Archive for June, 2012

Greenspan and Godley

Michael Stephens | June 26, 2012

Alan Greenspan is apparently writing a book to determine why economic models (all of them, he says) failed to sniff out the financial crisis and ensuing recession. “While the models themselves capture the nonfinancial part of the economy rather well,” says Greenspan, “they’ve been wholly inadequate in understanding how the complex financial system works, both in the United States and globally.”

As it happens, the Levy Institute’s Hyman P. Minsky Summer Seminar just finished up, and last week Gennaro Zezza presented on the stock-flow consistent model used here at the Institute.  The approach embedded in this model, originally inspired by Wynne Godley and still being refined and expanded, is notable for the manner in which it looks at the relationship between finance and the real economy.  For an explanation of its contours and to see how it differs from some of the more orthodox models Greenspan presumably has in mind, this paper by Zezza (“Fiscal Policy and the Economics of Financial Balances”) is a good place to start.  As the paper illustrates, the model has had a pretty good track record.

Godley and Marc Lavoie’s “Monetary Economics” (recently discussed by Lavoie in a twopart interview with Philip Pilkington) describes some of the early challenges with obtaining good data on the financial flows that are part of this approach (pp. 24-25).  But as Godley and Lavoie wrote, “[t]he problem now is not so much the lack of appropriate data … but rather the unwillingness of most mainstream macroeconomists to incorporate these financial flows and capital stocks into their models, obsessed as they are with the representative optimizing microeconomic agent.”


Next Up for the Broccoli Brigades: The Consumer Financial Protection Bureau

Michael Stephens | June 25, 2012

Brad Plumer reports that a Texas-based bank and a pair of conservative advocacy groups have filed suit against the Consumer Financial Protection Bureau, claiming that the agency is unconstitutional (the agency was created by the Dodd-Frank Act and was a longtime cause of senatorial candidate Elizabeth Warren, who had a hand in setting it up).

Normally, this is the sort of story that wouldn’t merit a pause.  But given the fact that we’re now patiently waiting for the Supreme Court to rule on the constitutionality of the Affordable Care Act (“Obamacare”), with many expecting that the Court will strike down some portion of the law—a scenario very few people took seriously when the law passed—anyone interested in financial regulatory reform should probably start paying attention to this lawsuit.  (Plumer has posted a copy of the suit, which also targets FSOC, the Financial Stability Oversight Council.)

Despite the numerous flaws in the regulatory approach taken by Dodd-Frank, many of which have been highlighted by Levy Institute scholars (see, for instance, here, here, and here), Randall Wray and Yeva Nersisyan argued (in a paper written when the law was being put together) that the idea of the CFPB was “the best part of the proposal put forward by Washington.”

According to a CFPB spokesperson cited by Plumer, “this lawsuit appears to dredge up old arguments that have already been discredited.”  Stand ready for those old arguments to be given new life.  And be on the lookout for some shiny new arguments, likely of the slippery slope variety; preferably involving a cruciferous vegetable.


So What Exactly Was Robinson’s “Cheap Money Policy”?

Greg Hannsgen | June 21, 2012

In my last post, I quoted Joan Robinson, the renowned Cambridge University economist, on the determinants of long-term interest rates. The mention of Robinson was made in the context of a comment on the Fed open market committee meeting earlier this week and Chairman Ben Bernanke’s press conference on Wednesday. For those who might be curious, here is the “cheap money” scenario from Robinson that I mentioned in the earlier post; astute readers will notice parallels in recent Fed history:

The first move in the campaign is for the Central Bank to dose the banks with cash, by open market purchases. The amount of advances the banks can make is limited by the demand from good borrowers. The demand is very inelastic (though it shifts violently up and down with the state of trade), so the banks, between whom competition is highly imperfect, see no advantage in cheapening their price. The redundant cash reserve must go into bills. Any rate of return is better than none. The banks with redundant cash find themselves in much the same position as a group of firms with surplus capacity and zero prime costs. If perfect competition prevailed, the bill rate would go to next to nothing and the banks could not cover their costs. They therefore fix up a gentlemen’s agreement which keeps the bill rate steady at a low level. The bill rate is maintained at this low level by the Central Banks giving another dose of cash whenever it threatens to rise.

If the Central Bank is operating in the old orthodox manner, its power ends here, and the authorities must rely on the dealers in credit to bring the long rates down. Nowadays the authorities reinforce the action of the banking system by going into the bond market directly. If necessary, they issue bills in order to buy bonds, the quantity of money being adjusted to whatever level is required to keep the bill rate at its bottom stop. The low interest rates may slow down the velocity of active circulation so that money, as the saying is, stagnates in pools. Long hoards are swollen by the fall in current rates and bear hoards by the fact that expected future rates are not yet revised.

As time goes by, experience of a long rate that is persistently somewhat lower than the expected rate lowers the expected rate and so lowers the actual rate further. The yield on shares falls in sympathy with the bond rate. Thus the whole complex of rates gradually falls through time. If the authorities take it gently and do now try to push the rate down too fast, and if they stick consistently to the policy, once begun, so that the market never has the experience of today’s rate being higher than yesterday’s, it is hard to discern any limit to the possible fall in interest rates (except the mere technical costs of dealing) so long as the full-employment interest rate is below the actual level of rates or is held below it by a budget surplus or other means.

Joan Robinson, in “The Rate of Interest” (1951) from The Generalization of the General Theory and Other Essays, published by St. Martin’s Press, New York, 1979, pages 163–64. (The date of the original article was stated as 1952 in my earlier post; that is the publication date of the first edition of the book, which appeared under the title The Rate of Interest and Other Essays. My apologies for any inconvenience caused by this error.)


A Continuation of the Fed’s “Cheap Money Policy”?

Greg Hannsgen | June 20, 2012

As I write, markets are wondering what Fed Chairman Ben Bernanke will say about interest rates in a press conference taking place this afternoon. Many economists, including some on the Federal Reserve’s rate-setting committee, are arguing that the Chairman is courting inflation with his policies of keeping interest rates low. He has been using three main approaches to this task:

(1) keeping short-term interest rates low through open market operations;

(2) buying and holding medium- and long-term bonds in a direct bid to keep longer-term rates low; and

(3) saying that it is likely to keep the federal funds rate near zero for an extended period of time.

Task (1) has been the usual approach of the Fed in modern times (since the early 1950s perhaps); task (2) has been important since the Fed’s response to the financial crisis beginning in 2008 or so. The current version of task (2) consists largely of a “twist” operation in which short-term securities are sold to pay for purchases of long-term securities. Task (3) is a commitment of sorts about short-term rates that helps to keep longer-term rates down. Tasks (2) and (3) are the most directly relevant to mortgage and auto loan rates, which are longer-term rates.

Economists, including critics of the Fed’s expansionary policies, sometimes refer to this three-pronged approach as a “cheap money policy,” but many who oppose “cheap money” have claimed that it would not be possible to maintain such a policy for very long (economic laws, or perhaps the bond markets’ worries about future inflation, would prevent this).

In a 1952 essay, Joan Robinson argued that a modern central bank could achieve a low long-term interest rate, but that it would take a long time to do so, in comparison to the quasi-real-time control the Fed enjoys over the federal funds rate. continue reading…


What Would a Grexit Look Like?

Michael Stephens | June 19, 2012

Slate‘s Matt Yglesias nicely captures the gap between the reactions of opinion-makers to the Greek election results and the reactions of markets (Sunday’s electoral results point to a coalition government centered around New Democracy and Pasok): “Markets were supposed to be reassured. Instead they’re freaking out. European stock markets are declining, and Spanish bond yields are back into the 7 percent danger zone. What went wrong?  Perhaps the better question to ask is how it ever got to be conventional wisdom that maintaining the Greek status quo was the reassuring option?”

A Greek exit from the eurozone is still very much a live possibility.  And given that the election results represent a continuation of the status quo, you might say a Grexit is even more likely.  If you believe the status quo is unsustainable, and that only something like a Greek New Deal would bring the growth necessary to pull Greece out of its depression, then there is little room for optimism.  So what would a Greek exit actually look like?  C. J. Polychroniou tackles this question in a new policy note.

Polychroniou argues that it was a mistake not to allow Greece to proceed with an orderly default two years ago.  While Greece is in for some economic pain whether it stays on the euro or returns to the drachma, it would, he argues, be better off in the latter scenario given a well-worked-out strategy for an orderly default (which is to say, better off compared to being continuously “rescued” with what are essentially bailouts of the EU’s banks attached to austerity directives, leaving Greece with the doubtful task of substantially reducing its debt-to-GDP ratio while shrinking its economy).  Polychroniou’s assessment of the relative costs of a Greek exit is based in part on his reading of the background political conditions:

The gloom-and-doom scenario involves a disorderly default on Greek government debt and assumes that Greece will be completely cut loose. This scenario essentially removes all political considerations from the picture and is highly unlikely to happen. It is a scenario much closer to a Hobbesian “state of nature,” when a Machiavellian outcome is far more probable. Indeed, a more likely scenario is that the Grexit will be orderly (the German Ministry of Finance and virtually all major banks,
including the ECB, have already made contingency plans), and that both the EU and the IMF will become involved in damage control.

Read it here.


What This Election Isn’t About

Michael Stephens | June 18, 2012

This received little attention, but President Obama recently sat down for an interview with Mark Halperin of Time magazine.  The interview didn’t generate anything you might call “newsworthy,” littered as it was with tired exchanges like this one:

Q: “Why not in the first year, if you’re [re-]elected — why not in 2013, go all the way and propose the kind of budget with spending restraints that you’d like to see after four years in office?  Why not do it more quickly?”

A: “Well because, if you take a trillion dollars for instance, out of the first year of the federal budget, that would shrink GDP over 5%.  That is by definition throwing us into recession or depression.  So I’m not going to do that, of course.”

No, of course not.  There isn’t anything surprising about this response, with the President mechanically delivering the Keynesian line.  But it does reinforce something about this election:  that it’s shaping up to be a battle between contrasting visions, Keynesian vs. Austerian, and a referendum on the President’s implementation of his preferred Keynesian approach.  That’s what will make this election so satisfying for anyone interested in economic policy and what makes it a rare occasion for the public to deliver their verdict on the last few years’ worth of Keynesian management, and to decide if they want to move in a different direction.

Except that’s all false.  That’s not what this election is about—not at all.

The exchange quoted above is actually taken from an interview of Republican presidential nominee Mitt Romney.  It’s Romney who is explaining in a matter-of-fact, offhand way that reducing the deficit in the short term would be disastrous for the economy.  It’s Romney embracing the Keynesian argument.

This election may be about optimal tax rates for the wealthy and the long-term size of government (or more accurately, the size of government programs serving the poor), but it is not, as Romney’s unguarded moment demonstrates, about competing visions of short-term macroeconomic management.  Instead, it’s a battle of pretend visions—of economic policy, of the way the political system works, and of fiscal reality. continue reading…


Some Views on the “Cliff”

Greg Hannsgen | June 15, 2012

On the topic of public policy, this Works Progress Administration (WPA) poster from the 1930s seems particularly relevant this year. You may have heard of the “fiscal cliff” that the federal budget will fall off in January, under existing law. It will be quite a fiscal contraction, if it happens as scheduled: about 4 percent of last year’s GDP, to use these numbers from the Congressional Budget Office (CBO). This total includes both tax increases and spending cuts, but not the offsetting effects of “automatic stabilizers,” such as lower income taxes for people whose incomes are adversely affected by the cliff itself. The CBO report projects that this set of changes would lead to a recession early next year. (Briefly, the changes that make up the cliff are (1) the expiration of the “Bush tax cuts,” the 2 percent payroll-tax holiday, and some other tax cuts; (2) the across-the-board spending cuts broadly agreed to by President Obama and Congress as part of last summer’s deal to raise the debt limit; (3) the end of new emergency extended unemployment benefits; (4) reduced Medicare doctor payment rates; and (5) tax increases included in the “Obamacare” health act passed by Congress in 2010.)

I chose the image at the top of this post out of many available free-of-charge at the Library of Congress’s WPA-poster archive mostly because of its cliff theme (this poster happens to depict a place in the state of New York, perhaps a few hours’ drive from the Institute). But we also hope the image will offer readers some hope—as the WPA did for unemployed artists and others during the 1930s. The White House and many in Congress are working on legislation that may lessen the severity of next year’s fiscal crunch. These important proposals will mostly aim to delay or cancel scheduled changes to spending programs and the tax code. To really tackle the unemployment problem, however, Washington ought to consider a large-scale public-employment program a bit like the WPA. As the website for our employment policy and labor markets research program points out, “Levy Institute scholars have proposed a full-employment, or job opportunity, program that would employ all who are willing to work and increase flexibility between economic sectors…”  You might want to take a look at some of the many publications at that website that deal with the potential design and impact of full-employment, direct job creation programs.


Austerity Wars: A New (False) Hope

Michael Stephens | June 14, 2012

The intensity of the debate over whether the Baltic economies (Estonia, Latvia, and Lithuania) should serve as models for the rest of the eurozone periphery has been raised a couple notches.  Last week, Paul Krugman noted that the Estonian recovery, while positive, has not been as remarkable as austerity supporters tend to imply.  This prompted a vigorous reaction from Estonia’s head of state (unless there’s someone impersonating Toomas Hendrik Ilves on Twitter).  But let’s bracket for the moment this question of how impressive the Baltic recoveries have been.  They are growing again, and that’s at least something.  Last week, Rainer Kattel and Ringa Raudla put out a policy note that focused on a different aspect of the problem:  whatever you think of the results, to what extent is the Baltic experience replicable?  If the rest of the eurozone periphery can’t reproduce the conditions that led to Baltic growth, then this isn’t a terribly useful model.

The argument is supposed to be that austerity and internal devaluation (that’s basically trying to get your real wages to fall in order to regain competitiveness) should be credited for the recoveries in the Baltics (incomplete though they may be).  As C. J. Polychroniou has been pointing out, the latest attempts at internal devaluation don’t appear to be working terribly well in the rest of the periphery.  But perhaps if Greece and the rest of the GIPSI countries were to suck it up, bite down hard, or whatever is the tough love phrase of the day, they might come out on the other end with a Baltic-type recovery.

The problem with this argument, as Rainer Kattel and Ringa Raudla point out, is that there was very little actual “adjustment” in Estonia, Latvia, and Lithuania.  The Baltic recoveries are largely attributable to economic factors that have little to do with austerity policies.  The recoveries were largely “outsourced,” as Kattel and Raudla put it.  First, the Baltic states have been relying on advanced use of EU structural support funding (as Kattel and Raudla note, a stunning 20 percent of Estonia’s budget is made up of EU funds), and second, Baltic exporters are deeply integrated with the Scandinavian and Polish economies, both of which weathered the crisis quite well. Finally, all of the Baltic economies have very flexible labor markets, accompanied by an usual amount of emigration—which is in part why (very high) unemployment rates have started to tick down.  This is simply not a model that could be replicated periphery-wide.

Moreover, Kattel and Raudla provide reasons to believe that the “outsourced” Baltic recoveries are unsustainable.  The whole thing is worth reading.  A One-Pager version is available here.


Help Is Not on the Way

Michael Stephens | June 11, 2012

An update on the distressing state of fiscal and monetary policy in the United States and Europe:

Chairman of the Federal Reserve to Congress:  “I’d be much more comfortable, in fact, if Congress would take some of this burden from us ….”

Congress to Bernanke:  No thanks.  And while we’re on the subject, we would be much more comfortable, in fact, if you’d just stop carrying the load entirely. Kindly leave the economy in the ditch right there.  Or as Binyamin Appelbaum put it in his NYTimes report:

Republicans on the committee pressed repeatedly for Mr. Bernanke to make a clear commitment that the Fed would take no further action to stimulate growth.  “I wish you would look the markets in the eye and say that the Fed has done too much,” Representative Kevin Brady of Texas told Mr. Bernanke.  Democrats, by contrast, inquired politely after the Fed’s plans and showed surprisingly little interest in urging the Fed to expand its efforts.

Perhaps the private sector can muddle through on its own?  Here’s a graph from the Levy Institute’s Strategic Analysis showing employment and unemployment rates going back to 2000:

To fill the gap in the employment rate represented by that orange area, according to the macro team “the nation needs to find jobs for about 6 percent of the working-age population, or roughly 15 million people. Since the working age population has been growing on average by 2.4 million people per year, or 205,000 each month, job creation that barely reaches a threshold of that number multiplied by the current employment-population ratio of about .59 will not narrow the gap.”  Last month the economy generated an estimated 69,000 new jobs.  You don’t need your calculator to figure out that won’t narrow the gap.

And how are things in Euroland?  continue reading…


Lessons of the JPMorgan Chase Affair: What Is All This Risk For?

Michael Stephens | June 8, 2012

After the news broke of his firm’s (now $3 billion) loss on a hedge gone awry, Jamie Dimon quipped: “just because we’re stupid doesn’t mean everybody else was.”  Stupidity, however, is beside the point.

Jan Kregel has pointed out how a lot of the discussion surrounding this episode is designed to give the impression that this was just a matter of personal folly and bad judgment.  Get rid of a few people, tweak a model, and everything should be fine.  But there’s far more to this story, says Kregel in a new policy note.  First, the fact that management appeared not to recognize what was going on in a unit that reported directly to them suggests that JPMorgan was too big to manage.  And if it’s too big to manage, it’s too big for regulators to supervise effectively.

But simply making banks smaller won’t solve the problem either, according to Kregel—not if they’re allowed to engage in the same kinds of trades on the same kinds of assets.  Here he captures the “heads they win, tails we lose” dynamic of the post-Gramm-Leach-Bliley banking world:

[S]ince the passage of the Gramm-Leach-Bliley Act in 1999, the major activity of banks is to profit from changes in the prices of the assets held in its trading portfolio—and for JPMorgan Chase, in its hedging of its global portfolio. This activity generates little new investment and virtually no employment. If the bank guesses right, it makes capital gains for its shareholders; if it guesses wrong, and other banks have made the same guesses, the government and the general public are called upon to bear the losses. The problem is not simply that the banks are too large; it is that they generate shareholder returns by betting on changes in asset prices in their portfolios rather than by betting on investments in real productive activities that create income and employment for the economy as a whole.

The last line here is fundamental.  Dodd-Frank approaches the regulatory challenge by trying to make banks’ trading activities less risky.  But risk alone is not the issue for Kregel. The problem isn’t simply speculation or riskiness per se, but that “they are engaging,” he says, “in the wrong kinds of investments and the wrong kinds of risks.”  What Dodd-Frank fails to do is to reorient the banking system from speculating on price changes in exotic assets toward speculating on the real economy: on the ability of entrepreneurs to identify and pursue business opportunities that generate employment and real output.

Read it here.