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Raising Reserve Requirements to Slow Inflation: China Shows How It is Done Print
Sunday, 17 April 2011 08:04

U.S. economists seem to not understand that central banks can raise reserve requirements as a way to control inflation. This is apparently the reason they find it inconceivable that the Fed could buy and hold large amounts of debt without leading to inflation. If the Fed buys and holds the debt, then the interest on the debt would be paid to the Fed and then refunded to the Treasury. In this way it would impose no net cost to taxpayers.

If the Fed were to buy and hold say $3 trillion of the debt being incurred due to the downturn, then it would reduce the projected interest burden in future years by close to $150 billion a year (@ $1.5 trillion over a decade), a bit less than 1.0 percent of GDP. Given the national obsession with reducing the deficit, it would be reasonable to expect that this would be one of the policies on everyone's list.

For some reason it is never mentioned. This is presumably because our economists don't have a very good understanding of economic policy. (They didn't see the $8 trillion housing bubble that wrecked the economy.)

Therefore, this NYT article on how China is raising reserve requirements to slow inflation should be important news to those in economic policy-making positions. China's central bankers would probably even be willing to provide tutorials to Federal Reserve Board Chairman Ben Bernanke and others to explain how they are raising reserve requirements. Maybe then this policy could be included on the list of ways to reduce the deficit.

Addendum:

The Fed can buy bonds by printing money. It does this all the time and is actually buying large amounts of money now. The issue is whether it can continue to hold the bonds when the economy starts to recover or whether to prevent inflation, it will have to sell the bonds, thereby pulling money out of circulation.

The fact that China's central bank seems to understand, which U.S. policy analysts do not, is that raising reserve requirements is an alternative mechanism to pulling money out of the economy by selling bonds. If the reserve requirement is twice as high, it has roughly the same impact as cutting the money supply in half.

Those who think China's 5.5 percent inflation rate somehow shows that raising reserve requirements is an ineffective policy have to deal with the fact that its central bank has also been trying to reduce the money supply directly. Obviously neither policy has been pursued with sufficient vigor if the goal is to bring down inflation. Of course, the vast majority of people in China would probably prefer something like the 9.0 percent growth it is now enjoying, coupled with 5.5 percent inflation (fueled in large part by rapid wage growth) than a much slower growth rate and lower inflation.

 
Why Is It a Problem if Poor People Increase Their Consumption? Print
Sunday, 17 April 2011 07:40

The NYT described the problem facing developing and rich countries as they try to reverse imbalances in trade:

"The problem is that developing nations, losing business from their best customers, hope to replace sales by increasing domestic consumption — selling to the same customers developed nations are trying to reach."

Actually this should in principle not be a problem at all. It would mean that people in developing countries have rapid increases in their standard of living. This is what is supposed to happen in the world economy as the developing world catches up to the rich countries.

Due to incredible mismanagement of the world financial system in the wake of the East Asian financial system (i.e. Alan Greenspan, Robert Rubin, Larry Summers saving the world [thanks James]) capital flows reversed course in a big way to go from poor countries to rich countries, especially the United States. The harsh conditions that the IMF imposed on the countries that fell into crisis led developing countries to accumulate massive amounts of currency reserves to avoid ever being in a situation where they would be dependent on the IMF for help.

This reverse flow led to the large imbalances seen today. It is understandable that the developing countries would not want to be in a situation where they are again borrowing heavily from abroad and therefore could need outside assistance at some point, but this is because they cannot count on an international financial system that protects their interests rather than just the interests of rich country banks. 

This is all a question of simple accounting identities. These points should have been noted in the article.  


 
Medicare Costs More Under Ryan Plan and the Iraq War Costs More Than a Hamburger Print
Saturday, 16 April 2011 04:32

The NYT produced its entry in the understatement of the year contest telling readers that:

"A Congressional Budget Office review of the Ryan proposal predicted that retirees would pay more for their health care under it than they would under traditional Medicare."

Yes, this is true. But this is not a question of spending a few extra dollars a month for health care under the Ryan plan. The CBO projections show that under the Ryan plan, seniors would soon be spending more than half of their income to buy a Medicare equivalent plan. This is both due to the cost shifting from the government to individuals, but even more importantly CBO projects that Ryan's plan will lead to much higher health care expenses since it will be less effective in containing costs than the traditional Medicare program.

The CBO projections imply that Ryan's plan would add more than $30 trillion to the cost of providing Medicare equivalent policies over the program's 75-year planning period. The additional cost under the Ryan plan is an amount that is approximately equal to $100,000 for every person in the country or 6 times the size of the projected Social Security shortfall. This sum is the pure waste, it does not count the costs shifted from the government to seniors. 

 
Debt and Interest Rates: Isn't There a Bond Market in the United States? Print
Friday, 15 April 2011 21:55

The NYT contrasted the situation of the United Kingdom when it sells its debt to the United States:

"In that sense, comparing the British and American deficit-cutting plans becomes a bit more difficult. In Europe the bond market is the ultimate judge of deficit-reduction plans. In the United States, by contrast, the global demand for Treasury bills, and the benefits of the Federal Reserve Board’s easy-money “quantitative easing” policy, have kept 10-year bond yields well below those of Britain."

Let's see, the bond market determines interest rates for British debt and who exactly is determining the interest rate on U.S. debt, "global demand?" In both cases the bond market determines interest rates, although the exact set of factors will differ. It is interesting that the interest rates on U.K. and U.S. debt is almost exactly the same at the moment, which suggests that the markets view them as equally risky.

 
Brooks Bemoans the Lack of a Free Lunch for Representative Ryan Print
Friday, 15 April 2011 04:05

That would be at the White House of course. Brooks is upset that:

"It is sad, although not strange, that in today’s Washington they have never had a serious private conversation. The president has never invited Ryan over even for lunch."

Brooks goes on to tell us five things that Ryan "believes" that Obama does not.

"First, he believes that aging populations, expensive new health care technologies and the extravagant political promises have made the current welfare state model unsustainable. Fundamental reform is necessary or the whole thing will collapse, here and in Europe.

Second, he believes that seniors and the middle class cannot be excused from the benefit cuts that will have to be imposed to rebalance these systems. Third, he believes that health care costs will not be brought under control until consumers take responsibility for their decisions and providers have market-based incentives to reduce prices.

Fourth, he believes that tax increases should not be part of these reforms because the economic costs outweigh the gains. Fifth, he does not believe government can nurture growth and reduce wage stagnation with targeted investments."

 

Let's look at some of these points more closely.

Number one is certainly a very peculiar belief given the fact that Japan and most countries in Europe in have much older populations than the U.S. and are still showing comparable rates of productivity growth. It would be interesting to know what sort of timeline he envisions for this scenario since it would take many decades for the age composition of the United States population to catch up to its older neighbors, all of whom continue to see growing economies.

The second belief only makes sense if the first one is true, which the evidence in the world does not support in any obvious way.

The third belief is contradicted by the experience of the dozens of countries who have comparable quality health care systems to the United States and pay less than half as much per person. Most, if not all, of them rely less on co-payments and other patient contributions than the United States. It is also worth noting that if the United States had the same per person health care costs as any other wealthy country, it would be looking at huge budget surpluses rather than deficits.

The fourth belief assumes that there are no areas where the government can possibly do things better than the market. Ryan and Brooks may not understand this point, so I will explain.

If the government can provide a service like health care insurance or retirement pensions more efficiently than the private sector, as a vast body of evidence suggests, then it means that we would either want higher taxes or a less efficient economy. It does appear that Ryan would prefer the latter. His Medicare proposal would add more than $30 trillion to the country's health care costs over Medicare's 75-year planning period. This amount, which reflects the pure increase in costs, not the shift from the government to beneficiaries, is almost 6 times the projected shortfall in the Social Security program.

The fifth point seems to imply that Ryan thinks that in 2011 we have somehow stumbled on the optimal level of government support for infrastructure, education, and research and development. I suppose God may have spoken to Representative Ryan, but the rest of us might view the optimal degree of government support as a matter to be determined by evidence at each point in time. This means the level could be very different in 1961, 2011, and 2041 depending on the possibilities available.

As Brooks has described Representative Ryan's positions, it seems that the Congressman holds many views that are contradicted by a vast body of evidence. Representative Ryan may be a very nice guy (I met him once in his district where we debated Social Security privatization. He seemed nice enough.), but do we really think it's important for President Obama to spend his time and the taxpayers' money having lunch with someone who is so out of touch with reality?

 
NPR Longs for the Prosperity of the 1830s Print
Friday, 15 April 2011 04:01

I'm not kidding. At the top of the hour intro to Morning Edition they told listeners that the United States paid off its debt in 1835 and was debt free. It then added "too bad it only lasted for a year."

Most economists and analysts would evaluate the well-being of an economy and society by its per capita income, life expectancy, literacy rates and other such measures. NPR apparently uses the debt level of its government.

 
Dana Milbank, Washington Post Fashion Correspondent, Wonders What the World Would Look Like If It Was Run By Progressives Print
Thursday, 14 April 2011 22:11

Dana Milbank has apparently been assigned to the fashion beat at the Washington Post. His column on a rally at which the Progressive Caucus outlined their budget proposal, noted that caucus Chairman Raul Grijalva was,  "wearing a tie that hung loose from his neck and ended five inches above his waistband." He went on to tell readers that he was unimpressed with the group's platform encouraging readers to speculate what would happen "if progressives ran the world."

Let's see, I suppose that we could have ten years of zero job growth, 25 million people unemployed, underemployed or out of the workforce altogether, declining real wages, millions of homeowners losing their homes, and tens of millions of homeowners underwater.


 
Has God Been Talking to the Washington Post? Print
Thursday, 14 April 2011 04:57

In its article covering President Obama's speech on the budget yesterday the Washington Post told readers that:

"Obama acknowledged that the debt must be tackled faster than he has previously proposed."

It is only possible to "acknowledge" something which is true. The Post obviously believes it is true that "the debt must be tackled faster than he has previously proposed," but that does not make it so. This is the Post's opinion. A real newspaper would have reported that President Obama "said that the debt must be tackled faster than he has previously proposed." It would not have implied that its view of the world is the unquestioned reality, especially in a front page news story.

Remarkably, the coverage of the President's speech in both the Post and the NYT included no mention of the recession. The main reason that the deficit has soared in the last three years is because of the economic collapse that followed the crash of the housing bubble.

If the deficit is reduced substantially before the economy has gotten back to near full employment levels of output the main effect will be to slow growth and throw more people out of work. This fact was never mentioned in either piece even though President Obama proposes to have his deficit reduction targets to become binding in fiscal year 2014, a point at which the unemployment rate is still projected to be 7.2 percent. By contrast, the first stimulus package was put into law under President George W. Bush when the unemployment rate was just 4.7 percent.

Both articles made reference to the deficit reduction plan from the President's deficit commission. This is wrong. There was no plan from the commission. The co-chairs of the commission, Erskine Bowles and Alan Simpson, never put their plan up for a vote because they knew they lacked the majority needed for passage. The plan referred to in these articles is only the proposal of the two co-chairs. It is not the plan of the commission.

This should be a simple point for a major newspaper to get right.

 
Misrepresenting the Policy Debate on China: Is the NYT Covering Up for Obama Print
Thursday, 14 April 2011 04:29

The NYT discussed the agenda of an upcoming meeting of G-20 finance ministers. It focused on efforts to pressure China to raise the value of its currency.

This discussion implied that the United States must depend on its ability to pressure China to change its currency policy. In fact, the United States does not have to rely on China changing its policy, it can force a change with unilateral action.

Specifically, just as China sets an official exchange rate of the yuan against the dollar that is below the market value of the yuan, the U.S. could set an exchange rate of the dollar against the yuan that is equal to the market value of the yuan.

This could mean, for example that the Treasury Department would announce a policy whereby it would buy yuan at the rate of 4 yuan for a dollar. This compares to the rate of 6.7 yuan to a dollar supported by China's government. While it would be illegal under China's laws for its nationals to take advantage of this exchange rate, it is likely that many businesses and wealthy individuals would find ways to evade the law. This would make the exchange rate set by the Treasury the effective exchange rate in the market.

It is a policy decision by the Obama administration not to take this route. This should have been pointed out by the article. Obviously the Obama administration has chosen to not really push aggressively to raise the value of China's currency.

China's government knows that the U.S. can take these steps and has chosen not to, therefore it may infer that the push to raise the value of its currency is not really a priority and is instead being done for political purposes. This NYT article supports the Obama administration's efforts to mislead the public on this topic.

 
Dana Milbank Missed the Health Care Reform Act Print
Wednesday, 13 April 2011 07:22

This is the only thing that readers can infer from his reference to President Obama's "refusal to propose a viable solution" to the debt problem. In fact, the Congressional Budget Office projects that the health care bill approved by Congress last year will trim tens of trillions of dollars off the long-term deficit. One can only conclude that Milbank wasn't aware of the bill in making this accusation.

 
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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.

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