What happened to the global economy and what we can do about it
Category: External perspectives
Right here. I wouldn’t ordinarily just pass along a link you can find elsewhere, but I can’t help remarking that that makes two former chief economists of the IMF to take this position. That was Simon’s old job; his article on the topic is here. Of course, you are free to keep whatever opinion you may have about the IMF and its chief economists.
(Thanks to Mark Thoma for flagging this.)
I am struck by the degree of consensus among mainstream economists about how to deal with the current recession. Greg Mankiw, Chairman of President Bush’s Council of Economic Advisors from 2003 to 2005, wrote a New York Times op-ed arguing for a Keynesian response to the recession – which is what Summers, Stiglitz, and all the other Democrats are calling for.
It’s also a wonderfully clear exposition of the challenge, considering in order the logical possibilities for increasing aggregate demand. Mankiw doesn’t quite come out and endorse an increase in government spending, although he does say it’s the only component that can plausibly be increased (as opposed to consumption, investment, and net exports). He holds out some hope for expansionary Federal Reserve policy. In any case, it’s a quick read and worth it.
Simon and Peter argued in Real Time Economics earlier today that we need some inflation (see the post just before this one) – not only because deflation is bad, but also because it helps protect asset values, including the assets for which the government is now on the hook.
James Hamilton at Econbrowser has a plan for how to create some inflation (he suggests a target of 3%). And if that doesn’t work, he has an even more clever plan.
For those who can’t get enough of the GM topic, Economix (NYT) has links to posts for and against bankruptcy. Right now it’s 10-5 in favor of bankruptcy, although I’m not sure that Mitt Romney’s vote should have the same weight as those of, say, Martin Feldstein, Gary Becker, and Paul Krugman.
However, the bankruptcy/bailout dichotomy leaves out what I think is the best solution: a government-brokered reorganization, which may or may not require bankruptcy – a prepackaged bankruptcy, as it’s sometimes called. This would be very different than just letting GM go into Chapter 11 and hoping for the best, especially given the lack of debtor-in-possession financing these days (thanks to the commenters who pointed this out). Andrew Ross Sorkin, for example, argues for a prepackaged bankruptcy, and even Romney calls for a “managed bankruptcy” (without many deatils) – yet they are lumped in with the the others, like George Will, who argue against any government intervention. (See the link above for all the links to individual posts.) So I don’t think 10-5 is a very accurate count.
Update: Five professors who really are experts on the auto industry (and one of whom is a colleague of Simon at Sloan) have a highly readable paper with their proposal out. They favor a non-bankruptcy restructuring plan that is overseen by the government and also has some provisions to ensure that the reorganization is in the public interest, such as increased fuel efficiency standards and a prohibition on paying dividends to shareholders.
The morning after the election, I wrote a post on our country’s long-term priorities. #3 on the list was retirement savings.
While the retirement savings problem predates the current crisis, the decline in the value of financial assets has made it tougher all around. One reader pointed me to a particular aspect of the problem I wasn’t aware of. Earlier this year, the Pension Benefit Guaranty Corporation (PBGC) shifted its asset allocation from 15-25% equities to 55% equities. The PBGC, which is part of the federal government, guarantees private-sector pension plans and is funded by premiums paid by those plans; if a company’s pension fund goes bankrupt, the obligations are shifted to the PBGC. This, as Zvi Bodie and John Ralfe pointed out back in February, is particularly problematic for the PBGC, because then an economic downturn has a triple impact on the fund: first, as equity values fall, company pension funds face larger funding gaps; second, as companies go bankrupt, their pensions get shifted to the PBGC, increasing its liabilities; third, as equity values fall, the PBGC’s assets fall, increasing its funding shortfall. Bodie and Ralfe argue that increasing the proportion of equities may increase the expected return, but only at the cost of increased risk, in any timeframe.
(By contrast, because the Social Security Trust Fund is invested in Treasury bonds, it should be doing OK. Long-term concerns about Social Security funding, of course, are still valid.)
We’ve gotten a number of questions about mortgage restructuring proposals, both in email and in comments. One reader asks: “How does one get around the securitization problem? The Treasury seems to be able to change rules with the sweep of a wand lately, why not the REMIC [Real Estate Mortgage Investment Conduit] rules too?” Tom K also raises this issue in a comment.
I doubt that Treasury could unilaterally modify the rules governing the securitization trusts (in which a loan servicer manages a pool of loans on behalf of the many investors who own a share of that pool). Despite the ease with which Treasury seems to be flinging money around and the, um, liberties they seem to be taking with the terms of the TARP legislation, Treasury can’t really force anyone to do anything, legally. For example, Treasury has no authority to force a bank to accept a recapitalization, which (in my opinion) is why the recapitalization terms are relatively generous: they did not want to take the risk of the core banks turning them down.
The securitization issue raises similar legal barriers. A bit of background: To generalize, the loan servicer has a legal obligation to act in the interests of the investors in the loan pool; if it doesn’t, it opens itself up to lawsuits. Now, if all of the investors have the same interests, and the service restructures a delinquent mortgage in a way that provides more value than a foreclosure, then everyone is happy. There are (at least) three problems, however. The first is a coordination problem: getting all of the investors to agree that they are happy. The second is a problem of conflicting interests: because a typical CDO is structured so that some investors get the first payments and some get the last, a mortgage modification could help the interests of some investors and hurt the interests of others. The third is a tax problem: for technical reasons, a mortgage restructuring could be treated as a new loan, which creates a tax liability (this is a REMIC rule).
This is why I think this will require legislation, and even that could be challenged as an expropriation of property.
If there are other ideas out there, please suggest them.
What to do when you don’t have $233.95 to pay your bill. From Geekologie.
One of our readers recommended the Congressional testimony by Andrew Lo during last Thursday’s session on hedge funds. Lo is not only a professor at the MIT Sloan School of Management, but the Chief Scientific Officer of an asset management firm that manages, among other things, several hedge funds. He discusses a topic – systemic risk – that has been thrown around loosely by many people, including me, and tries to define it and suggest ways of measuring it. He recommends, among other things, that
Lo also has a talent for explaining seemingly arcane topics in language that should be accessible to the readers of this site. The testimony is over 30 pages long, but it’s a good read. Here are a couple of examples to whet your appetite.
Continue reading “Systemic Risk, Hedge Funds, and Financial Regulation”
One of our commenters pointed out that we have failed to say anything about India, despite its large and growing importance in the global economy. Simon’s colleague Arvind Subramanian (whom we have linked to before, including this morning) has a new opinion piece, originally posted at the Peterson Institute.
India and the G-20
The upcoming G-20 summit meeting in Washington provides an opportunity for India to help shape the new global economic architecture in line with its strategic and economic interests. India should propose short-term, crisis response actions to help limit the economic downturn; advance a clear, medium-term agenda; and push for a political commitment by all countries to keep markets open and prevent trade barriers from going higher.
Although the G-20 has been in existence for nearly a decade, this is the first G-20 summit meeting, and many participants will be looking to Prime Minister Manmohan Singh, a respected economist in India and throughout the world, for a particular contribution.
What does India bring to the G-20 table? As a long-time spokesperson for the G-77, India has a record of assuming a leadership role. But in the past, this role was often used to assert India’s right to retain sovereignty. In the words of Strobe Talbott, the former diplomat who now leads the Brookings Institution, India has been on many issues a “sovereignty hawk,” protecting its own interests at the expense of global cooperation on issues ranging from nuclear proliferation to trade. But with India’s growth, and in an era of globalization, its interests—and its perception of its interests—have changed. India now has a keen stake in sustaining an open global trading system. Accordingly, its leadership should now be harnessed for a different cause. Moreover, India has begun to realize that it needs to contribute to sustaining this system rather than assuming that the status quo can be taken for granted. But trading partners are wary of India, viewing India’s role in the trade negotiations as unhelpful. It would be a singular achievement if India can manage to reassure G-20 participants on this score. In short, leadership comes naturally to India. The question is going to be the cause for which India harnesses this leadership role.
As Aaditya Mattoo of the World Bank and I have argued [pdf], for India the medium-term agenda should include: First, reforming the financial architecture, including by strengthening the International Monetary Fund’s capacity to respond to crises and enhancing its legitimacy through radical governance reform to give greater say to the emerging powers. Second, securing the future openness of the trading system, which would require a commitment to go beyond completing the current Doha agenda in two ways: deepening rules in existing areas (especially services) and developing rules in new areas (to deal with undervalued exchange rates, cartelization of oil markets, investment restrictions and environmental protectionism). Third, reforming the makeup of the bodies involved in global decision-making, including the creation of a more representative membership than the G-7.
Arvind Subramanian is a Senior Fellow, Peterson Institute for International Economics and Center for Global Development, and Senior Research Professor, Johns Hopkins University
Even with all the chaos in the US economy these days, the G20 summit approaching this weekend is bringing the global financial system to the top of the agenda, at least for the few days. One of the issues of the past few weeks has been volatility in currency prices as (most) countries with overvalued currencies and large current account deficits see their currencies fall. The flip side of this situation is countries with undervalued currencies and large current surpluses – most notably, China. Arvind Subramanian presents one solution in the Financial Times: treat undervalued currencies as a form of trade barrier and manage them through the WTO.
A few weeks ago, three economists at the Federal Reserve Bank of Minneapolis set off a debate among Internet-addicted economists by claiming that, in essence, lending to the real economy was just fine and anyone who said there was a credit crisis was wrong. (See my initial reaction, as well as links to the original paper and several perspectives.) Now we have been treated by four economists at the Federal Reserve Bank of Boston, who argue that there was, in fact, a credit crisis. In particular, they say:
and similar points. Take a look; some of the charts are fascinating.
Conservative economist and deficit hawk Martin Feldstein is arguing that we need an economic stimulus package now (immediately after the election) that is big ($100 billion won’t cut it) and long. OK, he didn’t explicitly say it should be long, but he did say this:
Previous attempts to use government spending to stimulate an economic recovery, particularly spending on infrastructure, have not been successful because of long legislative lags that delayed the spending until a recovery was well underway. But while past recessions lasted an average of only about 12 months, this downturn is likely to last much longer, providing the scope for successful countercyclical spending.
This is basically what we said in the National Journal and what Simon said in this morning’s testimony. I’m not claiming that Feldstein listens to what we say (I strongly doubt it). But his op-ed emphasizes the fact that most economists from across the political spectrum are on the same page on this issue.
Update: “Business executives and Republicans” are on board, too.
Economic stimulus is in the air. (Simon, in fact, is testifying on the subject before the Joint Economic Committee later this week.) Menzie Chinn at Econbrowser has a data-heavy post today on multipliers – the impact on GDP of in different types of stimulus (tax rebates, tax cuts, unemployment benefits, etc.). He concludes that the stimulus should include extended unemployment benefits, aid to state and local governments, and infrastructure spending. To the counterargument that infrastructure spending takes too long to have an impact, he shows multiple GDP forecasts, all tending to show a protracted recession (and, note, getting worse with each update). If you read one article about the stimulus, read this one.
(Like Simon argued in the National Journal, but with more data.)
One of the challenges of the current financial crisis/credit crunch/recession/whatever you call the mess that we’re in is that there are so many things going on at once – stabilizing the financial system, housing, economic stimulus, regulation, emerging markets crisis, now incipient currency crisis, … Luckily, there are many other smart commentators out there working weekends when we all should be spending more time with our families.
On the topic of regulation and economic stimulus, Mark Thoma cites and expands on Larry Summers, who argues that we need to not just give the economy a boost in the short term, but take advantage of the opportunity to take steps – both investments and regulation – to boost productivity in the long term.
Mark Thoma (again) and Yves Smith both provide roundups and analysis of the currency crisis, which Simon raised a couple of days ago. Quick summary: it could be bad.
So if you can’t sleep, there’s plenty to read and worry about. (Or you could watch the World Series.)
Paul Krugman has a reputation as an angry liberal polemicist. But he’s also very good at giving clear, simple explanations to some basic questions about the financial crisis. His recent interview with Terry Gross on Fresh Air covers a lot of fundamental topics and concepts, such as where the money for the bailouts comes from. Advanced readers probably won’t learn much, but newcomers could find it very helpful.
The Baseline Scenario 