What Was Glass-Steagall?

I don’t think that Robert Reich actually knows.

Some argue Glass-Steagall wouldn’t have prevented the 2008 crisis because the real culprits were non-banks like Lehman Brothers and Bear Stearns. But that’s baloney. These non-banks got their funding from the big banks in the form of lines of credit, mortgages, and repurchase agreements. If the big banks hadn’t provided them the money, the non-banks wouldn’t have got into trouble. And why were the banks able to give them easy credit on bad collateral? Because Glass-Steagall was gone.

Pointer from Alex Tabarrok. Reich seems to think that Glass-Steagall was some sort of magical regulation that allowed regulators to keep banks from making unwise loans.

In fact, my understanding (like most commentators, I have not actually read the law itself) is that it was intended to separate commercial banking from investment banking. That is, one type of institution could take deposits and make loans, and another type of institution could underwrite securities. It started to fall apart in the 1970s, when money market funds were invented, allowing investment banks to issue debt that looked a lot like deposits. This caused banks to complain that financial activity was going to shift out of banks, which was going to hurt banks and make bank regulation irrelevant. The 1980s were spent with lobbyists and legislators trying to work out a fair way for commercial banks to compete in investment banking and vice-versa.

Ironically, what Reich is describing, with commercial banks lending to investment banks, shows that the two were still somewhat separate even ten years ago. I am willing to be corrected, but as far as I know, there was nothing in Glass-Steagall to stop a commercial bank from lending to an investment bank. Repurchase agreements and lines of credit were not forbidden. And when Reich says that non-banks received mortgages from commercial banks, he is completely unhinged.

I continue to believe that the Nirvana Fallacy it what drives a lot of analysis of the financial crisis, and of government intervention in general. That is, if you believe that Nirvana is achievable through government intervention, then if we have disappointing outcomes it must be because government is being held back from intervening the way it should.

The overall Atlantic piece to which Tyler refers includes comments from some left-leaning economists that are actually reasonable concerning the irrelevance of Glass-Steagall. But on the whole, the left is locked into its Nirvana fallacy of financial regulation.

Three Version of Stagnationism

John Cochrane clarifies helpfully.

The cause of sclerotic growth is the major economic policy question of our time. The three big explanations are 1) We ran out of ideas (Gordon); 2) Deficient “demand,” remediable by more fiscal stimulus (Summers, say) 3); Death by a thousand cuts of cronyist regulation and legal economic interference.

Read the whole post. He make the case for (3).

Start with the Nirvana Fallacy

Bryan Caplan writes,

The claim that “free-market dogma” is the “reigning economic policy” of the United States or any major country seems so absurd, so contrary to big blatant facts (like government spending as a share of GDP, for starters), that I’m dumb-founded. Sure, I could defend this position with demagoguery. But if I wanted to intelligently argue in favor of the claim that neoliberalism actually guides economic policy in any major country, I literally wouldn’t know where to start.

I would suggest starting with the Nirvana fallacy. That is, take the point of view that things could be almost ideal if your preferred policies were in place. Then compare reality to this ideal. When reality falls short, you can infer that your preferred policies are not in place.

This approach works equally well for people who prefer more statist policies and for people who prefer more libertarian policies. For the former, the flawed state of current outcomes are sufficient to demonstrate the futility of free-market dogma, which must be the only thing standing in the way of Nirvana. For the latter, the flawed state of current outcomes are sufficient to demonstrate the futility of government intervention, which must be the only thing standing in the way of Nirvana.

Can Bad Nurture Make Things Worse?

Neerav Kingsland writes,

It’s very easy to see how a totally dysfunctional environment could negatively impact students, whereas it’s a little more difficult to tease out the additional impact on students once the basics are in place.

There may be exceptions to the null hypothesis on the extreme down side. That is, the very worst parents, the very worst teachers, and the very worst schools might have an adverse effect on young people that is causal, significant, long-lasting, and replicable.

Margins of Adjustment

Tyler Cowen quotes from the abstract of a paper by André Kurmann, Erika McEntarfer, and James Spletzer

In our data, only 13 percent of workers who remain with the same firm (job stayers) experience zero change in their nominal hourly wage within a year, and over 20 percent of job stayers experience a reduction in their nominal hourly wage. The lower incidence of downward wage rigidity in the administrative data is likely a function of our broader earnings concept, which includes all monetary compensation paid to the worker (e.g. overtime pay, bonuses), whereas the previous literature has almost exclusively focused on the base rate of pay. When we examine firm labor cost adjustments on both the hours and wage margins, we find that firms have substantially more flexibility in adjusting hours downward than wages. As a result, the distribution of changes in nominal earnings is less asymmetric than the wage change distribution, with only about 6 percent of job stayers experiencing no change in nominal annual earnings, and over 25 percent of workers experiencing a reduction in nominal annual earnings.

A few comments.

1. At the link, it says, “Preliminary and incomplete. Do not cite without permission of authors.”

2. This finding, if established, would only damage macro theory to the extent that bonuses and other fringe benefits are the alternative margins of adjustment. If the alternative margin of adjustment is hours, then that would actually serve to reinforce the macro theory that says that real output falls when nominal GDP growth is slower than expected because nominal wages are sticky.

3. I should note that there also are alternative margins of adjustment that can reduce price stickiness relative to list prices. For example, a restaurant could keep its prices constant but reduce portion sizes or quality. A clothing store could keep its list prices constant but change the size and frequency of discounts.

Timothy Taylor on the Tech Sector

He writes,

My own guess is that the applications for IT in the US economy will continue to be on the rise, probably in a dramatic fashion, and that many of those applications will turn out to be even more important for society than Twitter or Pokémon Go. The biggest gains in jobs won’t be the computer science researchers, but instead will be the people installing, applying, updating, and using IT in a enormously wide range of contexts. If your talents and inclinations lead this way, it remains a good area to work on picking up some additional skills.

This sounds right to me. The technological advances have been rapid, but the process of deploying applications goes more slowly.

Formalize This

A commenter asks,

Which formalization would you argue adequately considers specialization and trade? An Edgeworth box?

This is a good question, because mainstream economists cannot “see” anything that is not in a formal model.

My answer in this case is a definite “No.” The Edgeworth box is an example of two-by-two economic modeling. Other examples include the Ricardian model of comparative advantage and the Heckscher-Olin-Samuelson model of international trade.

The most important aspect of specialization and trade is that we specialize in just a few tasks but we enjoy the products of millions of tasks. This fact was noticed by Adam Smith, but it has not been “formalized” in any useful way that I can think of. So the formal modelers are like drunks who have their preferred lamp posts, but the watch that need to look for is somewhere else.

DSGE Models Are Not Micro-founded

Mark Thoma quotes George Evans,

First, because it is a carefully developed, micro-founded model incorporating price frictions, the NK model makes it possible to incorporate in a disciplined way the various additional sectors, distortions, adjustment costs, and parametric detail found in many NK/DSGE models.

No! There is no specialization and trade in these models. You can call such a model “micro-founded” all you want. It isn’t. These empty modeling exercises do not deserve to be called micro-founded. They do not even deserve to be called economics.