Prophet der Pleite
Oliver Hartwich and I have an article in Juedische Allgemeine profiling Nouriel Roubini. Linked text is in German, but an English language version can be found here.
posted on 17 September 2009 by skirchner in Economics, Financial Markets
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Minsky Remembered
Eric Falkenstein recalls Hyman Minsky:
I was Minsky’s TA while a senior at Washington University in St.Louis in 1987, and took a couple of his advanced classes, which regardless of the official name, were all just classes in Minskyism. He was a maverick, but perhaps a bit too much, being a little too dismissive of others, as he hated the traditional Samuelson/Solow Keynesians as much as the Friedmanite Monetarists. He always thought a market collapse was just around the corner…
Most articles celebrating Minsky have a strong subtext, kind of like Krugman’s wistful remembrance of his undergraduate macro based on the General Theory, that if we only go back to the days when Nixon famously said ‘we are all Keynesians now’, we would have more faith in government top-down solutions. That was when Federal spending was 30% of GDP. Now it’s 40%. Economists did not abandon Keynesianism because they are capitalist dupes, rather, it was inconsistent, generated poor models of economic growth, and it neglected the micro economic factors that make all the difference between a North Korea and South Korea: free markets, property rights, decentralized incentives. A Keynesian thought he could steer the economy via two controls, the budget deficit and the Fed Funds rate, and indeed in the short run these are very powerful tools, but in the longer run, rather unimportant.
It is reassuring that the critics of mainstream macro have nothing better than Minsky to turn to, but still no less excusable.
posted on 16 September 2009 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy
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A Policy-Induced Financial Crisis
John Cochrane and Luigi Zingales, on how policymakers induced a financial crisis a year ago today:
the main risk indicators only took off after Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke’s TARP speeches to Congress on Sept. 23 and 24—not after the Lehman failure.
The risk of Citibank failure (the Citi-CDS spread) and the cost of interbank lending (the Libor-OIS spread) rose dramatically after Ben Bernanke and Hank Paulson spoke to Congress. On Sept. 22, bank credit-default swap (CDS) spreads were at the same level as on Sept. 12. On Sept. 19, the S&P 500 closed above its Sept. 12 level. The Libor-OIS spread—which captures the perceived riskiness of short-term interbank lending—rose only 18 points the day of Lehman’s collapse, while it shot up more than 60 points from Sept. 23 to Sept. 25, after the TARP testimony.
Why? In effect, these speeches amounted to “The financial system is about to collapse. We can’t tell you why. We need $700 billion. We can’t tell you what we’re going to do with it.” That’s a pretty good way to start a financial crisis.
See also Cochrane on Krugman:
Krugman’s article is supposedly about how the crash and recession changed our thinking, and what economics has to say about it. The most amazing news in the whole article is that Paul Krugman has absolutely no idea about what caused the crash, what policies might have prevented it, and what policies we should adopt going forward. He seems completely unaware of the large body of work by economists who actually do know something about the banking and financial system, and have been thinking about it productively for a generation.
posted on 15 September 2009 by skirchner in Economics, Financial Markets
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Vindicating Fightback
I join the history wars with an op-ed in today’s Australian taking issue with Paul Kelly’s claim that ‘the defeat of Dr Hewson’s policy [of Reserve Bank reform] laid the basis for the successful monetary policy of the Keating-Howard era.’ I make the case that:
Far from being a repudiation of Fightback, as Kelly suggests, subsequent developments have largely vindicated its vision for monetary policy reform.
continue reading
posted on 15 September 2009 by skirchner in Economics, Financial Markets, Monetary Policy, Politics
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The Merchants of Doom
Juedische Allgemeine, Germany’s leading Jewish newspaper, recently asked Oliver Hartwich and I to write a profile of Nouriel Roubini as a counter to the numerous puff pieces in the Anglo-American press. The German language version has yet to appear online, but there is an English language version in today’s Age:
For years, he argued that the US current account deficit would lead to a US dollar crisis and higher interest rates, pushing the US economy into recession. But that was not how the financial crisis unfolded.
One of Professor Roubini’s few specific predictions was that the US would experience zero GDP growth in the fourth quarter of 2006. This was far off the mark: the actual result was 3 per cent. After this embarrassment, he backed away from his recession prediction, writing in January 2007 that ‘it is not clear whether the bust of the housing bubble in the US will lead to a soft landing as the consensus view goes or a hard landing that could take the form of a growth recession or, less likely now, an outright recession’. The professor was hedging his bets in early 2007, clearly uncertain about the direction for the US economy.
The Age also runs a self-refuting profile of Steve Keen headed ‘This Keen professor overlooked by MSM [mainstream media].’ If only!
While on the subject of Keen, Christopher Joye has prepared a handy route map for Keen’s house price forecast death march from Canberra to Mt. Kosciusko.
posted on 10 September 2009 by skirchner in Economics, Financial Markets, House Prices
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The Political Psychology of Activist Fiscal Policy
David Hirshleifer ponders the loaded character of the language behind activist fiscal policy:
Regardless of who’s right on the economics, clearly the ‘stimulus’ language captures the pro side perfectly, and the con side not at all. Indeed, the term immunizes the mind to opposing evidence…
So, here’s a political psychology question. Why did opponents gullibly swallow the stimulus terminology, and thereby defeat?
The antidote to the loaded language of activist fiscal policy is to draw attention to the government’s inter-temporal budget constraint. Few people would regard the announcement of a $42 billion future tax increase as ‘stimulatory’, but that is exactly what the federal government’s unfunded fiscal stimulus package amounts to in the absence of an explicit commitment to future cuts in government spending.
(HT: Don Boudreaux)
posted on 08 September 2009 by skirchner in Economics, Fiscal Policy
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Lehman Brothers’ Failure Was Not Pivotal
Even Steven Pearlstein recognises that the failure to rescue Lehman Brothers was not the pivotal event of last year’s financial crisis:
subsequent events have only confirmed that, if Lehman had somehow been rescued, things would not have turned out a whole lot better for Citigroup, or Washington Mutual or Wachovia or Bank of America, or any of the institutions that eventually needed cash injections from the Treasury. And it certainly would have done nothing to save AIG or Merrill, whose rescues were set in motion during the same Lehman weekend. For the reality is that, underlying the liquidity crisis of last fall was a massive credit crisis—too many risky loans made on loose terms and based on overly optimistic assumptions. Lehman’s failure may have sped up the process by which all this lousy lending was revealed and the losses acknowledged, but the financial reckoning was inevitable.
The final point is a political one. A year ago, in the wake of the Bear Stearns rescue, the public—left, right and center—was hopping mad about government bailouts of Wall Street. Paulson isn’t just kidding when he says that if he had used taxpayer money to save Lehman, impeachment proceedings would have begun against him the following day.
posted on 06 September 2009 by skirchner in Economics, Financial Markets
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The Children of Julian Simon
Literally.
posted on 03 September 2009 by skirchner in Economics
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The Welfare Costs of Federal Infrastructure Spending
Henry Ergas and Alex Robson highlight the welfare costs of federal infrastructure spending:
Australian Government spending on infrastructure projects has increased rapidly in recent years, and especially so over the course of 2009. In this paper, we examine the processes for project evaluation, in the light of the Government’s commitment, in the 2008-09 Budget, to “(infrastructure) decision making based on rigorous cost-benefit analysis to ensure the highest economic and social benefits to the nation over the long term .. (and to) transparency at all stages of the decision making process.” We find that contrary to this commitment, significant projects have been approved either with no cost-benefit analysis or with cost-benefit analysis that is clearly of poor quality. Moreover, despite the commitment to transparency, very little information has been disclosed as to how most projects were evaluated.
To better assess the quality of project evaluation, we examine the largest single project the Commonwealth Government has committed to – the construction of a new National Broadband Network – and find that in present value terms, its costs exceed its benefits by somewhere between $14 billion and $20 billion dollars, depending on the discount rate used. We also find that it is inefficient to proceed with the project if its costs exceed $17 billion, even if the alternative is a world in which the representative consumer cannot obtain service in excess of 20 Mbps and even if demand for high speed service is rising relatively quickly. This amount of $17 billion is well below current estimates of the costs the NBN will involve, especially if (as the Government has pledged) the NBN is to serve non-metropolitan areas.
posted on 02 September 2009 by skirchner in Economics, Fiscal Policy
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Resolving Equity and Bond Market Divergence
Richard Cookson suggests two scenarios for the resolution of the current episode of equity and bond market divergence:
The benign argument for bond yields (and equities) revolves around supply. Many pundits and investors have been in a lather about the vast quantities of debt that governments have to issue. But if an unexpected mountain of supply raises the risk premium that investors demand for holding longer dated paper, the opposite is also true: supply that becomes less Everest-like than feared would reduce it.
So the benign explanation for why bond yields have been falling even as equity markets have been rallying is that worries about the surge in government bond issuance are lessening as signs of recovery mount.
That in turn should lead to a fall in government issuance and thus long-term yields, especially since inflationary pressures (apart perhaps from the UK) are so muted and yield curves so steep by historical standards.
And if that’s right, lower government bond yields would increase the appeal of riskier assets, equities included.
Effectively, the ex ante equity-risk premium would be driven higher because the long-term risk-free rate, but not the growth rate, would be lower.
Sadly, there’s also an altogether more malign explanation. Much as was the case in Japan in the 1990s, it could be that low government bond yields are telling you that this recovery is unsustainable once the monetary and fiscal medicine wears off.
It could be saying that, thanks to the required private sector deleveraging, especially in the US and UK, the long-term potential growth rate of the developed world is much lower than it was. That would lead to a sharply lower ex ante equity risk premium and thus potentially dreadful returns from equities.
Unfortunately, another lesson from Japan in the 1990s is that the world’s lowest bond yields can co-exist with the world’s worst fiscal policy outcomes. This makes the first of Cookson’s scenarios less plausible. We are more likely to end up with whatever is behind door number two.
posted on 01 September 2009 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy
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The Political Economy of House Price Doom-Mongering
The Rismark Monthly for August suggests the following explanation for house price doom-mongering:
It’s very easy to rip into housing since it is a non-institutionalised asset class. All of Australia’s 8.4 million homes are owned by highly dispersed and faceless families. Australian and international equities, LPTs, unlisted commercial property, hedge funds, and private equity are, by way of comparison, mostly owned and controlled by powerful institutional stakeholders—fund managers, super funds, investment banks, corporates and/or super high net worths. In turn, most of the analysts, strategists, economists, investors and journalists’ business models are built on these asset-classes succeeding. It therefore makes little commercial sense to bludgeon them with the relentless hysterics we hear about housing. In contrast, bricks and mortar is easy game. There are few if any institutional constituents to annoy. Just anonymous individual families with little authority and influence.
Making unsubstantiated claims about a forthcoming housing Armageddon is a win-win situation. With one hand you distract attention away from the poor performance of your own Australian equities portfolio, while with the other you boost the likelihood of unsuspecting retail money flowing your way.
While this explains the sell-side bias against housing, it is harder to understand the buy-side interest in doom-mongering. Presumably, the media know their own market and stories of housing boom and bust undoubtedly sell.
posted on 31 August 2009 by skirchner in Economics, Financial Markets, House Prices
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A Supply-Side View of Global Housing Markets
Matthew Hassan looks at the supply-side of global housing markets, finding that Australia has one of the world’s most under-supplied markets, which in turn explains the resilience of Australian house prices. Hassan’s simple indicator does a good job explaining cross-national variation in house price growth.
posted on 28 August 2009 by skirchner in Economics, Financial Markets, House Prices
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More Survey Evidence for Ricardian Equivalence
Andrew Leigh uses survey evidence to estimate the amount by which the 2009 fiscal stimulus payments boosted spending in Australia. The cross-sectional variation in the spending rate finds evidence in favour of Ricardian equivalence:
The third variable tabulates the spending rate against respondents’ degree of worry about government debt. This is a loose test of Ricardian equivalence – the theory that consumers will only spend a payment if it is accompanied by a reduction in government expenditure. Respondents who are more worried about government debt (and therefore perhaps more concerned that government payments now will lead to tax increases in the future) are significantly less likely to spend the rebate. For example, only 25 percent of respondents who are very worried about government debt spent the rebate, as compared with 46 percent of respondents who are not at all worried bout government debt. This difference remains significant even in a multivariate regression.
The survey results find that just under 60% of respondents save the payments/paid off debt, while 40.5% claim to have spent it. Leigh suggests this points to a marginal propensity to consume out of the stimulus of 0.41 to 0.42. However, he also notes an obvious limitation of the Australian survey data:
the US questions asked respondents whether the rebate would lead them to increase spending, while the Australian question asked respondents whether they would spend the money. In theory, Australian respondents who did not think that the money would increase their overall spending might nonetheless have told the interviewer that they would spend it, if they thought that the question related to cash flow rather than net expenditure.
Because stimulus payments are fungible with other income, the survey question does not directly address the issue of whether recipients increased their overall spending. This problem also afflicts the Westpac-Melbourne Institute survey noted by Leigh. The ANU survey results may therefore overstate what is already a low MPC.
Meanwhile, Peter Garrett discovers the marginal propensity to import.
posted on 27 August 2009 by skirchner in Economics, Fiscal Policy
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Mid-Week Linkfest
The strangest bid in the worst of the worst of the US equity market.
How not to fall down the data mine.
Uncertainty and the negative equity risk premium.
How ‘peak oil’ nonsense leads to bad public policy.
Rule of law in the US ‘at the level of China’.
Tony Makin on Keynesian economics.
posted on 26 August 2009 by skirchner in Economics, Financial Markets, Oil
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Anchoring Fiscal Expectations
Eric Leeper argues that expectations for fiscal policy are as important as those for monetary policy. Leeper points to ‘an egregious example of non-transparent fiscal policy’:
the recent $787 billion American fiscal stimulus plan. Leading up to the introduction and passage of the American Recovery and Reinvestment Act, the entire economic rationale for thestimulus package consisted of the job creation prediction in a document by Romer and Bernstein (2009). The document claims it “suggests a methodology for ensuring the package contains enough stimulus. . . [to] create sufficient jobs to meet the Presidentelect’s goals [p. 2].” An appendix reports multipliers for a permanent increase in government spending and decrease in taxes of 1 percent of GDP. Four years after the initial stimulus, government purchases raise GDP by 1.55 percent, while tax cuts raise GDP by 0.98 percent. Sources for these numbers are reported as the Federal Reserve’s FRB/US model and “a leading private forecast firm.”
To assess how this rationale for stimulus measures up in terms of transparency, I raise some questions that are not addressed in the Romer-Bernstein document, but are important for anchoring fiscal expectations:
• What are the economic models underlying the multiplier numbers and are those numbers reproducible?
• Why consider permanent changes in fiscal variables when the Act makes transitory changes?
• What are the consequences of the stimulus for government debt?
• What are the repercussions of significantly higher government debt?
• Will the debt run-up be sustained or retired?
• How will policies adjust in the future to either sustain or retire the debt?
• What “methodology” does this document suggest for gauging the necessary size of fiscal stimulus?
Some might accuse me of finding a straw man to ridicule. But this is an important example because of its potential impact on the world economy.
The same questions could be asked in the Australian context.
Robert Carling and I make a similar case for rules-based fiscal policy here.
posted on 25 August 2009 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy
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