Accounting Identities - NYTimes.com

Accounting Identities - NYTimes.com:

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

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

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

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

It follows that

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

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

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

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

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

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

And the slump goes on.

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

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

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

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

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

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

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

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

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

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

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

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

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

Economics and Politics - Paul Krugman Blog - NYTimes.com

Economics and Politics - Paul Krugman Blog - NYTimes.com:

Mike Konczal has has another excellent post, this time on the whole question of why employment remains so low. As he points out,

Why is unemployment so bad in this recession? There are two theories at work. The first is a story of aggregate demand. The second theory is one of a mismatch in skills.

What he doesn’t say explicitly, although it’s clearly implied, is that these two theories have very different policy implications. If it’s aggregate demand, we should be doing everything we can to raise demand, including fiscal expansion and unconventional monetary policy. If it’s mishmash mismatch, we should do nothing, because any effort to create jobs leaves part of the work of depressions undone.
So how would you decide between these theories? The answer is to look at the evidence — specifically, to ask whether what we see bears the “signature” of one story or the other. The aggregate demand story suggests that we should see depressed employment in all industries, that we should see workers of every skill type facing a poor job market. The mismatch story says that we should see surpluses of labor in some places, but shortages in others.
And Mike shows that the data overwhelmingly fit the demand story, not the mismatch story; Every single major industry has seen a rise in involuntary part-time work; so has every major occupation. There’s no hint that any major kind of labor, in any sector, is in short supply.
Let me add another piece of evidence. We’ve been talking a lot lately about the NFIB data on small businesses, and how weak sales — not concern about taxes or regulation — has soared as the perceived biggest problem. But there’s something else these data show: concerns about quality of labor have plunged:

National Federation of Independent Businesses

This strongly suggests that it’s a weak labor market for everyone out there, and businesses have no trouble finding the workers they need; they just don’t know what to do with those workers, given weak demand.
The evidence, then, is overwhelmingly in favor of a demand story. But the mismatch people don’t want to hear that — and they have substantial influence. And so the slump goes on.

Yglesias: [Also] see the new paper from Arjun Jayadev and Mike Konczal showing that a big shortfall in demand (PDF) rather than a sudden uptick in skill mismatch is the main story of the recession. 

Fannie / Freddie Acquitted « Modeled Behavior

Read the whole thing:

Fannie / Freddie Acquitted « Modeled Behavior: "being creepy, a bad person, or even a usual suspect does not make one automatically guilty of any particular crime. In this case government subsidies in the housing market are a bad idea for a host of reasons and have been for years. I will testify to this with vigor and passion.

However, that does not mean that Fannie or Freddie caused the housing bubble. Indeed, by my count they were among the biggest victims of it."

Matthew Yglesias » In Praise of TARP

TARP was a smashing success EXCEPT that its benefits were skewed towards the benefit of wealthy bank executives and shareholders. That is the big problem. That problem also creates the moral hazard that increases chances of a repeat of the same kind of crisis.

Matthew Yglesias » In Praise of TARP: "TARP, the Troubled Asset Relief Program, looks set to go down in history as one of the most unfairly maligned policy initiatives of all time. The government took hundreds of billion dollars, gave it to banksters, and in exchange all we got was this lousy$7 billion in profit. Which is to say that even if TARP had no positive impact on the economy whatsoever, it had a negative cost to taxpayers. How many programs can you say that about? And how many of them are toxically unpopular? ...TARP was both a good idea and nothing less than an exposure of the myth of the free market. There’s an idea out there about a free market that operates “naturally” and produces a certain distribution of wealth and income. Any further interventions into that marketplace to ensure that prosperity is broadly shared constitutes some kind of illegitimate “redistribution” of wealth and income from its natural state. This is not, however, an accurate description of how any economy featuring a modern banking system works. A world in which we simply didn’t have banking and finance would be, overall, a much poorer world. But a world with banking and finance requires various forms of management—monetary policy, regulation of the financial system, and intervention amidst panics and crises. TARP and the associated activities of the Federal Reserve were examples of such intervention and were good ideas. But they highlight that public policy decisions are integral to the creation and sustainment of modern capitalist economies. Under the circumstances, wise and moral policymakers will necessarily attempt to ensure that the prosperity they create is broadly shared by law-abiding members of the community.

Matthew Yglesias » Inflation Targeting vs Price Level Targeting

Matthew Yglesias » Inflation Targeting vs Price Level Targeting: "I want to try to keep doing posts that explain some basic monetary policy concepts, since I think these issues are important but most people aren’t very familiar with them. Today, let’s consider the difference between two kinds of targets a central bank can set for itself. One would be inflation targeting and the other would be price-level targeting. The inflation rate is the rate at which the price level increases, so these are similar ideas. Indeed, in a world of perfect execution they’d be equivalent. This is what the world looks like if the central bank is successfully hitting a two percent inflation target:

And here’s how things look if the central bank is successfully hitting a target for two percent growth in the price level:

It looks the same. Because these are the same thing. But it looks different if you factor in the inevitable occurrence of problems.

For example, suppose the economy has a sharp unexpected burst of deflation:

Here the blue line represents somewhat successful inflation rate targeting—after a few problems, the inflation rate regains stability at two percent. The green line, by contrast, represents somewhat successful price level targeting—after a few problems the price level catches up with its previous two percent annual growth path. That means a couple years of below-trend inflation are met with some years of faster-than-usual inflation to make up the lost ground. This is a subtle distinction, but for someone who signed a long-term contract denominated in nominal terms back in 2007, it has big implications for the financial state of things in 2011, 2012 and beyond.