Has Monetary Policy Been Contractionary?

Greg Mankiw and Paul Krugman have been providing graphs of certain interest rates and the exchange rate with a little commentary. Greg poses this query:

You observe an economy sinking in recession. As this occurs, real interest rates are rising, and the currency is strengthening. What shock, or set of shocks, could have caused these events?

Paul notes:

Bernanke’s problem, and ours. This picture shows the target Fed funds rate, the usual tool of monetary policy; the 10-year Treasury rate; and two rates that actually matter to the private sector, the mortgage rate and the rate on Baa-rated corporate bonds. The Fed has had no success in reducing mortgage rates, and corporate borrowing costs have gone up, not down. Add in falling expectations of inflation, and in real terms monetary policy has gotten tighter, not easier.

House Slaves and Hidden Imams

Ayman al-Zawahiri, the #2 of al-Qaeda, has issued a tape denouncing Obama. The headlines have screamed "racial slur!" and the "official" translation had him describing Obama as a "house negro." The actual term was "abd al-bayt," which literally means, "house slave," not flattering, but not a racial slur, and also inaccurate, given that he is about to become the house master, arguably, something that makes the al-Qaeda crowd unhappy.

Now while Obama has promised to go after Osama, I think the fact that al-Zawahiri has been doing these tapes since 2004 with no appearances by Osama means that the latter is either incapacitated or dead. If dead, I can see them keeping the illusion of him still alive going. Although they are Sunnis, this sort of resembles the Shi'i cult of the missing 12th Iman, who supposedly went into Occultation and will reappear in the world as a messianic savior at some point, with various current leaders claiming access to him. Osama could be the radical Sunni Hidden Imam, with Obama chasing a Hidden Imam Osama.

Now That's Leverage!

"Tangible assets, which don't include goodwill or intangibles, are 55 times the bank's tangible equity .... Citi's leverage worries some investors. Furthermore, possibly making matters worse are proposed accounting-rule changes that, if adopted, will prompt banks in 2010 to bring some off-balance-sheet assets back onto their books.

Tangible assets rise to nearly 59 times tangible equity if Citi has to bring about $120 billion in credit-card assets back onto its books in 2010, as is likely. Citi also may have to consolidate some of the roughly $670 billion in mortgage assets currently held by off-balance-sheet vehicles.

If the bank had to consolidate just 20% of these mortgage assets, tangible assets would rise to about 63 times tangible equity.

Reilly, David. 2008. "Job Losses Won't Cut It for Citigroup." Wall Street Journal (18 November): p. C 10.

Unions, Unemployment & Shorter Hours

by the Sandwichman

What's up? Unemployment is up. What to do about it?

Samuel Gompers said, in 1887, "The answer to all opponents to the reduction of the hours of labor could well be given in these words: 'That so long as there is one man who seeks employment and cannot obtain it, the hours of labor are too long.'"

In 1932, President William Green of the A. F. of L., "estimated that if the hours actually being worked at the present time were distributed on the basis of thirty hours a week among the working population the 12,000,000 now unemployed could be put to work."

In 1962, the AFL-CIO Federationist put the case this way:

The case for shorter hours does not rest on the notion it is the best way. It is based rather on the view, supported by ample evidence in the past decade of mounting unemployment, that: (1) other economic measures to achieve full employment are not being applied and perhaps cannot be applied; and (2) even if other economic policies are successful in stimulating greater growth in the period ahead, the rate of advance in technology and other labor-displacing changes is gathering such momentum that, unless part of the gains in efficiency are distributed in reductions in hours, it is virtually inevitable that it will show up in persistent and increased unemployment.

"There's no question that the long-term salvation of work lies in reducing working hours," said Thomas R. Donahue, secretary-treasurer of the AFL-CIO in 1993.

So today, 2008, with unemployment on the rise, what's the word from the AFL-CIO on shorter hours?

Bailouts and JAWBS

by the Sandwichman

Presumably... implicitly... tacitly... these bailouts are all about saving JAWBS.

I mean, is there any other rationale for them that would pass political muster? So can someone direct the Sandwichman to an econometric study that estimates just how many net JAWBS are saved or created per Billion Bail Dollars (BBD)? Note I said net JAWBS -- I don't want to hear any lump-of-labor silliness about the amount of work being fixed so that if someone gets laid off from CitiBank there won't be any new dog-walking or paid blogger positions opening up.

Obviously, economists have studied this matter thoroughly and there's a consensus out there about this stuff. Right?

Unemployment in the Automobile Industry

PS: Dan Becker also told me that he just testified before Congress in the automobile hearings, shocking the politicians are telling them that there are now more unemployed automobile workers than employed.

Did Al Gore Almost Save the Automobile Industry?

The automobile industry is on the ropes, dying a death of 1000 cuts, most of them self-inflicted. Virtually everybody knows about the stubborn reliance on SUVs and other gas hogs, as well as the foray into non-automobile finance. I heard an interview with Dan Becker, the director of the Safe Climate Campaign, described another angle that in my ignorance I had not heard before.

I contacted Dan for some more information. What follows are my rough notes from my phone conversation regarding The Partnership for New Generation of Vehicles:

Vice President Al Gore told the Big Three that he wanted them to develop a sedan-size car that could get 80 miles a gallon. What is surprising is that they complied. Each one produced a prototype -- a single prototype and then left the project to die. What was striking about Dan's presentation was that the prototypes seem to have been relatively solid.

Word of Detroit's success helped to spark Japanese interest in developing something similar. Coming from an island far from its oil supplies, MITI was interested in transportation alternatives. Of course, California's requirement for zero emission vehicles (which my neighbor was instrumental in squashing) also played a role in interesting the Japanese, but the Gore angle and the successful prototypes were new to me.

Amity Schlaes Criticizes Lord Keynes Only to Display Her Own Ignorance

Why did Bloomberg print this nonsense?

The Great Society of that period was the ultimate Keynesian experiment, and it didn't work very well ... The jobs that Keynes emphasized were AWOL: America became accustomed to high levels of unemployment.

Paul Krugman objects:

The Great Society wasn’t deficit spending, it wasn’t intended to create jobs, and the economy of the 1960s wasn’t depressed. It was social engineering; we can talk about how well or badly it worked, but it had nothing whatsoever to do with Keynesian economics. Now, LBJ did engage in some Keynesian economics: namely, he imposed a contractionary fiscal policy in the form of a tax surcharge in an effort to cool an overheating economy.

Paul is basically correct but let’s go further. The big Keynesian fiscal experiment was that 1964 tax cut, which did seem to work fairly well as the economy returned to full employment by late 1965. While Paul and I were both too young in 1965 to have been included in the discussions between the Council of Economic Advisors and President Johnson, I have had the pleasure of hearing from those who were what kind of macroeconomic advice the CEA gave the President during December 1965. Realizing that the economy was at full employment and seeing the triple whammy of tax cuts, proposed Great Society domestic spending, and the run-up in Defense Department spending from the Vietnam War, the CEA strongly urged the President to push for fiscal restraint lest the Federal Reserve would have to raise interest rates to choke off excessive demand. The President fired back that the Great Society was important to him and that he was not ready to pull out of Vietnam. The President also noted that getting a reversal of the 1964 tax cuts would be politically difficult. The Federal Reserve did raise interest rates in 1966 leading to the 1966 Credit Crunch, which held inflation at bay. However, the Federal Reserve later reversed course unfortunately. So we eventually got a delayed and lukewarm version of the fiscal restraint that the CEA recommended way back in late 1965 – as Paul noted. Too little and too late.

For Schlaes to blame the run-up in inflation on the Keynesian economists that advised President Johnson only shows she has absolutely no clue. But then we knew that already.

Force Them to Lend?

My restful sleep continues to be disturbed by Willem Buiter, who writes

I am in Slovenia today, talking to bankers, entrepreneurs, managers, politicians, government officials and academics. The story is the same here as in every country I have visited since mid-September 2008: the banks aren’t lending. They don’t lend to each other. They don’t lend to non-financial businesses and they don’t lend to households....The macroeconomic consequences of this lending paralysis are potentially disastrous. It could turn a global recession into a global depression, with many years of stagnation and cumulative declines of GDP of 10 percent or more.

His solution?

I propose the following form of forced lending by banks to non-financial businesses. Every loan that matures during the coming year gets extended/renewed for another year on the same terms as the maturing loan. This applies to both secured and unsecured loans. Likewise every credit line or overdraft facility that expires during the coming year gets extended/renewed for another year. Expiring loans, credit lines or overdraft facilities that had an original maturity of less than a year or more than a year will have the same interest rate for the one-year extension/renewal as the original arrangement.

Yes, force them to lend. This is a rather blunt instrument, I would say. It would roll over some loans that should absolutely not be renewed, and it would not direct financing to new, previously unfinanced projects. I think bankers won’t like it. They wouldn’t like my “Plan B”, creating a public competitive financial entity, either. So which one should it be?

Buiter’s approach has the advantage of using the existing institutions: the same personnel, the same chains of command, the same office layouts—nothing new that could create friction or delay at a time when we particularly don’t need it. My approach would be vastly less expensive for the public (and therefore more feasible in direct financial terms) and would be capable of making more rational distinctions at the micro level. But one way or the other, we have to shift the narrative quickly. What needs to be rescued are not the financial markets but the real economies, the incomes and employment, that are the substance of our standard of living.

Report from the Galbraith Conference in New York, 11/14

I previously posted what I was planning to say, which I did, at the Conference on "The Financial Crisis, the US Economy, and International Security in the New Administration," organized by James Galbraith at New School University on Nov. 14, and sponsored by Economists for Peace and Security. They will have a full video up at some point on their website at http://www.epsusa.org, and currently have the full program. I shall focus on main points presented by others, with an emphasis especially on new policy proposals, and will not cover the remarks by quite a few who spoke. I may add more later.

Galbraith indicated he would be presenting many of the ideas to the Obama economic transition team this week, as well as in a keynote address he gave yesterday to Congressional Democrats at EPI.

Galbraith was the first speaker and recounted points that have appeared in an article by him in this month's Challenge magazine. His main proposals were to revive the New Deal Housing Ownership and Loan Corporation (HOLC), strongly supported by others as well, to reinstitute general revenue sharing to support state and local governments, to institute an infrastructure investment fund, with emphasis on green technologies, and to increase social security benefits.

Joseph Stiglitz called for converting the housing tax deduction to a tax credit for poorer homeowners, for the government to make mortgage payments for those who become unemployed, and to institute a law forbidding US banks from dealing with foreign ones that do not conform to global banking standards.

Pierre Calame supported establishing global commodity buffer stocks to moderate price fluctuations of basic commodities.


Allen Sinai forecast a 24 month recession, which he considers to have begun in January 2008, and called for a $350 fiscal stimulus package. Others called for larger such packages.

Teresa Ghilarducci supported Galbraith's proposal on converting tax deductions to credits, and also supported having the government pay employers' contributions to fica for the duration of the recession, and finally a much-discussed proposal to lower the medicare eligibility age to 55.

Perry Mehrling provided an insightful account of how the Fed has become effectively the world's central banker, taking much of the world's dodgy paper onto its books. He proposed establishing an insurance scheme for credit-default swaps that would involve them providing appropriate collateral, and would also requiring turning them into operating with transparency through an exchange rather than over the counter.

Gary Dymski supported my proposal for using shared appreciation mortgages and called for more direct efforts to prevent "exploitative" housing lending, as well as directing some of the infrastructure spending towards housing, high speed rail networks, and such social support services as child care.

John Eatwell called for increasing the regulatory authority of the IMF, noting that the Forum for Stability has many ideas that it could use. This did not come out of the G-20 summit, but another idea he supported did, that of establishing "colleges of supervisors" (Eatwell said "regulators") in which the regulators meet and coordinate their activities from the main nations that a particular multinational financial entity operates.

Paul Davidson supported establishing the 1944 "Keynes Plan" that would have a strong central bank, with international clearing units, and a responsibility placed on surplus nations for making adjustments. With the large stimulus plan in China happening, this may be occurring to some degree at this time, especially as the Chinese seem to be allowing some RMB appreciation.

Missing: the strange disappearance of S. J. Chapman’s theory of the hours of labour (13)

Conclusion
In his article on the canonical labour-supply model Derobert (2001) mentioned Chapman's theory in connection with Hicks's description of it as "the classical statement of the theory of 'hours' in a free market." Derobert dismissed Chapman's theory as "excessively complicated" and as "more of an amalgam than a synthesis" (p. 204). He also described it as lying "somewhere between Jevons's analysis and the canonical model" (p. 204). Chapman's theory lies between Jevons and the current canonical model only in a narrow chronological sense. Although Chapman's analysis did indeed develop Jevons's earlier discussion of the hours of labour, it bears little resemblance to the income-leisure choice model. Instead, it incorporates the opportunity-cost concept without at the same time abandoning the idea that work provides intrinsic satisfactions and dissatisfactions.

Perhaps Chapman's theory could indeed be considered "excessively complicated" in the non-pejorative sense that life itself is too complicated to describe in a mathematical model. The income-leisure choice model simply ignores Chapman's theory, it doesn't refute, refine, simplify, adapt or transcend it. In its ignorance of Chapman's theory, it tacitly assumes proportionality between hours worked and output produced. In the bargain, mainstream analysis implies an identity between market goods purchased and economic welfare. Leisure time disappears – even as a commodity. The hypothetical purchase of leisure time leaves behind no receipts to be reckoned in the calculation of national income. Thus Barone's book-keeping artifice involves writing entries in disappearing ink – a practice that might elsewhere be reckoned as fraudulent.

Sydney Chapman's theory of the hours of labour was both insightful and authoritative. It was widely accepted by eminent English economists of its day. It buttressed the novel conclusions that the ideal hours of work for maximizing social welfare would be shorter than those for maximizing profits and that the hours of work set in a competitive market may be too long even from the standpoint of maximizing output. Yet that acknowledged authoritative theory was displaced by what? A simplifying assumption? A semantic device? A book-keeping artifice? An absent-minded lapse of theory? In place of an established theory has sprung up a mathematical model of income-leisure choice in which the face of actual work is unrecognizable. With the centennial of its original presentation fast approaching, it is fitting that economists should re-examine what opportunities have been sacrificed and what – if anything – has been gained by this remarkable instance of theoretical substitution.

Bibliography

Abstract: Sidney Chapman's theory of the hours of labour, published in 1909 in The Economic Journal, was acknowledged as authoritative by the leading economists of the day. It provided important insights into the prospects for market rationality with respect to work time arrangements and hinted at a profound immanent critique of economists' excessive concern with external wealth. Chapman's theory was consigned to obscurity by mathematical analyses that reverted heedlessly to outdated and naïve assumptions about the connection between hours and output. The Sandwichman is serializing "Missing: the strange disappearance of S. J. Chapman's theory of the hours of labour" on EconoSpeak in celebration of the centenary of publication of Chapman's theory. (To download the entire article in a pdf file, click on the article title.)

Missing: the strange disappearance of S. J. Chapman’s theory of the hours of labour (bibliography)

References

Altman, M. (2001) 'A behavioral model of labor supply: casting some light into the black box of income-leisure choice', Journal of Socio-Economics, vol. 33, pp. 199-219.

Barone, E. (1908/1935) 'The ministry of production in the collectivist state', in (F.A. Hayek, ed.), Collectivist Economic Planning, pp. 245-290.

Bergson, A. 'A reformulation of certain aspects of welfare economics', Quarterly Journal of Economics, vol. 52, pp. 310-334.

Bohm-Bawerk, E. von. 1894 'One word more on the ultimate standard of value', Economic Journal, vol. 4, pp. 719-724.

Chapman, S. J. (1909) 'Hours of labour', Economic Journal, vol. 19, pp. 353-373.

Derobert, L. (2001) 'On the genesis of canonical labor supply model', Journal of the History of Economic Thought, vol. 23, pp. 197-215.

Edgeworth, F.Y. (1894) 'One word more on the ultimate standard of value', Economic Journal, vol. 4, pp. 724-725.

Farzin, Y. H. and Akao, K.-I. (2006) 'Non-pecuniary work incentive and labor supply', Note di Lavoro 21, Milan: The Fondazione Eni Enrico Mattei

Green, D. I. (1894) 'Opportunity cost and pain cost', Quarterly Journal of Economics, vol. (8?), pp. 218–229

Hicks, J.R. (1932/1963) The Theory of Wages, London: Macmillan.

Hicks, J.R. (1939/1946) Value and Capital, London: Oxford University Press.

Hicks, J.R. and Allen, R.G.D. (1934) 'A reconsideration of the theory of value (part 1)', Economica, vol. 1, pp. 52–76.

Jennings, A. (2004) 'Dead metaphors and living wages: on the role of measurement and logic in economic debates', In (D.P. Champlin and J.T. Knoedle, eds.), The Institutionalist Tradition in Labor Economics, Armonk, N.Y.: M.E. Sharpe, pp. 131-145.

Lewis, H. G. (1957) 'Hours of work and hours of leisure', in Proceedings of the Ninth Annual Meeting, Madison: Industrial Relations Research Association, pp. 195-206.

Marshall, A. (1961) Principles of Economics, 9th edition, London: Macmillan for the Royal Economic Society.

Nyland, C. (1989) Reduced Worktime and the Management of Production, Cambridge: Cambridge University Press.

Pagano, U. (1985) Work and Welfare in Economic Theory, New York and Oxford: Basil Blackwell.

Pencavel, J. (1986)'Labor Supply of Men: A Survey', in (O. Ashenfelter and R. Layard, eds.), Handbook of Labor Economics, Amsterdam: North Holland. pp. 3-102

Philp, B., Slater, G. and Harvie, D. (2005) 'Preferences, Power, and the Determination of Working Hours', Journal of Economic Issues, vol. 39, pp. 75-90.

Pigou, A.C., (1920) The Economics of Welfare, London: Macmillan.
Robbins, L. (1929) 'The economic effects of variations of hours of labour', Economic Journal, vol. 39, pp 25-40.

Robbins, L. (1930) 'On the elasticity of demand for income in terms of effort', Economica, No. 29 (Jun., 1930), pp. 123-129

Robbins, L. (1930) 'The conception of stationary equilibrium', Economic Journal, vol. 40, pp. 194-214.

Scitovsky, T. (1992) The Joyless Economy: The Psychology of Human Satisfaction, New York and Oxford: Oxford University Press.

Scitovsky, T.(1951) Welfare and Competition, Chicago: R.D. Irwin.

Spencer, D. A. (2003) 'The labor-less labour supply model in the era before Philip

Wicksteed', Journal of the History of Economic Thought, vol. 25, pp. 505-513.

Spencer, D. A. (2004) 'From pain cost to opportunity cost: the eclipse of the quality of work as a factor in economic theory', History of Political Economy, vol. 36, pp. 387-400.

Tribe, K. (2004) 'Sydney Chapman', Oxford Dictionary of National Biography, Oxford University Press.

Walras, L. (1954) Elements of Pure Economics: or, the Theory of Social Wealth, translated by William Jaffe, Homewood, Illinois: Richard D. Irwin.

Abstract: Sidney Chapman's theory of the hours of labour, published in 1909 in The Economic Journal, was acknowledged as authoritative by the leading economists of the day. It provided important insights into the prospects for market rationality with respect to work time arrangements and hinted at a profound immanent critique of economists' excessive concern with external wealth. Chapman's theory was consigned to obscurity by mathematical analyses that reverted heedlessly to outdated and naïve assumptions about the connection between hours and output. The Sandwichman is serializing "Missing: the strange disappearance of S. J. Chapman's theory of the hours of labour" on EconoSpeak in celebration of the centenary of publication of Chapman's theory. (To download the entire article in a pdf file, click on the article title.)

Clown on Wall Street

Maybe a picture is worth a thousand words. Here are clowns -- not the ones in the executive suites, but real clowns -- ringing the opening bell on the New York Stock Exchange.

From Financial Crisis to Currency Crisis: Is Britain Next?

The suggestion by Willem Buiter that Britain may already be on its way to a collapse of its currency and possible sovereign default has been making waves in the UK, but deserves attention here as well. First of all, the mechanism he describes is exactly the one I have been harping on for the US:

If there is doubt in the markets about whether the solvency gap of the banking system is smaller than the fiscal spare capacity of the government, we could have a UK public debt crisis. Fear of default would cause an across-the-board rush of out sterling assets. Fear that the authorities would choose to monetise the UK public debt and deficits rather than defaulting, would also cause a sharp decline in the value of sterling.

There are fiscal limits to what governments can do, and pledging to bail out all investors who have claims on the financial system is not the same as being able to actually carry out this pledge. Moreover, a run on sterling would not only signal the failure of the British bailout plan; it would set in motion currency shockwaves that would ricochet through the global economy. Money fleeing the pound would have to go somewhere else, but this somewhere would then find itself on a hair trigger, as fears of currency and default risk escalate. My reference period for the earlier Depression is not 1929, for which there were domestic solutions, but 1931-32, when a cascade of currency runs rendered national monetary policymakers helpless.



Having signed on to Buiter’s main point, I want to emphasize some divergences:

1. Britain’s risk is, like Iceland’s, a function of the size of its banking sector liabilities relative to the economic size of its currency area. It can crank up the denominator by joining the eurozone—if it can. The political impediments in this environment are simply too great, however. If Britain starts to melt, would the euro powers risk their own solvency to save it?

2. The US has a far larger GDP, but its numerator is also much larger, since the epicenter of the crisis was in US-generated assets, all of which matter because the Fed has committed itself to making good on all claims on US financial institutions, whatever their country of origin.

3. The dollar is a reserve currency as the pound is not. This gives the US much more breathing space, and the amount of claims needing to be satisfied would not be altered by a potential devaluation, since it’s all in dollars. What this means, though, is simply that the dollar can hold on longer than the pound; it doesn’t mean the dollar is invincible. It is ultimately subject to the same constraints laid out in Buiter’s analysis (and mine).

4. The British exposure is somewhat less than meets the eye. The City is the repository for an undisclosed but certainly very substantial pool of mideast petro-profits. Their placement is essentially a political, not a market-based choice. No doubt the failed occupation of Iraq has reduced the geopolitical subservience of the Gulf potentates, but it is hard to believe that they would simply withdraw their funds in a crisis. They remain vulnerable domestically—even more so as oil prices fall—and still depend on Anglo-Saxon guarantees of their continued rule.

5. Buiter’s solution, to move first on trimming the claims (haircuts) before assuming public liability for them, is entirely sensible, and roughly equivalent to the asset window I briefly described in my own proposal two months ago. The problem is that he gives no attention to the collapse of the real economy. In fact, he would exacerbate it by cutting back fiscal stimulus, which he sees as unaffordable. Here I think he misses perhaps the most important point: that a principle reason for reversing the bailout strategy is to have the resources to sustain employment and income. Moreover, the finance for renewed growth is essential, and if the strict austerity Buiter (rightly) seeks to impose on financial markets only dulls the private appetite for assuming new risk, a public financial entity must pick up the slack.

Federal Revenue Sharing & NYC’s Mass Transit System

I woke up this morning to hear that New York’s Metropolitan Transit Authority (MTA) may lay off 1500 workers in order to address a projected $1.2 billion deficit. Maybe it is because I live on the Upper East side of Manhattan but every morning’s subway ride (the Lexington line) involves pushing and shoving just to get into the subway car. The thought of service cutbacks strikes me as just absurd. MTA says it was hoping for funds from the state of New York but I know Governor Patterson is also trying to address a revenue shortfall.

Of course, we could avoid the layoffs and the service cutbacks if Congress decides to expand Federal revenue sharing. It would be one way to counter the usual pro-cyclical nature of state & local fiscal policy that we noted here. I just hope this is on the agenda of President-elect Obama.