Category: Equitablog

Things I Won’t Have Time to Say: Rethinking Macro Policy III Conference, Washington D.C., April 15-16

Posted on by Brad DeLong

Rethinking Macro Policy III: Progress or Confusion?

Things I am almost surely not going to have time to say I:

It could have turned out very differently.

It could have been–as those of us who more-or-less hooted Raghu Rajan down at Jackson Hole in August 2005 wrongly thought—-that the money-center universal banks did understand their derivatives books; that asset-price innovation variances did drift up or down with time relatively slowly; that the weak point in the global economy in the mid 2000s was the global imbalance of the US trade deficit, and the possibility that some large bad actor had been selling unhedged dollar puts on a very large scale–not the subprime mortgages on houses built in the desert between Los Angeles and Albuquerque, and the use of securities based on those subprime mortgages as core banking reserves.

It could have been that, after the financial crisis, trust in financial intermediaries would rebuild itself quickly. It was not certain ex ante that trust would remain nonexistent, giving rise to our extraordinary, ludicrous, bizarre, and apparently permanent upward spike in liquidity preference.

It could have been that the North Atlantic’s central banks, even stuck at the zero lower bound on short-term safe nominal interest rates, would have been able to nail market expectations. Markets could have been confident of a rapid return to normalcy in the path of nominal demand. That would have provided cash holders with powerful incentives to spend on real assets. That would have created not the L but rather the U or even the V-shaped recovery that we all wish we had and had had.

It could have been the case that fiscal expansion–even at the zero short-term safe interest-rate nominal bound, even for reserve-currency printing sovereigns–would have proven ineffective, or even counterproductive. It was Karl Smith pointed out to me that in the guts of even the IS-LM model, a principal channel through which fiscal policy expands I+G is via reducing the perceived average riskiness of debt, and thus getting households to hold more debt. It is not guaranteed that a sovereign that issues more debt thereby necessarily reduces the perceived riskiness of the average piece of debt.

But we all go to the blackboard with the economy behalf, rather then the economy we used to think we had.

If Paul Krugman were here, he would say that if he has had an analytical edge since 1995, it was because he stopped taking macro after his class with Jim Tobin, and since 1995 we have been living in Jim Tobin’s world. I will say that if I have had an analytical edge, it would be because my Econ 2410 teacher, Olivier Blanchard, made us spend weeks–it seemed then like months–decoding Lloyd Metzler’s paper, “Wealth, Saving, and the Rate of Interest”, from the early 1950s.

If you had asked me back in 2005 whether the world could possibly turn out to be as “Old Keynesian” as it has turned out to be over the past decade, I would have said: No.

Suppose you had told me back in 2005 that the Federal Reserve was going to take the size of its balance sheet north of $4 trillion in the forthcoming decade. I would have immediately leveraged up as far as I possibly could on nominal debt. I would then have sat back and waited for the inflation to make me rich.

Now there are two possible ways we can respond given how the world has surprised us over the past decade.

We can turn our excellent brains to constructing increasingly implausible rationalizations for why what we thought in 2005 was right after all.

Or we can mark our beliefs to market.

I strongly recommend the second.

That is all I am going to say about fiscal policy in the short run–with the note that these days the “short run” is not the two or three years I used to teach my undergraduates, but rather a period of time that is uncertainly and terrifyingly long.

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U.S. firms’ high debt loads amplified the Great Recession

Posted on by Bridget Ansel

One of the dominant narratives of the Great Recession is the important role of U.S. household debt in the intensity and duration of the economic contraction between the end of 2007 and the middle of 2009, and the subsequent slow recovery. Research by Atif Mian of Princeton University and Amir Sufi of the University of Chicago documents the critical role of accumulating mortgage debt by U.S. households in the subsequent massive pull back in consumption once house prices started to collapse in 2006 and 2007.

Yet U.S. households weren’t the only economic actors adding debt in the years leading up to the Great Recession. New research by Xavier Giroud of the Massachusetts Institute of Technology’s Sloan School of Management and Holger Mueller of the Stern School of Business at New York University shows that the financial leverage of companies was also instrumental to the length and severity of the sharp economic contraction. The new paper , argues that while household debt, as emphasized by Mian and Sufi, is very important to understanding the last recession, the balance sheets of employers were central to the economic downturn as well. As Giroud and Muelle put it, “households do not lay off workers. Firms do.”

The two authors find that the way households responded to the collapse in housing prices mattered, but only in so much as it affected companies as the consumers of their products and services pulled back on consumption. But how that enduring decline in consumer spending affected the large economy through employment trends depends on how firms reacted to this decline. Giroud and Mueller examined that link by looking at the changes in employment by establishment between 2007 and 2009. (A quick reminder: an establishment is a physical location where business is done and a firm can have one or more establishment.)

In short, they find that the establishments of firms that increased their debt load during the years prior to the Great Recession responded to the economic downturn by firing more workers compared to the establishments of low-leveraged firms. The response was so different between the highly indebted firms’ establishments and the more frugal ones that all of the jobs lost due to the collapse in housing prices were at high-leverage firms’ establishments. Furthermore, the communities around the nation with more establishments of high-leveraged firms saw higher employment losses.

One way to interpret Giroud and Mueller’s findings are that these more indebted firms couldn’t access credit during the recession so their only choice in responding to the pull back in consumption was to fire workers. In other words, the tightening of credit markets during the Great Recession played a role to in the large-scale employment losses at the time.

But why did these firms take on so much debt? The authors are silent on that issue, but there are potential reasons for this build-up: leveraged buyouts, share buybacks, or debt-heavy mergers and acquisitions. They could be the reason many firms were unprepared to weather the large shock when it arrived.

A potential lesson to be drawn from this new paper is that the effects of household debt and the tightening of credit markets are more intertwined than economists and policymakers usually consider. The bursting of the housing bubble might have been the primary driver in starting the sequence of events that resulted in the Great Recession, but the credit markets and the balance sheets of firms played an important role in disseminating that huge shock. The role of debt writ large in our economy is quite important after all.

 

 

Must-Read: Adam Ozimek: The New Liberal Consensus Is a Force to Be Reckoned with

Posted on by Brad DeLong

Must-Read: Adam Ozimek: The New Liberal Consensus Is a Force to Be Reckoned with: “Paul Krugman… provides what I think amounts to the basic case…

Low wages… are not the product of inscrutable market forces, but rather choices… connecting rising income inequality with the decline in workers’ bargaining power.

It’s not just Paul Krugman and liberal politicians like Barack Obama and labor secretary Tom Perez embracing this ‘new consensus’ either. Even some centrist economists like Larry Summers and Robert Rubin have been making similar arguments…. This is… a conclusion that is drawn from recent trends in empirical research… Arin Dube and coathors… Justin Wolfers, Adam Posen, Jacob Funk Kirkegaard and others…. An increasing number of pundits and economists who look at the literature on minimum wages and other research on labor markets and conclude that the stronger unions, higher wages, and more labor market regulations are a good idea…. Those who don’t buy the ‘new consensus’, again including myself, have a lot to worry about…. Rebuttals are piecemeal, attacking the minimum wage or unions alone, while the new consensus provides a whole story.  Just as importantly, those voicing dissent are outnumbered…. Nobody else has a very easy-to-tell story right now, or at least those that do have good stories aren’t addressing the recent trends in empirical evidence…. Right now, new liberal consensus proponents have the upper hand in this argument, at the very least rhetorically and certainly in terms of sheer quantity of output and controlling the conversation. Libertarians, conservatives, old fashioned neoliberals, and other liberals who disagree need to do a better job. I suspect there are actually a lot of liberal economists who don’t embrace this new consensus, but we aren’t hearing much from them. This consensus appears to be a big part of Hillary Clinton’s economic agenda, so if there are going to be alternatives now is the time to speak up.

Things to Read on the Evening of April 14, 2015

Posted on by Brad DeLong

Must- and Should-Reads:

Might Like to Be Aware of:

Must-Read: Josh Zumbrun: Is Your Job ‘Routine’? If So, It’s Probably Disappearing

Posted on by Brad DeLong
Is Your Job Routine If So It s Probably Disappearing Real Time Economics WSJ

Must-Read: Josh Zumbrun: Is Your Job ‘Routine’? If So, It’s Probably Disappearing: “The American labor market and middle class was once built on the routine job…

…workers showed up at factories and offices, took their places on the assembly line or the paper-pushing chain, did the same task over and over, and then went home. New research from Henry Siu at the University of British Columbia and Nir Jaimovich from Duke University shows just how much the world of routine work has collapsed…. Over the course of the last two recessions and recoveries, a period beginning in 2001, the economy’s job growth has come entirely from nonroutine work…. Examples of routine manual jobs in their classification system include rules-based and physical tasks, such as factory workers who operate welding or metal-press machines, forklift operators or home appliance repairers. Routine cognitive jobs include tasks done by secretaries, bookkeepers, filing clerks or bank tellers…. Nonroutine manual jobs include occupations like janitors or home-health aides. Finally, nonroutine cognitive jobs include tasks like public relations, financial analysis or computer programming….

In the most recent recession, routine jobs collapsed and simply have not recovered, with employment in both cognitive and manual jobs down by more than 5% if the tasks are mostly routine. “Historically these occupations rebounded,” Mr. Siu said. “It suggests a startling fundamental shift in the way the labor market is behaving.”… In the late 1980s, routine cognitive jobs were held by about 17% of the population and routine manual jobs by about 16%. Today, that’s declined to about 13.5% and 12%…. Mr. Siu and Mr. Jaimovich see no reason the trend would abate…

Note that these jobs are “routine” only in the sense that they involve using the human brain as a cybernetic control processor in a manner that was outside the capability of automatic physical machinery or software until a generation ago. In the words of Adam Smith (who probably garbled the story):

In the first fire-engines, a boy was constantly employed to open and shut alternately the communication between the boiler and the cylinder, according as the piston either ascended or descended. One of those boys, who loved to play with his companions, observed that, by tying a string from the handle of the valve which opened this communication to another part of the machine, the valve would open and shut without his assistance, and leave him at liberty to divert himself with his playfellows. One of the greatest improvements that has been made upon this machine, since it was first invented, was in this manner the discovery of a boy who wanted to save his own labour…

And Siu and Jaimovich seem to have gotten the classification wrong: A home-appliance repair technician is not doing a routine job–those jobs are disappearing precisely because they are not routine, require considerable expertise, are hence expensive, and so swirly swapping out the defective appliance for a new one is becoming more and more attractive.

Must-Read: Wolfgang Münchau: Macroeconomists Need New Tools to Challenge Consensus

Posted on by Brad DeLong

Wolfgang Münchau: Macroeconomists Need New Tools to Challenge Consensus: Secular stagnation–a sharp fall in growth rates lasting a very long time…

…is not something that you can easily square with the current generation of macroeconomic theories and models…. The advent of chronic instability…. The present tools used by mainstream macroeconomists cannot deal with this adequately. New ones are needed. They exist in other disciplines, but to macroeconomists they look as weird today as the abstract stuff looked to mathematicians of the 19th century. For the moment, the traditionalists still rule. They managed to go beyond the ideological turf wars of the 20th century, by taking a leap towards a new generation of economic models that were technically complex–in the sense of 19th century mathematics…. The so-called dynamic stochastic general equilibrium (DSGE) models were…just not able to deal with the shocks we eventually got…. The modern models have at least three questionable features… a single macroeconomic equilibrium… linearity….. Few of these criticisms left a lasting impression on the profession. The mainstream invested a life’s work in developing their DSGE models. They will not let go easily…. My hunch is that, unlike in mathematics, the successful challenge will come from outside the discipline, and that it will be brutal.

Must-Read: Simon Wren-Lewis: Macro Teaching and the Financial Crisis

Posted on by Brad DeLong

Simon Wren-Lewis: Macro Teaching and the Financial Crisis: “We end up with textbooks that still have the completely out of date LM curve at their heart (and associated AD curves, plus Mundell Fleming, and even money multipliers)…

…but additional chapters where the AS curve becomes a Phillips curve, and money targeting gives way to Taylor rules. The student ends up totally confused, if they ever get to those later chapters. And after the financial crisis, a new edition will have a chapter devoted to that crisis, but not much in earlier chapters will change. This is not the case with the third textbook by Wendy Carlin and David Soskice… a complete rewrite of their earlier ‘Macroeconomics: Imperfections, Institutions, and Policies’. Luckily all the features of that earlier book that I really liked are retained… a supply side based on imperfect competition… a core model (the 3 equation model) which dispenses with the LM curve, and replaces it with a ‘monetary rule’ curve… open economy analysis is now fully integrated with the 3 equation model…. But by far the most important change… [is] three chapters on the financial sector… banking… a wedge between the ‘policy’ interest rate and the interest rate relevant for the IS curve…. how the financial system can be a source of instability… the financial crisis of 2008…. Mark Gertler on the back cover writes: ‘This is an exciting new textbook. Overall, it confirms my belief that macroeconomics is alive and well’. That pretty well sums up my reaction.

Today’s Must-Must-Read: Matthew Yglesias: A Chart Obamacare’s Critics Have a Hard Time Explaining

Posted on by Brad DeLong
A chart that Obamacare s fiercest critics will have a hard time explaining Vox

Matthew Yglesias: A Chart Obamacare’s Critics Have a Hard Time Explaining: “The share of Americans who lack health insurance coverage plunged again last quarter…. More than 3 million… went from uninsured to insured over the past quarter…

…way lower than where it was when the company started counting. Every time one of these quarterly reports comes out, I hear from conservatives saying to me that of course a law that mandates the purchase of insurance and then subsidizes it will succeed in getting people health insurance. And I agree! But conservatives didn’t always. A year or two ago, people up and down the food chain from incredibly popular conservative media celebrities to incredibly obscure conservative think tank wonks were making the case that Obamacare wasn’t expanding coverage. Rush Limbaugh… Rich Lowry… an American Enterprise Institute health policy scholar…. A decline in the uninsured rate is, in part, a reflection of the growing strength of the economy and the accelerating pace of job creation…. [But] conservatives also predicted that Obamacare would destroy the economy. In a 2011 press conference, John Boehner used the phrase ‘job killing’ once every two minutes. Then in 2012 we had the best year of job creation since 2005. In 2013 we had an even better year of job creation. Then in 2014, we had an even better year, the best since 1999.

How to bypass U.S. estate taxes

Posted on by Bridget Ansel

Tomorrow is tax day, which comes amid a burgeoning debate around our annual payments to Uncle Sam. One particular fight has broken out this week over the estate tax— which affects only those Americans with estates worth more than $5.43 million per person or $10.86 million per married couple. This means the estates of 99.85 percent of all Americans will not be subject to the estate tax.

What’s more, this debate on estate taxes misses one critical point—that a loophole allows many of those who are wealthy enough to face estate taxes to largely bypass the law altogether. This is done through the clever usage of a complicated tax-preferred savings vehicle called a Grantor Retained Annuity Trust, or GRAT, which those at the tippy top of the U.S. wealth and income ladder use to pass on their estate to heirs without it being subject to the full estate tax.

Here’s a basic description of how GRATs work. The first step for the very wealthy is to place a large amount of assets into a GRAT, with instructions that the entire amount should be returned to them over a specified period of time (two annual payments over two years, for example). Because individuals are not taxed when gifting to themselves, no taxes are levied on the original value of the assets placed in GRATs. Any earnings in excess of the assets originally placed in these GRATs accrue to trusts that are bequeathed to specified beneficiaries.

When the GRAT is first set up, the U.S. Internal Revenue Service gives a “gift value” estimate, based on the IRS “Section 7520 Code,” of how much they expect the assets to increase in value. Once the term of the GRAT expires, the wealthy individual who set up the GRAT, the grantor, will have received the original contribution plus this theoretical interest. In December 2014, the 7520 code was 2 percent. So if an individual created a two-year GRAT in that month and put in $1 million, they should receive back the original $1 million contribution and 2 percent interest via annuity payments through December 2016. Any excess appreciation earned beyond the original contribution and IRS assumed rate of return can be transferred to beneficiaries—estate tax free.

Not surprisingly, many savvy grantors will put assets in GRATS that have a good chance of increasing exponentially more than assumed rate of return set by the IRS. Many of the original Facebook founders, for example, put their pre-IPO Facebook stock into GRATs—and then saw their value increase well beyond the predicted IRS rate. Or consider gambling magnate Sheldon Adelson, who set up GRATs during the Great Recession of 2007-2009 using much of his Las Vegas Sands Corp. stock, which had plummeted in value. Because the stocks’ value rebounded as the U.S. economy recovered, he was able to shelter a half a billion dollars for his heirs, none of which will be taxed.

Even if the initial value of the GRAT does not increase to these degrees,  giving heirs $100,000, let’s say (which, relative to some GRATS, is actually small), grantors can continuously reinvest their money in GRATS again and again until they die. And doing so is court approved. A 2000 U.S. tax court ruling found that Audrey Walton’s (part of Walmart Stores, Inc.’s Walton family) GRAT was indeed legal as long as the grantor is alive. If grantors die during the term of their GRATs, all the assets are indeed subject to the inheritance tax (making a short-term, two-year GRAT a popular option among older grantors).

The Obama administration proposes to discourage such practices by requiring a 10-year minimum term on GRATs, but the probability of enacting any kind of restriction in the current political climate is slim. Very wealthy Americans are not obligated to report how much each GRAT passes on to heirs. But one estimate puts the amount that bypassed the estate tax at $100 billion since 2000.

The estate tax was originally enacted in 1916 in order to break up the oligarchic power base created during the Gilded Age of the late 19th century. The soaring wealth gap was not squashed altogether, although it was greatly diminished in part through the economic transformation instigated by World War II. Yet the estate tax has provided a relatively consistent stream of government revenue ever since. What’s troubling, though, is the loophole’s contribution to today’s widening wealth gap, which is at its highest point since the 1920s.

There is a valid debate to be had over the degree to which the estate tax can help alleviate rising wealth and income inequality in the United States, but it remains somewhat irrelevant if the premise on which that debate is based—the existence and enforcement of an estate tax for the wealthiest families—is far too easy to circumvent through the use of GRATs or other similar loopholes.

 

Things to Read on the Evening of April 13, 2015

Posted on by Brad DeLong

Must- and Should-Reads:

Might Like to Be Aware of: