Liquidity Traps, Credit Crunches, the Past Two Recessions, and Interest Rates on Long-Term BBB Debt

Jack Healy and Vikas Bajaj tell us that the cost of borrowing has zoomed up:

But with the credit markets still tight, corporations are being forced to pay much higher interest rates than they did a few years ago, putting more strain on balance sheets already hammered by falling profits and a grinding recession.

For those of you who have heard we are in a liquidity trap, remember that this refers to short-term interest rates on government debt whereas Healy and Bajaj are talking about long-term corporate debt. Interest rates on 20-year Federal bonds aren’t that high but credit spreads are:

Even companies with strong credit ratings are paying about 5 percentage points more than the federal government to borrow money, according to Standard & Poor’s. That is more than double the premium they paid last January. Companies with so-called junk credit ratings are paying a 15 percent premium. “That’s an extraordinary spread,” said Diane Vazza, head of global fixed-income research at Standard & Poor’s. “That’s unprecedented in the speculative-grade market.”

Sloped Curve takes these market rates to suggest that Paul Krugman is wrong about the liquidity trap argument:

Professor Krugman is also discussing only one side of the issue when it comes to where the economy is today. Professor Krugman is taking the fact that the US is in a liquidity trap for granted, and that the US is wrestling with the zero-lower-bound for interest rates, even though there are obvious reasons for why you would argue that the US is not in or near a liquidity trap ... the economic actors are not exposed to 0% interest rates. No final loans to private individuals or companies are made at or near a 0% interest rate ... There is another phenomenon, that is not a liquidity trap, but that can also create disinflation and even short-lived deflation. The phenomenon is a credit crunch. In a credit crunch credit becomes hard and/or expensive to come by, and this dampens the willingness to borrow, spend and invest. The difference between a liquidity trap and a credit crunch is that in a liquidity trap people have ample access to cheap credit and still choose to not borrow money, while in a credit crunch people do not borrow money either because they can't or because they view borrowing as too expensive. The basic attributes of these two phenomena are such that they are mutually exclusive. In a credit crunch you have limited access to cheap credit, in a liquidity trap you have ample access to nearly free credit; you can't have both.

I would beg to differ that one cannot have both as we are talking not only about interest rates are very different types of financial instruments but also about very different aspects of monetary policy. Our graphs are based on the monthly averages of interest rates on 20-year government bonds, AAA corporate bond rates, and BBB from January 1994 to December 2008. If we go back to 2001, it is interesting to note that the interest rate on BBB debt as of October 2001 was about the same as the interest rate as of January 2001 despite the fact that both AAA rates and rates on 20-year Federal bonds fell slightly. You may recall that this was the period where short-term rates fell dramatically but longer-term rates fell more modestly. But the big story was the climb in credit spreads – especially the BBB spread (BBB-s) which began in 2000 and continued through 2002. During the current recession, long-term Federal bond rates have fallen more dramatically but interest rates for companies with credit ratings of BBB or lower have increased as credit spreads have skyrocketed.

Traditional monetary policy can lower risk-free interest rates but recessions are also often associated with rising default risk. This recession in particular seems to have one of its underlying causes being increases in default risk and the associated troubles facing our financial institutions. Maybe this is why Ben Bernanke is frustrated with certain politicians not getting the need to release the remaining TARP funds:

This may be as close as we’re going to get to a Fed chairman labeling some in Congress as irresponsible. Sure, Federal Reserve Chairman Ben S. Bernanke was typically careful with his wording in a Jan. 13 speech in London. “The public in many countries” is “understandably concerned” that government is spending money to rescue the financial industry, “when other industries receive little or no assistance,” Bernanke said. After explaining how the world economy “is critically dependent on the free flow of credit,” Bernanke issued his challenge: “Responsible policy makers must therefore do what they can to communicate to their constituencies why financial stabilization is essential for economic recovery and is therefore in the broader public interest.” Three days after that speech, 33 of 39 Republican senators ignored Bernanke’s warning and voted against releasing the remaining $350 billion in Troubled Asset Relief Program money. (So did eight Democrats, mostly liberals, plus independent Bernie Sanders of Vermont.) Fortunately, that left enough supporters, mostly Democrats, to clear the release of the much-needed money. Too many senators shrugged their shoulders at Bernanke’s wise words.

As one of the fiscal stimulus critics that Greg Mankiw loves to cite, Gary Becker writes:

It is relevant in answering this question that the origins of this recession were in the financial sector, and especially in the excessive mortgage credit to sub prime and other borrowers. The widespread collapse of the financial sector, and the wholesale retreat from risky assets, clearly has called for a highly pro-active Fed. But it is not obvious why this should lead to greater confidence in the power of government spending stimulus packages. Of course, perhaps the prior emphasis on crowding out, and skepticism toward the stimulating effects of government spending, were wrong, or that recessions were too short and mild after the 1981-82 recession to call for Keynesian-type stimulus packages.

Becker has already been criticized for failing to note that interest rates were very high in 1982 but are nearly zero now. But he may indeed be right for the type of non-traditional monetary policy being advocated by our FED chairman today. Alas, many in the Republican Party are against both fiscal stimulus and this non-traditional monetary policy. I just don’t get it!

Update: Paul Krugman is kind enough to link to my post and then writes:

Well, my definition of a liquidity trap is, purely and simply, a situation in which conventional monetary policy — open-market purchases of short-term government debt — has lost effectiveness. Period. End of story. Now, if you prefer a different definition of a liquidity trap, OK; call our current situation a banana, instead. But changing the name does not change the essential fact — namely, conventional monetary policy has lost effectiveness. Yes, there are other things the Fed could do — and it’s doing them, on an awesome scale. But they’re controversial, precisely because, unlike conventional monetary policy, they involve picking and choosing among potentially risky investments. And there’s a much stronger case for fiscal policy than in normal times, because we don’t know how well these unconventional measures will work.

Might I add that I agree with Paul 100%!

The Fed as Financial Regulator

The Washington Post reports about a move afoot to give the Federal Reserve more regulatory power over the financial system.

http://www.washingtonpost.com/wp-dyn/content/article/2009/01/25/AR2009012501686.html?hpid=topnews

Considering that the Federal Reserve is supposed to be independent of the government, it would seem that getting such powers to the Fed would be ill-advised.

In addition, considering that the Fed's posture in the bailout makes the Treasury Department looks like a paragon of transparency, giving such powers to the Fed seems even more questionable.

When the Democrats promised change, I thought they meant change for the better. Maybe I was wrong.

Observations on China

I'm just now getting my energy back after my trip to China and a bout of food poisoning that I brought back. I hope I can be more attentive to the blog.

Just as an experiment, I tried to record a 15 minute discussion about my observations of China. I have to warn you that you should not expect any deep insights from fairly quick trip in which I spent most of my time in the corridors of various universities.

http://www.archive.org/details/ObservationsOnChina

The First Fleet Whores on Australia’s Invasion Day

Today is Australia Day, though the vast majority of Australian aboriginal people would understandably prefer to call it ‘invasion day’. At least in these times Aboriginal grievances in relation to this awkward day get some mainstream media airing. The plight of my white female ancestors still doesn’t. They were the unwilling and much-abused first immigrants to this country.

“The First Fleet consisted of 1,480 people more than half of whom were convicts. There were 586 male and 192 female convicts as well as a large number of seamen, marines, servants and officials. Only a tiny fraction of these were accompanied by their wives and children.”

“…Within the penal colony, women were assigned only one main function – they were there primarily as objects of sexual gratification. The main difficulty, as far as the British authorities were concerned, was to find a sufficient number of women convicts, and to do this they had to impose preponderantly harsher sentences on women.….

The sexual abuse of female convicts began on the ships. Although after 1811 the women traveled on separate ships from the male convicts, they had the crews to contend with. WHR Brown told the Select Committee on the State of Gaols in 1819 that:

“These women informed me, as well as others of their shipmates, that they were subject to every insult from the master of the ship and sailors; that the master stript several and publickly whipped them; and that one young woman, from ill treatment, threw herself into the sea and perished, that the master beat one of the women that lived with me with a rope with his own hands till she was much bruised in her arms, breasts, and other parts of her body. I am certain, from her general good conduct, she could not have merited any cruelty from him.” [1]

My great, great grandmother was Mary O’Neill born in Maitland in New South Wales in 1843. On the genealogical history now finally revealed it is possible that she was related to another Mary O’Neill. A woman that is referred to in the journal of William Elyard, a surgeon superintendent on the "John Bull" which sailed from Cork on 25 July 1821 via St. Jago, to arrive in Sydney on 18 December 1821. Mary is described as one of “an aggressive pair” of women. Mary O'Neill and another woman, Ellen Nolan, were “identified as assaulting one of the men while cleaning” on this “troublesome voyage” of the convict ship taking the women to the Paramatta Factory. [2] The latter “operated as a prison, a maternity home, a marriage bureau, an employment exchange and a hostel or refuge for women in transit between jobs. All its inmates, however, were strictly speaking prisoners...’ What a comment on the common status of all females of the lower classes!” [3]

So cheers to our Mary O’Neills and our damned whores. May we continue to break the handle of many a hammer in our go-slow rebellions against enslavement and worse.

“…..the damned whores the moment that the[y] got below fel a fighting amongst one another and Capt Meredith order the Sergt. Not to part them but to let them fight it out…..”
- Lt Ralph Clark of the First Fleet, ‘The Journals and Letters of Lt Ralph Clark 1787-1792.



[1] In CMH Clark, ‘Select Documents in Australian History 1788-1850, Angus & Robertson, Sydney, 1965, p48. As quoted in ‘Damned Whores and God’s Police’ by Anne Summers.

[2] Will Elyard’s Journal.
http://members.optusnet.com.au/elyard/elyard_aust/wsg1771-voy.htm

[3] ‘The most outrageous conduct’ Convict rebellions in colonial Australia
By Tom O'LINCOLN
http://www.anu.edu.au/polsci/marx/interventions/convicts.htm

The Fiscal Policy Debate Today on the Sunday Talkies – Who Listens to Economists?

While the Republicans are complain that the Democrats are not considering their ideas, Nancy Pelosi says that good ideas will be considered:

Appearing on ABC's This Week, Nancy Pelosi said that Republicans have had the opportunity to be included in crafting the stimulus bill -- even if not many of their ideas have been adopted. "Well, we will take some," said Pelosi. "We will judge them by their ability to create jobs, to -- to help turn the economy around, to stabilize the economy, and to see how much they cost."

John McCain appeared on Faux News and said:

In an appearance on Fox News Sunday, John McCain said he won't vote for President Obama's stimulus package as it stands now. McCain said there need to be more tax cuts for businesses, payroll tax cuts, and for existing tax cuts to be made permanent: " Well, the plan was written by the majority in -- a Democrat majority in the House, primarily. And so, yeah, I think there has to be major rewrites if we want to stimulate the economy."

Mark Thoma brings us a piece by Larry Mishel that basically says McCain and his Republicans colleagues are clueless.

"Not a Cure All, But..."

by the Sandwichman

From the Globe and Mail Report on Business, yesterday:

Yes you can: Save jobs by sacrificing your time and money.

As employers and employees confront the spectre of mass layoffs, creative measures are coming to the fore, including individual workers cutting their workweek to four days, with a proportional cut in pay.

The idea gained currency this week in U.S. President Barack Obama's call-to-duty inauguration speech. America's recovery, he said, in part will rely on "the selflessness of workers who would rather cut their hours than see a friend lose their job."

The Sandwichman points out the potential pitfall of the "proportional cut in pay" line. If workers are expected to handle the same workload in four days, it's just a speed-up with a pay cut. And what does that do to consumer spending? Here's where government needs to step in to make up the difference in pay as part of its economic stimulus package. More on that angle from Dean Baker in Monday's Guardian.

Charlton Heston: Gun Nut or Sandwich Man?

Sandwichman thinks he may have discovered a way to build traffic to the site. For the record, Sandwichman wonders, "what's the fuss?" One the one hand, I feel more threatened by SUV drivers talking on cel phones than I do by goons carrying guns. On the other hand, how come there isn't a second amendment right to bring your own damn water or toothpaste onto an airliner? I mean, "airport security" is so obviously about conditioning people to follow orders and not question authority.

Galbraith Part 2 on "Can Obamanomics Solve the Crisis?"

James K. Galbraith has a second part to his interview with Paul Jay on the real news. He goes on greater length about how it would be unwise to cut social security or medicare. He worries that Obama may be listening to those who want this, including conservative Democrats, but also notes that his public statements so far have not specifically said what to do about social security. "Wait and see," says Galbraith. He also addresses several other issues including the status of the dollar and the need for aid to those in danger of home foreclosures.

The link.

A Grammar of the Multiplier

by the Sandwichman

Paolo Virno's A Grammar of the Multitude is a short book, but it casts a very long shadow. Behind it looms the entire history of the labor movement and its heretical wing, Italian "workerism" (operaismo), which rethought Marxism in light of the struggles of the 1960s and 1970s....

6.5. Thesis 4

For the post-Fordist multitude every qualitative difference between labor time and non-labor time falls short...

The concept of "full employment" is obviously essential to any consideration of the Keynesian "multiplier". Yet the very distinction between employment and unemployment is what, according to Virno, is at stake in Post-Fordist society.

The Sandwichman can do little more here than simply to note the existence of the operaismo analysis. I have my reservations about the degree of abstraction of that analysis and it's exclusive historical contextualization in a brief and recent expanse of European history. Nevertheless, the very term, "Post-Fordist," calls into question glib manipulation of Keynesian terminology.

If we can say that Fordism incorporated, and rewrote in its own way, some aspects of the socialist experience, then post-Fordism has fundamentally dismissed both Keynesianism and socialism. Post-Fordism, hinging as it does upon the general intellect and the multitude, puts forth, in its own way, typical demands of communism (abolition of work, dissolution of the State, etc.). Post-Fordism is the communism of capital.

James Callaghan, in 1976:

We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists, and in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step.

Barro on the Fiscal Policy Multiplier: Does He Understand the Full Employment Constraint?

Robert Barro writes an op-ed critiquing the Obama fiscal policy proposal that is far below his intellectual standards. He starts off well:

Team Obama is reportedly using a number around 1.5. To think about what this means, first assume that the multiplier was 1.0. In this case, an increase by one unit in government purchases and, thereby, in the aggregate demand for goods would lead to an increase by one unit in real gross domestic product (GDP). Thus, the added public goods are essentially free to society. If the government buys another airplane or bridge, the economy's total output expands by enough to create the airplane or bridge without requiring a cut in anyone's consumption or investment. The explanation for this magic is that idle resources -- unemployed labor and capital -- are put to work to produce the added goods and services. If the multiplier is greater than 1.0, as is apparently assumed by Team Obama, the process is even more wonderful. In this case, real GDP rises by more than the increase in government purchases. Thus, in addition to the free airplane or bridge, we also have more goods and services left over to raise private consumption or investment.

In other words, Barro understands that the Keynesian multiplier theory rests on the proposition that the economy is below full employment – which seems like a plausible characterization of today’s economy. But then Barro pulls some empirical research from a period where we were likely near full employment:

A much more plausible starting point is a multiplier of zero. In this case, the GDP is given, and a rise in government purchases requires an equal fall in the total of other parts of GDP -- consumption, investment and net exports. In other words, the social cost of one unit of additional government purchases is one … What do the data show about multipliers? Because it is not easy to separate movements in government purchases from overall business fluctuations, the best evidence comes from large changes in military purchases that are driven by shifts in war and peace. A particularly good experiment is the massive expansion of U.S. defense expenditures during World War II … I have estimated that World War II raised U.S. defense expenditures by $540 billion (1996 dollars) per year at the peak in 1943-44, amounting to 44% of real GDP. I also estimated that the war raised real GDP by $430 billion per year in 1943-44. Thus, the multiplier was 0.8 (430/540). The other way to put this is that the war lowered components of GDP aside from military purchases. The main declines were in private investment, nonmilitary parts of government purchases, and net exports -- personal consumer expenditure changed little. Wartime production siphoned off resources from other economic uses -- there was a dampener, rather than a multiplier.

After saying “good grief”, I turn the microphone over to Paul Krugman:

Consumer goods were rationed; people were urged to restrain their spending to make resources available for the war effort. Oh, and the economy was at full employment — and then some. Rosie the Riveter, anyone? I can’t quite imagine the mindset that leads someone to forget all this, and think that you can use World War II to estimate the multiplier that might prevail in an underemployed, rationing-free economy.

Mainstream Media Fights for the Little Guy in the Spirit of the Muckrackers

This article shows the ridiculous lengths that economists can go in defending the indefensible:

I. J. ALEXANDER DYCK, University of Toronto - Joseph L. Rotman School of Management
DAVID A. MOSS, Harvard Business School - Business, Government and the International Economy Unit

LUIGI ZINGALES, University of Chicago, National Bureau of Economic Research (NBER), Centre for Economic Policy Research (CEPR), University of Chicago - Polsky Center for Entrepreneurship, Graduate School of Business, European Corporate Governance Institute (ECGI)

We argue that profit-maximizing media help overcome the problem of "rational ignorance" highlighted by Downs (1957) and in so doing make elected representatives more sensitive to the interests of general voters. By collecting news and combining it with entertainment, media are able to inform passive voters on politically relevant issues. To show the impact this information has on legislative outcomes, we document the effect "muckraking" magazines had on the voting patterns of U.S. representatives and senators in the early part of the 20th century. We also show under what conditions profit-maximizing media will cater to general (less affluent) voters in their coverage, providing a counterbalance to special interests.

Galbraith on "Can Obamanomics Solve the Crisis?"

The answer is, maybe not. The crisis is deep and more direct intervention will be needed in both banking and shoring up purchasing power, according to James K. Galbraith in an interview on the real news, accessible here.

He especially worries about the shift I have posted on here in a worried manner that Obama seems to have drunk the social security kool-aid and may be looking at long term cutbacks in benefits. Instead of my "stand pat" and do nothing to/with social security, he actually calls for increasing social security benefits.

BTW, the tux he is wearing in the clip was apparently for going to some bipartisan inaugural ball in honor of John McCain. Go figure.

BIG in Japan... Work Sharing

by the Sandwichman

This is how it begins. With baby steps. Experience with these kinds of programs in the past is that people learn they actually like the extra free time.

In the deep south of Japan sits the tiny island of Himeshima. Farmers cultivate delicious prawns, the rare chestnut tiger butterfly flitters around the beach and 2,400 islanders wallow in total job security.

It has been so on Himeshima for 40 years and suddenly, faced with the most alarming economic downturn since the Second World War, everyone from the central Government in Tokyo to the country's biggest industrial conglomerates is desperate to copy its secret: work sharing...

Tactics for hard times as Japanese turn to job-sharing

Business groups split over work sharing

Helping Employers Cut Hours, Not Jobs

Business bigwig suggests work-sharing schemes to cope with tough times

"the selflessness of workers who would rather cut their hours than see a friend lose their job..."

President Obama

INAUGURAL ADDRESS

As we consider the road that unfolds before us, we remember with humble gratitude those brave Americans who, at this very hour, patrol far-off deserts and distant mountains. They have something to tell us, just as the fallen heroes who lie in Arlington whisper through the ages. We honor them not only because they are guardians of our liberty, but because they embody the spirit of service; a willingness to find meaning in something greater than themselves. And yet, at this moment — a moment that will define a generation — it is precisely this spirit that must inhabit us all.

For as much as government can do and must do, it is ultimately the faith and determination of the American people upon which this nation relies. It is the kindness to take in a stranger when the levees break, the selflessness of workers who would rather cut their hours than see a friend lose their job which sees us through our darkest hours. It is the firefighter's courage to storm a stairway filled with smoke, but also a parent's willingness to nurture a child, that finally decides our fate.

Our challenges may be new. The instruments with which we meet them may be new. But those values upon which our success depends — hard work and honesty, courage and fair play, tolerance and curiosity, loyalty and patriotism — these things are old. These things are true. They have been the quiet force of progress throughout our history. What is demanded then is a return to these truths. What is required of us now is a new era of responsibility — a recognition, on the part of every American, that we have duties to ourselves, our nation, and the world, duties that we do not grudgingly accept but rather seize gladly, firm in the knowledge that there is nothing so satisfying to the spirit, so defining of our character, than giving our all to a difficult task.

ACCEPTANCE SPEECH, DEMOCRATIC NOMINATION

America, this is one of those moments.

I believe that as hard as it will be, the change we need is coming. Because I’ve seen it. Because I’ve lived it. I’ve seen it in Illinois, when we provided health care to more children and moved more families from welfare to work. I’ve seen it in Washington, when we worked across party lines to open up government and hold lobbyists more accountable, to give better care for our veterans and keep nuclear weapons out of terrorist hands.

And I’ve seen it in this campaign. In the young people who voted for the first time, and in those who got involved again after a very long time. In the Republicans who never thought they’d pick up a Democratic ballot, but did. I’ve seen it in the workers who would rather cut their hours back a day than see their friends lose their jobs, in the soldiers who re-enlist after losing a limb, in the good neighbors who take a stranger in when a hurricane strikes and the floodwaters rise.

This country of ours has more wealth than any nation, but that’s not what makes us rich. We have the most powerful military on Earth, but that’s not what makes us strong. Our universities and our culture are the envy of the world, but that’s not what keeps the world coming to our shores.

Instead, it is that American spirit – that American promise – that pushes us forward even when the path is uncertain; that binds us together in spite of our differences; that makes us fix our eye not on what is seen, but what is unseen, that better place around the bend.

Gun Nuts Exposed at Distorting Data and Results

In the latest Econ Journal Watch, just out, Ian Ayres and John J. Donohue III have a paper, "Yet another refutation of the more guns, less crime hypothesis - with some help from Moody and Marvell" accessible (hopefully) at http://www.aier.org/ejw/archive/comments/doc_view/4018-ejw-200901?tmpi=component&format=raw.

Besides recounting how the major study by John Lott and Mustard has lots of data problems and cut off just before the post-1992 crime decline, they focus on a paper by Moody and Marvell that claims that a study of 24 states showed a reduction in crime for increasing access to guns. It turns out that in this study 23 of the 24 states had the opposite result, and the aggregate result was solely due to Florida. However, the data in Florida is all messed up and also probably caught a general crime wave decline due to a regression to the mean after the Mariel boat landings from Cuba in the early 1980s. I am not doing their paper justice, but the media discussion is often dominated by Lott and his allies who are now pushing for loosened gun laws in Virginia, and are counting on Dems laying low and not challenging their incessantly repeated claims that such gun law relaxations reduce crime. They should not lay low. The claims are baloney and lies, based on distorted date and misrepresentations of results from ones with better data.