Should-Read: Stephen Cecchetti and Kim Schoenholtz: The financial crisis, ten years on

Posted on by Brad DeLong

Should-Read: Stephen Cecchetti and Kim Schoenholtz: The financial crisis, ten years on: “The crisis began on 9 August 2007, when BNP Paribas announced they were suspending redemptions… http://voxeu.org/article/financial-crisis-ten-years

In 2007, the US and European financial systems lacked two key shock absorbers: adequate capital to meet falls in asset values, and adequate holdings of high-quality liquid assets to meet temporary liquidity shortfalls. Lacking these, the financial system was vulnerable to even relatively small disturbances, like the BNP Paribas announcement…

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Must-Read: Ben Thompson: Google and The New America Foundation, Google’s Monopoly, Google’s Stupidity

Posted on by Brad DeLong

Must-Read: Best thing I have seen so far on Google, Open Markets, and the New America Foundation:

Ben Thompson: Google and The New America Foundation, Google’s Monopoly, Google’s Stupidity: “From the New York Times… https://stratechery.com/2017/google-and-the-new-america-foundation-googles-monopoly-googles-stupidity/

…The New America Foundation has received more than $21 million from Google; its parent company’s executive chairman, Eric Schmidt; and his family’s foundation… helped to establish New America as an elite voice in policy debates on the American left and helped Google shape those debates. But not long after one of New America’s scholars posted a statement on the think tank’s website praising the European Union’s penalty against Google, Mr. Schmidt, who had been chairman of New America until 2016, communicated his displeasure with the statement to the group’s president, Anne-Marie Slaughter, according to the scholar.

The statement disappeared from New America’s website, only to be reposted without explanation a few hours later. But word of Mr. Schmidt’s displeasure rippled through New America, which employs more than 200 people, including dozens of researchers, writers and scholars, most of whom work in sleek Washington offices where the main conference room is called the “Eric Schmidt Ideas Lab.” The episode left some people concerned that Google intended to discontinue funding, while others worried whether the think tank could truly be independent if it had to worry about offending its donors.

Those worries seemed to be substantiated a couple of days later, when Ms. Slaughter summoned the scholar who wrote the critical statement, Barry Lynn, to her office. He ran a New America initiative called Open Markets that has led a growing chorus of liberal criticism of the market dominance of telecom and tech giants, including Google, which is now part of a larger corporate entity known as Alphabet, for which Mr. Schmidt serves as executive chairman. Ms. Slaughter told Mr. Lynn that “the time has come for Open Markets and New America to part ways,” according to an email from Ms. Slaughter to Mr. Lynn. The email suggested that the entire Open Markets team—nearly 10 full-time employees and unpaid fellows—would be exiled from New America. While she asserted in the email, which was reviewed by The New York Times, that the decision was “in no way based on the content of your work,” Ms. Slaughter accused Mr. Lynn of “imperiling the institution as a whole”…

Slaughter, as part of her statement denying—and I quote, because in cases like this, specific words matter:

that Google lobbied New America to expel the Open Markets program because of this press release”, released three emails sent to Lynn. Slaughter claimed this was in the interest of transparency, but the emails refer to other correspondence that was not released. Not that it matters: the emails are damning, and make clear why Slaughter’s denial was so specifically worded: it seems highly likely the New York Times report is broadly correct…

There is a reason why, as far as I know, I have never quoted a think tank report on Stratechery. It’s not that they don’t do good work, it’s that it is often difficult to know who is paying the bills, and what that entails…. I am very intrigued to see how Open Markets is funded going forward; the obvious route is to find other corporate donors that oppose Google—there are a lot of them!—but for now Open Markets is raising money directly (I will not be contributing for the same conflict of interest reasons that I will not speak at Google). It seems past time for such a group to pursue an individually funded model like this: the Internet has drastically reduced transaction costs, and some percentage of the populace feels strongly about policy outcomes. It will be very interesting to see how this turns out.

All that said, it’s worth noting that nothing Google did here is illegal—nor should it be. It was merely stupid.

GOOGLE’S MONOPOLY: The bigger issue at play goes back to what, in my opinion, is one of the more important articles I’ve written on Stratechery—2016’s Antitrust and Aggregation…. One of the motivations behind Facebook and the Cost of Monopoly was to try to tease out a framework through which these aggregator monopolies might be deemed problematic…. In the U.S. antitrust is very much a political question; the current consumer and price-centric view of antitrust, which completely immunizes “free” services like Facebook and Google, is a relatively recent invention, coming to prominence under President Ronald Reagan in the 1980s. It follows, then, that any meaningful antitrust action against Google or Facebook or other aggregators depends on a significant shift in public opinion such that the foundation of current antitrust law is shifted. That is why this move by Google was so profoundly stupid. Some random press release was far less consequential than the press cycle of the last 24 hours…

When the next recession hits, how will fiscal stimulus affect government debt sustainability?

Posted on by Emilie Openchowski
Construction workers look at a highway road project funded by the American Recovery and Reinvestment Act in Columbus, Ohio.

There’s a strain of thinking that argues any options for fighting the next recession are bound by the response to the past recession and other previous policy decisions. Take, for example, fiscal policy. Because the U.S. debt-to-Gross Domestic Product ratio rose from about 35 percent before the start of the past recession in late 2007 to roughly 75 percent in the first quarter of 2017, does this higher level of debt bind the hands of policymakers for the next time they might consider a fiscal stimulus program?

Not really, says a new research paper released last weekend at the Federal Reserve Bank of Kansas City’s Economic Policy Symposium, better known by the meeting’s location in Jackson Hole. Economists Alan J. Auerbach and Yuriy Gorodnichenko of the University of California, Berkeley look at how higher government debt burdens might make future government stimulus programs quite costly. In other words, they investigate how much of an impact a stimulus program would have on being able to spend money in the future while servicing existing government debt.

Unlike many other studies of this question, these two economists don’t try to parse out the exact steps through which government spending would affect the sustainability of government debt. Instead, using a dataset covering 20 major countries that are members of the Organisation for Economic Co-operation and Development over a number of years from the 1980s to 2017, they measure how much an economic shock in the past changes the movement of a variable over time—in this case, interest rates and debt-to-GDP ratios, among others. The two economists find little evidence that short- and long-term interest rates increase after a fiscal shock, and that debt-to-GDP ratios don’t change that much either.

But there’s another important finding. Auerbach and Gorodnichenko note that these results differ depending upon when the fiscal stimulus happens. If the shock occurs when an economy is already in recession, then the effects are still quite muted. But if spending is increased when the economy is near full potential, then the increase in interest rates and debt-to-GDP ratio will be larger. How much these measures of sustainability would react to a stimulus plan today depends on how far U.S. GDP is from its potential.

Any successful future fiscal stimulus efforts may well depend on whether a high debt-to-GDP ratio will influence or impact the sustainability of future government borrowing. Auerbach and Gorodnichenko find that the cost of borrowing goes up slightly more when initial debt loads are higher, but the difference isn’t all that much. It seems unlikely that in the face of a recession even countries with high debt-to-GDP ratios would see large increases in the cost of borrowing if they spend to stimulate the economy. 

Policymakers who view the current debt-to-GDP ratio with trepidation, fearing that any attempt to increase spending during the next recession would result in unsustainable government debt levels, should take heart. As Equitablog’s own Brad DeLong and former U.S. Treasury Secretary Lawrence H. Summers have argued, strong government stimulus during a downturn might actually pay for itself. Fears of “bond vigilantes,” who would ostensibly flee U.S. government debt in the wake of a new stimulus program, are overblown. If anything, the fear should be that the government doesn’t spend enough to generate a strong recovery.

Should-Read: Charlie Stross: Houston: what are the long-term consequences?

Posted on by Brad DeLong

Should-Read: Charlie Stross: Houston: what are the long-term consequences?: “I’m interested in chewing over… the effect of losing a major city… to a weather event that is already the worst in 800 years… http://www.antipope.org/charlie/blog-static/2017/08/houston-what-are-the-long-term.html

…(with, potentially, worse to come) and flooding due to rainfall that will almost certainly exceed 100 centimetres in a week. What happens next? Lessons in flood defenses and disaster mitigation? Changes to urban planning regimes? A major economic crisis…. Houston’s economy [has] a[n annual] GDP on the order of $450Bn). Mass homelessness and destitution is a no-brainer: is this also going to destabilize the secondary insurance markets? What are the global consequences, outside the USA? Tell me what happens next. Let’s compare notes.

dpb: In the short term I expect a very well funded (dis)information campaign to ensure that everyone knows that summer storms have ABSOLUTLY NOTHING to do with increasing temperatures. There are no ice caps in Texas etc. Longer term we have had New Orleans, now Houston. Traditionally it takes a third event for people to take note…

Should-Read: Noah Smith: There’s Something the Matter With Ohio Too

Posted on by Brad DeLong

Should-Read: Noah Smith: There’s Something the Matter With Ohio Too: “Like Kansas, the state seems to be making economic and cultural choices that are holding it back… https://www.bloomberg.com/view/articles/2017-08-29/there-s-something-the-matter-with-ohio-too

…Virginia… Tyler Cowen wrote an excellent piece about how the state is a multicultural success story. Economically thriving… a large number of immigrants from all over the world. Those who attack that success are putting themselves on the wrong side of history. Virginia, of course, benefits from being close to Washington. Other states, such as New York, California, Texas and Illinois, have succeeded economically because of the wealth of huge, diverse cities like New York City, Chicago and Houston. And many sparsely populated states such as North Dakota are prospering mainly because of large endowments of natural resources. Meanwhile, states with none of these natural advantages, such as North Carolina and Minnesota, are making progress by leveraging higher education and technology clusters.

But a few states continue to flounder…. Exhibit #1 is Ohio…. The state has created jobs at a slower pace than the nation as a whole. Worse, Ohioans are getting paid less for the work they do…. The Buckeye State is… suffering a long, grinding slide into the lower ranks of U.S. states… at the center of the national opioid epidemic.

Why is this happening?… First, Ohio is part of the Rust Belt…. As University of California-Berkeley economist Enrico Moretti has shown, places that rely on old-line manufacturing have suffered economically and socially in recent decades, while centers of the knowledge-based economy—big cities, tech hubs and college towns—have thrived. Ohio Governor John Kasich… declaring his intent to remake the state as part of the “Knowledge Belt”… hard to do without getting more actual knowledge…. Ohio ranks 37th in terms of the percent of residents with bachelor’s degrees, and 30th in terms of advanced degrees. The state has no flagship public university system to rival the University of Michigan, University of Illinois or University of Wisconsin systems. The state provides comparatively little funding for poor residents to attend college…. Nor is Ohio getting sufficient talent from overseas….

In terms of diversity, too, Ohio stands out for resisting recent demographic trends…. A state that has difficulty accepting diversity limits its chances of becoming more prosperous…. If the state doesn’t do more to appeal to immigrants, fails to adapt to diversity, and allows higher education to lag, the state will never climb out of the doldrums it sank into during the days of the Rust Belt….

There are, however, some glimmers of hope…. Columbus, a relatively diverse city that is home to Ohio State University, is bucking statewide trends with booming employment, increasing population and rising wages. Ohio… can wallow in angry visions of the past, or it can try to follow the Columbus model and lift itself into the ranks of American success stories. The choice should be obvious.

How would homebuyers respond to a less generous U.S. mortgage interest deduction?

Posted on by Emilie Openchowski
A house for sale in North Andover, Massachusetts.

What would happen to U.S. homeownership rates, home sizes, and borrowing levels if tax reform reduces the generosity of the home mortgage interest deduction? A recent working paper examining the economic effects of the mortgage interest deductions in Denmark raises important questions about the appeal of such policies in the United States. The paper, by economists Jonathan Gruber of the Massachusetts Institute of Technology, Amalie Jensen of the University of Copenhagen, and Henrik Kleven of the London School of Economics, finds that the mortgage interest deduction in Denmark has no effect on homeownership but does have a meaningful effect on home size and a large effect on borrowing levels.

The authors use housing and tax records from Denmark to study the impacts of a 1987 reform. This tax policy change reduced the value of the mortgage interest deduction considerably for top-rate taxpayers, but not nearly as much or not at all for lower-rate taxpayers. They find that affected homebuyers responded most strongly to the subsidy in their financing decisions, reducing total borrowing by up to 20 percent. (See Figure 1.)

Figure 1

In response to the less generous tax subsidy, homeowners in Denmark reduced the size in square footage and the value of their homes when they moved. (See Figure 2.)

Figure 2

The reform, however, had no effect on the share of households owning a home in either the short or long run. (See Figure 3.)

Figure 3

These findings have important implications for the tax reform debate in the United States. The deductibility of mortgage interest is one of the largest tax expenditures in the U.S. tax code (an estimated $63.6 billion in 2017). Subsidies for homeowners have been primarily motivated by the possibility of positive externalities such as the social benefits of homeownership and greater spending by homeowners on their homes, yet there is no conclusive evidence on the existence of such externalities. As a result, many economists argue that the current policy leads to overinvestments in housing, as well as excessive borrowing by homeowners.

The finding that the tax subsidy has no effect on homeownership, even in the long run, refutes the argument that mortgage interest deductions promote possible positive externalities from homeownership regardless of whether such externalities exist, as the policy has no effect on whether families choose to buy or rent. Furthermore, the subsidy—at least as currently implemented in the United States—is inequitable because, among other reasons, high-income households tend to have greater mortgage debt and thus benefit more from the tax subsidy.

Policymakers may well have a chance to consider reforming the federal mortgage interest deduction in the coming months. Denmark’s experience with reform should be part of the debate.

Must- and Should-Reads: August 30, 2017

Posted on by Brad DeLong

Interesting Reads:

No one measure of inequality tells the whole story–income, wealth, and consumption should be considered together

Posted on by Emilie Openchowski
A shopper reaches for a milk product at a supermarket.

The Bureau of Labor Statistics, or BLS, releases the results of its annual Consumer Expenditure Survey, or CEX, today. This survey asks people to report their spending in dozens of categories, giving us a rich picture of what goods people are spending their money on. It is the only official source of data that allows us to track consumption inequality in the economy. Most of the public attention on inequality has been focused on income inequality: the distribution of what people earn. But economists actually consider two additional types of inequality—consumption inequality and wealth inequality.

Considering all three types of inequality holistically is important if we are to understand inequality in the United States. Income matters, certainly, but partisans of looking at consumption inequality argue that being able to buy essentials is a closer measure of a person’s well-being. Rising income inequality shouldn’t concern us too much, they argue, if consumption inequality is not rising with it. Stable consumption inequality suggests that the poor have no lost ground compared to the rich in overall well-being. As one proponent of this view rather memorably put it, “We eat bread, not paychecks.”

Unfortunately, consumption inequality has generally been the most difficult to measure due to the difficulty of collecting good data. Some studies based on the CEX have suggested that consumption inequality is not increasing in time with income inequality, or is increasing more slowly, while others show it increasing at the same rate. These contradictory findings are attributable to several known flaws with the survey.

Because the survey has a relatively small sample size, it can’t tell us much about the very richest earners. This is a problem with our income surveys as well. Recent studies of income inequality have remedied it by using administrative tax return data, which has let us see for the first time that the incomes of the top 1 percent are growing much faster than the incomes of the top 10 percent, for example, separating the fabulously rich from the merely rich. Beyond that, certain sections of the survey have been shown to be inaccurate, certain categories appear to match up to known aggregates much better than others, budget cuts have resulted in the survey being restricted in certain years, and the limited period of time (two weeks) that respondents are asked to keep records may bias the results.

This is a lengthy list of confounding data issues, so it’s no surprise that economists disagree about how much consumption inequality is changing. One of the most frequently cited and well-vetted studies suggests that consumption inequality is increasing at the same rate as income inequality. Recently published work, however, finds that Americans’ shopping habits may be reducing the accuracy of the survey for measuring inequality and suggests that accounting for this shows that consumption inequality has remained flat. There is one other survey that measures consumption—the University of Michigan’s Panel Study of Income Dynamics. Results from this survey tend to show increasing consumption inequality.

It may take some time for economists to adjudicate these conflicting findings. But either way, we shouldn’t consider any one measure of inequality in a vacuum. Even if consumption inequality is stable over time, that doesn’t mean it’s not a concern. The composition of spending matters. For example, if the rich are spending more on education than the poor, patterns of consumption may be reinforcing existing income differentials by decreasing economic mobility. In fact, this is what the data suggest. The richest decile of Americans spends 3.8x as much on education as the average consumer. Meanwhile, it spends just 2x as much on food and 2.1x as much on housing.

We should also consider that if income inequality is increasing while consumption inequality is not, that extra income has to go somewhere. If the rich are saving more income, their wealth must be increasing. This in turn could mean larger inheritances for the children of wealthy Americans, further cementing their status at the top and reducing economic mobility.

On a final note, we’d like to think that BLS will tackle flaws in the survey and improve our understanding of consumption, but the agency is cash strapped. The Health and Human Services appropriations bill freezes BLS funding at 2017 levels. The Council of Professional Associations on Federal Statistics indicates that BLS is $30 million per year short of what it needs to maintain present services. Without an increased investment, surveys such as the CEX are in jeopardy of being scaled back at precisely the time when we should be interested in expanding them so we can learn more about the most pressing economic issue of our time: economic inequality.

Must-Read: Alan J. Auerbach and Yuriy Gorodnichenko: Fiscal Stimulus and Fiscal Sustainability

Posted on by Brad DeLong

Must-Read: Alan J. Auerbach and Yuriy Gorodnichenko: FISCAL STIMULUS AND FISCAL SUSTAINABILITY: “The Great Recession and the Global Financial Crisis have left many developed countries with low interest rates and high levels of public debt… https://www.kansascityfed.org/~/media/files/publicat/sympos/2017/auerbach-gorodnichenko-paper.pdf?la=en

…thus limiting the ability of policymakers to fight the next recession. Whether new fiscal stimulus programs would be jeopardized by these already heavy public debt burdens is a central question. For a sample of developed countries, we find that government spending shocks do not lead to persistent increases in debt-to-GDP ratios or costs of borrowing, especially during periods of economic weakness. Indeed, fiscal stimulus in a weak economy can improve fiscal sustainability along the metrics we study. Even in countries with high public debt, the penalty for activist discretionary fiscal policy appears to be small.

Should-Read: Michael Spence: The Global Economy’s New Rule-Maker

Posted on by Brad DeLong

Should-Read: Michael Spence: The Global Economy’s New Rule-Maker: “Not too long ago, many pundits doubted that China could make the shift… to a service economy underpinned by domestic demand… https://www.project-syndicate.org/commentary/china-in-the-global-economy-by-michael-spence-2017-08

…But even if China’s economic transition is far from complete, its progress has been impressive… offloading its labor-intensive export sectors to less-developed countries with lower labor costs… shifted to more digital, capital-intensive forms of production, rendering labor-cost disadvantages insignificant….

As a result of these changes, China’s economic power is rapidly rising. Its domestic market is growing fast, and could soon be the largest in the world. And because the Chinese government can control access to that market, it can increasingly exert its influence in Asia and beyond. At the same time, China’s declining dependence on export-led growth is reducing its vulnerability to the whims of those who control access to global markets. But China does not actually need to limit access to its own markets to sustain its growth, because it can increase its bargaining power by merely threatening to do so…