Category: Economics

60 Minutes had a moving piece on Sunday about Wilmington, Ohio where thousands of people are losing their jobs due to the closure of the town's largest employer, DHL.  Many people had worked at the air distribution center for decades and through no fault of their own were losing their jobs, their health insurance and in one of the hardest losses of all, their community.  Barack Obama and John McCain both talked about Wilmington in their campaigns and yet for all their talk it's clear that neither monetary nor fiscal stimulus can do much for Wilmington.

One of the things that I do find very disturbing about this recession is that it is worldwide.  World trade may fall this year for the first time since 1982. As I argued earlier, the problem goes beyond any credit crunch, which according to the story below has been solved for trade.  The problem is a lack of demand.  Here is more frightening news on the trade front. 

Freight rates for containers shipped from Asia to Europe have fallen to zero for the first time since records began, underscoring the dramatic collapse in trade since the world economy buckled in October.

Trade data from Asia's export tigers has been disastrous over recent weeks, reflecting the collapse in US, UK and European markets.
Korea's exports fell 30pc in January compared to a year earlier. Exports have slumped 42pc in Taiwan and 27pc in Japan, according to the most recent monthly data. Even China has now started to see an outright contraction in shipments, led by steel, electronics and textiles.

A report by ING yesterday said shipping activity at US ports has suddenly dived. Outbound traffic from Long Beach and Los Angeles, America's two top ports, has fallen by 18pc year-on-year, a far more serious decline than anything seen in recent recessions.
"This is no regular cycle slowdown, but a complete collapse in foreign demand," said Lindsay Coburn, ING's trade consultant.

Idle ships are now stretched in rows outside Singapore's harbour, creating an eerie silhouette like a vast naval fleet at anchor. Shipping experts note the number of vessels moving around seem unusually high in the water, indicating low cargoes.

It became difficult for the shippers to obtain routine letters of credit at the height of financial crisis over the autumn, causing goods to pile up at ports even though there was a willing buyer at the other end. Analysts say this problem has been resolved, but the shipping industry has since been swamped by the global trade contraction.

The use of Google is not allowed:

The answer is here.

Hint: The year is 1942.

A banker has absconded with 86 billion from Dynasty Banking.  Dynasty Banking?  Is that an obscure Icelandic bank?  Almost, it's a bank in the massive world of Eve Online.

Two years ago in a post called The Future of Macroeconomics I wrote the following:

The massive theft from Dynasty Banking is creating a bank run.  There is no FDIC in Eve Online but other banks have agreed to lend Dynasty cash if it is needed – no doubt they fear contagion.  No word yet on whether fiscal or monetary stimulus is planned but I will watch the experiment with interest.

If this is not enough to boggle your mind, Eve Online is in fact an Icelandic firm!  Which explains why the money in Eve is called ISK, also the code for the Iceland Krona.  To bring the story full circle the Icelandic banking collapse is causing problems for the developer.

"The present currency restrictions are putting us in a straitjacket.
We are in talks with the government, but if we can't let capital in, we
might be compelled to leave Iceland, even though this would be against
our wishes."

EVE currently has around 300K subscribers.

Gudmundsson's comments come after those of CCP CEO Hilmar Petursson,
who told Edge in October following the banking collapse, "I’m fortunate
that CCP has hardly been affected by the economic crisis here. We now
have to take advantage of our status as a global company and maintain
our diversified banking relationships."

CCP also has offices in Atlanta and Shanghai.

Finally, in other news, we have this:

Royal Khanid Navy Grand Admiral Zidares Khanid this morning released a
statement claiming that Khanid Kingdom forces yesterday attacked
thirty-three separate Blood Raider Covenant targets – ranging from
unmanned installations to fully-defended outposts – in what the release
terms “an effort to strike a blow against the spreading blight of
willful heresy.”

Just thought you would want to know. Does your head hurt yet?

Thanks to Roger Avalos for the pointer.

Matt Ygelsias asks what’s the
stimulus-skeptics’ alternative prescription?  Tyler offers his recommendations below.  I'm somewhat less of a skeptic about fiscal policy than Tyler – there is a good case for moving up useful infrastructure spending (both public and private) today – but I agree with Tyler that it is too early to think that monetary policy is ineffective.  M1 is rising sharply, M2 is up.  Monetary policy works with lags.  As to what to do instead I have offered a number of possibilities including:

1) Investment Tax Credit Unlike traditional fiscal policy an investment tax credit cannot be
fully crowded out and it works best when it is expected to be
temporary. Cuts in income taxes stimulate the least when they are
expected to be temporary.  But in contrast, an investment tax credit
stimulates the most when it is expected to be temporary because a temporary
credit must be used now or lost while a permanent credit gives you the
option to wait.

2)  A supply side stimulus: The IRS knows how much income that each taxpayer reported last
year.  So let's cut everyone's marginal tax rate based on last year's
income.  In other words, suppose that last year Joe earned $66,520
which puts him in a 25% tax bracket.  Joe's tax schedule this year will
be exactly the same as last year except for every dollar earned above
$66,520 the tax rate drops

to 15%.   We do this for all
taxpayers so that each taxpayer has their own schedule and for each
taxpayer there is a decreasing marginal tax rate.Note that this plan increases the incentive to work and it doesn't
increase the deficit.  In fact, the Tabarrok plan increases tax
revenues!  The key is a marginal tax cut with a different margin for
every taxpayer based upon last year's return.

3). A cut in the payroll tax ala Singapore.  If employment is down reduce the cost of employing labor.  This policy has lot to recommend it because unlike a fiscal stimulus it lets the reallocation process work towards its long run equilibrium.  A construction stimulus, for example, pushes people into construction (or keeps them there) when perhaps labor could ultimately be more productive in other sectors of the economy.  The payroll tax cut enhances this reallocation effort it doesn't impede it.

4)  Don't Panic.  This is the policy that has cured most recessions.  The do anything and do it now mindset feeds panic.  I do think this recession will be longer than average and quite deep, it is a concern that it is worldwide.  But recessions are normal and we have unemployment insurance and other assistance programs to help people through tough times.  The economy will recover and its very possible to make things worse by trying to make things better.

Matt Yglesias asks a very good question:

So to pull a bit of the old burden-shifting, what’s the
stimulus-skeptics’ alternative prescription? At this point in time just
about everyone–liberal or conservative–agrees that it’s generally
preferable to eschew fiscal stimulus and let monetary policy do the
heavy lifting. The pro-stimulus analysis begins not with the idea that
fiscal stimulus is awesome, but with the observation that we’ve already
done a great deal of rate-cutting, can’t cut rates any deeper, and all
signs are of the situation getting worse. Is the anti-stimulus idea to
do nothing and hope for the best? To beg for the world’s surplus
countries (Germany, Japan, China, oil producers, Switzerland, etc.) to
do giant stimulus while we sit around? Are there “unconventional”
monetary policy tricks Bernanke needs to be trying?

Pulling together some previous posts, I recommend:

1. A certain amount of "defensive" fiscal policy aimed at keeping state and local government budgets roughly constant.  This will limit downside but it won't much "stimulate," for reasons which should be apparent in the graph shown by Matt.  In various emergencies it is inefficient that state and local governments are not allowed to run deficits but implicitly the Feds can do it for them.

2. Unorthodox monetary policy, as advocated by Robert Lucas and also, earlier, Keynes.  You can stimulate AD at much lower cost this way.  "Cutting short rates" is by no means synonymous with "monetary policy."

3. Bank recapitalization.  This will cost lots and we should reallocate money away from "stimulus" toward this problem.  Falling aggregate demand is a derivative problem in today's crisis but this is a fundamental problem.  There is a vague sense on the Democratic side that "we can do everything" but the reality is that of the budget constraint, not "guns and butter together."  Have you noticed that Obama is not presenting a consolidated recapitalization/stimulus bill?  That is no accident.

I should add that I am skeptical of tax cuts as a form of stimulus, so we should evaluate tax reforms on their own merits, which involves broader questions about the overall path of spending and taxes.  But if you wish to go this route, cutting the payroll tax is probably the most promising idea.

From Thomas Philippon and Ariell Reshef, I thought this was an important paper:

We use detailed information about wages, education and occupations to
shed light on the evolution of the U.S. financial sector over the past
century. We uncover a set of new, interrelated stylized facts:
financial jobs were relatively skill intensive, complex, and highly
paid until the 1930s and after the 1980s, but not in the interim
period. We investigate the determinants of this evolution and find that
financial deregulation and corporate activities linked to IPOs and
credit risk increase the demand for skills in financial jobs. Computers
and information technology play a more limited role. Our analysis also
shows that wages in finance were excessively high around 1930 and from
the mid 1990s until 2006. For the recent period we estimate that rents
accounted for 30% to 50% of the wage differential between the financial
sector and the rest of the private sector.

Here is a summary article on the piece and one of the lessons is that the future of the income inequality debate lies at the micro-micro level.  The authors claim, by the way, that this 30 to 50 percent wage differential can be expected to disappear.  Right now that looks like a pretty safe bet.

It comes not from a professional economist but from Warren Buffet, here goes:

Sadly, that's about as scientific as we've been able to get.

Matt Yglesias has a very good post on Robert Barro's latest.  Brad DeLong seems to agree with Matt.  Paul Krugman uses the word "boneheaded" to describe the Barro piece.

This exchange is a good micro-cosm of how the stimulus debate has proceeded.  A highly respected anti-stimulus economist puts up some anti-stimulus evidence in a highly imperfect test (in Barro's defense, he did cover more than just WWII).  The anti-stimulus economist is attacked by pro-stimulus economists.  But the pro-stimulus proponents are focused on attack.  They are not putting up comparable empirical evidence of their own for the efficacy of fiscal policy and there is a reason for that, namely that the evidence isn't really there.

I fully admit that I don't trust the oft-cited evidence that tax cuts are 4x better stimulus than government spending boosts; I think the result is a mirage from underspecified models.  Overall we simply don't know how well the proposed stimulus will work — if at all (is aggregate demand always the relevant war?).  It's a kind of Hail Mary pass, an enduring belief in aggregate demand macroeconomics at the theoretical level, even in light of broken banks, sectoral shifts, and nasty, failing expectations, all mixed in with hard to spend well, slow to come on line, monies.  Yes it could work but our agnosticism should be strong rather than just perfunctory. 

Writing polemics against market-oriented economists, no matter what the failings of such economists (and I am one of them, and I have failings), doesn't get us out of that box.

I'll say it again to the pro-stimulus forces: a stimulus is going to happen, so I'd love to be cheered up by your evidence.  Put it on the table.

I also am confused by Krugman's view of the relevance of WWII.  On his blog, at the end of a discussion of how the historical example of WWII doesn't much apply, he writes:

I can’t quite imagine the mindset that leads someone to forget all
this, and think that you can use World War II to estimate the
multiplier that might prevail in an underemployed, rationing-free
economy.

And he is upset at Barro for thinking that the WWII experience does apply.  Fair enough, but a) the War didn't start at full employment, and b) is it possible that Barro received this impression from reading Krugman himself?  In Rolling Stone last week Krugman wrote:

It
took the giant public works project known as World War II – a
project that finally silenced the penny pinchers – to bring
the Depression to an end.

The lesson from FDR's limited success on the employment front,
then, is that you have to be really bold in your job-creation
plans. Basically, businesses and consumers are cutting way back on
spending, leaving the economy with a huge shortfall in demand,
which will lead to a huge fall in employment – unless you
stop it. To stop it, however, you have to spend enough to fill the
hole left by the private sector's retrenchment.

If you read both Krugman passages closely, there is not actually a literal contradiction.  But still, a fundamental decision has to be made on whether to run away from the WWII evidence or not.  I say the WWII evidence does not apply and so I am closer to Krugman as he writes on his blog.

Either way you cut it, there aren't any boneheads in the room.

Here are a few key graphs from Time Magazine's cover story.  Read them carefully.

Did the last line give it away?  The article is describing the recession of 1991, an unusually mild recession that preceeded one of the biggest expansions in American history.

Thanks to Roger Congleton for the link.

You'll find the link here; I believe that Megan McArdle has a role in managing the site.

And who do I choose to link to but myself.  Here is my guest post on bank nationalization.  I could have stressed further that bank nationalization works best in small countries with a small number of banks.  The more banks a country has, the greater the danger that nationalizing a few of them will make the rest much harder to recapitalize, thereby leading to a kind of contagious need for nationalization.

But enough of me (can any blogger say that with a straight face?).  Here is a good post on the perils of Medicare reform.

You'll find them here.  They are all excellent but I thought Kevin Murphy was the most to the point.  

The issue is here, I was sent this summary of the articles:

Are the most capable women and the most
capable men equally capable? Previously, Garett Jones, John
Johnson, and Catherine Hakim questioned Christina Jonung's and
Ann-Charlotte Ståhlberg's call for more women in economics. Now
Jonung and StÃ¥hlberg respond. 

Banks don't function well at low levels of capitalization, so there is a strong and understandable tendency to want to "do something."  Everyone says nationalization is not intended as a long-term solution but the question is whether government ownership will succeed in building up a greater capital cushion for the banks.  If the environment for banking is not favorable, it won't and banks will have to stay nationalized.

How many years of profits are needed to create the cushion of capital which is required for re-privatization?  And how many years of government ownership will be needed to generate that many years of profits?  Will banks owned by the government be allowed to pursue profits, rather than lending to troubled industries in the districts of influential Congressmen?  Or will government just stick money in the bank and hope they have thereby created a sound enterprise?

You might take the line: "Government is bad at running bail-outs, but it sure is good at running banks," but of course that's a tough sell.

Those are the questions you should be asking.  Admittedly the alternatives to nationalization don't currently look so great either.

Kevin Drum adds some good points.  Felix Salmon offers ongoing coverage.

The liquidity trap is often cited as the reason why fiscal policy is required to get us out of the downturn. 

My view is this: the short-run nominal interest rate is different than is
socially optimal but that doesn't mean the economy is in a trap.  Liquidity trap proponents have lots of good evidence for the former proposition but much less evidence for the latter notion of a true trap.

I think of liquidity trap arguments as stressing the extreme importance of a single market price, namely the relative price between cash and T-Bills.  In general I am suspicious of macroeconomic arguments which place so much weight on a single price being out of whack.  You can put the Austrians into this camp (the loan rate of interest is wrong) and you can put the supply-siders into this camp (the tax rates on labor or perhaps capital are too high).  Even though I think the short-run interest rate is "wrong," from the point of view of social optimality, that is not a driving fact of central macroeconomic importance.  This doesn't have to be a "pro market" argument: in fact one can think that many different prices and quantities have comparably important degrees of "wrongness."

Here's a short list of economists who have expressed (varying degrees of) skepticism about liquidity trap arguments: D.H. Robertson, Jacob Viner, Milton Friedman, Philip Cagan, Don Patinkin, Auerbach and Obstfeld, Robert H. Lucas, Greg Mankiw, and, I might add, Bernanke and Blinder.  You can make a case for adding Franco Modigliani to the list, although his article is cryptic in some regards.  Leo Svensson has many interesting papers critical of the idea of a liquidity trap as a binding constraint. 

It is possible that of these people are wrong but they do all understand Keynes's theory of interest and they do all understand how the liquidity trap is supposed to work.  Nor are they merely citing "the real balance effect" as it is usually dismissed.  These economists just don't think that so much in an economy can revolve around a single incorrect price.  Many or all of them believe that monetary policy can work on other prices as well and through other channels.

There is also some good evidence that maybe the Great Depression wasn't a liquidity trap either.  Here is some evidence against Japan having been in a liquidity trap in the 1990s.  Neither of those papers is definitive; my point is that people who are skeptical of the liquidity trap argument aren't simply being pigheaded or ideological.

The overall point is that this talk of a liquidity trap — as a true trap (and not just another screwy price) — is a speculative hypothesis, not an obvious truth.

And unless you regard "the liquidity trap" as a true trap, you needn't favor such a large fiscal stimulus.