Archive for November, 2012

New Records for Fiscal and Regulatory Irresponsibility

Michael Stephens | November 21, 2012

From 2009 to 2012, the US federal deficit shrank from 10.1% of GDP to 7% of GDP.  That’s the fastest deficit reduction we’ve seen in six decades—and all before the fiscal cliff has kicked in.  Here’s the chart from Jed Graham:

Put this alongside a record-setting contraction of government employment and a 7.9 percent unemployment rate, and what you have is a portrait of fiscal irresponsibility.  A lot of this deficit reduction has to do with the fact that the economy is now growing (albeit feebly), instead of contracting, but looking at this chart should also reinforce how dangerous and unnecessary it is that we’ve decided to create an austerity crisis at this moment.  (This “austerity crisis,” by the way, should really be understood to include both the possibility of going over, and staying over, the fiscal cliff AND the possibility of the cliff being replaced by a “grand bargain” on deficit reduction.)  The last time the deficit was reduced at a faster rate was in 1937, when the government embraced a hard pivot to austerity and the economy tumbled back into recession.

But don’t worry, we aren’t reliving the history of the 1930s.  Not exactly.  We are combining fiscal irresponsibility with regulatory negligence.  The Financial Stability Board (FSB) reported on Sunday that the shadow banking sector, after contracting in 2008, has rebounded nicely and is doing just fine.  Although it hasn’t quite seen the growth it did prior to the crisis, when it doubled in size from 2002 to 2007 (from $26 trillion to $62 trillion), the shadow banking sector reached $67 trillion globally in 2011—a new record, and “equivalent,” says the FSB, “to 111% of the aggregated GDP of all jurisdictions.”


Incorrect Economic Historian Is Incorrect

Thomas Masterson | November 20, 2012

Amity Shlaes, whose main claim to fame is an allegedly new history of the Great Depression, thinks we may be in trouble as a result of the election. Looking beyond her alarmingly alliterative title (“2013 Looks to be a Lot Like 1937 in Four Fearsome Ways!”  Oooh! Scary!) she has some valid points. Of course she is talking about the stock market not the real economy, which produces the jobs and the economic benefits most people rely on for a living. And, unfortunately, she doesn’t realize where she is right.

But first, what are the four fearsome factors that will drive us to doom? First, a federal spending spree before the election. Shlaes uses “the old 19% rule” as a benchmark to argue that because federal government spending in 2012 “when the crisis was long past” was 24.3% of GDP, clearly the Obama administration was spending up a storm. To argue that the crisis is long past, one must be willing to ignore the employment crisis that still hasn’t left us, but let’s give her this one. Whether this is a problem given current economic conditions is another story. If it’s the debt implications you’re worried about, it is worth noting that revenues as a percentage of GDP are also quite low historically speaking, just over 15% for the last few years (see CBO’s historical budget data).

Shlaes’ second fear factor is a bath of cold water afterwards. Roosevelt restored budget balance in 1937 and since that very topic (and who David Petraeus was or was not sleeping with) is all people are talking about in Washington these days it seems likely we’ll get spending cuts and tax increases in the next budget. The “depression within the Depression” was the result of exactly this fiscal restraint. This is where Shlaes is quite right, though she doesn’t actually come out and say this: whether the President and Congress jump off the fiscal cliff together, which would reduce spending across the board, or avoid it by cutting spending on everything but defense instead, we are in for poor economic performance indeed.

Shlaes’ third scary thing is the fearsome attack on the status quo. In 1937, this meant raising the top marginal rate from 56% (where it had been raised by Hoover in 1932 from 25%) to 62% (this actually passed in 1936) and the undistributed profits tax. This, and Roosevelt’s attempts to pack the Supreme Court meant that (stock) markets “shivered.” Note that this year, Obama is talking about raising the top rate to, um, 39.6%, which is where it was before the Bush tax cuts. Remember how much markets were “shivering” in the 1990s? Me neither.

continue reading…


Fiscal Muddle

Michael Stephens | November 16, 2012

The fiscal cliff is very easy to explain.  What many in Congress and the press are saying we should do about it is more confounding.

If you were the sort of person who took expressions of policy preferences at face value, you would think that fiscal conservatives and deficit hawks would be ecstatic about this thing we’re calling the “fiscal cliff”—because contrary to our increasingly muddled popular dialogue, the fiscal event about which everyone is raising alarms is just a large and rapid reduction of the budget deficit (about $600 billion of spending cuts and tax increases scheduled for 2013).  Given the widespread deficit hysteria we’ve witnessed over the last few years, it is likely confusing to a lot of unsuspecting observers that so many in Washington and the mainstream press are dead set against this particular piece of deficit reduction.

The American public has been ill-prepared for this consensus.  We’ve been told, ad nauseum, that fiscal “stimulus” didn’t and doesn’t work.  But the case for fiscal stimulus is simply the flip side of a case against austerity that few seem to realize (or are willing to recognize) that they are making. continue reading…


In the Eurozone, Look to the Design Defects

Michael Stephens | November 15, 2012

Today Eurostat announced that the eurozone has plunged back into recession.  If you’re looking for a good explanation of the eurozone’s problems, you will only get so far by looking at the policy failures of particular countries.  The most fundamental problems—those that won’t go away with a mere shift in policy at the national level—are rooted in the very setup of the euro system.

In October, the Columbia Law School-sponsored series “Modern Money and Public Purpose” held a seminar that featured Yanis Varoufakis and Marshall Auerback on the design defects of the eurozone.  Varoufakis began his presentation with these lines:  “Greece is not important enough to be occupying the headlines around the world for three years.  Imagine a situation where a crisis in the state of Delaware was threatening to bring the United States of America down.  If that happened, then the problem would not be with Delaware, it would have been with the United States of America.” (video below)


Quantitative Easing and Bank Lending

Michael Stephens | November 13, 2012

Randall Wray on quantitative easing and the accumulation of reserves:

When the Fed buys assets, it purchases them by crediting banks with reserves. So the result of QE is that the Fed’s balance sheet grows rapidly—to, literally, trillions of dollars. At the same time, banks exchange the assets they are selling (the Treasuries and MBSs that the Fed is buying) for credits to their reserves held at the Fed. Normally, banks try to minimize reserve holdings—to what they need to cover payments clearing (banks clear accounts with one another using reserves) as well as Fed-imposed required reserve ratios. With QE, the banks have ended up with humongous quantities of excess reserves.

As we said, normally banks would not hold excess reserves voluntarily—reserves used to earn zero, so banks would try to lend them out in the fed funds market (to other banks). But in the ZIRP environment, they can’t get any return on lending reserves. Further, the Fed switched policy in the aftermath of the crisis so that it now pays a small, positive return on reserves. So the banks are holding the excess reserves and the Fed credits them with a bit of interest. They aren’t thrilled with that but there’s nothing they can do: the Fed offers them a price they cannot refuse on the Treasuries and MBSs it wants to buy, and they get stuck with the reserves.

A lot of people—including policy makers—exhort the banks to “lend out the reserves” on the notion that this would “get the economy going.” There are two problems with that. First, banks can lend reserves only to other banks—and all the other banks have exactly the same problem: too many reserves. A bank cannot lend reserves to your household or firm. You do not have an account at the Fed, so there is no operational maneuver that would allow you to borrow the reserves (when a bank lends reserves to another bank, the Fed debits the lending bank’s reserves and credits the borrowing bank’s reserves). Unless you are a bank, you cannot borrow them.

The second problem is that banks don’t need reserves in order to lend. What they need is good, willing, and credit-worthy borrowers. That is what is sadly lacking. Those who are credit-worthy are not willing; those who are willing are mostly not credit-worthy.

And we should be glad that banks are not currently lending to the [non-credit-worthy]. Here’s why: that’s what got us into this mess in the first place.

Read the rest here.


Kick the Can, Please

Michael Stephens | November 9, 2012

As Dimitri Papadimitriou recently observed, the overwhelming push for austerity in the United States is partly driven by the sense that deficit reduction simply cannot wait:

Many in Washington and the media are convinced that the recovery is well underway, and if spending cuts and tax increases are delayed for even a year it will be too late to tame inflation and tighten fiscal policy on a soaring economy. The urgency rests on unfounded optimism. We still have a very long way to go before the economy is anywhere near healthy enough to heat up. The GDP is now, and has long been, far below trend.

Here’s how Papadimitriou and Greg Hannsgen illustrate the point in a recent policy brief:

It is rather odd to be concerned about deficit reduction coming “too late” (i.e. that the black line will rise above the pink line), given how far we are from the historical growth trend.  As Papadimitriou and Hannsgen put it:  “Based on the present state of the economy, any notion that implementing better policy would be mostly a matter of precise timing is patently absurd.  The gap between recent real GDP growth and the historical trend is so large that the danger of overshooting the trend is hard to imagine.”*

Many proposals in this budget battle, including some coming from alleged “deficit doves,” call for replacing the fiscal cliff (over $500 billion in deficit reduction in 2013 alone) with what is essentially a different austerity package spread out over a longer time frame (the consensus target seems to be about $4 trillion of deficit reduction over ten years), otherwise referred to as a “grand bargain” in the media.  But notice that even if we continue on our current austerity-lite path (that is to say, without the fiscal cliff and without a grand bargain), and we continue to add jobs at roughly the same rate we’ve been adding them lately, we likely won’t be back to full employment for ten years. continue reading…


Financial Instability Conference, Berlin

Michael Stephens | November 8, 2012

An upcoming Levy Institute conference:

From November 26 to 27, the Levy Economics Institute of Bard College will gather top policymakers, economists, and analysts at the Hyman P. Minsky Conference on Financial Instability to gain a better understanding of the causes of financial instability and its implications for the global economy. The conference will address the challenge to global growth affected by the eurozone debt crisis; the impact of the credit crunch on economic and financial markets; the larger implications of government deficits and the debt crisis for U.S., European, and Asian economic policy; and central bank independence and financial reform.  Organized by the Levy Economics Institute and ECLA of Bard with support from the Ford Foundation, The German Marshall Fund of the United States, and Deutsche Bank AG, the conference will take place Monday and Tuesday, November 26 to 27, in Frederick Hall, 4th fl., Deutsche Bank AG, Unter den Linden 13–15, Berlin.

A full schedule and list of participants can be found here.


Why You Should Be Worried About the Size of the Public Sector

Michael Stephens | November 7, 2012

Last month, numbers from the Bureau of Labor Statistics suggested that the years-long decline in public employment had finally halted, but Friday’s BLS report revealed that we moved back into negative territory in October:  the public sector as a whole (federal, state, and local) shrank by 13,000 jobs.  This should serve as another reminder that a significant part of this jobs crisis is self-inflicted.  There is a lot of policy work that needs to be done to help bring the economy back to full employment, but one of the baby steps the government can take in dealing with the crisis is this:  stop firing so many people.

Here’s Floyd Norris back in August, writing about a fact that has received far too little attention in our civic dialogue:

Employment in state and local government peaked at a seasonally adjusted 19.8 million workers in August 2008. Since then, the total is down by 697,000, or 3.5 percent. Since World War II, the only comparable decline was in 1950 and 1951, when payrolls fell by 3.7 percent.

The recession left state and local governments, where most government jobs are located, in a very real budget bind, leading to a rate of layoffs unprecedented in over half a century.  While the federal government also saw its revenues drop precipitously when the recession hit, unlike states and municipalities, it is currently under no economic constraint to balance its budget. The Recovery Act (ARRA) provided some aid to states and municipalities to help cover their budget shortfalls, but it was clearly insufficient, and now that the American Jobs Act (which featured further aid to states) has disappeared from the public radar there is little reason to believe that more help is on the horizon.  In fact, despite all the fiscal space the federal government has at its disposal, a large(r) dose of federal austerity is scheduled for 2013 that will do even more damage to public payrolls (here’s one estimate of the damage from the Congressional Research Service).

To put public job creation or preservation back on the policy radar, to begin forming a public consensus around rebuilding the public sector workforce (or just halting its demolition), there has to be some widespread acceptance of the fact that government has, in this particular sense, shrunk—and shrunk significantly—over the last four years.  From a purely rhetorical standpoint, the case for direct job creation, or aid to states for direct job preservation, should be a relatively straightforward argument to present to the public (compared to, say, something like quantitative easing).  But the task is made much more difficult if we’re making the arguments in a context in which everyone knows that government has become bloated during President Obama’s time in office. continue reading…


Fiscal Policy Debates and Macro Models Abound in the News

Greg Hannsgen | November 1, 2012

Many of the themes in fiscal policy, economic growth, and distribution that we have been working on here have been in the news lately. Scholars from many fields are weighing in. One common theme is dynamics and their importance:

1)      Evidence of a self-reinforcing fiscal trap in operation in Britain, forwarded by the NIESR, a British think tank:  Dawn Holland and Jonathan Portes argue today in Vox that in the UK austerity has led to higher debt-to-GDP ratios, defying the predictions of orthodox macro models. For something from our Institute on the topic of fiscal traps, including the UK example, you might take a look at this public policy brief from Dimitri Papadimtriou and me, posted just last week.

It is important to keep in mind, as the authors of the British study point out, that fiscal austerity is hardly the only cause of the economic crises now underway in much of the world. For example, they get at the problem of coordinating macro policies in a group of open economies. Above this paragraph is a diagram from our brief, illustrating, among other things, the role of Minskyan financial fragility in generating crises in many places in the world. This role is shown by the light green arrows in the diagram, which show how rising numbers of “Ponzi units,” (firms and households that need to borrow in order to make their interest payments) can play a role in a fiscal trap. Spending cuts or tax increases are sometimes “self-defeating” in this view because they undermine the tax base—the amount of activity subject to taxation. The mechanism involved is a Keynesian multiplier effect. Internationally, there are many examples of this problem these days.

2)      More on models of economic growth and income distribution and their relationship to models from applied mathematics in letters to the editor of the Financial Times (here and here) and in a blog post from a mathematician: The FT letters discuss, among other things, the perhaps debatable role of unemployment in keeping real wages from rising. On the other hand, the blog post discusses various kinds of discontinuous dynamic behavior that fall under the rubric of catastrophe theory, mentioning a classic business-cycle model by Nicholas Kaldor and various sorts of straws that break camels’ backs. Author Steven Strogatz notes that “in some…cases (boiling water, optical patterns), the picture from catastrophe theory agrees rigorously with observation. But when applied to economics, sleep, ecology, or sociology, its more like the camel story—a stylized scenario that shouldn’t be taken for more than it is: a speculation, a hint of something deeper, a glimpse into the darkness.”

All of these ideas play a role in numerous macroeconomic models, including the one that I discussed in this post, which features CDF interactive graphics. New macro team hire Michalis Nikiforos has been working on many of these issues, too.