The Fed Is Political

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.

On Neoliberalism

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.

The Public Is Not Easily Manipulated

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.

Deus ex Machina

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."

Seriously? 

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.

Developments in the DPRK

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.

Budget Politics and Power Laws

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. 

Understanding

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).

The Fed Is Political

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?