Archive for February, 2012

Greece and Misleading Fables

Michael Stephens | February 29, 2012

Yanis Varoufakis, former adviser to the Greek Prime Miniser and co-author of “A Modest Proposal,” delivers this special report for Channel 4 News on the situation in Greece:

(credit to Naked Keynesianism)

A quick comparison of working hours for supposed Greek “grasshoppers” and German “ants,” or of the generousness of their governments’ respective social welfare expenditures, should help dispel the tiresome insect talk.

Update:  There is a good interview of Varoufakis posted today at Naked Capitalism that opens with a discussion of “the essence of the economists’ inherent error”: continue reading…


A Cycle to Watch Out For

Greg Hannsgen | February 27, 2012

Perhaps we’re back to our old ways. For many moons, the household savings rate has again been falling, though it is still above the levels reached in the years leading up to the home loan crisis of 2007–2009. There are even some signs of a resurgence of the mortgage-backed securities industry. Could the economy be riding a merry-go-round familiar to students of economic history, as concerns about financial fragility, risky borrowing, and small nest eggs ebb and flow with the headlines of the day?

There is an economic term for this type of historical pattern that has not been prominent in recent debates. In loose terms, an epistemic cycle is an economic cycle of learning, knowing about, or understanding certain issues or facts; for example, the dangers of reckless consumer borrowing. The late Hyman Minsky of our Institute wrote authoritatively about the tendency of financial risk-taking to build up over time in the years following a crisis, as people gradually let their guard down after a fight to save the financial system. Eventually such trends would bring on a crisis and a subsequent return to more cautious behavior, especially on the part of banks and regulators.

This leads to the question of whether policymakers can reduce the danger that risky levels and types of borrowing will return over the coming years, as people begin to put the financial turmoil of the past few years into perspective. Economists of all stripes tend to be pessimistic about such issues, ironically in many cases because of a belief that human behavior is generally rational in one way or another.

One concept that often comes up in discussions of policies for dealing with the aftermath of the crisis is moral hazard, which was the subject of an interesting essay in yesterday’s New York Times. continue reading…


Will the Central Bank Bailouts Ever End?

L. Randall Wray | February 24, 2012

(cross posted at EconoMonitor)

Guess which US bank holds assets equal to a fifth of US GDP.

Now guess what percent of its assets have extremely long maturities, greater than ten years: a) 10%; b) 20%; c) 30%; d) 40%; e) 50%.

Answer: The Fed, and e) 50% of its assets have ten years or more to maturity.

Recap. The global financial crisis (GFC) began about four years ago. The Fed pulled out all the stops to save the biggest banks. As I discussed previously the Fed engaged in “deal-making” designed to protect creditors of failing banks, and used Section 13(3) to create Special Purpose Vehicles that engaged in legally questionable lending and asset purchases to save banks and shadow banks. Four years later, the Fed’s balance sheet is still humongous and it is even increasing its interventions in recent weeks through loans to foreign central banks.

A recent speech by Herve Hannoun at the Bank for International Settlements, “Monetary policy in the crisis: testing the limits of monetary policy” (link below) shows that ramping up the role for central banks has taken place all over the world. Indeed, in emerging market economies, the central banks have assets equal to 40% of GDP. In large part that is due to accumulation of foreign currency reserves among countries like China and Brazil–a topic beyond the scope of this blog. But the intervention by central banks during this GFC is entirely unprecedented–and is starting to worry most observers, who are asking when, or if, this will ever end.

Graph 1: Central bank assets, and as share of GDP

Graph 2: Maturity of assets

You can find the BIS report here.

To be sure, I do not share the worry of the BIS and many other commentators that the central bank expansions will cause inflation. My worry is this: the “too big to fail” (or as my colleague Bill Black calls them “systemically dangerous”) institutions have learned that no matter what they do, they will be saved and their top management will never be punished. continue reading…


Papadimitriou on Cross Talk

Michael Stephens | February 23, 2012

Everyone from Amity Shlaes to Mitt Romney and the European Commission has been telling us lately that slashing government spending under current economic conditions will depress growth.  On “Cross Talk” Dimitri Papadimitriou debates the merits (or lack thereof) of austerity and explains why the United States of Europe needs to become more like the United States of America:

At the end of the last exchange, when Fragkiskos Filippaios asks, with respect to the idea of a common fiscal policy for Europe, “who’s going to be responsible for that?” you can hear Papadimitriou’s reply:  the European Parliament.  For more on his views about how to complete the incomplete Union in Europe, see Papadimitriou’s latest policy brief, “Fiddling in Euroland.”


Reader’s Guide to the Limitations of Orthodoxy

Michael Stephens | February 22, 2012

Matías Vernengo does a quick review of “Getting Up to Speed on the Financial Crisis,” which is a survey of work on the global financial crisis that will be published in the Journal of Economic Literature.  “Getting Up to Speed” is intended as a “one-weekend-reader’s guide” to the crisis.  It offers, says Vernengo, a fine selection of the relevant orthodox literature on the financial crisis.  The problem is that that such a selection only gets you so far in understanding the crisis and its roots:

The biggest problem with their paper is not the limited number of documents reviewed, which seem to be fairly representative of conventional views on the financial crisis, but the limitations of what the mainstream of the profession knows about the crisis, and worse, what the profession clearly does not know it does not know, the unknown unknowns, so to speak. And that is why ignoring heterodox and progressive contributions has been very harmful for the profession.

Vernengo points to a number of heterodox contributions that provide more comprehensive accounts of the dynamics underlying the crisis, including Wynne Godley’s (1999) “Seven Unsustainable Processes” (if you haven’t read this Godley piece, it’s worth your time).  Read Vernengo here at Triple Crisis.

Also take a look at Gerald Epstein’s follow-up, in which he quotes the rather revelatory first sentence of “Getting Up to Speed” (emphasis is Epstein’s):

“Many professional economists now find themselves answering questions from their students, friends, and relatives on topics that did not seem at all central until a few years ago, and we are collectively scrambling to catch up.” …

Note how damning of mainstream macroeconomics this statement is: the key dynamics of the crisis – massive leverage and credit expansion, fed by the shadow banking system, that contributed to a housing bubble and crash – all elements of a macroeconomic dynamics well known to more than one generation of economists trained in the economics of Keynes and Minsky.


Fiddling in Euroland

Michael Stephens | February 21, 2012

The Financial Times got its hands on a confidential “debt sustainability analysis” that was circulated among eurozone finance ministers.  The gist of the analysis is that the austerity measures being imposed on the Greek population will depress growth so brutally that the government will almost certainly not meet its debt reduction targets:

…even under the most optimistic scenario, the austerity measures being imposed on Athens risk a recession so deep that Greece will not be able to climb out of the debt hole over the course of a new three-year, €170bn bail-out.

It warned that two of the new bail-out’s main principles might be self-defeating. Forcing austerity on Greece could cause debt levels to rise by severely weakening the economy while its €200bn debt restructuring could prevent Greece from ever returning to the financial markets by scaring off future private investors.

In other words, the latest rescue plan for Greece could be classified (if one were feeling deeply generous) under the category of “buying time.”  But buying time for what exactly?

In this policy brief, Dimitri Papadimitriou and Randall Wray tell us that the eurozone must ultimately move in one of two directions:  either toward a coordinated breakup or toward the development of some real fiscal and monetary policy capacities, which means having the European Central Bank step up as a buyer of last resort for member-state debt and increasing the fiscal space of the European Parliament so that it is able to stimulate growth.  The Union, in other words, must be severed or completed. continue reading…


The Washington Post Goes “Unconventional”

Michael Stephens | February 20, 2012

Dylan Matthews had a piece on Modern Monetary Theory in the Washington Post yesterday that featured Levy Institute scholars James Galbraith and Randall WrayWaPo also put together a “family tree” that displays some Post Keynesian and New Keynesian lineages.

The piece has been bouncing around the internet, first with some supportive comments by Jared Bernstein (he critiques the political viability of being able to control inflation through tax increases and insists on the long-term challenge we face due to rising health care costs).  Both Dean Baker and Kevin Drum ask what’s so special about MMT, with Drum suggesting a focus on views about inflation.  According to Drum, this is the central question:

So should we focus instead on a genuine target of 4% unemployment, reining in budget deficits only when we fall well below that? That depends a lot on what you think the productive capacity of the country really is, and the mainstream estimate of NAIRU, the highest unemployment rate consistent with stable inflation, is around 5.5% right now. If that’s the right estimate, then you could argue that we’ve been doing OK for the past few decades. But if full employment is really more consistent with an unemployment rate of 4%, then we’ve been wasting an awful lot of productive capacity for nothing.

Of course, you might also want to consider MPT, or Modern Petro-Monetary Theory. Rather than asking what level of economic growth kicks off unacceptable inflation, it asks what level of economic growth kicks off an oil price spike that produces a recession and higher unemployment. I have to admit that I increasingly think of the economy in those terms these days.

In comments at Mother Jones, Galbraith engages with Drum’s “MPT” point: continue reading…


Let’s Make a Deal

L. Randall Wray | February 17, 2012

It has been recognized for well over a century that the central bank must intervene as “lender of last resort” in a crisis. In the 1870s Walter Bagehot explained this as a policy of stopping a run on banks by lending without limit, against good collateral, at a penalty interest rate. This would allow the banks to cover withdrawals so the run would stop.

Once deposit insurance was added to the assurance of emergency lending, runs on demand deposits virtually disappeared. However, banks have increasingly financed their positions in assets by issuing a combination of uninsured deposits plus very short-term nondeposit liabilities (such as commercial paper). Hence, the GFC actually began as a run on these nondeposit liabilities, which were largely held by other financial institutions.

And here is where the issue gets complicated. As I argued in a previous blog post, banks and other institutions relied largely on “rolling over” short-term liabilities (often, overnight). But when reports about the quality of bank assets began to surface as subprime mortgage delinquencies rose, financial institutions began to worry about the solvency of the issuers of the liabilities. As markets came to recognize what had been going on in the securitization market for the past half-decade, “liquidity” dried up—no one wanted to hold uninsured liabilities of financial institutions.

In truth, it was not simply a liquidity crisis but rather a solvency crisis brought on by all the risky and fraudulent practices.

Not only did all “finance” disappear, but there was also no market for the trashy assets—so there was no way that banks could sell assets to cover “withdrawals” (again, these were not normal withdrawals by depositors but rather a demand by creditors to be paid). As markets turned against one institution after another, financial institution stock prices collapsed, margin calls were made, and credit ratings agencies downgraded securities and other assets. The big banks began to fail.

Government response to a failing, insolvent, bank is supposed to be much different than its response to a liquidity crisis. It has always been the standard view—dating all the way back to Bagehot—that lender of last resort does not apply to an insolvent institution. Indeed, since 1991 the Fed has been prohibited from lending to “critically undercapitalized” institutions without first obtaining explicit prior approval of the Secretary of the Treasury. And no matter what the Fed officials or the banksters claim, the big banks were “critically undercapitalized”, and the Fed did lend to insolvent banks—against the 1991 statute that was enacted precisely to prevent the Fed from avoiding the fiscal discipline of congressional appropriations. (Walker Todd 1997) I’ll have more to say about that in a later blog. But let’s turn to other problems with the bailout. continue reading…


Definitely Not a Keynesian Suggestion

Michael Stephens | February 16, 2012

The people at Bloomberg appear to have made a curious error on their website yesterday.  They have attributed an op-ed to Amity Shlaes that was almost certainly not written by her.  You see, Amity Shlaes is a well-known skeptic of Keynes and all things Keynesian, having written the bible for those who like to claim that the New Deal made the Great Depression worse.  (For a nice takedown of such claims, as well as Shlaes’ contributions in particular, see this Levy Institute policy brief.)

The Bloomberg op-ed in question contends that the Obama administration’s intention to withdraw militarily from Afghanistan and other places will devastate those countries’ economies.  This is because, according to the op-ed, establishing US military bases in foreign countries boosts economic growth there.

The real Amity Shlaes would have carefully instructed us that such public interventions not only cannot increase economic growth (even in the context of a downturn) but will actually decrease it (the New Deal, you see, is what made the regular ol’ Depression “Great”).

Now if this was written by Amity Shlaes, it is a peculiar way of announcing her conversion.  But let’s not quibble over ceremony.  If it is indeed Shlaes, let’s follow her lead.  In order to boost the growth rate in a time of economic malaise here at home, we should invite the US military to occupy the United States; we could even pay them a bonus to do it (Shlaes’ calculations suggest this might still be worth our while).

But if the military is too busy increasing other countries’ growth rates, I have another idea.  We could initiate an emergency recruitment drive for the US Army and station the new troops here in the United States, carrying out nation building in particularly distressed economic regions (there are, I believe, a few million people without jobs who would welcome the opportunity).  Of course we might need to build some new infrastructure bases to facilitate these operations here in the US, and may have to hire some additional support staff.

And if the threat of being shipped overseas and put in harm’s way is a barrier to recruitment, we could always create a new, strictly domestic branch of the military that recruits civilians to engage in nation building through repairing schools and providing social services.  We could call it, I don’t know, the Civilian Conservation Nation Building Corps, or something like that.  But none of that Keynesian nonsense please.


The New European Economic Dogma

Michael Stephens |

If it controlled its own currency, the usual thing for a country like Greece to do in these circumstances would be to devalue.  Since it doesn’t control its own currency, Greece is being “asked” to pull off an internal devaluation, or as C. J. Polychroniou puts it:

Essentially, what they agreed to are additional measures that are specifically designed to reduce the standard of living for the majority of the working population as a means of improving the nation’s competitiveness. Aside from firing civil servants, the new memoranda are all about major private sector wage cuts and an overhaul of labor rights.

This is from Polychroniou’s newest one-pager, “The New European Economic Dogma,” released yesterday.  Polychroniou takes on what he regards as the flawed ideology behind the policies that are being dumped on the Greek people; policies motivated by an ambiguous and, says Polychroniou, toxic conception of “competitiveness.”

Read the one-pager here.