Category: Economics

Let’s say it one more time, shall we? Not that it’ll do any good…

The Washington Post Still Has Not Noticed the $8 Trillion Housing Bubble

News apparently takes a long time to reach downtown Washington, D.C. That is the only conclusion that Washington Post readers can have after seeing the paper attribute the economic downturn to: “the ways the subprime mortgage crisis that began in 2007 would ripple through the economy.”

Of course the downturn was not due to subprime mortgage crisis, it was due to the collapse of a housing bubble. Residential construction would not have been cut by more than 50 percent if the issue was just the subprime crisis. It fell by 50 percent because the bubble led to enormous overbuilding of housing.

Similarly the saving rate has risen by more than 6 percentage points, leading to falloff in annual consumption of more than $600 billion. This is not the result of the subprime crisis. This is the result of the loss of $6 trillion in housing bubble wealth, along with the loss of $6 trillion in stock market wealth which was supported by housing bubble driven growth.

The subprime crisis was a triggering event. Had there not been an enormous housing bubble in the process of bursting the subprime crisis would have had little macroeconomic consequence. This news may at some point reach the Post. 

…

Dean Baker

The Incidental Economist:

How many wrongs make a right?

… If there is one thing I would love for all Americans to have in mind when evaluating politicians’ pronouncements about what we have done or should do with respect to government health spending it is this graph of projected federal revenue and spending as a percent of GDP, from the CBO:

Dean Baker (of course):

Fun With George Will

The Washington Post likes to run columns that are chock full of mistakes so that readers can have fun picking them apart. That is why George Will’s columns appear twice a week. …

… Will’s conclusion that stimulus does not work is like seeing someone throw a few buckets of water on their burning house and then telling the first department not to waste time with their houses, because obviously water will not be effective against the fire. …

Dean Baker. This is one of those persistent memes (forgive me) that wants constant swatting.

Wealthy Countries May Become Less Crowded and the NYT Wants Us to Be Scared

The NYT reported on new projections from the Population Reference Bureau showing continuing increases in population in the developing world and slow or negative growth in wealthy countries. Low birth rates in the wealthy countries are projected to lead to a rise in the ratio of retirees to workers. The NYT described this prospect as “sobering.”

There is no obvious reason that people in wealthy countries should be concerned about the prospect of a rising ratio of retirees to workers. This ratio has been increasing for a century. The projected increase in the elderly dependency ratio is largely offset by a decline in the number of dependent children. At the worst, the rise in the dependency ratio will offset some of the gains in wage growth associated with rising productivity, as has been the case in prior decades. So, it is not clear what the NYT wants readers to find “sobering” about this news.

The article also implied that a large jump in the share of GDP going to Social Security and Medicare is due to the aging of the population. Much of the cause of the projected increase in spending on these programs is the projected increase in per person health care costs. If per person health care costs in the United States fell to the levels in Germany or Canada, the share of GDP devoted to these programs in 2050 would be little different from what it is at present.

Paul Krugman:

The Facts Have A Well-Known Keynesian Bias

There are many things to say about Alan Greenspan’s op-ed yesterday, none of them complimentary. But what struck me is the passage highlighted by Tim Fernholz:

Despite the surge in federal debt to the public during the past 18 months—to $8.6 trillion from $5.5 trillion—inflation and long-term interest rates, the typical symptoms of fiscal excess, have remained remarkably subdued. This is regrettable, because it is fostering a sense of complacency that can have dire consequences.

You know, some people might take the fact that what’s actually happening is exactly what people like me were saying would happen — namely, that deficits in the face of a liquidity trap don’t drive up interest rates and don’t cause inflation — lends credence to the Keynesian view. But no: Greenspan KNOWS that deficits do these terrible things, and finds it “regrettable” that they aren’t actually happening. The triumph of prejudices over the evidence is a wondrous thing to behold. Unfortunately, millions of workers will pay the price for that triumph.

via Brad DeLong

More to the previous point. This is Stephen Gandel, writing for The Curious Capitalist at TIME.com.

Paul Krugman’s War on Austerity

At a time when most people are saying the path out of the financial crisis and European debt problem is for individuals and governments around the world to cut back, Paul Krugman wants us to spend, spend, spend.

 

So how much we spend on supporting the economy in 2010 and 2011 is almost irrelevant to the fundamental budget picture. Why, then, are Very Serious People demanding immediate fiscal austerity?

 

The answer is, to reassure the markets — because the markets supposedly won’t believe in the willingness of governments to engage in long-run fiscal reform unless they inflict pointless pain right now. To repeat: the whole argument rests on the presumption that markets will turn on us unless we demonstrate a willingness to suffer, even though that suffering serves no purpose.

Krugman has of course been calling for additional stimulus spending for a while. So it may be easy to dismiss Krugman as a liberal who, despite his Nobel, is no longer in touch with economics. But he’s not the only one calling for more spending.

 

Besides Krugman, Martin Wolf of the Financial Times has been arguing against government cut backs in the wake of the economic slowdown as well.

 

This is all very well, many will respond, but what about the risks of a Greek-style meltdown? A year ago, I argued – in response to a vigorous public debate between the Harvard historian, Niall Ferguson, and the Nobel-laureate economist, Paul Krugman – that the rapid rise in US long-term interest rates was no more than a return to normal, after the panic. Subsequent developments strongly support this argument.

 

US government 10-year bond rates are a mere 3.2 per cent, down from 3.9 per cent on June 10 2009, Germany’s are 2.6 per cent, France’s 3 per cent and even the UK’s only 3.4 per cent. German rates are now where Japan’s were in early 1997, during the long slide from 7.9 per cent in 1990 to just above 1 per cent today. What about default risk? Markets seem to view that as close to zero. . . .

The question is whether such confidence will last. My guess – there is no certainty here – is that the US is more likely to be able to borrow for a long time, like Japan, than to be shut out of markets, like Greece, with the UK in-between.

 

The debate here is between about what we should care about more: The current state of the economy or a perception about the long-term state of the economy. Because right now it seems in our best interest to spend more money on jobs programs, extending unemployment benefits and other stimulus programs. The problem is that all of that additional spending along with the current roughly $1.5 trillion deficit is going to get us into trouble. Krugman comes down on the side of it is more important to worry about people suffering now. The Tea Partiers, and many economists, care more about what the spending now could to the welfare of our children.

The problem with this argument, as Wolf points out, is that the bond market doesn’t see the Armageddon that the Tea Partiers, gold hoarders and other see. The 10-year bond yield is at historic lows. Now you can make the argument that markets are irrational. Technology stocks and houses were not as safe as we thought. And that may be true about US bonds as well. And so to send this country further into debt just because there is currently some bullishness in the bond market is foolish. Here’s Tyler Cowen making that very point:

 

In the blogosphere, discussions of market constraints are too heavily influenced by interest rates, which also “measure” an ongoing flight to safety.  (U.S. rates have fallen of late, but does that mean our fiscal position has improved?  Hardly.)  . . . . The real interest is only one indicator of where fiscal policy is at.  The point that interest rates serve multiple functions, and don’t always communicate direct market information very well, comes from…John Maynard Keynes.  Let’s at least keep that possibility in mind.

Yes, the bond market should tell us everything. You have to believe it tells us something. National economies are very large. And they can turn around very quickly. It’s not like our own personal economics. Getting out of credit card debt is very tough. Our incomes down change very much, and our spending patterns are ingrained in who we are. The US economy does surprising things. Who knew that Clinton was going to be able to get us into a surplus situation. Who would have guess that Bush would have been able to screw that up so quickly. And what about the financial crisis. Economies are very hard to predict. Interest rates even more so. So policy makers should go with what they know. We don’t know what our current deficits will mean for our children or even interest rates a year from now. We do know that people are unemployed and suffering financially. I say go with that.

 

Not much posting recently, for various reasons; let’s see if we can do something about that.

Here’s a sample of an ongoing discussion of what I take to be the most critical issue, at least in the short to medium term, for the US economy. Paul Krugman has been the most visible and consistent proponent of more stimulus. When the original stimulus bill was passed, he argued strongly against dropping a big lump of aid to the states, and it’s pretty obvious now that he was right.

Many congressional Democrats are now running for the austerity hills, presumably in anticipation of the November elections. I doubt it’ll get them elected, but it’ll almost certainly screw the economy.

Deja vu vu — epistemic relativism rides again: What Happened To “What Works”?

by digby

So even the excuse for the Austerity Campaign is bullshit. Here’s Krugman:

Consider, if you will, the comparative cases of Ireland and Spain.

Both countries appeared, on the surface, to be fiscally responsible until the crisis hit, with balanced budgets and relatively low debt. Both discovered that this was an illusion: revenues were buoyed by immense real estate bubbles, and when the bubbles burst they plunged into deficit — and found themselves potentially on the hook for large bank losses.

The countries responded differently, however. Ireland quickly embraced harsh austerity; Spain has had to be dragged into austerity, and still faces major political unrest.

So, how’s it going? This article is typical of what you read: it describes the Irish as doing what has to be done, while the Spaniards dither. And it has good things to say about how the Irish response is working:

Much bitterness but also stoicism; markets impressed by Irish resolve to bite the austerity bullet.

Well, I guess that’s right — if by “markets impressed” you mean a CDS spread of 226 basis points, compared with 206 points for Spain; not to mention a 10-year bond rate of 5.11 percent, compared with 4.46 percent for Spain.

So, I’m glad to hear that Ireland’s stoic acceptance of austerity is reassuring markets; it must be true, because that’s what everyone says. Because if I didn’t know that, I might look at the data and conclude that markets actually have less confidence in Ireland than they do in Spain, and that austerity in the face of a deeply depressed economy doesn’t actually reassure markets at all.

But hey, what are you going to believe: what everyone knows, or your own lying eyes?

Everything’s Kabuki apparently, even this.

So, what’s really going on here? I’ve posited that it’s a Shock Doctrine move to take advantage of global economic insecurity to dismantle the welfare state. Krugman has said that he thinks part of it economists want to “appear tough.” Brad Delong thinks it might have to do with governing elites being too distant from the concerns of ordinary people. I think everyone agrees that this seems to have come up out of the blue and goes against what most experts assumed to be the accepted economic prescriptions for decades until now.

I feel as if we are watching a slow motion train wreck, mouths agape, powerless to do anything to stop it — the Very Serious People are all on board, assured in their own minds, for different reasons, that history has ended and nothing that came before can possibly be of any consequence.

In fact, I feel exactly the same way I felt in the lead up to the Iraq war.

Ezra Klein – Galbraith: The danger posed by the deficit ‘is zero’

Galbraith: The danger posed by the deficit ‘is zero’

James Galbraith is an economist and the Lloyd M. Bentsen Jr. chair in government and business relations at the University of Texas at Austin. He’s also a skeptic of the prevailing concern over America’s long-term deficit. With many people now comparing America’s fiscal condition to Greece, I spoke with Galbraith to get the other side of the argument. An edited transcript of our conversation follows.

EK: You think the danger posed by the long-term deficit is overstated by most economists and economic commentators.

JG: No, I think the danger is zero. It’s not overstated. It’s completely misstated.

EK: Why?

JG: What is the nature of the danger? The only possible answer is that this larger deficit would cause a rise in the interest rate. Well, if the markets thought that was a serious risk, the rate on 20-year treasury bonds wouldn’t be 4 percent and change now. If the markets thought that the interest rate would be forced up by funding difficulties 10 year from now, it would show up in the 20-year rate. That rate has actually been coming down in the wake of the European crisis.

So there are two possibilities here. One is the theory is wrong. The other is that the market isn’t rational. And if the market isn’t rational, there’s no point in designing policy to accommodate the markets because you can’t accommodate an irrational entity.

…

Ezra Klein.

Did financial illiteracy contribute to subprime crisis?

It makes intuitive sense that complicated mortgage products would pose the most danger the borrowers who were least able to understand them. But did that intuition bear out in the real world? Sadly, yes. According to a new paper by Kristopher Gerardi, Lorenz Goette and Stephan Meier, “foreclosure starts are approximately two-thirds lower in the group with the highest measured level of numerical ability compared with the group with the lowest measured level. The result is robust to controlling for a broad set of sociodemographic variables and not driven by other aspects of cognitive ability or the characteristics of the mortgage contracts.”

To translate that back into English, borrowers with the most financial literacy were two-thirds less likely to be in foreclosure than borrowers with the least financial literacy. That result remained even after controlling for demographic characteristics such as education and income and the specific mortgages both groups signed. Bottom line: “Twenty percent of the borrowers in the bottom quartile of our financial literacy index have experienced foreclosure, compared to only 5 percent of those in the top quartile. Furthermore, borrowers in the bottom quartile of the index are behind on their mortgage payments 25 percent of the time, while those in the top quartile are behind approximately 10 percent of the time.”

What seems to be happening here is not that folks who are financially illiterate choose worse mortgages so much as folks who are financially illiterate make more financial mistakes once they have their mortgages. Either way, it’s a reminder of the extraordinary asymmetry of information that stands between borrowers and lenders. You can download the full paper here (pdf).

And the second.

The Dollar, the Deficit, and Accounting Identities

It would be great if people who reported on the budget deficit for major news outlets could be required to know the basic accounting identities that get taught in every introductory economics class. The key one that almost none of them seem to know is that the trade deficit (X–M) is equal to the sum of public and private savings (T–G)+(S–I). This identity means that if the United States is running a trade deficit, then the sum of public and private savings must also be negative. That has to be true — it is an identity. It’s just like 2 + 2 = 4. It is always true.

This matters for all the nutty deficit hysteria because no one every asks the deficit hawks how they would like to see the identity met. The U.S. has a large trade deficit because of the value of the dollar. At a given level of GDP, the main determinant of the trade deficit is the value of the dollar. Politicians and even many economists like to hyperventilate about “competitiveness” and talk about how we’re going to improve our trade situation by getting a better trained and educated work force, rebuilding the infrastructure, or fixing the tax code. But even if you gave any of these characters everything they wanted in whichever direction, there is no plausible story where their policy of choice would have even half the impact on competitiveness and trade as a 10 percent reduction in the value of the dollar — and even then we would only see the impact after many years.

So, the trade deficit is determined by the value of the dollar for all practical purposes. But, most of the deficit hawks see a fall in the value of the dollar as the worst possible outcome. This is their horror story. People will worry about whether the U.S. can pay its debts and then the dollar would fall, the horror, the horror!

Okay, so the deficit hawks want the U.S. to run a large trade deficit. Then the next question is what the rest of the equation should look like. Since they want a balanced or near balanced budget, the deficit hawks must want very low private savings. Again, we can hope to get the identity met by having high levels of private investment, but neither they, nor anyone else, has anything in their bag of tricks that will appreciable raise the level of private investment.

This means that Peter Peterson, David Walker and the rest of the deficit hawk crew want workers to have very low private savings, so that they will have nothing to live on in retirement when we cut their Social Security and Medicare. They may not say this, and it’s possible that they don’t even understand it themselves, but that is the logical conclusion of their position.

That may make Peter Peterson look bad, but accounting identities are even more powerful than rich Wall Street investment bankers with a billion dollars to buy newspapers, reporters, and economists.

—Dean Baker

It’s quiet. Too quiet. So let’s see if Dean Baker has something to say. Heres the first:

NYT Joins Efforts to Scare Public About the Size of Government Debt

Peter Peterson, the billionaire Wall Street investment banker, is devoting more than $1 billion to a campaign to whip up fears about budget deficits in order to force cuts in Social Security and Medicare. It almost looks as though the NYT has joined the effort.

It printed an article today that uses a measure of government debt that is explicitly designed to be misleading. The article reports on the debt of Greece, but then adds in a discussion of the debts of other countries, including the United States.

The calculations are misleading because they compare future obligations over many decades to the current year’s GDP. The honest way to do this calculation is to compare future obligations to projected GDP over the time horizon in which these obligations will be met. However, this calculation would produce a much lower ratio. (The debt in the case of the U.S. would be around 6 percent of GDP.)

It is also worth noting that in the case of the United States, the vast majority of the projected deficit is due to exploding health care costs. If the country fixed its health care system it would instead have large surpluses.

—Dean Baker