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Martin Feldstein and Robert Rubin Discover Bubbles Print
Friday, 15 August 2014 04:26

In one of the more remarkable shows of chutzpah in modern economic policy, Martin Feldstein and Robert Rubin penned a joint oped in the Wall Street Journal warning that the Fed needs to take seriously the risk of asset bubbles. The basis for the chutzpah is that this column is appearing in the summer of 2014 instead of the summer of 2004, when it could have saved the United States and the world from an enormous amount of suffering.

Had these men written a similar column in 2004 warning about the housing bubble (as some of us were desperately trying to do at the time) it undoubtedly would have received enormous attention in both the policy and financial community. Both men were considered the pillars of economic wisdom for their respective parties. Feldstein served as head of the Council of Economic Advisers under President Reagan and had trained most of the other leading lights of conservative economics. Rubin has served as Treasury Secretary under President Clinton and had advanced the careers of figures like Larry Summers and Timothy Geithner.

Unfortunately, instead of warning of the bubble, they were profiting from it. Rubin was a top executive at Citigroup, which was one of the biggest actors in the securitization of subprime mortgages. Feldstein was on the board of AIG, which was issuing credit default swaps on mortgage backed securities with a nominal value well into the hundreds of billions. 

For what its worth, their current warnings are misplaced. The Fed has to concentrate on trying to promote growth and getting people back to work. The risk from inflated asset prices that they identify are primarily a risk that some hedge funds and other investors may take a bath when asset prices (like junk bonds) move to levels that are more consistent with the fundamentals.

Unlike the housing bubble, these inflated asset prices are not driving the economy. This means that the economic repercussions of a decline in the price of assets like junk bonds will be largely limited to the losses of the people who invested in them. That is the way a market economy works. People make bets and some lose, so what?

It is also worth noting that Federal Reserve Chair Janet Yellen is far ahead of Feldstein and Rubin on the problem of bubbles. Last month she warned of the over-valuation of some assets in her congressional testimony. Since then the price of these assets, notably junk bonds, has fallen, reducing the potential risk they pose to the financial sector. It makes far more sense to deal with out of line asset  prices by trying to use targeted actions to bring them back into line than to throw millions of people out of work, and reduce the bargaining power of tens of millions more, by raising interest rates.

A Rapidly Aging Population Is Not a Depression Problem Print
Friday, 15 August 2014 04:09

Matt O'Brien had a good piece in Wonkblog pointing out that the current downturn in the euro zone has been worse for these countries than the Great Depression. However it does get part of the story wrong.

At one point it outlines the troubles of the region:

"The combination of zombie banks, a rapidly aging population and, most importantly, too-tight money have pushed it into a "lowflationary" trap that makes it hard to grow, and is even harder to escape from. That's what happened to Japan in the 1990s, and now, 20 years later, its nominal GDP is actually smaller than it was then."

The aging of the population, and therefore a slow-growing or declining labor force, does not belong on the list of problems here. What matters for well-being is per capita growth. (That is not the only thing that matters, but insofar as GDP matters it is GDP per capita.) If the population is growing very slowly or even shrinking slowly, it will likely be associated with lower overall growth, but not necessarily with lower per capita GDP growth.

Germany has managed to get its unemployment rate down to 5.1 percent, compared to 7.8 percent before the downturn, in spite of having considerably lower growth than the United States over this period. Its employment rate for prime age workers (ages 25-54) has risen by 3.0 percentage points, compared to a drop of 3.5 percentage points in the United States. 

As a result of its slow population growth, few in Germany would see its slow economic growth as being a problem. In fact, most view the economy as being relatively prosperous right now. This is one of the reasons that the country is reluctant to support measures that would help its neighbors, since Germany is not really sharing in their pain at the moment. Similiarly, Japan's slow population growth meant that most people in the country were not suffering in the way that its weak GDP growth may have suggested.

Consumers Aren't Being Cautious, They Are Spending As Much as We Can Reasonably Expect Them to Spend Print
Thursday, 14 August 2014 07:20

In its report on retail sales in July, the Washington Post told readers that consumers are being "cautious," since there was little increase from June's levels. Actually, with the saving rate hovering between 4-5 percent of disposable income, consumers are spending about as much as we can reasonably expect them to spend.

The current saving rate is well below the level of the pre-bubble years, which averaged close to 8.0 percent. The ephemeral wealth of the stock and housing bubbles drove the saving rate to lower levels. But if we pull out these unusual periods, the current saving rate is unusually low, not high as the Post article would imply.

Stocks, Flows, and Abenomics Print
Thursday, 14 August 2014 07:05

Matt O'Brien had an interesting post in Wonkblog on the market reactions to Abenomics. O'Brien points out that the rise in Japan's stock market and the fall in the value of the yen since Abe took office are the result of market movements when Japan's markets were closed. This means that the movements in the stock market were driven by traders in Europe, the United States and elsewhere. O'Brien shows that Japan's stock market has actually declined slightly in the period when the Japanese market was open and the yen has risen in value, implying that Japanese investors don't share the views of foreign investors.

This takeaway is not quite right. It is important to remember that the outstanding amount of equity or currency vastly exceeds the amount that is bought and sold in a day or month. Japanese investors obviously noticed the dramatic rise in the stock market and the fall in the yen over the last year and a half. If they did not believe that these movements were based on solid economic foundations, presumably they would have sold their stock and bought yen in a way that offset these movements.

To see this point, imagine you had shares of stock in a company that were trading at $100 per share. Imagine you went away on vacation for two weeks, out of reach of the Internet. When you came back you discovered that the shares were selling at $150 each. If you did not believe that the higher price accurately reflected the outlook for the company's future profit potential, then presumably you would dump your shares and pocket the profit. 

This is clearly not going on in Japan. While the actions of Japanese traders may very slightly be offsetting the enthusiasm of foreign investors, for the most part they obviously share this enthusiasm or they would not be willing to hold the stock of Japanese companies at current prices.

Harold Meyerson Says Management Is Ripping Off Shareholders Print
Thursday, 14 August 2014 04:58

Harold Meyerson had an interesting column about how the problem of inequality is not just about low wages at the bottom, but also about people at the top ripping us off. However part of his story is not exactly right.   

At one point the column tells readers:

"As a recent study in the Harvard Business Review concluded, a 'survey of chief financial officers showed that 78% would "give up economic value" and 55% would cancel a project with a positive net present value — that is, willingly harm their companies — to meet Wall Street’s targets and fulfill its desire for "smooth" earnings.'"

While Meyerson portrays this smoothing as benefiting shareholders, as he describes the process, it is actually coming at the expense of shareholders. If the company is sacrificing long-term profitability to meet earnings targets then most shareholders are likely losing in this deal. The most likely winners would be top managers whose bonuses are tied to meeting earnings targets or who have options coming due at specified times.

This distinction is important since it describes alternative political paths. The situation as Meyerson describes it clearly indicates the potential of an alliance with shareholders against top management. Since CEOs and other top management are an important part of the 0.1 percent, reducing their pay could have a substantial impact on income distribution, especially when the spillover effects are taken into account.

In this case, the nature of the problem is a corporate governance structure in which the directors, who are the immediate governing body of the corporation, act in the interest of top management instead of shareholders. Empowering shareholders would then be an effective way to rein in CEO pay.

Robert Samuelson Reports on Incompetent Business Owners Print
Wednesday, 13 August 2014 23:11

Every now and then someone inadvertently says something that is truer than intended. Such is the case with a quote that appears in Robert Samuelson's column today.

The piece is devoted to bemoaning the reduction in entrepreneurship which Samuelson somehow thinks is tied to slower job creation. (This relationship is pretty damn weak, but no reason to waste time here.) At one point Samuelson list five possible reasons for the decline in entrepreneurship. Number one is:

"Schools — K-12 plus colleges and universities — aren’t turning out enough skilled workers. 'I have jobs,' said one Texas entrepreneur. 'I just don’t have the talent to fill them.'"

This entrepreneur is likely closer to the mark than he or she realized. The way you find skilled workers is by offering higher wages than your competitors. There are undoubtedly people in the country who have the skills that this entrepreneur needs. If he can't get them to work for him then obviously he is not offering a high enough wage, or as he said, "I just don't have the talent to fill them."

Of course it is possible that this entrepreneur could not afford to offer a high enough wage to attract the skilled workers, but then he really doesn't have the jobs. This would be like someone complaining that they couldn't get a doctor to treat them, without noting the fact that they were only willing to pay $30 an hour. The problem in that case is that the person is unwilling to pay the going wage for doctors.

This story is about as simple as economics gets. If there were a shortage of skilled workers then their wages would be rising. As it is, there is no major group of workers who are seeing rapidly rising wages, therefore it is not plausible that there are shortages of skilled workers.

The problem is likely just what Samuelson quotes the entrepreneur as saying, he lacks the talent to properly run a business.

(Btw, if Samuelson is really looking for causes for the decline of entrepreneurship, the collapse of anti-trust enforcement should probably be on his list.)

When Germany Spends Money It Helps Its Neighbors Print
Wednesday, 13 August 2014 04:57

NPR harshly criticized a change in Germany's social security system which allows workers to collect benefits at age 63, rather than the previous age of 65, if they had contributed to the retirement system for 45 years. The piece repeated claims that this expansion of the retirement system was hypocritical, since Germany is demanding austerity from other members of the euro zone. It also implied that it would be a large expense, telling listeners that 50,000 workers are taking advantage of the reduction in the retirement age.

It would have been worth noting that increased spending by Germany helps it neighbors. Since the euro zone is suffering from inadequate demand, when Germany spends more money it helps Italy and Spain since it will create more demand for their goods and services.

These countries may resent that Germany has the money to spend, just as poor people may resent that rich people have the money to spend, but in the context where the rich do have the money, the poor are better off if they spend it than if they don't. While people in the rest of the euro zone have plenty of grounds for resenting the austerity demanded by Germany, which is causing mass unemployment and costing the region trillions of dollars in lost output, if they really don't want Germany to spend more on its retirees, then they must want higher unemployment and less growth in their own countries.

It would also have been useful to put the numbers here in some context. Germany has a labor force of a bit under 43 million, or roughly 28 percent of the size of the U.S. labor force. This means that this flood of new beneficiaries would be equivalent to an addition of 200,000 retirees to the U.S. Social Security system. That would be an increase of approximately 0.6 percent.

The piece also claimed that Germany is facing a labor shortage as more workers retire. It is difficult to know what this is supposed to mean. In a market economy if there are fewer workers, people switch from less productive jobs to more productive jobs. This means that there might be fewer people working in convenience stores, or as housekeepers, and kitchen workers. What's the problem?


Note: Typos corrected.

Japan's First Quarter Growth is Relevant to Its Second Quarter Contraction Print
Wednesday, 13 August 2014 04:13

The NYT ran an AP article on the contraction in Japan's economy in the 2nd quarter of 2014. The article noted the 6.8 percent annual rate of contraction and told readers that this posed a real problem for Abenomics.

While this rate of decline is undoubtedly a cause of concern, it would have been worth mentioning that its economy grew at a 6.7 percent annual rate in the first quarter. The big factor in this seesaw was a sharp rise in the consumption tax that went into effect in April. This tax increase led many people to pull major purchases forward. As a result, they bought cars, appliances, and other expensive items in the first quarter that they would have otherwise bought in the second quarter.

The modest net contraction over the two quarters taken together should still be cause for concern, but it is a very different world than one in which an economy is sinking at close to a 7.0 percent annual rate.

Maybe the Housing Market in DC is Slow Because Prices Are Too High Print
Tuesday, 12 August 2014 07:02

The Washington Post had an article dedicated to uncovering the reason that the housing market in Washington has been slow in recent months. While it runs through several possible explanations it leaves off the most obvious one: prices are too high.

Inflation adjusted house prices are more than 50 percent above their pre-bubble levels. Back in good old econ 101 we always taught that if supply exceeded demand then the price should fall. The fact that prices in DC are so far above their pre-bubble level would be good evidence that this is the problem.

The Fed's Vice Chair Still Doesn't Know About the Housing Bubble Print
Tuesday, 12 August 2014 04:51

News apparently travels slowly in the nation's capital. The New York Times reported on a speech by Stanley Fischer, the vice chair of the Fed, in which he expressed confusion over the causes of the weak recovery.

It would have been helpful to express the views of economists who could have expressed surprise over Fischer's confusion. When the housing bubble collapsed, there was a massive loss of demand. Spending on residential construction fell back by more than 4.0 percentage points of GDP. With the loss of $8 trillion in housing wealth, consumption fell back by close to 3.0 percentage points of GDP. This created a total gap of 7 percentage points of GDP, which is close to $1.2 trillion in today's economy.

Residential construction has recovered to some extent, but it is still well below its bubble peaks. Unless we see another bubble, there is no reason to expect construction to get back anywhere near its 2005-2006 share of GDP. Consumption has also recovered to some extent, but without the bubble wealth that drove it, there is no reason to expect it to reach the same share of output as in the bubble years.

Unless Fischer has some very novel theory of the economy, there would have been no reason to expect a more rapid bounce back of the economy than what we saw, especially after the federal government turned to austerity in 2011. It would have been helpful if the NYT had focused on the seeming confusion in Fischer's thinking.



Having read Fischer's speech, I think the confusion is more in the reporting than in the speech, which seems largely on the mark on the current state of the economy. The spelling of "Fischer" has also been corrected.

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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.