Results for “interest rates risk fed” 63 found
Does the Obamacare mandate actually make people better off?
Here is my latest NYT Upshot column, on the topic of the Affordable Care Act. Here is what is to me the key excerpt:
But there is another way of looking at it, one used in traditional economics, which focuses on how much people are willing to pay as an indication of their real preferences. Using this measure, if everyone covered by the insurance mandate were to buy health insurance as the law dictated, more than half of them would be worse off.
This may seem startling. But in an economic study, researchers measured such preferences by looking at data known as market demand curves. Practically speaking, these demand curves implied that individuals would rather take some risk with their health — and spend their money on other things — partly because they knew that even without insurance they still would receive some health care. These were the findings of a provocative National Bureau of Economic Research working paper, “The Price of Responsibility: The Impact of Health Reform on Non-Poor Uninsureds” by Mark Pauly, Adam Leive, and Scott Harrington; the authors are at the Wharton School at the University of Pennsylvania.
One implication is that the preferences of many people subject to the insurance mandate are likely to become more negative in the months ahead. For those without subsidies, federal officials estimate, the cost of insurance policies is likely to increase by an average of another 7.5 percent; even more in states like Oklahoma and Mississippi. The individuals who are likely losers from the mandate have incomes 250 percent or more above the federal poverty level ($11,770 for a single person, more for larger families), the paper said. They are by no means the poorest Americans, but many of them are not wealthy, either. So the Affordable Care Act may not be as egalitarian as it might look initially, once we take this perspective into account.
I should stress that, at this point, I don’t see any realistic alternative to trying to improve ACA. Still, I find it distressing how infrequently this problem is acknowledged or dealt with, probably from a mix of epistemic closure, a “health insurance simply has to make people better off” attitude, and a dose of “let’s not give any ammunition to the enemy.” In fact, I think a lot of Democratic-leaning economists and commentators are doing a real disservice to their own causes on this one.
It’s worth noting that Kentucky, one of the best-functioning ACA state exchanges, just elected a Republican governor who very explicitly pledged to tank the current set-up as much as possible, Medicaid too. I think it’s time to admit this is not just Tea Party activism or Hee Haw political stupidity, rather a large number of the people subject to the mandate simply are not better off as would be judged by their own preferences. And that is not a secondary problem of Obamacare, it is a primary problem.
Interestingly, I found the NYT reader comments on my piece to be fairly supportive, which is not always the case. There’s a good deal of “this happened to me, too,” and not so much raw invective about whatever defects I may have.
I think it is a big mistake to argue Obamacare is on the verge of collapse, or whatever other exaggeration of the day may be at hand. Still, I don’t find the current set-up of the exchanges to be entirely stable, at least not in terms of ongoing popularity, much less consumer sovereignty.
A key question is what happens moving forward. One option, which I had not initially expected, is for the exchanges to narrow and evolve into an expanded version of some of the earlier plans for a segregated high-risk pool. In that case, the argument would morph from “don’t worry, enough people will sign up for the exchanges” into “the welfare effects here are still positive, because fortunately not everyone signs up for the exchanges.” The high risk pool would then at some point require additional subsidies. In the past, I argued that the penalties for not signing up were too low, but under this scenario it may be desirable to lower rather than raise those penalties.
We’ll see. The piece covers other issues as well, do read the whole thing.
Here is Megan on the costs of ACA plans. Here are some interesting calculations from Jed Graham.
I worry about the carry trade
Remember, in a global economy with multiple currencies, or an economy with lots of price variation, the notion of a single “real interest rate” is tricky. The standard Fisherian story implies real interest rate near-neutrality across a wide set of expected monetary policy decisions. Say expected inflation goes up, the nominal interest rate goes up, and the real rate stays constant, except for a small liquidity effect.
But that story will not apply across the board. If, for instance, you live and consume in Jakarta, and you do not hold a PPP theory of the exchange rate, as indeed you should not, well, borrowing in dollars just got more expensive in real terms (with complicated qualifiers depending on forward rates which in reality don’t predict future currency movements so well). Or if the Fed lowers nominal rates, your real borrowing rate goes down, maybe by more or less the same percentage amount as the nominal rate went down for the Americans.
And if those Indonesians are optimistic about the performance of their own currency vis-a-vis the U.S. dollar, crikey! — their current real interest rates from dollar borrowing appear to be very low indeed. And if we are considering the individuals who hold disproportionate shares of non-USD currencies, almost by definition they are overly optimistic about the non-USD currencies.
And there are yet further complications which the nice weather today prevents me from outlining (what if those Indonesians are the marginal investors and they push around the market price for the Americans?)
All of which makes the Fed’s job much tougher. Here is the latest from Bloomberg:
Since the 2008 financial crisis, companies across emerging markets have been borrowing dollars and converting them into local currencies as part of a massive carry trade. This practice has helped U.S. dollar shadow banking go global as the effects of near-zero U.S. interest rates seep into all corners of the world economy.
That’s the main finding of a new report released Thursday by the Bank for International Settlements, an institution in Basel, Switzerland, known as the central bank for central banks.
The paper, co-authored by Valentina Bruno, a finance professor at American University, and BIS Economic Adviser and Head of Research Hyun Song Shin, serves as a follow-up to a report released by the bank in January that found firms outside the U.S. have borrowed $9 trillion in U.S. dollars, up from $6 trillion before the global financial crisis.
To be sure, we do not know how harmful these practices might be, or not. Here is FT coverage of the same:
By doing so companies become shadow banks, financial intermediaries moving dollars into local economies. Note, manufacturers do not have to explicitly act like hedge fund managers. Simply depositing funds with a local bank will help it to extend credit to other customers, while buying local commercial paper provides funds to domestic businesses.
The realisation prompts further questions. If it becomes more expensive to borrow in dollars, because say China fears prompt less dollar lending, will the corporate carry trade stop? Will it matter if it does?
I simply wish to reiterate that, no matter how many times commentators cite the low rate of price inflation, there are risks on both sides of the Fed’s forthcoming monetary policy decision.
Here is my much earlier post on monetary policy and the carry trade. Beware the too-rapid acceptance of the strict Fisherian equation! Once again, we do not live in a representative agent world and furthermore the multiplicity of agents speak a variety of languages and use a variety of currencies.
The Ferguson Kleptocracy
In Ferguson and the Modern Debtor’s Prison I wrote:
You don’t get $321 in fines and fees and 3 warrants per household from an about-average crime rate. You get numbers like this from bullshit arrests for jaywalking and constant “low level harassment involving traffic stops, court appearances, high fines, and the threat of jail for failure to pay.”
The DOJ report on the Ferguson Police Department verifies this in stunning detail:
Ferguson has allowed its focus on revenue generation to fundamentally compromise the role of Ferguson’s municipal court. The municipal court does not act as a neutral arbiter of the law or a check on unlawful police conduct.
… Our investigation has found overwhelming evidence of minor municipal code violations resulting in multiple arrests, jail time, and payments that exceed the cost of the original ticket many times over. One woman, discussed above, received two parking tickets for a single violation in 2007 that then totaled $151 plus fees. Over seven years later, she still owed Ferguson $541—after already paying $550 in fines and fees, having multiple arrest warrants issued against her, and being arrested and jailed on several occasions.
Predatory fining was incentivized:
FPD has communicated to officers not only that they must focus on bringing in revenue, but that the department has little concern with how officers do this. FPD’s weak systems of supervision, review, and accountability…have sent a potent message to officers that their violations of law and policy will be tolerated, provided that officers continue to be “productive” in making arrests and writing citations. Where officers fail to meet productivity goals, supervisors have been instructed to alter officer assignments or impose discipline.
Excessive, illegal and sometimes criminal force was used routinely:
This culture within FPD influences officer activities in all areas of policing, beyond just ticketing. Officers expect and demand compliance even when they lack legal authority. They are inclined to interpret the exercise of free-speech rights as unlawful disobedience, innocent movements as physical threats, indications of mental or physical illness as belligerence. Police supervisors and leadership do too little to ensure that officers act in accordance with law and policy, and rarely respond meaningfully to civilian complaints of officer misconduct. The result is a pattern of stops without reasonable suspicion and arrests without probable cause in violation of the Fourth Amendment; infringement on free expression, as well as retaliation for protected expression, in violation of the First Amendment; and excessive force in violation of the Fourth Amendment.
Here is one example:
In January 2013, a patrol sergeant stopped an African-American man after he saw the man talk to an individual in a truck and then walk away. The sergeant detained the man, although he did not articulate any reasonable suspicion that criminal activity was afoot. When the man declined to answer questions or submit to a frisk—which the sergeant sought to execute despite articulating no reason to believe the man was armed—the sergeant grabbed the man by the belt, drew his ECW [i.e. taser, AT], and ordered the man to comply. The man crossed his arms and objected that he had not done anything wrong. Video captured by the ECW’s built-in camera shows that the man made no aggressive movement toward the officer. The sergeant fired the ECW, applying a five-second cycle of electricity and causing the man to fall to the ground. The sergeant almost immediately applied the ECW again, which he later justified in his report by claiming that the man tried to stand up. The video makes clear, however, that the man never tried to stand—he only writhed in pain on the ground. The video also shows that the sergeant applied the ECW nearly continuously for 20 seconds, longer than represented in his report. The man was charged with Failure to Comply and Resisting Arrest, but no independent criminal violation.
Here is another, especially interesting, example:
While the record demonstrates a pattern of stops that are improper from the beginning, it also exposes encounters that start as constitutionally defensible but quickly cross the line. For example, in the summer of 2012, an officer detained a 32-year-old African-American man who was sitting in his car cooling off after playing basketball. The officer arguably had grounds to stop and question the man, since his windows appeared more deeply tinted than permitted under Ferguson’s code. Without cause, the officer went on to accuse the man of being a pedophile, prohibit the man from using his cell phone, order the man out of his car for a pat-down despite having no reason to believe he was armed, and ask to search his car. When the man refused, citing his constitutional rights, the officer reportedly pointed a gun at his head, and arrested him. The officer charged the man with eight different counts, including making a false declaration for initially providing the short form of his first name (e.g., “Mike” instead of “Michael”) and an address that, although legitimate, differed from the one on his license. The officer also charged the man both with having an expired operator’s license, and with having no operator’s license in possession. The man told us he lost his job as a contractor with the federal government as a result of the charges.
Although the report says the initial stop was constitutionally defensible, the initial stop was also clearly bullshit. “The officer arguably had grounds to stop and question the man, since his windows appeared more deeply tinted than permitted under Ferguson’s code.” Deep tinting!!!
Missouri, like most states, has a window tint law which essentially requires that tinting not be so dark as to impede the ability of the driver to see out of the car. Ok. But why does Ferguson have a window tint law! What this means is that you can be fined for driving through Ferguson for window tinting which is legal in the rest of Missouri. Absurd. Correction: the code appears to be the same as the state code but passed as a municipal ordinance so fines were collected locally. The purpose of the law was simply to extract more blood:
NYTimes: Last year Ferguson drivers paid $12,400 in fines for driving cars with tinted windows. They paid another $4,905 for loud music coming out of their cars.
The abuse in Ferguson shouldn’t really surprise us–this is how most governments behave most of the time. Democracy constrains what governments do but it’s a thin constraint easily capable of being pierced when stressed.
The worst abuses of government happen when an invading gang conquer people of a different race, religion and culture. What happened in Ferguson was similar only the rulers stayed the same and the population of the ruled changed. In 1990 Ferguson was 74% white and 25% black. Just 20 years later the percentages had nearly inverted, 29% white and 67% black. The population of rulers, however, changed more slowly so white rulers found themselves overlording a population that was foreign to them. As a result, democracy broke down and government as usual, banditry and abuse, broke out.
Interview with John Cochrane
There are many interesting bits from the interview, sometimes polemic bits too, here is one excerpt:
EF: What do you think are the biggest barriers to our own economic recovery?
Cochrane: I think we’ve left the point that we can blame generic “demand” deficiencies, after all these years of stagnation. The idea that everything is fundamentally fine with the U.S. economy, except that negative 2 percent real interest rates on short-term Treasuries are choking the supply of credit, seems pretty farfetched to me. This is starting to look like “supply”: a permanent reduction in output and, more troubling, in our long-run growth rate.
This part reminds me of some ideas in my own Risk and Business Cycles:
There is a good macroeconomic story. In a business cycle peak, when your job and business are doing well, you’re willing to take on more risk. You know the returns aren’t going to be great, but where else are you going to invest? And in the bottom of a recession, people recognize that it’s a great buying opportunity, but they can’t afford to take risk.
Another view is that time-varying risk premiums come instead from frictions in the financial system. Many assets are held indirectly. You might like your pension fund to buy more stocks, but they’re worried about their own internal things, or leverage, so they don’t invest more.
A third story is the behavioral idea that people misperceive risk and become over- and under-optimistic. So those are the broad range of stories used to explain the huge time-varying risk premium, but they’re not worked out as solid and well-tested theories yet.
The implications are big. For macroeconomics, the fact of time-varying risk premiums has to change how we think about the fundamental nature of recessions. Time-varying risk premiums say business cycles are about changes in people’s ability and willingness to bear risk. Yet all of macroeconomics still talks about the level of interest rates, not credit spreads, and about the willingness to substitute consumption over time as opposed to the willingness to bear risk. I don’t mean to criticize macro models. Time-varying risk premiums are just technically hard to model. People didn’t really see the need until the financial crisis slapped them in the face.
I’ve long believed the risk premium is the underexplored variable in macroeconomics and finally this is being rectified.
The new “carry trade”?
Loosely regulated non-bank lenders have emerged as among the biggest beneficiaries of the Federal Reserve’s ultra-low interest rates with three specialist categories increasing their assets by almost 60 per cent since the height of the financial crisis.
Such lenders, widely considered part of the “shadow banking” system, have expanded rapidly on the back of investors who are clamouring for the higher returns on offer from financing riskier types of lending.
From the FT, there is more here.
For how long can the carry trade go on?
Here is a rather scary article by @exantefactor, consider it speculative and please use with care, nonetheless I thought it was worth a ponder. Here is one bit:
This QE carry trade nightmare became reality last week, and the Eurodollar pit was ground zero. As carry trade asset prices come under pressure due to rising US real interest rates, investors are forced to sell Eurodollars to hedge higher financing costs and negative gamma exposure. The magnitude of the selling implies that there is a lot of money exposed, but it’s not clear what still needs to unwind.
Last week, there were rumors of bond dealers who were both liquidating MBS inventory and ceasing to bid on these securities until quarter end. There were also accounts of liquidity drying up in the Treasury market. When dealers cease to bid on the assets that collateralize the loans for carry trades, the system is frozen. This is serious.
If you believe the accounts in the media, you would think the Fed believes the move in the front end of the yield curve, including the Eurodollar strip, is a misinterpretation of Fed tightening. The Eurodollar market not only has an interest rate component but also a credit component, and one interpretation of the blow out in the strip is a spike in banking system credit risk.
…Make no mistake about it: Bernanke is blowing up the QE trade he engineered. The question for markets at this juncture is not what assets are exposed to this trade but rather how much capital is exposed and who will take the other side of the unwind. The move in the most liquid part of the rates curve suggests that the position is very deep; the reluctance of dealers to bid on financing collateral suggests the bid is very shallow. Finding a level where that bid/ask comes together is likely to be a very disruptive process, and if history is any guide, the “collateral” damage will be felt around the world.
The full article is here, hat tip goes to Izabella Kaminska. Is “we haven’t been understanding the carry trade” the key to unpacking some otherwise puzzling recent asset price movements?
Are we living in a time of asset bubbles?
Here is one typical complaint about bubbles, from Jesse Eisinger, excerpt:
We are four years into the One Percent’s recovery. Now, we are in Round 3 of quantitative easing, the formal term for the Fed injecting hundreds of billions of dollars into the economy by purchasing longer-term assets like Treasury bonds and Fannie Mae and Freddie Mac paper. What’s that giving us? Overvalued stocks. Private equity firms racing to buy up Arizona real estate. Junk bond yields at record lows. Ratings shopping on structured financial products.
These are dangerous signs of prebubble activity.
Here is a Krugman rebuttal. I will offer a few points on a series of debates which in general I have stayed away from.
1. I don’t find most predictive discussions of bubbles interesting, while admitting that such claims often will prove in a manner correct ex post. “OK, the price fell, but was it a bubble? I mean was there froth, like on your Frappucino?” Or to quote Eisinger, it might also have been “dangerous signs of prebubble activity” (what happens between the “prebubble” and the “bubble”? The “nascent bubble”? The “midbubble”? The “midnonbubble”?)
2. Good news and improving conditions may well bring more bubbles or greater likelihood of bubbles, but that is hardly reason to dislike good news and improving conditions.
3. Relative to measured real interest rates, stocks look cheap right now. That doesn’t mean they are, but reread #1.
4. No one understands the term structure of interest rates, no matter what they tell you. Reread #1.
5. I don’t see why anything particular about the current state of affairs, at least in the United States, needs to be “unwound.” I sometimes draw a distinction between those of us who have been thinking about interest on reserves since S. Tsiang, Fischer Black, and the Reserve Bank of New Zealand, and those of us who have not.
6. One coherent definition of bubble is that of a hot potato, traded in a world of heterogeneous expectations, but which must ultimately pop, because eventually the price of that asset will consume all of gdp, a bit like those old Tokyo parking spots. Fair enough, but I don’t see that in many asset markets today if any (Bitcoin for a while?).
7. Another coherent definition of a bubble has less to do with a dynamic price path and ongoing resale for gain, but rather there may be a (temporary) segmentation across classes of asset market buyers. The obvious candidate here is that many people and institutions have been frightened into Treasuries and away from almost everything else. That could mean we have a real interest rate bubble, but it also could mean that lots of other assets are undervalued, at least if the liquidity effect defeats the higher real interest rate effect of moving out of Treasuries. (It would be odd to think that a shift of funds out of Treasuries and into stocks would cause stock prices to fall, but perhaps some people fear this.)
I don’t agree with this view, but I do feel I understand it. The most likely “bubble” is then in real interest rates, due to a (temporary?) skewing of the risk premium. That all said, I do not think this should be called a bubble. Changes in the risk premium and “bubbles” have traditionally been considered alternative explanations for asset prices. Reread #1, and reread #4 while you’re at it.
8. Ruchir Sharma made some interesting points yesterday:
Far from fighting off a deluge of foreign capital, leaders from India to South Africa are struggling to attract a greater share of global capital flows in order to fund widening current account deficits. Over the past decade, the foreign exchange reserves of the developing world grew at an average annual rate of 25 per cent, swelling from $570bn in 2000 to $7tn in 2011. But over the past year, the average rate slowed to a crawl of barely 5 per cent.
The idea that money is still flooding emerging markets misses the big picture, which is that global cross-border capital flows are down 60 per cent from their 2008 peak. The largest shares of cross-border capital flows are in bank loans, trade and foreign direct investment, which are slowing worldwide.
9. I expect the real economy over the next twenty years to be more volatile than it was say in the 1990s. In that sense, many current asset market prices may be revised and quite dramatically. Still, I don’t find the bubble category to be so useful in this regard. We really don’t know what is going to happen and that is why the current prices are wrong, not because of a “bubble.”
10. I am probably done blogging about bubbles for a while. Satisfying you was not the goal of this post, but that is in the nature of the subject area, not out of any desire for spite.
Thoughts on how to avoid another Great Depression
This is another excellent Martin Wolf column, read the whole thing. Here is one excerpt:
Before now, I had never really understood how the 1930s could happen. Now I do. All one needs are fragile economies, a rigid monetary regime, intense debate over what must be done, widespread belief that suffering is good, myopic politicians, an inability to co-operate and failure to stay ahead of events. Perhaps the panic will vanish. But investors who are buying bonds at current rates are indicating a deep aversion to the downside risks. Policy makers must eliminate this panic, not stoke it.
I believe people should take more seriously the notion that the ECB will remain hopeless, and that the crisis can only be addressed by some kind of joint US-German-UK-toss-in-the-other-sound-countries radical multilateral move. Which is not to say I am predicting that. But at least in principle, those three countries can get something done and they also have stronger common interests than those across the eurozone, sorry to say.
Just to make the comparison biting, what if we postponed the costly benefits part of ACA for a year (it may be struck down anyway) and send $200 billion directly to Spain and its banks? Is more money needed? Use this as an excuse to get rid of farm subsidies and cut defense spending. Surely the Germans would then chip in too, and perhaps even the Chinese, if we made the donors club sound exclusive and toney enough. Drop hints about various silly islands (not Taiwan).
Have the new QEwhatever driven by purchases of Spanish mortgages. If they keep the money abroad, we lose only the cost of the paper or the electronic bookkeeping entries. If they buy American goods and services with it, consider it QEwhatever as applied to American exports rather than mortgage paper. No liquidity trap there, and the Fed doesn’t itself have to choose which exports to buy. Combine with the Fed’s FX swap facility in some kind of nefarious way, and we can invent four or five new acronyms. And so on. We would still have a long, grinding worldwide recession but perhaps much less of an AD collapse with it.
I understand that Obama may not be the binding constraint here, but is he even thinking about pulling this off? Is he sitting around wishing for it? Is anyone talking to him about these options?
Excess Reserves and Intraday Credit
In my 2008 post, Interpreting the Monetary Base Under the New Monetary Regime, I argued that the massive increase in bank reserves was neither a necessary harbinger of inflation (as people on the right feared) nor a sure sign of a liquidity trap (as people on the left claimed) but rather represented, at least in part, a sensible aspect of the new regime of paying interest on reserves. I wrote:
When no interest was paid on reserves banks tried to hold as few as possible. But during the day the banks needed reserves – of which there were only $40 billion or so – to fund trillions of dollars worth of intraday payments. As a result, there was typically a daily shortage of reserves which the Fed made up for by extending hundreds of billions of dollars worth of daylight credit. Thus, in essence, the banks used to inhale credit during the day – puffing up like a bullfrog – only to exhale at night. (But note that our stats on the monetary base only measured the bullfrog at night.)
Today, the banks are no longer in bullfrog mode. The Fed is paying interest on reserves and they are paying at a rate which is high enough so that the banks have plenty of reserves on hand during the day and they keep those reserves at night. Thus, all that has really happened – as far as the monetary base statistic is concerned – is that we have replaced daylight credit with excess reserves held around the clock.
A post today at Liberty Street Economics, the blog of the New York Federal Reserve illustrates and explains how the excess reserves have reduced transaction costs in the payment system and risk to the Federal Reserve.
The last chart shows the level of intraday credit extended by the Federal Reserve to Fedwire participants, measured as the daily maximum amount extended by the Federal Reserve. There has been a dramatic decline in the amount of credit extended since the expansion of reserve balances in October 2008. The reduced level of daylight credit has the benefit of reducing the risk exposure of Federal Reserve Banks, as well as the Federal Deposit Insurance Corporation’s (FDIC) fund. Indeed, the expected losses to that fund would be greater if some of the assets of a failed bank had been pledged to a Federal Reserve Bank to collateralize a daylight overdraft, as the collateral would not be available to pay other creditors of the bank. With a greater amount of reserves in the system, banks largely “prepay” for their liquidity needs by maintaining large reserve balances with which to fund their outgoing payments.
Bubbles and economic potential and potential gdp
Here is a Krugman post on the question, here are earlier posts from Sumner and Yglesias. I will put my remarks under the fold…This topic is easiest to understand if you sub out the United States and sub in Greece. There is no AD boost that can (anytime soon, without a lot of extra growth kicking in), restore Greece to its previous output peak and its previously expected performance-to-come. Circa 2006, Greece was in an unsustainable position, if for no other reason the market didn’t understand the correct risk premium for Greece. Once the correct risk premium is applied, Greek output falls and furthermore numerous (related) bad events kick in and also a whole set of previous plans are shown to be unsustainable (and no this doesn’t have to be an Austrian argument!). The gap between Greece’s current path, and the path previously envisioned for Greece is thus:
a. part AD gap which can be fixed by AD policy
b. part a difference in risk premia, and for Greece the old risk premium, when the country borrowed at very low rates, was wrong and is gone more or less forever. The concomitant financial and fiscal stability is gone too.
c. part a difference in enthusiasm in supply, based on the differences between earlier expectations that “get rich quick” really does apply to Greece, and the current more pessimistic expectation that “get rich quick” is now unlikely, and thus “smaller-scale, scrabble-around projects just to make ends meet” are the order of the day. DeLong gets at some of this here.
Greece does have to rebuild a) — don’t get sucked into aggregate demand denialism! — but it also has to rebuild b) and c) and perhaps other factors too. This follows rather directly from — dare I breathe the words? — the synthetic real business cycle/neo Keynesian models which form the backbone of contemporary macroeconomics and which Krugman apparently still doesn’t wish to recognize. (To various commentators and other bloggers: when I write macro on this blog I usually take knowledge of these models for granted; if you don’t know those models that is fine, call me arcane, but it doesn’t mean I am the one who is wrong.) Krugman runs through a bunch of weak arguments and responses, and counters them well enough, but he doesn’t see or consider the baseline response that would follow from standard contemporary macro, with the possible exception of his brief parenthetical phrase about credit conditions.
Turning for a moment to broader points, the astute reader will note that in this framework the current sluggishness of recovery need not be evidence for Old Keynesianism. An ineffective response to fiscal policy does not per se have to mean we just didn’t do enough fiscal policy. And so on. Maybe yes, maybe no, but all of a sudden there is a lot more room for agnosticism about macroeconomics and more broadly there is more room for epistemic modesty.
Contra Tim Duy, you can hold this mixed view without wanting to see the Fed raise interest rates. Just avoid the AD denialism.
Krugman defines “potential GDP is a measure of how much the economy can produce” but keep in mind that this quite possibly won’t be a unique number. With what risk premium? With what enthusiasm of supply? See my Risk and Business Cycles for an extended discussion and also numerous citations.
It’s also worth noting that while gdp is a useful “we can all agree upon what to measure” kind of concept, its real meaning is conceptually fairly slippery and “potential gdp” is not likely to be better pinned down at its foundations. Let’s not reify that concept above and beyond what it is worth.
In any case, we can be agnostic about the size of the potential gdp gap with regard to the United States today and indeed my original post very carefully used a question mark in its title. But there is no incoherence to assert that part of the apparent gap is due to the real side. The new learning about America is not about the correct risk premium for our debt (not yet at least), but about our financial fragility, how well our politics responds to crises, some worrying long-term trends in the labor market, possible misreadings of the productivity numbers, and a few other real factors. It really is possible that previous investment plans were based on expectations of the real economy that were wrong and unsustainable and now have been (partially?) corrected, with negative growth penalties looking forward.
Stephen Williamson offers very detailed comment, noting also that the recession started well over four years ago, which gives plenty of time for nominal resets, and we’ve seen no downward cascading spiral, so maybe there is a non-AD problem with getting back on track at the preferred rate. He also eschews AD denialism. Today Krugman has a brief note along the lines that the views of his opponents on these questions are “even worse than your first impression” but that is best thought of as a) his occasional churlishness, and that b) his writings on this topic do not, at least not to date, reflect a very thorough knowledge of the relevant literature(s).
Claims about monetary policy: the substitution of public credit for private credit
By flooring maturities out to two years then, and perhaps longer as a result of maturity extension policies envisioned in a forthcoming operation twist later this month, the Fed may in effect lower the cost of capital, but destroy leverage and credit creation in the process. The further out the Fed moves the zero bound towards a system wide average maturity of seven to eight years the more credit destruction occurs, to a US financial system that includes thousands of billions of dollars of repo and short-term financed-based lending that has provided the basis for financial institution prosperity.
I am surprised we don’t hear this claim more often. When it comes to expansionary fiscal policy, this kind of critique is common, namely that substitution of public debt for private debt makes subsequent “withdrawal” quite difficult. To get to Gross’s point, add on another step or two to the argument. Monetary policy and fiscal policy these days have melded. We pay interest on reserves. We have created a lot more safe securities through bank reserves, but ultimately as a substitute for private intermediation through M3. Through monetary policy, we are trying to expand but at the same time pushing out M3 and getting more bank reserves at the Fed, etc.
The problem with this argument, if interpreted as a critique, is that a superior alternative is hard to outline. It also places too much stress on the term structure rather than the absence of creditworthy borrowers. And besides, who wants extreme deflation? Still, this argument scares me. It illustrates how vulnerable our current position is and it illustrates that we have not solved the fundamental problems which became apparent in 2008-2009.
There is a lot of snorting at people who favor higher interest rates from the Fed. I do not agree with that recommendation, but Gross’s comment gives us some ability to understand it as a recommendation. Think of it as a combined exercise of plug-pulling and collapse of deflationary risk into the present, in the hope that private credit will emerge from the rubble as a source of future economic growth.
Jeremy Stein, a new FOMC nominee
Stein is one of the most creative contemporary economists, with some truly interesting and first-rate papers in the early to mid 1990s. He has kept up his quality and creativity since then. Most of the early papers are in mid-brow theory, industrial organization, and signaling. Here is one of his very recent papers on macroprudential regulation; it stresses the importance of dynamic bank recapitalization. He is a very smart and still underrated economist; he’s one of the few where I will more or less automatically start reading his papers when I run across them. I have no idea how he would do in the all-important political side of the job. From the paper, an excerpt:
If significant increases in capital ratios have only small consequences for the rates that banks charge their customers, why do banks generally feel compelled to operate in such a highly-leveraged fashion, in spite of the obvious risks this poses? And why do they deploy armies of lobbyists to fight against increases in their capital requirements? By way of contrast, it should be noted that non-financial firms tend to operate with much less leverage than financial firms, and indeed often appear willing to forego the tax (or other) benefits of debt finance altogether. In Kashyap, Stein and Hanson (2010) we argue that the resolution of this puzzle has to do with the unique nature of competition in financial services. Unlike in many other industries, the most important (and in some cases, essentially the only) competitive advantage that banks bring to bear for many types of transactions is the ability to fund themselves cheaply. Thus if Bank A is forced to adopt a capital structure that raises its cost of funding relative to other intermediaries by only 20 basis points, it may lose most of its business. Contrast this with, say the auto industry, where cheap financing is only one of many possible sources of advantage: a strong brand, quality engineering and customer service, and control over labor and other input costs may all be vastly more important than a 20 basis-point difference in the cost of capital.
Here he argues for a very gradual phase-in of tough capital requirements. In this paper he argues for a credit-based channel of monetary transmission, and here. This puts him in an alliance with early Bernanke. Here is his paper on the cyclical effects of Basel capital standards; he has done a lot of work with Anil Kashyap in that area. Here is his overly optimistic paper on the eurozone. In this paper he lays out his generally positive view of the efficacy of monetary policy, with a nod to Hyman Minsky on the debt issue.
Default in a liquidity trap
Here is a very interesting Krugman analysis of this problem. It ends up with the Fed owning all T-bills, and, in Anil Kashyap’s opinion (and mine; there’s not enough cash to cover all the required collateral) the Repo market collapsing. I do see an alternative path. Krugman writes:
What we normally say in a liquidity trap is that the Fed is keeping short-term interest rates at zero, which is as low as they can go because below that cash dominates bonds. And the Fed achieves that zero rate by being willing to buy short-term government debt whenever the rate threatens to rise above zero.
That’s a fair description, but perhaps it is a description rather than a binding equilibrium response; the Fed doesn’t have to do that and why should they if it ends in ruin? (There’s the further tricky question of whether Krugman’s assumption is holding expected fiscal policy constant.)
T-Bills are almost like money today, especially with low short rates. Think of higher default risk as like a Gesellian stamp tax on T-Bills. One equilibrium is that people spend more on durables as they shift out of liquidity, which has now been partially taxed. Another equilibrium is that everyone rushes into the truly safe asset, namely cash, and the T-Bills do truly disappear. Or heterogeneous agents may do a bit of both.
It would seem to boil down to the third derivative on the utility function. Still, empirically cash does not soak up all the periodic shifts out of other risky assets (e.g., commercial paper), so why should it soak up all the shifts out of T-Bills?
More concretely, in a liquidity trap model (which I reject, by the way, but that’s another story) an increase in default risk could have some expansionary properties.
Addendum: Brad DeLong offers comment.
Earthquakes and spending and deficits
Brad titles his post: “I Genuinely Do Not Understand Why There Is A Question Here…” and after quoting my post from yesterday writes:
If people thought that government debt was risky, its price would be falling as well. The fact that people are willing to pay more for government debt indicates that it is increasingly valuable–and so we should make more of it.
Ryan Avent comments as well. A few points:
1. My post and question is about spending, but Brad has shifted the discussion to borrowing. It’s easy enough to borrow more without increasing spending, if that is needed. It’s still an open question whether spending should go up.
2. The countervailing forces which might favor lower government spending simply aren’t mentioned. Those include lower wealth and higher tail risk. If those can’t, at least possibly, imply lower government spending, what could? The Japanese will need to spend on recovery, but must the U.S., normatively speaking, now feel compelled to spend more on its domestic programs? A priori? No way.
3. The earthquake and related events are a negative supply shock, so on Keynesian grounds they need not increase the case for activist fiscal policy.
4. Don’t forget that Mike Jensen answered Kenneth Arrow on risk in 1972. Even if government spreads its pecuniary losses over many taxpayers, the relevant real risk is the covariance of the value of government output with private consumption. Given that, an increase in risk still implies at least one force operating in favor of less government spending.
5. It is an oddly non-Keynesian or perhaps even anti-Keynesian point. In 1936 Keynes argued that the rate of interest did not allocate investment properly, or correctly signal the proper amount of investment, because interest rates also channeled liquidity preferences. Today this is a claim which DeLong and Krugman are arguing against.
In other words, it’s an open question, as my original post implied.
Megan McArdle had some to-the-point words:
It’s hard to argue that we should become more willing to borrow because Japan had an earthquake that will cut into global GDP.
And:
And the bad signals aren’t just to the federal debt market–the flight to quality is ultimately going to push things like mortgage rates down too. Would the people urging the government to take on as much debt as possible also urge our homeowners to once again leverage themselves as far as the banks will allow?
Update (12:25 pm) Reader abUWS has perhaps the best, most succinct metaphor I’ve ever seen for this argument:
“When the Titanic was sinking everyone eventually rushed to the stern of the ship. That didn’t mean that that part of the ship was actually safe.”
Addendum: Arnold Kling offers relevant comments.
Sumner and Krugman on zero MP workers
Scott's post is here, Krugman's is here. (My first post on the topic is here, my last post here). Let's start with Scott, excerpt:
This post by Stephen Gordon shows US employment in 2010:3 falling about 5% below its 2008:1 peak, while output seems to have declined only about 0.7%. This is what Cowen finds puzzling.
But I don’t see any puzzle at all. If employment didn’t change, I’d expect US output to grow at about 2% a year, which is the trend rate of productivity growth. Because we are looking at a two and a half year period, you’d expect output to grow roughly 5% with stable employment. Now assume that employment actually fell 5%. If the workers who lost jobs were similar to those who remained employed, I’d expect output to be flat over that 2.5 year period. Because output fell slightly, it seems like the workers who lost jobs were slightly more productive than those who remain employed.
Do I believe this? No, for several reasons I think they were less skilled than those who remained employed. Labor productivity growth (assuming we were at full employment) probably slowed in the most recent 2.5 years, as investment in new capital declined. Measured productivity continued to rise briskly, partly because technological progress continues in good times and bad, and partly because those workers still employed are somewhat higher skilled, or perhaps are trying harder in fear of losing their own jobs. So Tyler is probably right that those workers who lost their jobs have a lower than average marginal product. I just don’t see why zero is the natural starting point for consideration of the issue, as you only get that number by making some fairly extreme assumptions about technological progress coming to a screeching halt after 2008:
A few points:
1. The claim is that some workers have zero marginal product (net of employment costs), not all workers (as Krugman inexplicably ponders for two full paragraphs), and not even all unemployed workers. Just as a hypothetical example, if unemployment is 9.5 percent and the natural rate is 5.5 and zero MP helps account for half of that difference, that's two percent of the labor force at zero MP. Try hiring labor for a while and see how crazy that sounds.
2. Zero MP is a property which may hold in an AS-AD equilibrium, it is not a substitute for an AS-AD view. Krugman mischaracterizes the hypothesis here, by identifying it with "AD denialism." In my post which Krugman links to (and indeed for years), I've made it clear that demand matters in any coherent account of the equilibrium.
Oddly, Krugman himself stated one of the coherent versions of the Zero MP view in July 2010, and then he considered it possible and appropriately, he expressed uncertainty about what might be going on.
3. The Zero MP hypothesis is simply another way of talking about "labor hoarding," a well-known and time-honored idea, except that the labor is not in fact hoarded. It doesn't encounter strange paradoxes and it is more intuitive than when the labor is hoarded (which appears to violate first-order conditions). There is plenty of very specific and indeed striking evidence that the "previously hoarded labor" isn't being hoarded any more. That same link implies that Krugman's invocation of 1983 is a red herring and probably not a good instance for finding many zero MP workers. The "oughties" job market differs in a number of other "real" ways from the 1980s, including the fact that we've had no net job growth over the last decade, not even pre-crisis. Here is further evidence on how productivity patterns were different during the early 1980s.
4. For another take on #3, during the job-destroying periods of 2009, per hour labor productivity growth is rising at astonishing rates, try 3.4, 8.4, 7, and 6 percent, each quarter, annualized. That's not just the regular accretion of technological progress (though some of it may be), it is an artifact from dumping lower quality and zero MP workers. If I look in the second quarter and see labor hours go down 7.9 percent and see per hour productivity rise 8.4 percent, well, that's no proof but I sure go hmm….
5. I would not take it for granted that "normal" productivity growth continues in times of shock and crisis. Maybe yes, maybe no. Scott's talk of the "trend rate" is assuming that the growth and cyclical components are separable and that is begging part of the question.
6. The zero MP hypothesis helps explain why unemployment is so much more severe among the less educated and the lower earners. In contrast, Krugman writes: "As Mike Konczal points out, basically everyone’s unemployment rate has doubled, no matter their education level or location." In reality, that kind of multiplicative relationship is very much consistent with joint AS-AD determination, including a zero MP for many workers in the equilibrium. I'll write an entire blog post on that question soon, and then we'll see that this result actually discriminates against pure AD theories or is at best a neutral pointer.
7. What does the zero MP hypothesis add? First, the zero MP hypothesis explains why wage adjustments can't do the trick for a lot of the unemployed, as wages won't fall below zero. Second, the zero MP hypothesis explains why you need steady real growth, boosting the entire chain of demand, to reemploy lots of workers and reflation alone won't do the trick. (I still, by the way, favor reflation because I think it will do some good.) Those predictions are not looking terrible these days.
8. The AD-only theories, taken alone, encounter major and indeed worsening problems with the data. Year-to-year, industrial output is up almost six percent, sales up more than six percent, but the labor market has barely improved. How does that square with the AD-only hypothesis? Has it been seriously addressed? Arnold Kling also has relevant comments and in passing I'll note that the "increases in the risk premium" factor is being neglected in this discussion of Kling's points.
9. Krugman (not Scott), in particular, is proposing an alternative view with a) upward-sloping AD, b) downward-sloping AS, c) the implication that huge boosts in the minimum wage would restore the economy and employment, and d) requires a tight liquidity trap when the theoretical literature distinguishes between "interest rates literally at zero" and "interest rates near zero." His comparison of ZIRP and ZMP does not raise those issues on the other side of the ledger.
I think Scott is underplaying some of the more detailed facts about labor markets, such as mentioned in #3, #4, #6, and #8. Krugman simply isn't considering the stronger versions of the zero MP hypothesis and thus he is dismissive rather than confronting the very real problems in the AD-only point of view.
Addendum: Arnold Kling has more.