Economic integration

Wikipedia, the free encyclopedia:

The degree of economic integration can be categorized into six stages:

1. Preferential trading area
2. Free trade area
3. Customs union
4. Common market
5. Economic and monetary union
6. Complete economic integration

Economic integration also tends to precede political integration. In fact, Balassa believed that supranational common markets, with their free movement of economic factors across national borders, naturally generate demand for further integration, not only economically (via monetary unions) but also politically--and, thus, that economic communities naturally evolve into political unions over time.

This time will never be different

FT.com / Books / Non-Fiction:

The authors have put together a remarkable database on the external and domestic debt, trade, national income, inflation, exchange rates, interest rates and commodity prices of 66 countries from all over the world. The data go back more than 800 years in some cases, to the date of independence for most countries and into the colonial period for several.

What, then, do these data tell us?

The biggest lesson, alas, is that we have been here before. The details may change, but the story does not. Cycles of confidence and panic are inevitable in our world of debt, be that debt public or private, domestic or foreign. Credit is extended freely and then withdrawn brutally.

A second lesson is the recurrence of public sector debt crises. One of the salient features of the book is the light it sheds on the role of domestic public debt, on which data have hitherto been poor. This database shows how often high levels of domestic public debt have explained simultaneous outbursts of inflation and default on foreign debt, even though the latter appears to be at low levels. Crises on foreign debt also recur throughout the ages, from the default to Florentine bankers by Edward III of England, in the 14th century to the default of Argentina to its foreign creditors in 2001. In all, sovereign default turns out to be almost, though not quite, universal, with serial default on domestic, foreign or domestic and foreign debt quite common. No less universal, again particularly for emerging countries, are periods of currency debasement or, today, inflation.

A third lesson is that, while advanced countries appear to leave their days of sovereign default behind them (possibly, famous last words), this does not apply to banking crises. These are “an equal-opportunity menace”. As the authors note, “the incidence of banking crises proves to be remarkably similar in the high- and the middle- to low-income countries”. Out of the 66 countries in their sample, only Austria, Belgium, Portugal and the Netherlands managed to escape banking crises between 1945 and 2007. Financial systems are accidents waiting to happen.

Banking crises are also devastatingly expensive, in terms of lost national income and public debt. On average, note the authors, government debt rises by 86 per cent during the three years following a banking crisis. The red ink drowning the fiscal accounts of the crisis-hit US and UK are exactly what past experience would have led us to expect.

A fourth lesson is that bad things go together. In a boom, property prices jump, current account deficits explode, fiscal receipts soar and governments borrow easily; then, in the slump, property prices tumble, the financial system implodes, capital flows out, the currency falls, the fiscal deficit soars and inflation jumps.

The final lesson is that financial liberalisation and financial crises go together like a horse and carriage. It is no surprise, therefore, that the last 30 years have seen waves of financial crises, of which the latest one is merely the biggest. The current crisis is the worst since the Great Depression. Yet, argue the authors, no one should have been surprised by this outcome. The US showed all the classic symptoms of a country heading for crisis: a huge current account deficit; soaring house prices; headlong credit growth; and, let us not forget, excessively complacent regulators.

EconomPic

EconomPic:

Companies from Fast Retailing Co. to Sony Corp. are lowering prices to attract consumers who face record unemployment and plunging wages. A return to deflation that the economy only shook off in 2005 may weigh on growth as consumers and companies cut back spending in anticipation that prices will keep falling.

“We’ll soon start to see that there isn’t enough domestic demand to push up wages,” said Kyohei Morita, chief economist at Barclays Capital in Tokyo. “As households’ spending power falls, there’s concern that this deflation will lead to further deflation -- in other words, that we’ll enter into a deflationary spiral.”

Endogenous Business Cycle Models

Moral hazard can contribute to market bubbles (like the Nasdaq in 2000) and insurance cycles in which premiums collectively drop as companies compete for to lower them, but go to low and are all forced to raise them. It is not moral hazard, but durable capital goods, also have an investment cycle in which a high price for, say cranberries, induces many entrepreneurial farmers to invest in new cranberry bogs, but it takes several years for new production to come on line and once a perennial cranberry bog is created, the marginal cost is quite low, so prices suddenly drop to an a level that requires bankruptcy to close some of the farms in order to get back to a normal profit again. Cranberries went from nearly $1/# down to $0.18/# in 1997 with this kind of boom and computer memory chips have long suffered from this kind of cycle.

Richard Goodwin (1967) drew upon the biological 'predator-prey' model to explain the business cycle on the basis of 'class struggle'. The idea comes from biology in which there are natural cycles of booming populations and population decline because when a population of caribou grows, that reduces their food supply which weakens the caribou and increases the food supply of wolves. The wolf population then grows which reduces the caribou population until some of the wolves are near starvation and then the wolf population declines. The decline of the caribou population means more food supply for the survivors and once the predator population also declines, the remaining caribou begins growing once again. In Goodwin's model, businesspeople expand their businesses when wages are cheap, but in doing so, they bid up the cost of labor (wages) which makes them shrink their businesses which then causes them to reduce employment. It works for explaining fluctuations in an industrial economy, but it is less clear how it explains economic fluctuations in the service sector. Still, it is a good metaphor for economics in which there is an equilibrium model which is inherently unstable. The wolves and caribou (and grazing) are in an equilibrium that prevents massive overpopulation, but they still produce pretty big population swings. The "equilibrium" models of the macroeconomy have similar dynamics.

Goodwin's Predator-Prey Model of The Business Cycle:

Goodwin's model attempted to demonstrate the cyclical relationship between employment and wage share in a working economy. Goodwin's model is in fact not as controversial as it may sound: 'class struggle' and 'predator-prey' can invoke strident images of revolution and reaction, but nothing more radical than a standard Phillips Curve and a Kaleckian profit mechanism is at work.

The basic features of Goodwin's (1967) model can be stated simply: high employment generates wage inflation which can increase the wage share of workers in output; but this will, in turn, reduce the profits of capitalists and thus, in Kaleckian fashion, reduce future investment and output. That reduction in output will in turn reduce labor demand and employment and consequently lead to lower wage inflation or even deflation and thus reduce the wage share of workers. But as workers wage share declines, then profits increase and, with them, investment. This will lead to greater employment and thus improve the bargaining power of workers and consequently wages in Phillips Curve fashion and thus greater wage share in output - and the rest of the cycle then repeats itself. For good measure, Goodwin adds exogenous growth components - namely, labor supply growth and productivity growth.

Causes of Financial Crisis

Kevin Drum | Mother Jones:

Off the top of my head, here's a list of the various things people have blamed for last year's economic meltdown:
1. Housing bubble
2. Mortgage securitization mania
3. Massive growth of complex credit derivatives
4. Mortgage fraud, growth of NINJA/liar/HELOC/option ARM/etc.
5. Asian savings glut
6. Long-term current account imbalances
7. Ratings agency flimflam
8. 2007-08 oil shock
9. Overuse of leverage on Wall Street
10. Easy money policy from Fed
11. Reliance on bad risk models (VaR, CAPM, etc.) that led to consistent undervaluation of risk
12. Too much debt (both household and financial sector)
13. Government efforts to increase homeownership
14. Repeal of Glass-Steagall
15. Pay practices that provided incentives for risky behavior
16. Greenspan/Bernanke put (i.e., the widespread belief that Fed would bail out any big bank that failed)
17. Inadequate regulation of shadow banking sector
18. Poor bank capitalization regulations that allowed too much off-balance-sheet risk

The world economy is tracking or doing worse than during the Great Depression

Check out the link below. The graphs are fantastic and the authors are updating their graphs every couple months and it puts the current economic crisis in perspective. The US may be doing better than it did during the Great Depression so far, but the rest of the world is not.

(September 2009 update) | vox - Research-based policy analysis and commentary from leading economists:

"To summarise: the world is currently undergoing an economic shock every bit as big as the Great Depression shock of 1929-30. Looking just at the US leads one to overlook how alarming the current situation is even in comparison with 1929-30.

The good news, of course, is that the policy response is very different. The question now is whether that policy response will work. For the answer, stay tuned for our next column."

US macro disequilibria - Credit Writedowns

Charts of the day: US macro disequilibria - Credit Writedowns:

The United States had been living beyond its means for a very long time before the credit crisis finally hit. The truth of the matter is that U.S. monetary and fiscal policy rewarded risk-taking and leverage at the expense of prudence and saving.

The goal of government it seemed was to avoid the pain of recession and keep the economy growing at all times. Every time the U.S. economy would hit a stumbling block, the Federal Reserve would lower interest rates and flood the economy with money. Market participants learned to trust in the Greenspan Put — an understanding that they would be bailed out by Fed policy at the first signs of trouble.

...

Below are a number of charts that I have compiled which should make abundantly clear what the disequilibria were and how large they had become. Presently, this re-balancing is being forced upon us by a deep recession. It is unfortunate we could not have had the foresight to avoid the worst of things by taking corrective action earlier, particularly after the tech bubble in 2001.

History books will look on this period of U.S. history as one dominated by hubris, where fiscal and monetary policy were particularly reckless, leading the United States into a long period of decline.

Debt and savings

Housing and stocks

Time Of Adjustment - Russia vs. China

...the flaws in economic theory are many and varied. If there is one common theme, it is that the theory ignores the issue of time. Nowhere was this more apparent than in enthusiasm that Western economists had for Russia's rapid road to the market over China's slow and steady path. The story behind the tragedy of Russia's rapid road to the market provides an overview of the many reasons why China should continue to be sceptical about Western economic theory.

The outstanding difference between the transitions in Russia and China was the haste with which Russia undertook the task. This haste was encouraged by neoclassical economists, who advised Russia that the faster the transition occurred, the more effective it would be. One of the best-known economists involved in advising on the transition was Jeffrey Sachs, who is now Director of the Earth Institute at Columbia University. In a paper published in 1992, Sachs was emphatic that the only responsible pace of reform was high speed.

It might be thought that, since speed was such a key aspect of his recommendations, Sachs and economists like him must have modeled the impact of slow versus fast transitions and shown that the latter were, in model terms at least, clearly superior. But in fact the models from which economists took their guidance effectively ignored time. Rather than considering the time path that an economy might follow as the result of a policy change, these models presumed that the economy would move very rapidly from one equilibrium to another, and the time path of this change could be ignored.

This assumption of instantaneous change has been a key weakness of the dominant school of thought in Western economics since its inception in the 1870s. However, Russia was doubly unlucky that its period of transition coincided with the peak influence of the concept of “rational expectations” within this dominant school of thought. This intellectual fad took the neoclassical school's blasé approach to time to new and dangerous heights.

“Rational expectations” argues that consumers and producers in a market economy form their expectations in a rational manner—a statement that in itself seems innocuous. Of course there must be some people in an economic system who are irrational, but it would be foolish to assign much importance to their behavior when building a model of the economy.

However, what economists like Sachs meant by the phrase “rational expectations” was the ability to accurately predict the future of the economy.

...

Even though rational expectations has since fallen from favour in the West, I expect those who once believed in it would protest that their views were more subtle than my summary implies. I beg to differ. Though they occasionally expressed some concerns, in general neoclassical economists advised that “economic agents” could rapidly adapt to any change that was thrown at them, and that the faster change was implemented, the better. Consider, for example, the discussion of how fast Russia's transition should be in a 1992 paper by the neoclassical economist Murray Wolfson. One of his suggestions was:

Central planners seemingly should at once resign their posts and close their offices. Their departure simply would signal the market to move immediately to equilibrium. (Wolfson 1992: 37; emphasis added)

Implicit in this statement was the proposition that all Russia had to do to create a market economy was to shut down its system of central planning. In fact, markets require enormous legal, political and physical infrastructure. This should be obvious to Western economists, who after all live in advanced market (or more correctly, mixed market-state) economies. But the neoclassical vision of a market is a simple village fair where farmers and artisans bring their produce in the morning, haggle over prices, and leave in the evening with all products sold. Neoclassical economists were therefore oblivious to the many tasks that needed to be completed before a workable market infrastructure would be in place.

The belief that market processes occur instantaneously is obvious in the statement that the end of central planning would “signal the market to move immediately to equilibrium”. Less obvious is the obsession with “equilibrium” itself. As I argue later in this book, the obsession is a large part of the reason why neoclassical economics provides such a poor model of a market system.

Wolfson's discussion of a gradual approach to the transition in this paper showed how much economists relied upon the “rational expectations” belief that people are omniscient(and how little a role time plays little in the thought patterns of neoclassical economists). His argument that a gradual program would fail relied heavily on the surmised actions of “rational and reasonably knowledgeable economic agents”. As I point out, by “rational” he meant what ordinary language describes as “prophetic”: how could people acquire so profound a knowledge of a system they have not yet lived in that they could predict its behavior (and prices in it) before it existed?

Wolfson's policy prescriptions were as didactic and extreme as his actual analysis was simplistic. He advised that:

A rational expectations conclusion is that quitting communism Cold Turkey is the only way to get from A to B. In practice, governments must make the national currency convertible and allow it to float on legal as well as black markets, abolish the system of subsidies and direct plans and quotas, close plants that cannot compete, come quickly to a privatization of industry even if some inequities result, strictly control the money supply, and allow goods and services to find their own price on national and international markets. (Wolfson 1992: 39)

Wolfson did qualify his arguments with some concessions to reality, but in the end his recommendations were all for speed on the basis of a belief in the self-adjusting properties of the market economy populated not by people, but by gods.

Wolfson is far from a leading light of neoclassical economics, but his views were typical of those who recommended upon and helped implement the actual transition, as George Stiglitz makes clear in his book Globalization and its Discontents. The actual process of transition was also more subtle than the simplistic propositions put by Wolfson, with some attempt to stage the introduction of change. But in general, Russia undertook a far too rapid transition. Away from the fantasies of rational expectations economics, what this rapid exposure to international competition did was give ex-Soviet consumers instant access to Western goods, and expose Russian factories to open competition with their Western counterparts.

A time-based analysis would instead have supported a gradual transition, if only to give Russian factories time to introduce modern production technology, products and process control methods. Time would also have been set aside for the development of the framework for distribution and exchange of goods in a market system: systems of wholesale and retail distribution, respect for written contracts, systems for consumer protection, laws of exchange, lines of credit, bankruptcy laws.

Unfortunately for Russia, given the haste with which the actual transition was implemented, the only market systems that could rapidly develop were those that were already in place in the preceding socialist system—the black market that had always been there to lubricate the wheels of the shortage-afflicted Soviet system, just as market intrusions once permeated the feudal systems out of which capitalism itself evolved in Europe. That gave the upper hand to criminal elements in the development of entrepreneurial activity in Russia, in marked contrast to the breadth of involvement in entrepreneurship in China.

...The Russia specialist Marshall Goldman put this in perspective with his discussion of the different importance given to the output of consumer goods in Russia and China. He noted that the Russian “experts” were more focused upon closing down inefficient state enterprises than boosting the output of consumer goods.

In contrast, China kept state enterprises running while increasing the output of consumer goods. These twin policies had several beneficial effects. Goldman provided a pithy summary of the difference between the road recommended to Russia by Western economists, and the Chinese road:

The Chinese experience demonstrates that shock therapy is not the only way to proceed. To the shock therapists who warn that step-by-step, gradual economic reform is like crossing an abyss in two leaps, the Chinese gradualists respond that economic reform should be like crossing a river by feeling for one rock at a time. (Goldman 1996: 210)

Speech, Bernanke --Deflation-- November 21, 2002

It is nice to see that Bernanke was thinking about our current situation already seven years ago.

Speech, Bernanke --Deflation-- November 21, 2002: Deflation: Its Causes and Effects: Deflation is defined as a general decline in prices, with emphasis on the word 'general.' At any given time, especially in a low-inflation economy like that of our recent experience, prices of some goods and services will be falling. Price declines in a specific sector may occur because productivity is rising and costs are falling more quickly in that sector than elsewhere or because the demand for the output of that sector is weak relative to the demand for other goods and services. Sector-specific price declines, uncomfortable as they may be for producers in that sector, are generally not a problem for the economy as a whole and do not constitute deflation. Deflation per se occurs only when price declines are so widespread that broad-based indexes of prices, such as the consumer price index, register ongoing declines.
The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand--a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers.¹ Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending--namely, recession, rising unemployment, and financial stress.
However, a deflationary recession may differ in one respect from "normal" recessions in which the inflation rate is at least modestly positive: Deflation of sufficient magnitude may result in the nominal interest rate declining to zero or very close to zero.² Once the nominal interest rate is at zero, no further downward adjustment in the rate can occur, since lenders generally will not accept a negative nominal interest rate when it is possible instead to hold cash. At this point, the nominal interest rate is said to have hit the "zero bound."
Deflation great enough to bring the nominal interest rate close to zero poses special problems for the economy and for policy. First, when the nominal interest rate has been reduced to zero, the real interest rate paid by borrowers equals the expected rate of deflation, however large that may be.³ To take what might seem like an extreme example (though in fact it occurred in the United States in the early 1930s), suppose that deflation is proceeding at a clip of 10 percent per year. Then someone who borrows for a year at a nominal interest rate of zero actually faces a 10 percent real cost of funds, as the loan must be repaid in dollars whose purchasing power is 10 percent greater than that of the dollars borrowed originally. In a period of sufficiently severe deflation, the real cost of borrowing becomes prohibitive. Capital investment, purchases of new homes, and other types of spending decline accordingly, worsening the economic downturn.
Although deflation and the zero bound on nominal interest rates create a significant problem for those seeking to borrow, they impose an even greater burden on households and firms that had accumulated substantial debt before the onset of the deflation. This burden arises because, even if debtors are able to refinance their existing obligations at low nominal interest rates, with prices falling they must still repay the principal in dollars of increasing (perhaps rapidly increasing) real value. When William Jennings Bryan made his famous "cross of gold" speech in his 1896 presidential campaign, he was speaking on behalf of heavily mortgaged farmers whose debt burdens were growing ever larger in real terms, the result of a sustained deflation that followed America's post-Civil-War return to the gold standard.⁴ The financial distress of debtors can, in turn, increase the fragility of the nation's financial system--for example, by leading to a rapid increase in the share of bank loans that are delinquent or in default. Japan in recent years has certainly faced the problem of "debt-deflation"--the deflation-induced, ever-increasing real value of debts. Closer to home, massive financial problems, including defaults, bankruptcies, and bank failures, were endemic in America's worst encounter with deflation, in the years 1930-33--a period in which (as I mentioned) the U.S. price level fell about 10 percent per year.
Beyond its adverse effects in financial markets and on borrowers, the zero bound on the nominal interest rate raises another concern--the limitation that it places on conventional monetary policy. Under normal conditions, the Fed and most other central banks implement policy by setting a target for a short-term interest rate--the overnight federal funds rate in the United States--and enforcing that target by buying and selling securities in open capital markets. When the short-term interest rate hits zero, the central bank can no longer ease policy by lowering its usual interest-rate target.⁵
Because central banks conventionally conduct monetary policy by manipulating the short-term nominal interest rate, some observers have concluded that when that key rate stands at or near zero, the central bank has "run out of ammunition"--that is, it no longer has the power to expand aggregate demand and hence economic activity. It is true that once the policy rate has been driven down to zero, a central bank can no longer use its traditional means of stimulating aggregate demand and thus will be operating in less familiar territory. The central bank's inability to use its traditional methods may complicate the policymaking process and introduce uncertainty in the size and timing of the economy's response to policy actions. Hence I agree that the situation is one to be avoided if possible.
However, a principal message of my talk today is that a central bank whose accustomed policy rate has been forced down to zero has most definitely not run out of ammunition. As I will discuss, a central bank, either alone or in cooperation with other parts of the government, retains considerable power to expand aggregate demand and economic activity even when its accustomed policy rate is at zero. In the remainder of my talk, I will first discuss measures for preventing deflation--the preferable option if feasible. I will then turn to policy measures that the Fed and other government authorities can take if prevention efforts fail and deflation appears to be gaining a foothold in the economy.
Preventing Deflation
As I have already emphasized, deflation is generally the result of low and falling aggregate demand. The basic prescription for preventing deflation is therefore straightforward, at least in principle: Use monetary and fiscal policy as needed to support aggregate spending, in a manner as nearly consistent as possible with full utilization of economic resources and low and stable inflation. In other words, the best way to get out of trouble is not to get into it in the first place. Beyond this commonsense injunction, however, there are several measures that the Fed (or any central bank) can take to reduce the risk of falling into deflation.
First, the Fed should try to preserve a buffer zone for the inflation rate, that is, during normal times it should not try to push inflation down all the way to zero.⁶ Most central banks seem to understand the need for a buffer zone. For example, central banks with explicit inflation targets almost invariably set their target for inflation above zero, generally between 1 and 3 percent per year. Maintaining an inflation buffer zone reduces the risk that a large, unanticipated drop in aggregate demand will drive the economy far enough into deflationary territory to lower the nominal interest rate to zero. Of course, this benefit of having a buffer zone for inflation must be weighed against the costs associated with allowing a higher inflation rate in normal times.
Second, the Fed should take most seriously--as of course it does--its responsibility to ensure financial stability in the economy. Irving Fisher (1933) was perhaps the first economist to emphasize the potential connections between violent financial crises, which lead to "fire sales" of assets and falling asset prices, with general declines in aggregate demand and the price level. A healthy, well capitalized banking system and smoothly functioning capital markets are an important line of defense against deflationary shocks. The Fed should and does use its regulatory and supervisory powers to ensure that the financial system will remain resilient if financial conditions change rapidly. And at times of extreme threat to financial stability, the Federal Reserve stands ready to use the discount window and other tools to protect the financial system, as it did during the 1987 stock market crash and the September 11, 2001, terrorist attacks.
Third, as suggested by a number of studies, when inflation is already low and the fundamentals of the economy suddenly deteriorate, the central bank should act more preemptively and more aggressively than usual in cutting rates (Orphanides and Wieland, 2000; Reifschneider and Williams, 2000; Ahearne et al., 2002). By moving decisively and early, the Fed may be able to prevent the economy from slipping into deflation, with the special problems that entails.
As I have indicated, I believe that the combination of strong economic fundamentals and policymakers that are attentive to downside as well as upside risks to inflation make significant deflation in the United States in the foreseeable future quite unlikely. But suppose that, despite all precautions, deflation were to take hold in the U.S. economy and, moreover, that the Fed's policy instrument--the federal funds rate--were to fall to zero. What then? In the remainder of my talk I will discuss some possible options for stopping a deflation once it has gotten under way. I should emphasize that my comments on this topic are necessarily speculative, as the modern Federal Reserve has never faced this situation nor has it pre-committed itself formally to any specific course of action should deflation arise. Furthermore, the specific responses the Fed would undertake would presumably depend on a number of factors, including its assessment of the whole range of risks to the economy and any complementary policies being undertaken by other parts of the U.S. government.⁷
Curing Deflation
Let me start with some general observations about monetary policy at the zero bound, sweeping under the rug for the moment some technical and operational issues.
As I have mentioned, some observers have concluded that when the central bank's policy rate falls to zero--its practical minimum--monetary policy loses its ability to further stimulate aggregate demand and the economy. At a broad conceptual level, and in my view in practice as well, this conclusion is clearly mistaken. Indeed, under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero.
The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning. A little parable may prove useful: Today an ounce of gold sells for $300, more or less. Now suppose that a modern alchemist solves his subject's oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost. Moreover, his invention is widely publicized and scientifically verified, and he announces his intention to begin massive production of gold within days. What would happen to the price of gold? Presumably, the potentially unlimited supply of cheap gold would cause the market price of gold to plummet. Indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce of yellow metal.
What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.
Of course, the U.S. government is not going to print money and distribute it willy-nilly (although as we will see later, there are practical policies that approximate this behavior).⁸ Normally, money is injected into the economy through asset purchases by the Federal Reserve. To stimulate aggregate spending when short-term interest rates have reached zero, the Fed must expand the scale of its asset purchases or, possibly, expand the menu of assets that it buys. Alternatively, the Fed could find other ways of injecting money into the system--for example, by making low-interest-rate loans to banks or cooperating with the fiscal authorities. Each method of adding money to the economy has advantages and drawbacks, both technical and economic. One important concern in practice is that calibrating the economic effects of nonstandard means of injecting money may be difficult, given our relative lack of experience with such policies. Thus, as I have stressed already, prevention of deflation remains preferable to having to cure it. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.
So what then might the Fed do if its target interest rate, the overnight federal funds rate, fell to zero? One relatively straightforward extension of current procedures would be to try to stimulate spending by lowering rates further out along the Treasury term structure--that is, rates on government bonds of longer maturities.⁹ There are at least two ways of bringing down longer-term rates, which are complementary and could be employed separately or in combination. One approach, similar to an action taken in the past couple of years by the Bank of Japan, would be for the Fed to commit to holding the overnight rate at zero for some specified period. Because long-term interest rates represent averages of current and expected future short-term rates, plus a term premium, a commitment to keep short-term rates at zero for some time--if it were credible--would induce a decline in longer-term rates. A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years). The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields. If this program were successful, not only would yields on medium-term Treasury securities fall, but (because of links operating through expectations of future interest rates) yields on longer-term public and private debt (such as mortgages) would likely fall as well.
Lower rates over the maturity spectrum of public and private securities should strengthen aggregate demand in the usual ways and thus help to end deflation. Of course, if operating in relatively short-dated Treasury debt proved insufficient, the Fed could also attempt to cap yields of Treasury securities at still longer maturities, say three to six years. Yet another option would be for the Fed to use its existing authority to operate in the markets for agency debt (for example, mortgage-backed securities issued by Ginnie Mae, the Government National Mortgage Association).

Policy and housing: someone’s gotta give!

Angry Bear:

Housing demand is being propped up by government subsidies and low mortgage rates, and the level of supply is held back by low prices. Right now, the housing market is a complicated hodgepodge of policy, foreclosures, and very weary potential home-buyers.

Home sales are stabilizing; home building is stabilizing; and home prices (might be) stabilizing - the chart to the left illustrates a positive trend in sales away from distressed and first-time home-buyers, the targets of policy, according to the NAR. But what would the housing market look like if the massive policy expired this year? Not good, and it will.
Some points on the housing market:

1. Subsidies are set to expire. If the Fed continues to buy its average of $105 billion in GSE-backed MBS per month (see the NY Fed’s website for weekly updates), it will max out the announced $1.25 trillion in four months. The $8,000 tax credit for first-time home-buyers expires at the end of this year. The Fed’s Treasury buyback program will run its course by October.
2. There are several home price indices out there, each painting a slightly different picture of the level and trend in aggregate home values (see AB post).
3. The foreclosure modifications program is holding off some foreclosures; but the program is no match for market forces.
4. There is a large shadow inventory out there - potential sellers that are reluctant or unwilling (TIME calls some of these sellers “accidental landlords”) to relinquish home ownership at current prices. However, if home values continue to take baby steps forward, shadow sellers (new supply) will emerge.
5. There is a bimodal distribution of sales across the high-end and low-end housing markets. Low-end sales are hot, while the upper end is not.

The housing market still has a long, long way to go before unsubsidized demand equals supply at a price that doesn’t exacerbate foreclosures – strategic or otherwise. With virtually all of the subsidies expiring within four months, it’s hard to believe that policymakers won’t give.

So who’s gonna cry uncle? My bet’s on the Fed, as it lacks
does not require Congressional approval. Some Fed officials even tout that the MBS program should be scaled back; that’s ridiculous, given points 1. through 5. above. I agree with Daniel Indiviglio at the Atlantic: the Fed is more likely to increase its MBS purchase program, rather than to curtail or even adhere to the current limit.

By the way, the Fed and the Treasury have successfully dropped mortgage spreads to 2006 levels, even lower on the 30-yr; but it took an accumulation of $1 trillion in MBS to date to do that.

Does the Equation of Exchange Shed Any Light on the Crisis?

I think it is remarkable how well the Fed has done at keeping the US out of deflation and preventing a complete collapse in banking and output. Look at the graph below and see the dramatic fall in the money multiplier due to the financial collapse. The Fed has made equally dramatic increases in the monetary base.

Macro and Other Market Musings:

James Hamilton thinks the answer is no. In his reply to Scott Sumner's lead article at Cato Unbound, he questions Sumner's use of the identity MV = PY to explain the collapse of nominal spending over the past year. (In this equation M = money supply, V = velocity or the average number of times a unit of money is spent, P = price level, Y = real GDP, and PY = nominal GDP.) Hamilton contends the only meaningful use of the identity is to determine velocity (i.e. V=PY/M) and even then it is not totally reliable since it can vary based on the measure of money one uses.I believe, however, Hamilton under appreciates the insights this identity can shed on the crisis. It may not provide precise policy recommendations, but it does provide a starting point from which to think analytically and empirically about recent economic developments.

So what does this identity tells us about the crisis? To answer this question we first need to expand the identity a bit. To do so, note that the money supply is the product of the monetary base, B, times the money multiplier, m or

M = Bm.

Now substitute this into the equation of exchange to get the following:

BmV = PY.

Now we have an identity that says the sources of nominal spending are the monetary base, the money multiplier, and velocity. With this identity in hand we can asses the contribution of these three sources to the dramatic decline in nominal spending in the past year. Using MZM as the measure of money (see here for why MZM is preferred over M1 and M2) and monthly nominal GDP from Macroeconomic Advisers to construct velocity, the three series are graphed below in levels (click on figure to enlarge):

This figure indicates that declines in the money multiplier and velocity have both been pulling down nominal GDP. The decline in the money multiplier reflects (1) the problems in the banking system that have led to a decline in financial intermediation as well as (2) the interest the Fed is paying on excess bank reserves. The decline in the velocity is presumably the result of an increase in real money demand created by the uncertainty surrounding the recession. This figure also shows that the Federal Reserve has been significantly increasing the monetary base, which should, all else equal, put upward pressure on nominal spending. However, all else is not equal as the movements in the money multiplier and the monetary base appear to mostly offset each other. Therefore, it seems that on balance it has been the fall in velocity (i.e. the increase in real money demand) that has driven the collapse in nominal spending.

To get a better sense of what is happening with theses series note that log of the expanded equation of exchange can be stated as follows:

B+m+V = P+Y,

Now if we take first differences of the the quarterly log values of the series in the above identity we get a quarterly growth rate approximation. (Note, this approximation is not very good for large differences like the one for the monetary base in 2008:Q4.) Below is a table with the results in annualized values (Click to enlarge):

This table confirms what we saw in the levels: a sharp decline in velocity appears to be the main contributor to the collapse in nominal spending in late 2008 and early 2009 as changes in the monetary base and the money multiplier largely offset each other. It is striking that the largest run ups in the monetary base occurred in the same quarters (2008:Q3, 2008:Q4) as the largest drops in the money multiplier. If the Fed's payment on excess reserves were the main reason for the decline in the money multiplier and if the Fed used this new tool in order to allow for massive credit easing (i.e. buying up troubled assets and bringing down spreads) without inflation emerging, then the Fed's timing was impeccable. Unfortunately, though, it appears the Fed was so focused on preventing its credit easing program from destabilizing the money supply that it overlooked, or least underestimated, developments with real money demand (i.e. velocity). As a consequence, nominal spending crashed.

Now maybe this is self evident to some, but I find the above information from the equation of exchange useful as a starting point for discussing what went wrong and where to go from here.

All of the buzzwords in one post: quantitative easing, inflation and printing money

News N Economics:

Quantitative easing (QE) by the Fed has begun. But before we can address the Fed’s QE strategy, we must get one thing straight. First, a QE policy is not a zero interest rate policy (ZIRP). The federal funds target is currently 1%, and although the Fed has initiated a QE strategy, it has not declared ZIRP…yet. The next scheduled meeting is December 15-16, where the Fed may very well set the policy rate closer to 0%.

Without explicitly setting the federal funds target to 0%, the Fed is currently engaging in another non-traditional policy, quantitative easing (QE). Under a QE policy, the Fed increases bank reserves beyond levels consistent with ZIRP (technical definition according to Bernanke, Reinhart, and Sack). QE implies that the Fed no longer targets an interest rate.

The flood gates are open. The Fed is injecting the banking system with shiny new reserves (liquidity) and is no longer using open market operations to keep the effective federal funds rate – the overnight interbank loan rate – close to its target, currently 1%.

In laymen’s terms, the Fed is printing money under the QE policy; the idea of the Fed printing money has clearly caused some confusion for readers. Printing money is a pejorative term that is often associated with inflation, or worse, hyperinflation. In normal times, a QE strategy would certainly result in newly available money, but we are not in normal times.

The Fed is not printing money, rather it is printing high powered money, where high powered money is the monetary base (reserves).

What is the difference between money and high powered money? Money is a function of two things

1. The monetary base, which equals bank reserves plus currency in circulation
2. The money multiplier, or how quickly the base switches hands in a fractional reserve banking system (for a discussion of money creation, see this wiki article).

The Fed is raising the monetary base through its QE policy and increasing its balance sheet (credit extended to the banking system) from $884 billion on August 28 to $2.1 trillion on November 28. The Fed simply creates new monetary base (reserves) out of thin air; hence, the printing money connotation.
However, banks are hoarding the new base in the form of excess reserves, and lending has slowed significantly relative to the size of the new reserve base. Therefore, the money multiplier is collapsing.
Will the Fed’s QE strategy lead to inflation? In the short-term, no. The money multiplier is falling because the economy is in a nasty recession alongside a serious credit crisis. In this environment, the surge of high powered money will not cause prices to rise.
Prices can drop in a recession (deflation) because the demand for goods and services falls with rising unemployment and declining income. But the 2008 recession is accompanied (or partially caused) by a credit crisis that induces banks to hoard the new base as excess reserves; this adds to the deflationary pressures (possibly reducing the money supply). If deflation were to become embedded into consumer and firm expectations, then the macroeconomy could be facing a severe problem. So for now, and until the economy emerges from its recession, QE will not lead to inflation.

But what happens when the economy rebounds? Inflation becomes a serious risk if the Fed does not extract the high powered money. If the Fed gets it wrong, or its timing is off, then the money supply will rise quickly as banks start to lend more freely, and inflation results.

Deflation for dummies

News N Economics:

Deflation is a a nominal phenomenon and is determined by the quantity of money available in the economy relative to the demand for money. Deflation will result if:

• Strong productivity growth is not matched by a likewise increase in the money supply.
• Declining money supply due to restrictive monetary policy or a collapsing money multiplier.

Keynesian models allow for real shocks to the economy to affect price levels via aggregate demand. In this case, a crash in the housing market that affects aggregate consumption could cause price levels to decline as long as the Fed does not respond by cutting its nominal target to stimulate the macro-economy. Whatever the cause, deflation is a U.S. anomaly.

The chart lists annual inflation in the U.S. spanning back to the Great Depression. This 43-month recession saw deflation up to -10.74% and a severe contraction in economic activity; the average annual growth rate spanning 1930-1933 was -9.3%.
This is a perfect example to illustrate how deflation can be a serious problem. Driven by severely restrictive monetary policy (the central bank was not increasing the monetary base quickly enough), saving was wiped out and the availability of goods and services fell substantially.

The classic economic costs of deflation are:

• With debt obligations being set in advance and deflation occurring unexpectedly – think of a fixed mortgage rate –all nominal variables fall (labor income), except for those tied to preset debt obligations. The resulting economic impact is a transfer of wealth from the debtor to the creditor. The deflation gives easy money to those who made the fixed loans, and causes difficulty in making payments for those who took out the loans. Debtor spending falls (must consume less to make the mortgage payments) and saving falls, but this is unlikely matched by an increase in spending and saving on the part of the creditors. The aggregate effect can be disastrous: spending contracts, saving is wiped out and default rates skyrocket.
• Production and consumption decisions based on price expectations change. Consumers and firms do not know what to expect going forward, resulting in less demand and less production. If deflation becomes embedded in consumer expectations, consumers spending falls and economic growth suffers further.

Deflation is not an axiom of recessions. Prices fell during the 2001 recession and afterward because of the weak labor market. The rising unemployment rate put downward pressure on wages that dragged down price pressures, resulting in sharp disinflation (deflation on a monthly basis). Furthermore, prices fell in the 1981-1982 recession because Paul Volcker restricted the money supply with the exact intent of driving down inflation. However, during the 1980 recession, inflation hit 14.73% during the quarter that saw a -7.8% contraction.

Some say that the Fed is pushing on a piece of string: flooding the banking system with massive amounts of liquidity and seeing no stark improvement in the macro-economy. However, what the Fed is doing is maintaining positive money supply growth positive. As long as Bernanke keeps the liquidity hose on and the money multiplier doesn’t fall to zero, the money supply will not contract.
The money supply is growing and sharply reducing the probability that deflation – especially levels seen in the Great Depression – disrupts the macro-economy.

To be sure, the Fed is worried about deflationary pressures, as illustrated by its shift toward quantitative easing. However, the Fed is doing its job by keeping the money supply afloat. It’s Congress’ turn to step up with its $500 billion stimulus package to rescue the macro-economy.
Rebecca Wilder

Money creation - Wikipedia, the free encyclopedia

Money creation - Wikipedia, the free encyclopedia: Three ways to create money are; by manufacturing paper currency or metal coins, through debt and lending, and by government policies such as quantitative easing.

Money creation through the fractional reserve system

Main article: Fractional-reserve banking

Further information: Money supply

To avoid confusion, keep in mind that a "central bank" is not technically a federal institution - it is a private bank, not unlike other private banks, except for the fact that it has the right to control the initial issuance of debt-backed monies to a central government. Almost all nations have central banks, and almost all of the world's money supply is controlled not by governments, but by private bankers. Fractional-reserve banking creates money whenever a new loan is created. In short, there are two types of money in a fractional-reserve banking system, the two types being legally equivalent:

1. central bank money (M0 or MB = all money created by the central bank regardless of its form (banknotes, coins, electronic money through loans to private banks))
   
2. commercial bank money (M1 - M3 = money created in the banking system through borrowing and lending) - sometimes referred to as checkbook money^[5]

When a commercial bank loan is extended, new commercial bank money is created. As a loan is paid back, the commercial bank money disappears from existence.

Re-lending

The mainstream economics theory of monetary creation is that commercial bank money is created by commercial banks re-lending central bank money: the central bank (a privately-owned institution) lends money to another commercial bank, which re-loans part of it, due to fractional reserves, and this portion is in turn itself re-lent (it is re-re-lent central bank money). This theory is disputed by some schools of heterodox economics, such as monetary circuit theory.
The table below displays how central bank money is used to produce commercial bank money via successive re-lending in this theory.

Fractional-Reserve Lending Cycled 10 times with a 20 percent reserve rate
individual bank	amount deposited	amount loaned out	reserves
A	100	80	20
B	80	64	16
C	64	51.20	12.80
D	51.20	40.96	10.24
E	40.96	32.77	8.19
F	32.77	26.21	6.55
G	26.21	20.97	5.24
H	20.97	16.78	4.19
I	16.78	13.42	3.36
J	13.42	10.74	2.68
K	10.74
			total reserves:
			89.26
	total amount deposited:	total amount loaned out:	total reserves + last amount deposited:
	457.05	357.05	100
	commercial bank money created + central bank money:	commercial bank money created:	central bank money:
	457.05	357.05	100

Although no new money was physically created in addition to the initial $100 deposit, new commercial bank money is created through loans. The 2 boxes marked in red show the location of the original $100 deposit throughout the entire process. The total reserves plus the last deposit (or last loan, whichever is last) will always equal the original amount, which in this case is $100. As this process continues, more commercial bank money is created. For more information on how this system works, see Fractional-reserve banking.
An earlier form of such a table, featuring reinvestment from one period to the next and a geometric series, is found in the tableau économique of the Physiocrats, which is credited as the "first precise formulation" of such interdependent systems and the origin of multiplier theory.^[9]

Money multiplier

The expansion of $100M through fractional-reserve lending at varying rates. Each curve approaches a limit. This limit is the value that the money multiplier calculates.

The most common mechanism used to measure this increase in the money supply is typically called the money multiplier. It calculates the maximum amount of money that an initial deposit can be expanded to with a given reserve ratio – such a factor is called a multiplier.

Formula

The money multiplier, m, is the inverse of the reserve requirement, R:

This formula stems from the fact that the sum of the "amount loaned out" column above can be expressed mathematically as a geometric series with a common ratio of 1 − R.
To correct for currency drain (a lessening of the impact of monetary policy due to peoples' desire to hold some currency in the form of cash) and for banks' desire to hold reserves in excess of the required amount, the formula

can be used, where Currency Drain is the percentage of money that people want to hold as cash and the Desired Reserve Ratio is the sum of the Required Reserve Ratio and the Excess Reserve Ratio.
Example
For example, with the reserve ratio of 20 percent, this reserve ratio, R, can also be expressed as a fraction:

So then the money multiplier, m, will be calculated as:

This number is multiplied by the initial deposit to show the maximum amount of money it can be expanded to.

Money creation through quantitative easing

Main article: Quantitative easing

Quantitative easing refers to the creation of a significant amount of new money (usually electronically) by a central bank. It is sometimes referred to as "printing money". This money is created to stimulate the economy, in particular to promote lending by banks. The central banks use the created money to buy up large quantities of securities from banks. This appears as deposits and gives the banks new money to lend. These securities could be government bonds, commercial loans, asset backed securities, or even stocks. Quantitative easing is usually used when lowering official interest rates is no longer effective because they are already close to or at zero.

See this graph of the Fed's balance sheet to see a history of what happened.  In March 2008, Bear Sterns collapsed which caused the Fed to do "qualitative easing" in which it reduced the quality of its assets from the safest possible short term government debt to loans to the banking industry.  Then when Lehman Brothers collapsed in September, the Fed engaged in quantitative easing in earnest.   Japan pioneered quantitative easing during their liquidity trap deflation, but unfortunately, it has not brought an economic recovery to Japan.  At best it has kept Japan's banks alive. 

Alternative theories

The above gives the mainstream economics theory of money creation. In heterodox economics, alternative theories of how money is created include:

• Chartalism, which holds that money is created by government deficit spending, and emphasizes (and advocates) fiat money.
• Circuitist money theory, held by some post-Keynesians, which argues that money is created endogenously by the banking system, rather than exogenously by central bank lending. Further, they argue that money is not neutral – a credit money system is fundamentally different from a barter money system, and money and banks must be an integral part of economic models.

Debt Fueled Economic Growth

EconomPic:

Ignoring the massive spike in government related debt (Federal, State, AND Local) for the time being and focusing instead on household liabilities as a percent of the national income, we see mortgage debt is now at 70% of GDP (more than double the level seen in the 1980's and 50% more than that seen at the beginning of this decade) and consumer debt is now at 18% of GDP.

The importance of all this is of course that all that debt that has been added over the years has been a huge contributor to that GDP. The fear is that the debt has just pulled a lot of consumption forward rather than infrastructure or other long term investments that will provide future growth opportunities.

Who is this debt owed to?  I presume most of it is just owed to other Americans.  The current account deficit represents the additional debt that is owed abroad.  Nevertheless, increasing credit tends to increase GDP and if that credit was spent on productive investment that makes the country more productive, then it will be easy to unwind the increase in debt.  If not, well...
The mortgage debt is a far bigger deal than the other debt because it is on a much bigger scale.  They should be graphed on the same scale and then it would be clearer.

Keynesian beauty contest

Keynesian beauty contest - Wikipedia, the free encyclopedia:

A Keynesian beauty contest is a concept developed by John Maynard Keynes and introduced in Chapter 12 of his work, General Theory of Employment Interest and Money (1936), to explain price fluctuations in equity markets. Keynes described the action of rational agents in a market using an analogy based on a fictional newspaper contest, in which entrants are asked to choose a set of six faces from photographs of women that are the 'most beautiful'. Those who picked the most popular face are then eligible for a prize.

A naïve strategy would be to choose the six faces that, in the opinion of the entrant, are the most beautiful. A more sophisticated contest entrant, wishing to maximize his chances of winning a prize, would think about what the majority perception of beauty is, and then make a selection based on some inference from his knowledge of public perceptions. This can be carried one step further to take into account the fact that other entrants would each have their own opinion of what public perceptions are. Thus the strategy can be extended to the next order, and the next, and so on, at each level attempting to predict the eventual outcome of the process based on the reasoning of other rational agents.

...

Keynes believed that similar behavior was at work within the stock market. This would have people pricing shares not based on what they think their fundamental value is, but rather on what they think everyone else thinks their value is, or what everybody else would predict the average assessment of value is.

Other, more explicit scenarios help to convey the notion of the beauty contest as a convergence to Nash Equilibrium.

Tobin tax: could it work? - OECD Observer

Tobin tax: could it work? - OECD Observer: "Tax avoidance would probably grow too, further reducing the Tobin tax's ability to yield revenue. Two principal types are likely: first, the migration of the foreign exchange market to tax-free jurisdictions; and second, the substitution of tax-free for taxable transactions.

Migration would occur unless all jurisdictions with major foreign exchange market turnover adopted the tax. Trading could be drawn to new sites, such as an offshore tax haven somewhere. This migration could be prevented by a punitive tax on all transactions with that haven, enabling trading to continue with complying sites. This penalty would reduce the risk of a migration flood gate being opened by a 'first mover'. But it would only work with small jurisdictions. If one of the larger established markets, like Frankfurt or Hong Kong for instance, did not adopt a Tobin tax, plenty of dealers would shift to that tax-free market and trade among themselves, without being affected by any punitive measures. The tax base would clearly be eroded as a result.

To stop substitution of taxable foreign exchange transactions by tax-free ones, the Tobin tax would have to cover several financial instruments and keep up with new ones created to circumvent the tax. For instance, a tax on spot transactions can be avoided easily by using short-dated forward transactions. So, these would have to be taxed as well. And as swap transactions combine a spot with an offsetting forward contract, they would also have to be taxed. Moreover, taxing currency swaps alone will not do, as a foreign exchange transaction can be replicated by a combination of a currency and treasury bill swap, thereby evading the currency market (and the tax) to some extent.

Even assuming the Tobin tax was feasible to operate, would it be economically desirable? Put another way, would it lower distortions in international capital markets and encourage less volatility, or crisis-prone investment and help alleviate poverty?

The original purpose of Mr Tobin's proposal -- to reduce 'excessive' exchange rate volatility -- has moved to the background. After all, the size of the monthly changes in the relative value of key currencies has not grown in line with the rise in international capital mobility of recent decades. On the contrary, as we have seen, the Tobin tax might well reduce the liquidity of foreign exchange markets. And because it reduces hedging activities in the market, it would encourage more pure speculation and hence lead to more, not less, volatility.

Most observers are less concerned with short-term volatility (which can be hedged) than with longer term misalignment of exchange rates, notably those of emerging markets. Such misalignment may at times be rooted in boom-bust cycles of private lending and investment to developing countries. But the Tobin tax would not be large enough to counter these cycles, whose risk-adjusted returns would, given the sudden swings from euphoria to panic, require extremely high tax rates to balance them.

There are other uncertainties too: can we be sure that political leaders today and tomorrow would use their Tobin tax receipts for development? Is the tax administratively feasible to collect? How would it affect aid?"

George Soros On Tobin Tax

George Soros: Open Societies, Sovereignty, and International Terrorism | Asia Society: "There has been a lot of discussion about the so-called Tobin tax on currency transactions. I think there is a case for such a tax, not only on currency transactions, but also on all financial transactions. But it is different from the one that has been put forward by James Tobin. It is not at all clear to me that a Tobin tax would reduce volatility in the currency markets. It is true that it may discourage currency speculation but it would also reduce the liquidity of the marketplace, so that chunky transactions, such as mergers and acquisitions, would have a greater impact on exchange rates. The case for a Tobin-type tax is different. The globalization of financial markets has given financial capital an unfair advantage over other sources of taxation. A tax on financial transactions would redress the balance. Why should there be a Value Added Tax (VAT) but no tax on financial transactions? On these grounds, the tax ought to be extended to all financial markets and not only currency markets. There are, however, many serious problems concerning the implementation of a Tobin tax. How to tax derivatives and synthetic instruments? How to collect the tax? Collection has to be worldwide including tax havens. How to enforce the tax? The collecting country has to be given a share of the proceeds. How big a share? All these problems could be resolved but they could also serve as an excuse for not introducing a Tobin tax. Moreover, it is not enough to introduce a tax; we must also ensure that it is put to good use."

Fact Sheet on Tobin Taxes

Fact Sheet on Tobin Taxes: What are Tobin Taxes?

They are simple sales taxes on currency trades across borders. The original proposal came from James Tobin, Ph.D., a Nobel laureate economist at Yale, but economists have since refined his approach. Tobin Taxes can be enacted domestically by national legislatures, but will require multilateral cooperation to be effectively enforced... Political will for passage is the major obstacle to be overcome, by citizen mobilization...

The proposal is important due to its potential to prevent financial crises. Also, the estimated $100 - $300 billion per year makes it possible to meet urgent global priorities, such as preventing global warming, disease, and poverty. Help turn the tide towards global solutions in the 21st century...

How Tobin-style Taxes would work:

• Currency speculators trade over $1.8 trillion dollars each day across borders. The market is huge, and volatile.
• Each trade would be taxed at 0.1 to 0.25 percent of volume (about 10 to 25 cents per hundred dollars)
• This would discourage short-term currency trades,about 90 percent speculative, but leave long-term productive investments intact.
• The currency market would thus shrink in volume, helping to restore national economic autonomy. Nations again could intervene effectively to protect their own currency from devaluation and financial crisis.
• Billions in revenue, estimated at $100 - $300 billion per year, would be generated.
• Revenue could go into earmarked trust funds to fund urgent international priorities.

Recent Macroeconomic Thought as an Interrupted Three-Cornered Cage Match

Recent Macroeconomic Thought as an Interrupted Three-Cornered Cage Match: "Recent Macroeconomic Thought as an Interrupted Three-Cornered Cage Match
Greenspanists, Producerists, Punchbowlers—and Nihilists
Download pdf version: 70.pdf">20090921 macro thought >70.pdf.

Also second part here. 

Growth vs. Safety

The Costs of Economic Growth, by Charles I. Jones, Stanford GSB and NBER, August 18, 2009:

In October 1962, the Cuban missile crisis brought the world to the brink of a nuclear holocaust. President John F. Kennedy put the chance of nuclear war at “somewhere between one out of three and even.” The historian Arthur Schlesinger, Jr., at the time an adviser of the President, later called this “the most dangerous moment in human history.”1 What if a substantial fraction of the world’s population had been killed in a nuclear holocaust in the 1960s? In some sense, the overall cost of the technological innovations of the preceding 30 years would then seem to have outweighed the benefits.

While nuclear devastation represents a vivid example of the potential costs of technological change, it is by no means unique. The benefits from the internal combustion engine must be weighed against the costs associated with pollution and global warming. Biomedical advances have improved health substantially but made possible weaponized anthrax and lab-enhanced viruses. The potential benefits of nanotechnology stand beside the threat that a self-replicating machine could someday spin out of control. Experimental physics has brought us x-ray lithography techniques and superconductor technologies but also the remote possibility of devastating accidents as we smash particles together at ever higher energies. These and other technological dangers are detailed in a small but growing literature on so-called “existential risks”; Posner (2004) is likely the most familiar of these references, but see also Bostrom (2002), Joy (2000), Overbye (2008), and Rees (2003).

...This paper explores what might be called a “Russian roulette” theory of economic growth. Suppose the overwhelming majority of new ideas are beneficial and lead to growth in consumption. However, there is a tiny chance that a new idea will be particularly dangerous and cause massive loss of life. Do discovery and economic growth continue forever in such a framework, or should society eventually decide that consumption is high enough and stop playing the game of Russian roulette? The answer turns out to depend on preferences. For a large class of conventional specifications, including log utility, safety eventually trumps economic growth. The optimal rate of growth may be substantially lower than what is feasible, in some cases falling all the way to zero.