Increase Investment During Recession

It is a no-brainer that the best time for government to increase investment is during a recession.  But instead, the US is reducing government investment.  It is absurd.
Recessions are the best time because:
1. Interest rates are low.
2. Resources are unemployed.  Both capital and labor is idle which is a tremendous waste.
3. There is a multiplier effect which reduces the severity of the recession.  When the government pays workers, they have more money to buy things and that helps the rest of the economy.
4. Even if you think that the multiplier effect is low, there is less probability that increased government investment creating inflation during a recession and higher inflation could actually help an economy during a recession anyhow. 

Here is another measure which just looks at government construction projects using another data set.  I adjusted for inflation using 1995 as the base year.  The stimulus only ameliorated the plunge in (mostly state and local) construction projects:

When Is Debt Meaningful? Is It Possible For Everyone To Save?

"Neither a borrower nor lender be"
Shakespeare's quote reveals that he didn't think much of borrowing.  Is it better to be a borrower or a saver?  Financial planners often say that everyone should save at least 10% of their income and most people think that government deficits are bad.  Many people worry about the US indebtedness to China and the debts that Greece and Spain owe to Germany.  Would the world be better off if every country saved?  Would the world be better off if every person always saved at least 10% of their income? 
In short NO.  It is impossible for every country to simultaneously save money.  A country can only save money by loaning it to another country which is a debtor.  An individual who saves money is typically creating a borrower because when you save money in a bank account or other financial investment, your saving is a loan that the bank (or other investment) must pay back to you, so a dollar of savings becomes a dollar of debt.  Instead of lending your cash, you could save it in a jar buried in the yard, but if everyone did that, it would be akin to a simultaneous increase in the demand for money and a decrease in the supply of money which would cause deflation and recession.  Saving money without lending it does not increase real resources.  Saving is only a virtue for society when it is converted into physical investment.  For example, most people save money by lending it to a bank which makes money by lending it back out and many of those people are making physical investments in physical capital.   If there is only 10% more savings without 10% more physical investment, that means that everyone is buying 10% less.  And that would mean that everyone would earn 10% less because a dollar spent is a dollar earned.  That means that incomes would drop 10% and so consumption would drop more like 20% to only achieve a 10% increase in savings!  And when everyone tries to spend their jars of money, it will just mean inflation and an economic boom, but everyone would be better off if there were a more constant rate of savings because that would avoid a recession.
Normally savings means that someone else owes you.  Peter works 10% harder than Paul this year and loans Paul the money so that Paul can work 10% harder than Paul next year and pay him back.  The only way for both Peter and Paul to simultaneously save is for them to both stockpile physical goods that they create.  There is no way for everyone to save their services so that they work hard now and somebody else works hard for them later, but everyone can save the physical products of their labor (goods) and enjoy them later.  That is the only way for everyone to simultaneously save, but that is not called savings.  That is called (physical) investment in macroeconomics.  Saving is a virtue only when it increases investment. 

Suppose the US has no foreign debts.  If the US has high amounts of internal debt, that should not be a problem because it is impossible for the US to have net debt if it has no foreign debt.  Each dollar owed creates a debtor and a saver and the two balance each other out.  Government debt is the same way.  If the government owes a large amount of money to private American citizens, then that means that American citizens have a large amount of savings!  No problem.  Many people think that government debt is burdening the country, but if so, then the government could just declare default tomorrow and wipe out all debt.  This was called jubilee in the Bible.  All debts were simply wiped out in Biblical times at regular intervals (every 7 or 49 years) by Jewish law.  But that would not make America any richer because we would still have the same real resources (nature, infrastructure, capital, and labor) as we had before.  Only the distribution of financial claims on real resources would have shifted dramatically.  The distribution of ownership of wealth does not matter except as an incentive for everyone to work, save and invest.  This is why a government default would be harmful.  It would create financial chaos as savers who thought they were rich suddenly become poorer and taxpayers who had been debtors, suddenly have their debts forgiven.  But within a couple years, the chaos would resolved and growth should continue based upon the real resources (real wealth) that was there all along.

The US also has foreign debt, but that is even easier to solve because US foreign debt is mostly denominated in dollars.  The US is the world's best producer of dollars and we can print them very cheaply.  The US could pay off all the foreign debt with newly printed dollars tomorrow.  That would cause a temporary increase in inflation, but if foreign debt were a big problem, then inflation would be a small price to pay.  Unexpected inflation is also just a transfer of financial resources from savers to debtors and it would further reduce America's debt load by reducing the real value of existing debt. 

In any case, although the US is the world's largest debtor nation in the amount of debt that we owe foreigners, our foreign assets earn high returns whereas the debt we own foreigners is mostly Treasuries (government debt) with very low (negative real) rates of return.  Many of US foreign assets are foreign subsidiaries of US corporations which have very high earning rates.  Thus, the US has higher earnings on our foreign assets than foreigners earn on their US assets:

Krugman expounds:

Suppose that for some reason the nation temporarily ends up being ruled by a guy who is driven mad by power, and decrees that... everyone will receive a large allotment of newly printed government bonds, adding up to 500 percent of GDP.  The government is now deeply in debt — but the nation has not directly gotten any poorer: the public, ...now owes 500 percent of GDP, but the public, in its role as investors, now owns new assets equal to 500 percent of GDP. It’s a wash.
So where’s the problem? Well, to pay interest on that debt, the government will have to raise a lot more revenue. Again, this is a wash — the extra revenue is matched by the extra income people receive as bondholders. But tax rates will have to go way up; ...this means that marginal tax rates will have to go way up.
And ...very high marginal tax rates act as a disincentive to productive activity. So real GDP may well fall significantly.
This is what I mean when I say that the burden of debt is about incentives, not about having to deliver resources to other people.

And national debt is not a burden on children.  My debt would be a burden on my children if our laws required children to pay off their parents' debts (like some countries have done), but my children would be paying somebody else's children who would benefit from my debt.  Dean Baker:

As a country we cannot impose huge debt burdens on our children. It is impossible, at least if we are referring to government debt. The reason is simple: at one point we will all be dead. That means that the ownership of our debt will be passed on to our children. If we have some huge thousand trillion dollar debt that is owed to our children, then how have we imposed a burden on them? There is a distributional issue — Bill Gates’ children may own all the debt — but that is within generations, not between generations. As a group, our children’s well-being will be determined by the productivity of the economy (which Brooks complained about earlier), the state of the physical and social infrastructure and the environment.
One can make the point that much of the debt is owned by foreigners, but this is a result of our trade deficit, which is in turn caused by the over-valued dollar.*

Our real burden on our children (or benefit) is the real capital, natural resources, and infrastructure we leave them.  If we destroy our natural environment, that will give them a real burden, but government debt will benefit American children who own the government bonds and hurt the American children who must repay them.  That is a wash unless the payment reduces their incentives to work because some children will pay too much taxes to want to work and other children will have too much inheritance to need to work.  In that case, a bought of inflation might be a good way to help reduce the real value of the debt and bring back the incentives to work. 

So why not just have zero taxes and borrow all government revenues?  Well, who would lend money to such a government?  The market will not lend money to a government that has no way to repay the loans.  Even a government with a poor plan for repayment would face an extremely high market interest rate and that would reduce the scope for profitable public projects because the cost of a highway would include an enormous interest bill.  Furthermore, excessive government borrowing would crowd-out private borrowing too and that would reduce private investment.  Government should borrow when that is a cheaper way to finance expenditures and it should tax when that is the cheaper way.  Right now, borrowing is cheaper than taxing because the 10-year bond has a negative real interest rate and with 20% unemployment in construction, infrastructure is cheaper to build than usual.  But we are cutting infrastructure spending instead of increasing it. 

*The trade deficit exactly equals net borrowing from foreigners.  It could be reduced by looser monetary policy which would help reduce the value of the dollar.

The Purpose of Finance

VOX:

While few would argue that the financial crisis has not brought the real economy down with it, there is considerably less clarity about what the positive contribution of the financial sector is during normal times. ...Financial recessions are both deeper and longer-lasting than normal recessions. At this stage of a normal recession, output would be about 5% above its pre-crisis level. Today, in the UK, it remains about 3.5% below. So this much is clear: Starved of the services of the financial sector, the real economy cannot recuperate quickly. ... As currently measured, however, it seems likely that the value of financial intermediation services is significantly overstated in the national accounts, for reasons we now explain.

Excess’ returns in the banking sector³

The headline national accounts numbers point to a significant contribution of the financial sector to the economy. For the US, the value-added of financial intermediaries was about $1.2 trillion in 2010 – equivalent to 8% of total GDP. In the UK, the value-added of finance was around 10% of GDP in 2009. The trends over time are even more striking. For example, they suggest that the contribution of the financial sector to GDP in the US has increased almost fourfold since the Second World War.
At face value, these trends would be consistent with large productivity gains in finance. Pre-crisis, that is what the bald numbers implied. Measured total factor productivity growth in the financial sector exceeded that in the rest of the economy (Figure 1). Financial innovation was said to have allowed the banking system to better manage risk and allocate capital. These efficiency gains in turn allowed the factors of banking production (labour and capital) to reap the benefits through high returns (wages and dividends).
Figure 1 Differential in TFP growth between financial intermediation and the whole economy^a,b

Source: EU KLEMS and authors' calculations. The EU KLEMS data are available online at www.euklems.net.

But crisis experience has challenged this narrative. High pre-crisis returns in the financial sector proved temporary. The return on tangible equity in UK banking fell from levels of 25%+ in 2006 to - 29% in 2008. Many financial institutions around the world found themselves calling on the authorities, in enormous size, to help manage their solvency and liquidity risk. That fall from grace, and the resulting ballooning of risk, sits uneasily with a pre-crisis story of a shift in the technological frontier of banks’ risk management.
In fact, high pre-crisis returns to banking had a much more mundane explanation. They reflected simply increased risk-taking across the sector. This was not an outward shift in the portfolio possibility set of finance. Instead, it was a traverse up the high-wire of risk and return. This hire-wire act involved, on the asset side, rapid credit expansion, often through the development of poorly understood financial instruments. On the liability side, this ballooning balance sheet was financed using risky leverage, often at short maturities.

Risk-taking versus risk management

In what sense is increased risk-taking by banks a value-added service for the economy at large? In short, it is not.
The financial system provides a number of services to the wider economy, including payment and transaction services to depositors and borrowers; intermediation services by transforming deposits into funding for households, companies or governments; and risk transfer and insurance services. In doing so, financial intermediaries take on risk. For example, when they finance long-term loans to companies using short-term deposits from households, banks assume liquidity risk. And when they extend mortgages to households, they take on credit risk.
But bearing risk is not, by itself, a productive activity. The act of investing capital in a risky asset is a fundamental feature of capital markets. For example, a retail investor that purchases bonds issued by a company is bearing risk, but not contributing so much as a cent to measured economic activity. Similarly, a household that decides to use all of its liquid deposits to purchase a house, instead of borrowing some money from the bank and keeping some of its deposits with the bank, is bearing liquidity risk.
Neither of these acts could be said to boost overall economic activity or productivity in the economy. They re-allocate risk in the system but do not fundamentally change its size or shape. For that reason, statisticians do not count these activities in capital markets as contributing to activity or welfare. Rightly so.
What is a demonstrably productive economic activity is the management of risk. Banks use labour and capital to screen borrowers, assess their creditworthiness and monitor them. And they spend resources to assess their vulnerability to liquidity shocks arising from the maturity mismatches on their balance sheets. Customers, in turn, remunerate banks for these productive services.
The current framework for measuring the contribution of financial intermediaries captures few of these subtleties. Crucially, it blurs the distinction between risk-bearing and risk management. Revenues that banks earn as compensation for risk-bearing – the spread between loan and deposit rates on their loan book – are accounted for as output by the banking sector. So bank balance-sheet expansion, as occurred ahead of the crisis, counts as increased value-added. But this confuses risk-bearing with risk management, especially when the risk itself may be mis-priced or mis-managed.
The upshot is a potentially significant over-estimation of the valued-added of the financial sector. The size of this effect is potentially very large. For example, Colangelo and Inklaar (2010) suggest that, for the Eurozone as a whole, adjusting for risk-taking would reduce the estimated output of the financial sector by about 25-40 % relative to the current methodology. If the same factor were applied in the UK, the measured contribution of the financial sector would suddenly drop to about 6-7.5% of GDP. That’s a measurement error of about £35-£55 billion based on 2009 data. The impact of this on overall GDP is likely to be smaller because half of the output of the financial sector is consumed by other businesses – so, while the measured value added of finance would drop, that of other sectors would increase.
Indeed, a banking system that does not accurately assess and price risk could even be thought to subtract value from the economy. Buyers and sellers of risk could meet instead in capital markets – as indeed they have, increasingly, following the crisis. The national accounts would capture such a transfer as a fall in GDP. But to the extent that capital markets are at present better able to price and manage that risk than banks, the opposite is actually true.

Implicit subsidies

There is a second, equally important, reason why the measured value-added of the financial sector in the national accounts may be seriously over-stated. We now know that the risk being taken by banks was not in fact borne by them, fully or potentially even partially. Instead it has been borne by society. That is why GDP today lies below its pre-crisis level. And it is why government balance sheets, relative to GDP, are set to double as a result of the crisis in many countries.
But if banking risks are not borne by banks, they will not be priced by banks, or investors in banks, either. The implicit support of the taxpayer and society will show up as an explicit profits bonus to the financial system. Lower risk means lower funding costs, which in turn means fatter banking profits. If there are expectations that the government cavalry always stands at the ready, excess returns will be harvested both pre and post-crisis.
Elsewhere, we have sought to estimate those implicit subsidies to banking arising from its too big-to-fail status. For the largest 25 or so global banks, the average annual subsidy between 2007-2010 was hundreds of billions of dollars; on some estimates it was over $1 trillion (Haldane 2011). This compares with average annual profitability of the largest global banks of about $170 billion per annum in the five years ahead of the crisis.
Government subsidies – whether implicit or explicit – cannot be said to have added to economic well-being in aggregate. At best, they are a sectoral re-distribution of resources from the general taxpayer to the banks. If raising taxes or lowering government revenues has deadweight welfare costs, this transfer is actually welfare-reducing. That effect, too, is completely missed by existing statistical measures of the contribution of the financial sector.

Conclusion

If risk-making were a value-adding activity, Russian roulette players would contribute disproportionately to global welfare. And if government subsidies were the route to improved well-being, today’s growth problems could be solved at a stroke. Typically, this is not the way societies keep score. But it was those very misconceptions which caused the measured contribution of the financial sector to be over-estimated ahead of the crisis.
Risk-management is a legitimately value-added activity. It lies at the heart of the services banks provide. Today’s debate around banking and bankers has usefully rediscovered that key fact, amid the rubble of broken balance sheets and wasted financial and human capital. Investors, regulators and statisticians now need to adjust their measuring rods to ensure they are not blind to risk when next evaluating the return to banking.

VOX:

• Figure 1 displays the fraction of US GDP produced by the financial and insurance sector. During the post-war period this fraction increased from 2% to 8%.
• The UK’s financial sector generated 9% of total British value added in the last quarter of 2008; this was only 5% in 1970.¹

Figure1. Value added of the finance and insurance sectors in the US (% of GDP)

Source: Bureau of Economic Analysis
An increase in inputs (capital and labour) is only part of the story. Value added per worker has also increased substantially. Weale (2009) reports that earnings per employee in the UK financial sector were 2.1 times average earnings in 2007. In Philippon and Reshef (2008), it is shown that the rise in the relative financial wage is related to financial deregulation.
The elevated position of the financial sector is even more obvious when we take a look at corporate profits.

• In the first couple of decades following the Second World War, profits in the financial sector were around 1.5% of total profits;
• Recently, this number was as high as 15%.

Pay versus output

Without doubt, these numbers indicate that the stakeholders in the financial sector (employees and investors) receive a substantial chunk of GDP. But the numbers do not necessarily imply that the sector produces this much. Nor do they imply that the actual value of what the sector produces has gone up a lot during the post-war period.
To understand why there could be a difference between the income received and the value of what is being produced, consider the basis of this deduction. In a competitive economy, the price of a good equals its marginal cost, and consumers buy it up to the point where their marginal benefit equals the price. If it is an intermediate good, the price equals the value of the good’s marginal productivity to the purchasers. Thus, the value of output works well as a measure of both the cost and the benefit to society. That’s the magic of the market.
However, if the sector is imperfectly competitive, the price will exceed the social marginal cost and we’ll see value added being artificially transferred between sectors. As the financial sector is very concentrated, this is one reason we should expect the payments to factors in banking to exceed the value created – taking, as a base case, the prices that would be observed if the sector were competitive.
A second wedge between wage and value arises from the implicit insurance that the financial sector gets. As financial service providers do not pay for the “moral hazard” they create, the true value of financial services is systematically less than the payment to factors. Curry and Shibut (2000) calculate that the fiscal cost, net of recoveries, of the 1980s US Savings and Loan Crisis was $124 billion, or roughly 3% of GDP. This cost ignores other costs such as output losses, and this was a relatively mild crisis. Laeven and Valencia (2008) consider 42 crisis episodes and find an average net fiscal cost of 13.3%.² It would not be fair to attribute these losses solely to the financial sector, but the magnitudes of the numbers suggest that this wedge could quantitatively be very important.
A third wedge comes from negative spillovers. The financial sector may provide services that are useful to a client, but not to society as a whole. For example, a financial institution may help to structure a firm’s financing in such a way that the firm pays less taxes. Such a transaction would not increase production, unless lower taxes help the firm to produce more. Nevertheless, such transactions will count as value added generated by the financial sector. A rather stark analogy could be drawn with the cigarette industry, where it is quite clear that the payments to factors do not really measure social value added since the cost of smoking-induced health problems falls on the taxpayer (in most nations).
Although the sector’s contribution is not easy to measure, there are some things we do know.

• First, the financial sector provides useful services. That is, the sector’s value added should be positive.
• Second, financial-sector value added reported in the national income accounts was probably overvalued in the years leading up to Great Recession.

The financial sector extracted huge fees from the rest of the economy to construct opaque securities that were so complex that only a few understood how risky they were.³ If fees (prices) had accurately reflected the true value of the products, then some of these fees should have been negative, since many such products were not beneficial to the buyer or to society as a whole.
Several important questions need answers.

• What are the reasons for the observed substantial increase in the share of GDP received by the financial sector?
• What are the services that the financial sector in today’s world does (or should) provide that increase the production of things we care about?
• What is the value of these services? This is a tough question for the type of products delivered by the financial sector, because the nature of the services changes over time. For products like computers, we can measure characteristics such as speed and memory and measure how much computing power you get. If a bank becomes better at preventing default, then it provides more “financial services” for each unit of loans issued. But how can we correct for such changes in risk exposure? One possibility to measure the effectiveness of the services provided is to investigate how differences in financial sectors across countries are related to valuable characteristics such as smaller business cycles, better life-time consumption patterns, and innovative firms not facing financing constraints.⁴

What is the value of modern finance versus traditional finance?

Although the financial sector has been in the limelight since the outbreak of the crisis, these questions have received little attention. There is a substantial academic literature investigating the positive (and negative) effects of the presence of developed financial markets on long-term growth.⁵ But there is not that much research done on the question of which aspects of the current financial system are important for today’s economies.
One would think that it is essential to fully understand what contributions the financial sector, and especially banks, can offer before engaging in a discussion on how to regulate this sector. If the key aspects of the financial sector that foster growth are relatively simple, then we would not have to worry that, say, increased capital requirements would have negative impacts on the economy. Then it would make more sense to worry about there being enough competition, so that we do not pay a lot for relatively simple activities. But if sustained economic growth requires a creative financial sector capable of performing complex tasks, then we should worry that regulation is not going to debilitate this sector.
It is surprising that these questions currently get so little attention. In an abstract sense, we know what roles financial institutions fulfil. In particular, (i) financial institutions avoid duplication both when monitoring loans and collecting information, (ii) they help to smooth consumption, and (iii) they provide liquidity.⁶ There are many enjoyable descriptions of some activities enacted in the financial sector that seem hard to reconcile with the laudable tasks thought of by economists. Moreover, knowing what the tasks of the financial sector are in theory does not tell us whether those tasks are fulfilled efficiently and at the right price. Nor does it tell us why the income earned by the financial sector has increased so much. As pointed out by Philippon (2008), in the 1960s outstanding economic growth was achieved with a small financial sector. Has it become more difficult to obtain information so that we now need to allocate more resources to the financial sector?
Some articles in the literature address the questions posed here. Chari and Kehoe (2009) use US firm-level data and find that the amount spent on investment exceeds the amount of internally-available funds (revenues minus wages minus material costs minus interest payments minus taxes) for only 16% of all firms considered. If investment could in principal be done using the firms’ own funds, then the role for financial intermediaries is obviously diminished. Haldane (2010) discusses in detail the earnings of the financial sector and concludes that “risk illusion, rather than a productivity miracle, appears to have driven high returns to finance”. Philippon and Reshef (2008) study wages earned in the financial sector and conclude that a large part of the observed wage differential between the financial sector and the rest of the economy cannot be explained by observables like skill differences, but is likely to be due to the presence of rents. Philippon (2008) argues that an increase in the types of firms that invest (young firms) can explain part of the increased income share of the financial sector; the increase in the last decade remains puzzling.
A similar view is expressed by Popov and Smets (2011), who argue that deeper financial markets in the US relative to those of the European continent are, to a large extent, responsible for the larger increases in productivity and faster pace of industrial innovation. One piece of evidence supporting this view is the empirical study of Popov and Roosenboom (2009), who find that better access to private equity and venture capital have a positive impact on the number of patents. Den Haan and Sterk (2011) reconsider the popular hypothesis that innovations in financial markets should make it easier for financial institutions to smooth business cycles. The idea of this hypothesis is that better access to bank finance ensures that consumers and firms do not have to make decisions that are bad for the economy as a whole, such as firing workers or postponing purchases which in turn could trigger additional layoffs. Den Haan and Sterk (2011) analyse in detail the behaviour of consumer loans and real activity, and find that there is no evidence that supports the hypothesis that financial innovations dampened business cycles, even when the recent crisis is excluded. Lozej (2011) addresses the same question using firm loans. Although the evidence presented by Lozej (2011) is a bit more mixed, there is at best weak evidence that the changes in the financial sector contributed to smaller business cycles during the period before the recent crisis.

Conclusion

The literature indicates that some tasks of the financial sector are beneficial, some attributes of financial institutions matter, and others matter less so or not at all. The recent publication of the Vickers report is a good occasion to investigate what activities of the financial sector are beneficial for today’s way of life, and whether they are affected by proposed regulation. Without doubt, various proposed changes in regulation will be costly for the financial sector and make it more difficult for the sector to perform some activities. But that is not necessarily a bad thing. If a change would cost the financial sector, say, one billion a year but does not affect the total amount being produced, then it just means that there is an extra billion for the other sectors.

Youth Unemployment and the Arab Spring

Rortybomb:

Is it useful to think of the Occupy movement more as a “left” movement or a “youth” movement?  To answer that question, it’s worth looking into data on the young, particularly as it relates to unemployment.
To leave the United States for a minute, one way people are trying to understand the Arab Spring is through the lens of mass youth unemployment and inequality.  Given how high unemployment has been in these MENA – Middle-East and North African – countries, what else could we expect besides revolution?
For instance, in early February then IMF chief Dominique Strauss-Kahn told a conference that ”this summer I made a speech in Morocco about the question of youth employment including Egypt, Tunisia, saying it is a kind of time bomb” and ”such a high level of unemployment, especially youth unemployment, and such a high level of inequality in the country create a social situation that may end in unrest.”  Here is the “youth unemployment” blog tag at the IMF to give you a sense of what people there have been saying about it.  In particular, they point out that it should be a major concern for the MENA and African regions.
Interestingly enough, there’s good research showing concern even before mass protests broke out.  Regional IMF officials Ratna Sahay and Alan MacArthur gave a January 23rd presentation - Challenges for Egypt in the Post Crisis World -  at the Egyptian Center for Economic Studies in Cairo (h/t WSJ).  Protests would begin a few days later.  Here’s a key slide from that presentation:

Part of you may want to immediately start getting your first-world privilege on.  Maybe you are furious at terrible, unresponsive, corrupt governments ignoring the plights of their populations.  Maybe you think that if these countries only had neoliberal, “flexible” wage contracts and a leakier safety net like we have in the United States then unemployment would be much better.
You may then head over to our monthly unemployment numbers and note that American youth unemployment is in the same ballpark as these MENA countries.
Let’s get some data going.  I’ve taken numbers from the IMF presentation slide above, and compared them to United States youth unemployment averages from January 2010 to October 2011 from the BLS’ CPS data.

I can’t find what ages are used for youth for “youth unemployment” in the IMF’s definition, and I’m not even sure if it is consistent across the different countries they estimated.  As such, I’m including ages 16-19 and ages 16-24, though I believe they are more likely looking at 16-24.  For 16-19, we are at the same level of youth unemployment for Egypt and well above the region as a whole.  At the broader 16-24 range, we are above Syria and Morocco, which both saw large-scale movement in the Arab Spring.

One potential explanation for the high level of youth unemployment in MENA countries is that they have huge demographic issues to deal with – they have a massive wave of people under 35 years of age to assimilate into their economics.  What’s our excuse...

Remember the increase from the 1960s onward reflects women entering the labor force.  And notice how it doesn’t improve after the early 2000s recession.  Every age group has seen a substantial drop in the employment-population ratio during this Lesser Depression, but no other group I’ve seen comes close to this plummet.  For the first time in half a century, a majority of young people aren’t working.

Via Brad Delong:

Is Regulatory Uncertainty a Major Impediment to Job Growth?: If regulation was a significant drag on business today, we would expect to see profits constrained after recent regulatory reforms were passed into law.  However, corporate profits as a share of gross domestic income have about recovered their pre-recession peak, and earnings per share in industries most affected by recent regulatory changes, such as energy and health care, have among the highest earnings per share of those in the S&P 500.  This growth is inconsistent with a corporate sector held back by regulation…. If regulatory uncertainty was the primary problem facing businesses, firms would prefer to use their existing capacity and current workers as much as possible, while avoiding building additional capacity until they are more certain about the contours of future regulation…. [T]hey would increase the hours of the workers they already employ rather than hiring additional workers.  We have seen no evidence of this…. Low capacity utilization is inconsistent with concerns about future regulatory risk, but aligns with weak demand holding back current production….
Since the end of the first quarter of 2009, real investment in equipment and software has grown by 26 percent – about five times as fast as the economy as a whole….

If regulatory uncertainty were having a significant impact on business performance, we would expect this to be reflected in capital markets.  However, financial indicators do not provide any evidence in favor of this hypothesis…. [C]orporate bond yields are low across a range of industries, suggesting that firms in industries facing greater regulatory risk, such as insurance and energy, are not being priced out of the market….
One commonly cited measure of uncertainty is the Chicago Board Options Exchange Market Volatility Index (known as the VIX), which measures the implied volatility of S&P 500 index options.  For most of the past year or so, the VIX has stood only a bit higher than in the pre-crisis period…. [T]he sharp increase in the VIX in August and previous sharp increases in late 2008 correspond to virtually identical movements in the VDAX, a similar measure calculated for the German stock market.  The correlation between these two indicators suggests that uncertainty in both countries primarily reflects global financial and economic conditions, rather than conditions specific to the United States, such as regulatory changes….
In an August survey of economists by the National Association for Business Economics, 80 percent of respondents described the current regulatory environment as “good” for American businesses and the overall economy. As noted above, in a recent Wall Street Journal survey of economists, 65 percent of respondents concluded that a lack of demand, not government policy, was the main impediment to increased hiring…

US Stimulus Worked?

Sullivan says the US economic stimulus worked because of a natural experiment comparing the US and the UK.  The United Kingdom did not adopt a stimulus.  Sullivan notes. “After three and a half years, U.S. GDP is just about returning to the pre-recession peak. That’s awful. But it’s far better than the U.K. where GDP is still five percent ($750 billion in US terms) below its pre-recession peak.”  Of course, two data points is just an anecdote and ceteris paribus does not apply, but this is about as good as it gets in macroeconomics.  I have yet to see an example of austerity working better than stimulus. 

Keynes vs. Hayek Debate

This might be a good essay for Macro
Bloomberg
BBC
Rap video
PBS

Friedman Supported Quantatative Easing

Beckworth:

did Milton Friedman actually recommend doing successive rounds of quantitative easing until nominal spending returns to normal levels? Let's have Milton Friedman speak for himself.  Here is an excerpt from a Q&A following a 2000 speech he delivered at the Bank of Canada (my bold below). 

David Laidler: Many commentators are claiming that, in Japan, with short interest rates essentially at zero,  monetary policy is as expansionary as it can get, but has had no stimulative effect on the economy. Do you have a view on this issue?

Milton Friedman: Yes, indeed. As far as Japan is concerned, the situation is very clear. And it’s a good example. I’m glad you brought it up, because it shows how unreliable interest rates can be as an indicator of appropriate monetary policy.

During the 1970s, you had the bubble period. Monetary growth was very high. There was a so-called speculative bubble in the stock market. In 1989, the Bank of Japan stepped on the brakes very hard and brought money supply down to negative rates for a while. The stock market broke. The economy went into a recession, and it’s been in a state of quasi recession ever since. Monetary growth has been too low. Now, the Bank of Japan’s argument is, “Oh well, we’ve got the interest rate down to zero; what more can we do?”

It’s very simple. They can buy long-term government securities, and they can keep buying them and providing high-powered money until the high powered money starts getting the economy in an expansion. What Japan needs is a more expansive domestic monetary policy.

The Japanese bank has supposedly had, until very recently, a zero interest rate policy. Yet that zero interest rate policy was evidence of an extremely tight monetary policy. Essentially, you had deflation. The real interest rate was positive; it was not negative. What you needed in Japan was more liquidity.

So yes, Milton Friedman did call for buying longer-term securities until a robust recovery takes hold.  He also notes that policy interest rates can be a poor indicator of  the stance of monetary policy.   I suspect, however, that Friedman would have preferred that such a monetary stimulus program be done in a more systematic manner than that of announcing successive, politically costly rounds of QE.  Imagine how much easier all of this would have been had the Fed announced a level target from the start and said asset purchases will continue until the level target was hit.  There would have been no need to announce the large dollar size of the asset purchases up front that attracts so much criticism.  There would also have been no need to announce successive rounds of QE that make it appear the previous rounds did not work.  More importantly, it would have more firmly shaped nominal expectations in a manner conducive to economic recovery.  The question is what type of level target would Friedman have supported?  This 2003 WSJ article indicates he might have liked a nominal GDP level target.

Finance Profits a Ripoff?

Yglesias » The Economics of Ripoffs:

The great genius of capitalism is facilitating mutually beneficial exchanges. I want a can of Diet Coke more than I want 8 pesos, so I hand 8 pesos over to a shopkeeper and he hands me a can of Diet Coke. Win-win. Then there’s fraud where you outright lie about what’s happening. That we understand, and it’s generally illegal.
But there’s this whole other world where, to a greater or a lesser extent, one party to the transaction is getting ripped off. We know this stuff happens. People buy lottery tickets, people put tokens into slot machines, and people pay fortune tellers. You can model all this behavior as self-interested and mutually beneficial by simply asserting that the people buying tickets are obtaining some large quantity of subjective utility from the lottery, but I think examining lottery marketing tends to cut against this interpretation. And this can move up from the realm of pure gambling. I saw a TV ad the other day marketing life insurance to AARP members. The idea of life insurance is that average payouts are less than average premiums (hence profit), but this bad investment may still be a good idea for your family because the economic impact of the loss of a breadwinner will be so devastating. But the whole logic of life insurance completely fails to apply to retired people.
I thought of this all recently in terms of continuing discussions of the mysterious sky-high profitability of the financial sector.
We often have this conceit that ripoffs are an economically marginal phenomenon that applies to, sure, tourists and gambling addicts and maybe naive poor people going to see tarot card readers. But if you look at the price premium people are willing to pay for “organic”-labeled products and the dubious science behind the theory that these products are superior to conventional varieties, I think it’s clear that yuppies aren’t immune to getting ripped off, either. And I think we should be open to the possibility that this is happening in finance. How much do the sundry pension fund beneficiaries, 401(k) holders, endowed nonprofit managers, etc. of the world really know about the investment game? Are they really that much more savvy and sophisticated than their working class lottery ticket buying peers? Or does their self-image as savvy sophisticates make them that much more prone to being ripped off? After all, Bernie Madoff was able to swindle a bunch of very sophisticated investors out of a great deal of money. He did it through actual, prosecutable, criminal fraud. But not every scam and ripoff is a fraud, and not everything that’s legal is a mutually beneficial transaction.

Median HH Income

Median income is down by 11% from its peak.  The median household is almost half way to the great depression. Felix Salmon:

Why has no one thought to do this before? Every month, the Current Population Survey goes out to a nationally representative sample of more than 50,000 interviewed households and their members. And in one of the questions, those households — or at least the households who didn’t answer the same question the previous month — are asked how much money they made, in total, over the past 12 months. That question has now been asked in 138 successive months, since January 2000. Which means that with a bit of clever analysis, it’s possible to put together an apples-to-apples comparison of what has happened to household income every month.
And when you do that, the results are very scary indeed.

 

...All of these numbers come from Gordon Green and John Coder, economists who both worked at the Census Bureau for more than 25 years. They’ve now set up a private company, Sentier Research, to collate these household income figures every month... Why is this work being outsourced to private-sector economists, rather than being done by the Bureau of Labor Statistics and published officially?

History of the 2008 Lesser Depression

This is an excellent history by Ezra Klein that explains what happened and the political struggles that shaped the outcome:  Could this time have been different?
Many commentators have critiqued Klein's article.  Krugman says Klein was not hard enough on Obama in a very I-told-you-so way that would be really annoying except that he really has been telling the same critique for a long time. He would never make it as a politician.  

IS LM Keynesian Links

Krugman Explains IS-LM

The BL-MP Model

 More on BL-MP

 IS-LM Watch: In the Country of the One-Eyed, the Self-Blinded Man Is in Bad Shape, or Something Department

The Tribal Dislike of John Hicks and IS-LM: History of Economic Thought Edition

 Hoisted from Comments: The Tribal Dislike of John Hicks and IS-LM

Something About Macro

Krugman: "I’d guess that at least half of university macroeconomists are either real business cycle types or take a Taylor-like position that they may be Keynesian in theory, but they oppose anything Keynesian in practice"

Krugman must be thinking about research macroeconomists in graduate schools.  The undergraduate textbooks never developed much interest in the real business cycle (RBC) theory.  Perhaps that is because RBC has no good applications and cannot be explained in simple terms that make any sense.  It requires too much mathematical abstraction to make sense and undergraduates would not be convinced without some stories to back it up. 

Regulatory Uncertainty Did Not Cause Recession

It's *Not* Regulatory and Tax Uncertainty.
If it were fear of Obama and Democratic policies, then the midterm elections would have seen economic boom because Democrats cannot do anything major anymore.
The recession would not have gone so far before Obama and the Democrats were elected.  
Business investment has already recovered more rapidly than it did in several past recessions.  Only housing investment remains depressed and it is difficult to understand why home buyers would be so worried about housing regulations when that is mostly regulated by state and local governments which vary widely in ideology and substance.

Mishel at the Economic Policy Institute has more:

Over at the American Enterprise Institute blog, James Pethokoukis responds to my recent paper, Regulatory uncertainty: A phony explanation for our jobs problem, and blog post. I presented evidence that trends in investment, private-sector job growth, unemployment, and work hours were not inferior in this recovery compared to other recent job-challenged recoveries. That is, I noted that this recovery fares well relative to the recoveries under George W. Bush and George H. W. Bush. If you look at what employers are doing rather than what trade associations are saying, you would see that uncertainty about regulations and taxation has not impeded job growth. What we are seeing is what you expect given the slow growth in GDP.
What was especially curious to me is that Pethokoukis has no counter-argument

Fiscal and Monetary Stimulus NOW!

Professional economic forecasters think that fiscal policy works: Paul Krugman directs us to a Goldman Sachs report.

http://www.project-syndicate.org/commentary/delong118/English  The calculations and logic of Keynesianism.
Martin Wolf:  Time to think the unthinkable and start printing again
a recent speech by Adam Posen (pdf), opens by speaking about how shy people are to do Keynsian or monetarist policies:

Both the UK and the global economy are facing a familiar foe at present: policy defeatism. Throughout modern economic history, whether in Western Europe in the 1920s, in the US and elsewhere in the 1930s, or in Japan in the 1990s, every major financial crisis-driven downturn has been followed by premature abandonment—if not reversal—of the macroeconomic stimulus policies that are necessary to sustained recovery. Every time, this was due to unduly influential voices claiming some combination of the destructiveness of further policy stimulus, the ineffectiveness of further policy stimulus, or the political corruption from further policy stimulus. Every time those voices were wrong on each and every count. Those voices are being heard again today, much too loudly. It is the duty of economic policymakers including central bankers to rebut these false claims head on. It is even more important that we do the right thing for the economy rather than be slowed, confused, or intimidated by such false claims.

A Special Finance Tax

The IMF is usually accused as being a conservative institution that favors elite bankers over the needs of everyday people.  Surprisingly, the IMF proposes taxing the finance industry to reduce financial excesses and pay for past bailouts:

The International Monetary Fund has proposed a set of broad taxes on the financial industry to guard against future crises, and the levies that would target "excess" profits and compensation as well as raise hundreds of billions of dollars in the United States alone.
In the agency's most detailed statement yet about how banks and finance companies should pay to offset their risk of failure, IMF staff outlined a possible "financial stability contribution" that would be based on the threat that a firm's collapse would pose to the economy. The levy, the IMF said, should raise an equivalent of at least 2 percent of a country's economic output -- around $300 billion in the United States -- and set it aside to underwrite the costs of putting failed institutions out of business.
A separate "financial activities tax" would impose taxes based on excess profit and perhaps pay, a proposal designed to discourage outsize executive bonuses and the sort of high-return but risky investments that helped drive the global economy into its worst recession in decades.

...[One purpose is] to recoup the public funds spent propping up the financial sector, and how best to raise money to pay for future problems.  The idea is a central issue in the financial reform debate under way in Washington and European capitals, where legislators have offered a range of measures: from a fee on large institutions, proposed by President Obama, to a tax on all financial transactions, being discussed in Europe.

...[The other purpose is] an effort to minimize the "systemic risk" posed by companies that grow so large that their failure can cascade into a larger crisis.
Taxing profits above a certain level "would become a tax on 'excess' returns in the financial sector," the staff paper said. "As such it would mitigate excessive risk-raking." The tax would also apply to "remuneration" -- possibly all the wages at a financial firm, but more likely executive pay and bonuses considered unreasonably high.