Saturday 28 February 2009

Public v. private forecasts

A while back Matt Nolan asked, over at TVHE blog, Question: Have economists been over-confident regarding their ability to predict things? Well I now ask a related question: Do public sector forecasters make more biased forecasts than private sector forecasters?

The following comes from a posting at Greg Mankiw's blog:
Here (in red) are the growth forecasts used to put out the new Obama administration budget, followed by the consensus forecast of a panel of "Blue Chip" private forecasters (in blue, naturally). (Source. Go to Table 3.)

2009: -1.2% -1.9%
2010: +3.2% +2.1%
2011: +4.0% +2.9%
2012: +4.6% +2.9%
2013: +4.2% +2.8%

Accumulating the difference, you find that Team Obama projects about 6 percent higher GDP in 2013 than do private forecasters.
Mankiw goes on to write
A related news story:

The Obama administration's outlook has private economists wondering: Has Rosy Scenario made a comeback?...

Nariman Behravesh, chief economist at IHS Global Insight, a major private forecasting firm, called the administration's forecasts "way too optimistic" and said it could represent a return to the overly optimistic forecasts of previous administrations confronted by surging budget deficits.

"They used to joke during the Reagan years that the highest ranking woman in the administration was Rosy Scenario," he said. "We may be seeing a return of Rosy Scenario."

The actual highest ranking woman on the economic team is named Christy, not Rosy, and here is what she had to say:

Speaking to reporters Thursday, White House economist Christina Romer called the projections an "honest forecast" by the administration's professional forecasters. "I'd reject the premise that we're noticeably rosier," she said. "We certainly are somewhat more optimistic, but certainly nothing out of the ballpark."
To me the Team Obama forecasts look just too politically convenient to be credible. But time will tell.

Mixed ownership: where does it get you?

Over at the Austrian Economists blog Peter J. Boettke describes the dangers of mixed ownership.

When talking about the situation in the US, Boettke makes the point that the current crisis isn't, as yet, moving in a full blown socialist direction. Instead, he argues, the US is moving toward some sort of mixed ownership form, where resources are retained in some private hands, but also the public hand is deep in control. Such, it would appear, is the fate of the US banking industry.

Boettke goes on to say
We are in trouble but it is a crisis of ideas that is most troubling. We are marching toward corporatist system as fast as the votes will take us. Who will say NO to this?
Later he writes
But there can be little doubt that we are turning over control of our economic life to the state as they did in Nazi Germany in the 1930s, and we must remember that the loss of our economic freedoms does entail an effective loss of political freedoms. F. A. Hayek 's The Road to Serfdom warned a free people how quickly they can lose their political freedom due to the pursuit even of well intentioned but poorly thought out ideas related to economic policy. Hayek's warning was directed at the Western allies, namely the UK and US, and he used Germany and Russia as his examples. At the time he wrote, intellectuals in the UK and US thought they could avoid the political pitfals of Germany and Russia while benefiting from the presumed 'superiority' of the economic model of government planning. Hayek's classic warning challenged that belief in the workability of democratic socialism.

Perhaps a more timely book to read than even Hayek would be Mises's Omnipotent Government and in particular the sections on the German economic model of national socialist policy. Our current policy path seems more along those lines, then outright expropriation of private property by the government. In the German model, Mises argued, private ownership was nominally maintained and the appearance of normal prices, wages and markets was kept. But in reality entrepeneurs were replaced by government appointed shop managers and the government dictated how the "capitalist" must use his funds and what wages workers must work for. Government effectively controlled production and distribution. "This is," as Mises put it, "socialism in the outward guise of capitalism. Some labels of capitalistic market economy are retained but they mean something entirely different from what they mean in a genuine market economy." (1944, p. 56)

This may very well be the direction we are heading. Slippery slopes, unintended consequences, regime uncertainty, etc., these are the concepts you need to understand in order to make sense of our current economic problems. Bad economic ideas have produced bad economic policies which in turn has resulted in bad economic consequences. The "solution" is not to be found in more bad ideas and bad public policies even if promoted by an eloquent and charismatic political leader.
A little theatrical perhaps, but not without basis. The kinds of problems that mixed ownership can bring can been seen from the New Zealand experience with the SOEs. While many are not in actual mixed ownership, the pressures that such ownership can bring about can, nevertheless, be seen in our recent history with the SOEs.

The SOE Act states that SOEs, basically, have to be run like normal non-government owned firms. In effect this requirement is the same as you could get if private owners have a stake in a firm. The private owners would, we assume, wish to maximise profits, but the government may not. And you see this with SOEs. The government often wishes to intervene in the running of SOEs to get them to carry out not profit maximising activities, just as it would if it had a partial stake in a mixed ownership firm. This problem of having SOEs (or mixed ownership firms) trying to serve two masters was noted more than 10 years ago by Spicer, Emanuel and Powell in their book "Transforming Government Enterprises: Managing Radical Organisational Change in Deregulated Environments" (The Centre for Independent Studies, 1996). They warned that there are two pressures on SOE's: the first being towards privatisation since the productivity and efficiency gains achieved by SOE are in danger of being eroded over time. Privatisation is a way of both cementing in the commercial orientation of enterprises and wringing out further gains resulting from the high powered incentive and control mechanisms which can be bought to bear in privately owned and publicly traded companies. The second pressure on SOEs is towards being pulled back into the public sector where social and political objectives can be more readily be meet. What we saw under the Clark government was the second of these pressures being very strong. But not for socially useful reasons. Most interventions seem to be more politically motivated.

These pressures would also be there for a mixed ownership firms and help explain why they don't do as well as fully privately owned firms. For example, Aidan Vinning and Anthony Boardman in "Ownership and Performance in Competitive Environments: A Comparison of the Performance of Private, Mixed, and State-Owned Enterprises", Journal of Law and Economics vol. XXXII (April 1989) conclude 'The results provide evidence that after controlling for a wide variety of factors, large industrial MEs [mixed enterprises] and SOEs perform substantially worse than similar PCs [private corporations].' The basic problem is that partial government ownership politicises the firm. We just have to hope we don't see a move in this direction in New Zealand.

The spending stimulus debate

Greg Mankiw points us to these two articles:
Brad DeLong of UC Berkeley is Pro.
Michele Boldrin of Wash U is Con.

Friday 27 February 2009

The job summit (updated x4)

My view has been that this would be a lot of hot air and b/s. For more informed opinion, to see if I'm right or not, check out the multiple postings over at The Visible Hand in Economics who are covering the summit more closely than I am.

Update: In the comments section Matt Nolan writes
We didn't aim to follow it - we just heard such bad quotes were felt obliged to make fun of it.

I can't believe the sort of rubbish they came out with - and I can't believe people are calling it a success. Seriously, a country-long cycle track.
From little I have heard of the summit I have to agree with Matt. So far it looks like it has lived down to my expectations :-( But I always assumed that it would be called a "success", these things always are. I just don't know what "success" means in this context.

Update 2: In a second comment Matt Nolan makes what I think are a couple of very good points. Matt writes
What can I say - I hoped for nothing, and instead I got a whole lot of lobby groups convincing the government to do things.

I wonder what sort of other subsidies we are going to see in the upcoming budget.

To think - our policy systems have gone crazy, and we only have 4.6% unemployment!
I to worry about what types and levels of subsidies and government (vote winning?) handouts we could see in the next budget. It's a lobby group's dream. Also Matt's point that policy systems have gone crazy when unemployment is only 4.6% is worth taking note of. What will happen if we get to the levels of unemployment we saw in the early 1990s? How much crazier could thing get? It's a worry.

Update 3: For another view of the job summit check out the series of posts at Not PC.

Update 4: For the party line on 'the job summit will save the world' view see, not surprisingly, Kiwiblog.

Great new economics paper

There is an interesting new paper forthcoming the Scottish Journal of Political Economy on "The (non)theory of the knowledge firm" (pdf). The abstract reads
This paper argues that the mainstream approaches to the theory of the firm do not provide a theory of the human capital based or knowledge firm. We examine the neoclassical theory of the firm, the transaction cost model, the incentive-system approach and the Grossman Hart Moore approach and argue that none of them is able to fully capture the changes to the firm that the movement towards a knowledge economy entails. We also consider the effects of knowledge on the organisation of production. Will production take place within a single large factory, or several smaller factories or even within households?
For those interested in the "knowledge economy" an interesting paper aimed a pointing out some of the shortcomings of the standard theory of the firm when applied to the human capital based firm.

The importance of economics education

Roger Kerr writes in today's Otago Daily Times about The Importance of Economics Education (pdf). He uses Mankiw's list of of propositions to which most economists agree and adds some comments relevant to New Zealand.

Kerr writes
In chapter two he [Mankiw] includes [in his first year textbook] a table of propositions to which most economists subscribe, based on various polls of the profession.

Below is a selection, together with the percentage of economists who agree, and some related comments in brackets.
  1. A ceiling on rents reduces the quantity and quality of housing available. (93%) (New Zealand does not have rent controls, but state housing and so-called tenant protection regulation have a similar effect. on the supply of private rental housing.)
  2. Tariffs and import quotas usually reduce general economic welfare. (93%) (There are theoretical exceptions to the case for free trade but, as another eminent economist Jagdish Bhagwati has written, “Basically, in the world of practical policy, the subtle qualifications do not really amount to a can of beans. If you want to bring prosperity to people, free trade is the way to do it.” With only low tariffs now and the free trade agreement with China, New Zealand is close to becoming a free trade economy like Hong Kong and Singapore.)
  3. Flexible and floating exchange rates offer an effective monetary arrangement. (90%) (This was not widely recognised until the early 1970s when the Bretton Woods system of fixed exchange rates broke down. New Zealand’s floating exchange rate regime has served us well in responding to the present financial crisis and recession.)
  4. Fiscal policy (eg tax cut and/or government expenditure increase) has a significant stimulative impact on a less than fully employed economy. (90%) (This point is less relevant to New Zealand than to a large economy like the United States because much of the spending would go on imports. Also the Keynesian mechanism only works if workers do not realise that higher inflation results from the stimulus and reduces their real wages and thereby the costs to employers of employing them.)
  5. The United States should not restrict employers form outsourcing work to foreign countries. (90%). (Nor should New Zealand: we benefit from globalisation. Fisher and Paykel Appliances is one company that has gone down this path. While Dunedin may have lost out in the process, the company should not have been subsidised by ratepayers in the first place and the move has assisted it to survive.)
  6. The United States should eliminate agricultural subsidies. (85%) (Bravo! This illustrates the point that many subsidies and regulations benefit private interests rather than the public interest. Just because another country has a particular policy doesn’t mean New Zealand should follow suit.)
  7. Local and state governments should eliminate subsidies to professional sports franchises. (85%) (The Auckland Regional Council, which recently lost $1.8 million on the David Beckham fiasco, should take note.)
  8. If the federal budget is to be balanced, it should be done over the business cycle rather than yearly. (85%) (This is the rule in the Public Finance Act, which now incorporates the Fiscal Responsibility Act.)
  9. Cash payments increase the welfare of recipients to a greater degree than do transfers-in-kind of equal cash value. (84%) (This calls into question programmes such as state housing. In the case of dysfunctional families, however, there may be a case for provision-in-kind – eg the equivalent of a food stamps programme.)
  10. A minimum wage increases unemployment among young and unskilled workers. (79%) (Regrettably, the Maori Party has not grasped the point that raising the minimum wage is likely to hit Maori disproportionately. The Council of Trade Unions has suggested to today’s Jobs Summit that the minimum wage should continue to be increased “to boost demand”. If that made sense, why not double or treble it? It doesn’t: in the absence of higher output from greater productivity, a higher wage for one person is a lower income for someone else. Aggregate spending power is unchanged.)
Let me add a few things I have said before. Given our government's recent moves on the minimum wage perhaps number 10 should be pointed out to them. Number 7 could be pointed out to the NZRU and NZ Cricket, along with the Dunedin City Council and Otago Regional Council . Number 6 would be great if followed by both the US and Europe. Number 2 needs to be emphasised a lot right now. Protectionism will not help the New Zealand economy. It will only help some areas at the expense of the rest of us and overall New Zealand will be worse off.

Kerr ends by saying
As Mankiw writes: “If we could get the American public to endorse all these propositions, I am sure their leaders would quickly follow, and public policy would be much improved. That is why economics education is so important.”

The same could be said about public understanding of economics in New Zealand.
I can only agree. As I have tried to argue here these unusual times don't call for unusual economics. Ordinary economics still holds, even in bad times, and the general public need to understand this. A more economically literate group of voters would mean that many of the stupid things we see governments doing right now could be stopped. Governments do respond if they think their polices will lose them votes.

EconTalk this week

Allan Meltzer, of Carnegie Mellon University, talks with EconTalk host Russ Roberts about the current state of monetary policy and the potential for inflation. Meltzer explains why inflation hasn't happened yet, despite massive increases in reserves created by Fed policy. Then he explains why inflation is coming and why it will be politically difficult for the Fed to stop it. Meltzer also analyzes the Japanese experience in recent years and talks about why so many investment banks overreached and destroyed themselves.

Sunday 22 February 2009

Wilkinson talks to Prescott and Phelps

Will Wilkinson wanted to know about the effects of the stimulus package, so he went and talked to Nobel Prize winning economists Edward Prescott and Edmund Phelps. He writes about it in his latest column for The Week.

Wilkinson wanted to know if the stimulus law will work. He writes
"Stimulus is not part of the language of economics," says Arizona State University economics professor Edward Prescott. I talked to Prescott just hours before Obama set the presidential pen to the stimulus bill. "There is an old, discarded theory that's been tried and failed spectacularly, which is where that language of stimulus comes from." The stimulus bill, Prescott told me, "is likely to depress the economy." Not long after Obama wowed the nation with his keynote address at the 2004 Democratic National Convention, Edward Prescott traveled to Stockholm to receive a Nobel Prize, shared with his frequent collaborator Finn Kydland, "for contributions to dynamic macroeconomics: the time consistency of economic policy and the driving forces behind business cycles." Which is to say, Prescott is one of his discipline's most influential and authoritative voices on precisely those technical issues behind the stimulus debate.
Wilkinson also talked with Edmund Phelps.
The most recent Nobel Prize awarded for work specifically in macroeconomics--the branch of economics that studies aggregate economic phenomena, the causes of recessions, and the effectiveness of government attempts to stimulate economic performance--went to Columbia University's Edmund Phelps in 2006. When I spoke to Phelps on Tuesday, he was rather less emphatically decisive than was Prescott about the dire prospects of the stimulus. But neither was he optimistic. "We're completely flying blind," Phelps said, suggesting that even the best of the best in macroeconomics don't know enough to predict with confidence how the stimulus will pan out. "There's a chance that some of the infrastructure spending will do the job of creating more work for earth-moving equipment and construction workers, Phelps noted. "I said, 'a chance'," he continued. "Now, there's also a chance that the perceived increase in the role of government of this sort will have some unanticipated effects on the animal spirits of entrepreneurs. These projects may stand as a sort of symbol of the weakening of the private sector."

Phelps is among the world's leading authorities on the way different economic systems enable or thwart the dynamic adjustment and entrepreneurial innovation that delivers long-run productivity and growth. By significantly increasing government involvement in so many sectors of the economy, Phelps worries the enacted stimulus plan could make the climate of investment more rather than less uncertain, and make growth-enhancing innovation less rather than more likely. Potential investors may become spooked by businesses increasingly dependent on government contracts, Phelps notes, since these firms may face additional regulations and bureaucratic requirements which may make them appear less able nimbly to adapt. Additionally, the anticipation of higher future taxes--the price of the current spending surge--could dampen consumer demand and "have a chilling effect upon the desire of entrepreneurs to innovate," Phelps says.

The incentives of entrepreneurs is central to Phelps' thought. Phelps says he "just doesn't understand" the argument that government can spur innovation through top-down subsidies for selected new technologies. Citing his Columbia colleague Amar Bhide, Phelps suspects that "a lot of money will be made by being in the right place at the right time and knowing the right people. Especially knowing the right people." Phelps is disturbed by the thought that we may be shifting from an entrepreneurial economy toward a lobbying economy. "A lot of potential entrepreneurs, who were contemplating making an innovation and launching it in the marketplace, will now think, 'Well maybe the safer thing to do is to try to get that government contract.' ... And nobody does the innovation. They're all too busy trying to get the government contract."
Shifting from an entrepreneurial economy toward a lobbying economy, New Zealand under Muldoon. And, it seems, increasingly under Key. Wilkinson goes on to say
Both [Prescott and Phelps] point to the importance of a stable framework of rules that makes the risk-taking and complex coordination of productive economic activity seem worthwhile. Both point to the hazards of suddenly, dramatically, and haphazardly rewriting the rules mid-game--even if the rules do need revising.
This is an important point that the current government would do well to take note of. Wilkinson ends by saying
Massive discretionary changes in the structure of economic incentives--the kind you get with "the most sweeping economic recovery package in our history"--tend not to brighten expectations and revive animal spirits. These interventions instead tend to unsettle consumers, investors, and entrepreneurs by vividly demonstrating how political discretion can so suddenly throw everything up for grabs. "The scary thing is," Prescott says, "when this doesn't work what do they do? Start panicking and throwing good money after bad?"
Well it's other people's money, so of course good will follow bad.

The Venturesome Economy

From comes this interview with Amar Bhidé of Columbia University. He talks to Romesh Vaitilingam about his new book, The Venturesome Economy: How Innovation Sustains Prosperity in a More Connected World. He explains why know-how developed abroad enhances prosperity at home, and why trying to maintain the US lead by subsidising more research or training more scientists will do more harm than good.

Bhidé has also been interviewed at EconTalk.

Saturday 21 February 2009

Unusual times implies unusual economics?

At the MonkeyWithTypewriter blog I came across this quote from John Key
"What we are trying painstakingly to point out is that our preferred option is commercial solutions for commercial problems. Government doesn't see itself as a banker. That said, these are highly unusual times and I believe we would be derelict in our duties if we didn't at least look to see whether there is some assistance we could practically give. Now, it may not always be financial assistance. It could be a change in laws or regulations. That's a possibility. In the case of Fisher & Paykel, I never said it couldn't fail. I simply said it was an important New Zealand company and certainly my preference would be to see it succeed and continue in New Zealand. We will look at whether it is practical for us to offer support to do that if that is what is required. At this point it hasn't been requested of the Government." (Emphasis added.)
while at The Austrian Economists I came across Peter Boettke making the point that Extraordinary Times Requires ... Well Ordinary Economics. I take Key's argument to be that these are unusual times and thus we can take measures we would not take in normal times. That is, we can override the economics that tell us, in normal times, that a given action is bad because these are extraordinary times, new economics somehow apply now. Well Boettke is right and Key is wrong.

Ordinary economics still holds, even in bad times, no matter what Key seems to think. Corporate welfarism is bad economics in good times and is still bad economics in bad times. Governments picking winners is bad economics in good times and is still bad economics in bad times. Removing market discipline is bad economics in good times and is still bad economics in bad times. Key should note that a bailout by the government gives businesses a reprieve that the market wouldn't give them, within free markets a firm has to be able to pay the ultimate price for bad decisions, whether it be in good times or bad, but when the government interferes, that discipline is removed. Over at Kiwblog we have David Farrar quoting Colin Espiner as writing
And after Fisher and Paykel Appliances saw its share price plummet 40 percent in a single day yesterday, Key again reached for the telephone and called up chief executive John Bongard.
All this shows that Key has an all too powerful interventionist streak, he is looking more like Muldoon everyday, and that is very bad no matter what the times!

Boettke quotes from Ludwig von Mises, Human Action (Henry Regnery, 1966), p. 885:
"The body of economic knowledge is an essential element in the structure of human civilization; it is the foundation upon which modern industrialism and all the moral, intellectual, technological, and therapeutical achievements of the last centuries have been built. It rests with men whether they will make the proper use of the rich treasure with which this knowledge provides them or whether they will leave it unused. But if they fail to take the best advantage of it and disregard its teachings and warnings, they will not annul economics; they will stamp out society and the human race."
Key should take these words to heart. Key should, as Boettke puts it,
Realize the inefficiency of government control with the crowding out of wealth creating investment, the systemic errors produced by knowledge problems, the unleashing of vested interests in the race for privileges, and the governmental habit of deficits, debts and debasement.
Key cannot eliminate or overturn the teachings of economics, but he can help, and seems to want to, make its worst predictions come true.

Interesting blog bits

  1. Greg Mankiw on "Create or Save".
  2. TVHE on Faux Marx.
  3. Philip Salter on Jacqui Smith and Public Choice Theory.
  4. Edward L. Glaeser suggests If You Got Money, It’s Time to Spend Some.
  5. Philip Booth on Time to suspend the minimum wage. (Suspend??? How about do away with!)
  6. Not PC on Property rights are human rights: let’s protect them say NZ academics!
  7. Don Boudreaux On the Keynesian Superstition

Interview with Robert Barro

From The Tax Foundation comes this Tax Policy Podcast. In it Robert Carroll talks with Robert Barro, the Paul M. Warburg Professor of Economics at Harvard University in Cambridge, Massachusetts. Professor Barro is also a senior fellow of the Hoover Institution at Stanford University and a research associate of the National Bureau of Economic Research. The discussion is about the recently passed federal stimulus package and Barro focuses his criticism on both the spending and tax provisions in the stimulus legislation, and makes some recommendations to lawmakers regarding permanent changes to the tax code that could spur long term incentives.

Deregulation and the financial panic

Phil Gramm, a former U.S. Senator from Texas, is vice chairman of UBS Investment Bank, has a piece in the Wall Street Journal on Deregulation and the Financial Panic: Loose money and politicized mortgages are the real villains.

Gramm argues that the current debate about the cause of the financial crisis is important because the reforms implemented by Congress in the US, and other governments around the world, will be profoundly affected by what people believe caused the crisis. Gramm writes
If the cause was an unsustainable boom in house prices and irresponsible mortgage lending that corrupted the balance sheets of the world's financial institutions, reforming the housing credit system and correcting attendant problems in the financial system are called for. But if the fundamental structure of the financial system is flawed, a more profound restructuring is required.
Gramm goes on to say that in his view there are two main factors that lead to the crisis.
The first was the unintended consequences of a monetary policy, developed to combat inventory cycle recessions in the last half of the 20th century, that was not well suited to the speculative bubble recession of 2001. The second was the politicization of mortgage lending.
About the problems with monetary policy Gramm says
Critics of Federal Reserve Chairman Alan Greenspan say he held interest rates too low for too long, and in the process overstimulated the economy. That criticism does not capture what went wrong, however. The consequences of the Fed's monetary policy lay elsewhere.
and expands on this by writing
In the 2001 recession, however, consumption and home building remained strong as investment collapsed. The Fed's sharp, prolonged reduction in interest rates stimulated a housing market that was already booming -- triggering six years of double-digit increases in housing prices during a period when the general inflation rate was low.

Buyers bought houses they couldn't afford, believing they could refinance in the future and benefit from the ongoing appreciation. Lenders assumed that even if everything else went wrong, properties could still be sold for more than they cost and the loan could be repaid. This mentality permeated the market from the originator to the holder of securitized mortgages, from the rating agency to the financial regulator.
On the topic of the politicisation of mortgage lending Gramm explains
Meanwhile, mortgage lending was becoming increasingly politicized. Community Reinvestment Act (CRA) requirements led regulators to foster looser underwriting and encouraged the making of more and more marginal loans. Looser underwriting standards spread beyond subprime to the whole housing market.

As Mr. Greenspan testified last October at a hearing of the House Committee on Oversight and Government Reform, "It's instructive to go back to the early stages of the subprime market, which has essentially emerged out of CRA." It was not just that CRA and federal housing policy pressured lenders to make risky loans -- but that they gave lenders the excuse and the regulatory cover.

Countrywide Financial Corp. cloaked itself in righteousness and silenced any troubled regulator by being the first mortgage lender to sign a HUD "Declaration of Fair Lending Principles and Practices." Given privileged status by Fannie Mae as a reward for "the most flexible underwriting criteria," it became the world's largest mortgage lender -- until it became the first major casualty of the financial crisis.

The 1992 Housing Bill set quotas or "targets" that Fannie and Freddie were to achieve in meeting the housing needs of low- and moderate-income Americans. In 1995 HUD raised the primary quota for low- and moderate-income housing loans from the 30% set by Congress in 1992 to 40% in 1996 and to 42% in 1997.

By the time the housing market collapsed, Fannie and Freddie faced three quotas. The first was for mortgages to individuals with below-average income, set at 56% of their overall mortgage holdings. The second targeted families with incomes at or below 60% of area median income, set at 27% of their holdings. The third targeted geographic areas deemed to be underserved, set at 35%.

The results? In 1994, 4.5% of the mortgage market was subprime and 31% of those subprime loans were securitized. By 2006, 20.1% of the entire mortgage market was subprime and 81% of those loans were securitized. The Congressional Budget Office now estimates that GSE losses will cost $240 billion in fiscal year 2009. If this crisis proves nothing else, it proves you cannot help people by lending them more money than they can pay back.

Blinded by the experience of the postwar period, where aggregate housing prices had never declined on an annual basis, and using the last 20 years as a measure of the norm, rating agencies and regulators viewed securitized mortgages, even subprime and undocumented Alt-A mortgages, as embodying little risk. It was not that regulators were not empowered; it was that they were not alarmed.

With near universal approval of regulators world-wide, these securities were injected into the arteries of the world's financial system. When the bubble burst, the financial system lost the indispensable ingredients of confidence and trust. We all know the rest of the story.
And the story doesn't have a happy ending.

Friday 20 February 2009

Fun from aid watch

William Easterly writes on his blog Aid Watch about Participation of the poor in mainstreaming gender empowerment for civil society stakeholders to promote country ownership of good governance for community-driven sustainable development. Now thats what I call a title!

Easterly goes on
I have just stumbled across a great series of articles on buzzwords in development. Some aid workers and development scholars are so jaded by these vague but ubiquitous buzzwords that they play “Development Bingo.” Whenever a development pro is giving a lecture, they hold Bingo cards marked with all the buzzwords and check them off whenever the lecturer mentions them in the talk. When they have got a full set of buzzwords, they stand up and shout “Development!” (No doubt leaving more than a few lecturers baffled.)
Read the whole thing, it's fun and makes an important point.

Could Kiwibank become a co-operative?

The above question is asked over at the Homepaddock blog. The idea seems to be to turn Kiwibank into cooperative bank which would expand into the agriculture sector. As a theory of the firm man I think it is a most interesting question. My short answer is, probably no. But why such an answer?

First lets ask why would you want to form a cooperative in the first place? One reason is that it can deal with "hold-up" problems. Take as an example of a group of grain farmers who need the services of a miller. Let assume that the market for millers, at least in the beginning, is competitive so the farmers can tender out a contract for a miller's services at the competitive price. The contract is awarded to a given miller. Grain is delivered to him by the farmers but the miller refuses to carry out the contracted for services unless the contract is renegotiated. Let me make an additional assumption here that transportation prices are high so that the miller has, effectively, a local monopoly. The farmers clearly have a problem, their grain will rot if not processed. The miller can "hold-up" the farmers, that is, force a renegotiation of the contract so that its terms are more favourable to the miller. Cooperative ownership of the mill by the farmers is one answer to this problem since the farmers do not have an incentive to hold themselves up.

But does this kind of story make sense in banking? Why would producers, say farmers, want to own a bank? There has to be either high contracting costs or monopoly problems, as in my example, for cooperatives to make sense. The problem with this in banking is that there are a number of banks in a fairly competitive market so it's not clear to me what advantage the cooperative would have.

One advantage of a cooperative is their low ownership costs. Normally monitoring of the management of a cooperative is undertaken by informed members, say farmers. These farmers produce a limited range of outputs, wheat, wool, milk etc, about which they are very knowledgeable. Clearly this is not the case for farmers about banking. Further, collective decision making is normally helped by the fact that the interests of the members of a cooperative are very homogeneous. While this would be true for farmers of a given output it is not true with regard to farmers and banking. Farmers would have interests as heterogeneous as normal shareholders of a bank. So in this case it is not clear to me what advantages the cooperative has. And its not clear that there is any other group who could function better, than farmers, as members of a cooperative Kiwibank, given that the aim is to expand into the agriculture.

Another thing to note is that the example Homepaddock gives of a cooperative bank, Rabobank, is a cooperative of other banks. The following comes from the Rabobank website:
Although now a major international financial services institution, Rabobank has retained its cooperative structure, with approximately 161 independent Dutch banks as its members. True to its cooperative origins, the bank’s primary interest lies in providing the best service, value and expertise, and in establishing mutually beneficial relationships with its clients and the communities in which they operate.
So the bank's members are other banks. I'm not sure if this is the form of cooperative that Homepaddock is really suggesting for Kiwibank, and if it is, you have to ask why would the other banks want to be involved in such a set up?

Or is Homepaddock suggesting that Kiwbank be turned into a cooperative owned by either producers, for example farmers as I have assumed above, or customers or workers. If so, which and why? As I said above it's not clear to me what the advantages of a cooperative would be in banking.

Thursday 19 February 2009

How can $8 a week help?

The stimulus bill that President Obama signed Tuesday includes $116 billion in tax credits that will come largely through reduced tax withholding from paychecks, over two years. That will put $8 a week into most Americans’ paychecks. So if you’re getting an extra $8 each week, and as a good citizen you want to do your part to get the economy going, what should you spend the money on, and why? The answers from a survey of economists are here. But a few examples are:

Tyler Cowen's answer is
In my view, fixing the banking sector is more important than getting the stimulus right. So if you can afford to lose the money, go to a large bank (more likely to be insolvent), find their most overpriced service, and buy as much of it as you can. That way you are doing your part to recapitalize our banking system.

If you’re stuck for ideas, just keep on using ATM machines, owned by other banks, so you can pay large fees to take out small sums of money from your checking account. When you need to, take all of your withdrawals and deposit them back in the account once again and start all over with the process.
and Greg Mankiw's answer is
How about buying a good economics textbook?
Ethan Harris's answer
Get a haircut. It is a purely domestically produced service with extremely high labor content. This means no drain in spending power out of the country: it is “Buy American” without violating any trade agreements. It also has a high impact on employment due to the high labor content. Finally, an $8 haircut–as opposed to the $100 variety– is probably being done by a low income person who is likely to spend rather than save the 8 bucks, ensuring strong second round spending effects. We will groom our way to recovery ...

How things change ...

The Wall Street Journal is reporting that Rice Growers Seek to Halt Falling Prices. Just a few months ago the food crisis was about ever increasing food prices and Southeast Asian nations were slapping export controls on rice in order to preserve more of the rapidly appreciating commodity for their own citizenry, but not now. The WSJ says
BANGKOK -- A delegation from Thailand, the world's biggest rice exporter, is asking Vietnam to help it stabilize the tumbling price of rice -- the latest indication of how agricultural markets have changed in the months since riots over food costs gripped parts of the developing world.

Industry experts aren't expecting any major price-fixing accords between the two countries, which together control about 45% of global rice exports.

A Thai participant in this week's meetings in Vietnam, held with representatives of its rice industry, emphasized that the two countries are speaking only in general terms about how to keep prices from falling from current levels.


"We have to stabilize the world price," said Chookiat Ophaswongse, president of the Thai Rice Exporters Association and a participant in the Vietnam meetings. If the effort isn't successful, he said, "it's going to hurt the overall market."
The report goes on to say
Just a few months ago, residents in poor countries took to the streets to protest the soaring price of rice and other food. Since then, grain prices have fallen about 30% from their peaks in mid-2008, according to the Food and Agriculture Organization of the United Nations.
An interesting note in the article is
Rice prices in Thailand probably would have fallen further, analysts say, without a government program that buys excess supplies from farmers.
Why would any government set out to keep food prices for their people, especially the poor who spend a greater share of their income on basic food, artificially high? Apart from this there is the problem that such a strategy could lead to over production. Will we see rices hills in Asia to go along with the butter mountains and wine lakes in Europe?

Douglas urges govt to stop picking winners

As a follow up to Matt Nolan's posting on Don’t bail out F&P and my posting on Don’t bail out F&P comes this news report from
The Government's approach to a possible bailout for Fisher & Paykel Appliances and next week's jobs summit are both ill-thought out and lack logic, former Finance Minister Sir Roger Douglas said.

Shares in Fisher & Paykel Appliances fell 35 percent to 65 cents on Monday after the whiteware maker warned that it expected net profit to fall sharply, that it was looking for new capital and a cornerstone shareholder amid tough trading conditions and a debt blowout.

"The Government has started talking about a bailout of Fisher & Paykel without any financial data on the issue and without seeking independent advice on the implications of a bailout. The only known advice that [Prime Minister John] Key sought was when he made a phone call to the managing director of Fisher & Paykel," said ACT MP and finance spokesman Sir Roger.

"How is Fisher & Paykel now meant to raise the finance required when any rational investor will fear that the company will be nationalised?" Sir Roger added.
Later in the report it is said
Sir Roger said recent talk about attaching conditions to a potential bailout, such as requirements that jobs stay in New Zealand, was worrying.

"Government should not be in the business of business. We've tried that before and it failed. Companies need to be competitive and innovate. Governments tend to monopolise and stagnate. Picking winners is no way to run an economy," Sir Roger said.

He added that although bailouts might reduce fears now, we would regret them in the future when we have to pay back the debt taken on to fund them. The Government could not afford to prop up businesses given its own accounts were in deficit. More spending meant more borrowing which meant higher taxes in the future.
One would hope that the government takes such advice. Why
Treasury is continuing to monitor major companies as the global recession deepens
is beyond me. The management and shareholders of "major companies" should be doing any monitoring required. As Sir Roger puts its
Government should not be in the business of business.
I agree totally.

Wednesday 18 February 2009

Interesting blog bits

  1. Matt Nolan asks Question: Have economists been over-confident regarding their ability to predict things?
  2. Carpe Diem on Forecasters: Economic Recovery in Q3 2009.
  3. Russell Roberts on Evidence against the multiplier.
  4. Art Carden on Notes on Julian Simon.
  5. William Easterly on Spies Play Economists, Economists Play Spies.
  6. Lucian Bebchuk on Congress Gets Punitive on Executive Pay.

Robert Mundell on stimulus

From Will Wilkinson comes this link to a January 9th Turkish TV interview with economics Nobel Laureate Robert Mundell on the stimulus.
Ipek Cem: There is talk of a stimulus package in the US. We also know that the average US citizen is highly leveraged as a consumer. And when we talk about stimulus we are also talking about consumer pending. How to make the two of them, you know work hand in hand?

Robert Mundell: Well there’s a lot of questions about “What a stimulus package really is?” And I don’t think the major has been taken called a stimulus package are going to be much of a stimulus. To a certain extent, monetary policy, an easy monetary policy, is stimulating for us. But that’s not the pack what we mean by a “stimulus package” because “Federal Reserve” can always do that. What they mean by that is government spending. But government spending doesn’t have that bigger effect. If you have a big increasing government spending, without monetary expansion, they have to finance that deficit by bringing bonds. So while the spending adds to demand, the selling of the bonds, takes away the demand. So if there’s a multiplier in one process, there is a negative multiplier with the other process. And the other fact is that the exchange rate is flexible. So if you sell more bonds with a stimulus pending interest rates rise a little bit. And the capital comes in, the current account deficit increases. The trade deficit increases. So a good part of that stimulus package goes to the rest of the world.

Ipek Cem: So what kind of policy measures would you be advocating at a time like this?

Robert Mundell: Well I think that the difficulty of all the banks, they need to recapitalize the bank, which everybody says it’s necessary. And is also true with corporation you need to recapitalize the corporations like “General Motors”, “Ford” and “Chrysler”. The glories, what used to be glories of American capitalism in the 20th century. American manufacturing. They need to be recapitalized, too. And instead of the government taking its stimulus package, the bailout package, recapitalizing, buying stocking these banks, it is much more important to look at what’s happenning right now, what the goverment is doing today to economy. What the government does to the corporation today is take thirty five percent of the profits of the corporation. And without putting anything in. So with the 35 percent of corporate tax, they take all that, draining the corporation from that, without putting anything in. And so what the best thing to do for stimulus is to reduce or eliminate the corporation tax. It is a double taxation anyway, because the capital pays the tax to the corporation and the profits are taxed at the corporate level after 35 % is taken out. And then there are also tax in the individual level. So eliminate it. By the way the revenue isn’t going to be very much because the corporate tax used to earn 5 % of GDP in revenue. It’s gone down about 1,5 % of GDP. So it doesn’t add too much. And in a recession period there won’t be any profits and tax, so the revenue will be very little. So you don’t loose too much, but you would, if you stimulate economy all the other taxes will increase. And the revenue then from the tax cuts of corporations will increase the tax of every other corporation. Just recently, Germany has cut it it corporation tax from 25 % to 15 %. That’s a very good move and that’s what the United States should do. I think, I was going to say from 35 % to 20 %, but it would be even better if they do it to 15 %.

Tuesday 17 February 2009

How bad is it when ....

even China can put the boot in over your protectionist policies. This from Greg Mankiw's blog:
The AP reports:

Measures in a $789 billion U.S. stimulus package that favor American goods are a "poison" that will hurt efforts solve the financial crisis, an editorial by China's official news agency said. Provisions in the U.S. stimulus bill approved Friday favoring American steel, iron and manufactured goods for government projects are protectionist measures that could trigger trade disputes, said the editorial....

U.S. labor groups that pushed hard for inclusion of the measures have argued that their main purpose is to ensure that U.S. Treasury dollars are used to the fullest extent to support domestic job creation.

China has promised to avoid "Buy China" protectionist measures in its own multibillion-dollar stimulus effort, and appealed to other governments to support free trade....

EconTalk this week

Amar Bhidé, of Columbia University and author of The Venturesome Economy, talks with EconTalk host Russ Roberts about the role of entrepreneurship and innovation in a global economy. Bhidé argues that the worries about outsourcing and America's alleged declining leadership in technology are misplaced. He argues that the source of prosperity is not technology per se but the application of technology to actual products that improve our lives and that the American venture system and labour market are very effective at the application of technology. The end of the conversation turns to the role of uncertainty in both venture capital and entrepreneurship but also to the role of financial institutions and financial innovation.

Monday 16 February 2009

Don’t bail out F&P

Matt Nolan has a posting at TVHE giving good advice: Don’t bail out F&P. The last we need is for the government to start picking winners in so much as it starts to decide which firms should survive because of a bail out and which shouldn't. Firm survival is matter for the market. As Matt puts it
[..] after all, what is growth promoting about forcing all of society to cover businesses mistakes?
There is no such thing as too big or too important to fail and business have to know this. Why run a firm well, if the taxpayer bails you out if you run it badly? A bailout by the government gives businesses a reprieve that the market wouldn't give them. Bailouts have at least two effects. They permit continued unwise use of resources and it creates what economists call moral hazard, the expectation of future bailouts and others hopping on the bailout wagon. Within free markets a firm can pay the ultimate price for bad decisions but when the government interferes, that discipline is removed.

Incentives matter: bike file

From the BBC:
A popular bicycle rental scheme in Paris that has transformed travel in the city has run into problems just 18 months after its successful launch.

Over half the original fleet of 15,000 specially made bicycles have disappeared, presumed stolen.

They have been used 42 million times since their introduction but vandalism and theft are taking their toll.

A picture is worth 1000 words ...

From Carpe Diem:

Sunday 15 February 2009

News flash: economists agree

Greg Mankiw has a News Flash: Economists Agree. Strange but true!

In chapter two of his first year textbook, Mankiw includes a table of propositions to which most economists subscribe, based on various polls of the profession. Below is the list, together with the percentage of economists who agree:
  1. A ceiling on rents reduces the quantity and quality of housing available. (93%)
  2. Tariffs and import quotas usually reduce general economic welfare. (93%)
  3. Flexible and floating exchange rates offer an effective international monetary arrangement. (90%)
  4. Fiscal policy (e.g., tax cut and/or government expenditure increase) has a significant stimulative impact on a less than fully employed economy. (90%)
  5. The United States should not restrict employers from outsourcing work to foreign countries. (90%)
  6. The United States should eliminate agricultural subsidies. (85%)
  7. Local and state governments should eliminate subsidies to professional sports franchises. (85%)
  8. If the federal budget is to be balanced, it should be done over the business cycle rather than yearly. (85%)
  9. The gap between Social Security funds and expenditures will become unsustainably large within the next fifty years if current policies remain unchanged. (85%)
  10. Cash payments increase the welfare of recipients to a greater degree than do transfers-in-kind of equal cash value. (84%)
  11. A large federal budget deficit has an adverse effect on the economy. (83%)
  12. A minimum wage increases unemployment among young and unskilled workers. (79%)
  13. The government should restructure the welfare system along the lines of a “negative income tax.” (79%)
  14. Effluent taxes and marketable pollution permits represent a better approach to pollution control than imposition of pollution ceilings. (78%)
As Mankiw writes
If we could get the American public to endorse all these propositions, I am sure their leaders would quickly follow, and public policy would be much improved. That is why economics education is so important.
Given our government's recent moves on the minimum wage perhaps number 12 should be pointed out to them. Number 7 could be pointed out to the NZRU and NZ Cricket, along with the Dunedin City Council and Otago Regional Council . Number 6 would be great if followed by both the US and Europe. Number 2 needs to be emphasised a lot right now.

Saturday 14 February 2009

Don't let judges tear up mortgage contracts

Todd J. Zywicki, professor of law at the George Mason University law and a senior scholar at the university's Mercatus Center, has an article in the Wall Street Journal in which he says, Don't Let Judges Tear Up Mortgage Contracts: That's the last thing troubled securities markets need. One could go further and suggest not letting ministers or the leader of the opposition tear them up either.

Zywicki opens his piece by saying
The nation faces a foreclosure crisis of historic proportions, and there is an understandable desire on the part of the federal government to "do something" to help. House Judiciary Chairman John Conyers's bill, which is moving swiftly through Congress (and companion legislation introduced by Sen. Richard Durbin) would allow bankruptcy judges to modify home mortgages by reducing both the interest rate and principal amount on the loan. This would be a profound mistake.
Take note politicians. Zywicki continues
In the first place, mortgage costs will rise. If bankruptcy judges can rewrite mortgage loans after they are made, it will increase the risk of mortgage lending at the time they are made. Increased risk increases the overall cost of lending, which in turn will require future borrowers to pay higher interest rates and upfront costs, such as higher down payments and points.
He also notes that incentives matter,
Allowing mortgage modification in bankruptcy also could unleash a torrent of bankruptcies. To gain a sense of the potential size of the problem, consider that about 800,000 American families filed for bankruptcy in 2007. Rising unemployment and the weakening economy pushed the number near one million in 2008. But by recent count, some five million homeowners are currently delinquent on their mortgages and some 12 million to 15 million homeowners owe more on their mortgages than the home is worth. If even a fraction of those homeowners file for bankruptcy to reduce their interest rates or strip down their principal amounts to the value of their homes, we could see an unprecedented surge in filings, overwhelming the bankruptcy system.
Zywicki also notes that the law of unintended consequences could come into play,
Finally, a bankruptcy proceeding sweeps in all of the filer's other debts, including credit cards, car loans, unpaid medical bills, etc. This means that a surge in new bankruptcy filings, brought about by a judge's power to modify mortgages, could destabilize the market for all other types of consumer credit.
But there are other problems,
A bankruptcy judge's power to reset interest rates and strip down principal to the value of the property sets up a dynamic that will fail to help many needy homeowners, and also reward bankruptcy abuse.

Consider that the pending legislation requires the judge to set the interest rate at the prime rate plus "a reasonable premium for risk." Question: What is a reasonable risk premium for an already risky subprime borrower who has filed for bankruptcy and is getting the equivalent of a new loan with nothing down?

In a competitive market, such a mortgage would likely fetch a double-digit interest rate -- comparable to the rate they already have. Thus, the bankruptcy plan would offer either no relief at all to a subprime borrower, or the bankruptcy judge would set the interest rate at a submarket rate, apparently violating the premise of the statute and piling further harm on the lender.
Zywicki sees as more worrisome is the opportunity for abuse.
Imagine the following situation: A few years ago a borrower took out a $300,000 loan with nothing down to buy a new house. The house rises in value to $400,000, at which time he refinances or takes out a home-equity loan to buy a big-screen TV and expensive vacations. He still has no equity in the house.

The house subsequently falls in value to $250,000, at which point the borrower files for bankruptcy, the mortgage principal is written down, and the homeowner keeps all the goodies purchased with the home-equity loan. Several years from now, however, the house appreciates in value back to $300,000 or more -- at which point the homeowner sells the house for a tidy profit.
But sill other problems could arise as any modification of a mortgage during bankruptcy will almost certainly increase the losses of mortgage lenders, and this may further freeze credit markets.
The reason is that when mortgage-backed securities were created, they provided no allocation of how losses were to be assessed in the event that Congress would do something inconceivable, such as permitting modification of home mortgages in bankruptcy. According to a Standard & Poor's study, most mortgage-backed securities provide that bankruptcy losses (at least above a certain initial carve-out) should be assessed pro rata across all tranches of securities holders. Given the likelihood of an explosion of bankruptcy filings and mortgage losses through bankruptcy, these pro rata sharing provisions likely will be triggered. Thus, the holders of the most senior, lowest-risk trances would be assessed losses on the same basis as the most junior, riskiest tranches.

The implications of this are obvious and potentially severe: The uncertainty will exacerbate the already existing uncertainty in the financial system, further freezing credit markets.
In summary,
If Congress wants to deal with the rising number of foreclosures, it should not create a new mess by converting the mortgage crisis into a bankruptcy crisis. Doing so will open the door to a host of unintended consequences that will further freeze credit markets, raise interest rates for new home buyers, and spread the mortgage contagion to other types of consumer credit.
The logic of this applies outside of the US. The problems Zywicki identifies would arise if politicians attempt to interfere with mortgages even in countries with different legal rules.

20 reasons it's okay to hate Valentine's Day (updated)

Let me repeat my posting from this time last year.

The Times has a list, 20 reasons it's okay to hate Valentine's Day. Number 14 is
It's such a rip-off. With flowers, dinner and cabs, you’re looking at a hundred quid minimum. Wouldn’t she just prefer the cash instead?
This has to be true, as any economist will tell you. Just giving her the cash must be pareto improving. With the cash she can either go out and buy what you would have bought, so she and you are no worse off, or she can buy what she really wants, and you would not have bought, so you will both be better off.

So next year, just give her the money guys.

Update: Over at the Stumbling and Mumbling blog, Chris Dillow takes issue with me about The rationality of Valentine's day. Homepaddock thinks me wrong as well. Jim Donovan disagrees with me here.

Incentives matter: smoking file

The BBC report that
Bribing smokers with cash incentives helps them stop, US research suggests.

Smokers are three times more likely to kick the habit for at least six months when they are paid up to $750 (£520), a new study has found.

Nearly 900 General Electric workers took part in the test across 85 US sites. The results were published in the New England Journal of Medicine.
(HT: Marginal Revolution)

Friday 13 February 2009

Meddlesome anarchy

Eric Crampton, econ department, and Brad Taylor, grad student in pol sci, have a new paper out on Anarchy, Preferences, and Robust Political Economy. The abstract reads:
We consider the relative robustness of libertarian anarchy and liberal democracy to meddlesome preferences. Specifically, we examine how the liberty of those wishing to engage in externally harmless activities is affected by people who wish to prevent them from doing so. We show that intense, concentrated meddlesome preferences are more likely to produce illiberal law in anarchy; while weak, dispersed meddlesome preferences are more likely to do so in democracy. Using insights from the economics of religion, we argue that anarchy is more likely than democracy to produce small groups with intense meddlesome preferences. Absent government provision of public goods, voluntary groups will emerge to fill the gap. Strict religious groups - 'sects' - are more able to overcome collective action problems and will therefore be more prevalent in an anarchic society. These sects are apt to instil intense meddlesome preferences in their members and have the ability to enforce them: anarchy produces the situation to which it is most fragile. Our argument reveals unresolved questions in the conventional understanding of institutional robustness.
Now go and read it! There will be an exam 9am Monday.

Deflation: the good and the bad

George Selgin has an article in The American Conservative on Deflated Expectations: When fear of falling prices becomes a self-fulfilling prophecy. His basic point is that there are two forms of deflation, the bad driven by demand shrinking and the good caused by supply expanding. The good kind of deflation is the result of increases in productivity. Research and development means new technology, efficiency gains, cost-cutting, price-cutting and, yes, deflation. Productivity gains mean that businesses could afford to sell their products for less since it is costing less to make them.

Selgin writes
And yet, for all the harm it has done, and might still do, deflation gets a bad rap. Although the Fed and other central banks don’t seem to realize it, deflation isn’t always as dangerous as it was in the 1930s. There’s another kind of deflation that can actually be a good thing. And when central banks stand in the way of this good sort of deflation, the results can be disastrous. The current bust is a case in point.

We’ll come back to that. But first, some more word association. The word this time is “innovation.” How about research and development, new technology, efficiency gains, cost-cutting, price-cutting … deflation.

Yes, deflation again. But this isn’t the bad deflation of the 1930s. It comes not from consumers having less money to spend but from them being confronted with more to spend it on. “Bad” deflation happens when demand shrinks; “good” deflation happens when supply expands.

The difference between the two sorts of deflation couldn’t be more basic. Most people grasp it without a hitch. Unfortunately, economists seem to be the exception, perhaps because of their obsession with the Great Depression and zeal to avoid repeating it. Nor has their understanding been aided by the fact that none of them has ever actually witnessed the good sort of deflation.

Yet good deflation isn’t just hypothetical. For much of the 19th century, when the gold standard prevented central banks from printing money willy-nilly, prices fell more often than they rose, and people considered that tendency to be perfectly natural. After all, technology was improving, so goods cost less to produce. Why shouldn’t prices reflect that reality? From 1873-96, for instance, prices in most gold-standard countries fell at an average rate of about 2 percent a year, while real output grew at correspondingly healthy rates of between 2 and 3 percent, thanks largely to productivity gains. That isn’t to say that there weren’t occasional crises—there were, and some involved a dose of bad deflation, driven by temporary lulls in lending and spending. But the general trend of spending was up, while the downward trend of prices remained within the bounds of underlying productivity gains and was for that reason perfectly benign: businesses could afford to sell their products for less as long as it was costing less to make them.
Selgin goes on to say
The complete disconnection of price movements from underlying real cost changes in modern times is a measure of contemporary monetary authorities’ laxness when it comes to preventing inflation, combined with their refusal to acknowledge the theoretical possibility of a benign deflation. That denial rests on sloppy economics that insist on conflating the consequences of good, supply-driven deflation with those of its bad, demand-driven counterpart.

Many experts insist, for example, that to allow any deflation is to risk putting people out of work because “sticky” wages and salaries will fail to keep pace with falling prices, causing rising labor costs to put a squeeze on employers. That’s a fine argument against bad deflation. But if output prices only decline when goods are being produced more efficiently, there’s no need for wages and salaries to fall along with them. On the contrary, productivity gains mean higher real wages and salaries in equilibrium, and the easiest way to achieve that equilibrium is to leave wages alone while letting the price level fall. When output prices are held up instead, money wages and salaries have to rise.

Next, consider the claim that deflation, or at least unexpected deflation, rewards creditors at the expense of debtors, increasing the likelihood of foreclosures. That’s true enough for bad deflation, when earnings are shrinking all around: with fixed loans to pay, something has to give, usually the loan payment. But the same isn’t true for good deflation. After all, if prices are falling because goods are becoming more abundant, why shouldn’t creditors get to enjoy that along with other income earners? Imagine that the extra goods drop like manna from heaven, with debtors and creditors grabbing like shares. What cause do debtors have for regretting the loans they negotiated? None at all. So far as theory can predict, if everyone had anticipated the falling price of manna, the terms of lending would have been no different. The debtors end up with more than before, but so what? The creditors can afford it.

Then there’s the claim that, if they permit deflation, the monetary authorities risk working themselves into a corner, like the present one, with short-term lending rates bottomed out at zero and no scope for any further easing of credit, at least by conventional means. That scenario raises the specter of an invincible deflationary spiral. But here again, while that’s plausible enough when bad deflation is in play, it’s quite implausible when all that’s happening is good deflation because a good deflation rate never exceeds an economy’s rate of productivity growth, and that rate itself sets a lower bound to equilibrium real rates of interest. It follows that as long as only good deflation is permitted, equilibrium nominal lending rates—real rates minus any anticipated deflation—never venture south of zero.

In sum, there’s no reason to fear good deflation or confuse it with its bad cousin. On the other hand, there is reason to fear central bank policies that prevent good deflation—especially those that cause prices to go up while production costs are going down. Such efforts trigger booms and busts.

Whenever productivity advances, so must real earnings. It follows that if output prices aren’t allowed to go down, input prices must go up. The same money creation that serves to prop up the prices of goods also puts upward pressure on the prices of labor and other factors of production. But as deflation-bashers never tire of reminding us, input prices are “sticky.” This means that, in the short run, money being pumped into the economy serves not to raise wages but to boost profits. And high profits, if projected into the future, boost asset prices. Yet the high profits aren’t sustainable because, although speculators may not know it, they are due to give way to higher costs. Voilà—a boom-bust cycle, and one that’s likely to catch investors off guard because the boom takes place in a setting of low inflation.
Selgin expands on these ideas in his book, published by the Institute of Economic Affairs, London, Less than Zero: The case for a falling price level in a growing economy.

Thursday 12 February 2009

Tyler Cowen interview

In this interview with The Daily Beast, economist and blogger Tyler Cowen says Timothy Geithner’s rumored bailout plan bears a disconcerting resemblance to the stimulus. The interview was done before the new Geithner plan was announced.

Here is one part:
It's a sort of finger in the dike approach with no clear vision, but maybe no one has a clear vision. And a finger in the dike is better than nothing. But it's not a great place to be.
Here is the closing bit:
The fact they're talking about an itty-bitty plan suggests to me they think things are manageable so it makes me more optimistic. I hope that’s not just them trying to trick me. So you can take their response actually as somewhat of a sign that things aren't as bad as the worst doomsayers are claiming.
Cowen now says
Today I am less optimistic about that.

Quote of the day

The role of the economist in discussions of public policy seems to me to be to prescribe what should be done in light of what can be done, politics aside, and not to predict what is "politically feasible" and then to recommend it.
Milton Friedman, "Comments on Monetary Policy", 'The Review of Economics and Statistics', 33 (3), August 1951: 186-191.

Social comparisons, perceptions of fairness and wellbeing

From comes this audio in which Armin Falk, director of the Bonn Laboratory of Experimental Economics talks to Romesh Vaitilingam about his experimental research on how people compare themselves with others and its impact on their health and wellbeing.

Interesting blog bits

  1. Economic Logic on Patents and copyrights are an abomination.
  2. Greg Mankiw on Bad ideas never die.
  3. Peter King asks Government intervention in the housing market: what works?
  4. Russell Roberts on Good politics vs. good economics. (Economics isn't winning.)
  5. Matt Nolan on Arnold Kling: Economics>Macro. (If you ask me, macro isn't economics! ;-))
  6. MacDoctor on 40kph.
  7. Homepaddock on It's not their money.
  8. William Easterly on Did Bill and Melinda Gates Claim Malaria Victories Based on Phony Numbers?

Wednesday 11 February 2009

Three reasons why central banking doesn't work

These are from Terry Arthur at the IEA Blog. They refer to the Bank of England but the three points apply more generally.
  1. Firstly, because over the last 50 years the Bank of England has devalued its notes to the point where today’s pound is worth only 5% of that in 1958.
  2. Secondly, because (like all nationalised central banks) the Bank of England lacks the feedback mechanism of free-market banking, it responds in exactly the same manner to a public demand for more money, whether or not that demand is to hold more money or to spend more money. A more perverse monetary policy is hard to imagine.
  3. Thirdly, the Bank of England’s other main job, the setting of short-term interest rates outside the market, necessarily destroys the market’s co-ordination of the structure of production, creating the cycle of boom and bust.

Brink Lindsey on Krugman's Nostalgianomics

Brink Lindsey, from the Cato Institute, has written a paper criticizing Paul Krugman's view that the period from 1950-1970 was some sort of golden era for economic policy. Krugman's view is based on the fact that this period involved high economic growth with relatively little inequality. Lindsey, on the other hand, views the immediate postwar era as one of lazy cartels, in which firms faced too little in the way of competition or creative destruction to warrant bidding up the price of executive talent.

Lindsey's article is Paul Krugman's Nostalgianomics: Economic Policies, Social Norms, and Income Inequality (pdf). The executive summary reads
What accounts for the rise in income inequality since the 1970s? According to most economists, the answer lies in structural changes in the economy— in particular, technological changes that have raised the demand for highly skilled workers and thereby boosted their pay. Opposing this prevailing view, however, is Princeton economist and New York Times columnist Paul Krugman, winner of the 2008 Nobel Prize in economics. According to Krugman and a group of like-minded scholars, structural explanations of inequality are inadequate. They argue instead that changes in economic policies and social norms have played a major role in the widening of the income distribution.

Krugman and company have a point. For the quarter century or so after World War II, incomes were much more compressed than they are today. Since then, American society has experienced major changes in both political economy and cultural values. And both economic logic and empirical evidence provide reasons for concluding that those changes have helped to restrain low-end income growth while accelerating growth at the top of the income scale.

However, Krugman and his colleagues offer a highly selective and misleading account of the relevant changes. Looking back at the early postwar decades, they cherry-pick the historical record in a way that allows them to portray that time as an enlightened period of well-designed economic policies and healthy social norms. Such a rosy-colored view of the past fails as objective historical analysis. Instead, it amounts to ideologically motivated nostalgia.

Once those bygone policies and norms are seen in their totality, it should be clear that nostalgia for them is misplaced. The political economy of the early postwar decades, while it generated impressive results under the peculiar conditions of the time, is totally unsuited to serve as a model for 21st-century policymakers. And as to the social attitudes and values that undergirded that political economy, it is frankly astonishing that self-described progressives could find them attractive.

Crampton is this your fault?!!! (updated)

The Globe and Mail report:
Two of Canada's largest unions are urging the federal government to adopt a Buy Canadian policy similar to the proposal that has been criticized in the United States.

At a joint press conference on Tuesday morning, the Canadian Auto Workers and the United Steelworkers said Ottawa should adopt a procurement policy that ensures the majority of public funds are spent on goods and services made in Canada.
Update: Crampton relies (from the comments section)
You're surprised that Canadian unions would advance this proposal?

Harper's been on a bail-out blowout of late. Hopefully he knocks back this bit of protectionism. Big picture, though, it's probably helpful that he has some pressure on him for this sort of thing, if only because it might help him to get an exemption to the US buy-American rules in exchange for his standing up to the overwhelming public demand etc.
No I'm not surprised. I would expect to see a lot more of this kind of thing in many other countries, including New Zealand, in the near future.

Becker and Murphy on the stimulus package

Given that the government has just announced that it will waste $500 million of taxpayers money on our very own stimulus package, it may have helped if John Key had read the recent Wall Street Journal article by Gary S. Becker, the 1992 Nobel economics laureate, a professor of economics at the University of Chicago and senior fellow at the Hoover Institution, and Kevin M. Murphy, a MacArthur Fellow, an economics professor at the University of Chicago and a senior fellow at the Hoover Institution, before making such an announcement.

Becker and Murphy make the obvious, to everyone but the government, point that There's No Stimulus Free Lunch: It's hard to spend wise and spend fast. Becker and Murphy ask the question
How much will the stimulus package moving in Congress really stimulate the economy?
This seems an important question. They look at the spending parts of the House and Senate bills -- over US$500 billion -- and assessed the quantitative effects of four basic factors.
  1. How much increase in Gross Domestic Product (GDP) can be expected from the stimulus package?
  2. The increased government spending in the stimulus package is supposed to be only temporary, until the economy returns to a full employment level, but probably won't be.
  3. The effects on consumers and businesses of the stimulus package depend not only on the stimulus to short-term GDP, but also on how valuable the spending is.
  4. There are no free lunches in spending, public or private.
On the first point they say:
So our conclusion is that the net stimulus to short-term GDP will not be zero, and will be positive, but the stimulus is likely to be modest in magnitude. Some economists have assumed that every $1 billion spent by the government through the stimulus package would raise short-term GDP by $1.5 billion. Or, in economics jargon, that the multiplier is 1.5.

That seems too optimistic given the nature of the spending programs being proposed. We believe a multiplier well below one seems much more likely.
About the second point they write:
The evidence of past expansions of government programs is just the opposite. Once created they tend to survive and grow over time, even when the increases initially were said to be temporary. The underlying reason for this is that interest groups develop around new and expanded programs, and they lobby to keep and expand those programs.

This implies that the spending programs in the stimulus package will continue to some extent after the economy has returned to full employment. The multiplier at that time will surely be much closer to zero. Looking several years ahead, then, the average stimulus from the expansion in government spending will be smaller, perhaps much smaller, than the short-term stimulus.
As Milton Friedman once put it "There is nothing more permanent then a temporary government program." On the third point Becker and Murphy say:
Whatever the merits of other government spending, the spending in this package is likely to have less value. A very large amount of money will be spent quickly over a two-year period: $500 billion amounts to about one-quarter of the total federal government annual spending of $2 trillion. It is extremely difficult for any group, private as well as public, to spend such a large sum wisely in a short period of time.

In addition, although politics play an important part in determining all government spending, political considerations are especially important in a spending package adopted quickly while the economy is reeling, and just after a popular president took office. Many Democrats saw the stimulus bill as a golden opportunity to enact spending items they've long desired. For this reason, various components of the package are unlikely to pass any reasonably stringent cost-benefit test.
Again, an example of the simple but important point that politics always overrides economics, no matter how bad the politics and how good the economics. As to the last point Becker and Murphy say:
The increased federal debt caused by this stimulus package has to be paid for eventually by higher taxes on households and businesses. Higher income and business taxes generally discourage effort and investments, and result in a larger social burden than the actual level of the tax revenue needed to finance the greater debt. The burden from higher taxes down the road has to be deducted both from any short-term stimulus provided by the spending program, and from its long-run effects on the economy.
These four points apply as much to New Zealand as they do to the US, so I would like to hear the government's reply to them. It is incumbent on both supporters, and opponents, of any stimulus package to evaluate each of these four factors. Has the government really done this? If so, what are their conclusions? If not, why not?

Tuesday 10 February 2009

John Taylor on the financial crisis

John B. Taylor, professor of economics at Stanford and a senior fellow at the Hoover Institution, has a piece in the Wall Street Journal on How Government Created the Financial Crisis. He opens by noting that
Many are calling for a 9/11-type commission to investigate the financial crisis. Any such investigation should not rule out government itself as a major culprit. My research shows that government actions and interventions -- not any inherent failure or instability of the private economy -- caused, prolonged and dramatically worsened the crisis.
The problems in the housing market, i.e. the housing boom and crash, were the result of monetary policy and a government induced relaxation in borrowing standards. A lack of liquidity was, wrongly, seen by many policymakers as the major problem and they attempted to fix things by trying to increase loan volume as far back as 2007. In 2008 there was additional "stimulus" and even lower federal-funds rates which were in turn followed by a set of arbitrary interventions, you know, selective bank bailouts, the inexplicable TARP etc.

Bernanke and Paulson come in for special blame, from Taylor, for creating regime uncertainty. Taylor writes:
On Friday, Sept. 19, the Treasury announced a rescue package, though not its size or the details. Over the weekend the package was put together, and on Tuesday, Sept. 23, Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson testified before the Senate Banking Committee. They introduced the Troubled Asset Relief Program (TARP), saying that it would be $700 billion in size. A short draft of legislation was provided, with no mention of oversight and few restrictions on the use of the funds.


The realization by the public that the government’s intervention plan had not been fully thought through, and the official story that the economy was tanking, likely led to the panic seen in the next few weeks. And this was likely amplified by the ad hoc decisions to support some financial institutions and not others and unclear, seemingly fear-based explanations of programs to address the crisis. What was the rationale for intervening with Bear Stearns, then not with Lehman, and then again with AIG? What would guide the operations of the TARP?
Taylor's basic point is that the government has created the crisis and is now deepening and prolonging it by trying to "fix" the problem by intervening in the economy, despite the fact that it was, to a large degree, their previous interventions created the problem in the first place. Read the whole article, its well worth the time spent.

EconTalk this week

Daron Acemoglu, of MIT, talks with Russ Roberts, the host of EconTalk, about the financial crisis and the lessons that need to be learned from the crisis. He argues that economists overestimated the stability of self-interest and ignored the institutional context of financial decision-making. He makes the case for new regulation and worries that political decisions will neglect the importance of growth.

Monday 9 February 2009

Local body politicians and pay rates

Over at Homepaddock it is noted that several mayors seem to think they deserve a pay rise:
Oh dear, if there’s a phrase that politicians should never utter it’s “we deserve a pay rise” and to be fair, the mayors interviewed by the Southland Times didn’t put it in exactly those words.

Queenstown-Lakes mayor Clive Geddes said:

“My own view, not speaking for myself but speaking for the councils and community chairs in this district, is that their remuneration is significantly below the effort and contribution they make.”

Central Otago mayor Malcolm Macpherson said:

. . . in my view people who do the sort of work that rural authority mayors do are pretty much underpaid as it is.

And Southland District mayor Frana Cardno said:

. . . Our councillors earn a pathetic amount that wouldn’t even cover the costs of them leaving their work for the day . . .

I suspect they all have a point, that council pay is less than fair compensation for the time and effort good councillors put into their work.
I would say this is wrong. If it were right, then no one would stand in the local body elections. After all, people will only stand if they think that the return, in whatever form, makes taking on the job worthwhile. And as people are doing these jobs at the current pay rate it can't be too low. In fact as there are normally more than one candidate for these positions it appears there is an excess demand, perhaps the pay rate is way too high. We should lower it!!

The sad thing about the stimulus bills

Peter Boettke at the Austrian Economists blog makes a very important point about the the stimulus bills and the role of economic analysis in designing a response to the current problems:
On a morning talk show today, one of the commentators made the wisest remark when he said ultimately the stimulus bill will not be determined on the basis of economics, but instead on ordinary politics. And that ladies and gentlemen is the problem.

Exactly. Convenient, lowest denominator politics will always override good economics.