Month: December 2011

Is the Fed our savior in financial regulation?

It seems odd to put up an actual substantive post on Christmas day, nonetheless here is my New York Times column on financial regulation.

Despite these problems, the United States may oddly enough be facing this new financial turmoil in a relatively safe position, though whether it’s safe enough remains to be seen. The Federal Reserve took the lead on future capital requirements just last week, but for the shorter run there is a more important Fed policy move. Starting in late 2008, as a response to our financial crisis, the Fed bought government and mortgage securities from banks on a very large scale.

Bank reserves at the Fed rose from virtually nothing to more than $1.6 trillion. Then the Fed paid interest on those reserves to help keep them on bank balance sheets.

It is estimated by Moody’s that America’s biggest banks now have liquid assets that are 3 to 11 times their short-term borrowings. In other words, it’s the cushion we’ve been seeking. Furthermore, a lot of those reserves sit in the American subsidiaries of large foreign-owned banks, protecting the European system, too.

This new safety comes not from regulatory micromanagement but rather from the creation of additional safe interest-bearing assets. While European economies have been losing safe assets through debt downgrades, the United States financial system has been gaining them.

Here is a relevant link from The Economist.  Here are links to Brad DeLong, David Wessel, and others, on related points.  Here is David Beckworth on safe assets.  The scarcity of safe assets is a critical theme today, and still we lack a satisfactory theory of collateral.  For instance, how many macroeconomists are well equipped to answer how “putting OTC derivatives on exchanges” will affect interest rates and output?

Here is another bit, which shows I have been changing my mind on interest on reserves:

The Fed’s stockpiled liquid reserves have met some heavy criticism. Hard-money advocates contend that they are a prelude to hyperinflation — although market forecasts and bond yields don’t bear this out — while proponents of monetary expansion have wished that banks would more actively lend out those reserves to stimulate the economy. That second view assumes that the financial crisis is essentially over, but maybe it’s not. As the euro zone crisis continues, it seems that Ben S. Bernanke has been a smarter central banker than we had realized.

Here is my earlier blog post, T-Bills as a substitute for financial regulation.  Here is my earlier post on monetary policy and bank recapitalization.  I view these as one piece, trying to explain why Bernanke has not been more aggressive with monetary policy along some dimensions.

The Fed (possibly) has foreseen that a scarcity of safe assets is a major macroeconomic problem — most of all in Europe — and has acted to limit this problem in the United States, even at the cost of having tighter money.  That means interest on reserves as a kind of synthetic T-Bills policy.  The interest induces demand to hold liquid reserves, which increases the buffer against a European financial implosion.  You can think of this policy as a substitute for the failure of regulators to get capital requirements right.

Overall, that means a monetary policy having to play the role of fiscal policy and regulatory policy, all at the same time.  No wonder so few people are happy with the outcome.

Through this lens, the Fed looks better, Congress, Dodd-Frank and the financial regulators look worse.  That dysfunctional government prevents an effective fiscal policy response — good and also politically sustainable projects — looks worse too.

Addendum: Arnold Kling comments.

Markets in everything

Esther Dyson reports, the link is added by me:

Specifically, Insidr brings together consumers who have practical questions about how to deal with a specific company and (mostly) former employees of that company. For example, you want to know whether you can still get the unlimited-data-roaming plan that your friend has, but the company refuses to give you a straight answer. Somewhere, a former employee (or perhaps a knowledgeable phone-store saleswoman) knows the answer.

What I’ve been reading

1. Garry Kasparov on Garry Kasparov, Part 1: 1973-1985, by Garry Kasparov.  Self-recommending!  His chess books are full of history, drama, and suspense, in addition to the chess, he is simply a great mind.

2. Michael Krondl, Sweet Invention: A History of Dessert.  The best book I know on the history of dessert, with plenty of information on India, my personal favorite dessert country.  There is also the short and useful Bread: A Global History, by William Rubel.

3. Nan Shepherd, The Living Mountain.  Written in the 1940s, published in the late 70s, ignored, just republished.  It’s like reading a poem.  The Guardian is on the mark to call it “The finest book ever written on nature and landscape in Britain.”

4. Katerina Clark, Moscow, The Fourth Rome: Stalinism, Cosmopolitanism, and the Evolution of Soviet Culture 1931-1941.  A revisionist take which portrays the culture of the era as about more than just about communism, in any case thought provoking.

5. Peter Conrad, Verdi And/Or Wagner.  A multifaceted comparison of the two composers, integrating music, politics, and history, readable and recommended.

6. William A. Barnett, Getting it Wrong: How Faulty Monetary Statistics Undermine the Fed, the Financial System, and the Economy.  He pushes his own work on Divisia monetar aggregates, although Scott Sumner will tell you that a steely focus on nominal gdp will suffice.

7. David Mikics, Who Was Jacques Derrida?  Recommended by Gordon, this book is a good intelligent and intelligible introduction to Derrida.

8. Ben Lerner, Leaving the Atocha Station.  So good (and short) that I read it twice in a row, it is a mock of “creative” slackers who decide they wish to live abroad.  One of my favorite novels of the year.

In my pile of review copies are Jonathan Schlefer, The Assumptions Economists Make, and Paula Stephan, How Economics Shapes Science.

Scrooge and Adam Smith

It will no doubt delight critics of economics everywhere to learn that Ebenezer Scroggie, the merchant who inspired Charles Dickens’ miserly tale, was related to Adam Smith:

Scroggie was born in Kirkcaldy, Fife; his mother was the niece of Adam Smith, the 18th century political economist and philosopher.”

Dickens, however, had mild dyslexia and read Scroggie’s headstone as “Ebenezer Lennox Scroggie – mean man” when in fact it read “meal man,” referring to Scroggie’s trade in corn. Scroggie by most accounts was actually the life of the party.

Hat tip to Tim Taylor who has further thoughts.

Labor supply and taxes

This is from Michael P. Keane, from the new Journal of Economic Literature (gated, ungated here), emphasis added by me:

I survey the male and female labor supply literatures, focusing on implications for effects of wages and taxes. For males, I describe and contrast results from three basic types of model: static models (especially those that account for nonlinear taxes), life-cycle models with savings, and life-cycle models with both savings and human capital. For women, more important distinctions are whether models include fixed costs of work, and whether they treat demographics like fertility and marriage (and human capital) as exogenous or endogenous. The literature is characterized by considerable controversy over the responsiveness of labor supply to changes in wages and taxes. At least for males, it is fair to say that most economists believe labor supply elasticities are small. But a sizable minority of studies that I examine obtain large values. Hence, there is no clear consensus on this point. In fact, a simple average of Hicks elasticities across all the studies I examine is 0.31. Several simulation studies have shown that such a value is large enough to generate large efficiency costs of income taxation. For males, I conclude that two factors drive many of the differences in results across studies. One factor is use of direct versus ratio wage measures, with studies that use the former tending to find larger elasticities. Another factor is the failure of most studies to account for human capital returns to work experience. I argue that this may lead to downward bias in elasticity estimates. In a model that includes human capital, I show how even modest elasticities—as conventionally measured—can be consistent with large efficiency costs of taxation. For women, in contrast, it is fair to say that most studies find large labor supply elasticities, especially on the participation margin. In particular, I find that estimates of “long-run” labor supply elasticities—by which I mean estimates that allow for dynamic effects of wages on fertility, marriage, education and work experience—are generally quite large.

Immigrants, welfare reform, and the U.S. safety net

That is the title of an intriguing new economics paper by Marianne Bitler and Hilary W. Hoynes, official NBER version here.  Remember when they cut some benefits for immigrants, circa 1996?  That can form the basis for a natural experiment, because non-immigrant poor families did not experience a similar cut in benefits.

I urge extreme caution in the interpretation, but here is one result:

The difference-in-difference estimates show that poverty rates declined for children in immigrant-headed households compared to natives post-welfare reform (2008-2009) relative to pre-reform (1994-1995).

But why?  There is more:

This result is unexpected but may be explained by a change in the composition of immigrant children (see Figure 3).  That is…the difference-in-difference reflects the decrease in immigrant poverty in the 1994-1999 period.

You can take this as a mix of optimism about immigrants and skepticism about some welfare programs, or perhaps optimism about how a health job market helps immigrants more than non-immigrants.  I don’t in Figure 3 see any actual measurement of the composition of immigrants, although immigrant households do show rising income levels over the critical years.  Stick by the caution mentioned above.  In any case, following the decrease in welfare benefits immigrant households rely more heavily on earned income, which should be taken as good news.  I would rather offer fewer benefits to immigrants and take more people in, to the extent that is the choice.

I don’t think this paper gets to the bottom of the puzzle it is studying, but it is an important piece of work.