Do 2007 Fed Transcripts Make Yellen Frontrunner To Succeed Bernanke?

I think maybe so.  There is a large photo of her above today's story in the Economy & Business section of the Washington Post entitled "Caught between two outlooks: Fed slow to abandon optimism even as a few sounded alarm, 2007 transcripts show."  Next to the photo of her is a quote by her from the Dec. 2007 meeting in which it is clear that she was one of the far-sighted ones who "sounded alarm" but failed to convince the FOMC to loosen monetary policy more vigorously at the time, when she was still President of the San Francisco Fed.  Bernanke was apparently torn, although he had made warning noises in the summer about deterioration of the markets.  Those who also "sounded alarm" with Yellen are identified as being Tim Geithner, then New York Fed President, Eric Rosengren, then a Fed governor, and Frederic Mishkin, author of the most widely used Money and Banking textbook, then also a governor.   Given that Janet Yellen is currently Vice Chair and apparently in good graces with Bernanke, and Obama is being fingered as a possible sexist, and that aside from being identified by Richard Shelby as an "inflation dove" (and he voted against her appointment), and she has avoided saying anything embarrassing in public or making many enemies, it would appear that she may well now be the frontrunner to replace Ben Bernanke as Fed Board Chair next year.  I would certainly support it.

Ironically, her most serious rival might prove to be fellow Wise Person, Geithner, if he is interested, now stepping down as Treasury Secretary.  He has been viewed by many as kind of a front man of the big banks and also somewhat dissed for not having an academic and professional background in economics, like Bernanke or Yellen have (although neither Greenspan or Volcker did).  However, there is reason to believe that he might well have been ahead of the rest of those in the inner Fed decisionmaking circles in worrying that the decline of the housing bubble could lead to a major financial crisis and economic downturn.  This would have been due to his deeper association with the New York financial markets and is given in a speech he gave on Sept. 15, 2006 in Hong Kong in which he mostly said optimistic things, but devoted several paragraphs near the end to warning that if there were a crisis he would be unable to get everybody in a room and just cut a deal to solve it the way his predecessor, McDonough did during the 1998 LTCM crisis. He noted that the links in the financial system through complex derivatives had become too obscure and global.  This speech can be found at http://www.ny.frb.org/newsevents/speeches/2006/gei060914.html .

While he was not identified in this article, other sources have identified a main opponent of the Yellen-Geithner-Rosengrim-Mishkin position as being Jeffrey Lacker, then and now the President of the Richmond Federal Reserve Bank.  Apparently there were specifically sharp arguments between him and Geithner over bank regulation, with Geithner seeing himself as having a national responsibility, whereas Lacker was protective of his oversight of the Bank of America and Wachovia Bank, both of which had their HQs in Charlotte, NC in his district.  Of course, more recently he has been the hawkish dissenting vote on the FOMC, although he has now stepped off it as a voting member.  An irony of this is that he was a Ph.D. student of Donald Hester at the University of Wisconsin-Madison, who is an old Keynesian and student of James Tobin's at Yale, where he crossed paths with Janet Yellen.  Curiously, Hester defends Lacker and his policy arguments, despite Lacker's apparent capture by the long-time monetarist research staff at the Richmond Fed.

In any case, here is one voice in support of the candidacy of Janet Louise Yellen to be the next Chair of the Board of Governors of the Federal Reserve System of the United States of America!  

Mitigation Versus Adaptation in Climate Change

Today I will take a stab at dispelling what I think is widespread confusion over what constitutes mitigating climate change, as against adapting to it.  Both are necessary, of course, but effective policy depends on understanding which is which.

Begin with the following stylized fact: reducing the severity of future climate change is essentially about keeping fossil fuels in the ground.  It is true that there are some benefits from tweaking carbon exchange (the carbon cycle that operates across the atmosphere and terrestrial and marine ecosystems)—for instance, by planting a forest—but the impacts are relatively small (not big enough to do most of the job) and of uncertain duration.  And someday there might be a feasible method for pulling the carbon out of the fuels we burn and re-sequestering it for near-eternity.  But for now these options are of limited value.  As Carbon Tracker noted last year, about 80% of hydrocarbon reserves have to be foregone if we are to achieve a reasonable likelihood of limiting warming to 2º C.

This gives us a rough and ready definition of mitigation: reducing the extraction of fossil fuels.  Everything else is adaptation.

But wait.  What about renewable energy?  Efficiency improvements?  Aren’t these about reducing the buildup of greenhouse gases?

To answer this it helps to distinguish between two types of adaptation: adaptation to climate change and adaptation to climate change policy.  An example of the first is reinforcing seawalls and dikes to minimize storm surges despite rising sea levels.  An example of the second is a wind farm.

A wind farm does not reduce carbon emissions.  What it does is to preserve energy services despite a decline in the rate of fossil fuel extraction.  In other words, it reduces the cost society has to pay in order to take the action that actually mitigates climate change, leaving the hydrocarbons in the ground.

The distinction is important.  Imagine a fossil fuel reserve with two uses, generating electricity and powering an industrial process.  Suppose we invest in a wind farm to replace the use of the fuel in electrical generation.  Now demand for the fuel drops, which lowers its price.  This may well lead to an increase in its industrial use—not fully offsetting of course, but partially offsetting.  The impact of the wind farm on climate mitigation is entirely measured by how much total fuel extraction is reduced, not by how much energy the farm produces.  Its principal function is to enable us to continue benefiting from electricity in the absence of burning fuels.

If you look at it this way, the accounting for carbon capping systems becomes much simpler.  It’s all about how much fuel (measured in terms of carbon equivalents) you do or don’t burn.  Everything else is about how to live with the consequences, both from limiting the use of fuels and from having to deal with climate change.  This is why a policy regime that offsets reductions in fuel combustion by granting credits to all sorts of green production investments is essentially trafficking in loopholes.

A Comment on What’s Causing the Rise in Inequality

I was at the ASSA session where Larry Mishel faced off against David Autor, and I came away thinking, like Jared Bernstein, that the EPI view of the world holds more water than the it’s-all-technology argument that Autor was defending.  The timing issues, including the discontinuities in the wage structure traceable to the early 1980s, are important, for instance.

Nevertheless, I think the whole debate suffers from insularity.  The critical technological developments of recent decades, especially digitization, computing and networking, have swept over the entire world.  They have transformed work in every developed country and much of the developing world.  Meanwhile, the dramatic rise in inequality, and the portions of the earnings distribution most impacted, differ tremendously.  You simply don’t see the same change in profile in most of continental Europe or Japan that you find in the US data.

Understanding these differences is where explanation would begin, in my opinion.  And here’s a hypothesis: analysts of income inequality in the US suffer from a dynamic, self-reinforcing lamppost effect.  They begin with a model of the world in which only the individual characteristics that workers bring to the market should matter for wage determination.  Then, to measure what’s taking place, they set up or utilize systems, like the CPS, to collect these individual data: your age, marital status, education, occupation and earnings.  Armed with this information, they crunch and recrunch the numbers to see which aspects of worker characteristics play the most important role.  The struggle to produce a convincing labor supply-based story generates demand for even more detailed individual-level observation on workers.  No doubt big data will be brought to bear shortly on this topic.

But what if the critical drivers of the wage structure have to do with the way work is organized in production systems?  I’m thinking here of decisions regarding how much autonomy workers can have at different levels within an organization, what monitoring and incentive mechanisms are adopted, how extensive are internal job ladders, etc.  All of these are affected by technology, of course, but only as refracted through organizational strategy, governance systems, market structure and the like.  We know about these things mostly through case studies because systematic data are not collected on them.  Anyone who has compared work organization and management across the “varieties of capitalism” knows that these matters are crucial, but it is difficult to construct formal tests in the absence of large sample data.  At best, matching workers to industry-level variables like age-adjusted average tenure and capital-labor ratios can generate proxies for what we really ought to measure directly but don’t.  (I have a little experience with the use of these proxies and am tempted to do more work with them.)

As for the policy implications, I think the change-in-the-nature-and-structure-of-firms story has rather radical implications.  How can we change how work gets done in America?

Addendum: This past week Gerald Davis’ book Managed by the Markets, has been the main assigned reading in the class I’m teaching.  It is excellent in describing, lucidly and concretely, how financialization has changed the American corporation.  This is the sort of account that could be written only by someone who has devoted a career to corporate finance and governance research.  It is a bit less effective when it strays into political theory and cultural criticism and also too Anglo-Saxon-centric, but at least what it says still makes sense if you know a bit about how the rest of the world is evolving.

Monetary Policy: From Managing the Monetary Base to Setting an Interest Rate Floor

I have been following the exchange between Paul Krugman and Steve Randy Waldman with great interest.  For one thing, as a textbook author, I need to understand how the instruments of monetary policy are changing, if in fact the pattern of the last few years represents a fundamental shift.  Moreover, it seems to me that the changes in Fed operating procedure may be related to tectonic forces at work in the financial system.  See if you agree.

The old way of doing business is that the Fed, like any other central bank, would buy and sell bonds on the open market in order to inject or soak up liquidity.  Its open market operations would supply or withdraw reserves at member banks, and these reserves would constitute the raw material from which the money supply was generated.  (The money multiplier told us how much ultimate money would be created from these reserves, assuming the banks lent out everything they didn’t need to meet their required reserve ratio.)  The motive for lending excess reserves was that they didn’t pay interest, and almost any other use of money did.

Then 2008 happened, and the Fed wanted to unfreeze a number of financial markets—corporate paper, mortgage backed securities, you name it.  To bolster demand by putting these assets on its balance sheet, so-called quantitative easing, it was necessary to pump out vast amounts of reserves.  At this point the Fed began paying interest on excess reserves.  You could see this as a subsidy to the banking system (the Geithner doctrine: feed the beast) or a way of sterilizing its interventions in these markets or both.  In any case, banks now hold substantial excess reserves and, thanks to the return they get, they are in no hurry to shed them.  The irony has not been lost on some of us that, at a time when there is official consternation about the unwillingness of banks to finance small businesses and other ostensibly worthy borrowers, the Fed is paying them not to lend.

So what does the future portend?  At the very least, the Fed will use this new interest rate instrument to manage the unwinding of its portfolio.  If the economy picks up and banks begin to draw down their excess reserves, the Fed, if it worries about inflation, can slow down the process either by traditional open market operations or by raising the interest rate it pays on reserves.  The latter has the advantage of not risking unwanted impacts in the asset markets from which the Fed would otherwise be withdrawing.  And if it thinks that some of these markets are overheating, it can sell a portion of its portfolio while simultaneously lowering interest rates on reserves, a sort of reverse sterilization.  This much is clear.

But would it make sense for the Fed to undertake a permanent shift toward interest rate management as a substitute for open market operations?  Maybe yes.  Recall that the logic of OMO was based on a financial system in which the monetary base set a constraint on aggregate lending capacity.  We are now in a different world.  In shadow banking (a terrible misnomer—we need a new name) collateral serves this function across a wide range of nonbank institutions and nondepository functions within banks.  Securitization has its own multipliers, and aggregate activity can fluctuate with hardly a nod to whatever the level of the monetary base happens to be.  That said, the Fed can always diminish lending capacity via its interest rate floor, redirecting a portion of funds toward a class of assets (excess reserves) that do not multiply.  Of course, the floor can also be understood as a form of interest rate targeting that works on a different margin than OMO used to.  That will require a bit of institutional description in future textbooks, I suspect.

Paul Krugman is right to emphasize that there is a fiscal side to the interest rate floor: it reduces the income the treasury would otherwise receive from the Fed.  Stripped of all complexity, the government is paying wealth-holders to not invest.  This is unimpeachably logical in a world in which the government is also supplying an attractive put for all sorts of potentially dodgy institutions and activities.

The Difference Between Greenhouse Gas Accumulation and Social Insurance Commitments in One Word

Fungibility.

Social insurance commitments are fungible across time; greenhouse gas accumulations in the atmosphere are not.  That’s why people who put up a big show about caring for future generations and do nothing about climate change are either oblivious or dishonest.

On Debt Ceiling Obama Speaks Loudly But Carries No Stick

Well, that really did it.  Obama has loudly declared that he will not negotiate with Congress over the debt ceiling.  He was riding high with the trillion dollar platinum coin gambit, only to hand it off to Treasury, which has now nixed it in conjunction with the Fed, even though Laurence Tribe had declared it legal.  Tribe had previously declared the other obvious weapon Obama could use against Congress blackmailing him into cutting entitlement program benefits unconstitutional, that is, for Obama to declare the debt ceiling unconstitutional, which it is. But now Obama is left with only some vague possibility of handing out some IOUs, which look less credible than either of the two now gone, or simply cutting a bunch of programs liked by the GOP in order to make interest payments on the debt if the ceiling is not raised.  His aides are claiming this gives him a strong hand because the GOP will be blamed if there is a default, but that is not of much comfort to those who are hoping to get jobs in an economy that for the moment is still growing, but might not be if there is a default.

The Moral Imperative of a Debt Ceiling

From this morning's New York Times:

Representative Jerrold Nadler, Democrat of New York, signed on to the trillion-dollar [platinum] coin plan, telling Capital New York: “It sounds silly but it’s absolutely legal. And it would normally not be proper to consider such a thing, except when you’re faced with blackmail to destroy the country’s economy, you have to consider things.” 

But he might find resistance from Representative Greg Walden, Republican of Oregon, who said he would introduce legislation to close the loophole and end the debate once and for all. 

“My wife and I have owned and operated a small business since 1986. When it came time to pay the bills, we couldn’t just mint a coin to create more money out of thin air,” Mr. Walden said.

Dear Bank of America:

As a lender to my small business, you should be the first to know of a decision I’ve decided to take.  It wasn’t easy, and I’ve given it a lot of thought, but now I’m convinced it’s the right course of action.  I won’t be making my next monthly payment.

It is true that I have already ordered shipments of equipment and materials using the funds I’ve borrowed from you.  It is also true that I have adopted a pricing policy that’s designed to increase market share at the expense of current cash flow.  The result of these choices is that my financial obligations will exceed my revenues for an extended period of time.

I have a line of credit that can cover this shortfall; we discussed it at length in our meeting last month.  I appreciate your willingness to finance it at a negative real interest rate.  But I now believe that it is immoral for me to increase my debt, which could be a burden on my children and grandchildren.  As a result, I have imposed a debt limit on myself—a limit which I refuse to raise.

I’m sure you can understand the sound principles on which this choice is based: taking on more debt is evil.  That’s why I have chosen instead to default on your loan, as well as withhold wages I’ve promised to pay to my workers.  Please support me in this virtuous undertaking.

Sincerely yours.....

Virginia Governor McDonnell Goes Off Deep End On Transportation Policy

The top story on the front page of today's Washington Post bears the headline "McDonnell wants to end Va. gas tax" [current VA governor].  This may seem parochial/provincial, but I fear that this unprecedented and completely ridiculous proposal may become some new popular meme among Republicans around the nation.  While the gas tax would be eliminated, the sales tax would be increased, along with many driver related fees, including some on alternative fuel vehicles, although the tax on diesel fuel would be maintained.  I note one possibly good thing is that they might also actually help fund the extension of the Washington metro to Dulles airport.

The argument for this is that the gas tax is supposedly a "dinosaur tax" that has delivered a declining stream of revenue.  Hence it is considered to be a great breakthrough that a GOP governor and a GOP Speaker of the Assembly have come out for a growing possible future source of revenue, an increase in the sales tax, although they are also planning to raid other areas of the budget to help fund transportation, which is a major problem, particularly in Northern Virginia.  As it is, the gas tax rate has not been raised since 1986, and Virginia is now tied for 42nd among states in its gas tax rate.  Obviously some substantial increase in that could be done with little negative effect.

I have three broad objections to this.  Let me label them political-philosophical, economic, and moral.  On the first I think that there is something to be said for the "user pays" approach to public finance.  For many public services I am not enthusiastic, particularly when the users may be poor or the service simply must be supplied.   I am thinking about such things as eduction and health care.  However, funding for highways has applied this principle very widely and successfully in the US, which probably has the best highway system in the world.  All states have gas taxes, and I simply see no rationale for abandoning this principle in this case, except for political cowardice (and indeed Grover Norquist has already denounced this evil proposal because of its tax increase).

On the economic front I am really thinking about the environmental front, or if you will from the standpoint of just plain old neoclassical economics, internalizing externalities, particular air pollution from vehicles, most importantly right now, GHGs such as CO2.  Indeed, ironically, the second story on the top of WaPo's front page was headlined "Nation set record for heat last year."  Yet in the long story on the gas tax there was not a single mention of the environmental issue.  Maybe all of Richmond has fallen under the sway of GOP Attorney General and current gubernatorial candidate, Ken Cuccinelli, who infamously subpoeaned the University of Virginia for all of Michael Mann's emails from when he was on the faculty there in a search for that smoking gun we all know is not there that global warming is, you know, just a hoax.  So, I guess none of these clowns thinks anything about this.  As it is, at other levels people are talking about imposing a carbon tax, which would certainly show up as an increased gas tax, with a possible offset of a cut in income taxes.  But here they are proposing to go the other way: eliminate the gas tax entirely and raise the sales tax.

Which brings us to the moral or normative or fairness issue, particularly income distribution and who is paying for this.  So we are to go from a user pays tax to a sales tax, which are well known to be regressive.  Heck, VA has an income tax.  At least they could have proposed to raise that instead, but no, we have to go for the most regressive approach possible, along with raising fixed fees, which are even more regressive.  But we know what a bunch of Republicans care about that.  Finally, there is the matter of in-state versus out of staters.  Now people driving through the state using its highways will pay for part of their upkeep if they stop to buy gas here.  If this gets adopted, we shall see rich out of staters driving gas-hog vehicles and not paying at all with poor in-staters who do not drive having to cover for them.   All of this is simply and rankly unfair as far as I can see.

Every time I think we have seen the height of stupidity in new proposals, someone comes up with something else that is simply egregiously indefensible.  This is another example, and it is happening right here in my very own state.  Gag.

Micro Up, Macro Down?

I have just read two posts, one by Justin Fox, the other by Paul Krugman, that make exactly the same point: microeconomics is doing just fine, but macro is riven by ideological disputes and insufficient use of evidence to resolve them.  Can this be true?

I certainly won’t argue with the take on macro.  Macro models draw on implicit social theory (what motivates individuals, how much deference we should give to their choices, how “social”, which is to say, interactive society actually is, etc.), and most empirical work is filtered through such models, so that testing merges with calibration.  It’s as bad as Fox and Krugman say it is.

But I’m basically a microeconomist, and I think economics is as ideologically driven and counterfactual in many of the topics I care about as it is in macro.  Apparently there is no evidence for this position: micro folks, as can be seen on display here in San Diego, are all in agreement, discussing each others’ papers in a friendly, collaborative way like monkeys grooming their neighbors’ furry backsides.  What does that imply about outliers like me?

In a nutshell, here is what I think is going on, based on my personal experience.  In the areas I work in, I find a lot of common ground with people trained in other social sciences, like psychology, political science and anthropology, and even more with those who have an applied policy background like education, labor relations and public health.  I am virtually unable to communicate on the same subjects with other economists, and I haven’t tried publishing in a “real” economics journal in decades.  (This is not an exaggeration.)

In other words, my view is that the crucial dividing lines in micro are drawn between economists and other kinds of researchers and not within the economics profession.  In macro, by contrast, the lines separate some economists from others.

I have avoided giving any specifics about what makes me such an apostate, since that would require a lot more writing, and I’m already late to an 8 am session I want to attend.  Let’s just say I find most economists' assessments of optimal this and preferred that to be based on implausible and repeatedly disconfirmed assumptions, and I think the substantive ends of policy should be taken instead from those who study ends substantively, like the aforementioned psychologists, public health specialists, environmental scientists, etc.  If you make that leap, you will have to cut the cord to a large part of economic theory, but you will fit in well enough with the hordes of people who don’t populate economics conventions.

Naturalism

Brad Delong lays into Thomas Nagel's new book for its claim that Naturalism ultimately fails to make sense of the world. I haven't read Nagel's book yet, but I certainly agree with Nagel that naturalism is nonsense. This isn't because I am a super-naturalist, but because I am a normative realist:: a naturalist picture of the world doesn't allow for the reality of authoritative norms.  For naturalists, whether Humeans or (most but not all) Kantians, there is no fact of the matter about what we have reason to do.  If so,  science itself - because it depends on the objective authority of norms concerning what we have reason to believe - wouldn't make sense.  Economists in general are naturalists avant la lettre: they believe, almost to a person, that our reasons flow simply from our desires. This is normative nihilism. Normative realists believe that something's being good gives us a reason to want it, while a nihilist reverses this and makes its being good simply consist in our wanting it. Nihilism is absurd and should be rejected. If Delong wants to maintain his naturalism, he needs to answer not only Nagel, but Derek Parfit's new book, On What Matters - his masterpiece- which makes the case for normative (especially moral) realism (what he calls cognitivist non-naturalism ) better than I've ever seen it made.

Happy New Year, everyone!

Was That the Last Word on Taxes?

Senator McConnell:

Predictably, the President is already claiming that his tax hike on the “rich” isn’t enough. I have news for him: the moment that he and virtually every elected Democrat in Washington signed off on the terms of the current arrangement, it was the last word on taxes.

Economist Andrew Samwick:

In over eight years of blogging, you won't find a single word of praise for the Bush-Obama tax cuts. As a matter of revenue, we now permanently have a tax system that will not raise enough revenue to cover our expenditures.

Mind you – Dr. Samwick served as the chief economist on the staff of the Council of Economic Advisors in 2003 and 2004 (when George W. Bush was President). The question is not whether we will eventually have higher taxes – we will. The question is in what form will those extra taxes be and who will pay them. Naturally, we are not getting as much honesty on this score from Republican politicians as we are getting from Republican economists.

Manufacturing a criterion of judgement

Almost anyone who has viewed images such as those, for example, presented by Edward Burtynsky would probably feel a high degree of anxiety.  For surely, the implications behind the emergence of giant urban-industrial wastelands are staggering.  Nature has been "pronounced dead" and is "desacrilised".  Writer Theodore Roszak noted this observation 40 years ago in 1972.  

Roszak warned then that "as time goes on, the technocracy is bound to grow exquisitely adept at distracting protest and tranquilising anxiety.  He prophesied that "the bulk of our brainpower and governmental energy will one day be employed concocting cover stories, propagating ingenious alibis, and applying public relations" with a "vast mandarin establishment of professional obfuscators" "at the top of our society"[1].  

And so it passed. ...

http://globe-alive.blogspot.com.au/2013/01/manufacturing-criterion-of-judgement.html

The Big Issues For 2013

Tyler Cowen has presented 14 big stories to watch for 2013 and has provided links to similar stories at The Guardian and the Financial Times, http://marginalrevolution.com/marginalrevolution/2012/12/stories-to-watch-for-in-2013.html .  I shall comment on a few of these both that he states and links to, as well as some I have on my own mind.

Given the passage of the minimalist fiscal cliff deal that raises some taxes but makes no major spending cuts, with the GOP supposedly now aiming to try to squeeze those out in a showdown later this year over raising the debt ceiling, I think that the top story for the US and world economy is indeed this forthcoming fight.  Cowen has as his fourth point a genuine concern that the fight will actually result in a failure to raise it on time and a default with potentially devastating consequences.  I agree that this is a real possibility and is indeed a serious danger to all of the above.  Maybe the coalition that passed the fiscal cliff bill will be reasonable on the debt ceiling, but some of those voting for it are lame ducks going out the door.  Obama has said that he will not stand for another replay of the insanity of what went down in August, 2011, but this will indeed require some drastic action.  The one that a lot of us have been urging is if the House goes bonkers  then he should move to shut this down once and for all by declaring the debt ceiling unconstitutional.  If he does not quite have he chutzpah for that, there is also the trillion dollar coin out, although I find that gimmicky.  If one is going to shut down this blackmail game once and for all, then eliminating the debt ceiling once and for all by declaring it unconstitutional is clearly the way to go.  In his speech this evening, Obama clearly has laid the ground by noting that the bills authorized by Congress must be paid.  In the end what may be holding him back on declaring it unconstitutional is that back in 2011 his old constitutional law professor at Harvard, Lawrence Tribe, declared it constitutional, but he needs to think about this very carefully and seriously.  If he screws up on this, and the House gets run by the loonies, things could indeed really go off the rails for the US and the world economies.

 Cowen's seventh point is that China needs to have a decent rebound.  Many may not realize how dicey things have gotten there.  Growth has decelerated to a 7.1% rate as of the third quarter of 2012.  Certainly China will need to adjust to having lower growth rates than it has had in the past, and this rate may be about what it can manage, although clearly many are hoping (and predicting) that it will rise again somewhat soon.  That would certainly aid global economic growth, but there remains a major fly in the ointment, aside from its overreliance on massive construction projects that seem to be increasingly of the diminishing returns variety, and that is its property bubble.  That may not burst, but there have been quite a few observers both in and out of China who have been very worried about this.  I would have to say that based on my own personal contacts, those in China have been more pessimistic about this situation than those outside of China.  I would say that a possible collapse of property values in China leading to a much more serious slowdown of the Chinese economy is probably the second (and possibly first) most serious threat to the global economy after the possibility of a screwup regarding the US debt ceiling.

His second point is concern about the Catalan independence movement in Spain.  This has not gotten much attention in the US, and there are a variety of ways that it could be resolved with little disruption to the world economy.  However, Spain remains the most crucial linchpin in the Eurozone, currently in a bad recession with youth unemployment at 50% and struggling to get its public finances sufficiently in order to keep the support from Germany and the various Eurozone financial institutions coming (and it should be kept in mind that prior to 2008, Spain was actually running a budget surplus, in contrast with Greece and some of the other troubled Eurozone economies).  While Cowen and others worry about Italy, I figure it will muddle through, but the Spanish efforts are completely complicated by the Catalan move to declare independence, both because it is one of the highest income parts of Spain, but also because its own debts are very large and it is likely that the EU may not even let it join, much less offer any assistance to it for dealing with them (arguments over Catalunya's ability control its own taxes is a central feature of its debate with the Spanish central government).  The bottom line is that the Spanish central government may simply be unable to negotiate successfully with both the Catalans and the Germans and other Eurozone powers.  A full bore Spanish default cannot be ruled out, and it is sufficiently large that this is the case that could really push the broader Eurozone situation into becoming the trigger for a broader global crisis.

Having mentioned China's problems, I note that more broadly the BRICS are not doing so well, and this will become a more serious problem in this coming year, although probably the problems of the other constituents of that group will not be bad enough to drag down the global economy.  But their collective problems constitute a dragging element where they had been a leading part of helping the world economy to recover from the Great Recession.  India's accumulating and multiple problems are Cowen's 12th point, and the possibility of a major political crisis in South Africa is his 7th.  Neither he nor his links mention Brazil or Russia, but the former has declerated to barely a 1% growth rate, which is far below what it has been doing in recent years.  Russia may be in the best shape of these, but if oil prices fall, it could also fall into difficulties, and clearly there is a serious political and corruption problem there that does not seem to disappear.

The Guardian provides discussons of both Iran and Israel, noting that both will have elections this year, with Israel's coming up quite soon.  Quite likely Netanyahu will be reelected, most likely with an even more hawkish coalition in his government.  Iran has a presidential election in June, and incumbent Ahmadinejad cannot run for reelection.  He has become quite alienated from the Mullah establishment, which will make it hard for him to get his favored candidate through.  Amazingly enough there is serious talk of relatively moderate former president Khatami running, although he will have to kowtow to the clerical establishment to do so.  This suggests the possibility of perhaps some opening to a settlement with the US over the nuclear issue that would keep the Israelis at bay from attacking.  Of course, the real leader is Vilayat-el-faqih Ali Khamene'i.  While hawks in Israel and the US have been warning for years that Iran will be at the point of being able to "break out" to build nuclear weapons quickly, there are more serious voices at this time saying that indeed this may be the year when that capability may be achieved.  If this is the case (or strongly perceived to be) and there is no agreement, there could be war, which could be catastrophic both economically and in other ways for the world economy and the world more generally.  However, it must be kept in mind that the US intelligence establishment, and even the Israeli one reportedly, agree that Khamene'i has not decided to build nuclear weapons and has issued numerous fatwas against having them at all.  It would be tragic if we go to war just on the possibility that they might have the capability of doing so.

Let me close this on a positive note.  I agree with Dean Baker and others that there is now a solid foundation for the US economy to continue to grow in a fairly solid, if unspectacular, way for the coming year, if it does not get derailed by one of the above potential crises, or something else not listed and possibly unforeseeable at this time.  There are two main sources for this optimism.  The most important one is that the crucial sector that generated the 2008 crisis has really hit bottom and now appears to be growing solidly, namely housing construction.  It will take a bad crisis to derail this recovery, which has been a long time coming, although it could happen (if a debt ceiling crisis resulted in an interest rate spike, that could do it). 

The other is the turnaround in the financial situation of most state and local governments, which unlike the federal government mostly face serious balanced budget rules.  The major source of decline in GDP and particularly of employment during the last two years has been this sector.  This decline now appears to be over.  While nobody is forecasting any noticeable increase coming from this sector (and a major move to austerity at the federal level could renew their decline), just having them not declining should help provide a support for the overall US economy to continue to grow in a reasonably solid way if one or another of the potential catastrophes lurking out there can be avoided.  And they could surprise everybody and actually engage in some expansion of spending and hiring.

So, happy new year one and all!

Mankiw – Soak the Middle Class

Mark Thoma reads Greg Mankiw so we don’t have to:

If people like Mankiw wanted cuts to social insurance so badly, why didn't they speak up and make this absolutely clear before the election? When Republicans accused Democrats of, for example, wanting to cut Medicare, why didn't Mankiw say yes, that's exactly what President Romney should do! I'm one of his advisors, I've made that clear, and here's his plan for cuts to Medicare, Social Security, Medicaid, and the like. Why pretend you are the defenders instead of the cutters? The answer is, of course, is that it's not what the public wants. The bipartisan budget wonks in Washington may have their own plan to cut social insurance, but guess what? We live in a Democracy, and the Romney/Mankiw view was rejected (so now Republicans try to get it through the back door by gumming up the legislative works and holding the economy hostage). It's not what people want. Acting like it is what they want through a misleading suggestion that it's in some bipartsan commission report that doesn't actually exist is contrary to the message the election delivered.

I’m not sure if Mark has read Greg’s latest NY Times oped yet:

Fairness, like beauty, is in the eye of the beholder. Unfortunately, people’s judgment is often based on anecdotes that distort rather than illuminate. The story of the undertaxed Warren Buffett and his overtaxed secretary looms larger in the public’s mind than it should ... These data suggest that the rich are not, as a general matter, shirking their responsibilities to support the federal government. To me, the current tax system looks plenty progressive. Others may disagree. One point, however, cannot be disputed: Even if President Obama wins all the tax increases on the rich that he is asking for, the long-term fiscal picture will still look grim. Perhaps we can stabilize the situation for a few years just by taxing the rich, but as greater numbers of baby boomers retire and start collecting Social Security and Medicare, more will need to be done. Which brings us back to the middle class … Ultimately, unless we scale back entitlement programs far more than anyone in Washington is now seriously considering, we will have no choice but to increase taxes on a vast majority of Americans.

Shorter Mankiw – if the middle class wants their Social Security and Medicare benefits, they must pay higher taxes as we already tax the rich way too much. Let’s be fair to Greg – there are a lot of Romney Republicans who privately agree with this sentiment. But this is not the public message that Mitt Romney campaigned on. Nor is it the message that the rest of the Republican political leaders wish to admit publicly.

After the Deal on Taxes – Where Are We Going on Expenditures?

Jonathan Weisman reports on the deal that passed the Senate:

In one final piece of the puzzle, negotiators agreed to put off $110 billion in across-the-board cuts to military and domestic programs for two months while broader deficit reduction talks continue ... Democrats were incredulous that the president had ultimately agreed to around $600 billion in new tax revenue over 10 years when even Mr. Boehner had promised $800 billion. But the White House said it had also won concessions on unemployment insurance and the inheritance tax among other wins.

Before spring arrives, we will have to face up to the issue of spending cuts. I suspect that the Republicans will insist that these cuts represent at least $600 billion over the next ten years and that none of these cuts come from the defense department. In other words, the Republicans will want cuts in Social Security, Federal expenditures on health care (think Medicaid and SCHIP), and a host of large cuts in other small Federal programs. But why not reduce defense spending? Progressives should call for all of this $600 billion over the next ten years – which turns out to be a mere 0.3% of the decade’s potential GDP. After all, current defense spending is running at 5.3% of GDP. Barney Frank recently made this case. Progressives need to continue to hammer this argument. We may not get all of the cuts in government spending from defense but if we don’t make this argument, I fear that the Republicans will get all they want at the end of the day.