It's Alberto Alesina's World and We're All Just Unemployed in It

Mar 5, 2013Mike Konczal

In March 2011, the new Tea Party had taken over the House, and it needed a plan for what it would do about the deficit. It proposed that the effects of imposing austerity, even when the economy is weak, "may be strong enough to make fiscal consolidation programs expansionary in the short term." How did it propose we cut the budget? We can look at Joint Economic Committee (JEC) Republican report, "Spend Less, Owe Less, Grow the Economy," for the answer:

In March 2011, the new Tea Party had taken over the House, and it needed a plan for what it would do about the deficit. It proposed that the effects of imposing austerity, even when the economy is weak, "may be strong enough to make fiscal consolidation programs expansionary in the short term." How did it propose we cut the budget? We can look at Joint Economic Committee (JEC) Republican report, "Spend Less, Owe Less, Grow the Economy," for the answer:

The Tea Party's study called for 85 percent spending cuts and 15 percent revenue increases. This was based largely off a 2009 study by Alberto Alesina and Silvia Ardagna of Harvard titled "Large changes in fiscal policy: taxes versus spending." This is the ur-text of expansionary austerity, which made the case, for example, "On the demand side, a fiscal adjustment may be expansionary if agents believe that the fiscal tightening generates a change in regime that 'eliminates the need for larger, maybe much more disruptive adjustments in the future.'"

Flash forward two years from that report to March 2013. President Obama and Congress have overseen $4 trillion dollars in deficit reduction set for the next ten years. What do the percentages look like? Here's a graphic from a recent New York Times blog post by Steve Rattner on the deficit deals:

Rattner points out that less than 20 percent has come from tax increases, just like Alesina called for. James Pethokoukis also noted these numbers and their connection to Alesina's work and referred to them as the "right" kind of austerity. But what does "right" mean here? There's a technical definition on changes to debt-to-GDP from the paper, but there's also the argument that the "right" kind of austerity would be "be less recessionary or even have a positive impact on growth."

That hasn't happened. In fact, the exact opposite is in play. Instead of expanding the economy, or even having little or no short-term effect, economists generally agree that this austerity (e.g. the sequestration) is cutting growth and reducing the number of jobs created. Suzy Khimm collects some numbers here, including Barclay's estimate, "In 2013, the fiscal drag from government austerity is expected to be between 1.5 and 2.0 percentage points." Where's the expansion? Where's the short-term confidence? This has been a complete failure.

Paul Krugman recently pointed out some choice quotes on who was right and who was wrong about Europe. To give you a sense of the mindset that created this line of reasoning, a set of arguments we are now trying out in the United States, let's look at how Alesina approached initial criticism of his work. In "The Boom Not The Slump: The Right Time For Austerity," my colleague Arjun Jayadev and I found that in virtually all the cases the adjustments were made when the economy was healthy, and in the few cases where it was not there was export-driven growth or interest rates were lowered (see also this Jared Bernstein summary of CRS' critique).

In a September 2010 paper for the Mercatus Center, here is how Alesina responded (my bold):

A recent paper by Jayadem and Konzcal [sic] (2010) argues that Alesina and Ardagna’s results do not apply to the current situation because fiscal adjustments on the spending side are expansionary only when they occur when the economy is already expanding. The criticisms of that paper are at best overstated... In addition, what is unfolding currently in Europe directly contradicts Jayadev and Konczal. Several European countries have started drastic plans of fiscal adjustment in the middle of a fragile recovery. At the time of this writing, it appears that European speed of recovery is sustained, faster than that of  the U.S., and the ECB has recently significantly raised growth forecasts for the Euro area.

I wonder how that ever turned out, even for just their debt-to-GDP ratios? Graph is from 2011-2012:

You can laugh, and you should, but do keep in mind all that needless suffering and the fact that this assessment of Europe's situation is what is now driving our fiscal policy.

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Won't Somebody Please (Not) Think of the Children? On the Benefits of Pre-K for Parents.

Feb 15, 2013Mike Konczal

I wrote a piece I was pretty happy with in The American Prospect called "The Great Society's Next Frontier." Given that health care had passed and wasn't going to be overturned, the question was what would be the next battles for the liberal project. Rather than showing the exhaustion of the liberal project, I found the recent State of the Union a nice checklist of things that have been done, as well as new areas to take the project next, with some markers for a longer-term agenda.

At the Prospect I noted that a mix of "predistribution" and redistribution to expand opportunities while boosting wages were going to be an important part, and two of the ideas that addressed those issues were present in President Obama's State of the Union address: a higher minimum wage and pre-K. Pre-K is going to be a big topic, and this Boston Review symposium by James Heckman is a great place to read what experts are saying.

There's a big debate starting about how good pre-K would be for the kids involved. Would it make them smarter, more capable adults, less likely to have pathological behaviors later in life and more likely to develop a rich range of capabilities and opportunities? There is also the conversation on what that will mean for the economy as a whole. Will an additional year of schooling make us an economically richer country? Will it be a better investment than the stock market?

But there's a very interested party missing from this conversation, and that is parents themselves, particularly mothers who are working or would like to be. As my colleague Bryce Covert notes, pre-K "would also be hugely important in helping parents of all incomes go to work and know that their children are in good hands."

I'm not sure what research has or has not been done on this topic, but here are some fascinating things. A 2011 report from UC Berkeley's Labor Center on the "Economic Impacts of Early Care and Education in California" highlighted some important points. Having access to a dedicated, high-quality preschool can reduce absenteeism and turnover for working parents. Child care arrangements often break down, usually on short notice, which causes work absences as well as other problems. Headaches over child care issues can reduce productivity.

This is a fascinating experiment, from the Labor Center report:

A study of public employees in New York City who were provided with child care subsidies found that the employees had a 17.8 percent decrease in disciplinary action compared to a control group that did not receive the subsidy. Overwhelmingly, those in the subsidy group reported leaving work less often, concentrating better at work, being more productive at work, and using fewer sick days to deal with child care issues.

Fathers can and do stay home with young children, but women are more likely to do this. And this will impact women's existence in the labor market. The OECD shows that the wage gap is significantly higher for women with children and notes that the United States' public investment in child care (ages 0-5) is 0.4 percent of GDP, compared the average OECD of 0.7 percent. Lack of child care access also impacts whether women start businesses and whether they have career arcs that take full advantage of their talents.
 
This strikes me as a politically volatile point to make, if only because few people make it. Why is that? Patrick Caldwell had a piece recently in The American Prospect about the Right's obsession with an Obama re-election campaign tool called "The Life of Julia." The online infographic showed how government structures and counterbalances the risks and opportunities we face over the course of our lives. The Right, correctly, understands this as a challenge to its vision of the primacy of the (patriarchal) family and the market as having complete dominion over those risks. Using the state to give parents, and especially women, more opportunities to inhabit other roles, either in the market or not, is going to run straight into the Right's worldview.
 
I noticed a bit of this on the Left as well, specifically the parts of the Left that are distrustful of public education. In the debate over "unschooling" (lefty homeschooling, usually as a critique of the conformity of public education), Dana Goldstein pointed out the class bias in this critique. She noted "more than 70 percent of mothers with children under the age of 18 are in the workforce. One-third of all children and one-half of low-income children are being raised by a single parent. Fewer than one-half of young children, and only about one-third of low-income kids, are read to daily by an adult. Surely, this isn’t the picture of a nation ready to 'self-educate' its kids." Having an additional year of school is a major boon for parents when you understand the stresses they face.
 
But again, I'm outside the policy topics I hang outside my wonk door. What's your take?
 
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I wrote a piece I was pretty happy with in The American Prospect called "The Great Society's Next Frontier." Given that health care had passed and wasn't going to be overturned, the question was what would be the next battles for the liberal project. Rather than showing the exhaustion of the liberal project, I found the recent State of the Union a nice checklist of things that have been done, as well as new areas to take the project next, with some markers for a longer-term agenda.

At the Prospect I noted that a mix of "predistribution" and redistribution to expand opportunities while boosting wages were going to be an important part, and two of the ideas that addressed those issues were present in President Obama's State of the Union address: a higher minimum wage and pre-K. Pre-K is going to be a big topic, and this Boston Review symposium by James Heckman is a great place to read what experts are saying.

There's a big debate starting about how good pre-K would be for the kids involved. Would it make them smarter, more capable adults, less likely to have pathological behaviors later in life and more likely to develop a rich range of capabilities and opportunities? There is also the conversation on what that will mean for the economy as a whole. Will an additional year of schooling make us an economically richer country? Will it be a better investment than the stock market?

But there's a very interested party missing from this conversation, and that is parents themselves, particularly mothers who are working or would like to be. As my colleague Bryce Covert notes, pre-K "would also be hugely important in helping parents of all incomes go to work and know that their children are in good hands."

I'm not sure what research has or has not been done on this topic, but here are some fascinating things. A 2011 report from UC Berkeley's Labor Center on the "Economic Impacts of Early Care and Education in California" highlighted some important points. Having access to a dedicated, high-quality preschool can reduce absenteeism and turnover for working parents. Child care arrangements often break down, usually on short notice, which causes work absences as well as other problems. Headaches over child care issues can reduce productivity.

This is a fascinating experiment, from the Labor Center report:

A study of public employees in New York City who were provided with child care subsidies found that the employees had a 17.8 percent decrease in disciplinary action compared to a control group that did not receive the subsidy. Overwhelmingly, those in the subsidy group reported leaving work less often, concentrating better at work, being more productive at work, and using fewer sick days to deal with child care issues.

Fathers can and do stay home with young children, but women are more likely to do this. And this will impact women's existence in the labor market. The OECD shows that the wage gap is significantly higher for women with children and notes that the United States' public investment in child care (ages 0-5) is 0.4 percent of GDP, compared the average OECD of 0.7 percent. Lack of child care access also impacts whether women start businesses and whether they have career arcs that take full advantage of their talents.
 
This strikes me as a politically volatile point to make, if only because few people make it. Why is that? Patrick Caldwell had a piece recently in The American Prospect about the Right's obsession with an Obama re-election campaign tool called "The Life of Julia." The online infographic showed how government structures and counterbalances the risks and opportunities we face over the course of our lives. The Right, correctly, understands this as a challenge to its vision of the primacy of the (patriarchal) family and the market as having complete dominion over those risks. Using the state to give parents, and especially women, more opportunities to inhabit other roles, either in the market or not, is going to run straight into the Right's worldview.
 
I noticed a bit of this on the Left as well, specifically the parts of the Left that are distrustful of public education. In the debate over "unschooling" (lefty homeschooling, usually as a critique of the conformity of public education), Dana Goldstein pointed out the class bias in this critique. She noted "more than 70 percent of mothers with children under the age of 18 are in the workforce. One-third of all children and one-half of low-income children are being raised by a single parent. Fewer than one-half of young children, and only about one-third of low-income kids, are read to daily by an adult. Surely, this isn’t the picture of a nation ready to 'self-educate' its kids." Having an additional year of school is a major boon for parents when you understand the stresses they face.
 
But again, I'm outside the policy topics I hang outside my wonk door. What's your take?
 
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Mother and child image via Shutterstock.com.

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Interview with Dube; EITC and Minimum Wage as Complements

Feb 15, 2013Mike Konczal

I have an interview at the American Prospect with Arindrajit Dube on the minimum wage as a policy mechanism. I learned a ton doing it, and I hope you check it out!

Meanwhile there's a lot of great material on the minimum wage coming out. Jared Bernstein addresses four of the key arguments for the minimum wage here. John Schmitt of CEPR has a great overview on the various theories on why a minimum wage hike shows little or not impact on unemployment here (wonkblog summary here).

I still notice many people arguing that we should just raise the earned income tax credit (EITC) for the working poor rather than raising the minimum wage. I brought it up in the interview, but it is worth mentioning again here, even in loud, bold text:

The EITC partially subsidizes employers, and as such the minimum wage is an excellent way to combat this. So it complements, rather than substitutes, for an EITC.

Economists love to tell people that who pays a tax is independent of who Congress wants to pay it. The "Tax These Evil Corporations Act" might fall entirely on people buying stuff from those firms instead of their shareholders. (If you like the jargon, economists say the tax incidence is independent of legislative intent.)

But suddenly when the tax is a tax credit, specifically an earned income tax credit, that tax magically goes exactly where Congress wants it to go. Technically it means that economists just assume that demand is perfectly elastic in low-wage markets, which is a bold assumption. If not, part of the tax is passed on, in this case to employers, who capture it in the form of lower wages. And since those who get the EITC are in the same labor market as those who don't, these wage declines extend to people who don't even get the EITC! Jesse Rothstein did an estimate finding that for every dollar of EITC, a worker's wage only goes up 73 cents. That's a big capture by employers.

If you want some elaborate theory, David Lee and Emmanuel Saez have a paper arguing that when this is the case (and if the EITC works primarily by bringing people into working, via an extensive margin, which it does), the minimum wage is an excellent complement to low-wage government transfers tied to work.

Or as Dube says, "We have different polices designed for different distributional goals. We need to think not in terms of a single policy, but instead think in terms of what is the right portfolio of policies given the range of objectives you have." The minimum wage is an excellent tool to boost the efficacy of government transfers, and it should be raised and tied to a cost of living raise. There's no magic bullets - there's just a variety of tools that reinforce each other.

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I have an interview at the American Prospect with Arindrajit Dube on the minimum wage as a policy mechanism. I learned a ton doing it, and I hope you check it out!

Meanwhile there's a lot of great material on the minimum wage coming out. Jared Bernstein addresses four of the key arguments for the minimum wage here. John Schmitt of CEPR has a great overview on the various theories on why a minimum wage hike shows little or not impact on unemployment here (wonkblog summary here).

I still notice many people arguing that we should just raise the earned income tax credit (EITC) for the working poor rather than raising the minimum wage. I brought it up in the interview, but it is worth mentioning again here, even in loud, bold text:

The EITC partially subsidizes employers, and as such the minimum wage is an excellent way to combat this. So it complements, rather than substitutes, for an EITC.

Economists love to tell people that who pays a tax is independent of who Congress wants to pay it. The "Tax These Evil Corporations Act" might fall entirely on people buying stuff from those firms instead of their shareholders. (If you like the jargon, economists say the tax incidence is independent of legislative intent.)

But suddenly when the tax is a tax credit, specifically an earned income tax credit, that tax magically goes exactly where Congress wants it to go. Technically it means that economists just assume that demand is perfectly elastic in low-wage markets, which is a bold assumption. If not, part of the tax is passed on, in this case to employers, who capture it in the form of lower wages. And since those who get the EITC are in the same labor market as those who don't, these wage declines extend to people who don't even get the EITC! Jesse Rothstein did an estimate finding that for every dollar of EITC, a worker's wage only goes up 73 cents. That's a big capture by employers.

If you want some elaborate theory, David Lee and Emmanuel Saez have a paper arguing that when this is the case (and if the EITC works primarily by bringing people into working, via an extensive margin, which it does), the minimum wage is an excellent complement to low-wage government transfers tied to work.

Or as Dube says, "We have different polices designed for different distributional goals. We need to think not in terms of a single policy, but instead think in terms of what is the right portfolio of policies given the range of objectives you have." The minimum wage is an excellent tool to boost the efficacy of government transfers, and it should be raised and tied to a cost of living raise. There's no magic bullets - there's just a variety of tools that reinforce each other.

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Can We Stabilize the Debt with Just $670 Billion in Deficit Reduction?

Feb 11, 2013Mike Konczal

During a radio debate in 1933, the British economist John Maynard Keynes said, “You will never balance the Budget through measures which reduce the national income.” In an attempt to forget this lesson and repeat the mistakes of 1937, the United States is set to put the sequestration into motion in a few weeks. This package of quickly enacted cuts will try to balance the budget by destroying a million jobs in the next two years and taking a chunk of GDP off growth.

President Obama is likely to call for replacing this sequestration with a deficit reduction plan of $1.5 trillion over the next 10 years in his State of the Union tomorrow night. This is as the deficit is falling quickly, from 7 percent of GDP in 2012 to a projected 5.3 percent this year. Obama's target number would build off the $2.4 trillion in deficit reduction already in place through the Budget Control Act and fiscal cliff deal for a total of nearly $4 trillion.

But what if we needed significantly less than $1.5 trillion at this point? What number would be necessary, under what conditions? Richard Kogan of the Center on Budget and Policy Priority (CBPP) has called for $1.4 trillion. There’s been an interesting pushback against this argument from Ethan Pollack of the Economic Policy Institute (EPI), who argues that CBPP’s numbers are far too high, and that the debt-to-GDP, or debt ratio, can be stabilized with less than half of that. Let's summarize this debate here.

If stabilizing the debt is the goal, everything depends on what we mean by stabilization. CBPP wants to stabilize the debt ratio with two conditions. The first is that it will be at the current rate of 73 percent, and the second is that it will occur by 2022, or within a 10-year window. Here is EPI's chart showing the current trajectory and the numbers proposed by CBPP and President Obama:

What Pollack notes is that if you relax either assumption, you can still have stabilization but at a significantly lower level of deficit reduction. If we relax the 73 percent requirement, and we target a debt-to-GDP level that is lower in 2022 than it was in 2018, we’d only need $670 billion dollars in deficit reduction, with $580 coming from policy savings (and the rest from interest). That's a lot less in brutal cuts while the economy is still weak. This would still stabilize the debt, as the debt-to-GDP ratio starts to decline. It would just stabilize it at a higher level.
 
What if we want a debt ratio of 73 percent, but we relax the time constraint? What if we worry less about an arbitrary 10-year limit and look at the long run? If we want to stabilize the debt outside the 10-year window at the current rate, we’d need a long-run deficit of 3 percent. That would only require $500 billion in cuts, of which $430 billion is policy savings. This is still long-run stabilization, which is what we'd want, rather than stabilization while the economy is still weak.
 
So we can have stabilization with significantly less upfront costs. But why focus on a number like this at all? Pollack also argues that this magic number approach is dangerous in two additional ways. A single number losses all the stuff that is important about the actual cuts. Are they phased in only after unemployment is low? Are they from reductions in spending on the automatic stabilizers keeping the economy afloat, like food stamps? Do they include measures that are good for the long-term, like a carbon tax? Like trying to figure out your health by only looking at your weight, using a single number to try and capture a large phenomenon confuses all the things that we know are important.
 
Also having a single number presented this way gives the impression that additional stimulus deployed in the next few years would add to the number. If we need $1.4 trillion in cuts to stabilize the debt over 10 years but want to do an additional $500 billion dollar stimulus in the next two, we don't need $1.9 trillion all of a sudden. Stabilization still takes place, just at a higher level.
 
Jared Bernstein of CBPP responds, arguing that "a) stabilizing at a lower level leaves us less exposed to higher interest payments when rates finally start to rise, and b) it will be a heavier political lift to argue for a cyclical deficits next time we hit a rough patch if we’re starting at 85% versus 73%. "
 
I would note a few things. The first is, for all the theorizing, economists are deeply conflicted about whether or not a higher versus a lower debt-to-GDP level matters. Right now, rather than just crowding out private investments, there will be a strong pull to crowd in actual economic activity. Or, to put it another way, when there’s a fiscal multiplier, increases in debt can help offset themselves; we could end up with a higher debt but a lower debt-to-GDP ratio.
 
Beyond that though, it isn’t clear that the level of debt would impact interest rates or if they would make us richer or poorer, even at full employment. A larger pool of debt at full employment might just increase savings, through a mechanism economists call Ricardian equivalence, which will lower interest rates. There are many different ways of understanding how these relationships could happen. Economists are divided on this; it’s not for nothing that Glenn Hubbard, in 2011, wrote that when it comes to the relationship between government debt and interest rates, "Despite the volume of work, no universal consensus has emerged."
 
We could use more cost-benefit analysis on this matter. Assuming a worst-case scenario that we are currently at full employment, so additional deficits are crowding out private investment, how different would interest rates be if we have an 80 percent debt ratio versus a 73 percent debt ratio? Again this evidence is mixed, but Eric Engen and R. Glenn Hubbard found that a one percent increase in debt-to-GDP increases government interest rates two basis points. So we are talking about the bad case scenario having an 0.16 percent increase in government interest rates. That's not trivial, but it also isn't a doomsday scenario. And this bad case scenario is going to be avoided by prioritizing cuts that could put a serious hamper on both demand and long-term investments? Is this really an exercise worth taking?
 
Follow or contact the Rortybomb blog:
  

 

During a radio debate in 1933, the British economist John Maynard Keynes said, “You will never balance the Budget through measures which reduce the national income.” In an attempt to forget this lesson and repeat the mistakes of 1937, the United States is set to put the sequestration into motion in a few weeks. This package of quickly enacted cuts will try to balance the budget by destroying a million jobs in the next two years and taking a chunk of GDP off growth.

President Obama is likely to call for replacing this sequestration with a deficit reduction plan of $1.5 trillion over the next 10 years in his State of the Union tomorrow night. This is as the deficit is falling quickly, from 7 percent of GDP in 2012 to a projected 5.3 percent this year. Obama's target number would build off the $2.4 trillion in deficit reduction already in place through the Budget Control Act and fiscal cliff deal for a total of nearly $4 trillion.

But what if we needed significantly less than $1.5 trillion at this point? What number would be necessary, under what conditions? Richard Kogan of the Center on Budget and Policy Priority (CBPP) has called for $1.4 trillion. There’s been an interesting pushback against this argument from Ethan Pollack of the Economic Policy Institute (EPI), who argues that CBPP’s numbers are far too high, and that the debt-to-GDP, or debt ratio, can be stabilized with less than half of that. Let's summarize this debate here.

If stabilizing the debt is the goal, everything depends on what we mean by stabilization. CBPP wants to stabilize the debt ratio with two conditions. The first is that it will be at the current rate of 73 percent, and the second is that it will occur by 2022, or within a 10-year window. Here is EPI's chart showing the current trajectory and the numbers proposed by CBPP and President Obama:

What Pollack notes is that if you relax either assumption, you can still have stabilization but at a significantly lower level of deficit reduction. If we relax the 73 percent requirement, and we target a debt-to-GDP level that is lower in 2022 than it was in 2018, we’d only need $670 billion dollars in deficit reduction, with $580 coming from policy savings (and the rest from interest). That's a lot less in brutal cuts while the economy is still weak. This would still stabilize the debt, as the debt-to-GDP ratio starts to decline. It would just stabilize it at a higher level.
 
What if we want a debt ratio of 73 percent, but we relax the time constraint? What if we worry less about an arbitrary 10-year limit and look at the long run? If we want to stabilize the debt outside the 10-year window at the current rate, we’d need a long-run deficit of 3 percent. That would only require $500 billion in cuts, of which $430 billion is policy savings. This is still long-run stabilization, which is what we'd want, rather than stabilization while the economy is still weak.
 
So we can have stabilization with significantly less upfront costs. But why focus on a number like this at all? Pollack also argues that this magic number approach is dangerous in two additional ways. A single number losses all the stuff that is important about the actual cuts. Are they phased in only after unemployment is low? Are they from reductions in spending on the automatic stabilizers keeping the economy afloat, like food stamps? Do they include measures that are good for the long-term, like a carbon tax? Like trying to figure out your health by only looking at your weight, using a single number to try and capture a large phenomenon confuses all the things that we know are important.
 
Also having a single number presented this way gives the impression that additional stimulus deployed in the next few years would add to the number. If we need $1.4 trillion in cuts to stabilize the debt over 10 years but want to do an additional $500 billion dollar stimulus in the next two, we don't need $1.9 trillion all of a sudden. Stabilization still takes place, just at a higher level.
 
Jared Bernstein of CBPP responds, arguing that "a) stabilizing at a lower level leaves us less exposed to higher interest payments when rates finally start to rise, and b) it will be a heavier political lift to argue for a cyclical deficits next time we hit a rough patch if we’re starting at 85% versus 73%. "
 
I would note a few things. The first is, for all the theorizing, economists are deeply conflicted about whether or not a higher versus a lower debt-to-GDP level matters. Right now, rather than just crowding out private investments, there will be a strong pull to crowd in actual economic activity. Or, to put it another way, when there’s a fiscal multiplier, increases in debt can help offset themselves; we could end up with a higher debt but a lower debt-to-GDP ratio.
 
Beyond that though, it isn’t clear that the level of debt would impact interest rates or if they would make us richer or poorer, even at full employment. A larger pool of debt at full employment might just increase savings, through a mechanism economists call Ricardian equivalence, which will lower interest rates. There are many different ways of understanding how these relationships could happen. Economists are divided on this; it’s not for nothing that Glenn Hubbard, in 2011, wrote that when it comes to the relationship between government debt and interest rates, "Despite the volume of work, no universal consensus has emerged."
 
We could use more cost-benefit analysis on this matter. Assuming a worst-case scenario that we are currently at full employment, so additional deficits are crowding out private investment, how different would interest rates be if we have an 80 percent debt ratio versus a 73 percent debt ratio? Again this evidence is mixed, but Eric Engen and R. Glenn Hubbard found that a one percent increase in debt-to-GDP increases government interest rates two basis points. So we are talking about the bad case scenario having an 0.16 percent increase in government interest rates. That's not trivial, but it also isn't a doomsday scenario. And this bad case scenario is going to be avoided by prioritizing cuts that could put a serious hamper on both demand and long-term investments? Is this really an exercise worth taking?
 
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How Do the Long-Term Unemployed Compare to the Rest of the Labor Market?

Feb 7, 2013Mike Konczal

The situation for the long-term unemployed looked significantly better after last week's jobs report. The average duration of unemployment dropped from 38.1 to 35.3 weeks over that month, which included statistical rebalancing for the population. A year ago, 43 percent of the unemployed were out of a job for more than 27 weeks; now that number is down to 38 percent.

This is a good development, though it intensifies two of my larger worries about how people will view the economy. The first is that we'll think the economy is doing too well. If we think the economy is healthy, then the Federal Reserve and Congress will put the brakes on too fast, killing the possibility that full employment, the best social program we have, will really happen. There is already evidence of this happening. The sequestration, which will kill a million jobs, looks increasingly likely to happen, even though there is little long-run justification for premature austerity.

The other, oddly, is that we'll think the labor market is so weak that it can no longer be helped by emgerency stimulus. Neil Irwin wrote an overview, as a result of the Scarborough and Krugman back and forth, of what I'll call "pundit macroeconomics." It's a theory of why pundits care about cutting social insurance and deficits even though the economic logic is missing. The missing part of this argument is that many elites feel that while there are too many unemployed, they are uniquely unqualified for the jobs that are available.

Let's update one of my favorite graphs around, which shows how likely it is that the unemployed will find jobs by the duration of their unemployment. I just got new data from the BLS that gives us these numbers through October 2012. Is there a relatively healthy short-term labor market, with a collapsed long-term one? Let's compare 2007, 2011, and 2012:

As you can see, no matter how long you've been unemployed, the labor market in 2012 is weaker than it was in 2007. It was less likely that those unemployed for less than 5 weeks could find a job in 2012 than they could in 2007. The same goes for the long-term unemployed.

This pushes back against recent research by Rand Ghayad and William Dickens of the Boston Fed. They dissagregate the Beveridge Curve by duration, arguing that our problems are primarily concentrated among the long-term unemployed. However, they are likely just picking up on changes in the long-term distribution of the unemployed (which, as noted above, has been collapsing since June 2012, when their data ends), rather than strictly structural elements. Looking at the labor market through the graph above, we can see that it is generally weak, which is not just a function of the long-term unemployed.

Is duration falling because the unemployed are simply dropping out of the labor force? Here's the transition from unemployment to no longer in the labor force, or the liklihood of the unemployed simply dropping out, comparing the pre-crisis time period and today:

Compared to before the recession, the long-term unemployed are less likely to drop out of the labor force. People are still looking for jobs, though a little less in 2012 than in 2011. That said, there wasn't a large pickup in this rate in 2012, so it is unlikely to be the primary driver in the drop of unemployment duration.

Rob Valletta of the Federal Reserve Bank of San Francisco just put out an economic letter on the long-term unemployed. He does the actual work of parsing out weekly transitions from the CPS data and finds this transition, the same dyanmic noted above.

If you break it down by month and look at it over a longer timeframe, it still has the same result. The labor market is depressed for everyone, not just a select group.

Notice the bump out at month 20 for the recovery period, where it actually goes above the expansionary period. Though it isn't clear what is driving this, it is likely both a function of an improving job market as well as people no longer qualifying for unemployment insurance. Unemployment insurance pulls in several directions then. It increases duration both through encouraging longer searches with better matches by providing liquidity. It provides stimulus to the economy, while also keeping people from leaving the labor force and giving up on their searches entirely.

Valletta also finds that "for most categories of workers, the share of long-term unemployment differs little from the share of short-term unemployment." There are some exceptions, notably younger workers. However, the long-term unemployed aren't a dumping ground for certain types of workers; it reflects a general malaise in the labor market.

This isn't to downplay the serious issues of long-term unemployment. The long-term unemployed do have a harder time finding jobs. But the best cure for this situation is to broadly boost the economy through fiscal and monetary stimulus while dealing with the housing market, rather than transitioning to either targeted job policy or deficit reduction.

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The situation for the long-term unemployed looked significantly better after last week's jobs report. The average duration of unemployment dropped from 38.1 to 35.3 weeks over that month, which included statistical rebalancing for the population. A year ago, 43 percent of the unemployed were out of a job for more than 27 weeks; now that number is down to 38 percent.

This is a good development, though it intensifies two of my larger worries about how people will view the economy. The first is that we'll think the economy is doing too well. If we think the economy is healthy, then the Federal Reserve and Congress will put the brakes on too fast, killing the possibility that full employment, the best social program we have, will really happen. There is already evidence of this happening. The sequestration, which will kill a million jobs, looks increasingly likely to happen, even though there is little long-run justification for premature austerity.

The other, oddly, is that we'll think the labor market is so weak that it can no longer be helped by emgerency stimulus. Neil Irwin wrote an overview, as a result of the Scarborough and Krugman back and forth, of what I'll call "pundit macroeconomics." It's a theory of why pundits care about cutting social insurance and deficits even though the economic logic is missing. The missing part of this argument is that many elites feel that while there are too many unemployed, they are uniquely unqualified for the jobs that are available.

Let's update one of my favorite graphs around, which shows how likely it is that the unemployed will find jobs by the duration of their unemployment. I just got new data from the BLS that gives us these numbers through October 2012. Is there a relatively healthy short-term labor market, with a collapsed long-term one? Let's compare 2007, 2011, and 2012:

As you can see, no matter how long you've been unemployed, the labor market in 2012 is weaker than it was in 2007. It was less likely that those unemployed for less than 5 weeks could find a job in 2012 than they could in 2007. The same goes for the long-term unemployed.

This pushes back against recent research by Rand Ghayad and William Dickens of the Boston Fed. They dissagregate the Beveridge Curve by duration, arguing that our problems are primarily concentrated among the long-term unemployed. However, they are likely just picking up on changes in the long-term distribution of the unemployed (which, as noted above, has been collapsing since June 2012, when their data ends), rather than strictly structural elements. Looking at the labor market through the graph above, we can see that it is generally weak, which is not just a function of the long-term unemployed.

Is duration falling because the unemployed are simply dropping out of the labor force? Here's the transition from unemployment to no longer in the labor force, or the liklihood of the unemployed simply dropping out, comparing the pre-crisis time period and today:

Compared to before the recession, the long-term unemployed are less likely to drop out of the labor force. People are still looking for jobs, though a little less in 2012 than in 2011. That said, there wasn't a large pickup in this rate in 2012, so it is unlikely to be the primary driver in the drop of unemployment duration.

Rob Valletta of the Federal Reserve Bank of San Francisco just put out an economic letter on the long-term unemployed. He does the actual work of parsing out weekly transitions from the CPS data and finds this transition, the same dyanmic noted above.

If you break it down by month and look at it over a longer timeframe, it still has the same result. The labor market is depressed for everyone, not just a select group.

Notice the bump out at month 20 for the recovery period, where it actually goes above the expansionary period. Though it isn't clear what is driving this, it is likely both a function of an improving job market as well as people no longer qualifying for unemployment insurance. Unemployment insurance pulls in several directions then. It increases duration both through encouraging longer searches with better matches by providing liquidity. It provides stimulus to the economy, while also keeping people from leaving the labor force and giving up on their searches entirely.

Valletta also finds that "for most categories of workers, the share of long-term unemployment differs little from the share of short-term unemployment." There are some exceptions, notably younger workers. However, the long-term unemployed aren't a dumping ground for certain types of workers; it reflects a general malaise in the labor market.

This isn't to downplay the serious issues of long-term unemployment. The long-term unemployed do have a harder time finding jobs. But the best cure for this situation is to broadly boost the economy through fiscal and monetary stimulus while dealing with the housing market, rather than transitioning to either targeted job policy or deficit reduction.

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Why the Republican CFPB Arguments Are Wrong

Feb 5, 2013Mike Konczal

It's been almost two years, and the GOP still refuses to approve a Consumer Financial Protection Bureau (CFPB) director without a significant overhaul of the agency. Check out Adam Serwer at Mother Jones as well as Jennifer Bendery at Huffington Post for more on this story. Forty-three Republican Senators signed a letter last week, one that is almost exactly the same as the one they signed in July 2011, blocking Cordray's nomination because they want major legislative changes to Dodd-Frank and the CFPB.

As congressional scholar Thomas Mann told Jonathan Cohn, this should be viewed as a form of modern day nullification. Dodd-Frank is the law of the land. Congress legitimately passed this law containing a CFPB designed to have certain features. Even though the GOP doesn't like it doesn't mean they can sabotage it or prevent it from working. And the CFPB needs a director to work.

The letter features a high-level complaint along with three specific changes they want. Beyond the letter, these three points are so common on the right that it is probably useful to point out that they are wrong. This is drawn from Adam Levitin's Congressional testimony on the matter as well as other CFPB analysis over the years. Bold is from the letter.

"...we have serious concerns about the lack of congressional oversight of the agency and the lack of normal, democratic checks on its sole director, who would wield nearly unprecedented powers."
 
The CFPB must regularly make reports and appear before Congress. The CFPB is subject to a veto of its actions by other financial regulators as represented by the Financial Stability Oversight Council (FSOC), a completely unique accountability feature that does not apply to any other regulators. The CFPB is subject to an annual audit by the GAO, which is then turned over to Congress, another unique form of accountability. It is also subject to the Small Business Regulatory Enforcement Fairness Act of 1996 (SBREFA), a feature of OIRA that doesn't apply to other financial regulators.
 
The CFPB is also limited in its actions by the text of Dodd-Frank itself. It can't mandate the offering of any financial product, force the extension of credit, regulate non-financial businesses, require businesses to offer products or credit, impose usury caps, or force consumers to take products. See, among other places, Section 1027 of Dodd-Frank for further restrictions. If you'd like to go further, you can see a list of 19 ways the CFPB is accountable here. Rather than having unprecedented powers, this agency is as accountable and has more checks than any other federal financial regulator.
 
"We again urge the adoption of the following [three] reforms:
 
1. Establish a bipartisan board of directors to oversee the Consumer Financial Protection Bureau."
 
The Office of the Comptroller of the Currency (OCC) and the former Office of Thrift Supervision (OTS), both federal financial regulators, both have single directors, so this is neither odd nor unprecedented. Some other agencies have boards, like the FDIC. There are some reasons to use one model over the other, but the GOP is not making a clear case for why a board of directors is superior to a sole director, much less a case sufficient to justify nullifying parts of Dodd-Frank. A single director encourages direct action, streamlined agency, and more accountability. Given what we've seen in the past 10 years with subprime, action is better than inaction.
 
Five directors can blame each other when things go wrong. Given the concern over accountability in the GOP's letter, a single director strikes me as the right way to go. There's more on oversight here.
 
"2. Subject the Bureau to the annual appropriation process, similar to other federal regulators."
 
Other federal banking regulators have their own independent budgets and are not subject to the appropriations process. The OCC, the FDIC, and the former OTS get their budgets from assessments from the financial institutions they regulate. The CFPB gets its budget from the Federal Reserve in order to avoid the capture that comes with being dependent on industry assessments. However, unlike those institutions, the CFPB has a statutory budgetary cap of 12 percent of the Federal Reserve's budget.

Congress consciously decided to fund the CFPB this way to prevent them from subjecting the important work that needs to be done to the annual appropriations process. This is normal in financial regulation and appropriate for the CFPB. You can read more about how this funding is designed to take the political economy of regulation into account here.

"3. Establish a safety-and-soundness check for the prudential regulators."
 
There is already a safety-and-soundness check at the OCC, which, through the FSOC, can vote on vetoing CFPB actions. Beyond that, safety-and-soundness is often synonymous with profit-making. The broken servicing model at the largest banks, for instance, is an abuse-ridden disaster for borrowers and lenders, but they are profitable activities that, de facto, boost the banks' safety-and-soundness via profits. The CFPB is meant to be a balance against this regulatory impulse. This was debated at length during the Dodd-Frank process, and Congress still decided to mandate the CFPB with its current mission.
 
Immediately after Obamacare passed, conservative David Frum argued, in a now famous piece called "Waterloo," that the GOP could have turned the bill into one far more favorable for conservatives with just a few GOP votes. But they didn't, and now they are stuck with a law they hate. The same dynamic is true for Dodd-Frank. If a dozen Senators and House GOP members decided to make a bipartisan bill in 2009, they could have likely gotten a CFPB that they would like better. But they didn't. And now they want to retroactively try and get that bill they chose not to enact.
 
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It's been almost two years, and the GOP still refuses to approve a Consumer Financial Protection Bureau (CFPB) director without a significant overhaul of the agency. Check out Adam Serwer at Mother Jones as well as Jennifer Bendery at Huffington Post for more on this story. Forty-three Republican Senators signed a letter last week, one that is almost exactly the same as the one they signed in July 2011, blocking Cordray's nomination because they want major legislative changes to Dodd-Frank and the CFPB.

As congressional scholar Thomas Mann told Jonathan Cohn, this should be viewed as a form of modern day nullification. Dodd-Frank is the law of the land. Congress legitimately passed this law containing a CFPB designed to have certain features. Even though the GOP doesn't like it doesn't mean they can sabotage it or prevent it from working. And the CFPB needs a director to work.

The letter features a high-level complaint along with three specific changes they want. Beyond the letter, these three points are so common on the right that it is probably useful to point out that they are wrong. This is drawn from Adam Levitin's Congressional testimony on the matter as well as other CFPB analysis over the years. Bold is from the letter.

"...we have serious concerns about the lack of congressional oversight of the agency and the lack of normal, democratic checks on its sole director, who would wield nearly unprecedented powers."
 
The CFPB must regularly make reports and appear before Congress. The CFPB is subject to a veto of its actions by other financial regulators as represented by the Financial Stability Oversight Council (FSOC), a completely unique accountability feature that does not apply to any other regulators. The CFPB is subject to an annual audit by the GAO, which is then turned over to Congress, another unique form of accountability. It is also subject to the Small Business Regulatory Enforcement Fairness Act of 1996 (SBREFA), a feature of OIRA that doesn't apply to other financial regulators.
 
The CFPB is also limited in its actions by the text of Dodd-Frank itself. It can't mandate the offering of any financial product, force the extension of credit, regulate non-financial businesses, require businesses to offer products or credit, impose usury caps, or force consumers to take products. See, among other places, Section 1027 of Dodd-Frank for further restrictions. If you'd like to go further, you can see a list of 19 ways the CFPB is accountable here. Rather than having unprecedented powers, this agency is as accountable and has more checks than any other federal financial regulator.
 
"We again urge the adoption of the following [three] reforms:
 
1. Establish a bipartisan board of directors to oversee the Consumer Financial Protection Bureau."
 
The Office of the Comptroller of the Currency (OCC) and the former Office of Thrift Supervision (OTS), both federal financial regulators, both have single directors, so this is neither odd nor unprecedented. Some other agencies have boards, like the FDIC. There are some reasons to use one model over the other, but the GOP is not making a clear case for why a board of directors is superior to a sole director, much less a case sufficient to justify nullifying parts of Dodd-Frank. A single director encourages direct action, streamlined agency, and more accountability. Given what we've seen in the past 10 years with subprime, action is better than inaction.
 
Five directors can blame each other when things go wrong. Given the concern over accountability in the GOP's letter, a single director strikes me as the right way to go. There's more on oversight here.
 
"2. Subject the Bureau to the annual appropriation process, similar to other federal regulators."
 
Other federal banking regulators have their own independent budgets and are not subject to the appropriations process. The OCC, the FDIC, and the former OTS get their budgets from assessments from the financial institutions they regulate. The CFPB gets its budget from the Federal Reserve in order to avoid the capture that comes with being dependent on industry assessments. However, unlike those institutions, the CFPB has a statutory budgetary cap of 12 percent of the Federal Reserve's budget.

Congress consciously decided to fund the CFPB this way to prevent them from subjecting the important work that needs to be done to the annual appropriations process. This is normal in financial regulation and appropriate for the CFPB. You can read more about how this funding is designed to take the political economy of regulation into account here.

"3. Establish a safety-and-soundness check for the prudential regulators."
 
There is already a safety-and-soundness check at the OCC, which, through the FSOC, can vote on vetoing CFPB actions. Beyond that, safety-and-soundness is often synonymous with profit-making. The broken servicing model at the largest banks, for instance, is an abuse-ridden disaster for borrowers and lenders, but they are profitable activities that, de facto, boost the banks' safety-and-soundness via profits. The CFPB is meant to be a balance against this regulatory impulse. This was debated at length during the Dodd-Frank process, and Congress still decided to mandate the CFPB with its current mission.
 
Immediately after Obamacare passed, conservative David Frum argued, in a now famous piece called "Waterloo," that the GOP could have turned the bill into one far more favorable for conservatives with just a few GOP votes. But they didn't, and now they are stuck with a law they hate. The same dynamic is true for Dodd-Frank. If a dozen Senators and House GOP members decided to make a bipartisan bill in 2009, they could have likely gotten a CFPB that they would like better. But they didn't. And now they want to retroactively try and get that bill they chose not to enact.
 
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Republican with tie image via Shutterstock.com.

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Live at the American Prospect: On the Treasury's Second Term Financial Reform Agenda

Feb 4, 2013Mike Konczal

I have a new piece at The American Prospect, on what Treasury will need to do in the 2nd term when it comes to financial reform:

Nevertheless, the Treasury secretary will be responsible for the overhaul of the legal and regulatory framework that governs the financial sector. The incoming Treasury secretary will have three chief responsibilities: complete the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act, determine how many of the new parts will work together going forward, and parry with congressional efforts to repeal parts of that law.

I hope you check it out.

I have a new piece at The American Prospect, on what Treasury will need to do in the 2nd term when it comes to financial reform:

Nevertheless, the Treasury secretary will be responsible for the overhaul of the legal and regulatory framework that governs the financial sector. The incoming Treasury secretary will have three chief responsibilities: complete the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act, determine how many of the new parts will work together going forward, and parry with congressional efforts to repeal parts of that law.

I hope you check it out.

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How is Inequality Holding Back the Recovery?

Feb 4, 2013Mike Konczal

Is inequality holding back our weak recovery? Joe Stiglitz argues it is, while Paul Krugman argues it is not. John Judis summarizes the debate at The New RepublicI want to rephrase the question and focus specifically on the two most relevant policy points.

Taxes: Stiglitz argues, "[T]he weakness of the middle class is holding back tax receipts, especially because those at the top are so adroit in avoiding taxes and in getting Washington to give them tax breaks." 
 
Right now our federal government's tax structure is progressive, while state and local taxes are regressive. Meanwhile, the federal government can borrow at cheap rates and run a large deficit without a problem, while state budgets are constrained and need to be balanced. As a result, large cuts and layoffs at the state and local level have counteracted much of the federal government's stimulus that comes from running a larger deficit. Indeed, Stiglitz's point that inequality makes it harder to fund education is a real life battle: we are currently seeing education funding by state and local governments collapsing in real-time.
 
Here's a chart on how regressive state and local taxes are from the Institute on Taxation & Economic Policy:

When it comes to state and local taxes, the top 1 percent pays 6.4 percent, the middle 20 percent pays 9.7, while the poorest 20 percent of families pay 10.9 percent. This isn't counting user fees, though a CEO with 300 times the income of a worker probably doesn't get 300 times as many drivers' licenses.
 
So, all things being equal, less inequality would mean less revenue for the federal government and more for state and local governments. Since a good plan for boosting demand would entail the federal government collecting less revenue (an extension of the payroll tax cut would have boosted demand) and state and local governments collecting more revenue and thus facing less austerity, less inequality would net provide more stimulus. I doubt it would matter that much, though it's an empirical matter on just how much it would provide.
 
Spending: The other debate has to do with the marginal propensity to consume. Evidence does find the rich are less likely to spend money on consumption than everyone else, and in a liquidity trap this matters. Steve Waldman at Interfluidity has a larger theory on why it has mattered over the past decades, but I want to focus on the complicating, narrow issue of wealth inequality.
 
A graph by Amir Sufi, using Federal Reserve data, shows a collapse in the median net worth of households, and his research and others finds that this is a driver of the collapse in demand:

Meanwhile, precautionary savings are still a problem.
 
So, all things being equal, what happens if we decrease inequality in a balance-sheet recession? I see two changes running in opposite directions. You could see an increase in spending by the median household, as they have a higher propensity to spend, plus more income could relieve their balance-sheet constraints. However, if more middle-class households have more of the country's income, they may save it even more aggressively; this would amplify the Paradox of Thrift and make the recession worse in the short term. It's not clear which of these effects would dominate over the other.
 
One way to deal with this is to boost net wealth while keeping incomes consistent, via debt forgiveness or reform our legal mechanisms like bankruptcy so they can handle allocating these losses, though that doesn't seem to be in the cards.
 
Follow or contact the Rortybomb blog:
  

 

Is inequality holding back our weak recovery? Joe Stiglitz argues it is, while Paul Krugman argues it is not. John Judis summarizes the debate at The New RepublicI want to rephrase the question and focus specifically on the two most relevant policy points.

Taxes: Stiglitz argues, "[T]he weakness of the middle class is holding back tax receipts, especially because those at the top are so adroit in avoiding taxes and in getting Washington to give them tax breaks." 
 
Right now our federal government's tax structure is progressive, while state and local taxes are regressive. Meanwhile, the federal government can borrow at cheap rates and run a large deficit without a problem, while state budgets are constrained and need to be balanced. As a result, large cuts and layoffs at the state and local level have counteracted much of the federal government's stimulus that comes from running a larger deficit. Indeed, Stiglitz's point that inequality makes it harder to fund education is a real life battle: we are currently seeing education funding by state and local governments collapsing in real-time.
 
Here's a chart on how regressive state and local taxes are from the Institute on Taxation & Economic Policy:

When it comes to state and local taxes, the top 1 percent pays 6.4 percent, the middle 20 percent pays 9.7, while the poorest 20 percent of families pay 10.9 percent. This isn't counting user fees, though a CEO with 300 times the income of a worker probably doesn't get 300 times as many drivers' licenses.
 
So, all things being equal, less inequality would mean less revenue for the federal government and more for state and local governments. Since a good plan for boosting demand would entail the federal government collecting less revenue (an extension of the payroll tax cut would have boosted demand) and state and local governments collecting more revenue and thus facing less austerity, less inequality would net provide more stimulus. I doubt it would matter that much, though it's an empirical matter on just how much it would provide.
 
Spending: The other debate has to do with the marginal propensity to consume. Evidence does find the rich are less likely to spend money on consumption than everyone else, and in a liquidity trap this matters. Steve Waldman at Interfluidity has a larger theory on why it has mattered over the past decades, but I want to focus on the complicating, narrow issue of wealth inequality.
 
A graph by Amir Sufi, using Federal Reserve data, shows a collapse in the median net worth of households, and his research and others finds that this is a driver of the collapse in demand:

Meanwhile, precautionary savings are still a problem.
 
So, all things being equal, what happens if we decrease inequality in a balance-sheet recession? I see two changes running in opposite directions. You could see an increase in spending by the median household, as they have a higher propensity to spend, plus more income could relieve their balance-sheet constraints. However, if more middle-class households have more of the country's income, they may save it even more aggressively; this would amplify the Paradox of Thrift and make the recession worse in the short term. It's not clear which of these effects would dominate over the other.
 
One way to deal with this is to boost net wealth while keeping incomes consistent, via debt forgiveness or reform our legal mechanisms like bankruptcy so they can handle allocating these losses, though that doesn't seem to be in the cards.
 
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Is the Right Shifting Course on Dodd-Frank?

Feb 4, 2013Mike Konczal

During the 2012 election, conservatives' main goal was to either repeal Dodd-Frank completely or remove such large sections of it that it was a completely different bill. There was very little engagement with the content of Dodd-Frank itself and how to make them work better. One important example was Republican candidates like Jon Huntsman calling for bold new financial reforms that were already part of Dodd-Frank

It now appears that the flagship policy journal on the right, National Affairs, is moving towards a reform rather than replace agenda for Dodd-Frank and financial reform. The latest issue featured an large, 7,000+ word article, "Against Casino Finance," by Eric Posner and E. Glen Weyl of University of Chicago law school. What's fascinating about the piece is less the authors' counter proposals for reform, which are lacking, than the fact that they accept two of the ideas put forward by financial reformers that have generally been resisted on the right. The first is that derivatives require regulation and the second is that prudential regulation of the largest systemically risky financial firms is necessary.

Let's take those in order. First the authors argue, "[I]n today's derivatives market...no such sensible restriction exists to separate the use of the instruments as insurance from their use as gambling devices." They describe these instruments as "pure gambling," or a transaction in which "one party loses exactly what the other party gains, and both are made worse off by the additional risk they take on in this bargain." They argue that these instruments can increase pure risks and are zero-sum, differentiating them from other trades. They go as far as to argue against the Commodity Futures Modernization Act of 2000.

It isn't clear what they think of the general Dodd-Frank approach to derivatives, which emphasizes transparency through exchanges and clearinghouses, capital adequacy, private enforcement, and regulation of intermediaries. Their focus is partially on the "insurable interest doctrine" of common law as it relates to insurance, which requires that a party to an insurance contract have a stake in the event. If you can't buy fire insurance on your neighbor's house, why can you buy credit insurance on his business if you don't have an ownership claim on it? That's a dog whistle for either banning so-called "naked" derivatives or running them under state-level insurance law. The vote to ban naked credit default swaps, proposed in the Senate by Bryan Dorgan, failed (and was generally opposed on the right). 

The other regulations relate to bailouts and prudential regulations. As they put it:

When banks fail, the government must act as lender of last resort.

Today, the government serves this role in two ways. First, it compels banks to buy government-supplied deposit insurance, which covers depositors up to $250,000. Second, it provides emergency loans at below-market rates -- bailouts -- to any financial institution whose collapse would take down enough banks with it to endanger the entire economy.

Few seriously doubt that governments must play this role.

Bagehot’s rule is usually summarized as, “Lend without limit, to solvent firms, against good collateral, at high rates." In exchange for this, certain regulations are necessary. Dodd-Frank includes higher capital and liquidity requirements for larger and riskier firms, as well as certain organizational requirements (loosely referred to under the term "living wills") to help with collapsing the company in question via FDIC's resolution powers.

Again, it would be interesting if they addressed the specific reforms to lender of last resort functions included in Dodd-Frank, or the combination of regulation and resolution. Section 13(3) of the Federal Reserve Act was amended so that "any emergency lending program or facility is for the purpose of providing liquidity to the financial system, and not to aid a failing financial company." and any such lending program has to have "broad-based eligibility.” Some have argued this is too loose to deal with a liquidity crisis. Do these authors agree? Are the regulations and FDIC's resolution powers sufficient in this case, or do we need a different approach?

Their specific recommendations for how the right should tackle Dodd-Frank, which is the last third of the piece, involve applying stricter cost-benefit analysis to all rules. There's no talk about repeal, or huge changes to the framework, or long court battles. Cost-benefit has significant problems, but that's a debate for another day. Conceptually, it is tinkering with Dodd-Frank rather than repealing it, which has dominated the conversation on the right. Will this signal a larger change?

Follow or contact the Rortybomb blog:

  

During the 2012 election, conservatives' main goal was to either repeal Dodd-Frank completely or remove such large sections of it that it was a completely different bill. There was very little engagement with the content of Dodd-Frank itself and how to make them work better. One important example was Republican candidates like Jon Huntsman calling for bold new financial reforms that were already part of Dodd-Frank

It now appears that the flagship policy journal on the right, National Affairs, is moving towards a reform rather than replace agenda for Dodd-Frank and financial reform. The latest issue featured an large, 7,000+ word article, "Against Casino Finance," by Eric Posner and E. Glen Weyl of University of Chicago law school. What's fascinating about the piece is less the authors' counter proposals for reform, which are lacking, than the fact that they accept two of the ideas put forward by financial reformers that have generally been resisted on the right. The first is that derivatives require regulation and the second is that prudential regulation of the largest systemically risky financial firms is necessary.

Let's take those in order. First the authors argue, "[I]n today's derivatives market...no such sensible restriction exists to separate the use of the instruments as insurance from their use as gambling devices." They describe these instruments as "pure gambling," or a transaction in which "one party loses exactly what the other party gains, and both are made worse off by the additional risk they take on in this bargain." They argue that these instruments can increase pure risks and are zero-sum, differentiating them from other trades. They go as far as to argue against the Commodity Futures Modernization Act of 2000.

It isn't clear what they think of the general Dodd-Frank approach to derivatives, which emphasizes transparency through exchanges and clearinghouses, capital adequacy, private enforcement, and regulation of intermediaries. Their focus is partially on the "insurable interest doctrine" of common law as it relates to insurance, which requires that a party to an insurance contract have a stake in the event. If you can't buy fire insurance on your neighbor's house, why can you buy credit insurance on his business if you don't have an ownership claim on it? That's a dog whistle for either banning so-called "naked" derivatives or running them under state-level insurance law. The vote to ban naked credit default swaps, proposed in the Senate by Bryan Dorgan, failed (and was generally opposed on the right). 

The other regulations relate to bailouts and prudential regulations. As they put it:

When banks fail, the government must act as lender of last resort.

Today, the government serves this role in two ways. First, it compels banks to buy government-supplied deposit insurance, which covers depositors up to $250,000. Second, it provides emergency loans at below-market rates -- bailouts -- to any financial institution whose collapse would take down enough banks with it to endanger the entire economy.

Few seriously doubt that governments must play this role.

Bagehot’s rule is usually summarized as, “Lend without limit, to solvent firms, against good collateral, at high rates." In exchange for this, certain regulations are necessary. Dodd-Frank includes higher capital and liquidity requirements for larger and riskier firms, as well as certain organizational requirements (loosely referred to under the term "living wills") to help with collapsing the company in question via FDIC's resolution powers.

Again, it would be interesting if they addressed the specific reforms to lender of last resort functions included in Dodd-Frank, or the combination of regulation and resolution. Section 13(3) of the Federal Reserve Act was amended so that "any emergency lending program or facility is for the purpose of providing liquidity to the financial system, and not to aid a failing financial company." and any such lending program has to have "broad-based eligibility.” Some have argued this is too loose to deal with a liquidity crisis. Do these authors agree? Are the regulations and FDIC's resolution powers sufficient in this case, or do we need a different approach?

Their specific recommendations for how the right should tackle Dodd-Frank, which is the last third of the piece, involve applying stricter cost-benefit analysis to all rules. There's no talk about repeal, or huge changes to the framework, or long court battles. Cost-benefit has significant problems, but that's a debate for another day. Conceptually, it is tinkering with Dodd-Frank rather than repealing it, which has dominated the conversation on the right. Will this signal a larger change?

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Morning Joe vs. the Barbell

Jan 29, 2013Mike Konczal

Paul Krugman was on Morning Joe yesterday, where he was peppered with questions about why he and other liberal economists aren't obsessed with long-term debt as a more pressing, or at least equally pressing, problem compared to mass unemployment. Joe Scarborough wrote a follow-up editorial implying that Krugman's opinion is isolated among economists without citing any actual economists. In response, Joe Weisenthal created a list of economists of varying backgrounds and political persuasions who agree with Krugman.

The segment focused on the idea that the only way to do stimulus is if we also do long-term cuts at the same time.

Some quotes to give a feel:

Joe Scarborough, 8m20s: "Medicare, Medicaid, health care costs, the defense budget, long-term drivers of a long-term debt... I say you can do two things at the same time."

Ed Rendel, 12m23s, 15m49s: "I don't think any of these things are mutually exclusive... I think we can [invest in infrastructure] while at the same time taking care of the long-term... Simpson-Bowles said we can do both. We can stretch out our debt reduction over a course of time and at the same time do some things that will spur the economy."

Joe Scarborough: "Won't that send a good message to the markets if we say, 'Hey listen, here's the deal. We are going to take care of what we have to do in the short term to get people back to work, but in the long term we are taking care of the long-term structure'?"

This is often referred to as a "barbell strategy" (from a Peter Orzag column). Do stimulus, do long-term deficit reduction, but only if you can do them together. As mentioned by the panelists, this is part of several bipartisan debt reduction strategies. Here's Domenici-Rivlin's Restoring America's Future Plan: "First, we must recover from the deep recession that has thrown millions out of work... Second, we must take immediate steps to reduce the unsustainable debt... These two challenges must be addressed at the same time, not sequentially."

It's weird that nobody on Morning Joe seems to understand the obvious problems with this strategy, so let's make a list.

1. There is no solid economic argument for this. There may be political arguments, as in that's the only way to build a coalition to get legislation through a partisan Congress, but they are just that, political. There's no decent economic argument for why if stimulus is a good idea, and long-term deficit reduction is a good idea, that you need to do both at the same time.

Scarborough's argument that "this would send a good message to the markets" implies that interest rates are a constraint, when instead they've been at ultra-low rates. It also seems to imply that additional stimulus would send the markets into a panic. It is true that if we passed a stimulus program interest rates could rise, but this would reflect the market thinking things were getting better, not worse.

2. The political argument for this is also weak, if only because it was the operative strategy over the past several years and didn't work. President Obama just tried to get some $225 billion dollars in stimulus in the fiscal cliff and looked to be willing to accept cuts in the inflation adjustments for Social Security as part of the package. Republicans turned this down. This stimulus was first proposed a year earlier in his American Jobs Act, which, as he told Congress, would be paid for by offsetting long-term budgets. This was dead on arrival.

And it is easy to see why. You can probably get some agreement on the content of a stimulus package, but to get a agreement on long-term deficit reduction, you would need the GOP to accept some new revenues or clarify what it wants on social insurance. It won't do the first outside constructed scenarios like the fiscal cliff and the latter has yet to happen.

3. As for the short term, alleviating unemployment is the most responsible budget action even though it increases the short-term deficit. Austerity is likely to give us a higher debt-to-GDP problem if it causes a double-dip recession. Our current deficit is so large because so many people are not working; more economic activity would mean more things to tax and fewer stablizers like unemployment insurance to pay for.

As Delong and Summers argue, additional fiscal stimulus in a depressed economy can largely offset its own costs. Or as John Maynard Keynes said in 1933, "It is the burden of unemployment and the decline in the national income which are upsetting the Budget. Look after the unemployment, and the Budget will look after itself."

4. As for the part of the budget that won't take care of itself, President Obama fought an ugly and costly battle to bend the cost curve of health care, in which he was accused of everything from creating death panels to looting benefits of seniors in order to pass them out to his army of Takers. Since he's already paid that price, why wouldn't he wait and see how well Medicare cost saving techniques work?

Maybe it's just me, but I find the "if you want to see full employment again, immediately dismantle some social insurance" to be like a form of ransom. Meanwhile millions of people are suffering needlessly as a result of the lack of action.

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Paul Krugman was on Morning Joe yesterday, where he was peppered with questions about why he and other liberal economists aren't obsessed with long-term debt as a more pressing, or at least equally pressing, problem compared to mass unemployment. Joe Scarborough wrote a follow-up editorial implying that Krugman's opinion is isolated among economists without citing any actual economists. In response, Joe Weisenthal created a list of economists of varying backgrounds and political persuasions who agree with Krugman.

The segment focused on the idea that the only way to do stimulus is if we also do long-term cuts at the same time.

Some quotes to give a feel:

Joe Scarborough, 8m20s: "Medicare, Medicaid, health care costs, the defense budget, long-term drivers of a long-term debt... I say you can do two things at the same time."

Ed Rendel, 12m23s, 15m49s: "I don't think any of these things are mutually exclusive... I think we can [invest in infrastructure] while at the same time taking care of the long-term... Simpson-Bowles said we can do both. We can stretch out our debt reduction over a course of time and at the same time do some things that will spur the economy."

Joe Scarborough: "Won't that send a good message to the markets if we say, 'Hey listen, here's the deal. We are going to take care of what we have to do in the short term to get people back to work, but in the long term we are taking care of the long-term structure'?"

This is often referred to as a "barbell strategy" (from a Peter Orzag column). Do stimulus, do long-term deficit reduction, but only if you can do them together. As mentioned by the panelists, this is part of several bipartisan debt reduction strategies. Here's Domenici-Rivlin's Restoring America's Future Plan: "First, we must recover from the deep recession that has thrown millions out of work... Second, we must take immediate steps to reduce the unsustainable debt... These two challenges must be addressed at the same time, not sequentially."

It's weird that nobody on Morning Joe seems to understand the obvious problems with this strategy, so let's make a list.

1. There is no solid economic argument for this. There may be political arguments, as in that's the only way to build a coalition to get legislation through a partisan Congress, but they are just that, political. There's no decent economic argument for why if stimulus is a good idea, and long-term deficit reduction is a good idea, that you need to do both at the same time.

Scarborough's argument that "this would send a good message to the markets" implies that interest rates are a constraint, when instead they've been at ultra-low rates. It also seems to imply that additional stimulus would send the markets into a panic. It is true that if we passed a stimulus program interest rates could rise, but this would reflect the market thinking things were getting better, not worse.

2. The political argument for this is also weak, if only because it was the operative strategy over the past several years and didn't work. President Obama just tried to get some $225 billion dollars in stimulus in the fiscal cliff and looked to be willing to accept cuts in the inflation adjustments for Social Security as part of the package. Republicans turned this down. This stimulus was first proposed a year earlier in his American Jobs Act, which, as he told Congress, would be paid for by offsetting long-term budgets. This was dead on arrival.

And it is easy to see why. You can probably get some agreement on the content of a stimulus package, but to get a agreement on long-term deficit reduction, you would need the GOP to accept some new revenues or clarify what it wants on social insurance. It won't do the first outside constructed scenarios like the fiscal cliff and the latter has yet to happen.

3. As for the short term, alleviating unemployment is the most responsible budget action even though it increases the short-term deficit. Austerity is likely to give us a higher debt-to-GDP problem if it causes a double-dip recession. Our current deficit is so large because so many people are not working; more economic activity would mean more things to tax and fewer stablizers like unemployment insurance to pay for.

As Delong and Summers argue, additional fiscal stimulus in a depressed economy can largely offset its own costs. Or as John Maynard Keynes said in 1933, "It is the burden of unemployment and the decline in the national income which are upsetting the Budget. Look after the unemployment, and the Budget will look after itself."

4. As for the part of the budget that won't take care of itself, President Obama fought an ugly and costly battle to bend the cost curve of health care, in which he was accused of everything from creating death panels to looting benefits of seniors in order to pass them out to his army of Takers. Since he's already paid that price, why wouldn't he wait and see how well Medicare cost saving techniques work?

Maybe it's just me, but I find the "if you want to see full employment again, immediately dismantle some social insurance" to be like a form of ransom. Meanwhile millions of people are suffering needlessly as a result of the lack of action.

Follow or contact the Rortybomb blog:

  

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