Month: August 2011

Ben Bernanke Doesn’t Get the Message

By James Kwak

I was on vacation last week (far from Jackson Hole) when Ben Bernanke gave his widely anticipated speech. The media (see the Times, for example) seemed to focus mainly on his criticisms of the political branches and economic policymaking, which were accurate enough. But in my opinion, Bernanke drew the wrong lessons from those observations.

He was very clear that the problem today is unemployment, not inflation:

“Recent data have indicated that economic growth during the first half of this year was considerably slower than the Federal Open Market Committee had been expecting, and that temporary factors can account for only a portion of the economic weakness that we have observed. Consequently, although we expect a moderate recovery to continue and indeed to strengthen over time, the Committee has marked down its outlook for the likely pace of growth over coming quarters. With commodity prices and other import prices moderating and with longer-term inflation expectations remaining stable, we expect inflation to settle, over coming quarters, at levels at or below the rate of 2 percent, or a bit less, that most Committee participants view as being consistent with our dual mandate.”

Continue reading “Ben Bernanke Doesn’t Get the Message” →

Is Meritocracy Good?

By James Kwak

Two years ago I wrote a post arguing that smart, well-educated, hard-working people did not deserve to make more money than other people, at least not as a normative (as opposed to a utilitarian) matter.

Last night I was re-reading A Theory of Justice by John Rawls. This is what he has to say on the matter (§ 12, pp. 73–74):

“[The liberal conception of the second principle of justice] still permits the distribution of wealth and income to be determined by the natural distribution of abilities and talents. Within the limits allowed by the background arrangements, distributive shares are decided by the outcome of the natural lottery; and this outcome is arbitrary from a moral perspective. There is no more reason to permit the distribution of income and wealth to be settled by the distribution of natural assets than by historical and social fortune. . . . Even the willingness to make an effort, to try, and so to be deserving in the ordinary sense is itself dependent upon happy family and social circumstances.”

Is This A Second Great Depression – Or Could It Become Something Worse?

By Simon Johnson

With the US and European economies having slowed markedly according to the latest data, and with global growth continuing to disappoint, a reasonable question increasingly arises: Are we in another Great Depression?

The easy answer is “no” – the main features of the Great Depression have not yet manifest themselves and still seem unlikely. But it is increasingly likely that we will find ourselves in the midst of something nearly as traumatic, a long slump of the kind seen with some regularity in the nineteenth century, particularly if presidential election-year politics continue to head in dangerous direction.

The Great Depression had three main characteristics, seen in the United States and most other countries that were severely affected. None of these have been part of our collective experience since 2007. Continue reading “Is This A Second Great Depression – Or Could It Become Something Worse?” →

A Foray into Monetary Policy and Tangentially Related Speculations

By James Kwak

Yesterday I wrote an Atlantic column about the bizarre situation that the Federal Reserve is in. Ordinarily, we think central bank independence is important because it permits the bank to take unpopular, anti-growth steps when the political branches of government want popular, pro-growth steps. But today we’re in Bizarro world: the political branches are intent on strangling the economy, so the Fed should be ignoring the political winds and stimulating the economy—especially since it’s clear that fiscal policy is off the table. Rick Perry just provided a last-minute dose of color.

Obviously Perry and the Republicans don’t want the Fed to stimulate the economy because they don’t want the economy to recover before the 2012 elections. But I think there’s something deeper here, which Mike Konczal gets at in this great post. Konczal summarizes the nineteenth-century gold-standard ideology this way: “Paper money decreases the power of the husband over his wife and the father over his family, loosens the natural leadership that serves as the best protection against ‘effeminate’ manners, and gives us a democracy without nobility.”

Continue reading “A Foray into Monetary Policy and Tangentially Related Speculations” →

How Big Is the Deficit, Anyway?

By James Kwak

According to its CBO score, the Budget Control Act of 2011 (a.k.a. the debt ceiling agreement) initially reduced aggregate budget deficits over the next ten years (2012–2021) by $917 billion, with a provision that ensures that deficits will be reduced by another $1.2 trillion (either through an agreement in the joint committee that is ratified by Congress, or through automatic spending cuts). The chatter in Washington is that even with the $1.2 trillion, this is still too small, and there is still this massive deficit hanging over our heads. This is true to an extent, but not the way you are being led to believe.

The first question is this: How big is the deficit anyway? The answer is pretty complicated—complicated enough for S&P to mess up (although in my opinion they made a rookie mistake, as I’ll explain later). Warning: lots of numbers ahead, though the only math is addition and subtraction.

Continue reading “How Big Is the Deficit, Anyway?” →

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.”

Continue reading “Money as the Ultimate Giffen Good” →

Should We Expect Another Round Of Bailouts?

By Simon Johnson

In the wake of recent equity market declines, the clamor for bailouts of various kinds grows ever louder around the world. Influential voices call for “leadership” from the US and Western Europe, and for policymakers in those countries to “get ahead of the curve”. This is all code for a simple and familiar plea: Do something that will protect investors, particularly creditors who have lent a lot of money to banks and countries that now appear to be in serious difficulty.

But providing another round of unconditional creditor bailouts in this situation would be a mistake. What we need is a combination of transparent losses where bad loans were made, combined with a ring fencing approach that protects sound governments and firms. There is no sign yet that policymakers are willing to make that distinction clear.

The situation around the world is undeniably bad. As Peter Boone and I argued in a Peterson Institute policy paper released a couple of weeks ago, Europe is most definitely “On the Brink” of a serious economic crisis that could involve widespread defaults or significant inflation or both. At the same time, Bank of America shares this week fell to their lowest in 2 years; with other large banks under pressure, there is a legitimate fear of rerunning the parts of the financial crisis of 2008-09. Continue reading “Should We Expect Another Round Of Bailouts?” →

Barack Obama and Harry Potter

By James Kwak

Helene Cooper of the New York Times wrote a “news analysis” story saying that the challenge for President Obama is this:

“Is he willing to try to administer the disagreeable medicine that could help the economy mend over the long term, even if that means damaging his chances for re-election?”

The problem, she goes on to say in the next paragraph, is that the economy is in bad shape:

“The Federal Reserve’s finding on Tuesday that there is little prospect for rapid economic growth over the next two years was the latest in a summer of bad economic news.”

Continue reading “Barack Obama and Harry Potter” →

S&P Ratings Destroy Information

By James Kwak

A lot of the theory of securities markets revolves around information: securities prices respond to changes in available information, you want to provide incentives for people to produce information, some kinds of information should be equally available to everyone, other kinds of information you should be able to trade on, etc. In the conventional model, rating agencies are information providers: they produce information that is useful to market participants, and thereby improve the functioning of the markets.

Well, forget all that. Nate Silver has the best article I’ve seen yet on S&P’s sovereign debt ratings, and the summary is that it isn’t pretty. Some of the things Silver finds, using some publicly available data and Stata, are:

Debt-to-GDP ratio alone is a better predictor of default risk than an S&P rating (meaning that the rating subtracts information provided by the debt-to-GDP ratio).
S&P ratings have almost no correlation with future default risk.
S&P rates European countries higher than other countries, all other things being equal—and look where that got us.
S&P ratings are serially correlated, which means they incorporate new information especially slowly.

Hopefully this will be one more nail in the coffin of regulations that incorporate NRSRO ratings.

(In other non-news, I’ve been forgetting to mention that I was on Benzinga Radio last week talking about the debt ceiling deal (mainly politics, not much economics). I was also on Letters and Politics on KPFA and KPFK in California this morning, talking about economic factors behind the stock market slide.)

Tax Loopholes and the French Revolution

By James Kwak

Today’s Atlantic column is about one of my favorite topics: the French Revolution. Actually, it’s mainly about tax expenditures and how traditional Republicans should want to eliminate them. Unfortunately, there are no traditional Republicans left, and Grover Norquist’s anti-tax pledge makes clear that you can’t eliminate tax expenditures unless you use all the revenue to lower tax rates below where George W. Bush put them.

So What? Part Two

By James Kwak

So, Standard and Poor’s went ahead and downgraded the United States yesterday, apparently because we have a dysfunctional political system. Who knew?

As I said before, I don’t think that S&P has added anything new to the world’s stock of information. In the short term, the most worrying thing about a downgrade is what I called the “legal-mechanical consequences”: the possibility that investors, who value their own opinions more than S&P’s anyway, might have to dump Treasuries because they are no longer AAA. Apparently, this is not going be a huge problem. Binyamin Appelbaum of the Times says that (a) many of the rules place Treasuries in a different category from other AAA securities to begin with and (b) since the downgrade only affects long-term debt, money-market mutual funds are safe.

Still, I think the whole thing is preposterous. S&P downgrading the United States is like Consumer Reports downgrading Coca-Cola. Consumer Reports is a great institution. For example, if you want to know how reliable a 2007 Ford Explorer is going to be, they have done more research than anyone to figure out the reliability history of every single vehicle. Those ratings are a real public service, since they add information to the world. But when it comes to Coke and Pepsi, everyone has an opinion already, and no one cares which one, according to Consumer Reports, “really” tastes better. When S&P rated some tranche of a CDO AAA back in 2006, it meant that some poor analyst had run some model fed to her by an investment bank and made sure that the rows and columns added up correctly, and the default probability percentage at the end was below some threshold. It might have been crappy information, but it was new information. When S&P rates long-term Treasuries AA+, it means . . . nothing. And if any serious buy-side investor were tempted to take S&P’s rating into account, she would be deterred by the fact that the analysis that produced the rating included a $2 trillion arithmetic error.

Continue reading “So What? Part Two” →

Would A Balanced Budget Amendment Make Sense?

By Simon Johnson

Some House and Senate Republicans have worked hard to ensure that a “balanced budget” constitutional amendment be included in the mix of policies under consideration to address longer-run fiscal issues in the United States. Such an amendment is presented as way to keep spending and deficits under control, by requiring that federal spending not exceed revenues.

But there are three main problems with this potential approach as it is currently articulated.

The first issue, which has been forcefully identified by Bruce Bartlett, is that there is no way to make this amendment work in practice. The language currently proposed would, as part of the “balance”, limit federal government spending to 18 percent of Gross Domestic Product (GDP), subject only to a potential override by a 2/3 majority in both houses of Congress. On the table, in effect, is a balanced budget amendment with a spending cap. Continue reading “Would A Balanced Budget Amendment Make Sense?” →

A Few Thoughts on the Debt Ceiling Deal

By James Kwak

1. Obama still has his hostage—if he wants it. As far as I can tell, the Bush tax cuts are nowhere in the debt ceiling agreement, which means that at current course and speed they expire at the end of 2012. Extending the tax cuts would reduce revenue by about $3.5 trillion over the next decade. According to news reports, Obama was willing to extend the Bush tax cuts in exchange for $800-1,200 billion of additional tax revenue—in other words, he was willing to cut taxes by about $2.5 trillion relative to current law. Boehner and Cantor walked out because of some combination of (a) they couldn’t get their members to vote for that tax “increase” or (b) they think they will be able to extend all the tax cuts if they negotiate that deal separately. I wouldn’t be so sure about (b). Remember, gridlock means the tax cuts expire.

2. The next step of the deal is that a joint Congressional committee is supposed to come up with a plan to reduce deficits by $1.2-1.5 trillion over ten years. If they fail to come up with a plan, or their plan is rejected by Congress, then there will be major automatic cuts in discretionary spending, including defense. (There will also be cuts in Medicare reimbursement rates, but not in Social Security or Medicaid.) The idea on Obama’s side is that the prospect of major defense cuts will force Republicans to negotiate. But if they were willing to let the government default rather than increase taxes—even by closing tax loopholes—why do we think they will be afraid of some defense budget cuts? Traditional Republicans may have liked high defense spending, but not the new breed. Ron Paul is basically an isolationist; Grover Norquist thinks the defense budget should be reduced.

Continue reading “A Few Thoughts on the Debt Ceiling Deal” →