The Central Insight of Macroeconomics: DeLong

Nice article from DeLong today:

"The central insight of macroeconomics is a fact that was known to John Stuart Mill in the first third of the nineteenth century: there can be a large gap between supply and demand for pretty much all currently produced goods and services and types of labor if there is an equally large excess demand for financial assets. And this fundamental fact is a source of big trouble...

The broad pattern is clear: the more that governments have worried about enabling future moral hazard by excessive bailouts and sought to stem the rise in public debt, the worse their countries’ economies have performed. The more that they have focused on policies to put people back to work in the short run, the better their economies have done.

This pattern would not have surprised nineteenth-century economists like Mill or Walter Bagehot, who understood the financial-sector origins of industrial depression. But it does seem to surprise not only a great many observers today, but also a large number of policymakers."

Worth reading the whole thing.

Euroskepticism

From Krugman today:

"So the academic euroskeptics have been proved right in their analysis. Now, that need not mean that the euro was a mistake: there were, after all, political economy considerations. And it certainly doesn’t have to mean that the thing should break up: doing that would be highly disruptive.

But there is, I think, a lesson here, namely that straightforward economic analysis has its virtues. Euro enthusiasts tended to be kind of cosmic about the whole thing, and dismissed the pedestrian cost-benefit approach taken by many US-based economists. Yet those costs and benefits did and do matter. And the crisis Europe is now having is very much the kind of thing those pedestrian analyses suggested was going to happen."

A nice summary of the cost-benefits approach to determining the optimal size for a currency union, and some of the factors that policy makers should take into account- labor mobility, fiscal integration, trade and ability to respond to asymmetric shocks are the main ones.

The Balanced Budget Multiplier: Shiller

A nice article on the balanced budget multiplier from Shiller.

"Researchers haven’t pinned down the deficit-spending multiplier either, even though that has been the focus of their efforts. In fact, a recent survey article on the effects of government stimulus by Alan Auerbach at the University of California, Berkeley, and two of his colleagues has found that “the range of mainstream estimates for multiplier effects is almost embarrassingly large.” Last month, a Congressional Budget Office study revealed similar uncertainty. The trouble comes in estimating how people will react in generating those subsequent rounds of spending.

But the balanced-budget multiplier is simpler to judge: If the government spends the money directly on goods and services, that activity goes directly into national income. And with a balanced budget, there is no clear reason to expect further repercussions. People have jobs again: end of story."

This seems to pick up the benefits of balanced-budget government spending in a nutshell. Government spending creates jobs- period. We can argue to the ends of the earth about whether the multiplier is .6 or 1 or 1.5, but at the end of the day when the government spends money in a depressed economy people who otherwise wouldn't have jobs will have jobs.

Another good point Shiller picks up on is that the problems of economic recovery are primarily political at this point in time:

"AT present, however, political problems could make it hard to use the balanced-budget multiplier to reduce unemployment. People are bound to notice that the benefits of the plan go disproportionately to the minority who are unemployed, while most of the costs are borne by the majority who are working. There is also exaggerated sensitivity to “earmarks,” government expenditures that benefit one group more than another.

Another problem is that pursuing balanced-budget stimulus requires raising taxes. And, as we all know, today’s voters are extremely sensitive to the very words “tax increase.”

But voters are likely to accept higher taxes eventually, as they have done repeatedly in the past. It would be a mistake to consider the present atmosphere as unchangeable. It’s conceivable that an effective case will be made in the future for a new stimulus package, if more people come to understand that a few years of higher taxes and government expenditures could fix our weak economy and provide benefits like better highways and schools — without increasing the national debt."

I think this political case is quite compelling and simple. The corporate and rentier sector of the US economy has done incredibly well out of the last decade at least. Corporate profits have rebounded exceedingly quickly from the crisis, but unemployment is still stuck at 9.8%- this is telling us that we have a political and moral problem rather than a purely economic problem. Those who benefited from driving the real economy off a cliff are now profiting from the aftermath. If now isn't the time for more progressive taxation arrangements and greater direct government investment in infrastructure and human capital in the US I don't know when is.

American Military vs. American Schools.

"The US military has fought five large-scale wars in the past fifty years, resulting in a draw in Korea, a defeat in Vietnam, and three inconclusive outcomes in Iraq (twice) and Afghanistan. That’s a record that makes the worst inner-city public school look pretty good. At least the majority of students, even at the worst schools, end up more or less literate."

Nice read here.

Krugman and Wells on Obama

"Even if Obama were suddenly to find an inner FDR, would anyone notice? His aloofness has become so indelibly registered in voters’ minds that if he tried to change style—even if he wanted to, a big “if”—this would immediately come across as opportunistic. Having trusted and been disappointed by Obama once before, they are very unlikely to give him another chance."

Hard hitting stuff- "Change you can believe in" has morphed into an aloof yuppie Presidency.

Krugman and Wells are interesting on the policy response to the artificially low peg of the remnimbi:

"The obvious American response is to threaten, and if necessary actually impose, countervailing duties on Chinese exports—a step that is backed even by strong advocates of free trade, such as Fred Bergsten of the Peterson Institute for International Economics."

And some closing thoughts on what liberals need to do more of in the future:

"In 2008, progressives fell for the fantasy of hope and change on the cheap; they believed Obama’s promise that the reforms America needed could float through on a tide of bipartisan reconciliation. It was not to be, and clinging to that illusion will only lead to more defeats. If progressives want to rebound, they’ll have to fight."

Balance Sheet Recessions

Ken Henry was made somewhat famous for his "go early, go hard, go households" fiscal prescription to the GFC. It is within the context of Henry announcing his retirement earlier in the week that this article from Mark Thoma concerning the correct fiscal response to a balance sheet recession became more poignant:

"The perception that the government bailed out undeserving wealthy bankers while leaving households to fend for themselves is a big part of the backlash against the policies put into place to help with the recession. That perception is correct, for the most part, and it will stand in the way of repeating this policy the next time there is a financial collapse. When the next balance sheet recession hits, and another one will hit no matter how hard we try to avoid it, we need to do a better job of helping households. Not only is this good economics – we will recover faster with this policy – the politics of helping households are far superior to those associated with bailing out banks."

Ken Henry resigns

Bernard Keane is great in Crikey on Ken Henry's resignation:

"It was on Rudd’s watch that Henry performed his greatest service to the nation. He had worked in Paul Keating’s office through the boom of the 1980s and into the savage recession that followed. He had seen, first hand -- indeed, been a part of -- an historic failure by Australian policymakers: a recession that, coupled with the Government’s embrace of micro-economic reform and the failures of state-owned banks, gouged deep holes in our social fabric that took a decade to repair.

Treasury’s response to the impact of the GFC, coupled with that of the Reserve Bank, made amends for that failure, to the extent that anything ever could. They stabilised our banking system, kept credit flowing, and launched two waves of stimulus that put a floor under falling consumer confidence and employment. Henry’s advice to Rudd and Swan "go hard, go early, go households" was the playbook for a spectacular policy success, mitigated only by some terrible implementation of one stimulus program by the Department of the Environment. But hundreds of thousands of Australians have jobs that wouldn’t have them if Henry, Stevens and their teams had repeated the errors of the late ‘80s and early ‘90s – chiefly using the levers of monetary and fiscal policy too late and ineffectively.

Between that and Henry's work on the GST -- first for Paul Keating in the Hawke years, then the real thing under Peter Costello -- he can lay claim to having been present at most of the key moments in recent Australian economic history.

Those hundreds and thousands of Australians remain entirely oblivious to their fate if Henry and Stevens hadn't got it right. Few of them would know who either was. Indeed, as is the way of things Henry’s reward for this remarkable feat -- not achieved anywhere else in the world – has been froth-mouthed abuse from conservatives, who first insisted stimulus wouldn't work and then insisted it wasn't necessary when it did work, none of them apparently equipped with the slightest understanding of or interest in the social and economic impacts of unemployment."

The stimulus was the right thing to do economically, morally and politically. We are lucky that Henry pushed so forcefully for its adoption.

Gordon Brown and the Financial Crisis of 2008

Enjoyed reading this review of Gordon Brown's recent memoirs from Robert Skidelsky:

"Misled by his success of 2008-9 in stopping the slide into depression, Brown remains too optimistic about what summitry can achieve. His "global compact" for growth, jobs and poverty reduction is a noble vision, to which we may stumble, through many new crises, but may well not. One can only hope that this brave, thoughtful, and decent man, who rose to the highest challenges but slipped on the lower slopes of politics, can find a post-political life commensurate with his abilities, interests, and power to do good."

A good person, who got the economic crisis broadly right, but lacked the personal charm and character to be politically successful.

For those interested Stiglitz writes a good article on the book as well.

"Much of Beyond the Crash will be familiar to readers who care about economics and globalisation, but seeing the issues through a political leader who helped shape globalisation for more than a decade provides new insights. Like many of us, Brown's thinking was shaped by the east Asian economic crisis and the clear need for financial regulation and global co-operation demonstrated by that crisis. He doesn't dwell, however, on the mistakes of the past, either those that led to that crisis or the more recent one. What he tries to do is to learn the lessons – as different as they may be from the conventional wisdom that prevailed before the crisis. He clearly sides with those who believe that unregulated markets may be prone to excessive volatility, with booms and busts in real estate and destabilising capital flows. While many of the advocates of liberalisation found it difficult to recognise that, for instance, there may be a need for capital controls at certain times, he unabashedly expresses his support. In praise of Malaysia's capital controls, he writes: "For a short time at least controls on capital can prevent, or at least reduce, the uncontrolled flow of short-term funds across borders." While he supports Hong Kong's response to the "double play" that attempted to bring down their currency, American officials who pushed unbridled globalisation have yet to recant on their criticisms...

Brown is outraged by the bankers' excessive risk-taking, their pursuit of greed. I can only surmise that had he looked more carefully at America's banks' predatory lending practices and the abuses in the credit card systems, how the financial system preyed on the least educated and financially unsophisticated, he would be even more outraged. But he does not dwell on these issues, though he devotes his last chapter, "Markets Need Morals", to the subject. And while his claim that markets need morals is right, I am not sanguine about their getting these morals. In their absence, government regulation will have to do.

There is still a debate about whether Brown's policies were effective. I believe that were it not for the strong Keynesian policies that he pushed around the world, the global downturn would have been much worse. We were at risk of moving into a global depression. I believe, too, that if he had not pushed his alternative approach of equity injections rather than merely buying bad assets from the banks, our financial system would be in much worse shape. (The Irish Republic is the one European country that has tried the alternative approach—not exactly an example for others to emulate.) ...

Given the size of the U.K. financial sector and the extent to which it was overleveraged, the U.K.'s problems were enormous, and, in my judgment, the success of Brown's response should have been widely acknowledged.

What is clear from this book is that Brown knew what needed to be done and tried to do it at a time when others were paralysed, captured by the financial community, or deluded by their past mistakes into trying to underestimate the severity of the crisis that their policies had helped create."

what use are investment banks?

Highly recommended reading from John Cassidy of the New Yorker on the social utility of Wall Street.

"Other regulators have gone further. Lord Adair Turner, the chairman of Britain’s top financial watchdog, the Financial Services Authority, has described much of what happens on Wall Street and in other financial centers as “socially useless activity”—a comment that suggests it could be eliminated without doing any damage to the economy. In a recent article titled “What Do Banks Do?,” which appeared in a collection of essays devoted to the future of finance, Turner pointed out that although certain financial activities were genuinely valuable, others generated revenues and profits without delivering anything of real worth—payments that economists refer to as rents. “It is possible for financial activity to extract rents from the real economy rather than to deliver economic value,” Turner wrote. “Financial innovation . . . may in some ways and under some circumstances foster economic value creation, but that needs to be illustrated at the level of specific effects: it cannot be asserted a priori.”

Haven't posted in a while: Housing prices

Some interesting things that I'm just catching up on following this economist article on global housing prices back midyear.

And now this follow up from the IMF.

"The econometric analysis suggests an overvaluation of 5-10 percent depending on the model specification." This was compared to an earlier paper suggesting overvaluation of around 15%. So we are overvalued, rather than in a bubble according to the IMF. Seems about right to me.