The political crisis in Thailand got me thinking about young/fragile/unstable democracies. I haven't spent too much time googling these thoughts so here goes:
Some defintions (or how should we define these terms?):
1. Young - a country that has been democratic but "not for too long of a time".
2. Fragile - a democratic country that shifts back and forth between democracy and autocracy OR a country whose democratic leader is unable to serve out his or her term and has had numerous elections or by-elections to find a new leader.
3. Unstable - a democratic country that has many "events" against the leadership, e.g. strikes, protests, attempted coups.
4. Democratic - any country that holds elections.
Research questions:
1. Are young democracies necessarily fragile/unstable?
2. Are there "old" democracies that are fragile/unstable?
3. Are fragility and instability synonymous?
These concepts don't lend well to quantification or any kind of a cross country analysis which is what I'd like to see. I may have to be content with narratives.
Update: From The Economist, comes charges that the revered king of Thailand ["Father"]constantly intervenes in politics:
Other countries, from Spain to Brazil, have overcome dictatorial pasts to grow into strong democracies whose politics is mostly conducted in parliament, not on the streets. Thailand’s failure to follow suit is partly because “Father” has always been willing to step in and sort things out: his children have never quite had to grow up. The Democrats, the parliamentary opposition, are opportunists, cheering on the PAD while seemingly hoping for another royally approved coup to land the government in their lap.
And I've always wondered if PAD had some implicit royal support since they were never arrested after taking over the airports and they've claimed to be acting in the King's name by carrying his pictures in rallies:
.... The death of one PAD member, apparently blown up in his car by the bomb he was carrying, was quickly buried. But the death of a young woman, reportedly when a police tear-gas canister exploded, became a cause célèbre.
Up to this point there were only whispers as to why the PAD enjoyed such lenient treatment—even from the army, which refused to help the police remove protesters from government offices. However, rumours of an extremely influential backer were confirmed when Queen Sirikit, attended by a clutch of cameramen, presided over the dead woman’s cremation. The king remained silent.
... But the PAD’s ever more menacing behaviour, the palace’s failure to disown it, and the group’s insistence that Thais must choose between loyalty to Mr Thaksin and to the king, may be doing untold damage to the crown itself. Some of Mr Thaksin’s voters must be contemplating the flip-side of the PAD’s argument: if the monarchy is against the leader they keep voting for, maybe it is against them. Such feelings may only be encouraged by the PAD’s condescending arguments that the rural poor, Mr Thaksin’s main support base, are too “uneducated” to have political opinions, so their voting power must be reduced.
And from a commenter (I hope I have the link right):
Thaksin may have been corrupt, although there are a lot more allegations than proofs floating around out there, and media-exaggerated nonsenses - but it's pretty hard to be a top level Thai politician and NOT be corrupt. What I think is that Thaksin was not corrupt enough - he had the insane idea of taking some of Thailand's tax money and spending it on peasants via farm loan writedowns or health care schemes or free public transit, things like that - and that infuriated the older ruling politicians ( who were all (and are) a great deal more corrupt, and openly so, than Thaksin ever thought of being), so, led by this extremely wealthy Sonti who apparently thinks the nation's coffers are his and his cronies personal chequing account, decided Thaksin had to go so the normal order of seriously corrupt politicians milking the nation's treasury could be resumed, and this spending money on the peasants brought to an end. All else followed, and continues following.
Or perhaps he was too corrupt. After his sale of Shin Corp he should have spent more time distributing his wealth among all the other corrupt politicians instead of keeping it all to himself.
Wednesday, December 3, 2008
Tuesday, November 25, 2008
Whatever the Fed is doing - it isn't working
Or, what if the Fed gave out all this money to the banks and none of them are lending it out?
Econbrowser Plan A didn't work. Plan B didn't work. I suggest the Fed get going on Plan C. ... So here's my suggested Plan C. The goal of monetary policy should be to achieve a core inflation rate of 3.0% (at an annual rate) over the next 6 months. That's something that can be accomplished without rate cuts or lending facilities, and here's how.
Step 1 is for the FOMC to form a clear determination that a 3% core inflation rate is indeed their immediate goal. If you hope to get somewhere, it's a good idea to start with a plan of where you're trying to go.
Step 2 is to communicate the goal to the public. Bernanke and Kohn should state clearly that they're worried by the October fall in the CPI, that they see a danger of too much slack in the economy developing, and that they will now be adopting quantitative easing with the goal of preventing further declines in the overall price level.
Step 3 is to start creating money and use it to buy up assets until the goal set out in Step 1 is achieved. What sort of assets? My answer here would be the exact opposite in philosophy of the kind of purchases and loans that the Fed has been implementing over the last year. The Fed has been trying to sop up the illiquid assets that nobody else wants. But I think what the Fed should be doing is instead acquiring assets of a type that would allow it to quickly reverse its position if a sudden shift in perceptions causes inflation to come in above the intended 3% target. The Fed can't afford to dump the illiquid securities it's been taking on recently, and that leaves it with substantially less flexibility to ease out of an expansionary policy once it starts to be successful.
My goal would therefore be to buy assets for the Fed that won't lose their value with a reversal of expectations and whose sell-off by the Fed wouldn't be itself an additional destabilizing force.
What specifically would such assets be? I'd start with those clearly undervalued TIPS. Next I'd buy short-term securities in the currencies relative to which the dollar has been appreciating. Here again if the Fed has to sell these off in a sudden change in perceptions, the Fed will have both made a profit and, by selling, be a stabilizing force. If we're still seeing no improvement, the Fed can start to buy longer-term Treasuries.
What if the policy is unsuccessful, and we still get severe deflation despite the 3% inflation target? In some ways, that's the best outcome of all, since, as I explained previously, in that scenario the Fed has solved the nasty problem of all that debt owed by the Treasury.
Over at Economist's View Mark Thoma says:
John Hempton disagrees with me and others that the problem in financial markets is fundamentally one of solvency, i.e. lack of adequate bank capital. He says it is a matter of trust, trust that was destroyed by lies and deceptive practices among other things. If he is right, bank recapitalization alone will not bring back the trust that is needed - well capitalized banks can still lie - and because of that he believes some sort of "full guarantee of all sorts of bank debt" is needed to get bank credit flowing again from financial wholesalers to financial intermediaries. His preferred solution to provide the necessary trust is bank nationalization - the government won't default on its obligations to provide payment - and this allows taxpayers to fully participate in the upside in return for assuming the risk inherent in guaranteeing debt payments ... We agree that fear is the problem, people will not be willing to provide financing if they are worried about getting their money back, the question is what is driving that fear, insolvency, something else, or both. If it is insolvency alone, then recapitalization ought to work, but if it is a lack of trust that a solvent bank balance sheet means what it says it means, then the problem is harder to fix unless you are willing to inject massive amounts of capital - enough to remove all doubt - or remove uncertainties from the books through a massive toxic asset purchase program (a public relations nightmare).
My thoughts are nationalization. It removes all uncertainty and gives taxpayers the upside. Perhaps what is needed is a financial version of the Powell Doctrine:
Overwhelming financial resources should be brought to bear on a crisis. The objective is to minimize uncertainty and bring stability and calm to the financial markets in the shortest time possible. The following list has to be answered in affirmitive:
1. Is a vital economic interest at stake?
2. Do we have a clear obtainable measureable objective i.e. volatility in stock market, etc.?
3. Have risks and costs been analyzed with best available information?
4. Will risks and uncertainty increase if we try all other possible smaller options?
5. Is there an exit strategy to recoup costs of bailout?
6. Have consequences of all actions been considered?
7. Will the action be supported?
8. Do we have international support?
I believe the answer to all of the above is Yes for nationalization of the financial industry/sector as far back as early October.
Update: Fama explains the reasoning behind nationalization (note: he does not support nationalization) as a debt overhang problem.
Update: Nationalisation Linkfest
Econbrowser Plan A didn't work. Plan B didn't work. I suggest the Fed get going on Plan C. ... So here's my suggested Plan C. The goal of monetary policy should be to achieve a core inflation rate of 3.0% (at an annual rate) over the next 6 months. That's something that can be accomplished without rate cuts or lending facilities, and here's how.
Step 1 is for the FOMC to form a clear determination that a 3% core inflation rate is indeed their immediate goal. If you hope to get somewhere, it's a good idea to start with a plan of where you're trying to go.
Step 2 is to communicate the goal to the public. Bernanke and Kohn should state clearly that they're worried by the October fall in the CPI, that they see a danger of too much slack in the economy developing, and that they will now be adopting quantitative easing with the goal of preventing further declines in the overall price level.
Step 3 is to start creating money and use it to buy up assets until the goal set out in Step 1 is achieved. What sort of assets? My answer here would be the exact opposite in philosophy of the kind of purchases and loans that the Fed has been implementing over the last year. The Fed has been trying to sop up the illiquid assets that nobody else wants. But I think what the Fed should be doing is instead acquiring assets of a type that would allow it to quickly reverse its position if a sudden shift in perceptions causes inflation to come in above the intended 3% target. The Fed can't afford to dump the illiquid securities it's been taking on recently, and that leaves it with substantially less flexibility to ease out of an expansionary policy once it starts to be successful.
My goal would therefore be to buy assets for the Fed that won't lose their value with a reversal of expectations and whose sell-off by the Fed wouldn't be itself an additional destabilizing force.
What specifically would such assets be? I'd start with those clearly undervalued TIPS. Next I'd buy short-term securities in the currencies relative to which the dollar has been appreciating. Here again if the Fed has to sell these off in a sudden change in perceptions, the Fed will have both made a profit and, by selling, be a stabilizing force. If we're still seeing no improvement, the Fed can start to buy longer-term Treasuries.
What if the policy is unsuccessful, and we still get severe deflation despite the 3% inflation target? In some ways, that's the best outcome of all, since, as I explained previously, in that scenario the Fed has solved the nasty problem of all that debt owed by the Treasury.
Over at Economist's View Mark Thoma says:
John Hempton disagrees with me and others that the problem in financial markets is fundamentally one of solvency, i.e. lack of adequate bank capital. He says it is a matter of trust, trust that was destroyed by lies and deceptive practices among other things. If he is right, bank recapitalization alone will not bring back the trust that is needed - well capitalized banks can still lie - and because of that he believes some sort of "full guarantee of all sorts of bank debt" is needed to get bank credit flowing again from financial wholesalers to financial intermediaries. His preferred solution to provide the necessary trust is bank nationalization - the government won't default on its obligations to provide payment - and this allows taxpayers to fully participate in the upside in return for assuming the risk inherent in guaranteeing debt payments ... We agree that fear is the problem, people will not be willing to provide financing if they are worried about getting their money back, the question is what is driving that fear, insolvency, something else, or both. If it is insolvency alone, then recapitalization ought to work, but if it is a lack of trust that a solvent bank balance sheet means what it says it means, then the problem is harder to fix unless you are willing to inject massive amounts of capital - enough to remove all doubt - or remove uncertainties from the books through a massive toxic asset purchase program (a public relations nightmare).
My thoughts are nationalization. It removes all uncertainty and gives taxpayers the upside. Perhaps what is needed is a financial version of the Powell Doctrine:
Overwhelming financial resources should be brought to bear on a crisis. The objective is to minimize uncertainty and bring stability and calm to the financial markets in the shortest time possible. The following list has to be answered in affirmitive:
1. Is a vital economic interest at stake?
2. Do we have a clear obtainable measureable objective i.e. volatility in stock market, etc.?
3. Have risks and costs been analyzed with best available information?
4. Will risks and uncertainty increase if we try all other possible smaller options?
5. Is there an exit strategy to recoup costs of bailout?
6. Have consequences of all actions been considered?
7. Will the action be supported?
8. Do we have international support?
I believe the answer to all of the above is Yes for nationalization of the financial industry/sector as far back as early October.
Update: Fama explains the reasoning behind nationalization (note: he does not support nationalization) as a debt overhang problem.
Update: Nationalisation Linkfest
The bailouts continue
In a previous post I asked if Citigroup could be next and thought they were safe (at the time). Well, it looks like not. Mark Thoma summarizes some thoughts on the Citi bailout - no one likes it.
Fortune ran an article on whether GE Capital and hence GE was safe:
... GE is known for seeing changes ahead of time - recognizing early, for example, that it had to go "green" - and responding to them faster and more creatively than the competition. Last year, however, signs began turning up that this admirable pattern wasn't holding at GE Capital. For example, the company had left the home mortgage business in 2000 but reentered it in 2004 when it was flying high, buying a subprime lender called WMC Mortgage from a private equity firm (the price was never announced). Home prices peaked in June 2006, yet it wasn't until a year later, with the subprime crisis on the front page of every newspaper, that GE Capital finally decided to bail out. WMC lost almost $1 billion in 2007 before GE dumped it in December. A Japanese consumer-lending company called Lake was another lousy business, but GE Capital again didn't face the music until it was too late. GE took a $1.2 billion loss on it last year after deciding in September to sell it - but by then consumer credit was deteriorating so fast that unloading it (to Shinsei Bank) took another year.
... Managers thought they were being bold in stress-testing their model against a percentage-point jump in rates, but didn't conceive of a sudden and nearly complete stop to interbank lending, a total absence of buyers for some securitized debt, and investors so panicked they're willing to accept negative interest rates to gain the safety of T-bills.
Last year it bought about $14 billion of them and this year over $1 billion, all at prices in the 30s. Now, just six days after suspending the repurchase program, it was selling $12 billion of shares to the public at about $22. That is, it was buying high and selling low.
Why was it so desperate for cash? The company offers only the blandest reasons for its move, but investors were clearly worried that commercial paper was an important factor. Commercial paper is how corporations borrow for short periods, typically just a few days, for immediate purposes; it's attractive because companies borrow only what they need, and interest rates are low. Lots of firms use commercial paper, frequently just for paying day-to-day bills, but no company uses it anything like GE. GE Capital alone has about $74 billion of commercial paper outstanding; the next largest player, J.P. Morgan, has about $47 billion. GE understood there was risk in relying so heavily on this source of funding but believed it was well prepared for any disruption through access to other sources, such as bank lines of credit.
On the morning of Oct. 1, the markets swirled with rumors that GE couldn't roll over its commercial paper coming due. Like so much else that has happened in recent weeks, this possibility would have seemed outlandish just a month before; a spokesman insists the company has experienced no such problems. But in light of GE's huge commercial paper obligations and the disruption of global credit markets, the rumors became just barely plausible. That's when the stock suddenly dropped 10%, and the price of GE credit default swaps jumped. Regardless of how realistic the market's fears were, the episode puts the Fed's decision five days later to backstop the commercial paper market in a new light, as a signal of support for the commercial paper market's biggest player.
... the company holds some $53 billion of off-balance-sheet assets that are pieces of securitized debt, some of which are hooked to interest rate swaps with counterparties that are now troubled, such as ABN Amro, owned by Fortis and RBS Group. Individually, none of those is enough to cause a major problem. But investors are justifiably spooked by the poorly understood web of connections interlocking global financial firms, which have caused such havoc over the past month, and they're unsure how GE might ultimately be affected.
Another example: GE Capital says that some of the debt it holds is extra-safe because it's covered by credit insurance. But in today's environment, how reliable are the credit insurers?
Investors worry also because GE Capital oversees one of the world's largest commercial real estate portfolios. Tom Shapiro of GoldenTree InSite Partners, a real estate investment firm, says commercial property values have declined 10% to 20% in some regions and are still falling. In addition, GE's portfolio includes residential-mortgage-backed securities, some with subprime exposure, for which there's virtually no market now. More uncertainty for investors.
Another concern is that the leverage in GE could be much higher than stated. Egan-Jones, an independent rating agency, calculates that GE is levered ten-to-one, a more conservative and higher number than the company's eight-to-one figure. Cofounder Sean Egan believes that, depending on the off-balance-sheet holdings, actual leverage could be still higher. His firm rates the company single-A.
Fortune ran an article on whether GE Capital and hence GE was safe:
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... GE is known for seeing changes ahead of time - recognizing early, for example, that it had to go "green" - and responding to them faster and more creatively than the competition. Last year, however, signs began turning up that this admirable pattern wasn't holding at GE Capital. For example, the company had left the home mortgage business in 2000 but reentered it in 2004 when it was flying high, buying a subprime lender called WMC Mortgage from a private equity firm (the price was never announced). Home prices peaked in June 2006, yet it wasn't until a year later, with the subprime crisis on the front page of every newspaper, that GE Capital finally decided to bail out. WMC lost almost $1 billion in 2007 before GE dumped it in December. A Japanese consumer-lending company called Lake was another lousy business, but GE Capital again didn't face the music until it was too late. GE took a $1.2 billion loss on it last year after deciding in September to sell it - but by then consumer credit was deteriorating so fast that unloading it (to Shinsei Bank) took another year.
... Managers thought they were being bold in stress-testing their model against a percentage-point jump in rates, but didn't conceive of a sudden and nearly complete stop to interbank lending, a total absence of buyers for some securitized debt, and investors so panicked they're willing to accept negative interest rates to gain the safety of T-bills.
Last year it bought about $14 billion of them and this year over $1 billion, all at prices in the 30s. Now, just six days after suspending the repurchase program, it was selling $12 billion of shares to the public at about $22. That is, it was buying high and selling low.
Why was it so desperate for cash? The company offers only the blandest reasons for its move, but investors were clearly worried that commercial paper was an important factor. Commercial paper is how corporations borrow for short periods, typically just a few days, for immediate purposes; it's attractive because companies borrow only what they need, and interest rates are low. Lots of firms use commercial paper, frequently just for paying day-to-day bills, but no company uses it anything like GE. GE Capital alone has about $74 billion of commercial paper outstanding; the next largest player, J.P. Morgan, has about $47 billion. GE understood there was risk in relying so heavily on this source of funding but believed it was well prepared for any disruption through access to other sources, such as bank lines of credit.
On the morning of Oct. 1, the markets swirled with rumors that GE couldn't roll over its commercial paper coming due. Like so much else that has happened in recent weeks, this possibility would have seemed outlandish just a month before; a spokesman insists the company has experienced no such problems. But in light of GE's huge commercial paper obligations and the disruption of global credit markets, the rumors became just barely plausible. That's when the stock suddenly dropped 10%, and the price of GE credit default swaps jumped. Regardless of how realistic the market's fears were, the episode puts the Fed's decision five days later to backstop the commercial paper market in a new light, as a signal of support for the commercial paper market's biggest player.
... the company holds some $53 billion of off-balance-sheet assets that are pieces of securitized debt, some of which are hooked to interest rate swaps with counterparties that are now troubled, such as ABN Amro, owned by Fortis and RBS Group. Individually, none of those is enough to cause a major problem. But investors are justifiably spooked by the poorly understood web of connections interlocking global financial firms, which have caused such havoc over the past month, and they're unsure how GE might ultimately be affected.
Another example: GE Capital says that some of the debt it holds is extra-safe because it's covered by credit insurance. But in today's environment, how reliable are the credit insurers?
Investors worry also because GE Capital oversees one of the world's largest commercial real estate portfolios. Tom Shapiro of GoldenTree InSite Partners, a real estate investment firm, says commercial property values have declined 10% to 20% in some regions and are still falling. In addition, GE's portfolio includes residential-mortgage-backed securities, some with subprime exposure, for which there's virtually no market now. More uncertainty for investors.
Another concern is that the leverage in GE could be much higher than stated. Egan-Jones, an independent rating agency, calculates that GE is levered ten-to-one, a more conservative and higher number than the company's eight-to-one figure. Cofounder Sean Egan believes that, depending on the off-balance-sheet holdings, actual leverage could be still higher. His firm rates the company single-A.
Depression economics
Not only do we know what caused the Great Depression, it seems like we don't really what ended the Great Depression:
MR: The traditional story is that President Franklin D. Roosevelt rescued capitalism by resorting to extensive government intervention; the truth is that Roosevelt changed course from year to year, trying a mix of policies, some good and some bad. ... In short, expansionary monetary policy and wartime orders from Europe, not the well-known policies of the New Deal, did the most to make the American economy climb out of the Depression.
Again MR: Bernanke notes that there were "remarkably strong" productivity gains throughout much of the 1930s, even though there was no capital deepening. This is a central puzzle which any account of the New Deal, or New Deal recovery, must incorporate. ... Rick Szostak's work suggests that the New Deal saw lots of labor-saving, process innovations, which meant both high productivity gains and pressure on labor markets at the same time. In my view most of these gains were simply the result of working through the implications of the earlier fundamental breakthroughs of the preceding twenty years. ... Whatever is the case (and we genuinely don't know), these productivity gains are central to the story of New Deal recovery. Roosevelt may deserve credit for some of them, or for allowing them to proceed, but don't assume that the New Deal caused such gains just because you see them in the gross data.
Arnold Kling via MR: The New Deal is a mythical event in history. Just as we revere the constitution as the basis for our government and we revere Abraham Lincoln for ending slavery and preserving the union, we are supposed to revere the New Deal as somehow providing the basis for our modern prosperity. Yet the policies of the New Deal are quite a mixed bag, to say the least. Most were discarded by 1950. The survivors include agricultural policies that were almost certainly wrong then and are almost certainly wrong now. Most of the financial regulations, such as interest rate ceilings on bank deposits, proved unworkable by the 1970s. Social Security, and its offspring Medicare, are going to be the next great financial crisis in this country.
Again, MR: Christina Romer writes:
This paper examines the role of aggregate demand stimulus in ending the Great Depression. A simple calculation indicates that nearly all of the observed recovery of the U.S. economy prior to 1942 was due to monetary expansion. Huge gold inflows in the mid- and late-1930s swelled the U.S. money stock and appear to have stimulated the economy by lowering real interest rates and encouraging investment spending and purchases of durable goods. The finding that monetary developments were crucial to the recovery implies that self-correction played little role in the growth of real output between 1933 and 1942.
Did the World War Help End the Great Depression? Joseph Cullen and Price Fishback write:
We examine whether local economies that were the centers of federal spending on military mobilization experienced more rapid growth in consumer economic activity than other areas. We have combined information from a wide variety of sources into a data set that allows us to estimate a reduced-form relationship between retail sales per capita growth (1939-1948, 1939-1954, 1939-1958) and federal war spending per capita from 1940 through 1945. The results show that the World War II spending had virtually no effect on the growth rates in consumption that we examined. This contrasts with Fishback, Horrace, and Kantor's (2005) findings of about half a dollar increase in retail sales associated with a dollar of New Deal public works and relief spending. Several factors contributed to this relative lack of impact. World War II spending often required a conversion of plants designed for civilian good production into military factories and back again over the 9 year period. Substantially higher federal tax rates that were paid by the majority of households imposed much stronger fiscal drags on the benefits of the spending. Finally, less of the military spending was earmarked for wages and use of locally produced inputs, which reduced the direct stimulus to the local economy. ... My [Tyler Cowen] understanding has long been that wartime orders from Europe, by 1940, provided the decisive turning point for the American economy. So if WWII did end America's Great Depression, it was not through the traditional mechanism of massive domestic fiscal stimulus.
Some notes by Jim Hamilton on how the New Deal may have prolonged the Depression:
Cole and Ohanian noted that many in the Roosevelt Administration believed that the severity of the Depression was due to excessive business competition that led to wages and prices that were too low. I actually agree, in a perverse sense, with part of that diagnosis-- I see the rapid deflation of 1929-33 as quite destabilizing. But I'm inclined to believe that the way to fix that would have been through a monetary and fiscal expansion rather than trying to lift nominal wages and prices back up by sheer government fiat. ... The purpose of the NIRA and NLRA was to promote labor and trade practice provisions so as to limit the extent of competition between firms and competition between workers. Among the NIRA codes that Cole and Ohanian highlight include minimum prices below which firms were not allowed to sell their products, restrictions on productive capacity and the amount that could be produced, and limitations on the workweek. Cole and Ohanian concluded on the basis of model simulations that these kinds of New Deal policies might have accounted for 60% of the persistence in the output gap. ... I openly confess to believing that government policies that were explicitly designed to limit manufacturing, agricultural, and mining output may indeed have had the effect of limiting manufacturing, agricultural, and mining output.
Finally, via Mark Thoma, the views on fiscal policy and Christina Romer:
Citing Free Exchange: Mr Cowen is seeking to use Ms Romer's findings as evidence that little expansionary action should be taken beyond easy money, but I'm not sure the paper reflects that conclusion. For one thing, it is the extraordinary monetary actions that made the difference during the 1930s—the abandonment of the gold standard coupled with massive capital inflow from Europe. But as importantly, Ms Romer doesn't say that fiscal policy couldn't have worked, just that it didn't. The reason it didn't, as many commentators have pointed out in recent weeks, is that president Roosevelt didn't do a particularly good job of employing it. He was stubbornly resistant to deficit spending, and he threatened to undo the progress made to 1937 with a misguided attempt to balance the budget, throwing the country back into recession.
And quoting, Edge of the West:
She’s very clear throughout that deliberate policy choices were key, and she thinks the deliberate policy choice of FDR to devalue in 1933/34 was most key.
But there’s nothing particularly prejudicial there against fiscal policy. Nor an argument about the superiority of monetary policy. But an empirical case that owing to planning and luck, monetary policy worked in the 1930s. And just now we haven’t stabilized the banks quite as the New Deal did in 1933.
MR: The traditional story is that President Franklin D. Roosevelt rescued capitalism by resorting to extensive government intervention; the truth is that Roosevelt changed course from year to year, trying a mix of policies, some good and some bad. ... In short, expansionary monetary policy and wartime orders from Europe, not the well-known policies of the New Deal, did the most to make the American economy climb out of the Depression.
Again MR: Bernanke notes that there were "remarkably strong" productivity gains throughout much of the 1930s, even though there was no capital deepening. This is a central puzzle which any account of the New Deal, or New Deal recovery, must incorporate. ... Rick Szostak's work suggests that the New Deal saw lots of labor-saving, process innovations, which meant both high productivity gains and pressure on labor markets at the same time. In my view most of these gains were simply the result of working through the implications of the earlier fundamental breakthroughs of the preceding twenty years. ... Whatever is the case (and we genuinely don't know), these productivity gains are central to the story of New Deal recovery. Roosevelt may deserve credit for some of them, or for allowing them to proceed, but don't assume that the New Deal caused such gains just because you see them in the gross data.
Arnold Kling via MR: The New Deal is a mythical event in history. Just as we revere the constitution as the basis for our government and we revere Abraham Lincoln for ending slavery and preserving the union, we are supposed to revere the New Deal as somehow providing the basis for our modern prosperity. Yet the policies of the New Deal are quite a mixed bag, to say the least. Most were discarded by 1950. The survivors include agricultural policies that were almost certainly wrong then and are almost certainly wrong now. Most of the financial regulations, such as interest rate ceilings on bank deposits, proved unworkable by the 1970s. Social Security, and its offspring Medicare, are going to be the next great financial crisis in this country.
Again, MR: Christina Romer writes:
This paper examines the role of aggregate demand stimulus in ending the Great Depression. A simple calculation indicates that nearly all of the observed recovery of the U.S. economy prior to 1942 was due to monetary expansion. Huge gold inflows in the mid- and late-1930s swelled the U.S. money stock and appear to have stimulated the economy by lowering real interest rates and encouraging investment spending and purchases of durable goods. The finding that monetary developments were crucial to the recovery implies that self-correction played little role in the growth of real output between 1933 and 1942.
Did the World War Help End the Great Depression? Joseph Cullen and Price Fishback write:
We examine whether local economies that were the centers of federal spending on military mobilization experienced more rapid growth in consumer economic activity than other areas. We have combined information from a wide variety of sources into a data set that allows us to estimate a reduced-form relationship between retail sales per capita growth (1939-1948, 1939-1954, 1939-1958) and federal war spending per capita from 1940 through 1945. The results show that the World War II spending had virtually no effect on the growth rates in consumption that we examined. This contrasts with Fishback, Horrace, and Kantor's (2005) findings of about half a dollar increase in retail sales associated with a dollar of New Deal public works and relief spending. Several factors contributed to this relative lack of impact. World War II spending often required a conversion of plants designed for civilian good production into military factories and back again over the 9 year period. Substantially higher federal tax rates that were paid by the majority of households imposed much stronger fiscal drags on the benefits of the spending. Finally, less of the military spending was earmarked for wages and use of locally produced inputs, which reduced the direct stimulus to the local economy. ... My [Tyler Cowen] understanding has long been that wartime orders from Europe, by 1940, provided the decisive turning point for the American economy. So if WWII did end America's Great Depression, it was not through the traditional mechanism of massive domestic fiscal stimulus.
Some notes by Jim Hamilton on how the New Deal may have prolonged the Depression:
Cole and Ohanian noted that many in the Roosevelt Administration believed that the severity of the Depression was due to excessive business competition that led to wages and prices that were too low. I actually agree, in a perverse sense, with part of that diagnosis-- I see the rapid deflation of 1929-33 as quite destabilizing. But I'm inclined to believe that the way to fix that would have been through a monetary and fiscal expansion rather than trying to lift nominal wages and prices back up by sheer government fiat. ... The purpose of the NIRA and NLRA was to promote labor and trade practice provisions so as to limit the extent of competition between firms and competition between workers. Among the NIRA codes that Cole and Ohanian highlight include minimum prices below which firms were not allowed to sell their products, restrictions on productive capacity and the amount that could be produced, and limitations on the workweek. Cole and Ohanian concluded on the basis of model simulations that these kinds of New Deal policies might have accounted for 60% of the persistence in the output gap. ... I openly confess to believing that government policies that were explicitly designed to limit manufacturing, agricultural, and mining output may indeed have had the effect of limiting manufacturing, agricultural, and mining output.
Finally, via Mark Thoma, the views on fiscal policy and Christina Romer:
Citing Free Exchange: Mr Cowen is seeking to use Ms Romer's findings as evidence that little expansionary action should be taken beyond easy money, but I'm not sure the paper reflects that conclusion. For one thing, it is the extraordinary monetary actions that made the difference during the 1930s—the abandonment of the gold standard coupled with massive capital inflow from Europe. But as importantly, Ms Romer doesn't say that fiscal policy couldn't have worked, just that it didn't. The reason it didn't, as many commentators have pointed out in recent weeks, is that president Roosevelt didn't do a particularly good job of employing it. He was stubbornly resistant to deficit spending, and he threatened to undo the progress made to 1937 with a misguided attempt to balance the budget, throwing the country back into recession.
And quoting, Edge of the West:
She’s very clear throughout that deliberate policy choices were key, and she thinks the deliberate policy choice of FDR to devalue in 1933/34 was most key.
But there’s nothing particularly prejudicial there against fiscal policy. Nor an argument about the superiority of monetary policy. But an empirical case that owing to planning and luck, monetary policy worked in the 1930s. And just now we haven’t stabilized the banks quite as the New Deal did in 1933.
Real returns to S&P 500
I was surprised about two things from this graph that was posted on Worthwhile Canadian Initiative.
1. Real returns between 1960 and 1990 were so low ~ 1 percent.
2. Real returns doubled only only recently.
Stephen Gordon was wondering if his paper which used pre-1993 data could be extended to include the latest data and concluded not. The obvious question is: What caused the increase in real return? Fundamentals or bubble?
P.S. Why is it so hard to get publicly (i.e. free) data on total return of the paper S&P 500? Neither S&P nor Bloomberg have these as downloads.
Monday, November 24, 2008
Repent all ye free market believers!
The end of the world must be near. Condemnations have begun to appear. (HT: EV )
... Our belief in the market – the midwife of technological invention – was the result. We have embraced globalisation, the widest possible extension of the market economy.
For the sake of globalisation, communities are denatured, jobs offshored, and skills continually reconfigured. We are told by its apostles that the wholesale impairment of most of what gave meaning to life is necessary to achieve an "efficient allocation of capital" and a "reduction in transaction costs". Moralities that resist this logic are branded "obstacles to progress". Protection – the duty the strong owe to the weak – becomes protectionism, an evil thing that breeds war and corruption.
That today's global financial meltdown is the direct consequence of the west's worship of false gods is a proposition that cannot be discussed, much less acknowledged. One of its leading deities is the efficient market hypothesis – the belief that the market accurately prices all trades at each moment in time, ruling out booms and slumps, manias and panics. Theological language that might have decried the credit crunch as the "wages of sin", a comeuppance for prodigious profligacy, has become unusable.
This monstrous conceit of contemporary economics has brought the world to the edge of disaster.
... Our belief in the market – the midwife of technological invention – was the result. We have embraced globalisation, the widest possible extension of the market economy.
For the sake of globalisation, communities are denatured, jobs offshored, and skills continually reconfigured. We are told by its apostles that the wholesale impairment of most of what gave meaning to life is necessary to achieve an "efficient allocation of capital" and a "reduction in transaction costs". Moralities that resist this logic are branded "obstacles to progress". Protection – the duty the strong owe to the weak – becomes protectionism, an evil thing that breeds war and corruption.
That today's global financial meltdown is the direct consequence of the west's worship of false gods is a proposition that cannot be discussed, much less acknowledged. One of its leading deities is the efficient market hypothesis – the belief that the market accurately prices all trades at each moment in time, ruling out booms and slumps, manias and panics. Theological language that might have decried the credit crunch as the "wages of sin", a comeuppance for prodigious profligacy, has become unusable.
This monstrous conceit of contemporary economics has brought the world to the edge of disaster.
The above is from Robert Skidelsky.
Experiments in economics
I read very quickly though Field Experiments by Harrison and List as well as Toward an Understanding of the Economics of Charity: Evidence from a Field Experiment by Landry et. al. I used to have an aversion to experimental economics but am getting around to the idea that for some interesting questions such as risk aversion, experiments may be necessary. While the survey article by Harrison and List (also in JEL 12/2004) left me confused in some parts, it convinced me that economists have learned a lot over the years.
One thing that puzzled me is that there isn't more of an intersection between survey sampling ideas (as well as randomization) with experiments. One of the things I zeroed on was the use of students in experiments (or convenience samples such as church goers). It seems that the ideas of stratification and sampling used in surveys and randomization should be introduced into experiments. (The survey article only touched on this -- they point out that even randomization has large recruiting costs but the reason these costs are borne is because randomization is in some way more acceptable than experimentation.) The biggest hurdle is cost and large scale experiementation probably hasn't made in-roads because experimental economics has not yet firmly become part of the toolkit of mainstream economists.
Perhaps with more experiments done over the Web, e.g. playing games of chance/answering questions on-line the line between surveys and experimentation will merge. I see recruiting as an ever growing problem with constant Polls, marketing surveys etc. the response rates have been declining for the past 20 years.
One last jab at JEL survey articles is that they tend to cover too much with too little depth and too much jargon. I think this article could have been made a lot simpler and narrower and hence more interesting.
One thing that puzzled me is that there isn't more of an intersection between survey sampling ideas (as well as randomization) with experiments. One of the things I zeroed on was the use of students in experiments (or convenience samples such as church goers). It seems that the ideas of stratification and sampling used in surveys and randomization should be introduced into experiments. (The survey article only touched on this -- they point out that even randomization has large recruiting costs but the reason these costs are borne is because randomization is in some way more acceptable than experimentation.) The biggest hurdle is cost and large scale experiementation probably hasn't made in-roads because experimental economics has not yet firmly become part of the toolkit of mainstream economists.
Perhaps with more experiments done over the Web, e.g. playing games of chance/answering questions on-line the line between surveys and experimentation will merge. I see recruiting as an ever growing problem with constant Polls, marketing surveys etc. the response rates have been declining for the past 20 years.
One last jab at JEL survey articles is that they tend to cover too much with too little depth and too much jargon. I think this article could have been made a lot simpler and narrower and hence more interesting.
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