Matthew Yglesias » Home Page

Matthew Yglesias » Home Page: "In 1950 Argentine income per head was twice that of Spain, its former coloniser. By 1975 the average ­Spaniard was richer than the average Argentine. Argentines were almost three times richer than Japanese in the 1950s; by the early 1980s the ratio had been reversed."

Dead Ideas from New Economists

Grasping Reality with Both Hands: "Dead Ideas from New Economists"

• Refuted economic doctrines #1: The efficient markets hypothesis at John Quiggin
• Refuted economic doctrines #2: The case for privatisation at John Quiggin
• Refuted economic doctrines #3: The Great Moderation at John Quiggin
• Refuted economic doctrines #4: individual retirement accounts at John Quiggin
• Refuted economic doctrines #5: Trickle down at John Quiggin
• Refuted economic doctrines #6: Central bank independence at John Quiggin
• Refuted/obsolete economic doctrines #7: New Keynesian macroeconomics at John Quiggin

credit card business model

Matthew Yglesias » Home Page: "The credit card industry’s business model is basically a disaster waiting to happen. If people pay their bills in a timely manner, the credit card companies don’t make much money. And if people default on their bills, they lose money. So the correct strategy is to try to get people to carry heavy month-to-month balances that charge usurious interest rates without ever quite tipping over the brink into default. So far, it’s worked out pretty well for them, but Eric Dash and Andrew Martin observe that the happy days may soon be over:"

But if unemployment breaches 10 percent, as many economists predict, the rate of uncollectible balances at some banks could far exceed that level. At American Express and Capital One Financial, around 20 percent of the credit card balances are expected to go bad over this year and next, according to stress test results. At Bank of America, Citigroup and JPMorgan Chase, about 23 percent of card loans are expected to sour

"Meanwhile, it strikes me as a bit of a problem for neoclassical economics that if market interactions worked the way they say they do, the entire credit card industry would barely exist. People would understand the true cost of failing to pay off their full monthly balances and would almost never do so. And credit card companies would compete with one another to offer consumers a better deal on lending terms rather than competing to get more-and-more clever about tricking people into taking out loans that ill-serve their interests."

Dismal scientists: how the crash is reshaping economics - The Atlantic Business Channel

Dismal scientists: how the crash is reshaping economics - The Atlantic Business Channel: "(1) Almost no-one predicted the world wide downtown. Academic economists were confident that episodes like the Great Depression had been confined to the dust bins of history. There was indeed much recent debate about the sources of 'The Great Moderation' in modern economies, the declining significance of business cycles.
...(2) The debate about the bank bailout, and the stimulus package, has all revolved around issues that are entirely at the level of Econ 1. What is the multiplier from government spending? Does government spending crowd out private spending? How quickly can you increase government spending? If you got a A in college in Econ 1 you are an expert in this debate: fully an equal of Summers and Geithner.
The bailout debate has also been conducted in terms that would be quite familiar to economists in the 1920s and 1930s. "

The Failure of the Economy & the Economists - The New York Review of Books

The Failure of the Economy & the Economists - The New York Review of Books: "In recent years the financial industry has accounted for an unusually large share of all profits earned in the US economy. The share of the 'finance' sector in total corporate profits rose from 10 percent on average from the 1950s through the 1980s, to 22 percent in the 1990s, and an astonishing 34 percent in the first half of this decade.[1]"

Why do some sectors of the economy have higher profits than other sectors? What would make the profits in finance increase more than 340% relative to the rest of corporate America? Do really efficient sectors of the economy tend to have higher profits or lower profits in the long run?

Another fundamental issue that the current discussion has overlooked almost entirely is the distinction between the losses to banks and other lenders that reflect genuine losses of wealth to the economy, and other losses that don't. When the value of your house falls, that's a loss of wealth to the economy as a whole. If you keep paying your mortgage, you bear the loss yourself: your net worth is diminished by the amount of the decline in the home's price. If you default on your loan, then someone else—maybe the bank that lent you the money, maybe some investor to whom the bank sold the loan—also bears part of the loss. If the government steps in and reimburses the bank, or the investor, the taxpayers will bear part of the loss as well. But however this loss is divided, what is inescapable is that someone, somewhere, will bear it. What much of today's debate is about is how these losses should be divided among homeowners, banks, loan-purchasing investors, and the taxpayers. But the loss must be borne by someone, and America's economy is poorer because it has occurred.

By contrast, suppose you and your neighbor have bet on whether today's peak temperature would exceed fifty degrees. One of you was right, the other wrong. One of you won, the other lost, and the amount the winner won is identical to what the loser lost. There is no loss of wealth to the economy, merely a transfer of wealth from the loser to the winner. Many of the huge losses that American financial institutions have sustained in the current crisis are of this second kind. None of them was betting on the weather, but they were taking positions that amounted to placing bets on outcomes that represented no change in wealth to the economy as a whole. And with regard to these positions, for every loser featured in the latest newspaper story about banks posting losses and turning to the government for bailouts there is also, somewhere, a winner.

Furthermore, there is a distinction between the value of housing declining while the physical housing remains used just in the same way as always and the case of a hurricane causing housing to decline in value by damaging or destroying it.

Why aren't consumers more worried about a depression?

In past, milder recessions, consumers (everyone) has been more worried about economic collapse than today:

Depression Scares Are Hardly New, by Robert Shiller, Commentary, NY Times: What is the chance that the current downturn will morph into another Great Depression? That question has been preoccupying people for months.

The popular mood has a huge impact on the economy, so it’s worth noting what many people seem to forget: Depression scares come and go. And by one authoritative measure, the current outbreak of concern has been surprisingly mild.

...A high score on the question means that the answers tilted toward continuous good times, with a low score tilting toward unemployment or depression. Since 1960, the average score has been 94.If we define a depression scare as any time the score is below 65, there have been four such scares since 1951. They were in the periods from 1974 to 1975, during which 47 was the lowest score; from 1978 to 1982, with a low of 41; from 1990 to 1992, with a low of 54; and from 2008 to 2009, with a low (to date) of 59. Note that so far, at least, the worst reading in the current scare has not been as bad as those of the previous episodes.

...But why is this new depression scare apparently weaker than the others...? ... One can only speculate. Now that oil prices have moderated, it’s possible that most people have less vivid worries than they did in 1974-75 or 1979-82 because their economic problems are not evident every time they shop or drive their cars.

During those earlier two scares, out-of-control inflation was widely visible, but today many people haven’t personally experienced rising unemployment and foreclosures. And it’s possible that the optimistic tone of the president and the Fed has assuaged some fears, and that people might believe that the government is fixing their problems.

This time, the reasons to fret about a possible depression may seem less concrete. For most people, the worries ... about things like bank stress-test results or the “OIS-Libor spread,” are rather hard to comprehend.

As Franklin D. Roosevelt famously said during the Great Depression, “the only thing we have to fear is fear itself.” Let’s hope that is true, and that the relative complacency in the general population is good news for the economy. ...

I haven't found a historical graph for the U of MI survey about depression, but that question is used to help create their index of consumer sentiment which is graphed since the late 1970s at FRED.

Is the US at imminent risk of inflation?

Alan Metzler says the US is in imminent risk of inflation:

Besides, no country facing enormous budget deficits, rapid growth in the money supply and the prospect of a sustained currency devaluation as we are has ever experienced deflation. These factors are harbingers of inflation.

Paul Krugman posts this graph of Japan's 'lost decade' as a counter example:

Krugman explains why budget deficits will not currently cause inflation here.

Perhaps they are both right, but Krugman is worried about the short run (2-5yrs) outlook and Metzler is worried about the long-run outlook (5-10yrs).

Here is a synthesis view:

Deflation raises questions about global recovery, by Martin Feldstein, Project Syndicate: The rate of inflation is now close to zero in the US and several other major countries. The Economist recently reported that economists it had surveyed predict that consumer prices in the US and Japan will actually fall this year as a whole, while inflation in the euro zone will be only 0.6 percent. South Korea, Taiwan and Thailand will also see declines in consumer price levels. ...
Deflation is potentially a very serious problem, because falling prices — and the expectation that prices will continue to fall — would make the current economic downturn worse in three distinct ways.

The most direct adverse impact of deflation is to increase the real value of debt. ... [T]he price level could conceivably fall by a cumulative 10 percent over the next few years. If that happens, a homeowner with a mortgage would see the real value of his debt rise by 10 percent. Since price declines would bring with them wage declines, the ratio of monthly mortgage payments to wage income would rise.

In addition..., deflation would mean higher loan-to-value ratios for homeowners, leading to increased mortgage defaults... A lower price level would also increase the real value of business debt, weakening balance sheets and thus making it harder for companies to get additional credit.

The second adverse effect of deflation is to raise the real interest rate... Because ... central banks have driven their short-term interest rates close to zero, they cannot lower rates further in order to prevent deflation from raising the real rate of interest. Higher real interest rates discourage credit-financed purchases by households and businesses. This weakens overall demand, leading to steeper declines in prices.

The resulting unusual economic environment of falling prices and wages can also have a damaging psychological impact on households and businesses. ... If prices fall at a rate of 1 percent, could they fall at a rate of 10 percent? ... Such worries undermine confidence and make it harder to boost economic activity.

Some economists have said that the best way to deal with deflation is for the central bank to flood the economy with money in order to persuade the public that inflation will rise in the future... In fact, the Federal Reserve, the Bank of England, and the Bank of Japan are doing just that under the name of “quantitative easing.”

Not surprisingly, central bankers who are committed to a formal or informal inflation target of about 2 percent per year are unwilling to abandon their mandates openly and to assert that they are pursuing a high rate of inflation. Nevertheless, their expansionary actions have helped to raise long-term inflation expectations toward the target levels. ...

Ironically, although central banks are now focused on the problem of deflation, the more serious risk for the longer term is that inflation will rise rapidly as their economies recover and banks use the large volumes of recently accumulated reserves to create loans that expand spending and demand.

Personal Savings Rate

Check out FRED's graph of US personal savings rates. Assignment:
1. What happens to savings rates during a recession? Remember that the 1990 and 2001 recessions were very mild compared to the other recessions. What happened to personal savings during the Great Depression?
2. What has been the savings rate trend since 1982? Why? (I don't have any great theories, but perhaps you can come up with something.)
3. What would the theory of Ricardian Equivalence predict?
4. Would did Reagan's supply-side economic theories predict would be the impact of lower marginal tax rates?