Is There Really a "Conservative Reform" Movement in Policy?

May 23, 2013Mike Konczal

A few years ago, Freddie DeBoer argued that the terms “left” and “liberal” in the political blogosphere were really more descriptive of argument style and political strategy rather than any actual ideological differences. I think there’s a similar issue at play in the wave of articles about conservatives seeking to reform the movement.

As 2013 rolls on, we are seeing more and more articles about conservative reformers. Ryan Cooper had a list of “reformish conservatives” at the Washington Monthly, and now Jonathan Chait has a great profile of Josh Barro at The Atlantic. I understand why these articles are written - they profile interesting conservative writers that people should read more. But I don’t think they actually make their point.

Here’s how Chait sets it up: “conservative reformists... [argue] that the GOP’s product itself, not merely its marketing slogans, needs to change. Writers like David Brooks, Ross Douthat, Reihan Salam, and Ramesh Ponnuru have made versions of this case for several years.”

So there are two elements. First, reformers think that the GOP is currently on the wrong track with its policies, and second, they believe there need to be more “middle-class-friendly solutions” in new policy. This is different than saying that reformers don’t argue that the economy is a giant Randian morality play, or that President Obama is a left-wing radical; it’s about specific policies.

Are either of these things true? I don’t see it. Or, I see it more on the marketing end than on the policy end. I’m going to keep specific individuals vague here and generalize, because the arguments are predicated on a general move rather than any idiosyncratic argument. Here’s what I take to be the current conservative policy consensus:

1. Social Security and Medicare should be privatized. The word privatization is a complicated one with a lot of meanings, but generally competition should come to Medicare and private accounts to Social Security. This is for budgeting reasons, but also ideological ones. As Yuval Levin wrote, “the vision that has dominated our political imagination for a century — the vision of the social-democratic welfare state — is drained and growing bankrupt.”

2. Everything that isn’t nailed to the floor should be block-granted to the states. From there, funding should be slowed, and private agents should be emphasized at all points. Welfare reform, but for everything (especially Medicaid).

3. The tax code is too progressive, and that was true even before the changes in the fiscal cliff. The number of brackets should be reduced, perhaps even to two. Taxes in general should be lower, with some base-broadening to balance it.

4. The way to deal with health care is to allow insurance purchases across state lines while supporting state-level pre-existing condition pools. Ending Obamacare by itself is smart policy, even if something doesn’t “replace” it. And if push comes to shove, universal coverage is not a necessary goal.

5. Inequality is largely a non-issue, manipulated by liberals to justify their programs. The rich work harder in a global market that rewards skills and superstars. The middle class is only stagnating if you ignore health care costs and the fact that you can consume better technology cheaper. The economy works far better for average people than liberals understand.

6. Global warming, to whatever extent it is happening, should not have a government response to try and reduce carbon. Market signals, technology, migration, and adapting are better and cheaper options for even the gloomiest predictions. Or, looking at it in a different way, growth will ultimately solve the problem of global warming, and so any government policy that hurts growth (which they all do) is the wrong option.

I don’t think I’m making a strawman here. (1-3 is directly from Paul Ryan.) So the question is: how many of the reformers disagree with any of those? This is the core of current policy, and I don’t know if any of the reformish crew even disagree with these statements, much less want to spend the energy challenging them.

Now what about disagreements? What are they adding to the table? As far as I read what reformers bring to the table, it consists of:

a. Monetary policy shouldn’t adopt a price stability mandate (or a gold standard, for that matter), and in fact Ben Bernanke could and should be doing more to help the recovery with the powers he has available. (Fiscal policy like the stimulus, however, is a bad idea that largely fails.)

b. Tax credits, particularly the earned income tax credit and the child tax credit, are successful programs which might even be expanded. They’re good even though they mean 47 percent of Americans pay no federal income tax, which conservatives hate. ("Predistribution" means of boosting low-end wages, like a higher minimum wage, should be avoided though.)

c. Financial institutions should hold more capital, and perhaps we should apply a “structural” reform to the sector like a size cap or siloing of functions.

d. The government protects incumbent interests in industry, both with obvious subsidies but also with certain property rights, like copyright.

Am I missing more? These are important things, but it’s really tough to think of this as a general new direction in policy. Much of it is actually a defense and potential extension of already-existing policies against people further to the right. And even here you’ll have major disagreements. (It is amusing to think of Timothy P. Carney writing a column about how Ben Bernanke needs to “commit to being irresponsible.”)

A lot of the reformer articles posit more aggressive conservative reformers like David Frum, Bruce Bartlett, and now Josh Barro. What stands out to me is that these three write as if the Obama administration happened. The rest of the reformers write as if his first term never happened as a baseline, and crucially that they can’t write stuff seen as getting in the way of repeal.

They also understand that the Great Recession destroyed the previous consensus that we had solved the question of the business cycle. It’s tougher to argue that we should have a radically smaller federal government when it looks like the size of the government and automatic stabilizers helped keep the Great Recession from becoming a Great Depression-like collapse. The reformers have bounced around on this topic, but aside from the three mentioned, they haven’t had conversions. Mostly they believe the Great Moderation should have just tried harder.

I’d emphasize one last thing about the policy of conservative reformers: in practice it will likely be more gestural than substantive. I don’t know enough to mediate the health care battles, but I do know financial reform pretty well. And as financial reform is often brought out as an example of new reformers at work, it’s interesting to watch the lack of attention reformers pay to the actual nuts and bolts of the process.

I don’t see reformers call for getting the head of the CFPB appointed. I don’t see them arguing that repealing FDIC’s new resolution authority powers should be taken out of the Ryan Budget. I don’t see them arguing that efforts to repeal derivatives regulations already are premature or bad policy. I don’t see them angry about the mess of the securitization servicing system, which is creating a nightmare of law-breaking in the housing market. I also don’t seem them arguing the opposite either.

It’s focused on “break up the banks!” Crucially, this gets its energy from the idea that We Should Do Something Big about financial reform, rather than how it plays into a larger set of regulations, laws, and markets. It’s to position the Republicans as Doing Something where the Democrats haven’t. It’s sadly less policy and more political strategizing.

Follow or contact the Rortybomb blog:

  

 

A few years ago, Freddie DeBoer argued that the terms “left” and “liberal” in the political blogosphere were really more descriptive of argument style and political strategy rather than any actual ideological differences. I think there’s a similar issue at play in the wave of articles about conservatives seeking to reform the movement.

As 2013 rolls on, we are seeing more and more articles about conservative reformers. Ryan Cooper had a list of “reformish conservatives” at the Washington Monthly, and now Jonathan Chait has a great profile of Josh Barro at The Atlantic. I understand why these articles are written - they profile interesting conservative writers that people should read more. But I don’t think they actually make their point.

Here’s how Chait sets it up: “conservative reformists... [argue] that the GOP’s product itself, not merely its marketing slogans, needs to change. Writers like David Brooks, Ross Douthat, Reihan Salam, and Ramesh Ponnuru have made versions of this case for several years.”

So there are two elements. First, reformers think that the GOP is currently on the wrong track with its policies, and second, they believe there need to be more “middle-class-friendly solutions” in new policy. This is different than saying that reformers don’t argue that the economy is a giant Randian morality play, or that President Obama is a left-wing radical; it’s about specific policies.

Are either of these things true? I don’t see it. Or, I see it more on the marketing end than on the policy end. I’m going to keep specific individuals vague here and generalize, because the arguments are predicated on a general move rather than any idiosyncratic argument. Here’s what I take to be the current conservative policy consensus:

1. Social Security and Medicare should be privatized. The word privatization is a complicated one with a lot of meanings, but generally competition should come to Medicare and private accounts to Social Security. This is for budgeting reasons, but also ideological ones. As Yuval Levin wrote, “the vision that has dominated our political imagination for a century — the vision of the social-democratic welfare state — is drained and growing bankrupt.”

2. Everything that isn’t nailed to the floor should be block-granted to the states. From there, funding should be slowed, and private agents should be emphasized at all points. Welfare reform, but for everything (especially Medicaid).

3. The tax code is too progressive, and that was true even before the changes in the fiscal cliff. The number of brackets should be reduced, perhaps even to two. Taxes in general should be lower, with some base-broadening to balance it.

4. The way to deal with health care is to allow insurance purchases across state lines while supporting state-level pre-existing condition pools. Ending Obamacare by itself is smart policy, even if something doesn’t “replace” it. And if push comes to shove, universal coverage is not a necessary goal.

5. Inequality is largely a non-issue, manipulated by liberals to justify their programs. The rich work harder in a global market that rewards skills and superstars. The middle class is only stagnating if you ignore health care costs and the fact that you can consume better technology cheaper. The economy works far better for average people than liberals understand.

6. Global warming, to whatever extent it is happening, should not have a government response to try and reduce carbon. Market signals, technology, migration, and adapting are better and cheaper options for even the gloomiest predictions. Or, looking at it in a different way, growth will ultimately solve the problem of global warming, and so any government policy that hurts growth (which they all do) is the wrong option.

I don’t think I’m making a strawman here. (1-3 is directly from Paul Ryan.) So the question is: how many of the reformers disagree with any of those? This is the core of current policy, and I don’t know if any of the reformish crew even disagree with these statements, much less want to spend the energy challenging them.

Now what about disagreements? What are they adding to the table? As far as I read what reformers bring to the table, it consists of:

a. Monetary policy shouldn’t adopt a price stability mandate (or a gold standard, for that matter), and in fact Ben Bernanke could and should be doing more to help the recovery with the powers he has available. (Fiscal policy like the stimulus, however, is a bad idea that largely fails.)

b. Tax credits, particularly the earned income tax credit and the child tax credit, are successful programs which might even be expanded. They’re good even though they mean 47 percent of Americans pay no federal income tax, which conservatives hate. ("Predistribution" means of boosting low-end wages, like a higher minimum wage, should be avoided though.)

c. Financial institutions should hold more capital, and perhaps we should apply a “structural” reform to the sector like a size cap or siloing of functions.

d. The government protects incumbent interests in industry, both with obvious subsidies but also with certain property rights, like copyright.

Am I missing more? These are important things, but it’s really tough to think of this as a general new direction in policy. Much of it is actually a defense and potential extension of already-existing policies against people further to the right. And even here you’ll have major disagreements. (It is amusing to think of Timothy P. Carney writing a column about how Ben Bernanke needs to “commit to being irresponsible.”)

A lot of the reformer articles posit more aggressive conservative reformers like David Frum, Bruce Bartlett, and now Josh Barro. What stands out to me is that these three write as if the Obama administration happened. The rest of the reformers write as if his first term never happened as a baseline, and crucially that they can’t write stuff seen as getting in the way of repeal.

They also understand that the Great Recession destroyed the previous consensus that we had solved the question of the business cycle. It’s tougher to argue that we should have a radically smaller federal government when it looks like the size of the government and automatic stabilizers helped keep the Great Recession from becoming a Great Depression-like collapse. The reformers have bounced around on this topic, but aside from the three mentioned, they haven’t had conversions. Mostly they believe the Great Moderation should have just tried harder.

I’d emphasize one last thing about the policy of conservative reformers: in practice it will likely be more gestural than substantive. I don’t know enough to mediate the health care battles, but I do know financial reform pretty well. And as financial reform is often brought out as an example of new reformers at work, it’s interesting to watch the lack of attention reformers pay to the actual nuts and bolts of the process.

I don’t see reformers call for getting the head of the CFPB appointed. I don’t see them arguing that repealing FDIC’s new resolution authority powers should be taken out of the Ryan Budget. I don’t see them arguing that efforts to repeal derivatives regulations already are premature or bad policy. I don’t see them angry about the mess of the securitization servicing system, which is creating a nightmare of law-breaking in the housing market. I also don’t seem them arguing the opposite either.

It’s focused on “break up the banks!” Crucially, this gets its energy from the idea that We Should Do Something Big about financial reform, rather than how it plays into a larger set of regulations, laws, and markets. It’s to position the Republicans as Doing Something where the Democrats haven’t. It’s sadly less policy and more political strategizing.

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Michael Kinsley Gets It Wrong On "Austerians"

May 23, 2013Mike Konczal

While I was on vacation, the Internet exploded over a column by Michael Kinsley beefing with Paul Krugman and his follow-up response. The biggest problem with his attempt to reclaim the word “austerians” from its detractors is that he doesn’t provide a working definition, an argument, or even specific people or proposals for what he has in mind. He apparently takes “austerian” to mean “anti-Krugman,” and since Kinsley and others feels that they don’t line up with Krugman, they must all be austerians.

This leads into the second biggest problem with Kinsley’s posts: he concludes that everyone is basically on the same page. It’s just a matter of how you weigh your priorities and concerns. Kinsley writes that “Krugman now says that what he is against is ‘premature’ fiscal austerity. So is everybody. They just disagree on what is ‘premature.’” Also that “[y]ou can be a right-wing Austerian, a left-wing Austerian, a right-wing Keynesian, or a left-wing Keynesian. And (as I also noted last week) the differences are not so great.” (My underlines.)

This is wrong. I’ll quickly summarize three different approaches to the deficit, trying hard to not make straw men of them. There’s (1) Team Keynesian, which thinks that the government should increase the short-term deficit, full-stop. Extend the payroll tax cut for two years. Invest in an infrastructure bank. Mail people checks. Get to the point where the Federal Reserve has traction again on the economy before worrying about the debt.

People in this category are all for ways to deal with the long-term deficit. But they realize that: (a) Medicare is the major driver of those costs, Obamacare needs a chance to deal with this, and it may even be working already; (b) reducing the long-term deficit should require a combination of taxes and spending, and the GOP will refuse any and all tax increases, making a deal impossible; and (c) the GOP wants to privatize Social Security and Medicare rather than bring them into a healthy long-term financial situation, so not everyone is even on the same page.

However, people in (2) Team Barbell think that stimulus must be paired with long-term deficit reduction at the same time. For an example, there’s the original Domenici-Rivlin 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."

I assume when Kinsley references needing to eat spinach along with dessert as macroeconomic policy he’s referring to a need for both stimulus and deficit reduction to complement each other. Sadly for him, there’s never been a clear economic case for why these should be addressed together, and plenty of evidence that addressing the second will do little for the first.

(Noah Smith started a conversation recently about whether elites want a slower recovery in order to do structural reform. The original Domenici-Rivlin reform quoted above basically said, “We know unemployment is devastating, and we know more upfront stimulus will help. However, we are going to need you to turn Medicare into a giant Groupon system in order to get it.”)

These two approaches are very different than the arguments for (3) Team Austerity. The argument here is that, if done right, austerity will have a negligible effect on the economy and could even increase prosperity by restoring confidence to private capital. This is not a strawman; it’s the economic plan the GOP put forward when they took the House in 2011, which they got from AEI, which they got from Alberto Alesina and Silvia Ardagna of Harvard.

The 2011 GOP plan also noted, “Analyzing 20 developed countries between 1946 and 2009, Reinhart and Rogoff found a distinct threshold for gross government debt equal to 90 percent of GDP.” They believed action was needed to avoid crossing this threshold, even if it might be painful. (Thankfully, it wouldn’t be according this argument.)

No Pain, No Gain?

Kinsley’s misdiagnosis that the policy disagreements are all a matter of relative priorities then leads him to believe that more weight on short-term pain will lead to better long-term conclusions: “I don’t think suffering is good, but I do believe that we have to pay a price for past sins, and the longer we put it off, the higher the price will be...The problem is the great, deluded middle class—subsidized by government and coddled by politicians.”

This set the Internet on fire. I’m genuinely not sure what he’s referencing here when he mentions the middle-class. Is Kinsley at the point where he doesn’t get editors? I’m going to rewrite this for him: “During the 2000s, the middle class borrowed way too much, speculating on housing and using fake home equity to go on a spending spree. Now that this bubble has burst, the middle class needs to spend less and save more. There will be, yes, suffering, but they should have been saving more all along. Americans didn’t save enough, and now they have to save more and work off all the bad debts.”

And here’s how I would have responded to that better argument: “Yes, but two things. The first is that everyone can’t all save at the same time. If everyone is saving, nobody is spending, and we start to hit some major problems. Second, the bad debts to be worked off aren’t set in stone. If unemployment is higher, or wage growth slower, or inflation is under-target, that means the pile of bad debts is even greater. Since they are greater, people save more, and then there are even more problems. So even if you have a strongly moralistic tone about what needs to be done, or read this as a pox on our middle class, stimulus in the short term is crucial.”

Because austerity won’t even do the job Kinsley is proposing it will do. In 1933, John Maynard Keynes said, “You will never balance the Budget through measures which reduce the national income.” He argued this because he was a childless gay hedonist saw that austerity won’t even function to reduce the debt load, because a weaker GDP will eliminate any debt savings. This is precisely what is happening in Europe, and it could happen here if we suffocate the recovery too early.

 

Follow or contact the Rortybomb blog:

  

 

While I was on vacation, the Internet exploded over a column by Michael Kinsley beefing with Paul Krugman and his follow-up response. The biggest problem with his attempt to reclaim the word “austerians” from its detractors is that he doesn’t provide a working definition, an argument, or even specific people or proposals for what he has in mind. He apparently takes “austerian” to mean “anti-Krugman,” and since Kinsley and others feels that they don’t line up with Krugman, they must all be austerians.

This leads into the second biggest problem with Kinsley’s posts: he concludes that everyone is basically on the same page. It’s just a matter of how you weigh your priorities and concerns. Kinsley writes that “Krugman now says that what he is against is ‘premature’ fiscal austerity. So is everybody. They just disagree on what is ‘premature.’” Also that “[y]ou can be a right-wing Austerian, a left-wing Austerian, a right-wing Keynesian, or a left-wing Keynesian. And (as I also noted last week) the differences are not so great.” (My underlines.)

This is wrong. I’ll quickly summarize three different approaches to the deficit, trying hard to not make straw men of them. There’s (1) Team Keynesian, which thinks that the government should increase the short-term deficit, full-stop. Extend the payroll tax cut for two years. Invest in an infrastructure bank. Mail people checks. Get to the point where the Federal Reserve has traction again on the economy before worrying about the debt.

People in this category are all for ways to deal with the long-term deficit. But they realize that: (a) Medicare is the major driver of those costs, Obamacare needs a chance to deal with this, and it may even be working already; (b) reducing the long-term deficit should require a combination of taxes and spending, and the GOP will refuse any and all tax increases, making a deal impossible; and (c) the GOP wants to privatize Social Security and Medicare rather than bring them into a healthy long-term financial situation, so not everyone is even on the same page.

However, people in (2) Team Barbell think that stimulus must be paired with long-term deficit reduction at the same time. For an example, there’s the original Domenici-Rivlin 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."

I assume when Kinsley references needing to eat spinach along with dessert as macroeconomic policy he’s referring to a need for both stimulus and deficit reduction to complement each other. Sadly for him, there’s never been a clear economic case for why these should be addressed together, and plenty of evidence that addressing the second will do little for the first.

(Noah Smith started a conversation recently about whether elites want a slower recovery in order to do structural reform. The original Domenici-Rivlin reform quoted above basically said, “We know unemployment is devastating, and we know more upfront stimulus will help. However, we are going to need you to turn Medicare into a giant Groupon system in order to get it.”)

These two approaches are very different than the arguments for (3) Team Austerity. The argument here is that, if done right, austerity will have a negligible effect on the economy and could even increase prosperity by restoring confidence to private capital. This is not a strawman; it’s the economic plan the GOP put forward when they took the House in 2011, which they got from AEI, which they got from Alberto Alesina and Silvia Ardagna of Harvard.

The 2011 GOP plan also noted, “Analyzing 20 developed countries between 1946 and 2009, Reinhart and Rogoff found a distinct threshold for gross government debt equal to 90 percent of GDP.” They believed action was needed to avoid crossing this threshold, even if it might be painful. (Thankfully, it wouldn’t be according this argument.)

No Pain, No Gain?

Kinsley’s misdiagnosis that the policy disagreements are all a matter of relative priorities then leads him to believe that more weight on short-term pain will lead to better long-term conclusions: “I don’t think suffering is good, but I do believe that we have to pay a price for past sins, and the longer we put it off, the higher the price will be...The problem is the great, deluded middle class—subsidized by government and coddled by politicians.”

This set the Internet on fire. I’m genuinely not sure what he’s referencing here when he mentions the middle-class. Is Kinsley at the point where he doesn’t get editors? I’m going to rewrite this for him: “During the 2000s, the middle class borrowed way too much, speculating on housing and using fake home equity to go on a spending spree. Now that this bubble has burst, the middle class needs to spend less and save more. There will be, yes, suffering, but they should have been saving more all along. Americans didn’t save enough, and now they have to save more and work off all the bad debts.”

And here’s how I would have responded to that better argument: “Yes, but two things. The first is that everyone can’t all save at the same time. If everyone is saving, nobody is spending, and we start to hit some major problems. Second, the bad debts to be worked off aren’t set in stone. If unemployment is higher, or wage growth slower, or inflation is under-target, that means the pile of bad debts is even greater. Since they are greater, people save more, and then there are even more problems. So even if you have a strongly moralistic tone about what needs to be done, or read this as a pox on our middle class, stimulus in the short term is crucial.”

Because austerity won’t even do the job Kinsley is proposing it will do. In 1933, John Maynard Keynes said, “You will never balance the Budget through measures which reduce the national income.” He argued this because he was a childless gay hedonist saw that austerity won’t even function to reduce the debt load, because a weaker GDP will eliminate any debt savings. This is precisely what is happening in Europe, and it could happen here if we suffocate the recovery too early.

 

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Beta: Universal Basic Income Calculator

May 14, 2013Mike Konczal

Click here to try a new Universal Basic Income calculator. You can click on which programs you'd like to turn into a UBI, and what taxes you'd be willing to put into motion, and it will tell you how large of a UBI can be supported with those resources. You can also type in your own numbers if you are interested.

Over the weekend I wrote a column for Wonkblog on why a Universal Basic Income would be a good idea. At the same time, Jesse Myerson and Alexis Goldstein discussed the topic in the first episode of their new podcast, Beyond the Pale. Matt Bruenig and Peter Frase discussed whether a UBI is Utopian, and have a fascinating exchange about the idea of a UBI and policy and strategy.

The calculator is in a beta-test mode, and it isn't nice looking, but it might be a useful exercise in how the numbers might actually work. I'll say that playing with the numbers makes me more sympathetic with Barbara Bergmann's point that a “fully developed welfare state deserves priority over Basic Income because it accomplishes what Basic Income does not: it guarantees that certain specific human needs will be met.” You have to jettison a lot of the welfare state, raise taxes a significant amount, or phase it out aggressive and remove the universal component, to get to numbers like $10,000. On the other hand, it isn't that hard to get to the $2,000-$3,000 range.

But I'm interested in what you think of it.

Follow or contact the Rortybomb blog:

  

 

Click here to try a new Universal Basic Income calculator. You can click on which programs you'd like to turn into a UBI, and what taxes you'd be willing to put into motion, and it will tell you how large of a UBI can be supported with those resources. You can also type in your own numbers if you are interested.

Over the weekend I wrote a column for Wonkblog on why a Universal Basic Income would be a good idea. At the same time, Jesse Myerson and Alexis Goldstein discussed the topic in the first episode of their new podcast, Beyond the Pale. Matt Bruenig and Peter Frase discussed whether a UBI is Utopian, and have a fascinating exchange about the idea of a UBI and policy and strategy.

The calculator is in a beta-test mode, and it isn't nice looking, but it might be a useful exercise in how the numbers might actually work. I'll say that playing with the numbers makes me more sympathetic to Barbara Bergmann's point that a “fully developed welfare state deserves priority over Basic Income because it accomplishes what Basic Income does not: it guarantees that certain specific human needs will be met.” You have to jettison a lot of the welfare state, raise taxes a significant amount, or phase it out aggressively and remove the universal component to get to numbers like $10,000. On the other hand, it isn't that hard to get to the $2,000-$3,000 range.

But I'm interested in what you think of it.

Follow or contact the Rortybomb blog:

  

 

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Liberal Wonk Blogging Could Be Your Life

May 9, 2013Mike Konczal

As the Reinhart-Rogoff story started up, Peter Frase of Jacobin wrote a critique of liberal wonk bloggers titled “The Perils of Wonkery.” Now that things have calmed down, I’m going to respond. Fair warning: this post will be a bit navel-gazing.

I recommend reading Peter’s post first, but to summarize, it makes two broad claims against liberal wonk bloggers. The first is the critique of the academic against the journalist. This doesn’t engage why wonk blogging has evolved or the role it plays. The second critique is the leftist against the technocratic liberal, which I find doesn’t acknowledge the actual ideological space created in wonk blogging. I find both of Frase’s arguments unpersuasive and also under-theorized. Let’s take them in order.

1. Liberal Wonks in Practice

Frase, a sociologist, locates the peril of wonkery in the fact that it needs to engage with academic research that often is more complicated than the writers have the ability to critically evaluate. “The function of the wonk is to translate the empirical findings of experts for the general public.” As such they are subject to a form of source capture, where they need to rely on the experts they are reporting on, as “they will necessarily have far less expertise than the people whose findings are being conveyed.”

We can generalize this critique as one that academics make of journalists all the time. Journalists don’t understand the subtlety of research and how it often functions as a discourse that changes over time. It’s a conversation on a very long time scale, rather than a race with winners and losers. They want dramatic headlines, conflicts, and cliffhangers, often over whether something is “good” or “bad” or other topics that make academics roll their eyes. Where researchers spend a lifetime on a handful of topics, reporters bounce from topic to topic, oftentimes in the course of a single day, made even worse through the “hamster wheel” of online blogs.

That’s a problem, as far as it goes. But bad journalism is easily countered by...good journalism. Source capture actually strikes me as one of the smaller problems wonk bloggers face. If journalists are worried that they are over-influenced by their source, they can just call another expert -- which is what Wonkblog did for the Reinhart/Rogoff studies. Wonk bloggers tend to focus on a group of related areas, and like any other journalist, they develop a list of the top researchers in any area to navigate complicated issues. They call people and ask questions.

It is true that in the wonk space, judgments on where the wonk’s self-declared expertise ends and where the line should be drawn on what is covered explicitly lie with the authors themselves. But this just makes explicit what is hidden in all of journalism, which is the problem of where to draw these lines.

It’s true that these debates take place within the context of existing policy research. A friend noted that Frase’s piece rests on a weird contradiction: it’s about how wonks don’t have enough expertise, but also how expertise is just a way of power and capital exerting itself and should be resisted. But that assumes that wonk blogging is just a replication of ruling ideology.

1.a What Creates Wonks?

We’ll talk about ideology more in a minute, but it’s surprising that Frase doesn’t even try to ground his analysis in the material base of institutions that create and fashion liberal writers. Frase seems to imply that the peril derives from personality-driven ladder-climbing, or to bask in the reflected glory of Serious People; he’s a step away from saying what wonks do is all about getting invited to cocktail parties.

But let’s try to provide that context for him. Why has “wonk” analysis risen in status within the “liberal” parts of the blogosphere, and what does that tell us about our current moment?

Contrasted with their counterparts on the right, young liberal writers come up through journalistic enterprises. That’s where they build their expertise, their approaches, their sensibilities, and their dispositions, even if they go on to other forms of opinion writing. Internships at The Nation, The American Prospect, or The New Republic are a common touchstone, with the Huffington Post, TPM, and Think Progress recently joining them. Though this work has an ideological basis, the work is journalism. Pride, at the end of the day, comes from breaking stories, working sources, building narratives, and giving a clear understanding of the scale and the scope of relevant actions. And part of that reporter fashioning will involve including all sides, and acting like more of a referee than an activist.

Where do young conservatives come from? They are built up as pundits, ideological writers, or as “analysts” or “experts” at conservative think-tanks. These conservatives then go out and populate the broader conservative infrastructure. As Helen Rittlemeyer notes, one reason conservative publications are declining in quality is because they are being filled with those who work at conservative think tanks (and are thus subsidized by the tax code and conservative movement money).

This is an important distinction when you see the numerous criticisms asking for wonky liberals to get more ideological. Bhaskar Sunkara argues that liberal wonks have a kind of “rigid simplicity” that is incapable of even understanding, much less challenging, the conservative ideology it is meant to counter. Conor Williams makes a similar argument, arguing that the “wonks’ focus on policy details blinds them to political realities.” In a fascinating essay comparing wonks to conspiracy theorists like Alex Jones, Jesse Elias Spafford writes in The New Inquiry that wonks “have risen to prominence because they come wrapped in the respectable neutrality of the scientist and have eschewed the partisan bias of the demagogue” and that, instead of agreed-upon facts, “our political discussions need to grapple with ideology and psychology, and with the underlying tendencies that draw people to particular ideologies.”

But just as there are numerous pleas for liberal writers to get more ideological, there are pleas on the right for more actual journalism. The post-election version of this was from Michael Calderone at Huffington Post, ”Conservative Media Struggles For Credibility. The hook was that everyone was excited because there was finally one genuinely good conservative congressional reporter in Robert Costa. Previous versions include Tucker Carlson getting boos at CPAC for saying, “The New York Times is a liberal newspaper. They go out, and they get the facts. Conservatives need to copy that.” Connor Friedersdorf issued a similar call back in 2008: “[a] political movement cannot survive on commentary and analysis alone! Were there only as talented a cadre of young right-leaning reporters dedicated to the journalistic project...the right must conclude that we’re better off joining the journalistic project than trying to discredit it.”

Meanwhile, the attempts by actual reporters (Tucker Carlson, Matthew Continetti) to build journalistic enterprises on the right (Daily Caller, Free Beacon) have collapsed into hackish parodies. The funders are wising up; the Koch Brothers are looking to just purchase newspapers wholesale rather than trying to build them out organically through the movement.

1.b Why Liberal Wonks?

Frase also makes no attempt to understand why wonk blogging has risen right now. And even a cursory glance at the historical moment makes it clear why wonk blogging has become important. From 2009-2010, several major pieces of legislation quickly came up for debate on core economic concerns: the ARRA stimulus and more general macroeconomic stabilization, health care reform, financial reform, immigration reform, unionization law, and carbon pricing.

Some passed, some didn’t. But all of these were complicated, evolved rapidly, and needed to be explained at a quick pace. Conventional journalism wasn’t up to the task, and wonks stepped up. As these reforms unfolded, often shifting week by week, there were important battles over how to understand the individual parts. There’s a passage from Alan Brinkley about businessmen asking, in 1940, if the “basic principle of the New Deal were economically sound?” Wonks had to answer the specific questions - is the public option important? - but also explain what parts were sound and why.

So I disagree with Spafford, who writes, “The startling rise of the wonk to political prominence has been buoyed in large part by the hope that the scientific objectivity of the technocrat might finally resolve political disagreement.“ The wonk rises more with the wave of liberal legislation of the 111th United States Congress, rather than the waves of centrist deficit reduction or conservative counter-mobilization.

It’s true that the right is more ideologically coherent and part of a “movement.” But it’s not clear to me that this is working well for them right now, or that liberals would be right to try a strategy of replication. Especially as I contest that wonk blogging doesn’t have an ideological edge.

2. Liberal Wonkery as Ideology

As an aside, here's Arthur Delaney's first wonk chart:

In Frase’s mind, wonkblogging is a “way of policing ideological boundaries and maintaining the illusion that the ruling ideology is merely bi-partisan common sense.” Wonk bloggers merely reproduce technocracy, performing the Very Serious Analysis that always comes back to a set of narrow concerns that coincide with ruling interests.

But is the background ideology of liberal bloggers a “ruling ideology” committed to the status quo? I don’t buy it. First off, just the act of writing about problems and potential policy solutions casts them as problems in need of a solution. Indeed, as many on the right have noted, a crucial feature of wonk blogging isn’t the creation of “solutions” to policy problem but the creation of “problems” in the first place.

Think of some of the things liberal wonk bloggers (at least in the economics space) focus on: unemployment; lack of access to quality, affordable health care; wages decoupled from productivity. These aren’t just put out there as crappy things that are happening. Wonks don’t focus on how there’s nothing good on television, or rain on your wedding day. And the problems they signal aren’t, usually, thought of as personal failings or requiring private, civic solutions. They are problems that the public needs a response for.

What does that amount to? If you link them together, they tell a story about how unemployment is a vicious problem we can counteract, that the shocks we face in life should be insured against, that markets fail or need to be revealed as constructed. And they don’t argue “just deserts” -- that some should be left behind, or that hierarchy and inequality are virtues in and of themselves -- and instead produce analyses in support of economic and social equality. Everyone should have access to a job, or health care, or a secure retirement.

In other words, they describe the core project of modern American liberalism. Keynesian economics, social insurance, the regulatory state and political equality: wonk blogging builds all of this brick by brick from the bottom-up. Signaling where reform needs to go is increasingly being viewed as the important role pundits and analysts carry out. And rather than derive them from ideology top-down, they’re built bottom-up as a series of problems to be solved.

Wonkiness-as-ideology has its downsides, of course. In line with Frase’s critique, wonky analysis makes virtues uncritically out of economic concepts like “choice” and “markets,” while having no language for “decommodification” or “workplace democracy.” They reflect the economic language of a neoliberal age. (Though if you are Ira Katznelson, you’d argue that this wonky, technocratic, public policy focus of liberalism was baked into the cake in the late 1940s.) There’s an element of liberalism that is focused on “how do we share the fruits of our economic prosperity” that hits a wall in an age of stagnation and austerity.

But I wouldn’t trade it for what the left seems to be offering. Indeed one of the better achievements of mid-century democratic socialism, Michael Harrington’s The Other America, was proto-wonk blogging. He identified problems. He consciously didn't mention ideology, knowing full well that stating the problem in the context of actually existing solutions would create the real politics. And if he had access to modern computing, Harrington certainly would have put a lot of charts in his book and posted them online.

Follow or contact the Rortybomb blog:

  

 

As the Reinhart-Rogoff story started up, Peter Frase of Jacobin wrote a critique of liberal wonk bloggers titled “The Perils of Wonkery.” Now that things have calmed down, I’m going to respond. Fair warning: this post will be a bit navel-gazing.

I recommend reading Peter’s post first, but to summarize, it makes two broad claims against liberal wonk bloggers. The first is the critique of the academic against the journalist. This doesn’t engage why wonk blogging has evolved or the role it plays. The second critique is the leftist against the technocratic liberal, which I find doesn’t acknowledge the actual ideological space created in wonk blogging. I find both of Frase’s arguments unpersuasive and also under-theorized. Let’s take them in order.

1. Liberal Wonks in Practice

Frase, a sociologist, locates the peril of wonkery in the fact that it needs to engage with academic research that often is more complicated than the writers have the ability to critically evaluate. “The function of the wonk is to translate the empirical findings of experts for the general public.” As such they are subject to a form of source capture, where they need to rely on the experts they are reporting on, as “they will necessarily have far less expertise than the people whose findings are being conveyed.”

We can generalize this critique as one that academics make of journalists all the time. Journalists don’t understand the subtlety of research and how it often functions as a discourse that changes over time. It’s a conversation on a very long time scale, rather than a race with winners and losers. They want dramatic headlines, conflicts, and cliffhangers, often over whether something is “good” or “bad” or other topics that make academics roll their eyes. Where researchers spend a lifetime on a handful of topics, reporters bounce from topic to topic, oftentimes in the course of a single day, made even worse through the “hamster wheel” of online blogs.

That’s a problem, as far as it goes. But bad journalism is easily countered by...good journalism. Source capture actually strikes me as one of the smaller problems wonk bloggers face. If journalists are worried that they are over-influenced by their source, they can just call another expert -- which is what Wonkblog did for the Reinhart/Rogoff studies. Wonk bloggers tend to focus on a group of related areas, and like any other journalist, they develop a list of the top researchers in any area to navigate complicated issues. They call people and ask questions.

It is true that in the wonk space, judgments on where the wonk’s self-declared expertise ends and where the line should be drawn on what is covered explicitly lie with the authors themselves. But this just makes explicit what is hidden in all of journalism, which is the problem of where to draw these lines.

It’s true that these debates take place within the context of existing policy research. A friend noted that Frase’s piece rests on a weird contradiction: it’s about how wonks don’t have enough expertise, but also how expertise is just a way of power and capital exerting itself and should be resisted. But that assumes that wonk blogging is just a replication of ruling ideology.

1.a What Creates Wonks?

We’ll talk about ideology more in a minute, but it’s surprising that Frase doesn’t even try to ground his analysis in the material base of institutions that create and fashion liberal writers. Frase seems to imply that the peril derives from personality-driven ladder-climbing, or to bask in the reflected glory of Serious People; he’s a step away from saying what wonks do is all about getting invited to cocktail parties.

But let’s try to provide that context for him. Why has “wonk” analysis risen in status within the “liberal” parts of the blogosphere, and what does that tell us about our current moment?

Contrasted with their counterparts on the right, young liberal writers come up through journalistic enterprises. That’s where they build their expertise, their approaches, their sensibilities, and their dispositions, even if they go on to other forms of opinion writing. Internships at The Nation, The American Prospect, or The New Republic are a common touchstone, with the Huffington Post, TPM, and Think Progress recently joining them. Though this work has an ideological basis, the work is journalism. Pride, at the end of the day, comes from breaking stories, working sources, building narratives, and giving a clear understanding of the scale and the scope of relevant actions. And part of that reporter fashioning will involve including all sides, and acting like more of a referee than an activist.

Where do young conservatives come from? They are built up as pundits, ideological writers, or as “analysts” or “experts” at conservative think-tanks. These conservatives then go out and populate the broader conservative infrastructure. As Helen Rittlemeyer notes, one reason conservative publications are declining in quality is because they are being filled with those who work at conservative think tanks (and are thus subsidized by the tax code and conservative movement money).

This is an important distinction when you see the numerous criticisms asking for wonky liberals to get more ideological. Bhaskar Sunkara argues that liberal wonks have a kind of “rigid simplicity” that is incapable of even understanding, much less challenging, the conservative ideology it is meant to counter. Conor Williams makes a similar argument, arguing that the “wonks’ focus on policy details blinds them to political realities.” In a fascinating essay comparing wonks to conspiracy theorists like Alex Jones, Jesse Elias Spafford writes in The New Inquiry that wonks “have risen to prominence because they come wrapped in the respectable neutrality of the scientist and have eschewed the partisan bias of the demagogue” and that, instead of agreed-upon facts, “our political discussions need to grapple with ideology and psychology, and with the underlying tendencies that draw people to particular ideologies.”

But just as there are numerous pleas for liberal writers to get more ideological, there are pleas on the right for more actual journalism. The post-election version of this was from Michael Calderone at Huffington Post, ”Conservative Media Struggles For Credibility. The hook was that everyone was excited because there was finally one genuinely good conservative congressional reporter in Robert Costa. Previous versions include Tucker Carlson getting boos at CPAC for saying, “The New York Times is a liberal newspaper. They go out, and they get the facts. Conservatives need to copy that.” Connor Friedersdorf issued a similar call back in 2008: “[a] political movement cannot survive on commentary and analysis alone! Were there only as talented a cadre of young right-leaning reporters dedicated to the journalistic project...the right must conclude that we’re better off joining the journalistic project than trying to discredit it.”

Meanwhile, the attempts by actual reporters (Tucker Carlson, Matthew Continetti) to build journalistic enterprises on the right (Daily Caller, Free Beacon) have collapsed into hackish parodies. The funders are wising up; the Koch Brothers are looking to just purchase newspapers wholesale rather than trying to build them out organically through the movement.

1.b Why Liberal Wonks?

Frase also makes no attempt to understand why wonk blogging has risen right now. And even a cursory glance at the historical moment makes it clear why wonk blogging has become important. From 2009-2010, several major pieces of legislation quickly came up for debate on core economic concerns: the ARRA stimulus and more general macroeconomic stabilization, health care reform, financial reform, immigration reform, unionization law, and carbon pricing.

Some passed, some didn’t. But all of these were complicated, evolved rapidly, and needed to be explained at a quick pace. Conventional journalism wasn’t up to the task, and wonks stepped up. As these reforms unfolded, often shifting week by week, there were important battles over how to understand the individual parts. There’s a passage from Alan Brinkley about businessmen asking, in 1940, if the “basic principle of the New Deal were economically sound?” Wonks had to answer the specific questions - is the public option important? - but also explain what parts were sound and why.

So I disagree with Spafford, who writes, “The startling rise of the wonk to political prominence has been buoyed in large part by the hope that the scientific objectivity of the technocrat might finally resolve political disagreement.“ The wonk rises more with the wave of liberal legislation of the 111th United States Congress, rather than the waves of centrist deficit reduction or conservative counter-mobilization.

It’s true that the right is more ideologically coherent and part of a “movement.” But it’s not clear to me that this is working well for them right now, or that liberals would be right to try a strategy of replication. Especially as I contest that wonk blogging doesn’t have an ideological edge.

2. Liberal Wonkery as Ideology

As an aside, here's Arthur Delaney's first wonk chart:

In Frase’s mind, wonkblogging is a “way of policing ideological boundaries and maintaining the illusion that the ruling ideology is merely bi-partisan common sense.” Wonk bloggers merely reproduce technocracy, performing the Very Serious Analysis that always comes back to a set of narrow concerns that coincide with ruling interests.

But is the background ideology of liberal bloggers a “ruling ideology” committed to the status quo? I don’t buy it. First off, just the act of writing about problems and potential policy solutions casts them as problems in need of a solution. Indeed, as many on the right have noted, a crucial feature of wonk blogging isn’t the creation of “solutions” to policy problem but the creation of “problems” in the first place.

Think of some of the things liberal wonk bloggers (at least in the economics space) focus on: unemployment; lack of access to quality, affordable health care; wages decoupled from productivity. These aren’t just put out there as crappy things that are happening. Wonks don’t focus on how there’s nothing good on television, or rain on your wedding day. And the problems they signal aren’t, usually, thought of as personal failings or requiring private, civic solutions. They are problems that the public needs a response for.

What does that amount to? If you link them together, they tell a story about how unemployment is a vicious problem we can counteract, that the shocks we face in life should be insured against, that markets fail or need to be revealed as constructed. And they don’t argue “just deserts” -- that some should be left behind, or that hierarchy and inequality are virtues in and of themselves -- and instead produce analyses in support of economic and social equality. Everyone should have access to a job, or health care, or a secure retirement.

In other words, they describe the core project of modern American liberalism. Keynesian economics, social insurance, the regulatory state and political equality: wonk blogging builds all of this brick by brick from the bottom-up. Signaling where reform needs to go is increasingly being viewed as the important role pundits and analysts carry out. And rather than derive them from ideology top-down, they’re built bottom-up as a series of problems to be solved.

Wonkiness-as-ideology has its downsides, of course. In line with Frase’s critique, wonky analysis makes virtues uncritically out of economic concepts like “choice” and “markets,” while having no language for “decommodification” or “workplace democracy.” They reflect the economic language of a neoliberal age. (Though if you are Ira Katznelson, you’d argue that this wonky, technocratic, public policy focus of liberalism was baked into the cake in the late 1940s.) There’s an element of liberalism that is focused on “how do we share the fruits of our economic prosperity” that hits a wall in an age of stagnation and austerity.

But I wouldn’t trade it for what the left seems to be offering. Indeed one of the better achievements of mid-century democratic socialism, Michael Harrington’s The Other America, was proto-wonk blogging. He identified problems. He consciously didn't mention ideology, knowing full well that stating the problem in the context of actually existing solutions would create the real politics. And if he had access to modern computing, Harrington certainly would have put a lot of charts in his book and posted them online.

Follow or contact the Rortybomb blog:

  

 

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What Would the "Financial Instability" Argument Look Like For Any Other Industry?

May 7, 2013Mike Konczal

It’s becoming a surprisingly influential argument given that it hasn’t been well presented or argued, much less vetted and challenged. What is it? The argument that we should raise interest rates or otherwise contract monetary policy in order to preserve “financial stability.”

Brad Delong says critiquing this idea is “PRIORITY #1 RED FLAG OMEGA,” while Nick Rowe argues that this idea “may be influential. And that idea is horribly wrong.”

Here’s one version of the argument, from a recent speech by Narayana Kocherlakota:

“On the one hand, raising the real interest rate will definitely lead to lower employment and prices. On the other hand, raising the real interest rate may reduce the risk of a financial crisis—a crisis which could give rise to a much larger fall in employment and prices. Thus, the Committee has to weigh the certainty of a costly deviation from its dual mandate objectives against the benefit of reducing the probability of an even larger deviation from those objectives.”

Tim Duy and Ryan Avent commented on this speech, which essentially argued that that raising rates would certainly cause a problem, but rates at their current value could cause even bigger problems.

Let’s be clear on the terms: should we risk another immediate recession (“lower employment and prices”) to preserve a thing called “financial stability?” Five immediate problems jump out from this argument. Nick Rowe emphasized tackling this on an abstract level; I’m going to focus on practical stuff.

1. This whole story seems predicated on the idea that expansionary monetary policy was behind the housing bubble and collapse. I think there’s very little hard evidence for that. Also, the basic stories surrounding interest rates, as JW Mason mentioned in a guest post here, being too low for too long have some serious contradictions. (For instance, if the problem is a “global savings glut,” expansionary monetary policy should push against that by reducing capital inflows.) So if the idea is to risk another recession in order to not repeat the 2000s, we should work with a clearer story about what went wrong in the housing bubble.

2. The term “reaching for yield” is often deployed in these arguments. Low rates means that traders have to take on bigger risks in order to earn a rate of return that is acceptable. (Is there a minimum level of profit that finance must make on lending? And should we throw people out of work to make sure they make it? I hadn’t heard of that, but sounds like a nice gig.)

But either way, it isn’t clear that low rates drive reaching for yield. Yields are the difference between lending and funding rates. And as JW Mason again writes in an important post, banks’ funding costs are also affected by the policy rate. “Looking at the most recent cycle, the decline in the Fed Funds rate from around 5 percent in 2006-2007 to the zero of today has been associated with a 2.5 point fall in bank funding costs but only a 1.5 point fall in bank lending rates -- in other words, a one point increase in spreads.” If anything, the story is the opposite of what people are arguing.

3. The best empirical evidence at understanding the “reach for yield” phenomenon I’ve seen comes from Bo Becker and Victoria Ivashina from Harvard University, “Reaching for Yield in the Bond Market.” Here’s a Voxeu summary, and here’s the research pdf. They look at holdings of insurance companies, and find that, “conditional on credit ratings, insurance portfolios are systematically biased toward higher yield, higher CDS bonds...It is also more pronounced for firms with poor corporate governance and for which regulatory capital requirement is more binding.”

This comes across as portfolio managers juking and manipulating capital requirements and the ratings agencies. The authors note that this is a major agency problem for insurance agencies. It was the strongest at the peak of the cycle, but went away during the recession.

Now if I told you we should keep the economy in a permanent recession because senior managers at insurance companies aren’t good at their basic job of monitoring mid-level portfolio managers you’d probably think I was crazy. And I would be. Especially since it seems that “reach for yield” is tied less to monetary policy and more to gaming ratings-based capital requirements.

4. If this is a serious problem, people should be talking about more serious forms of financial regulation. As a starter platform, we can raise capital requirements. Much of this “reach for yield” looks to be a regulatory arbitrage on ratings-based capital requirements, so, say, tripling the leverage requirement should net out the importance of the ratings agencies in capital requirements.

This is why a more coherent story about what we are concerned about when we think about “financial stability” would help. If we need to make the financial system less complex and prone to abusive practices, requiring parties of a derivatives contract to hold a stake in the underlying asset would do a lot. Are we worried about contagion? In that case, force banks to hold more capital as well as convertible instruments. About bad debts holding back the economy? Then reform the bankruptcy code, dropping the 2005 “reforms.” Some people are demanding more jail sentences, not only for the benefit of the public but for boards and shareholders who can’t keep their workers in line.

5. Because imagine this argument in the context of any other industry. Right now the interest rate is above where it needs to be to guarantee full employment. People are arguing that we should raise rates because banks might make loans, even though that is what the financial sector is supposed to do. (As Daniel Davies notes, “If the Federal Reserve sets out on a policy of lowering interest rates in order to encourage banks to make loans to the real economy, it is a bit weird for someone's main critique of the policy to be that it is encouraging banks to make loans.”)

Now imagine the government was going to take some land it owns containing oil and sell it to an oil company. Could you imagine someone saying, “We shouldn’t do this, because we can’t assume that oil companies are capable of drilling, refining and selling that oil” as a valid concern? Not concerns about random spills or global warming? But instead expressing concerns about whether the industry is capable of executing its most basic function.

Or take immigration. Imagine if a common response to letting a large number of high-skilled immigrants into the country would be “but we can’t assume that the labor market is capable of matching people with skills who want to work with employers who are willing to pay to complete jobs.” It’s tantamount to saying, “we shouldn’t assume that the labor market can do its basic function.”

It’s hard not to read the financial stability arguments as saying “look, we can’t trust the financial sector to accomplish its most basic goals.” If true, that’s a very significant problem that should cause everyone a lot of concern. It should make us ask why we even have a financial system if we can’t expect it to function, or function only by putting the entire economy at risk.

Follow or contact the Rortybomb blog:

  

 

It’s becoming a surprisingly influential argument given that it hasn’t been well presented or argued, much less vetted and challenged. What is it? The argument that we should raise interest rates or otherwise contract monetary policy in order to preserve “financial stability.”

Brad Delong says critiquing this idea is “PRIORITY #1 RED FLAG OMEGA,” while Nick Rowe argues that this idea “may be influential. And that idea is horribly wrong.”

Here’s one version of the argument, from a recent speech by Narayana Kocherlakota:

“On the one hand, raising the real interest rate will definitely lead to lower employment and prices. On the other hand, raising the real interest rate may reduce the risk of a financial crisis—a crisis which could give rise to a much larger fall in employment and prices. Thus, the Committee has to weigh the certainty of a costly deviation from its dual mandate objectives against the benefit of reducing the probability of an even larger deviation from those objectives.”

Tim Duy and Ryan Avent commented on this speech, which essentially argued that that raising rates would certainly cause a problem, but rates at their current value could cause even bigger problems.

Let’s be clear on the terms: should we risk another immediate recession (“lower employment and prices”) to preserve a thing called “financial stability?” Five immediate problems jump out from this argument. Nick Rowe emphasized tackling this on an abstract level; I’m going to focus on practical stuff.

1. This whole story seems predicated on the idea that expansionary monetary policy was behind the housing bubble and collapse. I think there’s very little hard evidence for that. Also, the basic stories surrounding interest rates, as JW Mason mentioned in a guest post here, being too low for too long have some serious contradictions. (For instance, if the problem is a “global savings glut,” expansionary monetary policy should push against that by reducing capital inflows.) So if the idea is to risk another recession in order to not repeat the 2000s, we should work with a clearer story about what went wrong in the housing bubble.

2. The term “reaching for yield” is often deployed in these arguments. Low rates means that traders have to take on bigger risks in order to earn a rate of return that is acceptable. (Is there a minimum level of profit that finance must make on lending? And should we throw people out of work to make sure they make it? I hadn’t heard of that, but sounds like a nice gig.)

But either way, it isn’t clear that low rates drive reaching for yield. Yields are the difference between lending and funding rates. And as JW Mason again writes in an important post, banks’ funding costs are also affected by the policy rate. “Looking at the most recent cycle, the decline in the Fed Funds rate from around 5 percent in 2006-2007 to the zero of today has been associated with a 2.5 point fall in bank funding costs but only a 1.5 point fall in bank lending rates -- in other words, a one point increase in spreads.” If anything, the story is the opposite of what people are arguing.

3. The best empirical evidence at understanding the “reach for yield” phenomenon I’ve seen comes from Bo Becker and Victoria Ivashina from Harvard University, “Reaching for Yield in the Bond Market.” Here’s a Voxeu summary, and here’s the research pdf. They look at holdings of insurance companies, and find that, “conditional on credit ratings, insurance portfolios are systematically biased toward higher yield, higher CDS bonds...It is also more pronounced for firms with poor corporate governance and for which regulatory capital requirement is more binding.”

This comes across as portfolio managers juking and manipulating capital requirements and the ratings agencies. The authors note that this is a major agency problem for insurance agencies. It was the strongest at the peak of the cycle, but went away during the recession.

Now if I told you we should keep the economy in a permanent recession because senior managers at insurance companies aren’t good at their basic job of monitoring mid-level portfolio managers you’d probably think I was crazy. And I would be. Especially since it seems that “reach for yield” is tied less to monetary policy and more to gaming ratings-based capital requirements.

4. If this is a serious problem, people should be talking about more serious forms of financial regulation. As a starter platform, we can raise capital requirements. Much of this “reach for yield” looks to be a regulatory arbitrage on ratings-based capital requirements, so, say, tripling the leverage requirement should net out the importance of the ratings agencies in capital requirements.

This is why a more coherent story about what we are concerned about when we think about “financial stability” would help. If we need to make the financial system less complex and prone to abusive practices, requiring parties of a derivatives contract to hold a stake in the underlying asset would do a lot. Are we worried about contagion? In that case, force banks to hold more capital as well as convertible instruments. About bad debts holding back the economy? Then reform the bankruptcy code, dropping the 2005 “reforms.” Some people are demanding more jail sentences, not only for the benefit of the public but for boards and shareholders who can’t keep their workers in line.

5. Because imagine this argument in the context of any other industry. Right now the interest rate is above where it needs to be to guarantee full employment. People are arguing that we should raise rates because banks might make loans, even though that is what the financial sector is supposed to do. (As Daniel Davies notes, “If the Federal Reserve sets out on a policy of lowering interest rates in order to encourage banks to make loans to the real economy, it is a bit weird for someone's main critique of the policy to be that it is encouraging banks to make loans.”)

Now imagine the government was going to take some land it owns containing oil and sell it to an oil company. Could you imagine someone saying, “We shouldn’t do this, because we can’t assume that oil companies are capable of drilling, refining and selling that oil” as a valid concern? Not concerns about random spills or global warming? But instead expressing concerns about whether the industry is capable of executing its most basic function.

Or take immigration. Imagine if a common response to letting a large number of high-skilled immigrants into the country would be “but we can’t assume that the labor market is capable of matching people with skills who want to work with employers who are willing to pay to complete jobs.” It’s tantamount to saying, “we shouldn’t assume that the labor market can do its basic function.”

It’s hard not to read the financial stability arguments as saying “look, we can’t trust the financial sector to accomplish its most basic goals.” If true, that’s a very significant problem that should cause everyone a lot of concern. It should make us ask why we even have a financial system if we can’t expect it to function, or function only by putting the entire economy at risk.

Follow or contact the Rortybomb blog:

  

 

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Monetary Policy's Jurassic Park Problem at the Zero Lower Bound

May 3, 2013Mike Konczal

Remember those scenes in Jurassic Park where everyone has to stand really still? The T-Rex finds the humans, but its dinosaur brain only senses movements, so as long as nobody moves an inch, they are safe. But if they even twitch, they are going to be ripped to shreds. Those scenes are great.

Last weekend, I wrote a piece for Wonkblog on monetary policy at the zero lower bound alongside austerity that got a great number of responses [1]. I want to respond to two points.

1. One thing I wanted to engage on, and a point I hope gets some additional comments in 2013, is that we had a major shift in “expectations” management at the zero lower bound with the Evans Rule. I think that this form of expectation management is a trial run for more serious moves like using a higher inflation target or a nominal GDP target to gain traction at the zero lower bound. So how has it gone, and how would we know?

I had thought a good measure of its success was whether short-term inflation would approach its 2 percent target, and whether or not it would go past. Other people, notably Matt O’Brien, had already flagged that 2 percent appeared to be a ceiling even with the Evans Rule in place.

Some seem to be abandoning the Evans framework entirely, such as Ryan Avent writing this week that “the Evans rule is consistent with prolonged, Japanese style stagnation.” [2] Others argue that a consistent nominal GDP with austerity is sufficient evidence to show that the Evans Rule worked.

I think this needs more exploration. We don’t often get a serious shift in expectations. That’s why I’m not sure how much the “gas pedal” from David Becksworth’s response is at play. Becksworth notes that the purchases in QE3 don’t automatically react to turbulence in the economy, and hopes that the Federal Reserve will buy more if the economy gets weaker. But if the expectations of where the Fed wants to end up are the real limiting factor for a robust recovery, why would a small change in purchases matter? This is partially why Greg Ip said the FOMC statement this week was “asymmetric,” even though the Fed said it might “increase or reduce” purchases: an increase is a small move, but a reduction is a genuine retrenchment.

2. Another point is that expectations are important. I want to push back on Ryan Avent implying I “knew what conclusions were going to be drawn before the experiment was ever run.” I actually turned more negative about the December announcement while researching the post. I spoke to several economists who supported the Evans Rule at the time to see where they stood months later. I heard from many that they were excited about the proposal at first, but that they thought the policy was undermined significantly by FOMC members’ comments in March.

What happened in March? As the Washington Post’s Ylan Q. Mui wrote in March, the Fed seemed split into two camps: “Hawks, who want to curtail quantitative easing programs because of the risks they create. And doves, who see evidence that they’re working well enough at stimulating growth that they might soon no longer be needed.” The Fed’s March minutes noted “that continued solid improvement in the outlook for the labor market could prompt the Committee to slow the pace of purchases beginning at some point over the next several meetings." Several economists I spoke with thought that this hurt the expansionary impact of monetary policy.

Watch this again in slow-motion: Aggressive monetary policy begins to expand the economy, or at least gives the impression the economy is expanding. Central bankers argue that this means that they can pull back quicker than expected. (They don’t pull back; they just say they will.) The expectations for future policy then collapse, because central bankers signal that it will end too soon. The economy then weakens, going back to where it started.

This is monetary policy in the style of those T-Rex scenes in Jurassic Park. The central bank says, “we are committing to extraordinary action,” and then everyone has to remain incredibly still for a long time. Just a random dovish member of the FOMC saying, “hey, maybe it’s working so well we should consider ending it early” is enough for dinosaurs to eat everyone the policy’s effectiveness in impacting expectations to collapse.

If you believe this is a serious problem for monetary policy, well, this is precisely the time inconsistency problem Krugman identified in the late 1990s for Japan. The neutrality of money will cause an expansion to push up either prices or output, provided markets believe that it is permanent and that the central bank won’t immediately rush to stabilize prices the moment it gets a chance. And if the comments in March show that central banks aren’t going to “credibly promise to be irresponsible” with the Evans Rule, how will they do it with 4 percent inflation?

Note that four months after the stimulus was passed, no Democrats would stand up and defend it. Yet the stimulus was carried out without a problem. Four months after the Evans Rule, it looked like Bernanke’s coalition was weakening, and that has major implications. The Wonkblog piece I wrote notes that the next step will have to be an explicit, permanent, new target. That would get around these issues about how permanent the monetary expansion will be. But if there’s barely enough support for the Evans Rule, it makes me worried we won’t get there anytime soon.

[1] Responses include: Scott Sumner, Matt Yglesias, Paul Krugman, Reihan Salam, Ryan Avent, David Becksworth, Uneasy Money, Ramesh Ponnuru, southofthe49th, as well as a communist anarchist critique at pogoprinciple which notes that my “post-Fordist national fascist state fiscal policy” is exhausted. And that while “Keynesians are playing checkers, the monetarists are playing three dimensional chess.” Hmmm.

[2] If the Evans Rule was a bust from the get-go, was all that 2012 energy put into trying to find clever ways of explaining “Delphic” versus “Odyssean” guidance language to a general audience a waste of time? Boo.

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Remember those scenes in Jurassic Park where everyone has to stand really still? The T-Rex finds the humans, but its dinosaur brain only senses movements, so as long as nobody moves an inch, they are safe. But if they even twitch, they are going to be ripped to shreds. Those scenes are great.

Last weekend, I wrote a piece for Wonkblog on monetary policy at the zero lower bound alongside austerity that got a great number of responses [1]. I want to respond to two points.

1. One thing I wanted to engage on, and a point I hope gets some additional comments in 2013, is that we had a major shift in “expectations” management at the zero lower bound with the Evans Rule. I think that this form of expectation management is a trial run for more serious moves like using a higher inflation target or a nominal GDP target to gain traction at the zero lower bound. So how has it gone, and how would we know?

I had thought a good measure of its success was whether short-term inflation would approach its 2 percent target, and whether or not it would go past. Other people, notably Matt O’Brien, had already flagged that 2 percent appeared to be a ceiling even with the Evans Rule in place.

Some seem to be abandoning the Evans framework entirely, such as Ryan Avent writing this week that “the Evans rule is consistent with prolonged, Japanese style stagnation.” [2] Others argue that a consistent nominal GDP with austerity is sufficient evidence to show that the Evans Rule worked.

I think this needs more exploration. We don’t often get a serious shift in expectations. That’s why I’m not sure how much the “gas pedal” from David Becksworth’s response is at play. Becksworth notes that the purchases in QE3 don’t automatically react to turbulence in the economy, and hopes that the Federal Reserve will buy more if the economy gets weaker. But if the expectations of where the Fed wants to end up are the real limiting factor for a robust recovery, why would a small change in purchases matter? This is partially why Greg Ip said the FOMC statement this week was “asymmetric,” even though the Fed said it might “increase or reduce” purchases: an increase is a small move, but a reduction is a genuine retrenchment.

2. Another point is that expectations are important. I want to push back on Ryan Avent implying I “knew what conclusions were going to be drawn before the experiment was ever run.” I actually turned more negative about the December announcement while researching the post. I spoke to several economists who supported the Evans Rule at the time to see where they stood months later. I heard from many that they were excited about the proposal at first, but that they thought the policy was undermined significantly by FOMC members’ comments in March.

What happened in March? As the Washington Post’s Ylan Q. Mui wrote in March, the Fed seemed split into two camps: “Hawks, who want to curtail quantitative easing programs because of the risks they create. And doves, who see evidence that they’re working well enough at stimulating growth that they might soon no longer be needed.” The Fed’s March minutes noted “that continued solid improvement in the outlook for the labor market could prompt the Committee to slow the pace of purchases beginning at some point over the next several meetings." Several economists I spoke with thought that this hurt the expansionary impact of monetary policy.

Watch this again in slow-motion: Aggressive monetary policy begins to expand the economy, or at least gives the impression the economy is expanding. Central bankers argue that this means that they can pull back quicker than expected. (They don’t pull back; they just say they will.) The expectations for future policy then collapse, because central bankers signal that it will end too soon. The economy then weakens, going back to where it started.

This is monetary policy in the style of those T-Rex scenes in Jurassic Park. The central bank says, “we are committing to extraordinary action,” and then everyone has to remain incredibly still for a long time. Just a random dovish member of the FOMC saying, “hey, maybe it’s working so well we should consider ending it early” is enough for dinosaurs to eat everyone the policy’s effectiveness in impacting expectations to collapse.

If you believe this is a serious problem for monetary policy, well, this is precisely the time inconsistency problem Krugman identified in the late 1990s for Japan. The neutrality of money will cause an expansion to push up either prices or output, provided markets believe that it is permanent and that the central bank won’t immediately rush to stabilize prices the moment it gets a chance. And if the comments in March show that central banks aren’t going to “credibly promise to be irresponsible” with the Evans Rule, how will they do it with 4 percent inflation?

Note that four months after the stimulus was passed, no Democrats would stand up and defend it. Yet the stimulus was carried out without a problem. Four months after the Evans Rule, it looked like Bernanke’s coalition was weakening, and that has major implications. The Wonkblog piece I wrote notes that the next step will have to be an explicit, permanent, new target. That would get around these issues about how permanent the monetary expansion will be. But if there’s barely enough support for the Evans Rule, it makes me worried we won’t get there anytime soon.

[1] Responses include: Scott Sumner, Matt Yglesias, Paul Krugman, Reihan Salam, Ryan Avent, David Becksworth, Uneasy Money, Ramesh Ponnuru, southofthe49th, as well as a communist anarchist critique at pogoprinciple which notes that my “post-Fordist national fascist state fiscal policy” is exhausted. And that while “Keynesians are playing checkers, the monetarists are playing three dimensional chess.” Hmmm.

[2] If the Evans Rule was a bust from the get-go, was all that 2012 energy put into trying to find clever ways of explaining “Delphic” versus “Odyssean” guidance language to a general audience a waste of time? Boo.

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Reinhart-Rogoff a Week Later: Why Does This Matter?

Apr 24, 2013Mike Konczal

Retreat!

Well this is progress. We are seeing distancing by conservative writers on the Reinhart/Rogoff thesis. In Feburary, Douglas Holtz-Eakin wrote, “The debt hurts the economy already. The canonical work of Carmen Reinhart and Kenneth Rogoff and its successors carry a clear message: countries that have gross government debt in excess of 90% of Gross Domestic Product (GDP) are in the debt danger zone. Entering the zone means slower economic growth. Granted, the research is not yet robust enough to say exactly when and how a crisis will engulf the US, but there is no reason to believe that America is somehow immune." (h/t QZ.)

Today, Holtz-Eakin writes about Reinhart and Rogoff in National Review, but drops the "canonical" status. Now they are just two random people with some common sense the left is beating up. "In order to distract from the dismal state of analytic and actual economic affairs, the latest tactic is to blame...two researchers, Carmen Reinhardt and Kenneth Rogoff, who made the reasonable observation that ever-larger amounts of debt must eventually be associated with bad economic news."

That's not actually what they said, and if you read Holtz-Eakin in February Reinhart-Rogoff is sufficient evidence to enact the specific plans he wants. Now there's no defense of the "danger zone" argument; just the idea that the stimulus failed. Retreat!

This is getting a bigger audience. (If you haven't seen The Colbert Report on the Reinhart/Rogoff issue, it's fantastic.) But going foward, plan beats no plan. And a critique isn't a plan. So what should we conclude about Reinhart-Rogoff a week later, now that the critique seems to have won? How should the government approach the debt?

Cliffs and Tradeoffs

One thing about the "cliff" metaphor is that there's no tradeoff that would make it acceptable. If you are driving, there are all kinds of tradeoffs you make with your route, but you'd never agree to a tradeoff that has you driving off a cliff. There were numerous other ways of describing this scenario, either the technical "nonlinearities" or the "danger zone" of Eakin just a few months ago.

With the danger zone metaphor now out of play, perhaps economists can see the relevant tradeoffs more clearly. Reinhart-Rogoff stand with a small negative relationship between debt and growth, one that is likely driven by low growth rather than high debt. And despite what you've heard, there's no literature that shows the casuation in the other direction.

But let's say they found it. Well, what's the relevant tradeoff? If there's even a basic fiscal multipler at work, the upside more than compensates for the downside. As Brad DeLong notes, if you consider a multipler of 1.5 and a marginal tax share of 1/3, the small correlation people are finding - Delong uses 0.006 percent from an in-house estimate - are more than canceled. Spending 2 percent more causes a bump of 3 percent of GDP, while debt goes up 1 percent of GDP. As Delong notes, "3% higher GDP this year and slower growth that leads to GDP lower by 0.06% in a decade. And this is supposed to be an argument against expansionary fiscal policy right now?"

And as the IMF noted recently, "Studies suggest that fiscal multipliers are currently high in many advanced economies. One important implication is that fiscal tightening could raise the debt ratio in the short term, as fiscal gains are partly wiped out by the decline in output." Now is the time to move away from austerity and towards more expansion. There are costs (though debt servicing is at a historic low), but the benefits outweight them.
 
Right now people are debating what level of debt-to-GDP we should level out at and how quickly that debt should begin to come down. There's also the debt ceiling battle coming at the end of the summer. This new information will influence all these conversations.
 
Was it Important?
 
Meanwhile, Ryan Avent at The Economist's Free Exchange writes about Reinhart-Rogoff here. To address one of his points, Avent also thinks that the Reinhart-Rogoff cliff results are overplayed as something that actually impacted policy. This is always a tricky question to answer, but Reinhart-Rogoff certainly dominated the sensible, mainstream conversation over the deficit and was a favorite go-to for conservatives in particular. I also think it was popular among journalists, because it was a straight-line number that was supposed to not require complicated modelng. Media Matters put together this video of people discussing the Reinhart-Rogoff cutoff:

(Bonus fun: in the video, at the 1m20s, Niall Ferguson refers to the 90 percent result as "the law of finance.")

I think the ideas matter. (Why else would we do this?) I think it's important to understand this revelation in light of other players moving against austerity, including both the IMF and the financial industry. As people reposition themselves, understanding that one of the core old ideas is now out of play allows a different reconfiguration of power. Also, it's worth repeating, it's becoming harder to pretend that austerity hasn't failed. It didn't even do the actual goal, which was reduce the debt-to-GDP ratios of the countries that were being targeted.

Citizens across the world who were normally indifferent are realizing that they were sold a bad bag of goods when it came to austerity and belt-tightening. They are now trying to figure out what happened, and how things could be done differently. As these are such critical issues, this examination is important. It's great we are having it.

Follow or contact the Rortybomb blog:

  

 

Retreat!

Well this is progress. We are seeing distancing by conservative writers on the Reinhart/Rogoff thesis. In Feburary, Douglas Holtz-Eakin wrote, “The debt hurts the economy already. The canonical work of Carmen Reinhart and Kenneth Rogoff and its successors carry a clear message: countries that have gross government debt in excess of 90% of Gross Domestic Product (GDP) are in the debt danger zone. Entering the zone means slower economic growth. Granted, the research is not yet robust enough to say exactly when and how a crisis will engulf the US, but there is no reason to believe that America is somehow immune." (h/t QZ.)

Today, Holtz-Eakin writes about Reinhart and Rogoff in National Review, but drops the "canonical" status. Now they are just two random people with some common sense the left is beating up. "In order to distract from the dismal state of analytic and actual economic affairs, the latest tactic is to blame...two researchers, Carmen Reinhardt and Kenneth Rogoff, who made the reasonable observation that ever-larger amounts of debt must eventually be associated with bad economic news."

That's not actually what they said, and if you read Holtz-Eakin in February Reinhart-Rogoff is sufficient evidence to enact the specific plans he wants. Now there's no defense of the "danger zone" argument; just the idea that the stimulus failed. Retreat!

This is getting a bigger audience. (If you haven't seen The Colbert Report on the Reinhart/Rogoff issue, it's fantastic.) But going foward, plan beats no plan. And a critique isn't a plan. So what should we conclude about Reinhart-Rogoff a week later, now that the critique seems to have won? How should the government approach the debt?

Cliffs and Tradeoffs

One thing about the "cliff" metaphor is that there's no tradeoff that would make it acceptable. If you are driving, there are all kinds of tradeoffs you make with your route, but you'd never agree to a tradeoff that has you driving off a cliff. There were numerous other ways of describing this scenario, either the technical "nonlinearities" or the "danger zone" of Eakin just a few months ago.

With the danger zone metaphor now out of play, perhaps economists can see the relevant tradeoffs more clearly. Reinhart-Rogoff stand with a small negative relationship between debt and growth, one that is likely driven by low growth rather than high debt. And despite what you've heard, there's no literature that shows the casuation in the other direction.

But let's say they found it. Well, what's the relevant tradeoff? If there's even a basic fiscal multipler at work, the upside more than compensates for the downside. As Brad DeLong notes, if you consider a multipler of 1.5 and a marginal tax share of 1/3, the small correlation people are finding - Delong uses 0.006 percent from an in-house estimate - are more than canceled. Spending 2 percent more causes a bump of 3 percent of GDP, while debt goes up 1 percent of GDP. As Delong notes, "3% higher GDP this year and slower growth that leads to GDP lower by 0.06% in a decade. And this is supposed to be an argument against expansionary fiscal policy right now?"

And as the IMF noted recently, "Studies suggest that fiscal multipliers are currently high in many advanced economies. One important implication is that fiscal tightening could raise the debt ratio in the short term, as fiscal gains are partly wiped out by the decline in output." Now is the time to move away from austerity and towards more expansion. There are costs (though debt servicing is at a historic low), but the benefits outweight them.
 
Right now people are debating what level of debt-to-GDP we should level out at and how quickly that debt should begin to come down. There's also the debt ceiling battle coming at the end of the summer. This new information will influence all these conversations.
 
Was it Important?
 
Meanwhile, Ryan Avent at The Economist's Free Exchange writes about Reinhart-Rogoff here. To address one of his points, Avent also thinks that the Reinhart-Rogoff cliff results are overplayed as something that actually impacted policy. This is always a tricky question to answer, but Reinhart-Rogoff certainly dominated the sensible, mainstream conversation over the deficit and was a favorite go-to for conservatives in particular. I also think it was popular among journalists, because it was a straight-line number that was supposed to not require complicated modelng. Media Matters put together this video of people discussing the Reinhart-Rogoff cutoff:

(Bonus fun: in the video, at the 1m20s, Niall Ferguson refers to the 90 percent result as "the law of finance.")

I think the ideas matter. (Why else would we do this?) I think it's important to understand this revelation in light of other players moving against austerity, including both the IMF and the financial industry. As people reposition themselves, understanding that one of the core old ideas is now out of play allows a different reconfiguration of power. Also, it's worth repeating, it's becoming harder to pretend that austerity hasn't failed. It didn't even do the actual goal, which was reduce the debt-to-GDP ratios of the countries that were being targeted.

Citizens across the world who were normally indifferent are realizing that they were sold a bad bag of goods when it came to austerity and belt-tightening. They are now trying to figure out what happened, and how things could be done differently. As these are such critical issues, this examination is important. It's great we are having it.

Follow or contact the Rortybomb blog:

  

 

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What's the Best Way to Help the Long-Term Unemployed? Full Employment.

Apr 24, 2013Mike Konczal

What's the best way to help the long-term unemployed? There's new concern about how difficult it is for the long-term unemployed to find jobs in light of an interesting study by Rand Ghayad, a visiting scholar at the Boston Fed and PhD candidate. Ghayad sent out resumes that were identical except for how long the candidate was unemployed, and the longer they were unemployed, the less likely it was they would get called back. Matthew O'Brien has a great writeup of the study here, and there's additional thoughts from Megan McArdle, Paul Krugman, Felix Salmon, and Matt Yglesias.

The impact of long-term unemployment on human lives is very real, and I think the government should be combating it using every tool it has. However, I want to push back on a few of the economic ideas that tend to hover in the background of these discussions; specifically, the idea that we should consider the long-term unemployed uniquely in trouble in this economy. Because, based on my interpretation of the evidence, the best approach to handling this problem is to aim for full employment.

It's well known that it is harder for those who have been out of the labor force the longest to find jobs. It would be weird if Ghayad hadn't found that result. There is a large debate in the literature about whether this is driven by employers or job candidates, and Ghayad provides a very useful study finding that employers are a key part here.

But let's look at the likelihood of finding a job in three different economic scenarios (2000, 2007, and 2012) by duration of unemployment:

But notice that when the economy is much stronger, as it was in 2000 when unemployment averaged 4 percent, the rate at which the long-term unemployed find jobs jumps up. Let's zoom in on the last category, the job-finding rate of those who have been searching for a job for 53 weeks or longer, and chart it back to 1995. (Since the data, provided by the BLS, is not seasonally adjusted, the number here is a 12-month rolling average.)

As you can see, it's much easier for the long-term unemployed to find jobs when there's a tight labor market, like there was in the late 1990s. This rate collapses in a recession, and with years of 7+ percent unemployment, it has stayed depressed.

A lot of people are drawing conclusions that something has broken in long-term unemployment based on a previous paper by Rand Ghayad, where he disaggregates the Beveridge Curve by unemployment duration. I've been critical of that paper. I think, strictly speaking, that the disaggregation just tells us that the long-term unemployed have become a larger percentage of the unemployed, which we knew. Meanwhile, the labor market is depressed for everyone, even short-term unemployed (also see SF Fed for more evidence of this). As the long-term unemployed are less likely to drop out of the labor market than in normal times right now, the dramatic increase in the long-term unemployed hasn't turned into a large drop in labor force participation like many worry about.

We should do things that are smart policies that target the long-term unemployed. Amy Taub of Demos has done convincing work on why ending credit checks as part of the job interview process would be a good idea. Extending unemployment insurance is also important. But the idea that we should change course away from boosting the general economy strikes me as a bad idea. The long-term unemployed experience the worst impact of a generally weak economy. But its that weak economy that is doing the damage. If unemployment was actually brought down, which we could do with more expansonary policy, then employers couldn't afford to be so choosy.

Follow or contact the Rortybomb blog:

  

 

What's the best way to help the long-term unemployed? There's new concern about how difficult it is for the long-term unemployed to find jobs in light of an interesting study by Rand Ghayad, a visiting scholar at the Boston Fed and PhD candidate. Ghayad sent out resumes that were identical except for how long the candidate was unemployed, and the longer they were unemployed, the less likely it was they would get called back. Matthew O'Brien has a great writeup of the study here, and there's additional thoughts from Megan McArdle, Paul Krugman, Felix Salmon, and Matt Yglesias.

The impact of long-term unemployment on human lives is very real, and I think the government should be combating it using every tool it has. However, I want to push back on a few of the economic ideas that tend to hover in the background of these discussions; specifically, the idea that we should consider the long-term unemployed uniquely in trouble in this economy. Because, based on my interpretation of the evidence, the best approach to handling this problem is to aim for full employment.

It's well known that it is harder for those who have been out of the labor force the longest to find jobs. It would be weird if Ghayad hadn't found that result. There is a large debate in the literature about whether this is driven by employers or job candidates, and Ghayad provides a very useful study finding that employers are a key part here.

But let's look at the likelihood of finding a job in three different economic scenarios (2000, 2007, and 2012) by duration of unemployment:

But notice that when the economy is much stronger, as it was in 2000 when unemployment averaged 4 percent, the rate at which the long-term unemployed find jobs jumps up. Let's zoom in on the last category, the job-finding rate of those who have been searching for a job for 53 weeks or longer, and chart it back to 1995. (Since the data, provided by the BLS, is not seasonally adjusted, the number here is a 12-month rolling average.)

As you can see, it's much easier for the long-term unemployed to find jobs when there's a tight labor market, like there was in the late 1990s. This rate collapses in a recession, and with years of 7+ percent unemployment, it has stayed depressed.

A lot of people are drawing conclusions that something has broken in long-term unemployment based on a previous paper by Rand Ghayad, where he disaggregates the Beveridge Curve by unemployment duration. I've been critical of that paper. I think, strictly speaking, that the disaggregation just tells us that the long-term unemployed have become a larger percentage of the unemployed, which we knew. Meanwhile, the labor market is depressed for everyone, even short-term unemployed (also see SF Fed for more evidence of this). As the long-term unemployed are less likely to drop out of the labor market than in normal times right now, the dramatic increase in the long-term unemployed hasn't turned into a large drop in labor force participation like many worry about.

We should do things that are smart policies that target the long-term unemployed. Amy Taub of Demos has done convincing work on why ending credit checks as part of the job interview process would be a good idea. Extending unemployment insurance is also important. But the idea that we should change course away from boosting the general economy strikes me as a bad idea. The long-term unemployed experience the worst impact of a generally weak economy. But its that weak economy that is doing the damage. If unemployment was actually brought down, which we could do with more expansonary policy, then employers couldn't afford to be so choosy.

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Are Student Loans Becoming a Macroeconomic Issue?

Apr 23, 2013Mike Konczal

What's the general economic consensus on the impact of student loans on the household finances of those who hold them? Here's "Student Loans: Do College Students Borrow Too Much—Or Not Enough?" (Christopher Avery and Sarah Turner, 2012), which argues, "[t]here is little evidence to suggest that the average burden of loan repayment relative to income has increased in recent years." Using data from 2004-2009, the authors find that "the mean ratio of monthly payments to income is 10.5 percent" for those in repayment six years after initial enrollment.

They boost that number with a 2006 study by Baum and Schwarz to conclude that two trends cancel each other out: there's rising debt but steady student debt-to-income ratios. How can this happen? It "can be attributed to a combination of rising earnings, declining interest rates, and increased use of extended repayment options." This is how, though average total undergraduate debt jumped 66 percent to a value of $18,900 from 1997 to 2002, "average monthly payments increased by only 13 percent over these five years. The mean ratio of payments to income actually declined from 11 percent to 9 percent because borrower.”

Let's put this a different way. If you asked economists looking at the data if student loans could be having a macroeconomic effect, especially through a financial burden on those that have them, they'd say that the actual percent of monthly income paying student loans hasn't changed all that much since the 1990s. They may be making larger lifetime payments, since they'll carry the debts longer, but that's a choice they are making, which could reflect positive or negative developments. Certaintly there's no short-term strain. So there aren't any economic consequences worth mentioning when it comes to student loans.

I always thought this approach had problems. First, they were only looking at the pre-crisis era, so we couldn't see the impact of student loans once we hit a serious problem. And they were just rough averages of short-term income aggregates, rather than looking at specific individuals with or without student-debt and seeing what kinds of spending, particularly on longer-term durable goods, they do. But since I had no data myself, I never pushed on this very hard. Part of the problem is that student loans have happened relatively quickly, so quantitatively it's hard for data agencies to adjust their techniques to "see" this data easily, and not just lump them in with "other debts."

That is starting to change. The Federal Reserve Bank of New York is doing some high-end analysis of student loans, and their economists Meta Brown and Sydnee Caldwell have a great post from last week, "Young Student Loan Borrowers Retreat from Housing and Auto Markets." They find that over the past decade, people with student loans were more likely to have a mortgage at age 30 and a car loan at age 25. In the crisis this edge has collapsed:

There's a similar dynamic for car loans.

The researchers argue that two obvious explanations stands out for this collapse. The first is that the actual future expected earnings have fallen for this group, so they are going to spend less. The second is that credit constraints are especially binding, as those with student loans have a worse credit score than those without.

Derek Thompson at The Altantic Business responds critically, arguing that: (1) cars and mortgages are falling out of favor with young people, so this is likely a secular trend; (2) young people are essentially doing a "debt swap," switching cars and mortgages for education to take advantage of an education premium, and the cars and mortgages will come later; and (3) though this is, at best, a short-term drag on the economy and reflecting short-term problems, it'll super-charge our economy come later.

What should we make of this?

(1) It's possible that there is a secular trend to it, with young people not wanting mortgages or cars. But why wouldn't the spread survive? "People with student loans" is a broad category of people, and it is difficult to assume that it's just people moving to become renters in urban cores driving the entire thing. The collapse of the spread between the two coinciding with the crisis makes it hard to believe it's just a coincidence.

(2) As discussed at the beginning, the overall idea in the student loan data literature is that student loans shouldn't have a negative impact on consumption, especially at the national level. The extra cost of servicing the debt is more than balanced out by the extra income earned, even if the length of the debt needs to adjust to meet that. Indeed, there's often a "best investment ever" or "leaving money on the table" aspect to the discussion of higher education and student loans. So if this data holds, it's a major change from the normal way economists understand this.

And the issue of student debt is where the problem with the "education premium" is going to hit a wall. The college premium is driven just as much by high school wages falling as it is by college-educated wages increasing, which has slowed in the past decade. So if you have to take on large debt to secure a stagnating college-level income, it suddenly isn't clear that it is such a great deal, even if there's a strictly defined "premium" over the alternative.

(3) It isn't clear that the upswing in people, particularly women, taking on additional education is involved with this collapse in borrowing, as the ages of 25 and 30 cut off many people in school. I think it would reflect the collapse in the housing market, but the auto loan market is there as well. It is true that the economy as a whole is deleveraging, but that is largely reflective of housing and foreclosures.

How much this reverts if we get back to full employment and whether there's a "swap" that could lead to a better long-term economy are good questions, but the fact that we even have to put the question these way shows a change in what economists believed about student loans. No matter what, this shows that education isn't enough of an insurance against the business cycle.

And I actually see it the other way - right now Ben Bernanke is working overtime to try and get interest rates to the lowest they've ever been, and he still can't induce borrowing by college-educated young people. Congress also lowered interest rates on new student loans, though too many student loans are out there at high rates given the disinflationary times. If the lower lending isn't the result of institutional issues with credit scores, that means college-educated young people are particularly battered in this economy. And there could be a low-level drag on the economy for the foreseeable future.

If the New York Fed is taking requests, the biggest question I have is how student loans are impacting household formations. Young people are living with their parents for longer at a point where getting an additional million homebuyers would supercharge the economy. Are they living at home because they are unemployed, or because they are un(der)employed and have student loans? If it is the second, then there's definitely a serious lag on the economy.

But the real issue revealed by this study is that this stuff is important. It is showing up in national data; the people arguing that student loans simply disappear under higher earnings now have a macroeconomic issue to deal with.

Follow or contact the Rortybomb blog:

  

 

What's the general economic consensus on the impact of student loans on the household finances of those who hold them? Here's "Student Loans: Do College Students Borrow Too Much—Or Not Enough?" (Christopher Avery and Sarah Turner, 2012), which argues, "[t]here is little evidence to suggest that the average burden of loan repayment relative to income has increased in recent years." Using data from 2004-2009, the authors find that "the mean ratio of monthly payments to income is 10.5 percent" for those in repayment six years after initial enrollment.

They boost that number with a 2006 study by Baum and Schwarz to conclude that two trends cancel each other out: there's rising debt but steady student debt-to-income ratios. How can this happen? It "can be attributed to a combination of rising earnings, declining interest rates, and increased use of extended repayment options." This is how, though average total undergraduate debt jumped 66 percent to a value of $18,900 from 1997 to 2002, "average monthly payments increased by only 13 percent over these five years. The mean ratio of payments to income actually declined from 11 percent to 9 percent because borrower.”

Let's put this a different way. If you asked economists looking at the data if student loans could be having a macroeconomic effect, especially through a financial burden on those that have them, they'd say that the actual percent of monthly income paying student loans hasn't changed all that much since the 1990s. They may be making larger lifetime payments, since they'll carry the debts longer, but that's a choice they are making, which could reflect positive or negative developments. Certaintly there's no short-term strain. So there aren't any economic consequences worth mentioning when it comes to student loans.

I always thought this approach had problems. First, they were only looking at the pre-crisis era, so we couldn't see the impact of student loans once we hit a serious problem. And they were just rough averages of short-term income aggregates, rather than looking at specific individuals with or without student-debt and seeing what kinds of spending, particularly on longer-term durable goods, they do. But since I had no data myself, I never pushed on this very hard. Part of the problem is that student loans have happened relatively quickly, so quantitatively it's hard for data agencies to adjust their techniques to "see" this data easily, and not just lump them in with "other debts."

That is starting to change. The Federal Reserve Bank of New York is doing some high-end analysis of student loans, and their economists Meta Brown and Sydnee Caldwell have a great post from last week, "Young Student Loan Borrowers Retreat from Housing and Auto Markets." They find that over the past decade, people with student loans were more likely to have a mortgage at age 30 and a car loan at age 25. In the crisis this edge has collapsed:

There's a similar dynamic for car loans.

The researchers argue that two obvious explanations stands out for this collapse. The first is that the actual future expected earnings have fallen for this group, so they are going to spend less. The second is that credit constraints are especially binding, as those with student loans have a worse credit score than those without.

Derek Thompson at The Altantic Business responds critically, arguing that: (1) cars and mortgages are falling out of favor with young people, so this is likely a secular trend; (2) young people are essentially doing a "debt swap," switching cars and mortgages for education to take advantage of an education premium, and the cars and mortgages will come later; and (3) though this is, at best, a short-term drag on the economy and reflecting short-term problems, it'll super-charge our economy come later.

What should we make of this?

(1) It's possible that there is a secular trend to it, with young people not wanting mortgages or cars. But why wouldn't the spread survive? "People with student loans" is a broad category of people, and it is difficult to assume that it's just people moving to become renters in urban cores driving the entire thing. The collapse of the spread between the two coinciding with the crisis makes it hard to believe it's just a coincidence.

(2) As discussed at the beginning, the overall idea in the student loan data literature is that student loans shouldn't have a negative impact on consumption, especially at the national level. The extra cost of servicing the debt is more than balanced out by the extra income earned, even if the length of the debt needs to adjust to meet that. Indeed, there's often a "best investment ever" or "leaving money on the table" aspect to the discussion of higher education and student loans. So if this data holds, it's a major change from the normal way economists understand this.

And the issue of student debt is where the problem with the "education premium" is going to hit a wall. The college premium is driven just as much by high school wages falling as it is by college-educated wages increasing, which has slowed in the past decade. So if you have to take on large debt to secure a stagnating college-level income, it suddenly isn't clear that it is such a great deal, even if there's a strictly defined "premium" over the alternative.

(3) It isn't clear that the upswing in people, particularly women, taking on additional education is involved with this collapse in borrowing, as the ages of 25 and 30 cut off many people in school. I think it would reflect the collapse in the housing market, but the auto loan market is there as well. It is true that the economy as a whole is deleveraging, but that is largely reflective of housing and foreclosures.

How much this reverts if we get back to full employment and whether there's a "swap" that could lead to a better long-term economy are good questions, but the fact that we even have to put the question these way shows a change in what economists believed about student loans. No matter what, this shows that education isn't enough of an insurance against the business cycle.

And I actually see it the other way - right now Ben Bernanke is working overtime to try and get interest rates to the lowest they've ever been, and he still can't induce borrowing by college-educated young people. Congress also lowered interest rates on new student loans, though too many student loans are out there at high rates given the disinflationary times. If the lower lending isn't the result of institutional issues with credit scores, that means college-educated young people are particularly battered in this economy. And there could be a low-level drag on the economy for the foreseeable future.

If the New York Fed is taking requests, the biggest question I have is how student loans are impacting household formations. Young people are living with their parents for longer at a point where getting an additional million homebuyers would supercharge the economy. Are they living at home because they are unemployed, or because they are un(der)employed and have student loans? If it is the second, then there's definitely a serious lag on the economy.

But the real issue revealed by this study is that this stuff is important. It is showing up in national data; the people arguing that student loans simply disappear under higher earnings now have a macroeconomic issue to deal with.

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Guest Post: The Time Series of High Debt and Growth in Italy, Japan, and the United States

Apr 22, 2013Deepankar Basu

Mike Konczal here. In light of the collapse of the argument for a "cliff" in debt-to-GDP ratio, the most pressing issue to figure out is what to make of any minor relationship between debt and GDP. Which way does the causation work? Arin Dube wrote about this last week. Today, Deepankar Basu, assistant professor of economics at the University of Massachusetts-Amherst, takes a deep dive into this data using time series methods. Though this will involve some complicated techniques and charts, this work is crucial for understanding the current situation. I hope you check it out!

Public Debt and Economic Growth in the Postwar U.S., Italian and Japanese Economies

Deepankar Basu

A recent paper by Thomas Herndon, Michael Ash, and Robert Pollin (HAP) has effectively refuted one of the most frequently cited stats of recent years: countries with public debt above 90 percent of GDP experience sharp drop offs in economic growth. This “90 percent” result was put into circulation in 2010 by a paper written by Carmen Reinhart and Kenneth Rogoff (RR) and was heavily circulated by conservative policymakers, commentators, and economists.

I think the most important issue in the subsequent discussion in blogs and newspaper op-eds (for a quick rundown see here) is the question of causality. Does the negative correlation between public debt and economic growth rest on high levels of public debt causing low economic growth, as RR and other “austerians” claim (we borrow this term from Jim Crotty)? Or is the causation the reverse of what the austerians say, meaning low economic growth causes higher public debt? Using the HAP data set for 20 OECD countries, economist Arindrajit Dube of University of Massachusetts-Amherst has shown that (a) the negative relationship between public debt and growth is much stronger at low levels of growth, and (b) the association between past economic growth and current debt levels is much stronger than the association between current levels of debt and future economic growth. This is strong evidence for the second causation argument, where low growth leads to high debt.

While Dube has worked in a single equation framework with a panel data set, in this article, I change gears and ask a time series question instead: what useful information, if any, can one extract about the relationship between public debt and economic growth from historical data for individual countries? In particular, I ask the following question: can data on historical coevolution of public debt and economic growth in the postwar U.S., Italian and Japanese economies tell us anything useful about possible causal relationships among these two variables? To briefly summarize the results, I find that the time series pattern of the dynamic relationship between public debt and economic growth in the postwar U.S., Italian, and Japanese economies is consistent with low growth causing high debt rather than high debt causing low growth.

Why I Chose the U.S., Italy, and Japan

As reported in Table A-1 of the HAP paper, there are only 10 countries in the sample of advanced economies from 1946-2009 that witnessed debt-to-GDP ratios above 90. These countries generally experienced years with debt/GDP above 90 consecutively, so they form easily observable episodes. However, in the postwar period very few of these episodes exhibit notably slow growth. The U.S. from 1946-2009 has already been explained in detail here as being caused by the reduction in government spending due to demobilization from World War II.

Mike Konczal here. In light of the collapse of the argument for a "cliff" in debt-to-GDP ratio, the most pressing issue to figure out is what to make of any minor relationship between debt and GDP. Which way does the causation work? Arin Dube wrote about this last week. Today, Deepankar Basu, assistant professor of economics at the University of Massachusetts-Amherst, takes a deep dive into this data using time series methods. Though this will involve some complicated techniques and charts, this work is crucial for understanding the current situation. I hope you check it out!

Public Debt and Economic Growth in the Postwar U.S., Italian and Japanese Economies

Deepankar Basu

A recent paper by Thomas Herndon, Michael Ash, and Robert Pollin (HAP) has effectively refuted one of the most frequently cited stats of recent years: countries with public debt above 90 percent of GDP experience sharp drop offs in economic growth. This “90 percent” result was put into circulation in 2010 by a paper written by Carmen Reinhart and Kenneth Rogoff (RR) and was heavily circulated by conservative policymakers, commentators, and economists.

I think the most important issue in the subsequent discussion in blogs and newspaper op-eds (for a quick rundown see here) is the question of causality. Does the negative correlation between public debt and economic growth rest on high levels of public debt causing low economic growth, as RR and other “austerians” claim (we borrow this term from Jim Crotty)? Or is the causation the reverse of what the austerians say, meaning low economic growth causes higher public debt? Using the HAP data set for 20 OECD countries, economist Arindrajit Dube of University of Massachusetts-Amherst has shown that (a) the negative relationship between public debt and growth is much stronger at low levels of growth, and (b) the association between past economic growth and current debt levels is much stronger than the association between current levels of debt and future economic growth. This is strong evidence for the second causation argument, where low growth leads to high debt.

While Dube has worked in a single equation framework with a panel data set, in this article, I change gears and ask a time series question instead: what useful information, if any, can one extract about the relationship between public debt and economic growth from historical data for individual countries? In particular, I ask the following question: can data on historical coevolution of public debt and economic growth in the postwar U.S., Italian and Japanese economies tell us anything useful about possible causal relationships among these two variables? To briefly summarize the results, I find that the time series pattern of the dynamic relationship between public debt and economic growth in the postwar U.S., Italian, and Japanese economies is consistent with low growth causing high debt rather than high debt causing low growth.

Why I Chose the U.S., Italy, and Japan

As reported in Table A-1 of the HAP paper, there are only 10 countries in the sample of advanced economies from 1946-2009 that witnessed debt-to-GDP ratios above 90. These countries generally experienced years with debt/GDP above 90 consecutively, so they form easily observable episodes. However, in the postwar period very few of these episodes exhibit notably slow growth. The U.S. from 1946-2009 has already been explained in detail here as being caused by the reduction in government spending due to demobilization from World War II.

Other than the U.S., the only two countries with debt-to-GDP above 90 percent and average growth below 2 percent are Italy and Japan, with 1 percent and 0.7 percent respectively. With the inclusion of the earlier years from 1946-1949, New Zealand’s average growth increases from RR’s reported -7.6 percent to 2.6 percent. That is why I chose to focus in this article on U.S., Italy and Japan.

For the U.S. economy, federal debt declined from its high value (more than 100 percent of GDP) in the immediate postwar years to its lowest level in the mid-1970s (less than 25 percent of GDP), thereafter increasing till the mid-1990s and falling again over the next decade or so before picking up again with the onset of the global financial and economic crisis in 2007. The growth rate of real GDP has fluctuated a lot in the postwar period, with average values being higher in the two decades after the end of WWII than after the 1980s.

The Italian economy has experienced a different pattern: low levels of public debt till the early 1970s followed by a three-decade-long increase, with contemporary debt levels remaining at historical highs. Japan witnessed a very similar pattern: low levels of public debt till the mid-1970s followed by four decades of steady increase, with contemporary levels of debt hovering at historical highs. In terms of economic growth, both Italy and Japan witnessed a gradual slowdown, even as growth fluctuated at business cycle frequencies, over the entire postwar period. Thus, for all the three countries, there is large variation over time in both the variables (public debt and economic growth), which can be exploited to investigate their dynamic interrelationships. 

To motivate the analysis, in Figures 1.1, 1.2, and 1.3, I give time series plots of public debt and economic growth (year-on-year change in real GDP) for the three economies that I have chosen for this analysis: the U.S. economy between 1946 and 2012, the Italian economy between 1951 and 2009, and the Japanese economy between 1956 and 2009.

FIGURE 1.1  (USA): Time Series plots, for the period 1946-2012, of (a) federal debt held by public as a share of GDP (top panel), and (b) year-on-year change in real GDP (bottom panel). Source: data for debt is from Table B-78, Economic Report of the President, 2013; data for growth is from NIPA Table 1.1.1 

FIGURE 1.2  (ITALY): Time Series plots, for the period 1946-2012, of (a) federal debt held by public as a share of GDP (top panel), and (b) year-on-year change in real GDP (bottom panel). Source: Herndorn, Ash and Pollin (2013).

FIGURE 1.3  (JAPAN): Time Series plots, for the period 1946-2012, of (a) federal debt held by public as a share of GDP (top panel), and (b) year-on-year change in real GDP (bottom panel). Source: Herndorn, Ash and Pollin (2013). 

Why Use a Time Series Framework

Why do I adopt a time series framework? Adopting a time series lens allows one to use a vector autoregression (VAR) analysis, a popular time series methodology that is especially suitable for studying rich dynamic interactions among a group of time series variables. The pattern of dynamic interactions (allowing for complex lagged effects) can be nicely summarized through plots of orthogonalized impulse response functions, which trace out the effect of an unexpected change in a variable on the time paths of all the variables in the system (orthogonalizing the error makes sure that the effect of impulses to one error is not contaminated by cross correlation with other errors in the system).  In other words, this allows a researcher to address the following question: how would the variables in the VAR evolve over time when impacted by an unexpected change in one of the variables, holding other things constant? The key phrases here are “unexpected change in one of the variable” and “holding other things constant.” How do we interpret these key phrases?

Recall that in a VAR, every variable is explained by its past values and by past values of the other variables in the system. Each equation also has an unexplained part, the random error term. Thus an impulse imparted to the error (i.e., the unexplained part) in one of the equations in the VAR, can be understood as an “unexpected change,” or change in the variable that is not explained by its own past values and past values of the other variables in the VAR. Orthogonalizing the errors, on the other hand, implies that a change in one error is uncorrelated by changes in other errors in the system. Hence, when the researcher traces out the impact of an impulse to one error, she is confident that it is not picking up effects of changes in the other errors. This is a clear advantage over cross sectional analysis of correlations among variables, where distinguishing the effects of changes in one variable from the other might be difficult.  

In addition, a VAR allows each variable to be endogenous; i.e., it not only allows for lagged but also contemporaneous interaction among the variables. Thus, the researcher is not forced to take an a priori stand on whether a variable is exogenous (or not) as in a single equation estimation framework (where the dependent variable is, by assumption, endogenous, and some of the independent variables are exogenous).

Of course, a VAR will not, by itself, address the issue of causality; one needs to impose additional restrictions to distinguish causality from correlation (i.e., to tackle the so-called identification problem). A common identification strategy is to adopt a “causal ordering” of the variables in the VAR, which is a way to restrict some of the contemporaneous effects among the variables. If a variable is causally prior to another, this means that changes in the second variable cannot have any contemporaneous impacts on the first. In a two-variable vector autoregression (VAR), there are only two possible orderings: the first variable can be assumed to be causally prior to the second, or vice versa.

So, one can use both orderings (instead of taking a stand on which is the correct structural relationship) and see if the shape of the impulse response functions change according to the ordering adopted. If it does not, then the pattern of dynamic interaction captured by impulse response functions can be thought of as a reasonable approximation of underlying structural relationships. The point is this: if the impulse response functions display qualitatively similar shapes in both ordering of variables (and remember there are only two possibilities here), then the dynamic patterns of interaction are independent of the ordering. Either of them can be used to address the question: how does the system react to an unexpected change in one variable? This is a common empirical strategy in the time series literature, and as such we adopt it here. (This strategy becomes difficult to implement and interpret when there are more than two variables in the system, in which case theoretically motivated restrictions are imposed to get identification.)

Two-Variable VAR Analysis for Individual Countries

To investigate the debt-growth relationship, I estimate a two-variable VAR with an optimal number of lags (where public debt as a share of GDP and year-over-year change in real GDP are the two variables) for each of the three countries separately: the U.S. economy for the period 1946-2012, the Italian economy over 1951-2009, and the Japanese economy over the period 1956-2009. (I choose the “optimal” number of lags using the Akaike Information Criterion.) I find three interesting results.

First, the contemporaneous correlation between the errors in the two equations of the VAR is negative for each of the three countries (-0.56 for the U.S., -0.54 for Italy, and -0.30 for Japan). This suggests that unexpected changes in debt and economic growth move in the opposite direction in each of these countries. This finding is in line with existing results, both of Reinhart-Rogoff and their critics.

Second, I conduct Granger non-causality tests to understand lags of which of the two variables in the VAR better helps in predicting the other. Table 1 summarizes Granger non-causality test results for the three countries. The first column in Table 1 tests whether debt does not Granger-cause growth; i.e., the null hypothesis that all lags of debt enter the growth equation with zero coefficients. A high p-value indicates that the null hypothesis cannot be rejected; i.e., lags of debt do not help in predicting growth. The entries in the first column are all relatively large and show that lags of debt do not help in predicting growth with high levels of statistical significance. This is true for all three economies, and especially for Italy (which has a p-value of 0.81).

The second column in Table 1 tests for the opposite direction of predictability: it tests whether growth does not Granger-cause debt; i.e., the null hypothesis that all lags of growth enter the debt equation with zero coefficients. A low p-value indicates that the null hypothesis can be strongly rejected; i.e., lags of growth do help in predicting debt. The entries in column 2 are all relatively small and show that lags of growth help in strongly predicting debt for all three countries (both U.S. and Italy have p-values of 0, and Japan has a p-value of 0.04).

This finding about Granger non-causality is in line with similar results reported in 2010 by Josh Bivens and John Irons for the U.S. economy. The fact that similar results hold for Italy and Japan, which have been witnessing relatively higher levels of public debt in the past few decades, is indeed a strong rebuttal of austerian claims. It demonstrates that low growth leading to (or helping to predict) high debt is more consistent with the time series data than high debt leading to (or helping to predict) low growth. Moreover, this is true not only for the U.S. economy but also for Italy and Japan. 

Third, I analyze plots of impulse response functions (IRF) to decipher possible directions of effects running between debt and growth for all three countries for the two possible “orderings” of the variables. Figure 2.1, 2.2, and 2.3 display the orthogonalized IRFs with the first “ordering,” where debt is assumed to be “causally prior” to growth (meaning changes in debt can have a contemporaneous impact on growth but not the other way around). Figure 3.1, 3.2, and 3.3 display the orthogonalized IRFs with the alternative ordering, where growth is assumed to be “causally prior” to debt (meaning changes in growth can have a contemporaneous impact on debt but not the other way around).

 

 

FIGURE 2.1. (USA): Orthogonalized impulse response functions using a Cholesky decomposition for a 2 variable VAR (debt and growth) with optimal number of lags (chosen with AIC). The recursive VAR is estimated with annual data for the U.S. economy for the period 1946- 2012 and 90 percent bootstrapped confidence intervals are included in the IRF plots. Ordering: Debt is causally prior to growth.

FIGURE 2.2. (ITALY): Orthogonalized impulse response functions using a Cholesky decomposition for a 2 variable VAR (debt and growth) with optimal number of lags (chosen with AIC). The recursive VAR is estimated with annual data for the Italian economy for the period 1951- 2009 and 90 percent bootstrapped confidence intervals are included in the IRF plots. Ordering: Debt is causally prior to growth.

FIGURE 2.3. (JAPAN): Orthogonalized impulse response functions using a Cholesky decomposition for a 2 variable VAR (debt and growth) with optimal number of lags (chosen with AIC). The recursive VAR is estimated with annual data for the Japanese economy for the period 1956- 2009 and 90 percent bootstrapped confidence intervals are included in the IRF plots. Ordering: Debt is causally prior to growth.

Impulse Response Function: Impact of Debt on Growth

Let us start with the first ordering. In the top panel (right) of Figure 2.1 (USA), a one standard deviation positive impulse to the debt shock (i.e., the error in the equation that predicts debt) reduces growth contemporaneously, but growth returns back to zero within a year and stays there after that. In the top (right) panel of Figure 2.2 (ITALY), a similar impulse to the debt shock reduces growth contemporaneously, and growth returns back to zero within the next two years and stays there after that (notice that the 90 percent confidence interval includes zero). In the top panel (right) of Figure 2.3 (JAPAN), a one standard deviation impulse to the debt shock reduces growth contemporaneously, but growth returns back to zero within a year and gradually falls over the next several years (though here, too, the 90 percent confidence interval includes zero).

What story do these pictures tell us? If debt has a contemporaneous effect on growth (but not the other way round), then an unexpected increase in the level of debt in any year (due, for instance, to an increase in the deficit of a government that has given a tax break) will reduce economic growth in that year, but the negative impact will be washed out relatively quickly. The system will return back to its original growth path within the next few years. The speed with which the system reverts back to its original state is quickest for the U.S, slower for Japan, and slowest for Italy.  

FIGURE 3.1. (USA): Orthogonalized impulse response functions using a Cholesky decomposition for a 2 variable VAR (debt and growth) with optimal number of lags (chosen with AIC). The recursive VAR is estimated with annual data for the U.S. economy for the period 1946- 2012 and 90 percent bootstrapped confidence intervals are included in the IRF plots. Ordering: Growth is causally prior to debt.

FIGURE 3.2. (ITALY): Orthogonalized impulse response functions using a Cholesky decomposition for a 2 variable VAR (debt and growth) with optimal number of lags (chosen with AIC). The recursive VAR is estimated with annual data for the Italian economy for the period 1951- 2009 and 90 percent bootstrapped confidence intervals are included in the IRF plots. Ordering: Growth is causally prior to debt.

FIGURE 3.3. (JAPAN): Orthogonalized impulse response functions using a Cholesky decomposition for a 2 variable VAR (debt and growth) with optimal number of lags (chosen with AIC). The recursive VAR is estimated with annual data for the Japanese economy for the period 1956- 2009 and 90 percent bootstrapped confidence intervals are included in the IRF plots. Ordering: Growth is causally prior to debt.

Let us now turn to the second ordering. In the top panel (right) of Figure 3.1 (USA), a one standard deviation impulse to the debt shock has no contemporaneous effect on growth, but there is a positive effect on growth for the next two years. In the top panel (right) of Figure 3.2 (ITALY), a one standard deviation impulse to the debt shock has no contemporaneous effect on growth, and a fluctuating (negative and positive) impact on growth which is not very precisely estimated (the 90 percent confidence interval includes zero). In the top panel (right) of Figure 3.3 (JAPAN), a one standard deviation impulse to the debt shock has no contemporaneous effect on growth, but growth experiences a positive impact for the next three years, after which it starts falling – all of which is estimated pretty imprecisely (the 90 percent confidence interval includes zero).

How should we interpret these pictures? In this case, only Italy displays a negative impact of debt on growth; both Japan and the U.S. show mildly positive impacts of unexpected changes in debt levels (though the effects are estimated pretty imprecisely). Thus, if it were the case that the contemporaneous effect between debt and growth runs from the latter to the former (as the second ordering assumes), then increases in levels of public debt might even have a positive impact on economic growth, as witnessed in the U.S. and Japan. Why might this be the case? This might be reflecting the positive multiplier effect on output growth of a boost to aggregate demand coming from an increase in the government’s deficit. Evidence for the U.S. and Japan suggests that this effect might be non-zero, at least in the short run.

Thus, for all three countries and in both orderings, an unexpected increase in debt in any year does not have any statistically significant negative effect on economic growth in future years. When I allow the contemporaneous effect to run from growth to debt, the short- to medium-term impact is positive for the U.S. and Japan, though the effects are not very precisely estimated. This evidence is contrary to RR’s claim that high debt leads to low growth.   

Impulse Response Function: Impact of Growth on Debt

Once again, let us start with the first ordering. In the bottom panel (left) of Figures 2.1 (USA), 2.2 (ITALY), and 2.3 (JAPAN), a one standard deviation impulse to the growth shock reduces debt unambiguously in the short and medium term. While debt starts returning to its initial level in the case of the U.S. economy after about five to six years, it keeps declining in the Italian and Japanese economies. (This seems to suggest that the impact of economic growth on debt levels is longer lasting in Italy and Japan than in the U.S.) The bottom panels (left) of Figures 3.1 (USA), 3.2 (ITALY), and 3.3 (JAPAN) display impulse response plots for a one standard deviation impulse to the growth shock for the second ordering. They paint a qualitatively similar picture to that seen for the first ordering.

So, what do these figures tell us? They show that an unexpected increase in economic growth (for instance, due to an increase in aggregate demand caused by expanding exports) will be associated with a decrease in levels of public debt. Hence, we can turn this picture around and infer the following: when there is an unexpected decrease in economic growth, it will be associated with an increase in the levels of public debt over the next several years. This is true for all the three countries and for both orderings of the variables in the VAR.

Moreover, unlike the effect of debt on growth (which we saw in the top panels of the figures), the effects of unexpected changes in growth on future debt levels are statistically significant (though imprecisely measured) up to about 10 years in the future. This evidence clearly supports the anti-austerian position that low growth leads to higher public debt.

Summary

To summarize, I find that the time series pattern of the dynamic relationship between public debt and economic growth in the postwar U.S., Italian, and Japanese economies is consistent with low growth causing high debt rather than the high debt causing low growth. I draw this conclusion from two types of analyses: Granger non-causality tests and an investigation of impulse response function plots.

Granger non-causality tests allow one to ask the following questions: (a) do debt levels in the past help in better predicting current economic growth, and (b) does economic growth in the past help in improving predictions of current debt levels? The evidence suggests that for the U.S., Italy, and Japan, the answer to the first question is a NO and the answer to the second is a YES.

Impulse response analysis allows one to address the following questions: (a) what is the impact of an unexpected increase in current debt levels on the future time path of economic growth, and (b) how does an unexpected decline in economic growth affect future levels of debt? The data suggests that an unexpected increase in debt levels has only a small effect on future economic growth but an unexpected decline in economic growth is associated with large and long-lasting increases in public debt levels.     

Thus, empirical evidence from time series analysis of the U.S., Italian, and Japanese economies seems to bolster the critique presented by our colleagues Herndon, Ash, and Pollin, as well as Dube and others, of the Reinhart-Rogoff claim that high public debt leads to low economic growth. If anything, the evidence supports causality running in the opposite direction: low growth causes higher public debt.

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