Nevertheless, the Treasury secretary will be responsible for the overhaul of the legal and regulatory framework that governs the financial sector. The incoming Treasury secretary will have three chief responsibilities: complete the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act, determine how many of the new parts will work together going forward, and parry with congressional efforts to repeal parts of that law.
Nevertheless, the Treasury secretary will be responsible for the overhaul of the legal and regulatory framework that governs the financial sector. The incoming Treasury secretary will have three chief responsibilities: complete the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act, determine how many of the new parts will work together going forward, and parry with congressional efforts to repeal parts of that law.
Is inequality holding back our weak recovery? Joe Stiglitz argues it is, while Paul Krugman argues it is not. John Judis summarizes the debate at The New Republic. I want to rephrase the question and focus specifically on the two most relevant policy points.
Taxes: Stiglitz argues, "[T]he weakness of the middle class is holding back tax receipts, especially because those at the top are so adroit in avoiding taxes and in getting Washington to give them tax breaks."
Right now our federal government's tax structure is progressive, while state and local taxes are regressive. Meanwhile, the federal government can borrow at cheap rates and run a large deficit without a problem, while state budgets are constrained and need to be balanced. As a result, large cuts and layoffs at the state and local level have counteracted much of the federal government's stimulus that comes from running a larger deficit. Indeed, Stiglitz's point that inequality makes it harder to fund education is a real life battle: we are currently seeing education funding by state and local governments collapsing in real-time.
When it comes to state and local taxes, the top 1 percent pays 6.4 percent, the middle 20 percent pays 9.7, while the poorest 20 percent of families pay 10.9 percent. This isn't counting user fees, though a CEO with 300 times the income of a worker probably doesn't get 300 times as many drivers' licenses.
So, all things being equal, less inequality would mean less revenue for the federal government and more for state and local governments. Since a good plan for boosting demand would entail the federal government collecting less revenue (an extension of the payroll tax cut would have boosted demand) and state and local governments collecting more revenue and thus facing less austerity, less inequality would net provide more stimulus. I doubt it would matter that much, though it's an empirical matter on just how much it would provide.
Spending: The other debate has to do with the marginal propensity to consume. Evidence doesfind the rich are less likely to spend money on consumption than everyone else, and in a liquidity trap this matters. Steve Waldman at Interfluidity has a larger theory on why it has mattered over the past decades, but I want to focus on the complicating, narrow issue of wealth inequality.
A graph by Amir Sufi, using Federal Reserve data, shows a collapse in the median net worth of households, and his research and others finds that this is a driver of the collapse in demand:
So, all things being equal, what happens if we decrease inequality in a balance-sheet recession? I see two changes running in opposite directions. You could see an increase in spending by the median household, as they have a higher propensity to spend, plus more income could relieve their balance-sheet constraints. However, if more middle-class households have more of the country's income, they may save it even more aggressively; this would amplify the Paradox of Thrift and make the recession worse in the short term. It's not clear which of these effects would dominate over the other.
One way to deal with this is to boost net wealth while keeping incomes consistent, via debt forgiveness or reform our legal mechanisms like bankruptcy so they can handle allocating these losses, though that doesn't seem to be in the cards.
Follow or contact the Rortybomb blog:
Is inequality holding back our weak recovery? Joe Stiglitz argues it is, while Paul Krugman argues it is not. John Judis summarizes the debate at The New Republic. I want to rephrase the question and focus specifically on the two most relevant policy points.
Taxes: Stiglitz argues, "[T]he weakness of the middle class is holding back tax receipts, especially because those at the top are so adroit in avoiding taxes and in getting Washington to give them tax breaks."
Right now our federal government's tax structure is progressive, while state and local taxes are regressive. Meanwhile, the federal government can borrow at cheap rates and run a large deficit without a problem, while state budgets are constrained and need to be balanced. As a result, large cuts and layoffs at the state and local level have counteracted much of the federal government's stimulus that comes from running a larger deficit. Indeed, Stiglitz's point that inequality makes it harder to fund education is a real life battle: we are currently seeing education funding by state and local governments collapsing in real-time.
When it comes to state and local taxes, the top 1 percent pays 6.4 percent, the middle 20 percent pays 9.7, while the poorest 20 percent of families pay 10.9 percent. This isn't counting user fees, though a CEO with 300 times the income of a worker probably doesn't get 300 times as many drivers' licenses.
So, all things being equal, less inequality would mean less revenue for the federal government and more for state and local governments. Since a good plan for boosting demand would entail the federal government collecting less revenue (an extension of the payroll tax cut would have boosted demand) and state and local governments collecting more revenue and thus facing less austerity, less inequality would net provide more stimulus. I doubt it would matter that much, though it's an empirical matter on just how much it would provide.
Spending: The other debate has to do with the marginal propensity to consume. Evidence doesfind the rich are less likely to spend money on consumption than everyone else, and in a liquidity trap this matters. Steve Waldman at Interfluidity has a larger theory on why it has mattered over the past decades, but I want to focus on the complicating, narrow issue of wealth inequality.
A graph by Amir Sufi, using Federal Reserve data, shows a collapse in the median net worth of households, and his research and others finds that this is a driver of the collapse in demand:
So, all things being equal, what happens if we decrease inequality in a balance-sheet recession? I see two changes running in opposite directions. You could see an increase in spending by the median household, as they have a higher propensity to spend, plus more income could relieve their balance-sheet constraints. However, if more middle-class households have more of the country's income, they may save it even more aggressively; this would amplify the Paradox of Thrift and make the recession worse in the short term. It's not clear which of these effects would dominate over the other.
One way to deal with this is to boost net wealth while keeping incomes consistent, via debt forgiveness or reform our legal mechanisms like bankruptcy so they can handle allocating these losses, though that doesn't seem to be in the cards.
During the 2012 election, conservatives' main goal was to either repeal Dodd-Frank completely or remove such large sections of it that it was a completely different bill. There was very little engagement with the content of Dodd-Frank itself and how to make them work better. One important example was Republican candidates like Jon Huntsman calling for bold new financial reforms that were already part of Dodd-Frank.
It now appears that the flagship policy journal on the right, National Affairs, is moving towards a reform rather than replace agenda for Dodd-Frank and financial reform. The latest issue featured an large, 7,000+ word article, "Against Casino Finance," by Eric Posner and E. Glen Weyl of University of Chicago law school. What's fascinating about the piece is less the authors' counter proposals for reform, which are lacking, than the fact that they accept two of the ideas put forward by financial reformers that have generally been resisted on the right. The first is that derivatives require regulation and the second is that prudential regulation of the largest systemically risky financial firms is necessary.
Let's take those in order. First the authors argue, "[I]n today's derivatives market...no such sensible restriction exists to separate the use of the instruments as insurance from their use as gambling devices." They describe these instruments as "pure gambling," or a transaction in which "one party loses exactly what the other party gains, and both are made worse off by the additional risk they take on in this bargain." They argue that these instruments can increase pure risks and are zero-sum, differentiating them from other trades. They go as far as to argue against the Commodity Futures Modernization Act of 2000.
It isn't clear what they think of the general Dodd-Frank approach to derivatives, which emphasizes transparency through exchanges and clearinghouses, capital adequacy, private enforcement, and regulation of intermediaries. Their focus is partially on the "insurable interest doctrine" of common law as it relates to insurance, which requires that a party to an insurance contract have a stake in the event. If you can't buy fire insurance on your neighbor's house, why can you buy credit insurance on his business if you don't have an ownership claim on it? That's a dog whistle for either banning so-called "naked" derivatives or running them under state-level insurance law. The vote to ban naked credit default swaps, proposed in the Senate by Bryan Dorgan, failed (and was generally opposed on the right).
The other regulations relate to bailouts and prudential regulations. As they put it:
When banks fail, the government must act as lender of last resort.
Today, the government serves this role in two ways. First, it compels banks to buy government-supplied deposit insurance, which covers depositors up to $250,000. Second, it provides emergency loans at below-market rates -- bailouts -- to any financial institution whose collapse would take down enough banks with it to endanger the entire economy.
Few seriously doubt that governments must play this role.
Bagehot’s rule is usually summarized as, “Lend without limit, to solvent firms, against good collateral, at high rates." In exchange for this, certain regulations are necessary. Dodd-Frank includes higher capital and liquidity requirements for larger and riskier firms, as well as certain organizational requirements (loosely referred to under the term "living wills") to help with collapsing the company in question via FDIC's resolution powers.
Again, it would be interesting if they addressed the specific reforms to lender of last resort functions included in Dodd-Frank, or the combination of regulation and resolution. Section 13(3) of the Federal Reserve Act was amended so that "any emergency lending program or facility is for the purpose of providing liquidity to the financial system, and not to aid a failing financial company." and any such lending program has to have "broad-based eligibility.” Some have argued this is too loose to deal with a liquidity crisis. Do these authors agree? Are the regulations and FDIC's resolution powers sufficient in this case, or do we need a different approach?
Their specific recommendations for how the right should tackle Dodd-Frank, which is the last third of the piece, involve applying stricter cost-benefit analysis to all rules. There's no talk about repeal, or huge changes to the framework, or long court battles. Cost-benefit has significant problems, but that's a debate for another day. Conceptually, it is tinkering with Dodd-Frank rather than repealing it, which has dominated the conversation on the right. Will this signal a larger change?
Follow or contact the Rortybomb blog:
During the 2012 election, conservatives' main goal was to either repeal Dodd-Frank completely or remove such large sections of it that it was a completely different bill. There was very little engagement with the content of Dodd-Frank itself and how to make them work better. One important example was Republican candidates like Jon Huntsman calling for bold new financial reforms that were already part of Dodd-Frank.
It now appears that the flagship policy journal on the right, National Affairs, is moving towards a reform rather than replace agenda for Dodd-Frank and financial reform. The latest issue featured an large, 7,000+ word article, "Against Casino Finance," by Eric Posner and E. Glen Weyl of University of Chicago law school. What's fascinating about the piece is less the authors' counter proposals for reform, which are lacking, than the fact that they accept two of the ideas put forward by financial reformers that have generally been resisted on the right. The first is that derivatives require regulation and the second is that prudential regulation of the largest systemically risky financial firms is necessary.
Let's take those in order. First the authors argue, "[I]n today's derivatives market...no such sensible restriction exists to separate the use of the instruments as insurance from their use as gambling devices." They describe these instruments as "pure gambling," or a transaction in which "one party loses exactly what the other party gains, and both are made worse off by the additional risk they take on in this bargain." They argue that these instruments can increase pure risks and are zero-sum, differentiating them from other trades. They go as far as to argue against the Commodity Futures Modernization Act of 2000.
It isn't clear what they think of the general Dodd-Frank approach to derivatives, which emphasizes transparency through exchanges and clearinghouses, capital adequacy, private enforcement, and regulation of intermediaries. Their focus is partially on the "insurable interest doctrine" of common law as it relates to insurance, which requires that a party to an insurance contract have a stake in the event. If you can't buy fire insurance on your neighbor's house, why can you buy credit insurance on his business if you don't have an ownership claim on it? That's a dog whistle for either banning so-called "naked" derivatives or running them under state-level insurance law. The vote to ban naked credit default swaps, proposed in the Senate by Bryan Dorgan, failed (and was generally opposed on the right).
The other regulations relate to bailouts and prudential regulations. As they put it:
When banks fail, the government must act as lender of last resort.
Today, the government serves this role in two ways. First, it compels banks to buy government-supplied deposit insurance, which covers depositors up to $250,000. Second, it provides emergency loans at below-market rates -- bailouts -- to any financial institution whose collapse would take down enough banks with it to endanger the entire economy.
Few seriously doubt that governments must play this role.
Bagehot’s rule is usually summarized as, “Lend without limit, to solvent firms, against good collateral, at high rates." In exchange for this, certain regulations are necessary. Dodd-Frank includes higher capital and liquidity requirements for larger and riskier firms, as well as certain organizational requirements (loosely referred to under the term "living wills") to help with collapsing the company in question via FDIC's resolution powers.
Again, it would be interesting if they addressed the specific reforms to lender of last resort functions included in Dodd-Frank, or the combination of regulation and resolution. Section 13(3) of the Federal Reserve Act was amended so that "any emergency lending program or facility is for the purpose of providing liquidity to the financial system, and not to aid a failing financial company." and any such lending program has to have "broad-based eligibility.” Some have argued this is too loose to deal with a liquidity crisis. Do these authors agree? Are the regulations and FDIC's resolution powers sufficient in this case, or do we need a different approach?
Their specific recommendations for how the right should tackle Dodd-Frank, which is the last third of the piece, involve applying stricter cost-benefit analysis to all rules. There's no talk about repeal, or huge changes to the framework, or long court battles. Cost-benefit has significant problems, but that's a debate for another day. Conceptually, it is tinkering with Dodd-Frank rather than repealing it, which has dominated the conversation on the right. Will this signal a larger change?
Paul Krugman was on Morning Joe yesterday, where he was peppered with questions about why he and other liberal economists aren't obsessed with long-term debt as a more pressing, or at least equally pressing, problem compared to mass unemployment. Joe Scarborough wrote a follow-up editorial implying that Krugman's opinion is isolated among economists without citing any actual economists. In response, Joe Weisenthalcreated a list of economists of varying backgrounds and political persuasions who agree with Krugman.
The segment focused on the idea that the only way to do stimulus is if we also do long-term cuts at the same time.
Some quotes to give a feel:
Joe Scarborough, 8m20s: "Medicare, Medicaid, health care costs, the defense budget, long-term drivers of a long-term debt... I say you can do two things at the same time."
Ed Rendel, 12m23s, 15m49s: "I don't think any of these things are mutually exclusive... I think we can [invest in infrastructure] while at the same time taking care of the long-term... Simpson-Bowles said we can do both. We can stretch out our debt reduction over a course of time and at the same time do some things that will spur the economy."
Joe Scarborough: "Won't that send a good message to the markets if we say, 'Hey listen, here's the deal. We are going to take care of what we have to do in the short term to get people back to work, but in the long term we are taking care of the long-term structure'?"
This is often referred to as a "barbell strategy" (from a Peter Orzag column). Do stimulus, do long-term deficit reduction, but only if you can do them together. As mentioned by the panelists, this is part of several bipartisan debt reduction strategies. Here's Domenici-Rivlin's Restoring America's Future Plan: "First, we must recover from the deep recession that has thrown millions out of work... Second, we must take immediate steps to reduce the unsustainable debt... These two challenges must be addressed at the same time, not sequentially."
It's weird that nobody on Morning Joe seems to understand the obvious problems with this strategy, so let's make a list.
1. There is no solid economic argument for this. There may be political arguments, as in that's the only way to build a coalition to get legislation through a partisan Congress, but they are just that, political. There's no decent economic argument for why if stimulus is a good idea, and long-term deficit reduction is a good idea, that you need to do both at the same time.
Scarborough's argument that "this would send a good message to the markets" implies that interest rates are a constraint, when instead they've been at ultra-low rates. It also seems to imply that additional stimulus would send the markets into a panic. It is true that if we passed a stimulus program interest rates could rise, but this would reflect the market thinking things were getting better, not worse.
2. The political argument for this is also weak, if only because it was the operative strategy over the past several years and didn't work. President Obama just tried to get some $225 billion dollars in stimulus in the fiscal cliff and looked to be willing to accept cuts in the inflation adjustments for Social Security as part of the package. Republicans turned this down. This stimulus was first proposed a year earlier in his American Jobs Act, which, as he told Congress, would be paid for by offsetting long-term budgets. This was dead on arrival.
And it is easy to see why. You can probably get some agreement on the content of a stimulus package, but to get a agreement on long-term deficit reduction, you would need the GOP to accept some new revenues or clarify what it wants on social insurance. It won't do the first outside constructed scenarios like the fiscal cliff and the latter has yet to happen.
3. As for the short term, alleviating unemployment is the most responsible budget action even though it increases the short-term deficit. Austerity is likely to give us a higher debt-to-GDP problem if it causes a double-dip recession. Our current deficit is so large because so many people are not working; more economic activity would mean more things to tax and fewer stablizers like unemployment insurance to pay for.
As Delong and Summers argue, additional fiscal stimulus in a depressed economy can largely offset its own costs. Or as John Maynard Keynes said in 1933, "It is the burden of unemployment and the decline in the national income which are upsetting the Budget. Look after the unemployment, and the Budget will look after itself."
4. As for the part of the budget that won't take care of itself, President Obama fought an ugly and costly battle to bend the cost curve of health care, in which he was accused of everything from creating death panels to looting benefits of seniors in order to pass them out to his army of Takers. Since he's already paid that price, why wouldn't he wait and see how well Medicare cost saving techniques work?
Maybe it's just me, but I find the "if you want to see full employment again, immediately dismantle some social insurance" to be like a form of ransom. Meanwhile millions of people are suffering needlessly as a result of the lack of action.
Follow or contact the Rortybomb blog:
Paul Krugman was on Morning Joe yesterday, where he was peppered with questions about why he and other liberal economists aren't obsessed with long-term debt as a more pressing, or at least equally pressing, problem compared to mass unemployment. Joe Scarborough wrote a follow-up editorial implying that Krugman's opinion is isolated among economists without citing any actual economists. In response, Joe Weisenthalcreated a list of economists of varying backgrounds and political persuasions who agree with Krugman.
The segment focused on the idea that the only way to do stimulus is if we also do long-term cuts at the same time.
Some quotes to give a feel:
Joe Scarborough, 8m20s: "Medicare, Medicaid, health care costs, the defense budget, long-term drivers of a long-term debt... I say you can do two things at the same time."
Ed Rendel, 12m23s, 15m49s: "I don't think any of these things are mutually exclusive... I think we can [invest in infrastructure] while at the same time taking care of the long-term... Simpson-Bowles said we can do both. We can stretch out our debt reduction over a course of time and at the same time do some things that will spur the economy."
Joe Scarborough: "Won't that send a good message to the markets if we say, 'Hey listen, here's the deal. We are going to take care of what we have to do in the short term to get people back to work, but in the long term we are taking care of the long-term structure'?"
This is often referred to as a "barbell strategy" (from a Peter Orzag column). Do stimulus, do long-term deficit reduction, but only if you can do them together. As mentioned by the panelists, this is part of several bipartisan debt reduction strategies. Here's Domenici-Rivlin's Restoring America's Future Plan: "First, we must recover from the deep recession that has thrown millions out of work... Second, we must take immediate steps to reduce the unsustainable debt... These two challenges must be addressed at the same time, not sequentially."
It's weird that nobody on Morning Joe seems to understand the obvious problems with this strategy, so let's make a list.
1. There is no solid economic argument for this. There may be political arguments, as in that's the only way to build a coalition to get legislation through a partisan Congress, but they are just that, political. There's no decent economic argument for why if stimulus is a good idea, and long-term deficit reduction is a good idea, that you need to do both at the same time.
Scarborough's argument that "this would send a good message to the markets" implies that interest rates are a constraint, when instead they've been at ultra-low rates. It also seems to imply that additional stimulus would send the markets into a panic. It is true that if we passed a stimulus program interest rates could rise, but this would reflect the market thinking things were getting better, not worse.
2. The political argument for this is also weak, if only because it was the operative strategy over the past several years and didn't work. President Obama just tried to get some $225 billion dollars in stimulus in the fiscal cliff and looked to be willing to accept cuts in the inflation adjustments for Social Security as part of the package. Republicans turned this down. This stimulus was first proposed a year earlier in his American Jobs Act, which, as he told Congress, would be paid for by offsetting long-term budgets. This was dead on arrival.
And it is easy to see why. You can probably get some agreement on the content of a stimulus package, but to get a agreement on long-term deficit reduction, you would need the GOP to accept some new revenues or clarify what it wants on social insurance. It won't do the first outside constructed scenarios like the fiscal cliff and the latter has yet to happen.
3. As for the short term, alleviating unemployment is the most responsible budget action even though it increases the short-term deficit. Austerity is likely to give us a higher debt-to-GDP problem if it causes a double-dip recession. Our current deficit is so large because so many people are not working; more economic activity would mean more things to tax and fewer stablizers like unemployment insurance to pay for.
As Delong and Summers argue, additional fiscal stimulus in a depressed economy can largely offset its own costs. Or as John Maynard Keynes said in 1933, "It is the burden of unemployment and the decline in the national income which are upsetting the Budget. Look after the unemployment, and the Budget will look after itself."
4. As for the part of the budget that won't take care of itself, President Obama fought an ugly and costly battle to bend the cost curve of health care, in which he was accused of everything from creating death panels to looting benefits of seniors in order to pass them out to his army of Takers. Since he's already paid that price, why wouldn't he wait and see how well Medicare cost saving techniques work?
Maybe it's just me, but I find the "if you want to see full employment again, immediately dismantle some social insurance" to be like a form of ransom. Meanwhile millions of people are suffering needlessly as a result of the lack of action.
I have a new article at Bloomberg View, titled The Fed Is More Out of It Than You Thought It Was. It's about the recently released Federal Reserve transcripts from 2007, and what they say about where the Fed was and wasn't looking when it came to weakness in the economy. It's also implicitly about coverage of the economic crisis that are overtly focused on the financial sector, relevant again in all the new TARP retrospectives that are out there. I hope you check it out.
I have a new article at Bloomberg View, titled The Fed Is More Out of It Than You Thought It Was. It's about the recently released Federal Reserve transcripts from 2007, and what they say about where the Fed was and wasn't looking when it came to weakness in the economy. It's also implicitly about coverage of the economic crisis that are overtly focused on the financial sector, relevant again in all the new TARP retrospectives that are out there. I hope you check it out.
