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.

Is Supply-Side Economics A "School Of Thought"?

"Supply-side economics" is an extremely common term in the media as Google searches demonstrate. But searches of the academic literature yield very few hits and most of these hits are not describing any sort of academic school of thought.  Supply-side economics is a political philosophy with economic implications, not a part of economics and that is why it rarely even merits a mention in economics textbooks.  THE central idea of the supply-side political philosophy is that lower taxes are good for the economy.  It is that simple.  Wikipedia also says that supply siders like lower regulation, and this is often part of supply side rhetoric, but that is a secondary issue and Wikipedia gives no examples of any regulations that supply siders oppose.  Supply siders generally support regulations that increase the rights of property holders and oppose things like minimum wage laws and environmental laws, but these are not as important to supply siders as low taxes and ideas about regulations are less universally agreed upon in this movement. 
The "supply-side economics" movement is closely associated with the Wall Street Journal (WSJ) editorial page which has long promoted the concept.  A WSJ journalist, Jude Wanniski, is often credited with coining the term in 1975 around the time when he clearly coined the term, "Laffer Curve", which is perhaps the most important tenant of supply side economics. 
Read Wikipedia for more explanation of supply-side economics.  It is pretty good, but I disagree with a few points, such as the characterization that "supply side economics is a school of macroeconomic thought".  It is as much a school of macroeconomics as Marxism is or as creationism is a school of biology.  None of these "schools" have much mainstream influence in academia even though they are common in the media and all have had a lot of political influence at different times and places. 

Deflation

Krugman on deflation:
inflation and deflation are not symmetrical. Four percent inflation does very little harm; four percent deflation is a disaster. Why? Three reasons:

1. The zero lower bound: you can always raise interest rates, but you can’t cut them below zero, so deflation means significantly positive real rates even in the depths of a slump, making monetary stabilization much harder if not impossible.
2. Nominal wage rigidity: it’s hard to get wage cuts — always has been, and always will be. So deflation messes up labor markets.
3. Debt: deflation is always contractionary, because it redistributes wealth to creditors and away from debtors, who are almost by definition more likely to be spending-constrained. And in the euro context this means that imposing deflation on debtor countries worsens the downward pressure on the European economy.
So European policy that requires deflation on the part of a large part of the zone is a real disaster.

And there is more.
4. The problem in a recession is that people want more money and less goods and services.  Deflation makes consumer, want to wait to buy stuff because prices are coming down and hoarding cash becomes even more attractive as it is going up in value.
5. Banks become less interested in lending money when they can earn a real interest rate by simply holding cash rather than lending it out to someone who may not pay it back as the real debt burden of a loan compounds with the deflation rate. The increased real interest rate burden of a loan (nominal interest rate plus the absolute value of the deflation rate) also makes borrowers more hesitant to borrow. 
6. (related to #3) Deflation can increase bankruptcy rates which reduces the spending of both the debtor and the creditor until it is sorted out which can take a long time.  Many simultaneous or big bankruptcies can paralyze a financial system and bring down an economy.  This was the fear during the 2008 financial crisis.  Even in the long run, bankruptcy is an expensive process with high transactions costs that reduce the productivity of an economy. 

Goldbuggery

Beware of investor 'tips'. There are often hidden financial ties to the investments that are being promoted. If you believe in the efficient market hypothesis, investing tips should be worthless.  Here is a "gold bug" email I got.  Be very skeptical.  

GOLD could be one of the biggest events in history–the one that could blow past what investors saw in oil, and dotcoms.
Powerful forces are at work, threatening financial chaos, yet I am bringing you one idea that could save you...

Gold could be marching to $2,500, $3,000 or even $5,000 an ounce.

Powerful forces are pushing gold to unprecedented highs. With a US currency crisis imminent, you should consider gold now. You can see that GOLD is where the opportunities have been recently...

	One hundred thirty-three analysts have projected gold will hit $2,500 an ounce–90 of them say the precious metal will hit $5,000– including the original gold bug, James Dines. Still others, like analyst Peter Schiff, are calling for $10,000 an ounce gold!
	Billionaire Steve Forbes is predicting a return to the gold standard while Utah defied the US government and made gold legal tender–more states are expected to follow in Utah's footsteps.
	George Soros, the world's greatest investor–the man who made $1 BILLION in one day on one trade–recently pulled $800 million out of gold funds, pouring it back into GOLD MINING COMPANIES.
	Gold is, and always has been, a bet against inflation and a protector of wealth. As you will see in my Special Report, we are in an inflationary spiral that's helping push gold to historic highs.

Was Housing or Banking Responsible For Recession?

Banker Daniel Davies claims that the bankers did not cause the recession. The housing industry did. Delong disagrees:

Alas! I think that the bankers did do it.

Lets start at the height of the U.S. housing boom in 2005:III, when residential construction reached its peak value as a share of potential GDP. At that moment it dawned on lenders that Option ARMS and subprime buy-to-let teaser mortgages were really not the best businesses to be in, and it dawned on potential borrowers that Option ARMS and subprime buy-to-let teaser mortgages were really not the best financial liabilities to assume--especially because they came bundled with an overpriced house. So after 2005:III the U.S. residential construction sector began to shrink. And it shrank, and shrank, and shrank. By the end of 2007--a little over two years later--it was down by 2.5% of potential GDP as housing prices fell and mortgage financing dried up.
But had the economy slid into recession? No. As residential construction stood down, exports stood up. Foreigners earning money from selling imports to the U.S. no longer invested their earnings in MBSs. Instead, they bought exports from the U.S. Residential construction down by 2.5% of potential GDP, exports up by 1.9% of potential GDP--the market economy was doing fine. It was rebalancing in response to a shock to fundamental expectations just as Jean-Baptiste Say would have said it ought to back in 1803. And Friedrich Hayek's claim--the claim of the entire Marx-Mellon-Hoover-Hayek axis, in fact--that a speculative bubble orgy like 2004-2006 was a sin that had to be paid for in blood and pain and fire and unemployment? Wrong, up until the end of 2007.

But what happened in the two years after the last quarter of 2007? Housing construction continued its decline, even though at the start of 2008 it was plausible and by the end of 2008 it was undeniable that the housing bust had been sufficiently long and deep to erase any Hayekian overbuilding of residences. And throughout 2008 equipment investment and exports fell off the cliff, gradually at first and then at a stunning pace.
Why did they do this? It wasn't because, as Daniel claims, of "the disappearance of a huge amount of household sector wealth. It did disappear. But wealth had disappeared before--remember Black Monday on the stock market in 1987, or the collapse of the dot-com boom?--without it triggering a Lesser Depression. It was because people recognized that banks that were supposed to have originated-and-distributed mortgage-backed securities had held on to them instead, that as a result a large chunk of the $500 billion in subprime losses had eaten up the capital base of highly leveraged financial institutions, and that you were running grave risks if you lent to a bank. The run on the shadow banking system that followed was the source of the crash as financing for exports and for equipment investment vanished, and then the whole thing snowballed.
No banks losing track of the risks they were running and holding on to assets that were supposed to be originate-and-distribute, no financial crisis, no credit crunch, and no Lesser Depression. The housing bubble would have deflated, unemployment would now be near 5%, exports would have boomed, and our biggest worry right now would probably be a "weak dollar".

 Both housing prices and housing starts peaked in 2005. The recession did not officially begin until just before the beginning of 2008. Note that the bubble in housing construction is long since over:

the housing bust since 2007 has been much larger than the mid-2000s housing boom, and that there is no overhang of overbuilt houses, rather the reverse:

Austerians In Europe

Krugman:

It took bad thinking and bad policy by many players to get us into the state we’re in; rarely in the course of human events have so many worked so hard to do so much damage. But if I had to identify the players who really let us down the most, I think I’d point to European institutions that lent totally spurious intellectual credibility to the Pain Caucus. Specifically:
- The OECD, which a year ago demanded both fiscal austerity and a sharp rise in interest rates, because, well, because. Recently the OECD surveyed Britain, concluded that inflation is likely to decline, unemployment to rise, and that the UK should therefore … continue with fiscal austerity and raise rates. As a correspondent wrote, “What planet are they living on? What planet am I living on?”
- The ECB, which bought totally into the doctrine of expansionary austerity, despite overwhelming evidence that it was false, and proceeded to raise rates in the face of a deeply depressed economy — possibly the straw that breaks the euro’s back.
- The BIS, which called for tighter monetary policy just three months ago, to fight a nonexistent inflationary threat. Did I mention that inflation expectations, as measured by the difference between yields on ordinary and index bonds, have been plunging like a stone?
I haven’t developed a full theory of the sociology going on here. But these organizations should be doing some agonized soul-searching, asking how they got it so wrong while posing as high priests of economic expertise.

Competing Theories Of The Lesser Depression

Mike Konczal:

For the next few posts I need to allude to an ongoing battle of ideas about what is troubling our economy and what solutions are available. I figured it might be a good idea to try and create some sort of topological map of the various clustering of ideas and policies that constitute these arguments as well as the overlap among them. This is a preliminary version of this map: I’d really appreciate your input about what is missing and how to make this better.
From those who think that the problem is related to demand and Keynesian ideas, there tends to be three areas of focus: fiscal policy, monetary policy and the debt hangover in the broken housing market. One can think all three are important – I certainly do – but most think one has priority over the others. Many will think one of the three isn’t in play or particularly useful as a focus of policy and energy. Here’s a rough map. Quotations are ideas, non-quotes are policies and parentheses are people associated with each:


This war of ideas is being fought in white papers and articles, and at academic institutions, policy shops and the blogosphere. As a general resources, here are the best one-stop resources online for most of the bulletpoints above:
Fiscal Policy as Expectation Channel: Woodford on Monetary and Fiscal Policy, Paul Krugman.
Quantatitive Easing: The World Needs Further Monetary Ease, Not an Early Exit, Joe Gagnon.
NGDP Targeting: The Case for NGDP Targeting: Lessons from the Great Recession, Scott Sumner.
Mass Refinancing: Economic Stimulus Through Refinancing — Frequently Asked Questions, R. Glenn Hubbard and Chris Mayer.
Inflation to help Deleveraging: U.S. Needs More Inflation to Speed Recovery, Say Mankiw, Rogoff, Bloomberg. Overcoming America’s Debt Overhang: The Case for Inflation, Chris Hayes.
Higher Inflation Target: A 2% Inflation Target Is too Low, Brad Delong.
Bankruptcy Reform/Cramdown: January 22nd, 2008 Testimony, Adam Levitin.
Foreclosure Spillovers: Foreclosures, house prices, and the real economy, Atif Mian, Amir Sufi and Francesco Trebbi.
Balance Sheet Recession: U.S. Economy in Balance Sheet Recession: What the U.S. Can Learn from Japan’s Experience in 1990–2005, Richard Koo.
Housing Backlog: There is a Boom Out There Somewhere, Karl Smith. Yes, Virginia, Our Housing Stock Is Now Way, Way Below Trend, Brad Delong.
Debt-for-Equity Swaps: Why Paulson is Wrong, Luigi Zingales.
Debt, Deleveraging, and the Liquidity Trap: Debt, deleveraging, and the liquidity trap, Paul Krugman. Sam, Janet and Fiscal Policy, Paul Krugman.
The flip-side to a demand crisis is a supply crisis, and there’s been a large effort to explain our high unemployment and below-trend growth as the result of supply-side factors. Having surveyed the arguments, I’ve split them into two categories. There are those who think that the government has created an increase in uncertainty. This is from a combination of deficits that scare bond vigilantes/job creators, new regulations that have killed all the potential new jobs as well as the government creating disincentives to work. The second area of focuses is on the productivity of the labor force, with special emphasis on skills mismatch, the characteristics of the long-term unemployed and the idea that something has changed fundamentally in our economy that will keep so many unemployed for the foreseeable future.

I’m making the productivity circle conceptually expansive enough to include “recalculation” stories, though I suppose I could add a third circle in the next version. I tend not to find these arguments convincing, but here are the arguments made in full as best as I could find them online:
European Policies: The U.S. Recession of 2007-201?, Robert Lucas. The classical view of the global recession, Gavyn Davies.
Expansionary Austerity: A Guide for Deficit Reduction in the United States Based on Historical Consolidations That Worked, AEI. Large changes in fiscal policy: taxes versus spending, Alesina and Ardagna.
Liquidate the Homeowners: Are Delays to the Foreclosure Process a Good Thing? Charles Calomiris and Eric Higgins.
Stimulus is Sugar: Geithner Finds His Footing: Zachary Goldfarb.
Two-Deficit Problem, Bond Vigilanties: Spend and Save, Noam Scheiber.
Great Vacation: Compassionate, But Inefficient, Casey Mulligan. The Dirty Secret of Unemployment, Reihan Salam.
Long-Term Unemployed: Potential Causes and Implications of the Rise in Long-Term Unemployment, Andreas Hornstein, Thomas A. Lubik, and Jessie Romero. 10 Percent Unemployment Forever?, Tyler Cowen, Jayme Lemke.
Great Stagnation: The Great Stagnation, Tyler Cowen.
Patterns of Sustainable Specialization and Trade (PSST): PSST vs. the Aggregate Production Function, Arnold Kling.
Labor Mobility: Housing Lock is not a Major Part of this Crisis, Plus Scatterplots of Deleveraging!,

Expectations and Monetary Policy

Yglesias:

Planet Money did an enlightening explanation of what an “operation twist” effort might look like for Morning Edition today, but it said something that I want to take issue with, namely the claim that “[t]he Fed has at its disposal one key tool: interest rates.” This is certainly what certain popular models say, but it doesn’t really make sense theoretically.
My thinking on this has been influenced a lot by the group of people who I guess we’re now calling “Market Monetarists” (PDF) but is arguably closer to the Old Keynesian view outlined in Chapter 12 of the “General Theory”. Specifically, this beauty contest issue:

Or, to change the metaphor slightly, professional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. It is not a case of choosing those which, to the best of one’s judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth and higher degrees.

The thing is, this works for the economy as a whole. If households anticipate rising incomes, they’re more likely to buy things. And if firms anticipate rising sales, they’re more likely to expand activities. And if firms expand activities, incomes are more likely to rise. So optimism about the state of things can be self-justifying. This isn’t a magic trick. If firms face binding constraints on their ability to produce, no amount of optimism will change that fact and all economies do face objective scarcities of natural resources and appropriately skilled labor. But within the range of objectively possible production, there’s a range of plausible outputs and expectations are crucial to determining how closely actual output matches potential output. Yet, as in Keynes’ beauty contest there’s this terrible indeterminacy. What do I expect the average expector to expect me to expect? What’s needed, in essence, is for someone to show up and tell us what to expect.
In this view, the key thing about the modern central banker is simply that we’ve all agreed that he’s the guy in charge. “Don’t worry folks, if your business is profitable you should be expanding production because all the other profitable businesses will also be expanding so there will be customers for your profitable products.” It’s a social convention, and the convention is self-validating. As long as we all agree to agree that we’ll agree that what the central bank says is important, it is important. This is why central banking is cloaked in mystery, why it’s “apolitical,” while meeting transcripts need to be delayed for years, etc. Central bankers have generally preferred to use short-term interest rates as their tool of choice, but this is fundamentally just one of the Wizard of Oz’s tricks. In an ideal world, the head of the bank would go on television waving a stopwatch and hypnotize the audience. To boost output say: “at the margin, you will on average decrease your interest in owning dollars and dollar-denominated safe liquid financial instruments.” To curb inflation say: “at the margin, you will on average increase your interest in owning dollars and dollar-denominated safe liquid financial instruments.” But of course everyone knows that stopwatches can’t really hypnotize people, so they use interest rates instead. With short-term nominal interest at zero, bankers need to pick a different instruments but there are plenty of things they could choose. What matters is that they choose something and back it up with some bold talk about how people are going to want to own fewer dollars and dollar-denominated safe liquid financial instruments.
This is all sounds kind of nuts, because it is. That’s why New Keynesians want to believe it’s all about interest rates and it’s why Market Monetarists like to daydream about an NGDP futures market. I think the world’s just a bit weird and nutty.

Political Business Cycle

When the economy is getting better, presidents are almost always re-elected and their party gains seats.  When the economy is getting worse, presidents usually lose and their party is also punished.  Nevermind that voters are often irrational in voting this way, it is a fact of life.  In a political system that depends upon checks and balances, this gives an incentive to the party that is out of the White House to block growth-enhancing policies. 

CNBC:

Top Congressional Republicans Tuesday took the unusual step of telling the Federal Reserve to refrain from further "intervention'' in the economy on the eve of a policy decision by the U.S. central bank.  The group, which included the top two Republicans in both houses of Congress, said the Fed's policies have been ineffective at supporting economic expansion and boosting employment.  ...The letter was signed by House Speaker John Boehner, Majority Leader Eric Cantor, Senate Minority Leader Mitch McConnell and Senate Minority Whip Jon Kyl.

It was a rare direct recommendation from Capitol Hill on monetary policy, which is supposed to be conducted free of political pressure.

The Fed said it had received the letter, which was made public by Republican leaders, but had no further comment.

With economic prospects fading dramatically after a damaging U.S. debt downgrade in August and an escalation of European financial turmoil, the Fed has made clear it is intent on taking further steps to lift growth. Fed officials argue that, while growth remains anemic, its unconventional monetary support have at least forestalled a prolonged period of damaging deflation.

Officials at the central bank differ on how best to address the economy's woes, analysts expect Bernanke to muster a consensus behind a plan to rebalance the Fed's portfolio to push down longer-term interest rates. 

..."We have serious concerns that further intervention by the Federal Reserve could exacerbate current problems or further harm the U.S. economy," the letter said. 

Further harm to the U.S. economy would only help Republican electoral power. 

Republican leaders were deeply critical of the Fed's move late last year to make additional bond purchases, and blocked a nominee to the Fed's board earlier this year. The nominee, Peter Diamond,

 Diamond won the Nobel Prize last year!  He was clearly qualified and yet they blocked him.  

Indeed, the Fed has become a political campaign issue ahead of next year's presidential elections, with Mitt Romney from Massachusetts saying he would not reappoint Bernanke and Texas Republican Rick Perry calling the Fed chief's actions "treasonous."

"If this guy prints more money between now and the election, I don't know what y'all will do to him in Iowa, but we would treat him pretty ugly down in Texas," Perry told supporters in Iowa last month.

Corporate Cash Hoarding

Yglesias: 

The Wall Street Journal has a nice piece on the growing phenomenon of corporate cash hoarding as American firms pile up more highly liquid assets rather than investing in expanding business activities.
This hasn’t attracted nearly enough mainstream attention, and a lot of the not-so-mainstream attention I’ve seen focused on it has been a little bit conspiratorial in tone. This is, however, precisely what a basic demand-side explanation of the recession would predict. If demand for oranges drops, normally people buy apples instead and the economy reconfigures. Or maybe demand for Toshiba laptops drops and people buy Apples instead. But it’s possible instead for demand for everything to drop, in which case people buy cash and cash-like instruments instead. Here, instead of the economy reconfiguring itself to produce fewer oranges and Toshibas and more apples and Apples, the economy instead reconfigures to produce fewer goods and services overall. Hence vacant retail storefronts, idle workers, factories skipping shifts, construction equipment sitting by the side of the road, etc.

What policymakers need to do is recalibrate expectations of demand growth. People need to think that over the next couple of years the United States will be working to rapidly close the gap between potential and actual production. Then these cash indicators will drop to more normal levels, and that itself will increase real output and employment.

And yet investment spending recovered a long time ago and is back to normal.  Housing investment is still down and all spending is a big sluggish. 

Delong:

I do think that this is not a bad way to look at (much of) what is going on in the current Lesser Depression. The boom of the 1990s had been driven by rising exports and, overwhelmingly, business investment in equipment investment and software as Bill Clinton's stabilization of the U.S. government's long-term finances and his shrinkage of the government had unleashed a high-investment, high productivity growth recovery. The recession of 2001 was driven primarily by a fall in exports and secondarily by a fall in business equipment investment. The mid-2000s recovery was led by residential investment, with exports and business equipment investment adding support.
That takes us up to the end of 2005.
With the start of 2006, the housing bubble bursts and residential construction investment begins to decline as a percentage of potential GDP. But for the first two and a half years exports stand up as housing construction stands down and the economy remains near an even keel even with the growing financial turmoil.
Then in late 2008 the economy falls off a cliff: business investment in equipment and software collapses, housing investment collapses further to far below any equilibrium level, and exports collapse. Exports and business equipment and software investment start to recover in the third quarter of 2009. If only their good recovery performance had been matched by a recovery in residential investment and an increase in government purchases, we would due fine.
But there was no recovery in residential construction. There was no increase in government purchases. And starting in 2010 the shrinking government sector puts additional downward pressure on the economy.

mean unemployment duration

FRED UEMPMEAN:

Land NOT Housing Bubble

Housing prices depend upon the cost of building which has been remarkably constant over the decades.  Land prices depend on population and income and speculation and is extremely variable.
Yglesias:

There was, obviously, a huge boom in the price of land in the United States of America during this period. But was there really an extraordinary boom in housebuilding?

At the height of the “boom” we were adding units about as quickly as we were adding them in the late 1970s, when the total population was smaller and China’s “opening up” was just a glimmer of an idea of a possibility. If the Federal Reserve was trying to engineer a homebuilding boom it didn’t really work.

Most graphs I have seen of housing starts are truncated around 1990.  That makes the recent 'housing' bubble look like an extreme expansion of housing supply.  But it was actually a slower increase than previous increases and it did not top out as high as in the early 1970s when the US population was much smaller.  The most notable feature of this graph is the recent bust, not the boom.   The housing bubble was in the price of housing which is mainly driven by the price of land:

Gold Prices Determined By Real Interest Rates

Krugman says that gold can be understood as a stock of an exhaustible resource. 

Here’s how it works. Imagine that there’s a fixed stock of gold available right now, and that over time this stock gradually disappears into real-world uses like dentistry. (Yes, gold gets mined, and there’s a more or less perpetual demand for gold that just sits there; never mind for now). The rate at which gold disappears into teeth — the flow demand for gold, in tons per year — depends on its real price:
Crucially, at least for tractability, there is a “choke price” — a price at which flow demand goes to zero. As we’ll see next, this price helps tie down the price path.
So what determines the price of gold at any given point in time? Hotelling models say that people are willing to hold onto an exhaustible resources because they are rewarded with a rising price. Abstracting from storage costs, this says that the real price must rise at a rate equal to the real rate of interest, so you get a price path that looks like this:

Obviously there are many such paths. Which one is correct? Given rational expectations (I know, I know) the answer is, the path under which cumulative flow demand on that path, up to the point at which you hit the choke price, is just equal to the initial stock of gold.
Now ask the question, what has changed recently that should affect this equilibrium path? And the answer is obvious: there has been a dramatic plunge in real interest rates, as investors have come to perceive that the Lesser Depression will depress returns on investment for a long time to come:

What effect should a lower real interest rate have on the Hotelling path? The answer is that it should get flatter: investors need less price appreciation to have an incentive to hold gold.
But if the price path is going to be flatter while still leading to consumption of the existing stock — and no more — by the time it hits the choke price, it’s going to have to start from a higher initial level. So the change in the path should look like this:

And this says that the price of gold should jump in the short run.
The logic, if you think about it, is pretty intuitive: with lower interest rates, it makes more sense to hoard gold now and push its actual use further into the future, which means higher prices in the short run and the near future.
 

Larry Summers has a similar theory.  Karl Smith agrees and adds that:

A simpler way to tell the story is this: after adjusting for risk the price of any asset has to rise at the long term interest rate.
Why?
Because if it rose slower than the long term interest rate then it you can make an easy profit by selling the asset buying bonds, earning interest on the bonds and then buying the exact same asset back later.
On the other hand if it rose faster than the interest rate you could make an easy profit buy borrowing money in the bond market, buying the asset, letting the asset go up in price and the sell it to pay off your bonds plus profit.
So we know all assets rise at the interest rate after accounting for risk.
So what happens when the interest rate goes down? Well we know that long term price appreciation will slow which means one of two possibilities
1) The current price will stay the same but slow price appreciation means the future price is lower
2) The current price will jump and slow price appreciation will get us to the same future price.
How do you know which one will happen? The short answer is that its almost always scenario (2).
The long answer is that declines in the interest rate that reflect declines underlying long run productive capacity will produce scenario (1). Declines that driven by nominal factors will produce scenario (2).

Housing prices also go up when the nominal interest rate declines for much the same reason.  In this case you can think of it as being that the cost of borrowing money declines which allows people to borrow more money for a home and spend more.  The main expense for homebuyers is not the house, but the interest and when the interest goes down, the ability to pay goes up which is the same thing as an increase in demand which raises prices.  This is a nominal interest story, and real interest rates should also have an effect on house prices, but I would wager that the nominal interest rate is almost always more important for driving house price changes. 

Quasi-Monitarism

Henry Kaspar:

My Discomfort with Quasi-Monetarism
Regular readers of the blog will be familiar with the term"quasi-monetarists": a group of economists that includes Nick Rowe, Scott Sumner or David Beckworth ...is trying to push the following, powerful message (with differing emphasis on the specific elements, depending on the author):

1. The cause of the crisis is excess demand for money (=money hoarding). Excess demand for money implies necessarily insufficient demand for goods (with sticky prices).

2. The way out of the crisis is a monetary policy that brings supply and demand for money back into equilibrium, and thus ends the hoarding of money.

...
Now here is how I see things:

1a. The main cause of the crisis is excess indebtedness -  of private households, [and]of the government. [This cause is called] a “balance sheet recession“ - a hypothesis that was originally popularized by Richard Koo, but by now is almost commonplace.

1b. Excess indebtedness forces debtors to reduce expenditures in order to be able to service their debts – i.e., it forces a transfer from debtors to creditors. The creditors’ propensity to spend is lower than that of debtors; after all this is why they are creditors. They would want to lend on the means transferred to them, but do not find enough households or firms willing and able to take on more debt. To use Brad DeLong’s term: there is a lack of safe assets.

1c. Because of the lack of safe assets creditors hoard money.

It is important to note that I agree with the quasi-monetarists on two points: (i) the problem is insufficient aggregate demand, and (ii) by logical necessity, the counterpart to insufficient demand for goods is money hoarding. But money hoarding is a symptom of the crisis, not its cause. Put differently, causality goes from lack of aggregate demand to money hoarding, not the other way round.
Nick Rowe ...often employs a nice thought experiment that describes the above identity more graphically – but can easily mislead if sloppily given a causal or even economic policy interpretation: suppose there was no money, and therefore also no possibility to hoard money - then there could be no lack of aggregate demand for goods. Does this not suggest that policy makers should focus on ending money hoarding? And aren’t things related to money the task of the central bank, i.e., isn’t monetary policy responsible here?
It does not – as there are more promising options to combat insufficient demand and (therefore) money hoarding (see below). This is the source of my discomfort with quasi-monetarism: a tendency to cut down the characterization of the crisis to the one aspect that helps pushing their (monetary) policy point. And this is important, as they way we present problems affects how we think about their solution.
My characterization suggests the following policy options:

2a. Debt relief. Debt relief reduces the debt payment burden and thus allows debtors to spend more of their income on goods. Hence, in the U.S., for example, schemes are needed that strengthen incentives for lenders to write down mortgage loans. And in Europe some debts of the most overindebted countries need to be cancelled.  

2b. Government indebtedness, i.e. expansionary fiscal policy.  If the private sector is incapable of absorbing all desired savings the government has to jump in – at least temporarily, while the private sector is paying down its excess debts. The government offers savers a safe asset (government bonds) and uses the funds to directly boost aggregate demand. This, however, is only an option when the government is not overindebted itself (as is the case in some GIPS-countries).

2c. Monetary policy comes at best in third place, as it is worst in addressing the crisis’ underlying cause. Monetary policy can stimulate aggregate demand only if it incentivizes the private sector to indebt itself. But the private sector is already overindebted, to a point where even nominal interest rates of zero or close to zero fail to generate enough willingness to take on debt. And, as is well known, at the zero bound monetary policy encounters some difficulties.

In one sentence: lack of demand and (therefore) money hoarding are there only because of
insufficient efforts to (i) reduce the private sector’s debt burden, and to (ii) compensate for the loss in demand from the overindebted private sector by sufficiently increasing demand from the public sector.
If so, policy makers should focus on promoting debt relief and boosting public sector demand, instead of placing all the burden on an instrument – monetary policy – that has hit a constraint.

I would add that monetary policy could produce inflation which would be a good thing for a "balance-sheet recession" because it would reduce the real debt burden for most people.  Much debt has a fixed interest rate.  Higher inflation reduces the real value of the debt and lightens balance sheets. Krugman added a few more comments on the above post:

So: an overall shortfall of demand, in which people just don’t want to buy enough goods to maintain full employment, can only happen in a monetary economy; it’s correct to say that what’s happening in such a situation is that people are trying to hoard money instead (which is the moral of the story of the baby-sitting coop). And this problem can ordinarily be solved by simply providing more money.

But we’re not in an ordinary situation here, we’re in a liquidity trap in which short-term interest rates have been driven to zero, yet the economy still languishes.

What that means is that when people are hoarding money, they’re no longer doing so because of its moneyness — the liquidity it provides, which makes money different from other assets. They’ve already got all the liquidity they want, since liquidity is free — you don’t have to sacrifice interest earnings to get more, so people are saturated. So at the margin, they’re holding money simply as a store of value.

Now, what monetary policy ordinarily involves is open-market operations: the central bank increases the supply of money by purchasing and removing from the market non-money assets. And this has traction because money is different from these other assets. In a liquidity trap, however, money isn’t different: at the margin an open-market operation just exchanges one store of value for another, with no economic effect.

So this is a situation in which the economic problems cannot be solved just by increasing the supply of money.

Now, in principle you can get traction by making money a less attractive store of value. In particular, if you can credibly promise future inflation, that will make the real return on money negative. But getting that kind of credibility is tricky, especially given the normal prejudices of central bankers. And in any case it’s very different from the kind of thinking we normally associate with monetarism, which focuses on the current money supply.

Nor does focusing on nominal GDP instead of M2 or whatever really bridge the gap. The point about M2-based monetarism was that it was supposed to give the Fed a target it could clearly control — although in a liquidity trap it turns out that even that isn’t true. Whatever else it is, and whatever virtues it may have, nominal GDP isn’t that kind of target.

Politicans Do Not Understand Economics

Politico:

“I think the best jobs bill that can be passed is a comprehensive long-term deficit-reduction plan,” said Sen. Tom Carper (D-Del.), discussing proposals to slash the debt by $4 trillion by overhauling entitlement programs and raising revenue through tax reforms. “That’s better than everything else the president is talking about — combined.”

TPM:

I asked Rep. Heath Shuler (D-NC) whether he agreed with CBO chief Doug Elmendorf — and by extension Obama — that the wisest economic path involves near term stimulus followed by long-run fiscal restraint. “I would definitely be at odds with his comment on that — I mean we’ve got to get our fiscal house in order,” Shuler said...
Rep. John Barrow (D-GA) said Obama’s actual jobs plan is much less important than the fact that he’s talking about the economy.
“The President’s jobs package is about instilling confidence — to be listening to folks out there,” he told reporters. “There’s a mixed media message going to folks back home, they’re not sure, are we paying attention to their plight. End of the day, what’s in, what gets passed at the end of the day in the President’s jobs package isn’t as important as the fact that we’re talking about, and more importantly that Boehner and Cantor are at least on the surface seem to want to do something with the President. That’s the kind of confidence we want to instill in the Super Committee.”

 NYT: 

“I have been very unequivocal,” said Representative Peter DeFazio, Democrat from Oregon. “No more tax cuts.”....“I have serious questions about the level of spending that President Obama proposed,” said Senator Joe Manchin, Democrat from West Virginia....

 And Republicans don't understand lowering the deficit hurts unemployment either. There are two possible mechanisms how deficit reduction (a reduction in demand) could increase aggregate demand. 
1. reduced government borrowing could reduce interest rates.  But interest rates are usually already very low during a recession and there is no evidence that this has ever worked.
2. The "confidence fairy".  The idea is that citizens are saving excessively much money because they are worried about government deficits and when the government stops borrowing, private citizens will feel more confidence and start borrowing and spending.  But there is no evidence for this either.    

unemployment and real wage growth (inequality)

Yglesias:

Here’s a great chart from the Washington Post illustrating the extent of the current jobs gap:

This also, however, illustrates the most important issue that nobody ever talks about. The Federal Reserve clearly has a policy over the past thirty years of treating upside and downside deviations from full employment asymmetrically. Only once during this period have they allowed unemployment to get “too low” and the deviation was small. By contrast, we’ve had four separate episodes of unemployment being “too high” and in three of those cases the magnitude of the deviation was larger than during the lone “too low” episode. Coincidentally (ha ha) this period corresponded with the only period of sustained real wage growth during the past thirty years.

Inflation of What?

Yglesias: 

Whenever a stat about flat or declining real median wages or income comes out, an immediate fight always breaks out as to what that statistic “really” means. These conversations often suffer from a lack of awareness of the extent to which the different price categories diverge over time. Here, for example, is an illustration of the main expenditure categories that have grown faster than the overall price level:

What this is telling you is that someone whose “real” income was the same in 2010 as in 1978 is going to have suffered a steadily eroding ability to afford health care services and school tuition. He’ll also have experienced a long period of increased gasoline affordability, followed more recently by a deterioration sufficiently severe as to have left him worse off on net terms. Housing, which many people on Twitter think has gotten more expensive, has actually kept pace with overall inflation (more on this later). Food is the same as housing in that regard. Most everything else has gotten cheaper relative to other goods and services. That’s computers, cars, etc., and to an extent the falling real cost of cars lets you offset the gasoline problem by getting more fuel efficient vehicles.
This means that the extent to which your flat real income represents a “really real” decline in living standards depends entirely on what stuff you buy. College tuition isn’t something everyone buys the way food or even something “everyone” buys the way cars are. Many people don’t go to college, and many of the people who do go to college went to college in the past (or their kids did) and are not impacted by ongoing developments in these prices. Some people are much sicker than others or are differently situated vis-a-vis ailing relatives. Technological progress in the health care sector isn’t uniform, so some diseases can be much better treated today while others are simply more expensively treated. Talking about averages is often important, but it obscures a great deal of variation.
Now onto housing. Have housing costs really increased at the pace of overall inflation since 1978? ...Housing tracks overall inflation for two reasons. One is that a house is made up of lots of different kinds of stuff and lots of different kinds of labor, so the fluctuations tend to even out. The other is that the differential quality of land isn’t factored into this. So the fact that specific parcels of high-quality land have grown more expensive isn’t considered in the analysis. The United States doesn’t suffer from an overall shortage of land, so it’s still perfectly possible to get a cheap house somewhere or other, but specific places have become more expensive. This concentrated increase in land prices is experienced as higher costs by some (the people who’ve moved to Brooklyn over the past 10 years) but as increased wealth by others (the parents of the kids I went to Grace Church School with in the ’80s). So here, again, the average masks a lot of differences.

High Unemployment Since 2000

Scott Winship:

There are somewhere between three and five out-of-work job-seeking Americans competing for each job opening. As shown in the chart below, competition for jobs among the unemployed remains greater than any time before the financial crisis, stretching back to the Great Depression.

From 1951 through 2007, there were never more than three unemployed workers for each job opening, and it was rare for that figure even to hit two-to-one.  In contrast, there have been more than three jobseekers per opening in every single month since September 2008.  The ratio peaked somewhere between five-to-one and seven-to-one in mid-2009.  It has since declined but we have far to go before we return to “normal” levels.

The bleak outlook for jobseekers has three immediate sources.  The sharp deterioration beginning in early 2007 is the most dramatic feature of the above chart (the rise in job scarcity after point C in the chart, the steepness of which depends on the data source used).  But two less obvious factors predated the recession.  The first is the steepness of the rise in job scarcity during the previous recession in 2001 (from point A to point B), which rivaled that during the deep downturn of the early 1980s.  The second is the failure between 2003 and 2007 of jobs per jobseeker to recover from the 2001 recession (the failure of point C to fall back to point A).

The next chart shows trends in job openings and in unemployment separately to tease out the dynamics in play.

Unemployment increased during the 2001 recession, but it subsequently fell almost to its previous low (from point A to B and then back to C). In contrast, job openings plummeted—much more sharply than unemployment rose—and then failed to recover. In previous recoveries, openings eventually outnumbered job seekers (where a rising blue line crosses a falling green line), but during the last recovery a labor shortage never emerged.

Social Secuity as Ponzi Scheme

Rick Perry says that Social Security is a Ponzi scheme.  One difference is that a Ponzi scheme requires all (or most of) its participants to have unrealistic expectations about the future and Social Security does not.  A Ponzi scheme requires exponential growth whereas Social Security does not.  There are some elements of similarity, but Social Security funding is more like the way public education is funded.  It is a pay-as-you-go intergenerational tax and transfer program.  If you think of it as a government spending program, then it isn't any different from education spending or defense spending.  If you think of it as being like an individual investment account (which it is not), then there are some Ponzi-like rises and falls in the return on investment (ROI) due to demographic shifts.  When the baby-boom generation was working, they paid a lot into Social Security and their parents got a really good deal (high ROI).  But the baby boom won't get as good of a deal (ROI) as generations before them because there will be fewer workers supporting them.  Demographic shifts make all spending programs more difficult, and create a Ponzi-like dynamic, but they do not make spending programs like Social Security inherently unsustainable.  Milton Friedman noted that Social Security has been called a Ponzi scheme by many of its opponents who seem to think it is unsustainable and fraudulent like a true Ponzi scheme. The Social Security Administration explains the difference in detail.