Friday, September 30, 2011

The Fed Is Political

. Friday, September 30, 2011

John Thacker, via TC:

Here’s a Hill poll on inflation, and here’s a Gallup poll, and here’s a Rasmussmen poll
While all differ on the exact numbers, they agree in broad strokes. The median voter is highly worried about inflation. Democrats are worried less about inflation, but still quite a lot. Indpendents are virtually indistinguishable from Republicans in worrying a lot about inflation. 
That means that the inflation/hard money bit from the GOP is not an appeal to the base. It’s actually a reach to the center
Worrying about inflation may be wrong– and I think it is wrong, according to the data– but it’s an attempt to go after the median voter, not play to the base.
We should remember most people are still employed, so inflation erodes the value of their wealth. Perhaps it would benefit the unemployed by stimulating AD, but that's still a minority of the population. The median voter* wants strong RGDP growth, not just NGDP growth.

*Yes, I know that's a simplification. I think it's fine for these purposes.

Thursday, September 29, 2011

On Neoliberalism

. Thursday, September 29, 2011

Henry Farrell reviews what sounds like a very interesting book, Colin Crouch's The Strange Non-Death of Neoliberalism. Farrell's discussion of the book prompted me to add it to my Amazon wish list. I do, however, have a conceptual quibble. According to Farrell, Crouch defines neoliberalism as the belief that "optimal outcomes will be achieved if the demand and supply for goods and services are allowed to adjust to each other through the price mechanism, without interference by government or other forces". In other words, it's a technical argument that markets allocate resources more efficiently when not interfered with by governments, in general. But then Crouch claims that neoliberalism is really "devoted to the dominance of public life by the giant corporation."

These two are obviously mutually exclusive. The first definition is apolitical, or perhaps anti-political, and is ultimately dedicated to using the tools of technocracy for utilitarian ends. The second is a statement of politics that prefers a statist-corporatist organization of power in society, and there's nothing utilitarian about it. And what I can't get from Farrell's review is whether Crouch is arguing that this is cognitive dissonance -- that neoliberals don't really understand what they're advocating -- or whether the anti-political neoliberal rhetoric is an intentional deceit. Or whether Crouch is confused about this himself.

So here's my quibble: I don't think either of those is the best explanation of the actual intellectual disposition of actual neoliberals. "Neoliberalism" is itself a pretty nebulous concept, which may be part of what Crouch is driving at here. The neoliberals that I have in mind exist on a continuum roughly from Brad DeLong to Greg Mankiw, or essentially the entire discipline of American economics and wonkery, who may disagree on some particulars of which technocratic policy may bring the best outcome but more or less agree on what the best outcome is (within fairly narrow bounds) and the fact that technocratic means are the best way of achieving it. Put another way, I see neoliberals as believing that politics messes up socially optimal policymaking rather than those who believe there is no such thing. As one example, see this recent piece by Peter Orszag.

So I see neoliberals as generally in agreement that markets are good, and therefore that market actors (including corporations) are good, but that under certain conditions markets can generate outcomes that are suboptimal relative to some social ideal. It is in these areas that government is useful. Neoliberals tend to agree that there should be a social safety net (even Hayek and Friedman admitted that much), and that externalities exist and can be quite powerful. They tend to think that in a first-best world markets and governments are two complementary tools that together can enhance utilitarian social outcomes.

In other words, I don't think that neoliberals are actually "devoted to the dominance of public life by the giant corporation". I do think that neoliberals generally believe that corporations produce important social goods so long as they operate in competitive markets, and when they do not -- or when structural factors tend to lead them to generate negative externalities -- they should be regulated. So neoliberals often advocate things like cap-and-trade auctions, oppose industrial policy (which is pro-corporation), and favor laxer restrictions on trade and immigration. To the extent that these policies negatively impact some groups in society, neoliberals generally advocate some sort of social insurance paid for by some sort of progressive taxation scheme.

This is completely distinct from a preference for distributive politics that favors protecting large corporations, or capital in general. In fact, corporatists are often mercantilist and pro-regulation (at least those that provide rents by creating barriers to entry). The only overlap I see is that corporatists and neoliberals both make use of, and attempt to legitimize, markets. But they do so in very different ways, because they think of the "market" differently. Both groups tend to think that markets are often distorted by political processes, but they vary in the normative value they place on that: it's exactly what corporatists want, and it's exactly what neoliberals decry. Corporatists love market failure; neoliberals hate it. In short, corporatists view politics in the same way as socialists, not neoliberals. Corporatists and socialists are on the opposite sides of the distributional battleground, while neoliberals are trying to avoid the combat entirely.

There are times when the neoliberals and corporatists can overlap politically well enough to be on the same side, and this is I think where the confusion sets in. Farrell recounts Crouch's discussion of Thatcher's reforms, with which I'm not familiar enough to discuss. But during the same period in the US we heard a lot about "trickle down" economics, where policies that benefited corporations would in turn benefit the rest of us. Neoliberals and corporatists were generally on the same side in that debate, but for different reasons: neoliberals believed it was true, while corporatists did not (or at least hoped not). And the experience of the US from 1980-2000 provided ammunition for both sides: the American economic experience was pretty good during that period, although it was much, much better for the wealthy than for the rest.

But neoliberals can just as easily oppose corporatists, and quite often do. I think a lot of this gets at what Farrell and Matt Yglesias were arguing about recently, so I was kind of surprised that Farrell didn't link his review to that discussion. Yglesias was arguing for a certain kind of neoliberalism that emphasizes growth plus greater redistribution (relative to the status quo) as being the utilitarian ideal, while Farrell was arguing that that doesn't accurately describe the political landscape so it should be discarded in favor of a more radical politics. Neither was adapting a corporatist line, but they nevertheless disagreed.

Tuesday, September 27, 2011

The Public Is Not Easily Manipulated

. Tuesday, September 27, 2011

During the Krugman/Crooked Timber kerfluffle this summer I argued that Krugman's argument that elite pundits and policy wonks ran roughshod over American politics was too simplistic; we also needed to account for voter preferences, especially on big-ticket policy decisions like the Bush tax cuts and the Iraq War. For this I was raked across the coals... after all, isn't public opinion created or manipulated by elites?

Via Chris Blattman, there is some new experimental research in the APSR (ungated) by John Bullock that shows that the effect of elites' cues on public opinion is not dominant:

An enduring concern about democracies is that citizens conform too readily to the policy views of elites in their own parties, even to the point of ignoring other information about the policies in question. 
This article presents two experiments that undermine this concern, at least under one important condition. People rarely possess even a modicum of information about policies; but when they do, their attitudes seem to be affected at least as much by that information as by cues from party elites. 
The experiments also measure the extent to which people think about policy. Contrary to many accounts, they suggest that party cues do not inhibit such thinking.  
This is not cause for unbridled optimism about citizens’ ability to make good decisions, but it is reason to be more sanguine about their ability to use information about policy when they have it.
That doesn't mean that elites can't use public opinion -- especially when it's an ignorant opinion -- to skew policies in ways that suit their own preferences. The selling of the Iraq War might be such a case, when the public was convinced in large numbers that Saddam Hussein was directly or indirectly response for the attacks on 9/11. It may be an example of the mass ignorance that Bullock describes. But as an exception to the general pattern that would have to be demonstrated rather than merely asserted. In general it's just not enough to say that the public is easily manipulated into accepting elite opinion.

Monday, September 26, 2011

Deus ex Machina

. Monday, September 26, 2011

Peter Orszag writes,

"our current legislative gridlock is making it increasingly difficult for lawmakers to tackle the issues that are central to our country’s future—issues like climate change, the hard slog of recovering from a financial slump, and our long-term fiscal gap. It is clear to everyone that a failure to act will lead to undesirable outcomes in these areas...What we need, then, are ways around our politicians."

Shorter Brad DeLong


"I like it when Ron Suskind uses nefarious tactics to make people I do not like look bad; I do not like it when he uses them to make my friends look bad."

Jacob Weisberg has it right, I think. But then I didn't spend dozens of posts in the middle of the 2000s giving lots of credence to Ron Suskind, so I've really got nothing at stake.

The Great Crash 2008, Part Three


In the last chapter of The Great Crash 1929, "Cause and Consequences", JK Galbraith offers his explanation for why the Great Depression rather than a typical recession followed from the stock market collapse. Or, as he put it, why the economy was "fundamentally unsound" in the run-up to the stock market crash. There are five reasons given (beginning on pg. 177 of the 2009 Mariner paperback, for those wishing to follow at home), and it's worth thinking about each to see how they may or may not relate to today. I'm going to do them in a series for the sake of brevity. This is the third.

The third cause Galbraith gives for the length and depth of the 1930s depression was that there was a bad banking structure. His words: 

[M]any of these [banking] practices were made ludicrous only by the depression. Loans which would have been perfectly good were made perfectly foolish by the collapse of the borrower's prices or the markets for his goods or the value of the collateral he had posted. The most responsible bankers -- those who saw that their debtors were victims of circumstances far beyond their control and sought to help -- were often made to look the worst. The banks yielded, as did others, to the blithe, optimistic, and immoral mood of times but probably not more so. ...
However, although the bankers were not unusually foolish in 1929, the banking structure was inherently weak. The weakness was implicit in the large numbers of independent units. When one bank failed, the assets of others were frozen while depositors elsewhere had a pregnant warning to go and ask for their money. Thus one failure led to other failures, and these spread with a domino effect.
The banking structure in 2008 is often characterized as being dominated by the concentration of market share in a few "too big to fail" firms that were able to exploit an implicit government guarantee and thus secure rents. This led these firms to engage in more risk-taking than they would have done absent a guarantee, so the best way to promote future financial stability is to reduce the size of these firms, thus eliminating the implicit government guarantee, thus forcing firms to internalize their risk-taking, thus leading to less risk-taking and more stability. But this was more or less the state of affairs in 1929, according to Galbraith. There were many small firms and no government guarantee. But that led to instability for the opposite reason as 2008: market share was too dispersed throughout the banking sector, with no financial institutions large enough to halt the spread of contagion.

I've blogged similar arguments to Galbraith's before (and before having read the book). A big part of the resolution of the 2008 crisis involved selling illiquid and/or insolvent firms (Bear Stearns, Merrill Lynch, Washington Mutual, Lehman Brothers, Countrywide, etc.). The only possible buyers for firms that large and with that many problems on their balance sheets was to find other large firms that could absorb them, like JP Morgan and Bank of America. This option was mostly not available in 1907 or 1929 but, combined with strong action from the Fed and Treasury, allowed the resolution of the financial crisis much more quickly and comfortably than in those previous crises. Indeed, the actual financial shock in 2008 was worse than in 1929, and possible worse than any in previous history. The fact that since that shock we've merely had a period of slowed growth and a fairly moderate increase in unemployment rather than a Great Depression is perhaps partially attributable to the fact that we dealt with this crisis much better than previous crises.

This line of thinking should give us pause when we consider whether having more small banks rather than fewer large banks would really be a good idea*. One way we might conceptualize this is to think in terms of patterns of financial integration. A financial system in which a relatively small number of firms are central to the system will generally react differently to crises than a system in which the distribution of links is more dispersed. Specifically, according to research on the spread of viruses and other crises through networks, highly-unequal systems are "robust but fragile": they are resilient to shocks in the periphery of the network, but fragile to shocks in the core. In 2008 we had a shock to the core, so the gut reaction is to reduce the importance of the institutions that comprise the core to the broader system. But that may only leave us susceptible to shocks anywhere in the financial system. This, warns Galbraith, is a very real possibility.

That doesn't seem to leave us with many good options. But here we may take some good news from the 2008 crisis: despite being a more severe financial crisis than 1929, the fallout was much less severe. This is obviously due to a number of reasons including the safety net and automatic stabilizers, as well as pretty drastic actions taken by the Fed and other central banks. But the Fed's actions were likely made more effective by the fact that they had to concentrate their efforts towards only a handful of firms at the center of the system. Once those firms were stabilized, the entire system was stabilized. The 1929 Fed didn't have that option.

This "solution" isn't much of one, admittedly. For one thing, it means that we may remain susceptible to types of crises similar to the one in 2008. That's little comfort. Additionally, it maintains the system of rents that these large firms are able to exploit, and that's unfortunate. But there may be ways of using the regulatory code, tax code, or criminal code to eliminate these rents in other ways. It may be possible to use the same tools or others to promote financial stability in other ways. In any case, it isn't obviously clear that a more decentralized financial system would be any more stable. It wasn't in 1929.

*Keep in mind that a stated goal of regulatory policy at both the domestic and international levels is to reduce the size and number of "systemically important financial institutions". These firms are likely to have higher capital requirements under Basel III, and Obama proposed a special tax for these firms. As far as I can tell these policies have had no effect at all on bank behaviors.

Sunday, September 25, 2011

Developments in the DPRK

. Sunday, September 25, 2011

I'm fascinated by accounts of North Korea, probably because the Hermit Kingdom is so isolated from the sources of information that I usually access. That may be changing a bit as North Korea tries to ramp up its tourism industry by luring (primarily) the Chinese nouveau-riche above the 38th parallel. Usually portrayals of the DPRK are pretty grim, but these photos from a journalist who went on a cruise have some moments of light and contain a lot of beauty. However the economic news is not so good:

The rationing system, the backbone of the socialist planned economy, has nearly collapsed. Some 4 million people still live on rations — 2.6 million in Pyongyang and 1.2 million soldiers. 
But a senior South Korean government official said 20 million North Koreans rely absolutely on the underground economy. 
“A North Korean family needs 90,000-100,000 North Korean won for living costs per month, but workers at state-run factories or enterprises earn a mere 2,000-8,000 won,” the source said. “So North Koreans have no choice but to become market traders, cottage industrialists or transport entrepreneurs to make up for shortages.” ...  
“Ordinary North Koreans have become so dependent on the private economy that they get 80-90 percent of daily necessities and 60-70 percent of food from the markets,” the security official said.
Obviously the situation is not sustainable in the long term. It will be interesting to see if North Korea begins making gradual Cuba-like reforms after the transition of power from Kim Jong-il to his son Kim Jong-un.

Friday, September 23, 2011

Budget Politics and Power Laws

. Friday, September 23, 2011

How does the United States government balance its budget? The Obama administration and Congress seem attached to the notion that balance is to be achieved via a "Grand Bargain" that delivers multiple trillions of dollars worth of savings all at once. Although a Grand Bargain may be welcome, this isn't how our political system operates.

On the one hand, the system isn't good at making large expenditure reductions. Consider the distribution of expenditure changes since 1945 (see figure to left). The distribution has power law characteristics: lots of small changes in expenditures and very few large changes. Moreover, expenditure reductions (white dots) are more difficult than expenditure increases (black dots). The frequent but small cuts are smaller than the frequent but small increases, and the infrequent but large cuts reduce spending by less than the infrequent but large increases. In short, the system is much better at increasing expenditures than at reducing them. And, typically it cuts expenditures a little bit at a time. Hence, asking for a substantial reduction in expenditures at one go cuts against the fundamental structure of budget politics in the United States.

On the other hand, the system isn't good at  increasing taxes sharply. The distribution for legislated tax increases also exhibits power law characteristics (see figure to the right). We see frequent but very small tax increases and very infrequent large tax increases. Moreover, the large tax increases have occurred under pressure of national emergency--mobilization for the Korean War for instance.  Hence, asking for a substantial increase in taxes also cuts against the fundamental structure of budget politics in the United States.

Seeking to balance the budget via a grand bargain thus asks the system to do the two things it seems least suited to do: sharply cut expenditures and raise taxes dramatically. Both outcomes seem unlikely given the story these simple statistics illustrate. The more likely way the US will move to a balanced budget is not through a Grand Bargain, but through a path that combines frequent but small reductions in expenditures with frequent but small tax increases.

Sources: The Log-Log Plot on US Domestic Outlays is from page 61 in Jones, Bryan D., Frank R. Baumgartner, Christian Breunig, Christopher Wlezien, Stuart Soroka, Martial Foucault, Abel Francois, Christoffer Green-Pedersen, Chris Koski, Peter John, Peter B. Mortensen, Frederic Varone, and Stefaan Walgrave. 2009. A General Empirical Law of Public Budgets: A Comparative Analysis. American Journal of Political Science 53(4): 855-73. 
I generated the Log-Log Plot on Tax Increases from data in Romer, Christina, and David Romer. 2008. A Narrative Analysis of Postwar Tax Changes. Berkeley: University of California, Berkeley. I note that my figure on tax increases is provisional as I input that data a couple years ago and never cleaned it so there may be errors. Thus, I am not certain that the distribution is a power law, butit is the case that large tax increases have been very, very rare. 



Angus Deaton has some new research that may help explain why political scientists are all neurotic:

According to Deaton’s analysis, the very act of thinking about politics makes Americans feel less happy and satisfied with their lives — an effect that’s almost as big as being unemployed.  
“People appear to dislike politics and politicians so much that prompting them to think about them has a very large downward effect on their assessment of their own lives,” he writes. “The effect of asking the political questions on well-being is only a little less than the effect of someone becoming unemployed, so that to get the same effect on average well-being, three-quarters of the population would have to lose their jobs.”
Welp, that explains a lot. Here's the paper (pdf).

Thursday, September 22, 2011

The Fed Is Political

. Thursday, September 22, 2011

Today's edition: Mike Konczal tries to rally liberals around the Fed-bashing flag:

For most policymakers and commentators on the left, aggressive monetary policy and inflation has long taken a backseat to fiscal and financial sector issues when it comes to discussing how to return our economy to its full potential. That has allowed the conservative movement and the financial sector to dominate the monetary discussion throughout our current recession—and their focus, as we have seen in recent weeks, is a perpetual fear about imminent hyperinflation. But liberals should be addressing monetary policy head-on, and they should do so by challenging conservatives’ definition of the term “credibility” as it applies to our central bank.
So when can we stop talking about the Fed as if it were an apolitical, technocratic institution?

"Macroeconomic Events Have Macroeconomic Causes"


That's D^2, saying we need to do better than "the bankers are all bastards" as an explanation of the state we're in. In my view he doesn't talk enough about the political causes of the recession, nor the international dynamics at play, but a good post nonetheless.

Wednesday, September 21, 2011

Few Links

. Wednesday, September 21, 2011

-- Cool interactive map of migration patterns.

-- Jeffry Frieden on Europe's "Lehman moment".

-- When hierarchical models are appropriate for time series cross-sectional data.

-- Excellent report on the economic situation, mostly in graphical form. Gist: it's about the banks.

-- Twitter debate between me and Dan Trombly over Hitchens, game theory, Marxism, GWOT, hegemonic stability theory, and other topics.

Tuesday, September 20, 2011

The Fed Is Political

. Tuesday, September 20, 2011

Another entry in a continuing series. The top four Republican congressional leaders -- McConnell, Boehner, Kyl, Cantor -- sent this open letter to Bernanke and the Board of Governors. Highlights:

It is our understanding that the Board Members of the Federal Reserve will meet later this week to consider additional monetary stimulus proposals. We write to express our reservations about any such measures. Respectfully, we submit that the board should resist further extraordinary intervention in the U.S. economy, particularly without a clear articulation of the goals of such a policy, direction for success, ample data proving a case for economic action and quantifiable benefits to the American people. ... 
We have serious concerns that further intervention by the Federal Reserve could exacerbate current problems or further harm the U.S. economy. Such steps may erode the already weakened U.S. dollar or promote more borrowing by overleveraged consumers. To date, we have seen no evidence that further monetary stimulus will create jobs or provide a sustainable path towards economic recovery.
Bold added. Of course the very things they worry about happening if the Fed pursues further easing are exactly the things that would boost growth: a depreciating dollar (which would boost exports) and increased consumer borrowing (which would increase domestic demand).



Fabio Rojas:

For example, when I was in graduate school, I often obsessed about work even when I was on vacation. But over the years, I learned to do what I want with whom I want and not to care about what people think. Not caring about what other people think is an important life skill. Just relax as much as you can and enjoy life.
I imagine that gets easier after tenure.

Monday, September 19, 2011

Stagnation and Economic Geography

. Monday, September 19, 2011

Noah Smith considers The Great Stagnation, and comes to similar conclusions as me [1, 2] but from a different starting point:

The basic idea of the theory is this: It is expensive to move products around. This means that if you have a factory, you want to locate it close to where your customers are, to avoid paying a bunch of shipping costs. Now consider two factories. The workers in the first factory will be the consumers for the second factory, and vice versa. So the two factories want to locate near each other ("agglomeration"). As for the workers/consumers, they want to go where the jobs are, so they move near the factories. Result: a city. The world becomes divided into an industrial "Core" and a much poorer agricultural "Periphery" that produces food, energy, and minerals for the Core. 
Now when you have different countries, the situation gets more interesting. Capital can flow relatively easily across borders (i.e. you can put your factory anywhere you like), but labor cannot. If you start with a world where everyone's a farmer, agglomeration starts in one country, but that country gets maxed out when the costs of density (high land prices) start to cancel out the effect of agglomeration. As transport costs fall and the economy grows, the industrial Core spreads from country to country. Often this spread is quite abrupt, resulting in successive "growth miracles" that get faster and faster (as each new industrial region starts out with a bigger global customer base). The evidence strongly indicates that agglomeration is the driver behind developing-world growth.  
But here's the thing: in the theory, the "old Core" doesn't keep getting richer. In fact, under some scenarios, it even gets slightly poorer while the "new Core" catches up. For a while, the negative effects of relocation trump the positive effects of progress.

So this could explain why we in the rich world are getting poorer. In the 50s, America was the only industrial "Core" that was not a pile of rubble. But since the 60s, we have seen successive "growth miracles": Japan and Europe in the 60s/70s, then Taiwan/Korea/Singapore in the 80s, then China since then, and now even India. In a New Economic Geography world, we would expect these successive relocations of manufacturing to hold down income growth in the U.S., even if technology was advancing as usual.

Smith calls this the "Great Location". I called it the "Great Redistribution". Smith emphasizes structural economic factors, while I tried to also incorporate political factors. But in general the two stories are congruous and probably complementary. (Arnold Kling has written a fair amount on this too.)

Cowen says in response to Smith that this doesn't tell us everything we want to know because "Median income begins to stagnate in 1973, before this trend is significantly underway". But I'm not sure about that. Is it just a coincidence that the Great Movement began right at the end of the Bretton Woods system? There was a series of perturbations in global markets related to the re-industrialization of Europe and Japan in the 1960s (as Smith notes). And even if the internationalist story can't explain everything, it can arguably explain more than a stagnation hypothesis, which can't account for the fact that average incomes have grown at roughly the same rates post-1973 as pre-1973. What has changed is the divergence between the mean and median of the distribution. This does not imply (to me, at least) a general economic stagnation, but rather a shift in how the economy is organized. Additionally, any account of changes to the US economy over the past 40 years that does not consider international factors is likely to be under-specified.

I had some of this "economic geography" logic in mind when I wrote my posts, but I honestly don't know that literature well enough to say much of anything about it other than the basic story that Smith laid out. That is, I'm sure people have empirically examined these questions in some depth; I just don't know where the consensus lies, if there is one. Clearly it's important enough, since a Nobel Prize was awarded for it. I'm just not sure what the state of that particular literature is.

Anyway, I'm happy to see international dynamics be brought into this discussion.

Saturday, September 17, 2011

Fighting Words

. Saturday, September 17, 2011

Scott Sumner goes hard after American political science:

Just one more reason why academics should pay no attention to “public opinion” polls. There is no such things as public opinion, there is only election results. No one knows what Americans would believe about Medicare if that sat down with all the government programs and tax revenues in a spreadsheet front of them, and told they had to equate the NPV of all future taxes with the NPV of all future spending. We simply don’t know. And anyone who argues otherwise isn’t thinking deeply enough about the issue.
Sumner calls this post "Thinking like an economist", which reminded me of my past post on the problem with economists.

The UNC political science department is well-known in academic circles for the study of public opinion in American politics, and the consensus view in Hamilton Hall is not that public opinion doesn't matter, much less that there is "no such thing". I very much doubt that Sumner has any familiarity with this literature, but he could start here and here and here. Public opinion matters a lot for policymaking, especially on issues that are salient with voters*. It even matters for the judiciary, even those with extreme job security such as the Supreme Court (see first link). It's not about voters having policy expertise, or what they'd do if they had to match the NPV of spending and revenue. The public does not even have to be coherent to have a major impact on policymaking, and not just via elections.

Let's take an example. Sumner is frequently exasperated by the Federal Reserve. He notes that the economy remains depressed several years after the beginning of the recession. He notes that Ben Bernanke has said that the Fed has plenty of tools to boost nominal GDP even at the zero interest rate bound. He notes that Ben Bernanke did a lot of research on both the Great Depression and Japan's lost decade, and thus understands the situation we're in quite well. The Fed does not face elections and is considered one of the most independent central banks in the world. And yet despite possessing the requisite expertise and policy tools the Fed is nowhere near as activist as Sumner would prefer.

How can we explain this? It could be that the Fed are a bunch of idiots, but Sumner does not believe that to be true at least in Bernanke's case. Or it could be that the Fed has just witnessed a series of events that have made them cautious. The Tea Party has had a major effect on American politics, and one ideological leader of the Tea Party -- Ron Paul -- wants to abolish the Fed and is now chairman of the House committee that oversees the Fed. Paul's book *End the Fed* has 375 reviews on, and nearly all of them give the book four or five stars. A Nobel Prize-winning economist -- Peter Diamond -- was blocked from joining the Fed by this element of the contemporary GOP. The leading candidate for the GOP presidential nomination recently threatened Bernanke with bodily harm and insinuated that he was a traitor. And Bernanke is a fellow Republican who was appointed by a Republican president. He has also been criticized by the left for bank-friendly policies. All of these groups want a monetary policy that is tighter than Sumner's preferred policy, and that is what the Fed has done.

Given all of this, isn't it at least plausible that the Fed feels constrained by public opinion? To my knowledge no studies have focused directly on this question, but as a potential contributing factor to Fed policy choices it seems at least plausible. Even if public opinion doesn't affect the Fed, the finding that it affects the Congress, presidency, and judiciary is very robust. So to be so dismissive is really silly.

*My guess is that the specific issue Sumner is discussing -- the tax penalty for married couples -- is not highly salient for most people. When it is, couples can easily (and cheaply) get legally divorced or remain unmarried as Justin Wolfers and Betsy Stevenson have done.  

Thursday, September 15, 2011

A Few Links in Lieu of Actual Post

. Thursday, September 15, 2011

-- Phil Arena has a great post on selectorate theory as applied by Bueno de Mesquita and Smith in this Foreign Policy article. Gist: if selectorate theory generates useful advice for leaders like Obama, then it isn't much good as theory.

-- John Quiggin on China.

-- Erik Voeten on the UN and a potential General Assembly vote on Palestinian statehood.

-- Hayek: *Monetary Nationalism and International Stability*, from 1937. Haven't finished this yet. Hoping it provides some impetus for a research project or at least a substantive blog post or two.

-- Michael Pettis is a must-read on balance of payments dynamics and currency issues, especially related to China. I've started a post on this, which I hope to finish soon.

Wednesday, September 14, 2011

The Great Crash 2008, Part Two

. Wednesday, September 14, 2011

In the last chapter of The Great Crash 1929, "Cause and Consequences", JK Galbraith offers his explanation for why the Great Depression rather than a typical recession followed from the stock market collapse. Or, as he put it, why the economy was "fundamentally unsound" in the run-up to the stock market crash. There are five reasons given (beginning on pg. 177 of the 2009 Mariner paperback, for those wishing to follow at home), and it's worth thinking about each to see how they may or may not relate to today. I'm going to do them in a series for the sake of brevity. This is the second.

Galbraith's second possible reason for why the 1930s depression was so great was that the corporate structure in the US economy was poor:

The fact was that American enterprise in the twenties had opened its hospitable arms to an exceptional number of promoters, grafters, swindlers, impostors, and frauds. This, in the long history of such activities, was a kind of flood tide of corporate larceny. 
The most important corporate weakness was inherent in the vast new structure of holding companies and investment trusts. ... dividends from the operating companies paid the interest on the bonds of the upstream holding companies. The interruption of the dividends meant default on the bonds, bankruptcy, and the collapse of the structure.

There are really two things here. First, Galbraith claims that the 1920s were prone to a widespread prevalence of fraud. Second, that corporations were structured in such a way that a disruption in finance would batter the real economy because financial firms owned many of the most important firms in the real economy. Throughout the book he offers a lot of evidence that fraud and other shenanigans were prevalent in the 1920s, although he does nothing to establish the claim that the 1920s were somehow worse in this regard than decades before or since. He does more throughout the book to show how the corporate structure was organized with productive firms downstream that were owned by financial firms upstream. The two were tightly linked, so that a major perturbation to one sector could have adverse effects on the others.

Some of these charges have been levied about the corporate system in the run-up to the 2008 crash. While I think claims that the financial crisis is a result of fraud or other criminal activity are generally over-stated, and I know of no reason to believe that criminal activity in the financial sector was more prevalent during the 2000s than other periods, there certainly was some of that going on. Perhaps more plausible is the argument that compensation schemes in major financial firms were skewed towards excessive risk-taking and boosting the short-run value of firms, not long-run stability. That may be true as well, although the only piece of research I've seen that directly examines that question finds the opposite (although another study shows that executives of large banks sold their companies stock more than they bought it, perhaps indicating that they didn't have much confidence in their firms' activities).

The second part of Galbraith's claim is more interesting to me, and potentially much more important. Was there was a shift in the underlying structure of the economy that altered the pattern of corporate organization? I don't know of any research showing the specific dynamic that Galbraith describes -- dividends from downstream productive firms paying for activities of upstream financial holding companies -- but something else happened:
From this analysis came two striking figures. The first is a map [above; click for larger version] of links between companies in five key economic sectors: technology, oil, other basic materials, finance linked to real estate and other finance. As of 2003, the sectors are relatively distinct, with real estate isolated. By 2008, they’re a tightly linked jumble, with finance at the center. 
I wrote about this research last year:
To me, there are two ways of looking at this. The first is the conclusion reached by Keim, that interdependence on its own can be stabilizing, until it reaches a critical mass, at which point increased interdependence destabilizes the system. Interdependence obviously went up throughout the 2000s. But another way to look at it is to examine the pattern of interdependence, rather than the occurrence of interdependence. 
It is clear that the financial sector became much more central to the economy, so the economy as a whole became much more susceptible to trouble in the financial sector. In this way, the U.S. economy appears to display a feature of non-random, hierarchical networks, which is that they are robust to shocks in peripheral parts of the network, but fragile to shocks at the center. In other words, if a shock had hit the peripheral oil sector (as happened, in fact, in the middle part of the decade), the increased interlinkages with finance would make the economy more resilient. But once a shock hit finance, the central sector, everything else was prone to collapse as well.
In other words, the major American industries -- tech, energy, real estate, etc. -- all became very strongly linked to finance. This generated lots of profits during the 2000s, but also left the entire economy more susceptible to a shock to the financial system. So the tightly-linked corporate structure that emerged in the 2000s may indeed have had quite a lot to do with why the financial panic had such a devastating (and persistent) effect on the real economy.

Tuesday, September 13, 2011

Basel Is Not "Anti-American"

. Tuesday, September 13, 2011

I see (via Felix Salmon) that JP Morgan executive Jamie Dimon thinks the Basel bank regulations are "anti-American". I have no idea what he means by that, but my working understanding of the Basel regulations is that from a competitiveness standpoint they are generally beneficial to large American firms (like JP Morgan), and generally harmful to European and Asian firms. As Salmon puts it:

I have no idea what Dimon thinks is anti-American about the Basel standards, which are certainly in the interests of the United States. In fact, by all accounts it was the US which was pushing for stricter rules, and had to compromise with the laxer Europeans, whose banks are much less well capitalized right now. US banks, including JP Morgan with its “fortress balance sheet”, are very well placed to navigate through the Basel rules and come out strong and dominant on the other side.  
European banks, by contrast, will have to raise a lot of very expensive equity. And UK banks, if the Vickers proposals are adopted, will be much less formidable in the international arena than they are right now, with most of their assets ring-fenced and unavailable for merchant-banking misadventures.
There are two basic ways to think about regulations like the Basel accords. The first way is to think in terms of externalities and welfare: regulations restrict the ability of banks to act riskily, which prevents them from generating negative externalities that spill over into the rest of society during financial crises. Thus, new regulations represent a redistribution away from banks to society at large. I think this is the wrong view.

A better approach, in my opinion, is to think of regulation as altering the competitive landscape in ways that benefit some firms and hurt others, and benefit some in the broader society while hurting others. Large incumbent firms often support new regulations that function as a barrier to entry for potential competitors. Regulations can lock in the market dominance of existing firms. This is what Salmon is talking about when he writes that "US banks are well placed to navigate through the Basel rules and come out strong and dominant on the other side".

So why is Dimon opposed to them? It could be that he doesn't appreciate this dynamic, but that sort of ignorance would wreak havoc on the assumptions used to generate the rent-seeking model of regulation. So let's not go there.

My guess is that Dimon recognizes the advantages of Basel rents but think they are smaller than the benefits to his firm of having lower regulations. That is, since JP Morgan is already at a competitive advantage over many of its competitors, and with the European banking sector apparently on the verge of collapse, he may believe that he doesn't need to collect rents for his firm to be profitable. If that's the situation, then the regulations restrict Dimon's flexibility without providing any significant competitive benefit.

That doesn't mean Basel is "anti-American" of course. For one thing, the Basel system could lock in market dominance for large American firms long into the future. For another, US policy makers hope to create a more stable financial system through Basel, not just secure profits for American firms. Of course Dimon may have a shorter time horizon, in which case the long-run benefits of Basel would be enjoyed by someone other than him, while the costs of initiation and compliance are borne by him and his friends.

Friday, September 9, 2011

Nothing New on Trade

. Friday, September 9, 2011

On the one hand, that title is a good thing. Many expected a global economic downturn to lead to trade wars. Many others expected asymmetric shocks to the global economy, in which exporting countries were perceived to be poaching jobs from importing countries, to have the same effect. But I recently finished Paul Blustein's excellent account of the Doha decade Misadventures of the Most-Favored Nations and a big theme is the battle of interests between the developed North -- especially the US and EU -- and the rest -- especially India, Japan, Brazil, and China. The book's narrative ended a few years ago, but little has changed:

India is unlikely to yield to a fresh effort by the developed countries to push for greater concessions by the larger emerging economies to salvage the World Trade Organisation's Doha Round of global trade talks. ...

With the US leading the chorus to demand further concessions from countries like India, China and Brazil, which will have to eliminate tariffs on some products for the round to progress, the talks have been stalled.
We haven't blogged a lot about trade here lately, but that's mainly because not a whole lot has gone on. The international trading system appears to be locked into the status quo for the time being. Interests are still far apart, and the gains from further coordination are not especially high. So the Doha agenda remains stalled.

Thursday, September 8, 2011

EU Fiscal Union Is Highly Unlikely, con

. Thursday, September 8, 2011

Edward Hugh reports that the Germans are laying down the gauntlet on the Greeks:

Only yesterday, German Finance Minsister Wolfgang Schaeuble informed members of the parliamentary budget committee that Greece is now perched on a "knife's edge". This follows hints from other leading German politicians (including Angela Merkel herself) that a Greek euro exit is no longer the unthinkable taboo topic which it had been to date.  
As if all of this wasn't clear enough, the Dutch Prime Minister Mark Rutte suggested yesterday in an FT article that expulsion from the Euro Area should be available as a disciplinary measure of last resort.
For detail on why things are coming to head now, see the link. The gist is that the "voluntary haircut" component of the most recent Greek bailout isn't working the way it was intended, and neither Greece nor Germany (and other Euro creditors) are especially interested in yielding to the other at this juncture. They may continue to muddle through as they have previously, but hopes that the recent bailout-plus-haircut approach is going to be sufficient have been weakened.

Banks Too Weak for Basel III?


It looks like many might be, especially in Europe:

Banking regulators are preparing to relax the new rules requiring banks to hold more liquid assets to be prepared for a new funding crisis, writes the Financial Times. ... 
A new report by JPMorgan estimates that 28 European banks showed a liquidity deficit of 493 billion euro billion at the end of last year. 
Only seven of the 28 banks tested comply with the  new standards, French banks being among the least prepared. In fact, JPMorgan analysts concluded that the requirements of liquidity for the banks must hold sufficient assets, easily sold to meet a 30-day-long funding crisis, will affect most sectors, and will cost about 12% of the average European banks earnings of 2012.
We've written a lot about the competitive nature of Basel III, and especially how American banks tend to have higher capital and liquidity ratios than many of their European counterparts. Basel III was really hard on European (and Japanese) banks, and it looks like many of them won't be able to meet their obligations in a timely manner, especially if the European debt situation deteriorates. And, of course, if European banks are allowed to defect from their Basel obligations then pressure will be placed on the US and other governments to allow their banks to do the same.

This is worth keeping an eye on.

Wednesday, September 7, 2011

EU Fiscal Union Is Highly Unlikely

. Wednesday, September 7, 2011

Phil Arena was fishing for a post from me on Europe in response to this:

Europe appears to be inching closer to a more centralized fiscal union that would eventually turn the euro zone into something resembling a United States of Europe.
Today we have news that a German court has ruled that Merkel's actions to bailout other European countries were not illegal -- good news for Merkel -- but that any new funding must be approved by the German legislature -- very bad news for Merkel. And yet even Merkel does not approve of the sort of measures that would create a "more centralized fiscal union" in Europe. Her joint statement with Sarkozy on August 16 repudiated eurobonds, as well as an extension for the European bailout mechanism, the EFSF. Meanwhile voters in Finland (and other countries) are starting to assert themselves by demanding increased collateral from Euroborrowers before they approve of new funding. Any one of the 17 EMU members can veto any agreement, and it looks increasingly likely that one or more of them will. And not just the creditors... the debtors are angry too. (Most recently Italian workers went on strike to protest a new austerity package, following similar protests in Greece, Portugal, and Spain.) The EU banking crisis looks like it's spreading, placing even greater burdens on public sector balance sheets and economic growth rates.

Meanwhile, where is the constituency for a greater fiscal union? Perhaps Sarkozy wants that, but Merkel does not. Voters in the Eurocore do not, and it's not even clear that voters in the Europeriphery do either, at least if that comes with supranational authority to set budgets and intervene into macroeconomic policymaking. Which it surely would.

So I just don't see how a fiscal union is politically possible. And I don't even see why it's desirable. Or more precisely, I don't see who would desire it. So I don't see it happening.

Is US Politics Really More Partisan Than Ever?


Matt Yglesias writes: 

Historically, the United States has been dominated by an ideology of non-partisanship driven by precisely the suspicion that the interests of a party or faction are not those of the country. And for most of America’s history, when parties were largely non-ideological, this made a ton of sense. A non-ideological party, after all, is basically just an interlocking web of patronage networks and party machines. If a Democrat is in the White House, then Tammany Hall gets to reward its supporters by handing out federal jobs in New York City. The machine couldn’t care less what the president thinks about “the issues” (unless the issue is civil service reform) it just wants a president who recognizes his affiliation with the machine.

Karl Smith agrees, and is working on spinning this line of thinking into a broader argument about republican democracy's role in the future of governance.

But I think this is completely wrong. This isn't my area of expertise -- I've tried to enlist one of my grad student colleagues for a guest-post, but he's busy so that can't happen until next week -- but my understanding of the relevant political science literature is that there is a sweet spot during which American politics is less-partisan*. That sweet spot was immediately following WWII, basically the Truman and Eisenhower administrations. Before that the parties were divided by the New Deal and intervention/isolationism in Europe. After that the parties were divided by race and social reform. The current party alignment isn't much different from the early 1970s, when the religious right aligned with the GOP, southern Democrats switched to the GOP, and liberal northern Republicans switched to the Democratic party.

But more fundamentally it's just really hard for me to buy an argument that rests on the assumption that the current political environment is more nasty or divisive than it's ever been. Given the history of political competition and instability in this country -- literally from its moment of inception -- today's political environment doesn't seem out of the norm. In fact, things might be more civil now than at most points in US history.

In any case, US politics has always been about competing interests. Whether those are transformed into ideology more or less now than before is thus not all that interesting of a question to me. It's asking about the window-dressing, not the structure of the building.

*I'm not sure partisanship is the best proxy for "ideological parties", but I think that's what Yglesias and Smith are really driving at anyway.

UPDATE: Michael Flynn has a great post (better than mine) looking at the same dynamics I'm concerned with but focusing on foreign policy. And as Phil Arena points out in comments here, Brendan Nyhan (and others) have covered this ground much better than I can. Here's one good example.

Tuesday, September 6, 2011

(Nearly) Daily Reminder That Everything Is Screwy

. Tuesday, September 6, 2011

Treasuries now more expensive than they've ever been:

Treasury 10-year note yields fell to an all-time low today as concern the euro area’s debt crisis will cripple financial institutions underpinned demand for the safest assets. A government report Sept. 2 showed no jobs were added in August, reinforcing concern the U.S. economy has slowed which may prompt additional stimulus by the Fed.

Monday, September 5, 2011

System Dynamics Remain Important

. Monday, September 5, 2011

(click here for animation)

Via TC, a data point that reinforces some research that the IPE@UNC crew has been conducting:

MFIs in Europe have drained their bank accounts at European banks by about €700 billion over the past year and half, which at current exchange rates is approximately $1 trillion. It seems that much of that money has recently found its way into the bank accounts that European MFIs keep in US banks. And conversely, it seems likely that the large inflow of cash deposits held at US banks this year is largely from European banks.

Putting it all together yields a compelling story: European banks are shifting their cash assets out of European banks and putting much of them into US banks. This has happened at a significant rate, with a net transatlantic flow from European to US banks that probably totals close to half a trillion dollars in just six months.
Given all of the trouble in the US banking sector over the past four years, and given the recent S&P shot, why would foreign funds continue to flow into the US rather than, say, emerging economies that continue to grow at high rates? This sort of behavior is not expected by most political science, economics, or finance research or by many in the pundit and investing classes.

One answer may be found by examining the network dynamics embedded in the international banking system, one representation of which is above. (This graphs in-degree, which are bank holdings from country i to country j. Tie strength is the amount of holdings, node size is cumulative in-degree from all countries in the network.) The international banking network is highly unequal, with the US as the most central node in the system. Highly unequal networks have different dynamics than other networks, one of which is a "preferential attachment" rule for organizing links between nodes. The rule states that, because of network externalities, nodes that attract a lot of links will tend to attract even more links in the future. Thus, the structure of the network is stable and self-reinforcing.

The US has attracted by far the most foreign bank holdings throughout the entire data series, and the intensity of these links has increased (in nominal terms) over time. That process hesitated briefly at the height of the financial crisis before resuming. So given the structure of the network and the dynamics that that structure implies, increased flows into the US -- especially during times of trouble like those currently plaguing Europe -- is exactly what we should expect. If we didn't continue to see this behavior that's when we would need to start looking for major changes to the organization of the global economy.

The Great Crash 2008, Part One


In "Cause and Consequences", the last chapter of The Great Crash 1929, JK Galbraith offers his explanation for why the Great Depression rather than a typical recession followed the stock market collapse. Or, as he put it, why the economy was "fundamentally unsound" in the run-up to the stock market crash that led to a prolonged slump. There are five reasons given (beginning on pg. 177 of the 2009 Mariner paperback, for those wishing to follow at home), and it's worth thinking about each to see how they may or may not relate to today. I'm going to do them in a series for the sake of brevity. This is the first.

Galbraith's first reason given for why the stock market collapse plunged the real economy into deep depression is the large amount of income inequality. Galbraith writes:

This highly unequal income distribution meant that the economy was dependent on a high level of investment or a high level of luxury consumer spending or both. The rich cannot buy great quantities of bread. ... Both investment and luxury spending are subject, inevitably, to more erratic influences and to wider fluctuations that the bread and rent outlays of the $25-a-week workman. This high-bracket spending and investment was especially susceptible, one may assume, to the crushing news from the stock market in October of 1929.

It's well-established that US income inequality increased dramatically over the two decades prior to the 2008 crash. Here's a snapshot of the share of national income going to the top 10% of income earners from the famous Piketty/Saez historical study of the American income distribution (labelled and discussed by Krugman here)

The graph ends a few years before 2008 but the trend didn't reverse in that time. What I like about Galbraith's explanation of the role of income inequality in the Great Depression is that there is a plausible causal story: with increased inequality the economy becomes more dependent on the fortunes of the high-bracket folks to maintain demand and investment; a shock to their finances via a financial crash thus hurts more than it otherwise would. This can link up with demand-side and structural explanations of the sclerotic US recovery. Too often discussions of contemporary income inequality lacks such a mechanism, and are much more normatively framed and politically charged. That's fine, but it doesn't really help us understand how income distribution affects the broader economy.

The question is whether Gailbaith's causal story matches the present. Let's look at some data on private investment. We know that there was a slump in housing, so let's check that first:

It drops off a cliff, but notice that that begins in late-2005. This is in line with the usual story that the housing collapse preceded and perhaps caused the financial collapse by deteriorating the value of the underlying assets on which securities were backed. For Galbraith's story to be true, we'd need to see investment drop off after the financial collapse destroyed the wealth of those at the top of the income distribution. And we do:

Note that in percentage terms, the dropoff post-2008 is more severe than what occurred during the 2001 recession. My back of the envelope estimate is that investment at the trough post-2001 was ~ 88% of the pre-2001 peak; In 2008 it was 78%. Moreover, investment fell more steeply more quickly post-2008 than post-2001. But it also rebounded in a sharper V-pattern than in 2001. If Galbraith's logic held, we might expect to see the opposite: a deeper, longer investment drought. Sometime like an 'L'- or 'U'-shaped pattern of recovery.

Let's look at some consumption data:

Here we see a much bigger dropoff post-2008 than post-2001, and it persists for much longer. While we've gotten back to pre-2008 levels, we haven't yet caught back up to trend. But is this slack enough to explain the persistent malaise in labor and financial markets? And is the slack in spending and investment attributable to income inequality rather than high unemployment? Is high unemployment attributable to income inequality? There's no obvious mechanism that explains it. At least not that I can think of.

It may be that increased inequality was a symptom of structural shifts in the global economy that pre-dated the crash. An effect rather than a cause. Post-crash inequality becomes a cause of ongoing economic weakness. However as a first explanation for the Lesser Depression I'd look elsewhere.

In any case, the major political battles in the US since the financial crisis have been on issues related to income distribution: health care, financial regulation, and progressive taxation vs. expenditure austerity. Maybe we could add classic Phillips-curve battles over unemployment/inflation tradeoffs.* This suggests that the cleavages in the economy break down along at least some of these lines. But this could be a consequence of the weak economy rather than a cause of it, especially since the political scene has shifted from fire-fighting to deficit-cutting.

*Krugman and others argue that right now there isn't much of a tradeoff and I tend to agree, but neither the political leadership of the GOP nor most pundits seem to believe him.

Sunday, September 4, 2011

This Is Embarrassing

. Sunday, September 4, 2011

Mearsheimer, in August 1990: Europe will revert to "untamed anarchy" and "Hobbes' war of all against all" in the post-Cold War era.


ht: Phil Arena 

Saturday, September 3, 2011

Universities Are Not (Only) About Education

. Saturday, September 3, 2011

Angus writes:

College football is a mess, with Ohio State and The U providing the latest "scandals" and with the pattern of conference jumping we've seen lately.

I think it's time to split big time football from academics. Dissolve the NCAA. Pay the players. Don't even force them to be students if they don't want to be students. Treat college football like an age 21 and under pro league. The schools rent out their facilities, names, supporters, etc. and the football program is separate from the school itself, just like the food service program.

I've long viewed college football, and college athletics in general, as a sort of "loss leader" for the university. A prominent sports program raises the university's status. Saying that it doesn't do much for the university's core mission only makes sense if you think the core mission is efficiently allocate resources towards the best educational environment possible.

But it clearly isn't. Universities exist for a host of reasons, most related to status and social networking rather than actual education. Which is why so many people are willing to pay huge premia to go to 4-year universities for basic classes rather than 2-year colleges, even though the class quality will usually be comparable or even better at the 2-year schools (b/c of smaller class sizes, professional teachers rather than researchers teaching those classes, same texts and curricula, etc.). And why many people are willing to pay even higher premia to go to flagship 4-year colleges rather than Eastern Small Town State, even though the actual education will be very similar.

So having high-profile sports programs does serve universities' core mission: it raises the university's status, and that attracts students and other sources of funding.

International Political Economy at the University of North Carolina: September 2011




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