Category: Economics
Would more planned savings be good? How can we lower perceived risk premia?
One common claim these days can be put in terms of the expectations theory of the term structure: since short-term rates cannot much fall, long-term rates cannot much fall either.
Yet I would not put this argument forward as the best available understanding of the issue. First, the expectations theory of the term structure has a dubious empirical record. Long and short rates change for somewhat mysterious reasons and the long rates do not forecast future short rates very well. Second, there is a distinction between Treasury and corporate rates and the latter are not zero, especially for small businesses.
One possibility is that true corporate real rates are better reflected by the status of letters of credit, standby loan agreements, and the like. One can view borrowing in terms of the value of an option, rather than a single numerical rate. Many businesses no longer feel they have lots of liquidity "on tap" when they might need it from their banks and so they hesitate.
In general, I think of this crisis as having damaged a lot of agency relationships, and as having led to tighter leashes. For instance, if you are a worker of um…"ambiguous" marginal product you may no longer get the benefit of the doubt. The high perceived risk premium in the labor market is preventing a lot of reemployment.
Returning to interest rates, the question is what could call true real rates to fall. The expectations theory of the term structure is not very useful in analyzing this problem. Changes in the perceived risk premium have been an embarassment and a confounding factor for the expectations theory for a long time.
Given that background, should we plan to save more? On the no side, I would not push "more savings" is the magical elixir in lowering real rates, since the major issue is again the perceived risk premium.
(By the way, if we lower real rates through Sumneresque inflation — which I favor — we are altering the spectrum of these agency dealings and injecting more risk into those relationships, possibly in a socially optimal manner; in any case that second-order effect has not seen enough analysis.)
Another anti-savings argument runs like this: if we switch from spending to savings, that requires longer-term production processes and resource reallocations. The new market forecasts of what to produce involve greater risk, namely Keynes's "dark forces of time and ignorance". If that increase in the risk is too stiff, an increase in planned savings could lead to a greater collapse in output, exacerbating both AD and AS problems.
A pro-savings argument runs like this: We're overly dependent on Chinese capital. T-Bill auctions are now being soaked up much more by domestic lenders and that is a good thing for the world state where the Chinese economy implodes.
Another pro-savings argument is about balance sheet repair and about satisfying the preferences of consumers for greater long-term risk protection.
A major pro-savings argument is: If savings are not to go up now (and they have been rising since the onset of the crisis, supposed Keynesian paradoxes aside), then when?
The long-run boundary conditions require Americans to save more at some point and here's a fundamental point about macro. I believe we are in a situation where the short-run and long-term boundary conditions are interacting. People want to see the longer-term "we have to save more" problem (as well as some other longer-term problems) partially resolved before having much lower shorter-term risk premia and thus a freer flow of capital and private investment and also more ambitious hiring policies.
That makes the ride especially bumpy and the recovery especially slow. Both the long-run and short-run conditions require partial resolution, at the same time, and yet the long- and short-run conditions point in some different directions.
I get nervous when I see Keynesian models emphasizing the short-term only or non-Keynesian approaches emphasizing the long-term only. The more insightful approaches see the short-term and long-term factors interacting in a not always so helpful manner.
Addendum: Krugman has a recent post on savings. I am confused by his insertion of the Fed into the classical loanable funds mechanism, which does not require a central bank. I am also surprised that he associates the paradox of saving with the liquidity trap; Keynes for instance believed in the paradox of saving even though he thought he had never seen a liquidity trap. It could be, however, that I am misreading him on both counts; I found the post difficult to parse.
A very good point from Dan Drezner
Quiggin thinks he’s only writing about the failure of free-market ideas, but he’s actually describing the intellectual life cycle of most ideas in political economy. All intellectual movements start with trenchant ways of understanding the world. As these ideas gain currency, they are used to explain more and more disparate phenomena, until the explanation starts to lose its predictive power. As time passes, the original ideas become obscured by ideology, caricature and ad hoc efforts to explain away emerging anomalies. Finally, enough contradictions build up to crash the paradigm, although current adherents often continue to advance the ideas in zombielike form. Quiggin demonstrates with great clarity how this happened to the Chicago school of economics. How he can think it won’t happen with whatever neo-Keynesian model emerges is truly puzzling.
Whether this applies to the Quiggin book is beside my point (I read an earlier draft of the manuscript but not the final). It is in any case a valuable observation and John Quiggin discusses it here. Drezner's full review, which covers a number of books, is here.
Why were the measured productivity gains so high in 2009?
You'll find the BLS statistics here, with a broader list of tables here. For the "Business Sector, output per hour," 2008 shows an overall growth rate of 1.1 percent.
The quarters of 2009 yield 6.1, 7.2, 8.3, and 3.5 percent growth rates.
The quarters of 2010 show 3.5 and 1.1 percent growth rates.
Total hours worked are falling through 2008 and falling at more than five percent by the third quarter of 2008.
In other words, there was a lot of "productivity growth" precisely when workers were being laid off, and not so much before or after. I interpret the "high productivity innovation" as the decision to lay the workers off, and the selection of workers, not the sudden advent and withdrawal of some new high productivity technology.
Sentences on bond bubbles
7. As asset maturities get shorter, the noise trader risk is diminished. This means that we can rely more on the prices of short term treasuries when formulating public policy. Temporary tax cuts are a no-brainer, while it is much harder to reliably measure the NPV of infrastructure investments with long payback periods.
8. The most important noise trader in the interest rate markets is China. Authorities are pushing for a much higher level of the savings than can be justified by the preferences of the Chinese people.
Here is a bit more.
The supply curve slopes upward
For background, Cyprus allows commercialization of the practice and many European nations do not:
According to a 2010 study by the European Society of Human Reproduction and Embryology, nearly 25,000 egg donations are performed in Europe for fertility tourists every year. More than 50% of those surveyed traveled abroad in order to circumvent legal regulations at home. The Cypriot government estimates that, each year, 1 in 50 women on the island between the ages of 18 and 30 sells her eggs. One NGO analyst says that among the island's Eastern European immigrants, the rate may reach 1 in 4, and some women give up their eggs several times in a year. By comparison, only 1 of every 14,000 eligible American women donates.
Here is the full story, the article is interesting throughout. Can you guess which women face the highest demand for their eggs? I thank Alex Mann for the pointer.
Arnold Kling, on a roll
Old consensus: we need Freddie and Fannie in order to make housing "affordable."
New consensus: we need them in order to "prevent further house price delclines," in other words, to make housing less affordable.
It's the Goldilocks theory of home mortgage intervention. Most of all, I am curious what is the underlying theory why few private investors would not, without the mortgage agencies, fund mortgages at the right price. I would gladly write a series of blog posts examining those theories, as many of those same investors buy riskier assets, such as some equities. Or is it simply an attempt to hold a finger in the dike?
Our either real or supposed inability to do away with the mortgage agencies over a five-year time horizon is one of the major reasons to be a pessimist about the American economy today. None of the underlying theories about these agencies, and why they are needed, are very good news for any of us. And that is perhaps why those theories are not articulated very often.
The permanent jam?
K. writes and tells me that she imagines someone writing a novel based on this incident and that I will assign it in my Law and Literature class. Here is the excerpt:
A number of people have written in, or tweeted (and don’t forget to find me in the tweetosphere), to tell me about a traffic jam in China, currently in its ninth day, that seems to be on the verge of evolving, as per Cortazar’s story “The Southern Thruway” (an inspiration for Godard’s Weekend), into some kind of makeshift settlement.
This has struck an enterprising verve in some locals, notes the BBC:
The drivers have complained that locals are over-charging them for food and drink while they are stuck.
Then again, what is the “market price” for selling food and drink to 100 km traffic jams?
Instant noodles have risen to four times their market price in this new Chinese city. This account, sent to me by Joshua Hedlund, notes that the jam is 62 miles long and offers good photos.
Is there a government bond bubble?
Here is a symposium over at The Economist:
It is better labeled a bubble in government spending (Viral Acharya)
No, there is a shortage of safe assets (Ricardo Caballero)
Bond yields are probably appropriately low (Stephen King)
Probably not, but approach low-probability risks carefully (Tyler Cowen)
Yes, and it's huge (Laurence Kotlikoff)
It's possible, but there is not enough evidence to be sure (Paul Seabright)
No, growth and deflation concerns have grown sharply (John Makin)
Current adjustments will reduce the risk of a repricing shock (Harold James)
The economics of cloning
Here is the abstract of a paper I have not yet read:
In this paper, we analyze the extent to which market forces create an incentive for cloning human beings. We show that a market for cloning arises if a large enough fraction of the clone’s income can be appropriated by its model. Only people with the highest ability are cloned, while people at the bottom of the distribution of income specialize in surrogacy. In the short run, cloning reduces inequality. In the long run, it creates a perfectly egalitarian society where all workers have a top ability if fertility is uncorrelated with ability and if the distribution of ability among sexually produced children is the same as among their parents. In such a society, cloning has disappeared….
That is by Gilles Saint-Paul (original paper here) and you will find it discussed here.
Sentences to ponder
As Mallaby is at pains to point out on a regular basis, hedge funds in fact have less leverage – a lot less – than banks. Many have none at all; those who do lever up tend to do so only by a factor of two or three, compared to leverage ratios in the 30 to 40 range for many investment banks and even commercial banks, in Europe.
That is Felix Salmon and there is more here.
From the comments
From Ezra's comments, this is ctown_woody:
Ezra,
To what extent is the Fed worried about making a visible commitment and failing? If Tyler Cowen and others are right that this slump is the end of family-deficit spending, it is quite conceivable that the Fed will fail to deliver that which it promises to deliver. At that point, the institutional players in the Fed will have lost credibility, which would lead to a lose of independence from politics.
So, to what extent is the Fed acting like Peter LaFleur from Dodgeball, "If you never try anything, you'll never fail"?
Pecuniary externalities
Samson, a loyal MR reader, requests:
Tyler,
What do you think about pecuniary externalities? What would be a good definition of such externalities, if you find them to be plausible? Without the fiction of an infinite number of buyers and sellers, why isn't it the case that any transaction through the price system, through an impact on price, causes an externality, and might one call such an externality a pecuniary externality? I cannot find much on this subject.
Thanks!
Economists try to make a distinction between pecuniary externalities — changes in price which merely redistribute wealth — and non-pecuniary externalities, which involve a real good or service being provided or denied at the margin. If the price of wheat rises, wheat consumers suffer a pecuniary externality. If you dump garbage on my lawn, that's a non-pecuniary externality, although it may be accompanied by a pecuniary externality, namely a decline in the value of the house. In the meantime, the lawn stinks.
The distinction is often a tricky one, especially in the absence of perfect markets. A lot of the complaints about health care markets are actually complaints about pecuniary externalities, namely that some people get priced out of the market. Alternatively, the risk of facing high prices for cancer treatment may make people nervous and insecure. The notion of "risk" often bundles together pecuniary and non-pecuniary externalities in a not-too-easy-to-separate form.
Efficiency and distribution are not always possible to separate, no matter what the first and second welfare theorems seem to imply.
What about people near subsistence? Say you redistribute $500 from a poor Haitian to a somewhat less poor Mexican, and the Haitian dies and the Mexican buys a used motorbike. Is that "just a transfer"? Or is it "a real resource loss"? I say it's the latter, but then virtually any redistribution will destroy some complementary value from the portfolio of the individual losing the money. What is then left to count as a pure transfer?
There is also no such thing as a pure lump-sum transfer when population is endogenous, either through child-bearing decisions or through taking risks with one's life.
The distinction between pecuniary and non-pecuniary externalities is useful, and hard to do without, but its foundations are shaky. In practical terms the weakness of the foundations matters most when we are doing health care economics or analyzing food subsidies (or comparable forms of aid) in poor countries. The richer and healthier the people are, the more likely the distinction can be invoked without much trouble.
And Samson is correct to think that large numbers of transactions involve pecuniary externalities, at least whenever the particular actions of a buyer or seller influence market price.
Markets in everything
With AwesomenessReminders, a real person will call you every day to tell you how much you rock. If you're not around, we will leave you a voicemail.
For the pointer I thank Paul Sas, who tells me they charge $10 a month.
Here is one of the owner's other sites, www.compassionpit.com: "Chat with an anonymous stranger who won't judge you." To my mind, that claim lowers the credibility of the awesomeness reminders quite a bit.
Interfluidity on the Treasury Meeting
Interfluidity has a very good and accurate post on the meeting with Treasury. It's a long post as it includes the background and context of what was discussed. Also includes links to other write-ups although interfluidity is wrong to say better write-ups.
The bad apples ruin the good
Horton's work raises many questions, not least because it contradicts other work suggesting that it is possible to improve poor workers' output by pairing them with good workers. By contrast, Horton found that "the bad apples ruined the good apples, and the good apples did nothing for the bad."
Here is much more of interest, on new developments in measuring worker productivity. In my view this effect is a significant factor behind the stickiness of wages. Negative signals often mean "get rid of the person" and not "renegotiate a lower wage." I thank an MR reader for the pointer.