Aug 27, 2012

PM Jams

Old school.

Capital Gains Taxes Aren't About Investment

Will Wilkinson, citing Econ 101, says old Mitt "13.9%" Romney might be paying too much in taxes:
In any case, the substantive intellectual question is whether it is a good idea to reduce capital-gains taxes, either a little or a lot. If it's a bad idea to raise rates, then Mr Romney might not be paying too little. If it's a good idea to cut rates, then he he might be paying too much.
Now, I happen to be in broad agreement with Scott Sumner, who argued in an episode of "Economics by invitation" earlier this year that "The proper tax rate on capital income is zero". Indeed, I agree with Mr Ryan when he says
"Raising taxes on capital is another idea that purports to affect the wealthy but actually hurts all participants in the economy. Mainstream economics, not to mention common sense, teaches that raising taxes on any activity generally results in less of it. Economics and common sense also teach that the size of a nation’s capital stock — the pool of saved money available for investment and job creation — has an effect on employment, productivity, and wages. Tax reform should promote savings and investment because more savings and more investment mean a larger stock of capital available for job creation. That means more jobs, more productivity, and higher wages for all American workers."
(Italics!) Indeed, the standard economics case for a tax preference for investment income is fairly strong.

Yet the real world looks somewhat different from these assumptions. First, it's not clear at all that this "capital gains" Romney is claiming actually has any tangible relationship whatsoever with real investment. On Planet Neoclassical low taxes on capital gains means more investment and a bigger capital stock. On Planet Earth the real investment sector of the economy is decent-sized, while the financial chicanery sector is much, much larger. Especially given the last few years, the idea of the financial sector being an efficient allocator of capital seems preposterous beyond words.

Hedge fund managers (who aren't even any good at investing) are the ultimate example of this—they get to claim their wages as capital gains through a loophole. But a perhaps better example comes from something Doug Henwood is constantly saying: Wall Street, in particular the stock market, is mostly not about uniting savers and borrowers—nearly all corporate investment comes out of profits. Instead it's about extracting money from companies, among other things.

Right now the overwhelming problem with the economy is a continuing mild-to-moderate depression and associated mass unemployment. From my perch it looks like Romney and his capital-gains collecting brethren are stymieing the policies that could lead back to full employment. (See him saying Bernanke should be fired for the Fed's half-assed monetary stimulus.)

In other words, not only does a Wilkinson-style argument ignore the reality of Wall Street's parasitism, it also ignores the political reality of how a hugely empowered cap gains-collecting class behaves—in a depression, they band together (with others) to stifle effective demand and prolong unnecessary misery. (Needless to say, that doesn't exactly bode well for aggregate investment.)

The real point of capital gains taxes is to reduce the power and influence of the creditor class, and keep them from strangling everyone else and themselves.

Aug 26, 2012

Is Autism Actually an Autoimmune Disorder?

This is just a first pass at this article, but it's very good and tracks quite closely with the little that I know about the subject. Money quote:
Since time immemorial, a very specific community of organisms — microbes, parasites, some viruses — has aggregated to form the human superorganism. Mounds of evidence suggest that our immune system anticipates these inputs and that, when they go missing, the organism comes unhinged.
The idea is that autism is one of a whole slew of disorders that have been increasing at a galloping rate, all tied to autoimmune problems, and the problem is a too-clean environment is leading to poorly calibrated immune systems. I have a special interest in this because my father (an otherwise quite healthy guy in good shape) was diagnosed with Type I diabetes awhile back. That kind (which has little to do with your diet) has also been on the increase, and some have postulated a similar hypothesis there.

This theory has been around for awhile (check out this Radiolab towards the end for some hilarious background), but it seems to be gaining steam. I'll be keeping on the beat—I'd gladly take some minor parasite infections if it would prevent my own Type 1 diagnosis.

Aug 25, 2012

RIP Neil Armstrong


...adding, strange voice, but amazing how precise and controlled he sounded. Quite good at speaking for such a notorious recluse.

Aug 23, 2012

My Shutterstock Career Begins

This is a chunk from the cover of the latest Washington Monthly:

Full article here. Yegads.

Aug 22, 2012

The Context of Chris Hayes' Racism Quote

Last Saturday, Chris Hayes had Richard Belzer, the actor and comedian on the show, and during and exchange with him, said "It is undeniably the case that racist Americans are almost entirely in one political coalition and not the other." Alex Tabarrok attacked criticized him for that, citing survey data showing equal racist representation in each party, while John Sides added some nuance showing racial resentment weighted more towards Republicans. Kevin Drum has the best case for Chris, I think, saying that while there are surely racists in every party...
[Republicans] tolerate racism in their ranks far more than Democrats do. Bernie Goldberg, a liberal turned conservative, admitted this on air earlier this year when he told Bill O'Reilly, "I am immensely uncomfortable with the bigotry on the right, and I don't care how many people don't like it. I am sick of it." Republicans are also more willing to make political appeals with an anti-minority racial subtext, as Fox News did during its Summer of Hate in 2010, or as Mitt Romney is doing now with his claims that Obama is gutting work requirements for welfare.
For the past 40 years, Republicans have opposed virtually every effort to address racism in the legislative sphere. Politically, this has been suicidal for their standing in the nonwhite community, and it's safe to say that they wouldn't have done this unless there was a corresponding benefit for them among whites. Quite clearly, appealing to white resentment of minorities is an important part of the Republican brand in a way it's not for Democrats, even if plenty of racists still inhabit the Democratic Party.
I agree. What's missing here is the context of the quote. Belzer was not a great fit on the panel, which as usual was talking wonky policy stuff, while he is more of a comedian and polemicist. Belzer changed the subject from Romney's and Ryan's tax returns to start talking about how maybe Romney was bullied into choosing Ryan by the base, and:
Belzer: ...the base, the word is disgusting, they are base—
Hayes: Well, they're human beings.
B: They are human beings, but—
H: They're our fellow citizens, we're just trying to understand them.
B: I mean, but what are the family values? Misogyny, racism, homophobia, warmongering...
H: Well, look, I don't know...
B: That's not hyperbole, Chris, but go ahead.
H: I don't want to get in an argument over the base, but I try to give people the charity that they—
B: Well most people are basically decent, but there's this core of racist elements within that party that is rearing its ugly head and unashamedly race-baiting, and it's disgusting.
H: I will say this: it is undeniably the case that racist Americans are almost entirely in one political coalition and not the other, and that the nature of American politics of the moment.
(Emphasis mine, of course. Find the video here, about 3:30 or so.) Hayes then immediately changed the subject back to Paul Ryan's tax returns.

It was an awkward exchange, and clearly driven by the fact that Belzer (a celebrity entertainer) did not have the policy chops to add anything substantial to the tax discussion, and so waded in and wandered off into the more friendly territory of a random diatribe against the Republican base. Hayes kept trying to head him off, and finally just ended the conversation with the line in question.

It is the case that appealing to white racial resentment has been part of Republican political strategy for more than a generation. It's tapered off somewhat in the last 15-20 years, but it used to be front and center. But regardless of which party the racists are in, we should acknowledge that this line came out of an exchange where Hayes was defending the Republican base's basic humanity against Belzer's broad stereotyping.

Aug 20, 2012

Internet Writing and the Content Vacuum

It's been a few times now I've had full weekday control of the Monthly's headline blog, Political Animal, and I feel like I have a decent idea now what it's like being at the top level of blogging. (Not to say that I am at the top level, of course, just that I've walked in those shoes for a few days and gotten some blisters.)

Anyway, the first thing I've noticed is that it is really, really hard to do well. I've had days before when I just didn't have anything to do and ended up at home writing 4-5 posts in one day on this site, but pro blogging is an entirely different beast. The expectation is that during the day you will write 10-12 posts. This includes an intro music video, a lunch links post, and evening links and/or video. So that means 7-9 short, punchy essays on something, with maybe 1-2 of those being longer and more worked out thoughts.

This ferocious demand for content is both good and bad. The iron weight of responsibiliy—the knowledge that there are high expectations and that this is a Big Chance for me to prove myself—is a powerful motivator. I usually have a pretty steady stream of decent ideas during the course of the day ("decent ideas" by blog standards), but I'm not all that great yet at capturing them and fleshing them out. I probably forget about 30% or so. (The fact that I get about half of these riding the train to work doesn't help.) Those expectations are good at making me harness myself and work as hard as I can.

On the other hand, occasionally during the blogging day I hit a wall—where I've written out all the ideas on my notepad, and I don't see anything interesting on Memeorandum or the big news sites. Panic starts to seep in. Come on, I think, gotta write something. Maybe I'll just point out some Romney lie (bottomless vein of material there) or make fun of some conservative. Now, nothing wrong with pointing out lies or doing a classic blog hit job on someone who really deserves it (e.g., Rich Lowry). The problem is that the need for new content is what's driving the post rather than an idea about something. It makes me feel boring and hackish, which kills my confidence, which makes the writing worse too. Easy to start a vicious cycle.

Furthermore, writing frantically all day long leaves me exhausted and wrung out, and less interested in catching up on my RSS or reading books, which is what ultimately drives new thoughts and posts. I just want to open a beer and watch Game of Thrones. David Carr had an interesting thought on how this sort of thing might have driven the recent plagiarism of Jonah Lehrer and Fareed Zakaria:
The self-cleaning tendencies of the Web got credit for unearthing the misconduct in the first place. Then again, the Web’s ferocious appetite for content — you are only as visible as your last post, as Clay Shirky recently said to me — probably had something to do with why Mr. Lehrer tried to feed the beast with retreads and half-baked work.
I think this should be combined with the increasing power law character of journalism. Like everything else, it's now dominated by a few hyper-famous people, a few more midlisters, and a gazillion striving nobodies. What this means for the hyper-famous is that the marginal utility of more product decreases very slowly—there's basically no limit to the amount of stuff someone like Zakaria can dump out, especially if you're willing to branch out into other forms. Radio, TV, columns, podcasts, speaking engagements—if Zakaria could stay awake 24/7, he could be making money continuously somewhere. (Of course, I reckon this trend has been around for a long time, but it seems to have been accelerated by the internet.)

The fact that the paragraph in question—a simple, bog-standard summary of gun law—was copied from a recent New Yorker (!) one of the most widely-read publications in the world, made some people speculate on Twitter that Zakaria didn't write the column, that it was some lesser employee or an intern. Plagiarizing from such a source is just flat idiotic, and it's hard to imagine Zakaria making such a mistake, even if he were a total amoral hack. I wouldn't be surprised. He'd be following in the footsteps of famous hack cartoonists (e.g., Jim Davis) who oversee a team of artists and writers and spend much of their time approving branded products.

It seems highly unlikely that I'll even have the option of fucking up as bad as Jonah Lehrer did (who resigned in disgrace from the New Yorker), but this is a good reminder of the pitfalls of success, and the importance of keeping a balanced perspective. If I had my dream job, I'd like to post 4-6 times during the day, and write longer pieces during the extra time. More importantly, I don't want to get into the situation where the demand for content pushes me so hard that I stop taking new stuff in. (I think I could get the hang of full-time blogging, say, but no more than that.) And Andrew Sullivan's habit of regular long breaks, disconnected from the machines, seems very smart, even necessary. I don't think I could keep up with the likes of Matt Yglesias or Joe Weisenthal, and trying looks like a recipe for burnout.

I imagine it's easier than it looks to fall into the corruption of stealing or lying, or the soft featherbed of hiring interns to do your stuff. But whatever happens, I will never forget that I got into journalism to discover new facts and stories, and to tell the truth, not to make huge piles of cash.

Aug 17, 2012

Friday Night Jams

In the honor of Paul Ryan, rock on:

...adding, good track, but what a lousy video. "Gore = Bush" looks singularly idiotic from this vantage point.

Aug 16, 2012

Rational Expectations and Assuming the Consequent

Here's John Kay giving an example of something that has always bothered me:
I used to tell students who queried the premise of “rational” behaviour in financial markets – where rational means are based on Bayesian subjective probabilities – that people had to behave in this way because if they did not, people would devise schemes that made money at their expense.
Here's another example from David Levine:
Take an example: how we might predict stock market crashes? Suppose that two behavioral psychologists, call them "Kahneman and Tversky," produce a model of "cognitive biases" that predicts when crashes will occur. The model tells us that the stock market will crash on October 28. Since the model is reliable and has a perfect track record, we naturally believe this prediction. So what would you do? You would sell all your stock on October 27. But of course if enough people do this the stock market will crash on October 27 and not October 28. So this apparently reliable model will be proven wrong.
The idea here is that markets can incorporate expectations about pretty much anything. So if you make a public, reliable predication about something that will happen, people will arbitrage the thing into reality before the predicted time. Hard to deny that scenario.

But all the work in this scenario is being done by "we naturally believe this prediction." Well, suppose "we" don't? Suppose you're an agoraphobic computer programmer living in a basement in Silver Spring, Maryland, and you make a financial model. Your model predicts a crash on October 28th this year. But no one believes you. Maybe you're dismissed as a crank in the lickspittle financial press. (Imagine that.) Or maybe you're really unconvincing in person. But your model is correct, and your prediction comes true, at precisely the time you said.

Being able to predict the precise time of a crisis is not common, of course, but the function of belief in validating this kind of argument for rational expectations is critical. To say that financial crises are unpredictable because people will arbitrage any model, and therefore rational expectations theory obtains, seems perilously close to saying "because rational expectations, therefore rational expectations."

In fact, many people have been in the general situation of our computer programmer. People like Michael Burry, who didn't predict exactly when the financial crisis would happen, but knew that it would happen at some point, and predicted correctly in broad outline and detail how it would happen. And what did people in his little fund do when he told them what was going to happen? They didn't believe him! Even after he made them millions of dollars, they still resented him for it for some reason.

Anyway, the idea that people will take widely accepted models into account seems true in a boring and obvious way. But to derive from that a rational expectations theory seems unjustified.

Aug 14, 2012

The DC Housing Market is Insanely Tight

We've been looking for a non-basement place as I might get a slightly better job at the Monthly and the girlfriend is going to grad school at American. But here's a quick view of how tight the housing market is in DC. From Craigslist:
I need a roommate to share a fully furnished 1 bedroom apartment in the Berkshires. The space available is a part of the living room that has been partitioned off and comes with a bed, nightstand and desk if you want it.
Partitioned off living room, got it. Price? $921.50. More housing, please?

Quote for the Day

"July was the warmest month on record in the U.S. The average temperature for the month came in at 77.6°F overall, which was 3.3°F higher than the 20th-century average, and 0.2°F warmer than the previous hottest month on record, set in July 1936 back in the Dust Bowl era. This came at the same time as the so-called drought footprint -- the area of the country affected by drought conditions -- reached a record high, and the worst drought since at least 1956 laid waste to hopes for a bumper corn and soybean crop, spurring the Agriculture Department to issue the largest-ever disaster declaration in its history." --Climate Central.

Aug 11, 2012

Paul Ryan and Pundit Herding

Starve granny! Because Serious Serious Serious!
Witness Lord Saletan in Slate earning a special citation to go with his Wanker of the Decade 5th Runner-Up award:
A wonderful thing has happened for this country. Paul Ryan will be the Republican nominee for vice president.
Ryan is a real fiscal conservative. He isn’t just another Tea-Party ideologue spouting dogma about less government and the magic of free enterprise. He has actually crunched the numbers and laid out long-term budget proposals. My liberal friends point out that Ryan’s plan leaves many details unclear. That’s true. But show me another Republican who has addressed the nation’s fiscal problems as candidly and precisely as Ryan has. He’s got the least detailed budget proposal out there, except for all the others.
What?? What kind of fiscal conservative starts out with a stupendous tax cut and refuses entirely to say how he'll pay for it? Wait, don't tell me. I think I smell me some High Broderism coming up.
Ryan refutes the Democratic Party’s bogus arguments. He knows that our domestic spending trajectory is unsustainable and that liberals who fail to get it under control are leading their constituents over a cliff, just like in Europe. Eventually, you can’t borrow enough money to make good on your promises, and everyone’s screwed. Ryan understands that the longer we ignore the debt crisis and postpone serious budget cuts—the liberal equivalent of denying global warming—the more painful the reckoning will be. There’s nothing compassionate about that kind of irresponsibility. 
Maybe, like me, you were raised in a liberal household. You don’t agree with conservative ideas on social or foreign policy. But this is why God made Republicans: to force a reality check when Democrats overpromise and overspend.
Tell, us, oh wise Lord, how The Other Side Is Also Wrong:
Ryan refutes the GOP’s bogus arguments, too. He proves that you don’t need private-sector experience to be a good lawmaker. He proves that a genuine conservative, as opposed to a Tea-Party ideologue, votes for bailouts when economic sanity requires them. Ryan also shows that a real conservative doesn’t worship any part of the budget, including defense. His expenditure caps can’t be squared with Romney’s nutty pledge to keep military spending above four percent of GDP. And Ryan destroys Romney’s ability to continue making the dishonest, anti-conservative argument that Obamacare is evil because it cuts Medicare. Now Romney will have to defend the honest conservative argument, which is that Medicare spending should be controlled.
Sheesh. One more gruesome graf:
So what? Screw the polls. Republicans will be on the right side of the spending debate. They’ll be on the right side of the substance debate, too. Instead of bickering about Romney’s tax returns and repeating the obvious but unhelpful observation that the unemployment rate sucks, we’ll actually have to debate serious problems and solutions. That’s great for the country.
What an ignorant, elitist twit. Anyway, let me set aside the fact this whole framing is insane. That's true and will continue to be so. As Yglesias says, we are in a depression, and neither party seems to care about that much anymore. Who gives a shit about taxes or the debt? People are literally paying us to take their money! Put people back to work! (Deep breath.)

What interests me about this is that somehow the elite pundit corps, led around by Paul Ryan and his cronies, have successfully managed to change the subject again from the great yawning unemployment crisis to the imaginary debt crisis. Occupy Wall Street gave us a few months of real problems, but now we're back.

How do the deficit scolds manage this? They're enormous hypocrites, Ryan more than most. He voted for every one of the Bush's budget-busting tax cuts, assorted wars, Medicare Part D, and TARP. As Jon Chait detailed in a great New York piece, Ryan used to be openly scornful of people who would put cutting the deficit above cutting taxes on the rich:
“We noticed that the green-eyeshade, austerity wing of the party was afraid of class warfare,” Ryan said during Bush’s first term. “They fear increases in the debt, and they were overlooking issues of growth, opportunity, and free markets.” For those uninitiated in the tribal lingo of Beltway conservatives, this may sound like gibberish. But those inside the conservative subculture invest these buzzwords with deep meaning. “Green eyeshade” is a term of abuse appropriated by the supply-siders to describe Republicans who still cared more about deficit control than cutting taxes. “Growth” and “opportunity” mean tax cuts that disproportionately benefit the rich, and “class warfare” means any criticism thereof. Ryan’s centrist admirers hear his frequent confessions that both parties have failed as an ideological concession. What he means is that Republicans were insufficiently fanatical in their devotion to cutting taxes for the rich.
And yet, this known history doesn't prevent Saletan from collapsing in uncontrollable ecstasy every time Paul Ryan says something.

There are two possibilities, I think. One is that Ryan is just really good at manipulating the ignorant, gullible, and lazy political press, who can't be bothered to put this stuff in context or read budgets and figure out what they mean. Or, Ryan just flatters the fiscal-conservative, pro-war, bipartisanship-uber-alles prejudices of the ignorant, gullible, and lazy political press, who can't be bothered to put this stuff in context or read budgets and figure out what they mean, so he gives them an excuse to write columns about Making Hard Choices on Entitlements (meaning starve granny and stick it to the poors).

Finally, Ryan is hated by the left, which is the ultimate Beltway stamp of approval. Nothing is ever so popular here as punching some good old hippie.

Whatever the case, I hope some enterprising young lefty politico out there is watching this collective media orgasm. It plainly doesn't matter what you put in your plan. If you can talk about the right things, sound like you know some statistics, and seem mild-mannered and polite, the centrist pundits will follow you like the Pied Piper. Might come in handy sometime.

Aug 7, 2012

Book Recommendation: *Wall Street*

On the recommendation of Henry Farrell, I picked up Doug Henwood's Wall Street, and I agree with Farrell that it's really good. Here's a taste:
In a soundbite, the U.S. financial system performs dismally at its advertised task, that of efficiently directing society’s savings towards their opti-mal investment pursuits. The system is stupefyingly expensive, gives terrible signals for the allocation of capital, and has surprisingly little to do with real investment. Most money managers can barely match market averages — and there’s evidence that active trading reduces performance rather than improving it — yet they still haul in big fees, and their brokers, big commissions (Lakonishok, Shleifer, and Vishny 1992). Over the long haul, almost all corporate capital expenditures are internally financed, through profits and depreciation allowances. And instead of promoting investment, the U.S. financial system seems to do quite the opposite; U.S. investment levels rank towards the bottom of the First World (OECD) coun-tries, and are below what even quite orthodox economists — like Darrel Cohen, Kevin Hassett, and Jim Kennedy (1995) of the Federal Reserve—term “optimal” levels. Real investment, not buying shares in a mutual fund.
Probably the most impressive thing about the book is it was written in 1997, at the height of Wall Street worship. I wholeheartedly endorse Farrell's recommendation for a kickstarter to fund an updated second edition. You can download the book for free here.

Aug 6, 2012

At the Oars

Before this Salmon trip, it had been three years since I'd rowed anything serious, but it worked out well. No flips or smashing into rocks.


"Congratulations to the MSL team and NASA JPL for the most flawless execution of an utterly insane plan. Our species has landed a goddamn truck on the surface of another world using a parachute and a flying crane. There are no words." --Maki

Epic win.

Aug 4, 2012

Weekend Jams

I'm going to a wedding this weekend, so it'll probably be some light posting until I get back. In the meantime, enjoy some tunes:


Aug 3, 2012

Excerpts from Bernanke

Just wanted to pull out a few excerpts from this brilliant paper which crystallizes a lot of my own monetary policy views:
The argument that current monetary policy in Japan is in fact quite accommodative rests largely on the observation that interest rates are at a very low level.  I do hope that readers who have gotten this far will be sufficiently familiar with monetary history not to take seriously any such claim based on the level of the nominal interest rate.  One need only recall that nominal interest rates remained close to zero in many countries throughout the Great Depression, a period of massive monetary contraction and deflationary pressure.  In short, low nominal interest rates may just as well be a sign of expected deflation and monetary tightness as of monetary ease.
A more respectable version of the argument focuses on the real interest rate.  With the rate of deflation under 1% in 1999, and the call rate effectively at zero, the realized real call rate for 1999 will be under 1%, significantly less than, say, the real federal funds rate in the United States for the same period.  Is this not evidence that monetary policy in Japan is in fact quite accommodative?  I will make two responses to the real-interest-rate argument.  First, I agree that the low real interest rate is evidence that monetary policy is not the primary source of deflationary pressure in Japan today, in the way that (for example) the policies of Fed Chairman Paul Volcker were the primary source of disinflationary pressures in the United States in the early 1980s (a period of high real interest rates).  But neither is the low real interest rate evidence that Japanese monetary policy is doing all that it can to offset deflationary pressures arising from other causes (I have in mind in particular the effects of the collapse in asset prices and the banking problems on consumer spending and investment spending).  In textbook IS-LM terms, sharp reductions in consumption and investment spending have shifted the IS curve in Japan to the left, lowering the real interest rate for any given stance of monetary policy.  Although monetary policy may not be directly responsible for the current depressed state of aggregate demand in Japan today (leaving aside for now its role in initiating the slump), it does not follow that it should not be doing more to assist the recovery. 
My second response to the real-interest-rate argument is to note that today’s real interest rate may not be a sufficient statistic for the cumulative effects of tight monetary policy on the economy.  I will illustrate by discussing a mechanism that is highly relevant in Japan today, the so-called “balance-sheet channel of monetary policy” 12 (Bernanke and Gertler, 1995).  Consider a hypothetical small borrower who took out a loan in 1991 with some land as collateral.  The longterm prime rate at the end of 1991 was 6.95% (Table 1, column 3).
Such a borrower would have been justified, we may speculate, in expecting inflation between 2% and 3% over the life of the loan (even in this case, he would have been paying an expected real rate of 4-5%), as well as increases in nominal land prices approximating the safe rate of interest at the time, say 5% per year.  Of course, as Tables 1 and 2 show, the borrower’s expectations would have been radically disappointed.   
To take an admittedly extreme case, suppose that the borrower’s loan was still outstanding in 1999, and that at loan initiation he had expected a 2.5% annual rate of increase in the GDP deflator and a 5% annual rate of increase in land prices. Then by 1999 the real value of his principal obligation would be 22% higher, and the real value of his collateral some 42% lower, then he anticipated when he took out the loan.  These adverse balance-sheet effects would certainly impede the borrower’s access to new credit and hence his ability to consume or make new investments.  The lender, faced with a non-performing loan and the associated loss in financial capital, might also find her ability to make new loans to be adversely affected.  This example illustrates why one might want to consider indicators other than the current real interest rate—-for example, the cumulative gap between the actual and the expected price level—-in assessing the effects of monetary policy.  It also illustrates why zero inflation or mild deflation is potentially more dangerous in the modern environment than it was, say, in the classical gold standard era.  The modern economy makes much heavier use of credit, especially longer-term credit, than the economies of the nineteenth century.  Further, unlike the earlier period, rising prices are the norm and are reflected in nominal-interest-rate setting to a much greater degree.  Although deflation was often associated with weak business conditions in the nineteenth century, the evidence favors the view that deflation or even zero inflation is far more dangerous today than it was a hundred years ago. 

The general argument that the monetary authorities can increase aggregate demand and prices, even if the nominal interest rate is zero, is as follows:  Money, unlike other forms of government debt, pays zerointerest and has infinite maturity.  The monetary authorities can issue as much money as they like.  Hence, if the price level were truly independent of money issuance, then the monetary authorities could use the money they create to acquire indefinite quantities of goods and assets.  This is manifestly impossible in equilibrium.  Therefore money issuance must ultimately raise the price level, even if nominal interest rates are bounded at zero.  This is an elementary argument, but, as we will see, it is quite corrosive of claims of monetary impotence.
On legal authority, it is true that technically the Ministry of Finance (MOF) retains responsibility for exchange-rate policy.  (The same is true for the U.S., by the way, with the Treasury playing the role of MOF.  I am not aware that this has been an important constraint on Fed policy.)  The obvious solution is for BOJ and MOF to agree that yen depreciation is needed, abstaining from their ongoing turf wars long enough to take an action in Japan’s vital economic interest.  Alternatively, the BOJ could probably undertake yen depreciation unilaterally; as the BOJ has a legal mandate to pursue price stability, it certainly could make a good argument that, with interest rates at zero, depreciation of the yen is the best available tool for achieving its legally mandated objective. 
Suppose that the yen depreciation strategy is tried but fails to raise aggregate demand and prices sufficiently, perhaps because at some point Japan’s trading partners do object to further falls in the yen.  An alternative strategy, which does not rely at all on trade diversion, is money-financed transfers to domestic households—-the real-life equivalent of that hoary thought experiment, the “helicopter drop” of newly printed money.  I think most economists would agree that a large enough helicopter drop must raise the price level.  Suppose it did not, so that the price level remained unchanged.  Then the real wealth of the population would grow without bound, as they are flooded with gifts of money from the government—-another variant of the arbitrage argument made earlier.  Surely at some point the public would attempt to convert its increased real wealth into goods and services, spending that would increase aggregate demand and prices.  Conversion of the public’s money wealth into other assets would also be beneficial, if it raised the prices of other assets.
The only counter-argument I can imagine is that the public might fear a future lump-sum tax on wealth equal to the per capita money transfer, inducing them to hold rather than spend the extra balances.  But the government has no incentive to take such an action in the future, and hence the public has no reason to expect it.  The newly circulated cash bears no interest and thus has no budgetary implications for the government if prices remain unchanged.  If instead prices rise, as we anticipate, the government will face higher nominal spending requirements but will also enjoy higher nominal tax receipts and a reduction in the real value of outstanding nominal government debt.  To a first approximation then the helicopter drops will not erode the financial position of the government and thus will not induce a need for extraordinary future taxes.  

Perhaps the Bank of Japan Law should be reviewed, to eliminate the possibility that such trivial considerations as the distribution of paper gains and losses between the monetary and fiscal authorities might block needed policy actions.  An alternative arrangement that avoids the balancesheet problem would be to put the Bank of Japan on a fixed operating allowance, like any other government agency, leaving the fiscal authority as the residual claimant of BOJ’s capital gains and losses. 

Aug 2, 2012

Aug 1, 2012

Why Are Small Countries Better at Economics?

Short answer: smaller banks.

Matt Yglesias points out that Poland has weathered the recession fairly well due to an enormous devaluation to restore competitiveness:

Polish Zloty to Euro exchange rate. Note the massive decline in mid-2008.
Matt O'Brien notes that this is largely due to the fact that Poland engaged in massive currency debasement—seen above—at the height of the crisis.
This is, I think, the closest thing you can find to a constant across countries that handled the crisis well. Smaller countries from Poland to Israel to Sweden were willing to engage in a form of expansionary monetary policy that primarily took the form of currency devaluation. Things look a bit different from the standpoint of a larger, less trade-oriented country but the same basic principle ought to apply.
The question, then, is why smaller countries are so much better at macroeconomic management. I think we can dispense with the idea that it's a failure of intellect among elite policymakers. These questions are fairly simple:
We don’t lack for technical means to counter people’s self-defeating impulse to hoard cash and safe financial assets. On the contrary, we have a whole cornucopia of options! The squabbling that has preoccupied me lately, between market monetarists and post-Keynesians and mainstream saltwater economists, is an argument over which of many not-necessarily-mutually-exclusive options would most perfectly address address this not-really-challenging problem.
There is no better evidence of this than Fed Chairman Ben Bernanke. He made his academic bones by harshly criticizing the Japanese response to their lost decade. His work back then made the case that Japan could easily escape its economy funk if had enough "Rooseveltian resolve:"
With respect to the issue of inflation targets and BOJ credibility, I do not see how credibility can be harmed by straightforward and honest dialogue of policymakers with the public. In stating an inflation target of, say, 3-4%, the BOJ would be giving the public information about its objectives, and hence the direction in which it will attempt to move the economy. (And, as I will argue, the Bank does have tools to move the economy.) But if BOJ officials feel 18 that, for technical reasons, when and whether they will attain the announced target is uncertain, they could explain those points to the public as well. Better that the public knows that the BOJ is doing all it can to reflate the economy, and that it understands why the Bank is taking the actions it does.
Yet today the Fed announced that though not only are they missing their employment target and their inflation target, they're still not going to do anything. It's as if we put Richard Feynman in charge of NASA, and he started talking about creationism and homeopathy. Barring mental illness, clearly something else is at work.

This rough inverse correlation between size of economic unit and quality of outcome (USA, Eurozone = failures; Sweden, Australia, Canada, Israel = successes) suggests that this is about power and money. In smaller countries, where banks don't have the kind of money and sheer size to command the complete attention of the world media when they get in trouble, the power gap between them and the regulators is small. The Israeli central bank can engineer a burst of inflation to work through an economic crisis and he isn't garroted by Tel Aviv bankers. Bernanke, on the other hand, looks to have been completely captured by Wall Street.

This is the reason to break up too-big-to-fail banks—not only because they're systematically risky (which can be true of small banks as well), but to break their power. All incumbent creditors will act to keep inflation as low as possible, it seems. If that means years of depression, so be it. But JP Morgan, with assets of $2.26 trillion (together with smaller firms, of course), has the political clout to strangle recovery. That kind of cash means they get to make sure if someone has to eat a loss, it damned sure isn't going to be them.