Archive for December, 2011

The Great Ricardian Equivalence Debate of 2011: Do Mainstream Economists Agree on Anything?

December 31st, 2011 9 comments

Krugman started it, in response to Lucas. Everyone piles on. Plutocracy Files has the list of links. (Plus don’t miss Nick Rowe’s, which includes a long comment thread.)

Here’s what wows me: all these world-classical economists are accusing each other of contradicting “textbook economics,” and circling through extraordinary contortions in their efforts to reconcile that school of economics with some version of reality.

There is no consensus. None.

Every one of these folks is bought into classical assumptions, or at least into the Keynesian/classical “synthesis” that’s embodied in the IS-LM model (a model that was created explicitly to render Keynes classical, i.e. without the the Keynes, and was later disavowed by its own creator, John Hicks, as nothing more than a “classroom gadget”).

And they’re all trying to do intergenerational macro in their heads, as a bunch of stylized and simplified thought experiments.

I just finished re-reading Lucretius, and the methodological similarities are striking.

Given that several of the world’s most notable “textbook” economists can’t agree on how to define what in physics would be the equivalent of angular momentum, some of us have to wonder if the whole discipline as taught today offers any useful macro-level insight or modeling utility at all.

I think it’s significant that an authoritative MMT voice has yet to weigh in (I think they all probably think it’s silly — or would be if it didn’t reveal such dysfunction), aside from a passing shot by Mike Norman.

Cross-posted at Angry Bear.

New Year’s Tax Wishes: If I Was Dictator of America

December 27th, 2011 4 comments

Based on the notions of economic efficiency that I laid out here, if I could do whatever I wanted I would make the following changes over a ten-year period. (Some faster, some slower, some phased in, some implemented instantly on a given date.) The appropriate amounts in each case require a better calculator than I have access to.

Tax All Corporate Profits Like S-Corps, and Eradicate Taxes on Corporations, Dividends, and Capital Gains. Credit for the idea goes to Milton Friedman (Capitalism and Freedom, page 174 in my edition). Shareholders pay taxes on the year’s corporate profits (at normal earned-income rates or higher), whether or not they’re distributed. No more double taxation, but no more preferencing over earned and interest income, or indefinite/eternal deferral.

Eradicate Tax Deductions for Interest Payments — Personal and Corporate. Mortgage- and corporate-interest deductions are terribly distortionary; they encourage borrowing — debt financing — over equity- and self-financing. And they’re regressive.

Eradicate Business Deductions for Employee Health Care/Insurance. Destroy the distortionary historical artifact of employer-based health care coverage. Stop discouraging self-employment and personal choice of health-insurance options. (Having been self-employed for decades, I take this very personally. It’s cost me many tens of thousands of dollars.)

Scrap the Cap on Social Security Taxes. Include all earned income. This only makes a terribly regressive tax somewhat less regressive, and it expands the tax slice from that still-regressive tax — a tax that discourages working for a living because it only taxes earned income. But it makes Social Security cash-flow solvent beyond the foreseeable horizon (revenues support outlays). Other propositions here should be scaled to compensate for its regressiveness and work disincentive.

Change All Local Property Taxes to Land-Value-Only Taxes. Land value taxes are the least distortionary taxes around. This would remove the disincentive to improve land. Since it’s non-distortionary, it would also be good to increase its total share of the tax take.

Greatly Expand and Simplify the Earned Income Tax Credit, and Deliver it on Weekly Paychecks. Beyond its manifest benefits to tens of millions, and turbocharger effect on the economy, it could allow for some reduction or eradication of other (economically inefficient) means-tested payments.

Tax Carbon. Since people/businesses aren’t paying for their negative externalities, it’s distortionary not to tax carbon. All hail Arthur Pigou. This is a non-progressive tax, so other taxes would need adjustment to compensate.

Reduce Income Taxes and Make Them More Progressive. As possible and needed, given the other changes, to achieve:

Overall Results:

1. Make the whole tax system — local, state, and federal combined — actually progressive. All the way from the bottom to the top.

2. Increase the total tax take by a few percentage points of GDP. Because Americans (notably, Tea Partiers) want the amount of government we’ve got. So they need to cover the costs. True conservatives pay their bills.

Cross-posted at Angry Bear.

Casey Mulligan Wonders Why People Use Unemployment Insurance

December 26th, 2011 5 comments

Casey Mulligan is curious: what could have caused the big uptick in the uptake on unemployment insurance in recent years?

It’s a mystery.

Or, maybe not:

Sorry, the JOLTS data only goes back to 2001.

Which directly addresses Mulligan’s basic assertion: People are lazy. They don’t like to work.

Well yeah. (People especially don’t like working at unpleasant jobs — those at the low end of the spectrum.)

But how lazy are they?

Rob Valletta and Katherine Kuang of the Federal Reserve Bank of San Francisco do a lot to answer that question. Returning here to an earlier post, on Valletta and Kuang’s study of unemployment insurance and unemployment. This graphic stands out:

People who quit their jobs or are just entering the job market aren’t eligible for unemployment compensation. People who lose their jobs are. The money quote:

The differential increase of 1.6 weeks for job losers is the presumed impact of extended UI benefits on unemployment duration. It is straightforward to translate this increase in unemployment duration into an effect on the unemployment rate, based on their proportional relationship and adjusted for the share of job losers in overall unemployment, which was about 67% in December 2009. The implied increase in the unemployment rate is quite small, slightly less than 0.4 percentage point, indicating that without UI extensions, the measured unemployment rate would have been 9.6% in December 2009 rather than the observed 10.0%.

Job losers (eligible for UIC)  take an extra week and a half to get jobs.

So the “obvious” is true: if you pay people not to work, they will work less, in aggregate. Some people will opt for “funemployment” insurance and take the summer off. But that simplistic truism hides the truly important reality:

The effect is very small — even when you throw five UI extensions into the mix.

Simplistic arithmetic based on this study suggests that any given moment, because of UIC there are about 600,000 people not working, who would be working without it. (.004 times the U.S. work force of 150 million.) That sounds like a lot, and it’s certainly enough to inflame many people’s hot-wired “cheater resentment” genes.

But I say: Get Over It. They’re a tiny percentage, and in the big picture the effects are trivial. The shortage-of-job-openings effect utterly dwarfs the “laziness” effect.

Maybe my resentment genes are pathologically inoperative, but these numbers do a hell of a lot more to light up my compassion genes — compassion for the 14.4 million hard workers who are protected from personal economic meltdown, resulting from an economic catastrophe that was none of their doing. (I won’t even start on how the whole economy is better off as a result of their spending.)

If 600,000 people at a time get a week and a half of extra leisure along the way — the kind of extended leisure time that I, lucky soul, have been blessed with throughout my life — I say more power to ’em.

Cross-posted at Angry Bear.

This Time Is Different: Federal Debt Didn’t Dive Before the Depression

December 23rd, 2011 26 comments

Randall Wray made a fascinating observation a while back:

Since 1776 there have been six periods of substantial budget surpluses and significant reduction of the debt. … The United States has also experienced six periods of depression. The depressions began in 1819, 1837, 1857, 1873, 1893, and 1929.

And I confirmed it (graphs):

Every depression in U.S. history was preceded by a big drop in nominal Federal debt.

Except this one. (Assuming that it would have been a depression absent herculean efforts by the Fed et al.)

gross debt

There was that dip in the 90s, but if we want to posit that, based on history, it was an at-least-necessary cause of the crash, we have to ask: why, in this case, did it take almost a decade to have its effect?

A lot of things have changed since 1929.

• We have the FDIC and similar (explicit and implicit).

• The Fed is a much more active player in controlling government “debt” levels.

• The financial system is far more globalized. International flows of financial capital are much larger in proportion to the real economy.

• The stock of outstanding private debt is proportionally much bigger relative to government debt. Ditto the issuance and retirement of private debt relative to government issuance.

• In the 00s in particular, private debt issuance went crazy.

I think there might be a story about private debt carrying the economy for years after government debt got pulled, so we didn’t experience the effect right away.

But I’d love to hear other and better-articulated stories to explain what strikes me as a pretty big anomaly.

This brief conversation might provide a springboard:

rjs: as i’ve understood it, when it became clear to george bush that if clinton surpluses continued & our debt was paid down, the financial system would soon experience a dearth of safe assets & would freeze up; so his adminstrations tax cuts were initiated in order to keep levels of AAA assets high enough for the markets to operate…

David Beckworth: I remember some commentators making that point back in the early 2000s. It would have been interesting to have seen, though, what would have happened had the debt been paid down. Would structured finance made even more AAA-securities to compensate? Would interest rates been lower back then too?

rjs certainly gives George Bush far too much credit for monetary sagacity. But the general point remains.

Cross-posted at Angry Bear.

A Surfeit of Dearth? Tight “Money” and the Decline of AAAs

December 23rd, 2011 1 comment

This Credit Suisse graph posted by Cardiff Garcia on December 5 has been getting some serious attention in wonkier sections of the econoblogosphere:

And Angry Bear‘s own Rebecca Wilder gave us this on December 21:

2007-2011 in charts: moving down in quality


…Vs. 2011

Brad DeLong discussed this on December 21, riffing off David Wessel’s piece where he jumps on the bandwagon with a tarted-up version of the Credit Suisse chart.

David Beckworth has the best commentary I’ve found on the subject so far:

many of these safe assets serve as transaction assets and thus either back or act as a medium of exchange.  AAA-rated MBS or sovereigns have served as collateral for repurchase agreements, which Gary Gorton has shown were the equivalent of a deposit account for the shadow banking system.   The disappearance of safe assets therefore means the disappearance of money for the shadow banking system. 

Emphasis mine.

This prompts me to suggest a radical idea that I’ve been hesitant to broach for fear of revealing myself to be the internet econocrank that I am: that all financial assets are, in some very real or at least useful definitional sense, “money” — even though you can’t necessarily use them to buy a pack of gum at the corner store (you have to trade them for something currency-like first). I’ll get back to that in a future post.

Izabella Kaminska made a similar point back in November:

quality collateral has become the most sought over security in town. So much so, in fact, that some quality collateral is hardly circulating.

…the best indicator of collateral crunch intensity is instead the repo rate. The lower the rate, the greater the crunch.

The wider the spread between Libor and the secured (repo) rate, the greater the general distress in the market. The following chart reveals just how good an indicator of general market stress it is:

“Some quality collateral is hardly circulating.” That starts to sound decidedly like a “velocity of money” argument.

And indeed, Cardiff Garcia frames it just this way:

Now, if you’ve read your Manmohan Singh (or your Izzy Kaminska or your Tracy Alloway), you’ll know that this availability is the first of two parts of the collateral shortfall effect. The other part is the shortening of “re-pledging chains”, otherwise known as a reduction in the velocity of collateral and which Singh explains thusly:

Intuitively, this means that collateral from a primary source takes ‘fewer steps’ to reach the ultimate client. This results from reduced supply of collateral from the primary source clients due to counterparty risk of the dealers, and the demand for higher quality collateral by the ultimate clients.

And why does it matter? Singh again, emphasis ours:

The “velocity of collateral”—analogous to the concept of the “velocity of money”—indicates the liquidity impact of collateral. A security that is owned by an economic agent and can be pledged as re-usable collateral leads to chains. Thus, a shortage of acceptable collateral would have a negative cascading impact on lending similar to the impact on the money supply of a reduction in the monetary base.

Brad DeLong gives us some theory that will sound familiar to readers of my recent posts:

And when an economy is short of AAA assets, it can fall into a recession — but not a monetarist or a Wicksellian recession, rather an Minskyite recession–because in the absence of long-enough collateral chains the web of banking intermediation would have to run on trust that isn’t there.

Again, emphasis mine.

The upshot: the global economy needs more babysitting scrip. Since money issuers continue to labor under the gold-standard fallacy that they can’t just create money, issue more scrip like the babysitting co-op did — that they have to “borrow” it (and this stricture is inscribed in law) — the only way to create that scrip is for governments to issue more bonds. So banks can issue money using those bonds as collateral, allowing shadow banks to keep their collateralized towers from teetering.

It’s a stunningly byzantine and dysfunctional approach to managing the supply of money to the real economy that produces human-consumable goods and services (though it works out very nicely for the bankers, personally). But it’s what we’re stuck with.

If this doesn’t make sense to you, try here.

Cross-posted at Angry Bear.

It’s Beginning to Look a Lot More Riskless (To the tune of…)

December 23rd, 2011 Comments off

There’s such fun in disastering.
When you’ve won the mastering.
Of the u-ni-verse!

Hat tip to RJ Sigmund:

Lyrics by Marcy Shaffer

It’s beginning to look a lot more riskless.
At least for guys like me.
It’s neat being this elite.
The government makes it sweet.
Complete with robber baron guarantee!

It’s beginning to look a lot more riskless.
Chill has turned to thrill!
We converged, now our flanks give thanks.
We merged all the ranks of banks.
That we did not kill!

When liquidity traps
Slid to maps of collapse?
We heeded treasury’s pleas.
Leapt to the call, and adept-er than all.
Kept the stall from becoming a freeze.
And since what cracked is still intact?
We act like regencies!

It’s beginning to look a lot more riskless.
Unemployment’s popped!
Though i know how the bleeding hearts.
Show their misleading charts.
Neighbor, all my labor costs have dropped!

It’s beginning to look a lot more riskless.
Bonuses restored!
When up yon in this monarchy.
Echelon-esty, you see.
Is its own reward!

Parades of more aides
For high frequency trades.
Since brigades want into our pools.
Incentive retentive
For those thought inventive.
Who plot augmentive new tools.
So abstruse that we’re let loose
To go produce new rules!

It’s beginning to look a lot more riskless.
As we nurse the purse.
There’s such fun in disastering.
When you’ve won the mastering.
Of the universe!

There’s such fun in disastering.
When you’ve won the mastering.
Of the universe!

“Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity Is Not Expensive”

December 20th, 2011 Comments off

Real Reasons Bankers Don’t Like Basel’s Rules: Clive Crook – Bloomberg. Why bankers’ whining about higher equity requirements is just that:

A much-cited paper by Stanford’s Anat Admati and colleagues — “Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity Is Not Expensive” — should have ended this debate once and for all. It dismantles the banks’ position step by painstaking step.

The study makes the crucial distinction between the interests of bank managers, bank shareholders and the public at large. Managers are being disingenuous. They do have reasons, valid after a fashion, for opposing higher capital requirements, just not reasons they can admit. The one they emphasize — cost of funding and its effect on future lending — is fit for public use, but bogus.

What might their real reasons be? If banks sell more shares, it’s true that the return on equity will fall. If managers’ pay is tied to return on equity (as it often is), they will be worse off. Shareholders, on the other hand, shouldn’t mind, because the risk of their investment is reduced in proportion. Taxpayers, of course, would be better off — less likely to be stuck at some point with the cost of bailing out the bank.

The paper is here.

Cross-posted at Angry Bear.

It’s the Private Debt, Stupid

December 20th, 2011 13 comments

I’ve gone on about this elsewhere, but thought I should bring it up front and center here.

While everyone hyperventilates about government debt, they don’t seem to be aware of the massively greater load of private debt, and its spectacular runup compared to government debt:

This from Steve Keen’s latest. (It’s not very long. There are lots of pictures. It makes every kind of sense. Read the whole thing.) The blue line is publicly held debt — not including money the government owes itself (on the consolidated budget) for Social Security and Medicare.*† The red line is debt of 1. households and nonprofits, 2. nonfinancial businesses, and 3. financial businesses.

Here’s how those sectors break out:

Again, you hear all sorts of hyperventilating from the morality-based school of economics about households/consumers going on a debt-financed spending binge, especially in the 00s. And that definitely happened. With the financial industry begging them to borrow — almost literally throwing money at them — and telling them authoritatively that it’s free because house prices always go up, it’s not surprising. Humans will be humans; who’s gonna turn down money when the powers that be — who presumably know a lot more about finance than a high-school-educated homeowner working at a lumber mill — say it’s free?

But that ignores the really massive runup: financial corporations’ debts. Starting at a little over 10% of GDP in 1970, they hit almost 80% by 2000, and when the crash hit they were over 120% of GDP  — a 10x, order-of-magnitude increase over 40 years.

The story explaining these pictures was told long ago — notably by Irving Fisher in 1933 (only after he had driven his Wall Street firm to ruin and lost everything, including his house, by clinging, Polyanna-like, to the kindergarten-ish Price-Is-Right! nostrums of classical economics). Minsky told it in cogent and convincing detail.

The basic story is very simple. It goes like this (in my words):

• Banks (and shadow banks) make money by lending. Bankers have every incentive to increase their loan books, even by extending questionable loans, because bankers don’t personally bear the eventual, down-the-road losses from loan defaults — they’ve gotten their money already.

• When banks run out of real, productive enterprises to lend to — enterprises that can pay back loans and interest from the production and sale of real goods that humans can consume — they start lending to speculators (gamblers) who are buying financial assets in hopes that their prices will rise.

• That lending — extra money being pumped into the system — does indeed drive up the price of financial assets, far beyond the value of the real assets that (according to most economists you listen to) supposedly underpin those financial assets’ value.

• Eventually people realize that the value of financial assets far exceeds the value of real assets — and far exceeds the capacity of the real economy to service the loans that drove up those financial asset prices. Prices of financial assets plummet, borrowers default because there just ain’t enough real income to service the loans, financial-asset prices plummet some more, all in a downward spiral — with all sorts of collateral damage to the real economy.

There’s your (economy-wide) Ponzi scheme. Households and nonfinancial businesses definitely participate (the financial industry makes it almost irresistible not to), but it’s driven by the financial industry, and a huge proportion of the takings go to players in the financial industry.

But as Keen points out, the powers that be almost completely ignore that simple story. He quotes one of Bernanke’s extraordinarily rare mentions of either Fisher or Minsky:

Fisher’s idea was less influential in academic circles, though, because of the counterargument that debt-deflation represented no more than a redistribution from one group (debtors) to another (creditors). Absent implausibly large differences in marginal spending propensities among the groups, it was suggested, pure redistributions should have no significant macro-economic effects… (Bernanke 2000, p. 24; emphasis added)

The rarity — inexplicable to me, at least — speaks even more loudly and eloquently than this blithely dismissive quotation does.

When really smart people like Ben Bernanke constantly ignore an elegant, simple, even obvious explanation that’s been lying on the ground, ready to pick up, for at least 75 years, you gotta figure they’ve got some incentive — whether they’re conscious of it or not. That’s what I talked about the other day.

Again, read Steve’s whole piece. And if you have any interest in economics and haven’t bought the new edition of his book yet, do.

* Please don’t try to dismiss this by pointing to the net present value of SS/Medicare liabilities extending into the infinite future. 1. Including those intra-government debts doesn’t change this picture much at all. 2. It’s a completely separate discussion, about whether we choose to provide those services out of current GDP over future years and decades. 3. If charges by health-care providers were rising at the same rate as inflation, even that future cost would not be a terrible burden. 4. Social Security is actuarily solid on a cash-flow basis for decades, and beyond the foreseeable future (75 years+) if we simply Scrap The Cap on the payroll tax, requiring high earners to pay their full share.

† I’m not clear whether he includes bonds held by the Fed — again, money the government owes itself, if you view Treasury and Fed as both being part of the government — which total a whopping $1.6 trillion or so, more than 10% of GDP, last I checked. I don’t actually know if Fed holdings are included in “debt held by the  public.” (You gotta wonder whether the Fed counts as “the public.”) Little help, so I don’t have to go Google it up myself?

Cross-posted at Angry Bear.

The Meme that Refuses to Die: Government Debt Must Be Paid Back

December 19th, 2011 6 comments

I’m stealing this headline directly from Sandwichman. He sez:

No it doesn’t. It almost never is. To pay back government debt, you have to run a budget surplus, and while there may be modest surpluses from time to time, they don’t add up to more than a minuscule fraction of all the accumulated debt. But don’t take it from me, look at the record.

Here’s a longer-term view, zoomed in on successive times slices so you can see the changes:

Do you notice our progenitors’ great-great-grandchildren (us) paying off our forebears’ debts? Yeah, neither did I. (It did happen once, and the result was economic catastrophe. Every depression in our nation’s history was preceded by a big decline in nominal Federal debt.)

Here’s the U.K.:

David Graeber, from Debt: The First 5,000 Years:

The reader will recall that the Bank of England was created when a consortium of forty London and Edinburgh merchants — mostly already creditors to the crown — offered King William III a £1.2 million loan to help finance his war against France.

To this day, this loan has never been paid back. It cannot be. If it ever were, the entire monetary system of Great Britain would cease to exist.

That was 317 years ago — in 1694.

Governments that issue their own money don’t have to pay off their debts. They actually can’t. In fact, they issue money — the money that’s necessary for a growing economy to operate — by deficit spending.

Private borrowers (and non-sovereign-currency states like Greece and Alabama) do have to pay off their debts (or default). That’s why the level of private debt, not sovereign debt, is the big management problem — a problem that neoclassical economics has not tackled, does not even have the theoretical apparatus to tackle.

Yes, of course: government debt and interest payments as a percentage of GDP are important issues. I’ll hand it back to Sandwichman:

The debt burden depends on the ratio of debt to GDP as well as the interest cost in servicing it. The way to reduce this burden is to have a combination of real economic growth, inflation and modest interest rates. If you want to show your solicitude for the well-being of future generations, demand macroeconomic policies that will boost demand and raise inflation a bit, consistent with continued low interest rates.

Today’s creditors will hate you. But your grandchildren will love you.

Update (thanks to Buffpilot at Angry Bear for finding holes): A more precise explanation of why a sovereign-currency issuer might “have” to pay back their debt: if they have committed to redeem their money for something else. For instance Argentina (dollar-denominated debt) and whole host of others who were on a gold standard, had promised to give gold in return for their money. If they can’t or won’t do so, that’s a default on their promise. The U.S. and the U.K. (among others) do not face that situation.

Cross-posted at Angry Bear.

250 Billion Reasons Why the Fed Hates Inflation (and Doesn’t Care About Employment)

December 18th, 2011 5 comments

Let’s start with the basics:

Increased inflation results in (in a sense, is) a wealth transfer from creditors to debtors.

Debtors get to pay off their loans in less-valuable dollars — dollars that can’t buy as much real-world stuff, stuff that humans can consume, that they value.

If you’re holding a hundred million dollars in bonds — you’ve lent out hundred million dollars — and bananas are going for a dollar apiece, an extra percent of inflation means that a year from now, you can only buy 99 million bananas. The people who borrowed the money from you get the other million bananas. If inflation stays up and the loan remains outstanding, they get another million bananas next year. You don’t.

You can start to see why creditors might be inflation-averse.

How big is this wealth-transfer effect? Here’s a quite conservative back-of-the-envelope calc.

Figure that there are somewhere north of $50 trillion dollars in private “credit market instruments” out there in the U.S. as of Q3 2011 ($120 trillion in total liabilities).

Do the math: 1% of $50 trillion is 500 billion dollars. One extra percent of inflation transfers that much wealth — buying power — from creditors to debtors. Every year.

This is probably an overstatement — many people/businesses are both creditors and debtors, so part of the transfer is from them to themselves. But still: let’s cut the number in half. An extra point of inflation transfers a quarter of a trillion dollars per year in buying power — real wealth — from creditors to debtors.

Because this effect impacts the huge existing stock of financial assets, 1. it is a permanent , and 2. its scale utterly dwarfs the relatively measly (and multidirectional) effects on flows — often second- or third-order effects — that (neoclassical) economists tend to go on about when discussing inflation. (“Money illusion,” “neutrality of money,” etc.)

And there are far fewer creditors than there are debtors. The effects of the transfer are concentrated on one side, diffused on the other. (See: Mancur Olson).

I’ll have a lot more to say about this in future posts, but keeping this short, I’ll bring it back to the the title of this post:

The Fed is run by creditors. And I’ve heard it said that financial incentives matter. The Fed governors have a huge incentive to keep inflation low, and ignore the other side of their dual mandate: employment.

We tend to talk in very big numbers these days, but a quarter of a trillion dollars a year seems like it’s still enough to get people’s attention.

Cross-posted at Angry Bear.