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Economic Outlook: Jobs, Spending v. Austerity, And Obama In Mexico

Hey All,

Finals week began for me today, so I do not have time to do a blog post today (we’ll see about tomorrow, and Next Thursday is also in question)

Some interesting econ news from the usual sources:

Paul Krugman writes on the implications of not having enough inflation on fiscal / monetary policy and economic recovery. This piece goes nicely with last weeks NN Economic Outlook.

There are plenty of pieces on the Jobs report out there. I have learned not to read to much into it, but some people are paid to do that and do a good job of hypothesizing potential causes and effects of changes / trends in the report.

Obama goes to Mexico, only days after the U.S. was rebuffed on the drug front,  and talks about the economic interdependence between the US and Mexico: After a dinner Thursday night with President Enrique Peña Nieto, Mr. Obama told the gathering “we agree that the relationship between our nations must be defined — not by the threats we face — but by the prosperity and opportunity we can create together. And if we are serious about being equal partners, then both our nations must recognize our mutual responsibilities.’’

“We understand that the root cause of much of the violence here — and so much suffering for many Mexicans — is the demand for illegal drugs, including in the United States,” Mr. Obama said. He also said most of the guns that are used to commit violence in Mexico come from the United States.

“I will continue to do everything in my power to pass common sense reforms that keep guns out of the hands of criminals and dangerous people that will save lives in both our countries,” he said to applause.”

Sounds like he’s putting the spotlight on the U.S. congress to pass the U.N. Arms treaty which addresses human rights violations causes by arms trade.

 

When this guy Obama gets lemons, he makes lemonade huh? I guess he’s had a lot of practice dealing with lemons in his first 5 years in office.

 

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Economic Outlook: Fiscal Policy, Monetary Policy, and the Zero Bound

Paul Krugman does a nice job of explaining why unprecedented monetary expansion (“quantitative easing”) has not really moved the needle in terms of reducing unemployment and increasing aggregate demand.

It would be prudent to remind the reader that there has been very little counterfactual analysis of the Feds policies since the Great Recession began (that I am aware of). The situation would almost certainly be worse, higher unemployment and deflation, had the Fed failed to act in the way it is. If you would like to read further on the downward spiral of debt, austerity and deflation in a depressed economy, Irving Fischer wrote on the subject following the Great Depression in a way that is both easy to understand and still as relevant today (perhaps even more-so given how much less politically charged expansionary monetary policy is post-gold standard).

A liquidity trap is a situation when slashing interest rates on government bonds to near zero percent is insufficient to provide enough credit to allow the economy to produce at full productive capacity. Investors would rather invest in safe government assets with almost no yield then invest in private markets.

I believe a liquidity trap is in itself justification for expansionary fiscal policy. It is basically investors saying to the government, “here, we don’t want to invest our money, so do it for us and just promise to pay us back in the future, don’t even worry about the interest”. But fiscal policy, which originates in the House of Representatives, is politically charged (especially when a government is already highly indebted, then every spending program comes under close scrutiny).

Monetary policy, on the other hand, is much more politically isolated. It originates within the Federal Reserve, which is staffed with economists who understand economics better than politicians. The Fed began by cutting rates, hoping to stimulate aggregate demand.

Once this conventional monetary policy failed, unconventional means were taken; the Fed is buying assets on a large scale, expanding the monetary base. The Fed has pledged to continue to pursue expansionary monetary policy by buying assets on a monthly basis until either the unemployment rate falls below a certain level (I believe 6.5%) or inflation rises above a certain level (I believe 2%).

The Fed made this announcement to try to change people’s expectations. Since you cannot cut nominal interest rates below zero percent (the “Zero Lower Bound”), the Fed hopes to stimulate demand by making people think that in the future inflation will be higher than it is now. If money is worth less in the future, then people will want to spend it now while it is worth more. More spending stimulates the economy and reduces unemployment.

So why has this policy been ineffective? Well, as I said before, I am not so sure it has been—certainly the situation would be worse right now, not only for America but for the rest of the world which overwhelmingly relies on dollars for international transactions.

But as to why expansionary fiscal policy would be unquestionably more effective, Professor Krugman hits the nail on the head:

“I’m not claiming that there is nothing the central bank can do; but as I’ve tried to explain before, monetary policy can, for the most part, gain traction under current circumstances only by changing expectations about future actions (and changing them a lot). Meanwhile, fiscal policy has a direct, current effect on the economy, which easily trumps attempts to move the economy by changing the Fed’s messaging.

Sorry, guys, but as a practical matter the Fed – while it should be doing more – can’t make up for contractionary fiscal policy in the face of a depressed economy.”

Think of beginners national income accounting, where aggregate demand (Y) = C (consumption) + I (investment) + G (government spending).

Fiscal policy can stimulate AD directly by increasing either G, C, or I depending on how the program is designed.  Monetary Policy, on the other hand, has a much less direct effect. It tries to incentivize people to act a certain way (increase C or I), but people do not always act “rationally” in the economic sense. Sometimes people are so risk averse that even reducing the yield on an investment does not reduce the demand for this investment (particularly in times of economic uncertainty, when I would argue investors tend to become more risk averse).

Also, there is inherently less scrutiny in exactly how monetary policy works. While it is true that some portion of fiscal expansion may be used inefficiently, it is much more tractable than monetary policy.

Monetary policy stimulates AD, but it can also feed into financial bubbles. By providing low interest loans to banks, the Fed is making a leap of faith that the money will be spent wisely. The money should be going to helping people restructure underwater mortgages, or generally providing low cost financing, freeing money for people to spend and stimulate demand. And to a certain extent it is does, but it can just as easily be spent in other less egalitarian ways. If this money goes to Wall St.  investments, the gains will be realized almost entirely by the wealthy.

Evidence exists that this is happening—unemployment remains stuck while financial markets have reached record highs. Securitization, which became taboo after the financial crisis hit, has began to become common practice again. Without meaningful financial reform, the Feds policies could be fueling the next asset bubble.

The Fed has maintained it is keeping a close watch on how its money is being spent, and given the suffering caused by the Great Recession I’m sure it is, but there is only so much it can do. The Fed cannot possibly micromanage how all of its “cheap money” is being spent. The Fed could try to only lend to more people-friendly institutions, such as “credit unions”, or establish mechanisms to lend directly to people and small businesses, but up until this point has either has not or cannot do so (either due to its mandate or due to insufficient manpower for such oversight).

So expansionary monetary policy has kept the recovery from not being worse than it is (or not being a recovery at all), but it has predictably fallen short of its intended goal. It needs to be complimented by expansionary fiscal policy. That’s not to say that there are no inefficient programs that can be made to more efficient–there almost assuredly are. The stimulus-advocate policymaker should have concrete examples of how resources can be used more effectively, if he has any hopes of convincing his austerity minded counterpart of coming to an agreement. Policy, like markets, requires both competition and coordination to be made as efficient as possible.

The Fed should not reverse course now, but should ensure proper oversight for its policies. The Federal government, on the other hand, seems to be slowly moving from austerity to stimulus. Will common sense and text-book macroeconomics prevail, or will business as usual continue? Only time will tell.

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Economic Outlook: The (Unsuprisingly) Dismal Jobs Report

The jobs report for March came out today, and it was not pretty:

“American employers increased their payrolls by 88,000 last month, compared with 268,000 in February, according to a Labor Department report released Friday. It was the slowest pace of growth since last June, and less than half of what economists had expected.”

“The unemployment rate, which comes from a different survey, ticked down to 7.6 percent in March, from 7.7 percent, but for an unwelcome reason: more people dropped out of the labor force, rather than more got jobs.

The labor force participation rate has not been this low — 63.3 percent — since 1979, a time when women were less likely to be working. Baby boomer retirements may account for part of the slide, but discouragement about job prospects in a mediocre economy still seems to be playing a large role, economists say.”

There are a number of reasons for this dismal jobs report. The most obvious explanation would be the sequester, but this is incorrect. The sequester has not had enough time to work its way through the economy enough to significantly affect unemployment–most economists agree unemployment will spike at the end of the year due to the sequester. The payroll tax holiday expiration is a more plausible cause; part of the “fiscal cliff” deal, the tax increase disproportionately hit low income American’s disposable income starting in January. Both policies compromise aggregate demand (the payroll tax through consumption, sequester through government spending), reducing any incentive businesses might  otherwise have to increase hiring.

 Is it surprising we have had stagnant growth and stubbornly high unemployment given the current conditions? Any economist who understands basic macroeconomics could have predicted the growth-recession that has come to define post-Great Recession America, given the current global economic environment and political gridlock here at home. Paul Krugman, who always seems to focus on the most pertinent indicators and explain complex economic issues in an accessible way, does it again:

“But is this really a surprise? I mean, it’s true that the incipient housing recovery has made many people somewhat optimistic — I’ve been one of them — but when all is said and done, we are following strongly contractionary fiscal policy in an economy in which monetary policy is still ineffective because of the zero lower bound. How contractionary? Look at CBO’s estimates of the cyclically adjusted budget deficit (third column):”

” That deficit has declined from 5.6 percent of potential GDP in 2011 to 2.5 percent in 2013 — that’s 3 percent of GDP, which is a lot of austerity. Not all of that cut has even hit yet — the sequester isn’t in the macro numbers yet — but the rise in the payroll tax is very clearly driving the latest bad numbers, which show big declines in retail.

This is really stupid; as long as we’re at the zero lower bound, austerity is a huge mistake.”

Driving most of this deficit is lower budget revenues, a legacy of the G.O.P.’s failed “starve the beast” theory of governance.

But enough finger pointing. The real issue here is how much austerity has been pushed through (3% of GDP) at a time when the private sector cannot make up the slack of reduced government spending (what the zero lower bound essentially means, that even at a 0% interest rate, the private sector still cannot provide enough capital for the economy to run at full capacity).

How far from full capacity are we? According to the CBO, America has produced under capacity by a large margin since  2009 (-6.8% in ’10, -6.2% in ’11, -5.7% in ’12 and an estimated -5.9% this year). If we multiply those numbers by the GDP of those years, we get this much lost output: $896.24 billion in ’10, $883.28 billion,$ 779.19 billion in  2012. That’s a whopping 2.558 trillion dollars over the last 3 years. If the U.S. government had captured 20% of that in tax revenue, that would’ve been an additional $511 billion in revenue over those 3 years (actually, these numbers are an underestimation, as the GDP gap is based off potential GDP I used real GDP).

Also alarming is that the 2013 projected output gap is supposed to go up, from 5.7% in 2012 to 5.9% in 2013. Not only is our economy recovering, austerity measures are actually pushing the economy in the wrong direction.

There is a large cost to both the government and the people with so much idle production capacity. The government has to pay more benefits and receives less tax revenue, exacerbating the federal deficit. People are sitting idle, their skills are deteriorating, not to mention the psychological effects of long term unemployment.

Once you correct for these automatic stabilizers, the U.S. is basically on a stable fiscal path. Automatic stabilizers are cyclical, they do not have to be addressed by policy as they adjust automatically based on the economy. Low revenue from inadequate taxation is structural, and requires tax reform. Spending on social programs and government employment did not get us into our current problem, and cutting these programs will not get us out of it–it will actually dig us into a deeper hole.

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Economic Outlook: Helping the Poor and Changing Our Standards, The DoJ vs. S & P

Say what you will, but you can’t say the Department of Justice isn’t going after the institutions responsible for perpetuating and deepening the housing crisis. First it went after the big banks (which recently settled for$ 8.5 billion), and now Standard & Poor’s (marking the first such case against a credit rating agency):

“The Justice Department plans to file civil fraud charges against the nation’s largest credit-ratings agency, Standard & Poor’s, accusing the firm of inflating the ratings of mortgage investments and setting them up for a crash when the financial crisis struck.”

The Justice Department has decided to sue S & P for $5 billion. S & P contends it did no wrongdoing leading up to the housing crisis. The company will point to the facts that the Fed didn’t even know the severity of the housing bubble just days before it popped, and that its ratings were similar to those of other agencies.

“The case is said to focus on about 30 collateralized debt obligations, or C.D.O.’s, an exotic type of security made up of bundles of mortgage bonds, which in turn were composed of individual home loans. According to S.& P., the mortgage securities were created in 2007, at the height of the housing boom. S.& P. was paid fees of about $13 million for rating them.

Prosecutors, according to the people briefed on the discussions, have uncovered troves of e-mails written by S.& P. employees, which the government considers damaging. Portions of those e-mails are likely to be disclosed in the government’s complaint, these people said. The firm gave the government more than 20 million pages of e-mails as part of its investigation, the people with knowledge of the process said.”

Here’s the role the DoJ will argue S&P played in perpetuating the housing bubble:

“The three major ratings agencies are typically paid by the issuers of the securities they rate — in this case, the banks that had packaged the mortgage-backed securities and wanted to market them. The investors who would buy the securities were not involved in the process but depended on the rating agencies’ assessments.”

The three major ratings agencies are S&P, Moody’s, and Fitch; at this point the suit is only set to be filed against S & P, although subsequent cases could implicate the other two agencies, especially if the DoJ is successful in proving wrongdoing between S & P and the financial institutions it rates.

Paul Krugman weighs in on why financial reform is still important: Financial reform and holding financial institutions responsible for past violations are not the same thing. But viewed together, they both represent taking America back from corporate interests and making the country work for the average U.S. citizen. It represents a Wall St. vs. Main St. fight that has been long overdue.

“How can the G.O.P. be so determined to make America safe for financial fraud, with the 2008 crisis still so fresh in our memory?…Right now, all the media focus is on the obvious hot issues — immigration, guns, the sequester, and so on. But let’s try not to let this one fall through the cracks: just four years after runaway bankers brought the world economy to its knees, Senate Republicans are using every means at their disposal, violating all the usual norms of politics in the process, in an attempt to give the bankers a chance to do it all over again.”

The Obama administration and the Justice Department seem to be thinking along the same lines as PK. Some may argue that more resources should be focused on holding responsible those individuals who were central in perpetuating the housing bubble. The issue with this goal is who to go after? Should it be the CEOs [who still received huge bonuses and salaries despite taxpayer bailouts]? Should it be the financial engineers who created derivatives that were too complex for most people to understand, or perhaps the bankers who made large commissions by knowingly selling mortgages to people who could not afford them?

By focusing on the organizations as a whole, and pursuing a civil case instead of a criminal case, the DoJ is giving itself the best opportunity to win the case. Sometimes we have to look past the narrow definition of what we feel would be “right” and instead focus on what is most feasible.  In these cases, a significant portion of the money won is supposed to go directly towards helping those whom were taken advantage of and lost their homes due to delinquent practices by financial institutions (who tend to be the poorest people who were seen as easy targets).    If the DoJ can prove wrongdoing by S & P and win this case, you can be sure that Moody’s and Fitch will be the next rating agencies in the hot seat.  Every dollar won back to help those who lost their homes due to illegitimate business practices by financial institutions is a dollar worth fighting for.

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