Swiss National Bank to Adopt a Negative Interest Rate:
“Switzerland is introducing a negative interest rate…
…on deposits held by lenders at its central bank, moving to hold down the value of the Swiss franc amid turmoil in global currency markets and expectations that deflation is at hand. The Swiss National Bank said in a statement from Zurich on Thursday that it would begin charging banks 0.25 percent interest on bank deposits exceeding a certain threshold, effective Jan. 22…
Alan Blinder believes that the “mainstream” is his brand of economics–MIT-Princeton-Berkeley. That economics is, in my view, very sensible about both market failure and government failure, and somewhat sensible (we here at Berkeley being most so) about long-run intellectual strategy. We also have–as the past ten years have taught us–remarkably little influence on policy, either macroprudential or macroeconomic, considering how smart and right we are.
Jeff Madrick and Arnold Packer, on the other hand, believe that the “mainstream” is Chicago-Minnesota-Stanford economics, which is not sensible about market failure, extremely wrongheaded about long-run intellectual strategy, and distressingly influential on issues of economic policy, especially considering how wrong and unwilling to do their proper homework they are.
I guess the next twenty years will show whether we or they were the true mainstream today…
‘What’s the Matter with Economics?’: An Exchange:
“According to both Jeff Madrick and Arnie Packer…
…I claim ‘that except for some right-wingers outside the ‘mainstream’…little is the matter’ with economics…. But it’s not true. I think there is lots wrong…. My review explicitly agreed with Madrick that (a) ideological predispositions infect economists’ conclusions far too much; (b) economics has drifted to the right… and (c) some economists got carried away by the allure of the efficient markets hypothesis.
I also added a few… we economists have failed to convey even the most basic economic principles to the public; and that some of our students turned Adam Smith’s invisible hand into Gordon Gekko’s ‘greed is good.’… the propensity to elevate modeling technique over substance… [and others that] (a) are not germane to policy, (b) are only slightly related to Madrick’s complaints, and (c) are very much ‘inside baseball’ stuff—and hence boring to readers of this Review….
Both Madrick and Queen Elizabeth are right that hardly any economists saw the financial crisis and the ensuing Great Recession coming… not realizing how large the subprime mortgage market had grown… how dodgy the mortgages packaged into mortgage-backed securities were… the crazy quilt of exotic derivatives… not believing that house prices would fall as far as they did…. However, faulty macroeconomic management was not among the causes of the horrors. That… does not exonerate the Fed, whose supervisory and regulatory performance was dreadful. My point is that the Great Moderation… ended because of… an overleveraged, overly complex, and underregulated financial system.
Yes, underregulated—which brings me back to the invisible hand. I thought I had laid this issue to rest by agreeing with Madrick that ‘the Invisible Hand is an approximation, usually not applicable in the real world without significant modification’… [like] antitrust laws, consumer protection, fair labor standards, health and safety regulation, financial regulation, and much more…. Yet Madrick still insists that ‘economists rely on a fairly pure version of the invisible hand most of the time.’ Not us mainstreamers….
Packer’s letter begins, and Madrick’s concludes, by disputing my claim that economists’ influence on policy decisions is greatly exaggerated…. [But] ven today, seventy-eight years after Keynes taught the world how to end recessions, many politicians in many countries refuse to follow his (now very mainstream) advice. That’s not a good show for what Packer calls ‘a powerful force in policy circles.’
:
Too big to resist: Wall Street’s comeback – FT.com:
“It was right to let Citigroup stay in business in 2009…
…even though it was effectively bankrupt. But should it be so much larger than it was six years ago? Is it healthy that Citi lobbyists wrote the clause, almost word for word, that was tucked into last week’s spending bill?
The question answers itself. It also points to two glaring deficiencies that will come back to haunt Washington when the next crisis strikes…. There has been no improvement in Wall Street’s culture–or in Washington’s revolving door habits. Bankers dismiss Elizabeth Warren, the Democratic senator from Massachusetts, as a populist. Perhaps they should listen to Bill Dudley, president of the New York Federal Reserve and a former Goldman Sachs partner….
At some point there will be another Wall Street crisis. It could be a decade away, or maybe next year. Markets run in psychological cycles in which fear gives way to greed and then hangover. Greed is once more in the ascendant. No law can stop the next bomb from detonating. No regulator can foresee it. But they could do much more to be ready for it when it comes. Here Mr Geithner’s moral fundamentalists have a point…
Must- and Shall-Reads:
Should Be Aware of:
:
Quick FOMC Recap:
“In normal times the Federal Reserve moves slowly and methodically…
…Policymakers were apparently concerned that removal of ‘considerable time’ by itself would prove to be disruptive. Instead, they opted to both remove it and retain it: ‘Based on its current assessment, the Committee judges that it can be patient…. The Committee sees this guidance as consistent with its previous statement that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program in October….’
If you thought they would drop ‘considerable time,’ they did. If you thought they would retain ‘considerable time,’ they did. Everyone’s a winner…. The April meeting is still on the table [for a rate increase], although I still suspect that is too early.
Yellen… dismissed falling market-based inflation expectations as reflecting inflation ‘compensation’ rather than expectations… dismissed the disinflationary impulse from oil… indicated that inflation did not need to return to target prior to raising rates, only that the Fed needed to be confident it would continue to trend toward target… unconcerned about the risk of contagion either via Russia or high yield energy debt…. The Federal Reserve… have their eyes set firmly on June… see the accelerating economy and combine that with, as Yellen mentioned, the long lags of monetary policy….
Believe it or not, the Fed is seriously looking at mid-2015 to begin the normalization process. And there is no guarantee that it will be a predictable series of modest rate hikes. As much as you think of the possibility that the hike is delayed, think also of the possibility of 1994.
…of health law critics and the business community, employers are not dropping coverage en masse and steering workers into the federally subsidized plans on the new Obamacare exchanges. In advance of the mandate finally kicking in, many are already increasing the number of employees offered coverage to ensure compliance. ‘The economic reality has changed,’ said Paul Fronstin, a senior associate at the Employee Benefit Resource Institute. Unemployment’s below 6 percent, down from the double-digit days in which the mandate was first debated. ‘Employers are remembering why they offered benefits in the first place–to compete for workers.’
The mandate is the Affordable Care Act’s last big piece of coverage expansion to be put into place. The Obama administration twice delayed it in the face of furious lobbying by the business community and repeated votes by the House to kill it…. ‘As we’ve gone along, I think there are other factors that have come into play – employee morale, retention of managers,’ said Michelle Neblett, director of labor and workforce policy for the National Restaurant Association. ‘I don’t hear people talking about dropping coverage, I hear about people figuring out how to afford to offer coverage.’…
…whose assumptions are known to be false[?]… Economists feel that they learn a great deal from such exercises…. Economists often analyze models that are ‘theoretical cases’, which help understand economic problems by drawing analogies between the model and the problem…. Models… data, experimental results, and other sources of knowledge… all provide cases to which a given problem can be compared. We offer complexity arguments that explain why case-based reasoning may sometimes be the method of choice and why economists prefer simple cases…
If someone handed you $10 right now, what would you do with it? Would you decide to spend it right away? Or would you stash it away? Or some combination of the two? The answer to that question would in part reveal your marginal propensity to consume, or MPC for short. This statistic goes a long way toward understanding the consumption behaviors of families. More or less, it tells us how much more spending happens when a household or individual gets more income or wealth. Economists have long debated what determines the marginal propensity to consume and its level to understand changes in demand in the economy.
A new working paper looks at how the amount of wealth inequality can affect the marginal propensity to consume and the resulting implications for policy. The authors, economists Christopher Carroll of Johns Hopkins University, Jiri Slacalek of the European Central Bank, Kiichi Tokuoka of the Japanese Ministry of Finance, and Matthew N. White of the University of Delaware, built a model that tries to replicate the dynamics that determine the amount of wealth inequality in an economy. In figuring out the dynamics that lead to the current levels of wealth inequality in the United States, the model also reveals the marginal propensity to consume among households across the wealth spectrum of the nation.
Carroll and his co-authors find an aggregate MPC, or average MPC for all households, ranging between 0.2 and 0.4. Their estimate is on the high end of other estimates. Their results mean, to return to the question posed above, if I gave you $10, you’d spend between $2 and $4.
Not everyone would spend these extra bucks the same way, of course, because not everyone has the same marginal propensity to consume. The authors find a wide dispersion in the MPC across the wealth distribution. For the most part, less wealthy households have much higher MPCs than wealthier households. But the economists find that the ratio between wealth and income is the key determinant of the MPC.
There are actually quite a few households in their model that have a fair amount of wealth, but a low wealth-to-income ratio, which in turn results in a high marginal propensity to consume. These households may be the “wealthy hand-to-mouth” that economist Greg Kaplan and Justin Weidner, both of Princeton University, and Giovanni L. Violante, of New York University, have written about. In contrast, a household that has a lot of liquid assets, such as investments in the stock market they could easily withdraw, tend to have a much lower MPC.
So what’s the actual real world importance of estimating marginal propensities to consume? Knowing which households are the most likely to spend an extra dollar can help make fiscal policy more effective. According to Carroll and his co-authors, any fiscal stimulus targeted toward individuals in the bottom half of the wealth distribution would be 2 to 3 times more effective than just a blanket stimulus.
Given the high and rising levels of wealth inequality in the United States, this finding should give some guidance to policy makers. Ignoring the distribution of wealth can undermine their ability to get the economy back on track.
This Time, It Is Not Different: The Persistent Concerns of Financial
Macroeconomics:
When the Financial Times’s Martin Wolf asked former U.S. Treasury Secretary Lawrence Summers what in economics had proved useful in understanding the financial crisis and the recession, Summers answered:
There is a lot about the recent financial crisis in Bagehot…
“Bagehot” here is Walter Bagehot’s 1873 book, Lombard Street. How is it that a book written 150 years ago is still state-of-the- art in economists’ analysis of episodes like the one that we hope is just about to end?
There are three reasons:
The first is that modern academic economics has long possessed drives toward analyzing empirical issues that can be successfully treated statistically and theoretical issues that can be successfully modeled on the foundation of individual rationality. But those drives are disabilities in analyzing episodes like major financial crises that come too rarely for statistical tools to have much bite, and for which a major ex post question asked of wealth holders and their portfolios is: “just what were they thinking?”.
The second is that even though the causes of financial collapses like the one we saw in 2007-9 are diverse, the transmission mechanism in the form of the flight to liquidity and/or safety in asset holdings and the consequences for the real economy in the freezing-up of the spending flow and its implications have always been very similar since at least the first proper industrial business cycle in 1825.
Thus a nineteenth-century author like Walter Bagehot is in no wise at a disadvantage in analyzing the downward financial spiral.
The third is that the proposed cures for current financial crises still bear a remarkable family resemblance to those proposed by Walter Bagehot. And so he is remarkably close to the best we can do, even today.
…because I’ve been there…. I had my road-to-Damascus moment… in 1998…. Back in 1998 I… believed that the Bank of Japan could surely end deflation if it really tried. IS-LM said not, but I was sure that if you really worked it through carefully you could show… doubling the monetary base will always raise prices even if you’re at the zero lower bound…. (By the way, I screwed up the aside on fiscal policy. In that model, the multiplier is one.)
To my own surprise, what the model actually said was that when you’re at the zero lower bound, the size of the current money supply does not matter at all…. Doubling the current money supply and all future money supplies will double prices. If the short-term interest rate is currently zero, changing the current money supply without changing future [money] supplies… matters not at all….
As a result, monetary traction is far from obvious. Central banks can change the monetary base now, but can they commit not to undo the expansion in the future, when inflation rises? Not obviously…. But, asks Evans-Pritchard, what if the central bank simply gives households money? Well, that is, as he notes, really fiscal policy…. I’m pretty sure that neither the Fed nor the Bank of England has the legal right to just give money away as opposed to lending it out; if I’m wrong about this, put me down for $10 million, OK?…
I can say that! How liberating!
You are almost surely not at the zero lower bound–in the liquidity trap–because there are few worthwhile investments to be made and so desired saving at full employment exceeds planned investment.
You are almost surely at the zero lower bound–in the liquidity trap–because the credit channel has broken down. Private financial markets can no longer mobilize enough of society’s risk-bearing capacity to keep The keeper risk spreads at reasonable levels. Nobody trusts investment banks and commercial banks to have the skill, competence, and incentives to correctly classify risks and so make win-win Bond sales to savers.
Basically, those who could usefully and profitably borrow and spend is liquidity-constrained. And those who would like to lend do not believe they can distinguish those who could usefully and profitably borrow from those who would simply take the money and run.
But even though private financial markets cannot mobilize risk-bearing capacity–in large part because nobody outside trusts the investment banks that could distinguish between sound and unsound long-run risks to be sound themselves, and so the limits to arbitrage have been reached (see Murphy and Shleifer)–the central bank can.
This is the point of the Bagehot Rule:
[The central bank] must lend to merchants, to minor bankers, to ‘this man and that man’…. In wild periods of alarm, one failure makes many, and the best way to prevent the derivative failures is to arrest the primary failure which causes them…. The ultimate banking reserve of a country (by whomsoever kept) is not kept out of show, but for… meeting a demand for cash caused by an alarm…. [W]e keep that treasure for the very reason that in particular cases it should be lent…. [W]e must keep a great store of ready money always available, and advance out of it very freely in periods of panic, and in times of incipient alarm…. The way to cause alarm is to refuse some one who has good security to offer…. If it is known that the Bank of England is freely advancing on what in ordinary times is reckoned a good security–on what is then commonly pledged and easily convertible–the alarm of the solvent merchants and bankers will be stayed…
Lend freely on “what in ordinary times is reckoned a good security–on what is then commonly pledged and easily convertible”.
This isn’t fiscal policy: once the economy has rebalanced the collateral is “good security” again, so the central bank acquires an asset that is, after the storm is passed and when the sea is calm again, worth more than the money it has lent.
This, however, does enrich those to whom the government lends: they value the cash the government lends to them in the crisis very highly, and so they spend it. The Bagehot rule says that the lending should be done at a “penalty rate”–so that nobody is happy that they had to resort to the discount window, and everybody wishes that they had been more prudent during the previous boom-bubble and had been able to ride out the crisis without support. But lend. This is expansionary. And it is not fiscal policy–the government is not giving money away or spending money by buying assets at prices that worsen its own future fiscal position and raise its debt.
This is what the Treasury and the Fed did during 2008-9 for too-big-to-fail financial institutions–albeit not at a penalty rate: lending to Goldman Sachs at 5% without obtaining any control rights at a time when Warren Buffett was demanding 10%, heavy option kickers, and control rights if things went seriously south was uncool. Lending to a Citigroup that was insolvent under any definition–that still, in spite of its enormous subsidies, has not recovered even 10% of its pre-crisis equity value–without as part of the “penalty rate” claiming 100% of the equity was seriously uncool. Yes: we are looking at you, Paulson, Bernanke, Geithner, Bush, Obama.
But there is no reason why, if the forecast is for continued depression, this policy should stop at too-big-to-fail financial institutions. They are not the only organizations and individuals that are liquidity-contrained by the collapse of the credit channel and the depression. They are not the only places where the Fed can do asset swaps that are truly not fiscal policy–i.e., not a net loss for the Fed given its time horizon–and yet are stimulative.
So: lend to everyone.
Lend to banks.
Lend to auto companies.
If things are bad enough, allow individual households to incorporate themselves as bank holding companies, join the Federal Reserve system, and borrow at the discount window on the security of their cars, their houses, their washing machines.
Do this at a penalty rate so that nobody is happy that they wedged themselves and had to resort to the discount window–which means taking equity-option kickers from individuals and corporations and decapitating the leadership of financial institutions that ought to have known better that find themselves forced to resort to the discount window. But do it.
How effective will such expanded Bagehot-Rule policies be? Are they the credit-channel equivalent of the real balance effect used in the 1940s to claim that Keynesian depressions were not really “equilibria”–a clever theoretical point, of no practical-policy force whatsoever?
I am not sure.
But it would have been really nice if somebody had tried it in 2008-9, so that now we would know.