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We Run the Risk of Political Interference Undermining Good Fed Policy Print
Friday, 26 August 2011 04:21

Morning Edition had a piece on the Federal Reserve Board's annual meeting at Jackson Hole. The segment included a comment from an analyst (link not available yet) saying that we are seeing the risk of political interference undermining good Fed policy.

This would have been a great comedic comment, if it were not said in complete earnestness. This is sort of like worrying that the performance of the Federal Emergency Management Agency would deteriorate after the departure of Michale Brown, except the damage caused by Brown's incompetence was trivial compared to the enormous suffering that has resulted from the Fed's incompetence.

The Fed (i.e. Alan Greenspan and his then sidekick Ben Bernanke) sat back and let the housing bubble grow to ever more dangerous levels. It possessed all the tools necessary to rein it in but chose to do nothing. This is like a school bus driver drunkenly swerving into oncoming traffic and killing all aboard. Incredibly, in Federal Reserve Board land, the driver comes to work the next day and no one says anything.

Yeah, we should worry that it gets worse than this! 

Another Problem of Drug Patents Print
Friday, 26 August 2011 04:04

The NYT has been reporting on the occasional shortages of important generic drugs that arise. It discusses possible answers today, but doesn't discuss the extent to which drug patents are a part of the problem. Because patents allow pharmaceutical companies to sell drugs at prices that are far above their competitive market price, there is relatively little interest among manufacturers in producing drugs that have come off patents. In many cases, the barriers created by the patent holders (e.g. the potential of legal harassment) means that they maintain an effective monopoly long after their patents have expired.

As a practical matter, it would be almost costless for the government to establish a stockpile of key off patent drugs. (They could contract it with a private firm.) If they bought up a million doses of each of 200 drugs, this would cost around $800 million. The drugs could be sold at prices that cover the cost of the purchase, storage, and wastage. It is difficult to see a good argument for not taking a costless measure that could ensure people's health while saving money.

Housing and Arithmetic: Why Do They Never Appear Together Print
Thursday, 25 August 2011 09:32
If I was still getting my paper copy of the NYT this article on the Obama administration's plan to allow more refinancing of Fannie and Freddie backed mortgages would have had me tearing it to shreds. The article refers to plans to allow easier refinancing for people who are now underwater or have bad credit. The piece tells us that refinancing could save homeowners lots of money:

"by one estimate, $85 billion a year."

It sure would be nice to see the name of the person who could be hanged with this estimate. According to the piece, Fannie and Freddie back $2.4 trillion in mortgages that have interest rates over 4.5 percent. If all of these mortgages were refinanced and the average saving was 1.5 percent, this would save homeowners $36 billion. This is just over 40 percent of our $85 billion estimate.

In fact, most of these mortgages could already be refinanced today, if the homeowners wanted to do so. Removing the obstacles for underwater homeowners or homeowners with bad credit would be unlikely to allow even one quarter of these mortgages be refinanced, providing a net savings of less than $9 billion.

If we look at the economic impact, we have to also remember that the interest payments were income for some people. The investors on average are certainly much richer than homeowners, but they would still spend some portion of their interest earnings. If we assume a 40 basis points gap in marginal propensities to consume (e.g. homeowners consume 90 percent of their additional income, investors consumer 50 percent) then the net boost to consumption from this measure would be less than $4 billion a year or 0.03 percent of GDP. 

The article discusses concerns that house prices are continuing to fall. Actually we should expect house prices to continue to fall, they are still close to 10 percent above their long-term trend. If there is a reason that we should expect house prices to stay above this trend, the NYT has never bothered to run a piece on it.

Finally, the piece includes comments from Frank E. Nothaft, the chief economist at Freddie Mac. Mr Nothaft made himself famous for repeatedly asserting during the bubble years that nationwide house prices never fall. If he has ever been right about anything connected with the housing market there is no record of it.

The Morality of the Other Side in the Class War Print
Thursday, 25 August 2011 07:55

The Washington Post and Robert Samuelson did their part in publicly passing along the marching orders from the rich and powerful to Ben Bernanke and the Federal Reserve Board. The word from these folks is "No Inflation!" If that means millions more people will suffer unemployment for a few more years, that's a price that the Post and Samuelson are willing to pay.

Of course the rich and powerful have numerous channels for making their concerns known to the Fed, they don't need the Post and Samuelson to put them into print. So, this really is a public service.

What's neat about this picture is that there is little dispute about the basic facts surrounding inflation. Inflation is a problem that stems from an overheated economy. Apart from war or political collapse there are no instances of inflation just shooting up from low levels into Weimar type hyper-inflation. This means that if we are going to have a problem with inflation, it will arise gradually and we will first have to get back to something near full employment. It will not just creep on us overnight when we are sleeping. (There can be supply induced inflation. Suppose Saudi Arabia's oil fields are blown up and the price of oil goes to $400 a barrel. This would cause inflation, but the Fed's actions are not going to affect this outcome.) 

The other basic fact is that moderate rates of inflation do very little harm. The economy operates every bit as well with 4-5 percent inflation as it does with 1-2 percent inflation. This is a heavily researched topic and the overwhelming majority of this research has found little or no negative effect from moderate rates of inflation (e.g. here and here).

Yet, both the Post edit board and Samuelson argue strongly that Bernanke should not risk higher inflation to try to reduce the unemployment rate. The edit told readers:

"the core rate of inflation (price increases excluding food and energy costs) has crept up to within striking distance of the Fed’s 2 percent target. Printing more money might push it above that, unleashing dangerous inflationary expectations."


Ooooooh, dangerous inflationary expectations. That's really scary. Since the core inflation rate has been above 2.0 percent for most of the last 50 years, it's hard to see what anyone would be worried about.

But then the Post gets to the substance of the matter:

"The Fed recently promised to continue making funds available to the financial system at nearly zero percent interest. While perhaps necessary in the short run, this policy amounts to a penalty on prudent savers and a reward to over-leveraged debtors."

Yep, we should really be worried about rewarding those over-leveraged debtors -- lazy bums, many of them are not even working. And the "prudent savers?" Yes, that woud include all those wealthy people with large amounts of money to invest. But hey, no class issues here.

Robert Samuelson also notes how more expansionary policy has the effect of transfering wealth from creditors to debtors in the context of discussing a proposal by Harvard economist to deliberately target 6 percent inflation for a couple of years:

"To be sure, higher inflation represents a wealth transfer to debtors (who repay in cheaper dollars) from creditors (who receive cheaper dollars). That’s unfair, Rogoff says, but it may be less unfair and disruptive than outright defaults by overborrowed debtors."

Samuelson concludes that the risks of inflation are just too great and then wrong tells readers:

"Remember: The economy’s basic problem is poor confidence spawned by pervasive uncertainties."

As noted in today's lesson on accounting identities, the share of GDP devoted to investment in equipment and software is almost back to its pre-crisis level. And, the saving rate is still below its post-war average, meaning that consumption is high, not low. The economy's basic problem is that the dollar is too high, which is causing a large trade deficit.

When we think about the trade-offs between inflation and unemployment it is important to remember that the tens of millions of people who are unemployed or underemployed today did not do anything wrong. It was people like Alan Greenspan and Ben Bernanke who messed up. And of course other actors in national policy debates, who were too obsessed with budget deficits to notice an $8 trillion housing bubble did not help either.

National Income Accounting for the Washington Post and Robert Samuelson Print
Thursday, 25 August 2011 07:06

National income accounting is really basic stuff. It is taught in every intro economics class. It would be a really great thing if only the people who wrote about and implemented economic policy understand it.

Today Beat the Press features a quick lesson in national income accounting for folks who clearly do not know it: the Washington Post editorial board and its columnist Robert Samuelson.

Starting at the beginning, we know that we can add up GDP on the output side by summing its components, consumption, investment, government, and net exports. This must be equal to the incomes generated in production. This gives us a basic identity that:

1) C+I+G+(X-M) = Y

where Y stands for income. This identity must always hold, it is true by definition.

We can then divide Y into disposable income, which is total income, minus taxes. This gives us:

2) Y = YD + T

We can then divide disposable income into savings and consumption, since by definition any income that is not consumed is saved. This gives us:

3) YD = C+S

since we now know that  Y = C+S+T, we can rewrite equation 1 as,

4) C+I+G+ (X-M) = C+S+T

we then eliminate consumption from both sides and we get:

5) I+G+(X-M) = S+T, rearranging terms gives:

6) (X-M) = (S-I)+(T-G)

This one actually has a clear meaning. X-M is exports minus imports, or the trade surplus, S-I is private saving minus private investment, and T-G is taxes minus government spending, or the budget surplus. This identity means that the trade surplus is equal to the sum of the surplus of private savings over investment and the government budget surplus. Remember, this is an accounting identity, it must be true.

Now, let's bring this back to the concerns that the Post and Samuelson raise today. Both are very concerned about inflation (I'll beat up on them for this is another post), but they also hold out the hope that the economy will get back to full employment once consumers and firms are more confident about the economy.

But consider the accounting identity. The country has a large trade deficit, which means that X-M is a large negative number. It's currently around 4 percent of GDP (just under $600 billion), but would certainly be much larger if the economy were near full employment. Imports rise with income, so that with a higher level of GDP the trade deficit would expand.

If X-M is negative, then either or both (S-I) or (T-G) MUST be negative. This means either or both that we have negative private savings or we have a budget deficit.

We can have the former with a very low private saving rate, as we did during the stock and housing bubble. In both periods there was aa consumption boom driven by transitory wealth created by the bubbles. It is difficult to understand why anyone would want a low private saving rate.

It means that people reach retirement with very little to support them other than their Social Security or Medicare, which both the Post and Samuelson want to cut. So no one can consistently want both low private saving and cuts to Social Security and Medicare, unless they want the elderly to be very poor. (It is in principle possible to raise investment, but in practice very difficult. The equipment and software investment share of GDP is already almost back to its pre-crash levels, so the prospects of further increases are very limited.)  

The other possibility is that we can have a large budget deficit, making T-G a big negative number. But, we know the Post and Samuelson hate budget deficits, they complain about them all the time.

For those who believe in accounting identities and evolution there is only one other place to go, we must get our trade deficit down. We need X-M to be a much smaller negative number. The best mechanism for getting the trade deficit down is reducing the value of the dollar.

A lower dollar would make imports more expensive for people in the United States, leading them to buy fewer imports. It would also make our exports cheaper for people living in other countries, leading them to buy more of our exports. Fewer imports and more exports translates into a smaller trade deficit.

So we should want a lower dollar, right? Not so fast, Samuelson explicitly warns that a falling dollar could be a bad consequence of higher inflation. The Post editorial never mentions a lower dollar as a possible benefit of more expansionary monetary policy.

What can we conclude from this? We can conclude that Samuelson and the Post do not know national income accounting.


The Secret of Summer Employment Print
Wednesday, 24 August 2011 07:29

I was going to swear off Casey Mulligan for the rest of the summer, but it can be hard to stick to a diet. He has a delicious new post and I just have to take a couple of swipes.

First, he criticizes me and Paul Krugman because we have praised studies of the impact of the stimulus that do not take account of displacement effects. Mulligan's example is the move of Yankee Stadium. He notes that the move created jobs in the new location but correctly points out that these was pretty much entirely offset by the jobs lost in the previous location.

This is a fair enough critique in the context of Yankee Stadium. In fact many claims of job creation by businesses (e.g. Boeing creating jobs in its proposed plant in South Carolina) are in fact stories of displacement. In the Boeing case, the jobs would be coming from unionized facilities in Washington State.

But how do we envision the job displacement in the stimulus story? If Illinois has more jobs in road construction due to the stimulus or more teachers in its classrooms, do we think this means fewer construction workers or teachers have jobs in Indiana or Wisconsin? It's a bit hard to see how that works. In the Yankee Stadium and Boeing example, we are taking something away and moving it to a new location. What exactly is being taken away in the stimulus story?

The other point Mulligan raises that deserves comment is his argument that more workers are employed in the summer because of the increased supply of young people looking for jobs. Mulligan sees this as evidence that the underlying problem is supply and not demand, since the additional supply of young workers seeking jobs led to more employment.

Of course there is a flip side to this picture that Mulligan has ignored. There is also increased demand in the summer. This is when families take vacations and go to beaches and resorts. That is both because the weather is better (not many lifeguards are employed on Coney Island in January) and because the kids are out of school. In other words, spending on tourism and recreation is highly seasonal.

We could use Mulligan's seasonal argument as a test of whether unemployment was driven by supply or demand factors if we could just isolate the supply side of the picture. But there is no easy way to do that and Mulligan certainly has not found one.

What Does S&P's Downgrade of Japan's Debt Mean? Print
Wednesday, 24 August 2011 04:58

The NYT reported on S&P's downgrade of Japanese government debt to the 4th highest level. It explained the downgrade by noting Japan's continued weak growth, political problems and concerns about deflation. These are factors that might concern the Japanese public when they vote for their leaders, but it is difficult to see what they have to do with bondholders holding Japanese government debt.

Bondholders are presumably worried about whether they will get paid back. None of the issues raised in this discussion have any direct bearing on whether Japan's government can repay its debt. In fact, since the debt is denominated in yen, it would be difficult to understand how Japan would be unable to repay its debt, unless it forgets how to print yen.

In fact, the concern about deflation undermines one of the arguments that is occasionally made in the context of the U.S. downgrade, that S&P is concerned about inflation eroding the value of the debt. While this story never made sense in any case, if Japan sees deflation then bondholders will actually be repaid in yen that are worth more than the yen they lent. (The credit rating agencies are not in the business of making inflation forecasts. Furthermore, if an increased risk of inflation was the basis for its downgrade then S&P should have downgraded all dollar denominated debt regardless of the issuer.)

It is important for the media to analyze the basis for these downgrades since there are serious questions about the competence of S&P and the other credit rating companies. They rated hundreds of billions of dollars of subprime mortgage backed securities as Aaa. They also gave top investment grade ratings to Lehman, Bear Stearns and AIG until their bankruptcies (or bailout in the case of AIG).

Given their abysmal track record, it is entirely plausible that there is no basis for their downgrades of sovereign debt. There certainly cannot be a prima facie assumption that they have any idea what they are doing. 

Even According to Fed Dogma, Inflation Is Not a Problem Print
Wednesday, 24 August 2011 04:30

The NYT told readers that the Fed will be reluctant to engage in more quantitative easing or take other steps to boost the economy because it is worried about inflation. It then told readers that inflation has been 3.6 percent over the last year, implying that this is a serious problem.

Actually, as a matter of policy the Fed has long focused on the core inflation rate, which excludes food and energy prices. Over the last 12 months, the core inflation rate has been just 1.8 percent, which is below its 2.0 percent target. Furthermore, in prior years the Fed had not even viewed the 2.0 percent core rate as a strict bound. The year over year inflation rate was consistently above 2.0 percent in two decades prior to the recent recession, with the exception of a period in 2003-2004 when the weak economy pushed inflation below this rate. In other words, if Bernanke and the Fed now view 2.0 percent core inflation as an upper bound, then this is a much stricter anti-inflation policy than they have applied in the past.


Furthermore, higher inflation is actually one of the goals of a quantitative easing policy. Higher inflation reduces the real interest rate. Firms are more likely to invest if they expect that they can sell the goods that they produce at a higher price in future years. This is why Bernanke actuallyadvocated that the Bank of Japan deliberately target a higher inflation rate in a paper that he wrote while he was still a professor at Princeton.

This is also the reason that deflation can be a problem as the article notes. However, there is no magic to zero. The problem of deflation is that the the inflation rate is lower than is desired. If the desired inflation rate is 4.0 percent, then the drop of the inflation rate from 0.5 to -0.5 percent is no worse than the drop from 1.5 percent to 0.5 percent. Deflation per se is only a problem when the rate of price decline is so rapid that it undermines the ability to plan. This was the case at the start of the Great Depression when prices were declining at a near double-digit annual rate.

President Obama Blames Darkness on Sunset Print
Tuesday, 23 August 2011 20:15

That is how CBS News would report it. In its discussion of the rise in the deficit in the years that President Obama has been in office it tells its audience:

"Mr. Obama blames policies inherited from his predecessor's administration for the soaring debt. He singles out:

  • "two wars we didn't pay for"
  • "a prescription drug program for seniors...we didn't pay for."
  • "tax cuts in 2001 and 2003 that were not paid for."

He goes on to blame the recession, and its resulting decrease in tax revenue on businesses, for making fewer sales, and more employees being laid off. He says the recession also resulted in more government spending due to increased unemployment insurance payments, subsidies to farms and funding of infrastructure programs that were part of his stimulus program."

It is likely that President Obama blames the recession for the rise in the deficit because it happens to be true. For example, the deficit was 0.4 percent of GDP in 1974. In 1976 it was 4.0 percent of GDP ($600 billion in today's economy). In 1981 the deficit was 2.6 percent of GDP. In 1983, in the middle of the recession, it hit 6.0 percent of GDP. In 1989 the deficit was 2.8 percent of GDP. The recession raised the deficit to 4.7 percent of GDP in 1992. And in 2000 the surplus was 2.4 percent of GDP. The impact of the recession, coupled with the war and the Bush tax cuts, turned this into a deficit of 3.5 percent of GDP in 2003.

In other words, this is not a debatable point. Recessions lead to deficits, and severe recessions, like the one that accompanied President Obama's move to the White House lead to large deficits. Reporters should know this and if they do, they should identify this as a fact to their audience, not an assertion by a politician to be viewed with skepticism.  

Alan Greenspan Insists That He Knows Nothing About the Economy Print
Tuesday, 23 August 2011 19:31

That's what the Dow Jones effectively told readers today. The article reported that in response to a question at a conference:

"Greenspan also said he believes that the sharp rise in gold prices is due to market concerns about inflation taking off in the long run. He noted how there has never been such a major expansion of credit in U.S. economic history."

Let's look this one up. There is an organization called the "Federal Reserve Board" that puts out really good data on credit. If we look at its most recent Flow of Funds accounts, we see that credit for the economy as a whole expanded at a 3.0 percent annual rate in 2009, a 4.2 percent annual rate in 2010, and a 2.3 percent annual rate in the first quarter of 2011, the most recent quarter for which data is available.

Has there ever been "such a major expansion of credit in U.S. economic history?"

Well, actually credit expanded more rapidly than the 4.2 percent rate in 2010 in every single year that Greenspan chaired the Fed. In fact, it expanded more rapidly in every year in this series (going back to 1976) and probably every year since the Great Depression. In other words, for Alan Greenspan night is day, up is down, he is looking at an extraordinarily slow pace of credit expansion and telling reporters that is the fastest on record.

Of course, Greenspan is probably not familiar with the Flow of Funds data. If he had been, he probably would have noted the historic drop in the ratio of homeowners' equity to market value that occurred even as house prices were soaring to record levels. (Rising house prices translate one to one into equity. Other things equal, rising house prices should have meant a rising ratio of equity to value.) This was a very clear warning sign about the housing bubble to those familiar with the Fed's data.

A serious news service should not be passing along such ill-informed nonsense to its readers uncorrected, except if its purpose is to point out that the person who chaired the Fed for almost two decades doesn't have a clue about the economy.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.