Archive for May, 2013

New Frontiers in Financial Wrongdoing and Instability

Michael Stephens | May 30, 2013

Benjamin Lawsky is the very first Superintendent of the New York Department of Financial Services (DFS), a regulatory body created in 2011 through the merger of the New York State Banking and Insurance Departments.  Lawsky spoke recently at the Levy Institute’s annual Minsky conference and he began with an appropriately Minskyan tune:

There is a constant danger that putting a thumb in the dyke in one part of the financial system will cause a leak to spring somewhere else. It’s a danger that well-intentioned reforms could push risk to ever-darker corners of the financial system, to financial products not yet envisioned by even the most farsighted regulators. … This is not to say, as some have suggested, that the art of financial regulation is a futile endeavor. … It just means that we should approach the constantly evolving landscape of the financial sector with, in my opinion, a deep sense of humility about the capacity of any one set of reforms or safeguards to permanently preserve the stability of our kinetic, frenetic, global financial system.

Hyman Minsky had definite views about how the financial structure should (and should not) be altered so as to create a more stable and prosperous capitalism, but he also emphasized that the work of financial regulation is never done.  It is part of the nature, part of the bargain, as it were, of finance-driven capitalism that new practices and sources of instability are constantly emerging.

In his speech, Lawsky described some concerning new developments in the financial sector, including a below-the-radar practice that garnered the attention of the DFS (ultimately resulting in a series of settlements, one of which was announced about an hour before Lawsky’s speech). continue reading…


The Role of the Fed in the Sustainability of the Long-term Budget

Michael Stephens | May 29, 2013

As noted, the Congressional Budget Office says that the federal deficit will shrink to 2.1 percent of GDP in two years and then start to grow again after 2015.  The most important factor contributing to the widening budget deficit over the next 10 years, according to the CBO, is not Social Security, or even Medicare, but a predicted rise in interest payments on the debt, as you can see here:

CBO_Projected Spending_May 2013

The net interest projection is based on assumptions about what policy decisions the Federal Reserve will make in the future; in this case, the Fed is assumed to raise interest rates substantially.  The deficit tops out at 3.5 percent of GDP in 2023 in the latest CBO forecast (which is just above the 40-year average of 3.1 percent of GDP), but it continues to climb outside of the 10-year window, and this is what has many people concerned.

Although much of the discussion of the long-term budget has been focused on “entitlements” and healthcare costs in particular, rising interest payments also play a key role in the CBO’s long-term forecast.  In fact, James Galbraith has argued that they play the key role in terms of arguments about the “sustainability” of the debt:

The CBO’s assumption, which is that the United States must offer a real interest rate on the public debt higher than the real growth rate, by itself creates an unsustainability that is not otherwise there. … Changing that one assumption completely alters the long-term dynamic of the public debt. By the terms of the CBO’s own model, a low interest rate erases the notion that the US debt-to-GDP ratio is on an “unsustainable path.” The prudent policy conclusion is: keep the projected interest rate down. Otherwise, stay cool.

continue reading…


This Time Is Indifferent

Michael Stephens | May 24, 2013

Whether it’s the terrible growth numbers in the eurozone (Eurostat), the revelation of spreadsheet errors in everyone’s favorite debt disaster study (for some of the non-spreadsheet-based problems with the Reinhart-Rogoff approach, see this 2010 working paper), or the fact that the US federal deficit is on track to shrink to a measly 2.1 percent of GDP in two years (CBO report here), the past couple months have offered up some embarrassing and inconvenient news for those who continue to push for austerity.

Nonetheless, we’re unlikely to see any of this dramatically alter the budget debate, and the key to understanding why is to appreciate that there is a significant constituency among austerity supporters for whom most of this data is irrelevant.  It’s not just that this information isn’t likely to persuade them, but that for a certain species of austerian, it couldn’t possibly.  After four years of fiscal fear-mongering, it has become clear that for some ostensible austerity supporters, it was never really about the deficit.

With last week’s updates, the CBO now predicts that the budget deficit will fall to 2.1 percent of GDP by 2015.  If that number means nothing to you, consider that the original Bowles-Simpson plan — the standard by which budget seriousness is measured in the press — called for a 2015 deficit of … 2.3 percent of GDP.  Pikers.

Yet, revealingly, there are some deficit hawks who are treating the rapid shrinking of the deficit as bad news — and not for the Keynesian reason that this indicates the government is failing to do its part in supporting the economy, as Bernanke stressed in his remarks yesterday, but because the disappearing deficit is easing congressional pressure to pass “entitlement reform” (which, as we’ll see below, does belong in scare quotes).

And lest you think this is all about concern for the long-term deficit, note that one of the reasons projections of future deficits have been falling is due to a slowdown in the growth of healthcare costs.  If this slower rate of cost growth maintains itself for any significant period of time, the story we’ve been hearing with regard to the long-term budget changes dramatically.  Here, according to the CEA‘s Economic Report of the President, is what Medicare spending will look like over the long term if the more recent trend in healthcare costs sticks: continue reading…


Working Paper Roundup

Michael Stephens | May 23, 2013

The Economic Crisis of 2008 and the Added Worker Effect in Transition Countries
Tamar Khitarishvili

Modeling the Housing Market in OECD Countries
Philip Arestis and Ana Rosa González

The Problem of Excess Reserves, Then and Now
Walker F. Todd

On the Franco-German Euro Contradiction and Ultimate Euro Battleground
Jörg Bibow

Currency Concerns under Uncertainty
Sunanda Sen

Indirect Domestic Value Added in Mexico’s Manufacturing Exports, by Origin and Destination Sector
Gerardo Fujii-Gambero and Rosario Cervantes-Martínez

Wages, Exchange Rates, and the Great Inflation Moderation
Nathan Perry and Nathaniel Cline

How the Fed Reanimated Wall Street
Nicola Matthews

Expanding Social Protection in Developing Countries
Rania Antonopoulos


Safety Nets vs Economic Empowerment

Michael Stephens | May 21, 2013

There are important changes in how many developing countries are approaching the problem of poverty. Specifically in the area of “social protection” policy — policies intended to prevent or alleviate income insecurity and poverty — these changes are reflected in attempts to move beyond one-off interventions and “safety nets” to policies designed to address some of the underlying problems causing economic vulnerability in the first place.

In a new policy brief, developed with support from the United Nations Development Programme, Rania Antonopoulos considers how women’s economic empowerment can be advanced in the context of this evolution in social protection policy.  She zeroes in on the ways in which social protection policies, while addressing income gaps, also shape women’s opportunities through the manner in which these programs “see” or “position” women (whether intentionally or not).  To explain how this “positioning” works, she points to three different policies for addressing food insecurity (all targeted at women): cash transfers, free delivery of food staples, and access to land plus subsidized seed and fertilizer.  While all these interventions are aimed at reducing food insecurity, Antonopoulos observes that “there are stark differences between them in terms of the process through which deprivation is addressed, and from a gender perspective, differences in the (implicitly) assigned positioning of the beneficiary”:

The first addresses income poverty by enabling women to participate in the economy as consumers, which they otherwise cannot do on their own. The second, in the case of free rationed food, allocates food directly to those deserving of support because of their destitute status and inability to cope. The third approach addresses the income gap through means that enable the beneficiary to engage in the economy as a producer.While all three reduce an identified deprivation, the last one acknowledges it as an outcome of social relations of exclusion in production (i.e., women farmers do not have access to necessary agricultural inputs and support systems) that often underpin people’s experiences of chronic poverty and vulnerability.

While Antonopoulos stresses that there is no one-size-fits-all approach that follows from these observations, these “positioning” dynamics should inform program design:  social protection instruments can reinforce gender inequalities, or leave them untouched, but they also offer the potential to help promote women’s roles as active participants in economic life. continue reading…


Hyman Minsky and the Employer of Last Resort

L. Randall Wray | May 17, 2013

A couple of weeks ago, I mentioned Hyman Minsky’s new book, Ending Poverty: Jobs, Not Welfare (there is also a Kindle version).  Take a look at the cover – Minsky looking like a bit of a rougue!

I thought you might enjoy my powerpoint presentation, given at the Levy-Ford annual Minsky conference in NYC in mid-April. It summarizes some of the main arguments of the book. However, you really need the book – it is brilliant, and a good antidote to all the silly arguments made by economists that we “need” to keep tens of millions of Americans unemployed.

As Keynes put it:

“The Conservative belief that there is some law of nature which prevents men from being employed, that it is ‘rash’ to employ men, and that it is financially ‘sound’ to maintain a tenth of the population in idleness is crazily improbable – the sort of thing which no man could believe who had not had his head fuddled with nonsense for years and years….” (J. M. Keynes)

Here’s the powerpoint.


Measuring Success in the Eurozone

Michael Stephens | May 16, 2013

The formation of the eurozone represents “the wildest experiment in financial history,” according to C. J. Polychroniou:

the eurozone was to involve the inclusion of independent states, with highly diverse economic systems and cultural settings, that were required to give up national currency sovereignty in exchange for a “foreign” currency without the backing of a treasury or a central bank ready to act as lender of last resort in the event of a financial crisis.

And with the eurozone mired in recession (the latest numbers from Eurostat are here) and a deep depression in Greece, it might look like a failed experiment.  But it only looks this way, Polychroniou suggests, if you think of economic growth and the wellbeing of the average worker as among the primary goals of the project.  The setup of the EMU is not the result of some set of technical errors or oversights.  It is consistent with a long-developing attempt, culminating in the Maastricht Treaty, at transforming a social market economy into a laissez-faire market economy:  “it stemmed,” Polychroniou writes, “from the very premises of the fundamentally neoliberal economic thinking that had begun to take hold of the mindset of European policymakers in the 1980s.”  If anything, he argues, the struggles in the eurozone, particularly on the periphery, are being seized on as an opportunity to accelerate this transformation, with Germany playing the role of “neocolonialist” in the process:

Germany has adopted toward the indebted eurozone member-states the same policy it carried out with regard to East Germany after unification: the destruction of its industrial base and the conversion of the former communist nation into a satellite of Berlin. The bank rescues masquerade as the rescue of nations, and are followed by the enforcement of unbearable austerity measures to ensure repayment of the “rescue” loans. Then comes the implementation of strategic economic policies aimed at reducing the standard of living for the working population and the shrinking of the welfare state, complete labor flexibility, and the sale of public assets, including state-controlled energy companies and ports. This constitutes the German strategy for pillaging the debt-laden economies of the Mediterranean region.

Read it here.


A Budget Surplus by 2015?

Michael Stephens | May 15, 2013

That’s the implication of a James Pethokoukis post linked to here by Reihan Salam.  Let’s assume for the sake argument that a federal budget surplus does emerge in 2015 (yesterday’s CBO report projected the 2015 deficit would be a mere 2.1% of GDP).  Salam expresses concern that such a scenario would leave Republicans, who have been banging the austerity drum since inauguration day 2009, in a political and policy bind.  It would allow Democrats to declare “mission accomplished,” as Salam puts it, leaving Republicans with no agenda.

One problem with this analysis is that it assumes the voting public would even recognize/concede the existence of a budget surplus.  If you’ve been paying any attention to US public affairs, you’ll have observed that the realm of empirical fact is a fiercely contested battlefield (see warming, global).  And on budget matters, as Dimitri Papadimitriou has pointed out, the battlefield is tilted in one direction:  “The deficit has arguably gained the distinction of being the single most widely misunderstood public policy issue in America. Just 6% (6!) of respondents in a recent poll correctly stated that it had been shrinking, which has in fact been the case for several years, while 10 times more, 62%, wrongly believed that it’s been getting bigger.”

Now, it ought to be mentioned that no one should get any credit for a budget surplus in 2015 (or for a deficit as low as 2.1% of GDP, as the CBO predicts).  Under current economic conditions, this would represent the continuation of an inexcusable fiscal policy error — and the reason it would be an error points to another problem with Salam and Pethokoukis’s political concerns. continue reading…


Deposit Insurance and Moral Hazard: Lessons from the Cyprus Crisis

Michael Stephens |

In a new policy note, Jan Kregel draws out some of the policy lessons of the Cypriot deposit tax episode for plans to create a system of EU-wide deposit insurance.  In addition to the necessity of a strong central bank (the ECB in this case) standing behind the deposit insurance scheme (which does not appear to be part of the current plans), Jan Kregel explains why a certain amount of moral hazard is inescapable.

We can see this by looking at two types of deposits that correspond to the dual functions of banks:  deposits of currency and coin, and deposits created when loans are made.  If a bank makes bad loans — and as Kregel points out, “it is the failure of the holder of the second type of deposit [loan-created deposits] to redeem its liability that is the major cause of bank failure” — the first type of depositor (of currency and coin) should not bear the brunt of these bad decisions.  The role of deposit insurance, one might argue, is to provide such protection.

But since deposit insurance has to be extended to all of a banks’ deposits (up to a certain level), including those created by loans, moral hazard is inevitable.  Ideally, deposit insurance would be structured in such a way as to distinguish between deposits based on currency and coin and deposits generated through loans, as well as between deposits created by good and bad loans (loans that default).  But if you examine how the banking system functions, says Kregel, this isn’t operationally possible:

Unfortunately, it is impossible in practice to make these distinctions between reserve deposits, defaulted-loan-created deposits, and deposits created by loans that are current. It is for this reason that there are limits on the size of insured deposits based on the presumption that the first type of deposits will be relatively small household deposits created by the transfer of reserves and used as means of payment or store of value. It thus limits coverage of the other types of deposits. However, this is clearly inequitable for the deposits held by borrowers who are still current on their loans.

As he explains, with some help from Minsky, it is the means of payment function that makes these distinctions practically impossible (for more on why this is, read the note here).  Kregel concludes that “It would thus seem impossible to design a truly fair deposit insurance scheme that eliminates the inherent moral hazard and the necessity of a contingent guarantee of the central bank.”


Kocherlakota on Low Interest Rates and Instability

Michael Stephens | May 7, 2013

Narayana Kocherlakota is the head of the Federal Reserve Bank of Minneapolis and is known for an uncommon feat in high-level policy circles:  he changed his mind.  Originally a monetary policy hawk, Kocherlakota has become a supporter of looser Fed policy.  He spoke recently at the Levy Institute’s Minsky conference in New York, and some reports of the speech–at least as rendered by headline writers–may create the impression that Kocherlakota has been reconsidering his conversion.

“Kocherlakota Says Low Fed Rates Create Financial Instability,” one publication announced.  In fact, what Kocherlakota said (see the full speech below) was far more nuanced (and to be fair, most of the media reports grasped the key points.  I’m told it’s fairly common for reporters not to write their own headlines).  He argued that low-rate policy can create phenomena that are commonly taken to be signs of financial instability:  “unusually low real interest rates should be expected to be linked with inflated asset prices, high asset return volatility and heightened merger activity. All of these financial market outcomes are often interpreted as signifying financial market instability.”

If low interest rates created financial crises of the sort that tanked the global economy in 2007/2008, this would be a pretty good argument for siding with the hawks.  But Kocherlakota’s actual, stated views are perfectly consistent with a zero-interest-rate policy creating only signs of instability.  The cost-benefit analysis facing the central banker therefore looks more like this, according to Kocherlakota (his emphasis):  “On the one hand, raising the real interest rate will definitely lead to lower employment and prices. On the other hand, raising the real interest rate may reduce the risk of a financial crisis—a crisis which could give rise to a much larger fall in employment and prices. Thus, the Committee has to weigh the certainty of a costly deviation from its dual mandate objectives against the benefit of reducing the probability of an even larger deviation from those objectives.”