitable, for at least two reasons.  The first is that policymakers are ill-informed and have poor incentives.  The second is that bank managers, periodically, like to take risk and we are unwilling to shoot or otherwise severely punish the failed ones.  Instituitions which transform liquidity can, sooner or later, find a way to take such precarious risks, no matter what the regulators do (it still may be worth trying regulatory restraint, however).  There's simply not enough downside risk in a wealthy, humane society.

The nineteenth century financial panic will prove the "norm" for human history.  The research question is how we avoided such panics for 1950-S&L crisis, or whatever you take the cut-off points to be.  The capital controls of Bretton Woods may be part of the answer (plus that is a strange economic period in a number of ways), although it is not obvious such controls could be made to work today.

More and more, people will turn to the wisdom of the great 19th century economists on financial panics, bank runs, and the like.  It was an intellectual mistake to think we had ever left that world for good.

I thank Benjamin Chabot and Mario Rizzo for useful conversations on this topic.  Bill Easterly offers related remarks, as does Paul Krugman.