Accounting Identities - NYTimes.com

Accounting Identities - NYTimes.com:

Peter Dorman has a good post on the meaning of deficit misses in Europe, This Is What Accounting Identities Look Like. It meshes with the way I’ve been trying to explain our mess lately; so let me go back to Sam and Janet — that is, to how to think about the role of debt in our problems.

The background to the world economic crisis is that we went through an extended period of rising debt. Now, one person’s liability is another person’s asset, so rising debt made the world as a whole neither richer nor poorer. It did, however, leave the borrowers increasingly leveraged. And then came the Minsky moment; suddenly, investors were no longer willing to roll over, let alone increase, the debts of highly leveraged players. So these players are being forced to pay down debt.

The process of paying down debt, however, must obey two rules:

1. Those who pay down debt must do so by spending less than their income.
2. For the world as a whole, spending equals income.

It follows that

3. Those who are not being forced to pay down debt must spend more than their income.

But here’s the problem: there’s no good mechanism in place to induce those who can spend more to do so. Low interest rates do encourage spending; but given the size of the debt shock, even zero rates are nowhere near low enough.

So since the world economy can’t raise the bridge, it is lowering the water: without sufficient spending from those who can, the only way to make the accounting identities hold is for incomes to decline — specifically, the incomes of those not constrained by debt must decline so as to create a sufficiently large gap between their (unchanged) spending and their incomes to offset the forced saving of debtors. Of course, the mechanism here is an overall global slump, so the debtors are squeezed as well, forced into even more painful cuts.

To avoid all this, we’d need policies to encourage more spending. Fiscal stimulus on the part of financially strong governments would do it; quantitative easing can help, but only to the extent that it encourages spending by the financially sound, and it’s a little unclear what the process there is supposed to be.

Oh, and widespread debt forgiveness (or inflating away some of the debt) would solve the problem.

But what we actually have is a climate in which it’s considered sensible to demand fiscal austerity from everyone; to reject unconventional monetary policy as unsound; and of course to denounce any help for debtors as morally reprehensible. So we’re in a world in which Very Serious People demand that debtors spend less than their income, but that nobody else spend more than their income.

And the slump goes on.

Why Quantitative Easing Needs to Involve Securities Other than Government Securities - Grasping Reality with Both Hands

Why Quantitative Easing Needs to Involve Securities Other than Government Securities - Grasping Reality with Both Hands:

The point--from one point of view, the neo-Wicksellian point of view--behind quantitative easing is to reduce the interest rate that matters for private business investment: the long-term, default-risky, systemic-risky, beta-risky, real interest rates at which private businesses finance their capital expenditures. You can reduce this flow-of-funds equilibrium interest rate and raise the level of economic activity in any neo-Wicksellian framework in two ways:

1. Reduce the 'safe' real interest rate on short-term, safe government bonds.
2. Reduce the various premia--duration, default, systemic risk, and beta risk--between the rates the Treasury pays to borrow in T-bills and the rates businesses pay to borrow.

Conventional open-market operations that lower the nominal interest rate on T-bills accomplish the first. Once the nominal interest rate on T-bills has been pushed to zero, quantitative easing policies that create expectations of higher future inflation continue to lower the real interest rate on T-bills and thus help the situation.

Suppose, however, that the nominal interest rate on T-bills is zero and that you cannot alter inflation expectations--cannot commit to keeping your quantitative easing permanent, cannot commit to an exchange rate path, whatever, you cannot do it and inflation expectations are immovable. Then what?

Then, as Paul Krugman says, quantitative easing is working be altering the spread between the short-term safe T-bill rate and the long-term, systemic-risky, beta-risky, default-risky rate. How does it do that? Lloyd Metzler and James Tobin would say that it does so by altering relative asset supplies--by taking duration risk, systemic risk, beta risk, and default premia off of private savers' books and placing them on the government's books (and thus on the taxpayers, who are a very different group of people than are private savers). To the extent that quantitative easing thus involves assets whose risk characteristics are very similar--federal funds and two-year T-notes, say--we would not expect even a lot of quantitative easing to have much of an effect on anything.

Thus a quantitative easing program that is going to have bite should involve Federal Reserve purchases of long-term risky private assets rather than merely long-term U.S. Treasuries. Hiring PIMCO as an agent to manage a long bond index portfolio naturally comes to mind--if one could avoid its front-running.

And, of course, the most effective quantitative easing program of all would involve the Federal Reserve issuing reserve deposits and using that purchasing power to buy the assets that are the furthest away in their risk characteristics from short-term government bonds: bridges, dams, the human capital of American citizens, police protection, research and development. The best quantitative easing program of all is a money-financed fiscal stimulus, as Jacob Viner said back in 1933

The Young, the Old, the Unemployed » New Deal 2.0

The Young, the Old, the Unemployed » New Deal 2.0:

College educated 20-24 year olds have the highest percentage increase in unemployment. This should go against a structural unemployment story, as college educated people have the ‘freshest’ skills and incredibly high mobility. It’s worth pointing them out in particular because if their careers hit a rough spot, hysteresis sets in and they’ll have serious wage losses years down the road (see this classic White House blog post on the subject by Peter Orszag). Their situation is also important because the crisis is often seen as a small deal for college educated workers.

The other thing that jumps out at me is that the unemployment rate for everyone 55-64 has more than doubled. One thing we aren’t talking about enough is that someone who is 60 and has been unemployed for a year isn’t going to find a decent job again. Other ways of looking at the labor search outcomes of 55-64 year olds are even more worrying.