Tag Archives: macroeconomics

Good Times for Capital

By James Kwak

Last week, the Wall Street Journal highlighted a Federal Reserve report on total household net worth. Surprise! Americans are richer than ever before, both in nominal and real terms.

At the same time, though, wealth inequality is increasing from its already Gilded Era levels. The main factor behind increasing household net worth over the past year was the rising stock market (followed far behind by rising housing prices). These obviously only help you if you own stocks—not if, say, you never had enough money to buy stocks, or you had to cash out your 401(k) in 2009 because you were laid off. Put another way, rising asset values help you if you are a supplier of capital more than a supplier of labor.

Is there anything we can do about this? The conventional wisdom from the political center all the way out to the right fringe is that we shouldn’t tinker too much with the wealth distribution—otherwise people won’t work as hard, which is bad for everyone. But perhaps it isn’t true.

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Fatal Sensitivity

By James Kwak

One more post on Reinhart-Rogoff, following one on Excel and one on interpretation of results.

While the spreadsheet problems in Reinhart and Rogoff’s analysis are the most most obvious mistake, they are not as economically significant as the two other issues identified by Herndon, Ash, and Pollin: country weighting (weighting average GDP for each country equally, rather than weighting country-year observations equally) and data exclusion (the exclusion of certain years of data for Australia, Canada, and New Zealand). According to Table 3 in Herndon et al., those two factors alone reduced average GDP in the high-debt category from 2.2% (as Herndon et al. measure it) to 0.3%.*

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Are Reinhart and Rogoff Right Anyway?

By James Kwak

One more thought: In their response, Reinhart and Rogoff make much of the fact that Herndon et al. end up with apparently similar results, at least to the medians reported in the original paper:

Screen shot 2013-04-18 at 4.20.55 PM

So the relationship between debt and GDP growth seems to be somewhat downward-sloping. But look at this, from Herndon et al.:

Screen shot 2013-04-18 at 4.18.02 PM

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More Bad Excel

By James Kwak

In 1975, Isaac Ehrlich published an empirical study purporting to show that the death penalty saved lives, since each execution deterred eight murders. The next year, Solicitor General Robert Bork cited this study to the Supreme Court, which upheld the new versions of the death penalty that several states had written following the Court’s 1973 decision nullifying all existing death penalty statutes. Ehrlich’s results, it turned out, depended entirely on  a seven-year period in the 1960s. More recently, a number of studies have attempted to show that the death penalty deters murder, leading such notables as Cass Sunstein and Richard Posner to argue for the maintenance of the death penalty.

In 2006, John Donohue and Justin Wolfers wrote a paper essentially demolishing the empirical studies that claimed to justify the death penalty on deterrence grounds. Donohue and Wolfers attempted to replicate the results of those studies and found that they were all fatally infected by some combination of incorrect controls, poorly specified variables, fragile specifications (i.e., if you change the model in minor ways that should make little difference, the results disappear), and dubious instrumental variables. In the end, they found little evidence either that the death penalty reduces or increases murders.

Now the macroeconomic world has its version of the death penalty debate, in the famous paper by Carmen Reinhart and Ken Rogoff, “Growth in a Time of Debt.” Thomas Herndon, Michael Ash, and Robert Pollin released a paper earlier this week in which they tried to replicate Reinhart and Rogoff. They found two spreadsheet errors, a questionable choice about excluding data, and a dubious weighting methodology, which together undermine Reinhart and Rogoff’s most widely-cited claim: that national debt levels above 90 percent of GDP tend to reduce economic growth.

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How Long Can We Finance the Debt?

By James Kwak

Everyone should know by now that the Treasury Department can borrow money at historically low rates. That is a major reason why some very smart economists think that the federal government should borrow more money in the short term (i.e., this year and next) and use that money to boost economic growth.

In the medium term (say, the next decade), however, the big question is how long we will be able to finance new government borrowing at such low rates. Today’s low rates are a product of several factors. One is certainly the slow rate of economic growth, in particular the depressed housing market, which has reduced demand for credit. But another factor is the Federal Reserve’s aggressive moves to keep long-term interest rates down; another is foreign central banks’ appetite for Treasuries.

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Money as the Ultimate Giffen Good

This post is contributed by StatsGuy, an occasional guest contributor and commenter.

Monday August 8 2011 witnessed a truly impressive financial spectacle—a natural experiment of the kind we see only once a century or so.  The S&P downgraded US debt, and the price of US Treasuries skyrocketed.

Many pundits were left scratching their heads.  Professional traders tripped over themselves trying to get out of the way.  Macroeconomists at least had an explanation, arguing that the downgrade meant substantially lower growth, and this forced people to shift into Treasuries since bonds rise when growth projections diminish.

While some macroeconomists have an inkling of what is going on, I suspect they got their causation backwards.  Why would an increase in a risk rating on debt directly lower growth projections?  Usually, the increases in risk ratings cause increases in interest rates, and it’s the rate hikes that harm growth.  But, um, nominal interest rates went down, right?  Shouldn’t that have helped growth?  More sophisticated economists will note that when they talk about rates, they mean the real rate (adjusted for inflation), and that if inflation expectations drop more than nominal interest rates, then real interest rates go up and this will slow growth.  However, this did not happen—real interest rates actually declined about 0.2% along most of  the yield curve between Monday the 8th and Tuesday the 9th.  And if real rates declined, how would this cause lower growth?  Instead, I suspect the decline in real rates was the outcome of lower expected growth.  It’s all very circular and confusing, but at least I’m not alone.  Others seem even more confused.

For example, Dick Bove said:  “We have people buying Treasury securities because they’re worried about the Treasury.  We’ve got people selling banks stocks, taking the cash and putting into the banks for safety. It doesn’t make sense. What you’re seeing is this adjustment is occurring and people are not sure how to react to this adjustment.”

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Good Government vs. Less Government

Or: Why the Heritage Freedom Index is a Damned Statistical Lie

This guest post was contributed by StatsGuy, a frequent commenter and occasional guest on this blog. It shows how quickly the headline interpretation of statistical measures breaks down once you start peeking under the covers.

Recently, a controversy raged in the blogosphere about whether neo-liberalism has been a bane or a boon for the world economy. The argument is rather coarse, in that it fails to distinguish between the various elements of neo-liberalism, or moderate deregulation vs. extreme deregulation. But if we take the argument at face value, one of the major claims of neoliberals is that countries in the world which are more neoliberal are more successful (because they are more neoliberal). I disagree.

My disagreement is not with the raw correlation between the Heritage Index and Per Capita GDP. A number is a number. My disagreement is with the composition of the index itself, and interpreting this correlation as causation between neo-liberalism and ‘good things.’

My primary contention below is that many of these measures used in the composite Heritage Index have nothing to do with less government, and a lot more to do with good government. It is these measures of good government that correlate to economic growth and drive the overall correlation between the “Freedom Index” and positive outcomes. Secondarily, I will argue that many of the other items in the index (like investment freedom) are not causes of growth, but rather outcomes of growth.

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The Discount Rate Mismatch

. . . or, how finance is like quantum mechanics.

This guest post is contributed by StatsGuy, an occasional commenter and contributor to this blog.

Many pundits like to discuss the issue of Maturities Mismatch – that banks borrow short (at low interest), lend long (at higher interest), take the profit and (allegedly) absorb the risk.  We often hear talk about how the Maturities Mismatch is integrally linked to liquidity risk – the sometimes self-fulfilling threat of bank runs – which the FDIC is designed to fight.  Rarely if ever do we see anyone making the connection to the Discount Rate Mismatch . . .  In fact you’ve probably never even heard of it, and neither have I.

What is the Discount Rate Mismatch?

It is the difference between the risk-free return on investment that investors demand, and the risk-free return on investment that can be generated by real world investments.  And by investors, I do not just mean individual retail investors or hedge funds.  I also mean retirement accounts and state pension funds as well, which rely on massive 8% projected returns in order to avoid officially recognizing massive fiscal gaps between their obligations and funding requirements.

It has been well documented that the existence of these gaps implicitly forces state and municipal retirement agencies to engage in risky investments to hit target asset appreciation goals.  This strategy sometimes works.  And, sometimes, it does not – as Orange County well remembers.

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Current Financial Conditions and Future Economic Activity

By James Kwak

David Leonhardt (hat tip Brad DeLong) discusses the risk of a double-dip recession. For Leonhardt, the main risks are the pending expiration of the fiscal stimulus and some of the Fed’s monetary stimulus measures, as well as continuing de-leveraging by households, which deprives the economy of its usual growth engine.

James Hamilton highlights a new financial conditions index developed by five economists — two from major banks and three from universities. The goal of the index is to estimate the impact of current financial variables on the future trajectory of the economy. For example, the level of current interest rates is likely to influence future economic outcomes. The paper evaluates several existing financial conditions indexes and finds that most of them show financial conditions returning to neutral in late 2009. It then describes a new index comprised of forty-four variables, which tends to do a better job of predicting economic activity than the existing indexes. (The authors admit that this is in part because they have the benefit of living through the recent financial crisis, which has shown the value of certain variables not included in previous indexes.)

So what?

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Things That Don’t Make Sense, Yuan Edition

“World Bank Chief Economist Justin Yifu Lin staked out a strong position against forcing China to let its currency appreciate as a way to rebalance the world economy.

“’Currency appreciation in China won’t help this imbalance and can deter the global recovery,’ he said in a lecture Monday at Hong Kong University.

“In an interview after the lecture, he said other countries shouldn’t intervene to keep their currencies cheap to boost their export sectors, calling it the ‘equivalent of protectionism.’”

You can read the rest at Real Time Economics. No, it doesn’t make more sense — except possibly as an expression of China’s policy.

By James Kwak

Productivity and Layoffs

One reason I like reading Brad DeLong is that he’s never afraid to admit a mistake — even when it isn’t technically a mistake, just a question of interpretation. Here is his comment on productivity growth of 9.5% (annual rate) in the third quarter:

“Back in the 1930s there was a Polish Marxist economist, Michel Kalecki, who argued that recessions were functional for the ruling class and for capitalism because they created excess supply of labor, forced workers to work harder to keep their jobs, and so produced a rise in the rate of relative surplus-value.

“For thirty years, ever since I got into this business, I have been mocking Michel Kalecki. I have been pointing out that recessions see a much sharper fall in profits than in wages. I have been saying that the pace of work slows in recessions–that employers are more concerned with keeping valuable employees in their value chains than using a temporary high level of unemployment to squeeze greater work effort out of their workers.

“I don’t think that I can mock Michel Kalecki any more, ever again.”

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Cognitive Dissonance and Global Macroeconomics

One of our readers not only suggested this post, but even sent me all the links; I’m just now getting around to writing it up. Thanks.

There has been a lot of talk about global imbalances, with most opinions varying from somewhat important (us) to very important (many global policymakers). Here’s Jean-Claude Trichet, for example, president of the European Central Bank, as reported by Reuters:

“The G20 has to address the issues of the domestic large imbalances between savings and investments, and of the set of unsustainable external imbalances.

“We know that these imbalances have been at the roots of the present difficulties. If we don’t correct them, we’ll have the recipe for the next major crisis. And this of course would be totally unacceptable.”

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Imbalances, Schmalances

We’ve been at first amused but more recently alarmed at how “global imbalances” are becoming many people’s preferred explanation of the financial crisis. At first you could brush it off this way: “global imbalances (read: ‘blame China’) . . .” But this explanation is going mainstream, not least because it is always more convenient for policymakers and bad actors to blame someone far away. For example, Dealbook (New York Times) kicked off a roundtable on the causes of the financial crisis this way:

“There is a conventional view developing on the financial crisis. The Federal Reserve’s policy of historically low interest rates spurred a worldwide search for higher risk and return. Concurrently, the entrenched United States trade imbalance led to a huge transfer of dollar wealth to Asian and commodity-based countries. The unwillingness of Asian economies, particularly China, to stimulate their own domestic consumption led these countries to reinvest the proceeds into the United States. This further contributed to lower American interest rates and further fueled the search for return.”

(Mortgage securitization gets mentioned, but only in the fourth paragraph!)

Simon and I took this on in our Washington Post online column this week, but I thought it was interesting enough to repost here in full, below.

***

The time is here for our nation to actually do something about the recent financial crisis — that is, do something to prevent it from happening again. But instead, many people are finding it easier to pass the buck than to, say, regulate the financial sector effectively.

The recent Group of 20 conference in Pittsburgh was replete with talk about “global imbalances,” which means — in the spirit of the “South Park” movie — “blame China!”

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Escape from Punchbowlism

This post was written by StatsGuy, a regular commenter here and very occasional guest contributor. We asked him to expand on the ideas he put forward in this comment on the relationships between monetary policy, international capital flows, and bank capital requirements.

Former Fed Chairman William McChesney Martin is most famous for his notorious quip that the job of the Fed is to “take away the punchbowl just as the party gets going.” It seems this has evolved into a full fledged theory of monetary management.

Unfortunately, structural problems – like trade imbalances, inadequate capital ratios, and weak financial regulation – severely constrain Fed monetary policy options by impacting currency flows and the value of the dollar. (Some specific mechanisms are listed in the previous comment.)

Why does this matter? Because it means the Fed cannot use monetary policy as effectively to keep the country going at full throttle and avoid a prolonged fall in utilization rates (unemployment and idle machines).  How can it be that capacity utilization is still lower than at the bottom of the 81/82 recession and we’re ALREADY raising the bubble/inflation alarm? (Paul Krugman discusses this here, and the answer is that the output gap is itself defined against neutral inflation, not just capacity utilization.)

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Recovery – or Not – in Words and Pictures

First, the pictures. Paul Swartz of the Council on Foreign Relations has a new version of his charts on the current recession in historical perspective, which I first linked to in June. The overall impression? We are still considerably worse off today than in other postwar recessions at this point (21 months in), although some indicators appear to be bottoming out.

Now the words. Edward Harrison of Credit Writedowns has a guest post at naked capitalism presenting the arguments for a robust recovery and for no recovery at all. He cites Joseph Stiglitz for the proposition that statistical GDP growth isn’t everything, and extends the point to argue that  you can have “low-quality” GDP growth if that growth is financed by debt without corresponding investment. When you happen to control the world’s reserve currency you can do this for quite some time, and there’s no saying we can’t do it for a while longer. So one possibility Harrison foresees is a reasonable growth fueled by cheap money, yet no change to some of our underlying economic problems, including a financial sector with a put option from the federal government.

By James Kwak