Monthly Archives: September 2013

Keith Hennessey and Edward P.Lazear on the Financial Crisis

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They write,

The best evidence suggests that the financial crisis was caused in large part by an unprecedented flow of funds into the United States and other developed economies.

Thanks to Michael Barone for the pointer.

Their essay is very well organized and well written. That does not mean that I agree with it. It is true that there is a tendency for large capital inflows to end badly (think of Latin America in the 1980s or Asia in the 1990s). However, we could have used those capital inflows to finance something other than a consumption binge funded by unsound mortgage loans.

One of their arguments is that the financial crisis was more like popcorn (a lot of institutions faltering for the same reason) than like dominoes (one institutional failure leading to another). They say that this argues against case-by-case rescues, and I agree with that. But they say it argues in favor of TARP, which they describe as a systemic solution. But a solution to what? How does transferring the real losses from the owners and creditors of distressed firms to the taxpayers solve anything? They write,

Five years later, TARP and the other policy actions taken during the financial crisis nevertheless remain widely unpopular. This tension between a policy success and intense political unpopularity is a defining feature of the actions taking during the financial crisis.

Of course, we do not have the counterfactual, so they can say that all they want. Just as proponents of the stimulus can say that it saved lots of jobs. Both TARP and the stimulus were followed by horrible economic performance, but you can always argue that it would have been worse without them.

The authors, both of whom were important officials under President Bush in 2008, also defend the GM and Chrysler bailouts.

If [Bush] chose not to extend the loans, he was advised that these firms would likely liquidate within weeks. Private sources of debtor-in-possession financing that would have been necessary to allow GM and Chrysler to continue absent government aid were simply unavailable.

Monetary Offset

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See Scott Sumner’s short paper.

estimates of fiscal multipliers become little more than forecasts of central bank incompetence. If the Fed is doing its job, then it will offset fiscal policy shocks and keep nominal spending growing at the desired level. Ben Bernanke would deny engaging in explicit monetary offset, as the term seems to imply something close to sabotage. But what if he were asked, “Mr. Bernanke, will the Fed do what it can to prevent fiscal austerity from leading to mass unemployment?” Would he answer “no”?

The Keynesian point of view is that the Fed “ran out of ammunition” when the Fed Funds rate went to zero. At this point, I do not know what to say to people who take that view. If it were true, then the fiscal multiplier should be bigger than one would otherwise expect. Yet it seems to have turned out smaller–the stimulus did less than predicted, and the austerity did less damage than predicted. And to me, it seems obvious that as long as there is stuff that the Fed can buy, including long-term bonds and foreign currency, it has “ammunition.” But the Keynesians routinely dismiss as incompetent anyone who who claims that the Fed cannot run out of ammunition. Perhaps Scott’s paper will force them to actually defend their position, although chances are that they will just continue to ignore or insult those with whom they disagree.

My own views do not align with either Sumner or the Keynesians. PSST is an alternative to the AS-AD story.

Revisiting the Great Stagflation

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Karl Smith writes,

I tend to think far little attention has been paid to the rapid increase in the work force due to the entrance of baby boomers and women. Economists are so sensitive to any argument against immigration they seem to forget that any growth model that I am aware of will predict a decline in per capita GDP if the population rises fast enough.

He cites a 1999 paper by Athanasios Orphanides, who wriote,

I examine the evolution of estimates of potential output and resulting assessments of the output gap during the 1960s and 1970s. My analysis suggests that the resulting measurement problems could be attributed in large
part to changes in the trend growth of productivity in the economy which, though clearly seen in the data with the benefi t of hindsight, was virtually impossible to ascertain in real-time.

I am glad to see folks renewing their interest in the Great Stagflation. I certainly spend a lot of time on it in the book that I am working on. In my case, I am particularly interested in the human dimension of how it affected economists. There was much more professional turmoil back then. For example, consider how quickly the great economists of the 1960s went from the center of the profession to its periphery. In 1968, if you had held a session at the AEA meetings featuring Walter Heller, Arthur Okun, Lawrence Klein, and Otto Eckstein, you would have needed a ballroom to accomodate everyone who wanted to attend. In 1974, you could have held it in a suite.

Contrast that with the impact of the Great Recession. Who were the big names before it hit? Blanchard, Woodford,, Bernanke, Gali. Who are the big names now? Same ones.

So in the 1970s, unexpected macroeconomic events create a dinosaur extinction. Today, nothing. Explain that to me.

Concerning the point raised by Karl Smith and Steve Waldman, as best I recall, economists back then were making adjustments for changes in the composition of the work force in their calculations of trend productivity growth. That was part of the story for poor economic performance, but not all of it. Some points to consider.

1. As I posted a while back, Alan Blinder thinks that much can be accounted for by a series of supply shocks–from oil price increases to Peruvian anchovy disappearances. I would add that I think that price controls were a self-inflicted supply shock, particularly in the oil market. At the time, many economists (Blinder among them) wrongly thought that price controls were a favorable supply shock. But I think that by messing up market adjustments they were an adverse shock.

2. I think that there was a lot of money illusion in financial markets in the 1970s. That is, people looked at high nominal interest rates and treated them as high real interest rates. Thus, as Modigliani and Cohn (you can Google Modigliani Cohn 1979) pointed out, the stock market seemed to be discounting real earnings at nominal rates. But the main problem was that real rates remained very negative. In my view, this was the fault of the private sector, although I think there was money illusion at the Fed as well. But in my view, regardless of what the Fed was doing with short-term rates, nobody was forcing long-term bond investors to take negative real rates. Yet that is what they did.

So the story I would tell is that the high inflation came from these negative real interest rates, and perhaps from the series of supply shocks Blinder discusses. The high unemployment came from the energy shock, exacerbated by the self-inflicted disruption of price controls.

Evidence for Teach for America

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In this study by Mathematica.

TFA teachers were more effective than the teachers with whom they were compared. On average, students assigned to TFA teachers scored 0.07 standard deviations higher on end-of-year math assessments than students assigned to comparison teachers, a statistically significant difference. This impact is equivalent to an additional 2.6 months of school for the average student nationwide.

They captured data on TFA teachers and non-TFA teachers, and nothing in the data (e.g., their educational backgrounds) predicted this result. Even though this study was carefully conducted, my prediction is that it will not hold up over time. I put my faith in the null hypothesis in education.

A Modern American Scandal

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Found by a CBS affiliate in New York.

Clandestine dinner parties like the one Leitner attended have become more common in New York City. And insiders told Leitner they are completely unregulated…

The Health Department refused to discuss the issue on camera but in a statement told CBS 2: “In New York City, people who offer meals to the public for money are considered food service establishments and need permits. The city does not allow meals to be served to members of the public in someone’s home.”

After I wrote this, but before I posted it, Art Carden gave it appropriate treatment.

Average is Over

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That is Tyler Cowen’s latest book, which I just finished. I will probably re-read parts of it and have more to say, but for now:

1. Tyler sees the tech sector as dynamic, while the education and health sectors have been stagnant, in part because of government control. In some sense, the difference between The Great Stagnation and his new book is that the former emphasizes the sectors that are doing poorly and the latter emphasizes the tech sector.

2. In part because of this shift in emphasis, this book came closer to reflecting my own views.

3. Tyler uses an arresting metaphor of a billionaire riding in a taxi in Calcutta, surrounded by beggars seeking his attention. One can imagine rich people being able to afford a lot of personal servants. The constraint on that will just be the time and effort needed to manage personal servants.

3. Tyler uses Freestyle chess (humans working with computer programs to compete) as a metaphor. There, I thought he stretched it a bit too much. He envisions a sort of Freestyle economics emerging. But to me there is a big difference between chess and economics in terms of what James Manzi calls causal density. In chess, there are a finite number (in fact, probably a small number) of important factors. Sorting through tens of thousands of games, a computer program can arrive at precise weights for those factors. To us, it is dazzling to see an early bishop sacrifice that a human would consider speculative, but the computer knows, based on “experience,” that this is the sort of position in which one can do without a black bishop.

But in economics, we are dealing with high causal density. This is particularly true in finance and macro. I am not convinced that sheer data analysis is going to produce dazzling results. Sure, a new data-crunching paper may add more value at the margin than a new JET paper, but that is not saying much.

4. For me, the most interesting chapter was the one on education. Tyler points out that the content-supplying and testing/grading functions of a professor can be automated relatively easily. The main role for humans is to supply motivation, coaching, and inspiration. I am reminded of an experiment in India in which grandmothers with no subject-matter knowledge are recruited to encourage young children to learn by praising their work.

A Local Pseudo-Currency

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A reader points me to this story.

What we want to do is create an appropriate scale currency for our region that will then serve the needs of our region. We used to have a system in this country of local currencies everywhere, and then there was a national currency, too. So that’s what we’d like to see again: regional currencies that work for their region and then a national currency — why not? You need that too so that you can trade across the country, or even an international currency.

I see this as analogous to frequent-flyer miles. It is a pseudo-currency that is worth something in some contexts but otherwise is not very liquid and is close to useless. As with frequent-flyer miles, the idea is to encourage customer loyalty, in this case to local merchants. I would be surprised if it turns out to be important.

A Public Sector Implosion?

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From Neil Irwin in the WaPo:

From July 2008 to January 2013, the sector shed more than 737,000 jobs. Had the jobs merely been maintained, the unemployment rate would be as much has half a percentage point lower.

Pointer from Mark Thoma.

From Mark Perry at AEI:

in the 50 months since June 2009 when the recession ended, more than 6.3 million jobs have been created in the private sector and the employment level today is 5.8% higher than in June 2009. Over that same period, government sector jobs have fallen by 3.3%, and by more than 750,000 jobs.

My guess is that state and local governments have to put relatively more money into Medicaid and into shoring up pension plans, which leaves them less to spend on new workers. Also, do not be so sure that this is macroeconomically important. It could be that if state and local governments had retained workers, then the private sector would not have expanded as much. In any case, the bigger story, numerically, is the drop in the labor force. As Brad Plumer puts it.

If the same percentage of adults were in the workforce today as when Barack Obama took office, the unemployment rate would be 10.8 percent.

What Would Keynes Have Done?

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Bradley Bateman writes,

He never said that the government could exactly hit some target. This is an idea that came from one of the first great Keynesian texts published in the late 1940s, Functional Finance by Abba Lerner

Bateman writes in a collection of essays called The Economic Crisis in Retrospect, which tries to ask what great economists of the past might have said about the financial crisis of 2008. It is published by Edward Elgar, which typically prices its products for libraries as opposed to the mass public. I was sent a review copy.

Bateman also claims that Keynes did not believe in running government budget deficits. “In many ways he was Libertarian.” Of course, he was always in favor of public works as a stimulus package, but Bateman claims that Keynes proposed using the government’s sinking fund to finance this. It is not clear to me why this is not deficit spending.

In another essay, on Joseph Schumpeter, Richard N. Langlois quotes from Capitalism, Socialism, and Democracy.

Capitalism, then, is by nature a form or method of economic change and not only never is but never can be stationary. And this evolutionary character of the capitalist process is not merely due to the…social and natural environment…The fundamental impulse that sets and keeps the capitalist engine in motion comes from new consumers’ goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates.

Langlois says that Schumpeter explained the business cycle by saying that it takes a while for signals of obsolescence to reach the firms that are affected. Langlois writes,

They do not stop making carbon paper right away. So there is an economic boom that starts as the new technology spreads. It creates what Schumpeter calls a secondary boom that is artificial. Because what should be happening is that resources should be being withdrawn from carbon paper at the same time they are being put into computers. But that does not happen. The carbon paper is still there because those signals have not yet reached those who finance carbon paper. Yet there is a boom in computers. The whole process is not sustainable.

The book has other interesting essays including one by Perry Mehrling, who gives his view that we need to extend government protection to shadow banking, as well as one by Thomas Sargent, who raises some doubts about that approach.

Although I found the book worth reading, and I may re-read Sargent’s essay (I found a video of Sargent delivering his essay, and I passed it along to Scott Sumner, who seems to have had as much difficulty as I did following it.), I would not put it at the top of your wish list.