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.

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.

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”?

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.

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.

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.

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.

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."

The Power of Economics vs. The Economics of Power

I just finished a draft of paper regarding the exclusion of the concept of power in economic theory.

Any comments will be appreciated.

http://michaelperelman.files.wordpress.com/2011/09/power.pdf

Kotlikoff’s Five Ideas to Boost the Economy

Laurence Kotlikoff has put forth 5 proposals to get us closer to full employment. Proposal #4 – “get prices and wages unstuck” – has already been rightfully criticized and his fifth proposal is fiscal contraction, which is even more absurd. But what about his first 3 proposals?

Proposal #1 is “stop paying interest on bank reserves”, which Kotlikoff argues would encourage banks to make more loans. But that is exactly the hope of any expansionary move by the Federal Reserve. The problem is not so much that the banks don’t wish to make new loans but firms are as interested in taking out loans when aggregate demand is so depressed.

Proposal #3 is in the same vein as its goal is more investment demand – “compel corporate America to invest”:

They are waiting for the economy to improve before they invest, but it won’t improve until they all do so. The president can help resolve this problem by assembling in one room the CEOs of the largest 1,000 U.S. companies and getting them to collectively pledge to double their U.S. investment over the next three years. If they all invested simultaneously, they would immediately create much of the demand needed to make their investments worthwhile.

Presidential jawboning as an inducement to increase investment? By the same logic – passing the President’s bill to increase public infrastructure investment would generate a similar self sustaining recovery. But then Kotlikoff rejects fiscal stimulus with this incredibly silly claim:

The president’s new-yet-familiar jobs bill entails more spending and more tax cuts, neither of which is affordable absent new revenue.

Which leaves us with his proposal #2:

President Barack Obama could call on the workers and shareholders in these companies to voluntarily hire 7.5 percent more workers and do everything possible to maintain the higher level of employment going forward. How, one might ask, would all the new workers be paid? Existing employees could agree to a 7.5 percent wage cut in exchange for immediately vested shares of their companies’ stock of equal value.

I leave it to others to discuss how his creative proposal might work.

Opera, Einstein, and Why Economics Is Not a Real Science

Congratulations (maybe) to the Opera (Oscillation Project with Emulsion-Tracking Apparatus) team for their (possibly) revolutionary finding that a few neutrinos were able to defy Einstein and travel from Geneva to central Italy faster than the speed of light.  If true, it will require a revision of basic physics that borders on science fiction.

I heard through the grapevine, however, that some senior scientists with this project did not give permission for their names to be on the article setting out the results, including one of the individuals who helped conceive and organize Opera from the start.  They are passing up the opportunity to be connected to a historic breakthrough in their field.  Why?

The answer is that, with such an extraordinary anomaly, there is a risk of error.  Mismeasuring the distance within the apparatus by 12 meters, for instance, would reverse the results.  Above all—and this is why economists should be interested—a physicist would suffer a huge, possibly irreparable blow to his or her career by being attached to a claim that is later found to be wrong.  Type I error (false positives) are taken very seriously.  The logic of this extreme asymmetry, so much weight on Type I, so much less on Type II, is explained in this earlier EconoSpeak post.

It’s rather different in economics, isn’t it?  If someone shows you have made a false claim in a published article, you can write a gracious response thanking the critic and go on. More likely, you will double down and spin out more studies defending your original argument.  Either way, if you’re wrong it’s no big deal.  Lots of the top economists in the professional firmament have been wrong at one time or another (or even all the time), and it hasn’t set them back.  Meanwhile, physics evolves over time toward ever-closer approximation of the real universe, while economics accumulates error along with insight.

UPDATE: Note that these neutrinos made their trip through the rugged terrain of the Alps and Apennines at an "impossible" speed.  I think they should be checked for doping, and if they turn up positive they should be disqualified.

Does John Cornyn Not Realize that Capital Gains is a Form of Income?

I guess private citizens don’t have the right to express their own views on tax policy without the Republican Party demanding to see their tax return:

Republicans on Capitol Hill have found a new hidden document conspiracy to push to now that President Obama's long-form birth certificate is a matter of public record. Warren Buffett, they demand, show us the tax return!

But what cracks me up is this statement from Senator Cornyn:

I know that Mr. Buffett's not likely to release his tax records but I'll bet what it'll show you is that most of what he earns is from capital gains, which is taxed at a 15 percent tax rate rather than deriving it as income [for] which he'd pay a much higher tax rate," Cornyn said. "If he doesn't derive ordinary income and if all of his, what he puts in his pocket is based on capital gains, I think that would be an important information.

Capital gains allow one to either consume more or enjoy an increase in one’s wealth. So it is income – but income taxed at a much lower rate than other characterizations of income. Which is the point that people that Mr. Buffett are making. If someone does not understand this simple point – then why are they qualified to serve in the Senate?

Dems to SuperCommittee – First Do No Harm (to employment)

Brian Beutler reports on a good idea from 11 Democratic Senators:

The idea here is to require CBO to analyze the Super Committee bill's impact on employment -- not just budget deficits. The goal is for members to know, and for journalists to report, not just that the legislation reduces deficits by some trillions of dollars, but that it might cost a huge number of jobs. If that's the story, then they'll be more amenable to considering direct job creation measures or at the very least finding deficit savings that don't lead directly to furloughs and layoffs.

For many of us – the output gap and the resulting effect on employment prospects should be priority #1 with the need to close the budget gap in the long-run being priority #2. I suspect the folks at CBO would be most happy to report the estimated impact on employment as well as the deficit from any proposed bill. And it should be mandatory for journalists to accurately portray these findings.