Monday, October 31, 2011

Does Italy Really Deserve To Be A Scary Halloween Story?

Last week after the latest European summit, most of the markets were jumping, with the Russell Index rising over 5% on Thursday, Oct. 28. Then word came that the spread over their German equivalents for Italian ten-year bonds had risen to over 6%, pushing the level in August just before the ECB began buying Italian and Spanish bonds, with the ECB this time supposedly doing so again, but not succeeding in halting the rise (maybe needed to do more, but the Germans and their constitution won't let them?). Now everyone is freaking out that perceived failures by Italy to reform will doom the euro and the EU, with the Daily Mail even fancifully forecasting major European war by 2018. Is all this really justified?

Of course, the simple answer is "yes" because the markets say so, and it is clear that Italy is so big that nobody can bail it out if it defaults. But how likely is that really? Yes, its debt-GDP ratio is about 120%, but it has had a greater than 100% such ratio for a majority of years over the last half century, with nobody much bothered as Italians have a high savings rate and most of this debt is internally owned. Indeed, for years Italy was the poster boy for Ricardian equivalence (high deficits, but high savings rate offsetting its stimulative effects). Furthermore, Italy is running a primary fiscal surplus, before interest payments on debt, generally viewed as not warranting such panic. More is going on here, and I think there are two parts, a short-term one and a long-term one.

The short-term one is simple: Silvio Berlusconi. Both Merkel and Sarkozy have barely been able to restrain their justified contempt for this 75-year old clown, who continues to hang onto power despite disastrous polls and multiple investigations about matters personally fiscal and sexual. His reform plan might actually be credible, although much of the problem is outsiders do not think he can get it through parliament, and his coalition is as shakey and quakey as they come. The centerpiece of raising the general retirement age from 65 to 67 looks like a mostly symbolic matter, given the budget is already in primary surplus. But, even though he continues to be "Il Cavaliere" strutting about in fancy suits on his TV channels and the front pages of the Italian papers, his support is less than 25%, reportedly confined mostly to elderly rural women who have not yet heard that the Roman Catholic Church has tired of fronting for him. He is the short term problem, and indeed he should go, as everybody says. But, the rascal is hard to get rid of, surviving a no-confidence vote (narrowly) a few weeks ago.

The longer term problem is that growth has slowed, now a ten year phenomenon of barely 1% per year growth. This is what has opened up the divergence of competitiveness between Italy and Germany and made for a need for Italy to devalue, thus ultimately straining the Eurozone with trade imbalances. It is easy to forget that Italy was a growth wonder back in the 70s, 80s, and even 90s, with its small clusters of exporting firms praised by Michael Porter. It is the increasing weakness of these firms that lies at the heart of Italy's longer run problems, and it is not obvious what can be done about it. Some say they are too small to deal with larger Chinese competitors or even the Mittelstand firms of Germany. I am in Florence where high-end textiles have been a big deal since the Benedictines produced them in the 1200s. Gucci, Pucci, and Salvatore Ferragamo all started here. Gucci has a production facility a block and a half from where I am staying, but they were bought out long ago by LvMH, the giant French firm. They are still hanging in there. Salvatore Ferragamo is still run by a widely admired family member, but can they continue to produce in Italy rather than China? I do not know. Many call for labor reforms in Italy, and some would help (including of academia), but this is indeed a longer term problem, and getting growth going again will not be helped by forcing a useless recapitalization of banks that will probably lead to cutbacks in lending and a return to outright recession in much of Europe.

Sunday, October 30, 2011

Krugman of Mass Destruction

UPDATE: See also Krugman, Ike, Keyserling, Keynes and Kalecki: "Siphoning Off a Part of the Annual Increment of GNP" in response to today's column by Krugman, "Bombs, Bridges and Jobs."

Paul Krugman, check your thoughts and your sources! In a blog post titled More Thoughts on Weaponized Keynesianism, Krugman wrote:
Economics, as I say often, is not a morality play. As far as creating aggregate demand is concerned, spending is spending – public spending is as good as but also no better than private spending, spending on bombs is as good as spending on public parks.
Economics is not a morality play but spending on bombs is NOT "as good as" spending on parks. In a comment, reader valuethinker from London pointed out that the lowest multiplier estimate for stimulus spending was for defense manufacture. This is not a trivial side issue but the core of the problem. Spending on the wrong things ultimately defeats the purpose of Keynesian stimulus. Keynes knew this. It's a shame Krugman doesn't know his Keynes.

In his post, Krugman also cited "the Kalecki point that admitting that the government can create jobs undermines demands that policies be framed to cater to all-important business confidence." Krugman linked to Rortybomb who linked to MRZine for the Kalecki paper. In that paper, Kalecki had more to say that is germane to Krugman's argument that "spending on bombs is as good as spending on public parks":
One of the important functions of fascism, as typified by the Nazi system, was to remove capitalist objections to full employment.

The dislike of government spending policy as such is overcome under fascism by the fact that the state machinery is under the direct control of a partnership of big business with fascism. The necessity for the myth of 'sound finance', which served to prevent the government from offsetting a confidence crisis by spending, is removed. In a democracy, one does not know what the next government will be like. Under fascism there is no next government.

The dislike of government spending, whether on public investment or consumption, is overcome by concentrating government expenditure on armaments. Finally, 'discipline in the factories' and 'political stability' under full employment are maintained by the 'new order', which ranges from suppression of the trade unions to the concentration camp. Political pressure replaces the economic pressure of unemployment.

So, yes, "spending on bombs is as good as spending on public parks" -- even better if you're a fascist! By the way, Professor Krugman. You still haven't replied to my earlier letter.

Friday, October 28, 2011

WSJ Oped Defends Perry’s Tax Proposal with More Supplyside Silliness

Yesterday’s oped can be found here:

One attack on a flat tax is that it won't raise enough revenue to fund the government—as if the current tax code is doing that well. But Mr. Perry and other Republicans shouldn't play this static revenue game. The flat tax is desirable precisely because of its spur to faster growth and more job creation, and the dynamic effect those would have on government revenues. The Perry campaign yesterday released a revenue analysis of its plan by John Dunham and Associates that estimated revenues of $2.781 trillion by 2014 and 19.5% of GDP by 2020 (compared to $2.3 trillion and 15.3% in fiscal 2011). All such estimates are speculative, but the point is that revenue history is on the side of the reformers. After the Reagan reform of 1986 that reduced tax rates to 28% from 50%, tax revenues rose by 36% from 1986 to 1990.

Oh boy – the old dynamic scoring canard that somehow fiscal irresponsibility would lead to faster growth! I find it fascinating, however, that the WSJ editorial page has now turned to the second half of the 1980’s rather talking about that alleged doubling of nominal Federal tax revenues (which of course included payroll taxes) following the 1981 tax cut. Memo to the WSJ editorial board – much of what happened since 1981 under Reagan included tax increases. But never mind that.

This John Dunham and Associates “analysis” was ably discussed by Matt Rognlie:

I never thought I’d see the day when I had to lecture a Republican presidential candidate on the importance of supply-side analysis, or the dangers of overexuberant demand-side logic. Apparently that day has come! The truth, of course, is that neither Rick Perry nor his staff have any idea of the analysis behind their numbers. Instead, they hired a consulting firm that specializes in using IMPLAN to create exaggerated estimates for the effect of particular industries (“Meat! Responsible for 5 trillion jobs!”) in order to please its lobbyist clients. The firm evidently knows nothing about tax analysis; it has no credentialed public finance economists on its staff and no experience in analyzing tax policy. When asked to conduct a study, it turned to the only game it knew: IMPLAN, which just happens to be a absurd way to analyze national fiscal policy.

Thursday, October 27, 2011

Weak GDP Growth and Fiscal Contraction

The advance estimate for real GDP during the 3rd quarter of 2011 is out showing annualized growth of only 2.5 percent with final sales growing by 3.6 percent (inventories fell). Consumption and fixed investment both grew but the said news is that real government purchases were unchanged. As BEA notes:

Real federal government consumption expenditures and gross investment increased 2.0 percent in the third quarter, compared with an increase of 1.9 percent in the second. National defense increased 4.8 percent, compared with an increase of 7.0 percent. Nondefense decreased 3.7 percent, compared with a decrease of 7.6 percent. Real state and local government consumption expenditures and gross investment decreased 1.3 percent, compared with a decrease of 2.8 percent.

In terms of 2005$, real government purchases were running at an annualized rate of $2508.2 billion in 2011Q3 according to this advanced estimate which is where we were in 2011Q2. This is actually below the $2509.6 billion figure for 2009Q1. Real government purchases peaked in 2010Q3 at $2570.3 billion (a mere 2.4 percent increase) but having been declining ever since. While this decline is most evident at the state and local level, Federal purchases (both defense and nondefense) are below their 2010Q3 peaks.

Our attempts at fiscal stimulus a couple of years ago were meager at best. Over the past year, we have been cutting government purchases. Isn’t any wonder why the Great Recession continues?!

Tuesday, October 25, 2011

Unemployment, Machines and Social Cost

Peter Frase reviews the e-book by Erik Brynjolfsson and Andrew McAfee of MIT, Race Against the Machine. Mark Thoma links to a New York Times review of the e-book.

To the Sandwichman, it looks like deja vu all over again. Eternal return of the same old, same old. I'm sure Professors Brynjolfsson and McAfee mean well, but it sounds to me like they are thinking inside the boxes -- and by boxes, I mean "those empty boxes" that D. H. Robertson lampooned in 1924:
The boxes, if I may make free with the metaphor, are not in my view properly to be loaded upon the same cab. It is almost as though one were a hat-box, and the other a monstrous compound of a box at the opera and a [flower?] box growing alongside a garden path.
"The problem of unemployment" is a phrase that has two meanings. One of those meanings has to do with an understanding of what unemployment is. The other has to do with the dislocations caused by unemployment and the search for a solution. You're not likely to find a good solution to unemployment if you don't understand what it is. And modern thought seems committed to avoiding such an understanding.

Unemployment is not an unfortunate accident, a structurally-inexorable tragedy or the just deserts of lazy people not spending enough time and effort honing their marketable skills. Unemployment is a functional relationship that both enables and compels firms to shift part of their overhead costs to society and individual workers. Is that so hard to grasp? Unemployment works -- that is until it doesn't anymore.

Guns don't kill people. People kill people. Machines don't discharge workers. Firms discharge workers. One would think, therefore, that unemployment would have something to do with "the nature of the firm" as well as the problem of social cost. All that other stuff is empty boxes.

Both John Maurice Clark and Ronald Coase examined "the nature of the firm and the problem of social cost." Clark received a standing ovation when he presented his paper, "Some Social Aspects of Overhead Costs," to the annual meeting of the American Economic Association in 1922. The reception of Ronald Coase's theorem by the Chicago school economists was initially more muted. George Stigler recalled the occasion when Coase was summoned to Chicago from the University of Virginia to explain:
We strongly objected to this heresy. Milton Friedman did most of the talking, as usual. He also did much of the thinking, as usual. In the course of two hours of argument the vote went from twenty against and one for Coase [with Coase voting for the affirmative] to twenty-one for Coase. What an exhilarating event! I lamented afterward that we had not had the clairvoyance to tape it.
There's just one little problem with "the problem of social cost." The word "unemployment" doesn't appear in Coase's article. Nor does the word "labor." The word "employment" does appear but it refers to employment of factors of production, not to jobs. That's what Sandwichman's paper, "The Problem with The Problem of Social Cost" (which will soon be edited into two complementary papers) is all about.

Sandwichman wants to know: is there a Sveriges Riksbank prize for taking down a Sveriges Riksbank prize-winner?

Perry’s Cut, Balance and Grow

To no one’s surprise, Rick Perry proposes another variation of the Republican dream of cutting taxes for high income individuals and still balancing the budget somehow. I’ll leave to others to have fun with his tax proposals as we focus on this:

We should start moving toward fiscal responsibility by capping federal spending at 18% of our gross domestic product, banning earmarks and future bailouts, and passing a Balanced Budget Amendment to the Constitution. My plan freezes federal civilian hiring and salaries until the budget is balanced. And to fix the regulatory excess of the Obama administration and its predecessors, my plan puts an immediate moratorium on pending federal regulations and provides a full audit of all regulations passed since 2008 to determine their need, impact and effect on job creation.

Where exactly is Perry proposing to slash Federal spending again? The Government Accountability Office shows that spending on Social Security and major health care entitlements were about than 10 percent of GDP in 2010 and will grow to 13.5 percent of GDP by 2030 even if we don’t repeal ObamaCare under the best of circumstances. If the Republicans have they way in their zest to gut Obamacare, health care entitlement spending will be even higher.

Federal purchases of goods and services were over 8.4% of GDP in 2010. Admittedly Federal spending as a share of GDP has been inflated by the recession but if we go back to 2007, Federal purchases were almost 7% of GDP of which 4.7% of GDP went to national defense. So even if we eliminated nondefense Federal government purchases somehow, the combination of defense spending, Social Security, and major health care entitlements would exceed 19% - even under the best of circumstances.

Of course – the notion of cutting government spending to get us out of a recession – or expansionary austerity - seems to be based on “some shoddy scholarship”.

Sunday, October 23, 2011

What Should OWS Demand?

Not that anybody has been waiting breathlessly for my opinion, but I’ve finally figured out the single, key demand that OWS should make.

To understand it, consider these premisses:

1. You would have to go back a century to find a time when the financial elite had as large a share of the loot as they do today.

2. In the absence of a large, well-organized countervailing force, money is power.

3. We don’t need new ideas to fix the economy.  The policy obsessed debate the details, but the main contours in debt writedowns, regulation, public investment and related domains are well understood.  The problem is that what is good for the economy is generally not profitable for the rich, and vice versa.  Because of the gross imbalance of power in this country, we are unable to do what needs to be done.

So what’s the key demand?  OWS does not need to make any demands on the Obama administration, much less the Republican shadow government in Congress.  It does need to make a demand on us, the lower 99:

Organize yourselves!  Get rid of the fatalism, cynicism and paralysis that took over when Obama turned out to be Mr. Wrong.  It isn’t about him in any case, it’s about the fact that there is no organized democratic force in America that can challenge the plutocrats.

Not everyone can become an urban camper, so the first item on the OWS, and the Occupy-your-city-goes-here, agenda should be how to expand the movement to reach the millions who would join if they knew how.  Keep the flexibility and commitment to democracy and reflection.  Avoid actions, like political endorsements, that would divide people or channel their energies away from the organizations they can control themselves.

Reach out and scale up.

Thursday, October 20, 2011

Philosophers Support Greek Austerity

Probably not, but suppose you read a newspaper story on the Eurozone crisis that emphasized the solemn obligation of Greece to repay its creditors and included a sentence like this:
Philosophers and Greece’s foreign lenders say the austerity measures are required to meet its obligations, but they are deeply unpopular with Greeks.
You might wonder whether philosophers, who glory in their argumentative skills, actually agree on this.

In fact, the sentence in today’s New York Times reads:
Economists and Greece’s foreign lenders say the austerity measures are required to modernize its economy, but they are deeply unpopular with Greeks.
Now I happen to be an economist myself, and I know and communicate with lots of other economists of varying political and doctrinal affiliations, and none of us—none—thinks that austerity fosters modernization.  How will across the board wage cuts and tax increases (on wages of course, since other forms of taxation can easily be evaded) turn the national railway system from a patronage machine into a transportation service?

The question behind the question is why the Times feels the need to give austerity an aura of professional approval.

I’m an economist, I think the Greek economy is dysfunctional on several levels, and I’m with the strikers.

Wednesday, October 19, 2011

Cain’s 9 Responses to His 9-9-9 Tax

Even before last night’s debate Herman Cain replied to his critics. Much of what he says here notes where his tax proposal would replace other taxes. For example, he objects to the regressivity charge by noting he would repeal the payroll tax adding:

Some critics have argued that the poor still come out behind because employers pay much of the payroll tax. That demonstrates a basic misunderstanding about how compensation works in the business world. An employer decides to accept a certain cost-of-employment for each employee, and the employer’s share of the payroll tax is part of that cost. It comes out of your compensation whether you realize it or not.

He also replies to Paul Krugman’s observation on his “business tax” thusly:

Paul Krugman of the New York Times makes this claim because we do not allow businesses to deduct the cost of labor from their taxable revenue. But the claim is bogus for several reasons. First, we are reducing the corporate tax rate from 35 percent to 9 percent, so the tradeoff is a much lower rate paid on more of a company’s income. Second, we treat capital and labor the same, both with the corporate tax and with the income tax. That is fair and neutral. What’s more, the current system taxes both capital investment by business and capital gains by individuals. That’s a double tax, and the 9-9-9 plan eliminates it.

Actually – his plan does eliminate profits taxes replacing them with a value added tax which he simply admits in his discussion of claim 7:

The 9-9-9 plan is a really an 18 percent value-added tax plus a 9 percent income tax.

In other words, the plan represents a major shift away from income taxation to value added taxation. As such his plan would indeed tend to shift the tax burden away from high income individuals towards the rest of us even as Mr. Cain protests against claim 3.

Hat tip to Paul Krugman for pointing us to the Tax Policy Center analysis of who gains and who loses from this proposed overall of the tax system. Howard Gleckman provides a nice summary:

A middle income household making between about $64,000 and $110,000 would get hit with an average tax increase of about $4,300, lowering its after-tax income by more than 6 percent and increasing its average federal tax rate (including income, payroll, estate and its share of the corporate income tax) from 18.8 percent to 23.7 percent. By contrast, a taxpayer in the top 0.1% (who makes more than $2.7 million) would enjoy an average tax cut of nearly$1.4 million, increasing his after-tax income by nearly 27 percent. His average effective tax rate would be cut almost in half to 17.9 percent. In Cain’s world, a typical household making more than $2.7 million would pay a smaller share of its income in federal taxes than one making less than $18,000. This would give Warren Buffet severe heartburn.

If I’m reading the TPC analysis correctly, on average taxes would go up by almost $800 per tax unit. It is laughable listening to the critiques offered by the other GOP candidates for President because they almost sound like Democrats. Yes they are correct when they say this represents a tax increase on the middle class. But don’t most of the Republican proposals for tax reform offer large tax cuts for the very well to do, while this party tries to pretend it also wants to reduce the deficit? OK – Paul Ryan thinks we can slash Federal spending by magic asterisk and the elimination of Medicare. But we know this is not going to happen. So at the end of the day – the Republican agenda has always been to shift the tax burden away from the rich and toward the middle class and the poor. While I in no way support 9-9-9, you have to give credit to Mr. Cain for at least trying to be honest about tax policy. Which is why he has zero chance of ever being nominated for President by the Republican Party.

Monday, October 17, 2011

Goldman Sachs Economists Recommend That the FED Target Nominal GDP

The recommendations for boosting the economy from Jan Hatzius and Sven Jari Stehn can be found here where they also advocate more Quantitative Easing. Of course the leaders of the Republican Party are opposed to such monetary policy – just as they are opposed to anything from the fiscal side that would actually improve economic performance.

Sunday, October 16, 2011

Leader Of Sraffian School Of Economics Dies

On October 14, Pierangelo Garegnani, genearlly acknowledged leader of the Sraffian School of economics passed away while attending a conference of the Society of Italian Economists in Rome, where he had been at La Sapienza University for decades. He was a deep and important scholar of strong views. An important question now arising is who will succeed him as Editor of the Sraffa papers, which remain far from being fully published at this time.

Thursday, October 13, 2011

The Real American Jobs Act – a 1937 Redux?

Manu Raju reports on the latest GOP political gimmick:

So they’re planning to roll out a jobs plan that amounts to a conservative’s dream agenda: targeting labor and environmental regulations, enacting a balanced-budget amendment to the Constitution, lowering corporate and individual tax rates, encouraging energy production and expanding free trade, according to a draft obtained by POLITICO.

Expanding free trade and reducing regulations will do little to shore up the lack of aggregate demand and hence will have little effect on GDP and employment. Drill baby drill isn’t exactly the solution to the Great Recession either. So let’s focus on the fiscal side of this proposal – balancing the budget as one cuts tax rates likely means massive reduction in government spending.

Bruce Bartlett noted that a similar turn to fiscal austerity led to the 1937 recession:

During 1937, Roosevelt pressed ahead with fiscal tightening despite the obvious downturn in economic activity. The budget deficit fell from 5.5% of GDP in 1936 to 2.5% in 1937 and the budget was virtually balanced in fiscal year 1938, with a deficit of just $89 million. The result was a huge economic setback, with GDP falling and unemployment rising. For this reason, Obama's economic advisers have been warning for some time that stimulus must be continued until full employment has returned.

The Republicans actually want to call their proposal to repeat this policy mistake “The Real American Jobs Act”?

Monday, October 10, 2011

Living in the Past

It’s tempting to compare our current slump with the Great Depression, but it runs the risk of failing to see how the world has changed over the last 80 years.  David Leonhardt of New York Times falls head over heels into this trap in his recent think piece on the upside of the Depression.

He makes a number of errors and omissions along the way (including a glaring ecological fallacy), but I’m not keeping score.  It’s his big idea that is so fundamentally wrong.

Leonhardt correctly points out that the 1930s was a decade of extraordinary technical advance, laying the basis for new industries that would propel economic growth after WWII.  He is also correct in seeing that the leading sectors of recent US expansion, health, finance and housing (read: suburbanization), are mostly bloat.  What has changed utterly since the days of Sloan and Sarnoff, however, is the national character of technology: there is none.

It used to be that nations really possessed technologies.  A corporation centered in a single country was the world leader not in a specific process or market niche, but an entire industry.  A country that could establish dominance in a rising industry could significantly boost its prosperity and power, and, in one form or another, industrial policy was king.

That’s over.  Engineering cultures around the world have largely converged, and progress is made via internationally coordinated partnerships.  Technologies do not have locations.  It doesn’t matter where the next new thing is originally developed; it will be financed, produced and marketed globally.  It is anachronistic to expect some new, world-shaking product to pull the US out of its long-term rut.

Of course, it is profoundly self-destructive for this country to starve its schools, not to mention spending billions to warehouse a large chunk of what is clearly seen as a surplus population in our prison archipelago.  Priorities certainly need to change, but the pathway out of the Depression is a poor guide.

Postscript: Maybe the next new thing (for the world economy) is cleaning up the mess left by some of the previous things, starting with decarbonization.

OWS and the Possibility of a Second Crash

This is a hazardous season for the global financial system.  European politicians dither in the face of impending sovereign defaults and a re-recession that imperil their core banks, and big players on this side of the Atlantic, like BoA and Morgan Stanley, are clearly staggering.  While the odds of a second financial meltdown during the coming month or two are still well under 50%, they are not at all negligible.

What if the meltdown arrives, and Wall Street is still occupied?

This is really up to the occupiers, and I hope they are huddling on a contingency strategy as I write.  If the bottom falls out, they will find themselves with an extraordinary public platform—if they are prepared to use it.

No Bailouts!

I should begin by saying that I like the idea of being a financial romantic.  But the real reason Paul Krugman is wrong about this hugely important question is that he is confusing (uncharacteristically) issues of liquidity and solvency.  He invokes Bagehot in support of a clear-eyed defense of bailing out the financial sector in its times of distress, but Bagehot was observing the need for a lender of last resort.

Lending and bailing are two entirely different animals.

We should expect the Fed to provide essentially unlimited liquidity if there is a run on the banking system—if the system is unable to cover the mismatch between its long-term assets and short-term liabilities.  As long as financial institutions have positive net worth at realistic asset prices, this will be nearly costless for the taxpayer and priceless for the economy.

But bailouts are something altogether different.  The financial system cries to be bailed out if it faces a solvency crisis, if the value of its assets are plunging and the last shreds of equity are at risk.  Examples of this kind of rescue include the injection of vast sums to buy up dubious mortgage-backed securities at face rather than market prices, assuming the liabilities of failing speculators like AIG toward their speculator counterparties, and so on.  The US government shouldn’t have done this the first time around, and they damned sure shouldn’t do it a second.  I would not be upset to see our legislators sign a blood oath against all manner of bailing.

Yes, a solvency crisis nearly always triggers a liquidity crisis, but you can patch the second without trying to reverse the first.

Another objection arises: how can you let banks fail if they are too big to fail?  Very generally, there are two alternatives: you can temporarily take ownership of them—wiping out the equity of their previous owners and sacking the management—while you use public money to resolve their net liabilities, or you simply let them fail while using public money to buy up their assets at liquidation prices to jumpstart a system of public banking.  I’d go for the second, but either is feasible and way, way preferable to bailouts.

Saturday, October 8, 2011

Occupying Occupying Wall Street?

I admit I was one of the doubters.  The initial actions of the occupiers—their diffuseness, the tendency toward  a psychological interpretation of the problem (greed versus niceness)—led me to think that this would be just another blip on the political radar.

How wrong I was.  There was a deep insight beneath the gentle anarchy, that a movement against the rule of finance must be amorphous, at least initially, so that as large a swath of society as possible could see themselves reflected in it.  Of course, it also helped that the timing was spot on: we are in the political season of debates between Republicans about how far back we should go—whether to 1959 (erase the 60s), 1932 (erase the New Deal), 1912 (erase the Fed and the income tax), or somewhere further on—but not a squeak from the other side against the dreadful politics of the Obama administration.  OWS is giving us the chance to have this missing debate out in public.  That’s why it has attracted labor unions, enviro groups and even a few dissident economists to its encampment in New York, while it spawns occubots in towns and cities across the country.

This success also presents a big risk, the potential for cooptation.  The problem is very specific: the Democratic Party has a modern history of deploying populist rhetoric during its campaigns (Clinton, Obama) and doing the bidding of Wall Street and its minions once in power.  This is one reason why the rhetoric has lost a lot of its force: denouncing the upper 1% sounds like a cynical ploy to get ordinary people, once more, to sign off on policies that will fleece the bottom 99.

It has to be added that the labor movement has not yet extricated itself from this game.  It talks the right talk, but when election time roles around class mobilization translates into staffing phone banks for just about any Democrat to the left of Newt Gingrich.

What I’m suggesting is that the occupards need to develop enough of a collective voice to distinguish their movement from generic populist rhetoric.  This is not at all the same as agreeing on a list of demands.  The point to bear in mind is that the fundamental problem is not that there aren’t good ideas out there, but that finance and allied wealth-holders who see the world through their portfolios have too much power.  The purpose of citizen activism should be to take that power away.  This will require, sooner or later, an institutionalized force separate from the Democratic Party that, while it may disagree internally about lots of things, knows that this power shift is job one.  In other words, it’s not about demands but self-definition—who we are and what brings us together.

99% is a start, but it needs that extra piece that clearly distinguishes itself from empty populism.  However it expresses itself, that piece has to be about breaking free of the hostage syndrome (of which Obama is the current spokesman) and calling for less money and less political power—a whole lot less—for finance.

Friday, October 7, 2011

Good and Bad Arguments against IS-LM

Start with the bad, i.e. Tyler Cowan:
1. It fudges the distinction between real and nominal interest rates, so it can put the two curves on the same graph.  Every time you write down an IS-LM model you should hear a clock start ticking in your head.  The longer the clock ticks, you more you need to worry about this problem because the more that a) the price level may change, or b) expectations about future price level changes will start to matter.
Weird.  There’s no price level in the model.  Obviously IS-LM is a theory about real interest rates, and real everything else.  If you had an expanded theory with price level changes, the IS-LM part of it would use real  magnitudes.  What’s the criticism?
2. It fudges the distinction between short-term interest rates (for the money market curve) and long-term interest rates (a determinant of investment).  They’re not the same!  Don’t assume they are the same, just to squash the two curves onto the same graph.
The yield curve requires another dimension but doesn’t change the logic.  This is an add-on to IS-LM, not a flaw.
3. It leads you to think that the distinction between non-interest bearing currency and short-term interest-bearing securities is a critical wedge for the economy.  It also implies that if all currency paid interest (a minor change, most likely, macroeconomically speaking), the economy would behave in a totally screwy way.  It probably wouldn’t.
Hey Tyler, all IS-LM requires is that money earn less.  If it earned more, the economy would be screwy indeed.
3b. The model leads you to believe that interest rates are more important than they probably are.
That depends on the slopes of the curves, doesn’t it?  This is not a criticism of the model per se.  (Besides, there isn’t a 3a.)
3c. For a while it treats “money” as the non-interest-bearing security, and then for a while it treats money as the transactions media behind AD, something closer to M2.
The whole point of the LM curve is that money is both of these at the same time: transactions demand and liquidity preference, remember?
4. It overemphasizes flows and under-emphasizes stocks of wealth.  The quantity theory approach, as wielded by Fisher and Friedman, does not induce individuals to make this same judgment.  For one thing, this distinction really matters when you’re trying to predict the macro effects of “window breaking.”  The flows perspective will usually be more optimistic than a perspective which recognizes both stocks and flows.
This is a valid criticism, but again, how would the addition of stocks alter the IS-LM logic regarding flows?  Incidentally, the broken windows thing works like this: assuming your broken windows are capital stock, and that a reduction in it raises its marginal product, your IS curve shifts out.  If you have heterogeneous capital, and the loss of one part of it reduces the marginal productivity of the rest, your IS curve could shift in, at least temporarily.  Obviously, if you add in wealth effects you will depress investment via the effective demand channel, but that’s something that IS-LM is not built to handle.  You can’t solder with a screw driver, and this is not an argument against screw drivers.
5. Those aggregate curves are not invariant with respect to expectations, including expectations of government policy.  You don’t have to believe in an extreme version of the Lucas critique to worry about this one.  Those curves are conditional and the ceteris paribus assumption is not to be taken lightly here.
Yes, the position and shape of the curves depend on all sorts of things.  And?
6. In the LM curve, what is the embedded reaction function of the Fed?  Good luck with that one.  Pondering this issue leads you to conclude that the whole model was written for an economy fundamentally different than ours.
There is no reaction function and that’s perfectly fine with me.  You can ask, what would happen if the Fed had this particular reaction function, but that’s not the same as making that function an assumed part of the model you use for other purposes.  Models should inform policies, not assume them.  (And empirically, do we think that central bank decisions are so predictable?)
7. The most important points, for instance about the significance of AD, one can derive from a quantity theory or nominal gdp perspective (for the latter, see my Principles text with Alex).
MV=PY?  All the relationships between interest rates and income are in the background.  The Keynesian Cross?  How does that express liquidity preference?

So much for the darts that don’t stick—what are some that do?

1. The LM curve assumes a fixed money supply.  This would be dubious if it were just a matter of portraying an irrational and nonexistent central bank reaction function, keep the money supply constant at all times!  It’s worse than that, because most money is created endogenously through the provision of credit.  The IS curve would have us imagine that different levels of investment are open to the economy, but somehow they don’t correspond to different levels of the money supply on the LM side of things.  This is a big, big problem.

2. The model abstracts from default risk, but in doing so it ignores connections between interest rates and real income.  (It also introduces a channel through which changes in the price level can alter the relationship between real variables.)  In other words, incorporating default is not just adding on something new, it’s taking account of logical connections between the variables you are already modeling.  Omitting default is not always a consequential flaw, but when it is it really is.

Incidentally, my criticisms are not competitive with Hicks and the Post Keynesians, who argue that IS-LM  does not capture the core of what JMK had to say.  This is correct, but a different matter.

Wednesday, October 5, 2011

Occupy Wall Street: Romney v. Bernanke

Two prominent Republicans have weighed in on the Occupy Wall Street protests. Presidential candidate Mitt Romney either does not get it or simply does not care:

Republican presidential frontrunner Mitt Romney on Tuesday compared the current anti-Wall Street protests to class warfare. “I think it’s dangerous, this class warfare,” Romney said to an audience of about 50 people in response to a question about the protests over such issues as high unemployment, home foreclosures and the 2008 corporate bailouts.

Federal Reserve chairman Ben Bernanke does get it:

Federal Reserve Chairman Ben S. Bernanke warned lawmakers Tuesday against cutting the budget too sharply with the U.S. economy still weak and facing new stresses from the European debt crisis. And the central bank chief expressed some empathy with protesters who have marched on Wall Street and in other cities in recent days complaining of the role of big financial institutions in creating the current economic mess. "Very generally I think people are quite unhappy with the state of the economy and what’s happening. They blame, with some justification, the problems in the financial sector for getting us into this mess and they're dissatisfied with the policy response here in Washington," Bernanke told Congress' Joint Economic Committee. "On some level I can’t blame them," he said. "Like everyone else, I’m dissatisfied with what the economy is doing right now." Bernanke noted the difficulty for Congress to rein in the long-term federal budget deficit while trying "to avoid fiscal actions that could impede the ongoing economic recovery." But he said that one factor weighing down the U.S. recovery is "the increasing drag" from cutbacks in government spending. "Notably, state and local governments continue to tighten their belts by cutting spending and employment in the face of ongoing budgetary pressures, while the future course of federal fiscal policies remains quite uncertain," Bernanke told the committee.

Of course the reason fiscal policy has not effectively dealt with the Great Recession comes from the power of two other Republicans – the Speaker of the House and Senator McConnell.

Saturday, October 1, 2011

Ron Suskind, Obama, Tim Geithner, Citigroup, and the Wall Street Occupation

Ron Suskind's new book describes how Obama wanted to follow the Scandinavian approach to financial crashes by shutting down the banks, wiping out shareholders, and bringing in new management. He charged Geithner with figuring out how to shut down Citigroup. Geithner preferred to ignore his boss's wishes. An earlier book, throws further light on the relationship between Geithner and Citigroup, in which Geithner was offered the job of running Citigroup.

Sorkin, Andrew Ross. 2009. Too Big to Fail: Inside the Battle to Save Wall Street (Allen Lane Penguin Books, London).

61: According to his account of the Lehman crisis, Geithner had been quietly approached in November 2007 by Weill and asked if he would be interested in becoming boss of Citi, a move that could garner him untold millions. Geithner was certainly interested, pondering the matter while on long walks round Larchmont with his dog, Adobe, but a firm offer never materialized.

At that time the credit crisis was really starting to bite, and the giant bank had just reported a record loss. "Weill had no executive function at Citi. He wouldn't be the one making that call if they were seriously interested in giving Geithner the job" points out one banking analyst in commenting on the story. "How else can we interpret this but as a nice juicy carrot being dangled in front of the President of the New York Fed by a bank that was going to need Fed help in a big way."