- July 31, 2012 is Milton Friedman’s 100th birthday. Here are two readings to celebrate the occasion: Remembering the Real Milton Friedman (David Beckworth); and NGDP Targeting is the Natural Heir to Monetarism (yours truly).
- Should the German public be angry about the euro crisis? Yes, but mad at whom? In this post, Josh Rosner gives a list—mad at EU technocrats who designed a bad system, mad at banks that made reckless investments, and others. Hat tip to Yves Smith via Economonitor.com for a good summary.
- Richard A. Muller, Prof. of Physics at UC Berkeley, used to be a climate skeptic. His studies of climate records led him to doubt the very existence of global warming. However, he believes that the duty of a scientist is to be skeptical. In this article from The New York Times, he explains how further research has convinced him that climate change is not only real, but is caused almost entirely by human activity.
Tuesday, July 31, 2012
Remembering Milton Friedman and Other Links for Your Classroom
Monday, July 30, 2012
Financial Reform: Five Reasons Why We're Screwed
This past week brought a spate of articles on the woes of financial regulation. John Kay writes
that the regulation we are getting “is at once extensive and intrusive,
yet ineffective and largely captured by financial sector interests.” James Kwak thinks that crude capture at the level of Congress is exacerbated by intellectual capture at the level of regulatory staff. John Gapper sees
a slightly different form of intellectual capture in which “any
oversight that is biased towards preserving stability will often shy
away from making life too difficult for banks.” Randal Wray sees
outright fraud—a system in which top corporate managers run their
institutions as weapons to loot shareholders and customers for their own
benefit. Although some of these writers use more measured language than
others, all of them seem to agree with Wray on one point: We’re
screwed.
So, can financial regulation be fixed, or not? Each writer points out reasons why effective financial regulation may be impossible, and I would add one more. As I see it, one of the biggest problems is that too many regulations, even those that are not tainted by capture, are prohibitions of specific risky activities, such as ownership of hedge funds or proprietary trading. This approach has two kinds of unintended consequences.
One is that prohibiting specific kinds of risks increases the incentives for fraudulently hiding them from investors, shareholders, and regulators. The other stems from the fact that financial institutions have an infinite menu of risky activities to choose from. If regulations prohibit some of them without curbing their inherent appetite for risk, they just move on to the next activity on their menu. Unfortunately, that activity may have a risk-return profile that is inferior both from financial managers’ own point of view and from that of the public interest.
It is like a parent who tries to get an obese child to take some weight off by saying, “No more chocolate ice cream, no more Big Macs.” The child just switches to mint chip ice cream and pizza.
In an earlier post, I used this diagram to illustrate the point. Regulators and bankers have different preferences so they seek different optimal points along the risk-return frontier. Ideally, regulators would like to find a way to induce banks to slide down and to the left along the frontier to a less risky point. Instead, by outlawing the specific strategies banks have used in the past, all they do is to drive them inward, away from the frontier and toward some new set of still risky but less efficient strategies. Both sides end up worse off.
The implication is that only two kinds of regulations could ever do any real good. One would be those that curb the risk appetite directly, for example, by changing compensation practices, by exposing financial executives to personal legal risks, or by other reforms of corporate governance. The other would be to break up institutions into small enough units that their failure can be tolerated. Of course, crude capture might make that kind of reform exactly the hardest to achieve. If so, then we really are screwed.
This post originally appeared in the "What's On Your Mind" department of Economonitor.com
So, can financial regulation be fixed, or not? Each writer points out reasons why effective financial regulation may be impossible, and I would add one more. As I see it, one of the biggest problems is that too many regulations, even those that are not tainted by capture, are prohibitions of specific risky activities, such as ownership of hedge funds or proprietary trading. This approach has two kinds of unintended consequences.
One is that prohibiting specific kinds of risks increases the incentives for fraudulently hiding them from investors, shareholders, and regulators. The other stems from the fact that financial institutions have an infinite menu of risky activities to choose from. If regulations prohibit some of them without curbing their inherent appetite for risk, they just move on to the next activity on their menu. Unfortunately, that activity may have a risk-return profile that is inferior both from financial managers’ own point of view and from that of the public interest.
It is like a parent who tries to get an obese child to take some weight off by saying, “No more chocolate ice cream, no more Big Macs.” The child just switches to mint chip ice cream and pizza.
In an earlier post, I used this diagram to illustrate the point. Regulators and bankers have different preferences so they seek different optimal points along the risk-return frontier. Ideally, regulators would like to find a way to induce banks to slide down and to the left along the frontier to a less risky point. Instead, by outlawing the specific strategies banks have used in the past, all they do is to drive them inward, away from the frontier and toward some new set of still risky but less efficient strategies. Both sides end up worse off.
The implication is that only two kinds of regulations could ever do any real good. One would be those that curb the risk appetite directly, for example, by changing compensation practices, by exposing financial executives to personal legal risks, or by other reforms of corporate governance. The other would be to break up institutions into small enough units that their failure can be tolerated. Of course, crude capture might make that kind of reform exactly the hardest to achieve. If so, then we really are screwed.
This post originally appeared in the "What's On Your Mind" department of Economonitor.com
Tuesday, July 24, 2012
How Flawed Leadership Selection Harms the Economies of China and the US
Sometimes you read one thing in isolation and it doesn’t make much
impression, but then you read something else and the pieces click
together. That was the case for me this week with two disparate articles
on how nations select leaders.
The first was written by Jon Huntsman, former Governor of Utah, Ambassador to China, and Republican presidential candidate. During the GOP primaries, Huntsman’s candidacy was distinguished by two things: An unusually high ratio of sense to nonsense during the debates, and an unusually low number of votes at the polls. Now he is free to speak out. In a Financial Times comment this week entitled “True Conservatives Despise America’s Crony Capitalism,” he wrote that Republicans should do the following:
The second article was by Minxin Pei, a professor of government at Claremont McKenna College. Pei’s article asks why China can’t pick good leaders.
China, like the United States, needs structural reforms. It has a housing bubble that is proving hard to deflate in an orderly manner, a fragile financial system, and a distribution of income that is becoming ever more unequal. Pei doubts that the leadership is up to dealing with these issues.
Of course, China’s political system is different from that of the United States in many ways. Where China has a one-party, authoritarian government with scheduled changes of leadership, the United States has a two-party, democratic government with scheduled changes of leadership. Beneath these obvious differences, though, there are similarities.
Pei thinks China’s problem lies in the fact that it does not select leaders on the basis of demonstrated abilities, but rather, on the basis of political patronage and ties to powerful interest groups. He writes that the most damaging effect of this Byzantine system is a “leadership prone to factional compromise, even policy paralysis.” That is why China has failed to undertake much-needed economic reforms to rebalance its economy.
The problem that afflicts both countries is one that Mancur Olson wrote about in The Rise and Decline of Nations. As economies grow strong and political systems mature, leadership becomes more and more beholden to coalitions of special interests that are more interested in dividing up the pie than in enlarging it or improving the quality of the stuff it is filled with. Once interest group politics becomes entrenched, nations decline.
It has been a quarter of a century now since Olson wrote that book. In the United States, factionalism has hardened and policy paralysis has become the norm. Over the same period, China has had a run of success that Olson could hardly have imagined, but it, too, is showing signs of the same factionalism and paralysis. In both countries, very different but equally flawed systems for selecting leaders exacerbate the problem.
Originally posted at Economonitor.com
The first was written by Jon Huntsman, former Governor of Utah, Ambassador to China, and Republican presidential candidate. During the GOP primaries, Huntsman’s candidacy was distinguished by two things: An unusually high ratio of sense to nonsense during the debates, and an unusually low number of votes at the polls. Now he is free to speak out. In a Financial Times comment this week entitled “True Conservatives Despise America’s Crony Capitalism,” he wrote that Republicans should do the following:
- Protect America’s economic dynamism by rolling back the power of incumbent business and political interests
- Reform the tax code by closing loopholes and flattening individual rates
- Open markets to allow clean fuels to compete with gasoline and diesel
- Reform the financial system so that the country is not held hostage by banks that are too big to fail
- Instead of pointlessly ranting against “Obamacare,” start slogging toward alternative healthcare solutions, with an emphasis on cost control measures like ending fee-for-service medicine
- Make sure defense budgets are driven by long-term strategic threats, not lobbyists
- Endorse term limits for Congress, campaign finance reform, and an end to the revolving door that blurs the distinction between regulators and regulated
The second article was by Minxin Pei, a professor of government at Claremont McKenna College. Pei’s article asks why China can’t pick good leaders.
China, like the United States, needs structural reforms. It has a housing bubble that is proving hard to deflate in an orderly manner, a fragile financial system, and a distribution of income that is becoming ever more unequal. Pei doubts that the leadership is up to dealing with these issues.
Of course, China’s political system is different from that of the United States in many ways. Where China has a one-party, authoritarian government with scheduled changes of leadership, the United States has a two-party, democratic government with scheduled changes of leadership. Beneath these obvious differences, though, there are similarities.
Pei thinks China’s problem lies in the fact that it does not select leaders on the basis of demonstrated abilities, but rather, on the basis of political patronage and ties to powerful interest groups. He writes that the most damaging effect of this Byzantine system is a “leadership prone to factional compromise, even policy paralysis.” That is why China has failed to undertake much-needed economic reforms to rebalance its economy.
The problem that afflicts both countries is one that Mancur Olson wrote about in The Rise and Decline of Nations. As economies grow strong and political systems mature, leadership becomes more and more beholden to coalitions of special interests that are more interested in dividing up the pie than in enlarging it or improving the quality of the stuff it is filled with. Once interest group politics becomes entrenched, nations decline.
It has been a quarter of a century now since Olson wrote that book. In the United States, factionalism has hardened and policy paralysis has become the norm. Over the same period, China has had a run of success that Olson could hardly have imagined, but it, too, is showing signs of the same factionalism and paralysis. In both countries, very different but equally flawed systems for selecting leaders exacerbate the problem.
Originally posted at Economonitor.com
Wednesday, July 18, 2012
US Inflation Near Zero in June, Deflation Risk Rises
The latest inflation data from the Bureau of Labor Statistics
show the CPI unchanged in June, following a 0.3 percent decrease in
May. For the full year, the CPI has risen just 1.7 percent, well below
the Fed’s target of 2 percent. Since the beginning of June, an important
indicator of the risk of Japanese-style deflation has begun to rise for
the first time in two years. >>>Read more
Follow this link to view or download a slideshow with the latest charts of inflation and deflation risk
Follow this link to view or download a slideshow with the latest charts of inflation and deflation risk
Monday, July 16, 2012
Manipulating the Numbers: Motive, Means and Opportunity
I have been thinking about some important parallels between the Libor
scandal and the failure of ratings for structured securities. The
parallels arise from the existence, in both cases, of the motive, means,
and opportunity to manipulate the numbers for private gain.
The means and opportunity arise from the fact that neither Libor nor ratings are objective reports of past events. Compare them, in that respect, to numbers like exchange rates or the outcome of T-bill auctions. The latter are reports of transactions that someone actually carried out. Libor and ratings, instead, are reports of transactions that someone thinks could possibly take place—borrowing that a bank could undertake if it wanted to in the case of Libor or future fulfillment of a financial obligations in the case of ratings. If someone says that something could happen, is that what they really think, or not? There is no way to check.
The motive for manipulation comes from two sources. One is the fact that the values of many financial instruments are pegged to these numbers. For example, the value of an interest rate swap changes as Libor changes, and the value of a credit default swap changes as ratings change. The other motive comes from regulatory reliance on the numbers. Banks (Barclays in particular) thought they could relieve regulatory pressure if they reported an ability to borrow cheaply. In other cases, financial institutions knowingly bought overrated securities so that they could indulge their appetite for risk while minimizing regulatory capital requirements.
With motive, means, and opportunity aligned in so tidy a fashion, is there any wonder that fraud took place?
All this makes one wonder about a different category of numbers that move markets, numbers like unemployment and inflation rates. Those, in principle, are objective reports of past events, unlike Libor or securities ratings. However, unlike exchange rates or T-bill prices, outsiders cannot easily verify them. The raw data are not easily accessible; and even if the raw data could be verified, the methodology of deriving the final numbers could be subject to manipulation.
Observers of emerging market economies, such as Argentina or China, frequently express doubts about reported inflation rates and other data. So do many people in the United States. Anyone who has ever blogged about inflation or unemployment rates is used to a hailstorm of comments along the lines of “Gummint lyin’ to us again!”
So far, though, most economists think our government number crunchers are doing an honest job, as best they can, given the inherent methodological difficulties and the budget constraints they face. (In support of that view, check out various bits of Congressional testimony by Keith Hall, posted here. Hall was Chief Economist of the Council of Economic Advisers from 2005 to 2008 and Commissioner of Labor Statistics from 2008 until earlier this year.)
I hope this professionalism lasts. If we learned from some whistleblower that the BLS had falsified a jobs report on the eve of an election, we would have a scandal that would make the Libor manipulation look like a tempest in a teapot.
Originally posted at Economonitor.com
The means and opportunity arise from the fact that neither Libor nor ratings are objective reports of past events. Compare them, in that respect, to numbers like exchange rates or the outcome of T-bill auctions. The latter are reports of transactions that someone actually carried out. Libor and ratings, instead, are reports of transactions that someone thinks could possibly take place—borrowing that a bank could undertake if it wanted to in the case of Libor or future fulfillment of a financial obligations in the case of ratings. If someone says that something could happen, is that what they really think, or not? There is no way to check.
The motive for manipulation comes from two sources. One is the fact that the values of many financial instruments are pegged to these numbers. For example, the value of an interest rate swap changes as Libor changes, and the value of a credit default swap changes as ratings change. The other motive comes from regulatory reliance on the numbers. Banks (Barclays in particular) thought they could relieve regulatory pressure if they reported an ability to borrow cheaply. In other cases, financial institutions knowingly bought overrated securities so that they could indulge their appetite for risk while minimizing regulatory capital requirements.
With motive, means, and opportunity aligned in so tidy a fashion, is there any wonder that fraud took place?
All this makes one wonder about a different category of numbers that move markets, numbers like unemployment and inflation rates. Those, in principle, are objective reports of past events, unlike Libor or securities ratings. However, unlike exchange rates or T-bill prices, outsiders cannot easily verify them. The raw data are not easily accessible; and even if the raw data could be verified, the methodology of deriving the final numbers could be subject to manipulation.
Observers of emerging market economies, such as Argentina or China, frequently express doubts about reported inflation rates and other data. So do many people in the United States. Anyone who has ever blogged about inflation or unemployment rates is used to a hailstorm of comments along the lines of “Gummint lyin’ to us again!”
So far, though, most economists think our government number crunchers are doing an honest job, as best they can, given the inherent methodological difficulties and the budget constraints they face. (In support of that view, check out various bits of Congressional testimony by Keith Hall, posted here. Hall was Chief Economist of the Council of Economic Advisers from 2005 to 2008 and Commissioner of Labor Statistics from 2008 until earlier this year.)
I hope this professionalism lasts. If we learned from some whistleblower that the BLS had falsified a jobs report on the eve of an election, we would have a scandal that would make the Libor manipulation look like a tempest in a teapot.
Originally posted at Economonitor.com
Thursday, July 12, 2012
The Illusory Benefits of Bringing Back the Draft
Writing in Tuesday’s New York Times, Thomas
E. Ricks makes a plea for reinstating the draft. His argument is
largely based on supposed economic benefits that I find questionable.
Here is why.
Ricks’ proposal would expand the draft beyond the military to make it a form of near-universal national service. Under his plan, combat units would continue to be filled by volunteers who would receive full military training, pay, and benefits, much as they do now. In addition, Ricks would add two new categories of service. >>>Read More
Readers who are interested in a longer analysis of the history and economics of conscription may want to consult this nice backgrounder by Joshua C. Hall of Beloit College
Ricks’ proposal would expand the draft beyond the military to make it a form of near-universal national service. Under his plan, combat units would continue to be filled by volunteers who would receive full military training, pay, and benefits, much as they do now. In addition, Ricks would add two new categories of service. >>>Read More
Readers who are interested in a longer analysis of the history and economics of conscription may want to consult this nice backgrounder by Joshua C. Hall of Beloit College
Sunday, July 8, 2012
More Weak Job Data: Have we Reached the Natural Rate? Is this as Good as it Gets?
The June report from the Bureau of Labor Statistics shows
continued weak growth of payroll jobs. Just 80,000 new jobs were
reported for the month, while an upward revision to the May data was
cancelled by a downward revision for April. The unemployment rate
remains stuck at 8.2 percent. What is more, the broad measure of
unemployment, U-6, is actually climbing again, after three years of
decline. The broad measure includes discouraged workers and those
involuntarily working part time. Is this as good as it is going to get? >>>Read more
Follow this link to view or download a classroom-ready slideshow with charts of the latest U.S. employment data
Follow this link to view or download a classroom-ready slideshow with charts of the latest U.S. employment data
Monday, July 2, 2012
The Moral Limits of Markets: When is Standing in Line Better than Paying a Price?
In his book What Money Can’t Buy: The Moral Limits of Markets, Harvard
Professor Michael J. Sandel invites us to engage in a public debate on
the proper role of markets in society. It is a question, he says, to
which economists do not give enough thought. I agree. I am happy to join
the debate.
First of all, I should make it clear that despite the title, the debate is not about what money can’t buy. There is little controversy about that. Sandel correctly points out that money can buy companionship but not friendship; sex but not love; or a statuette but not the honor associated with selection as the year’s best actor. The heart of Sandel’s argument is really about what money should not buy, or more precisely, what we should not offer for sale or buy if it is offered. The book covers a lot of ground—far too much to deal with all at once. This post will address the ethics of queuing, a method of allocating scarce goods that Sandel sees as morally superior to pricing for many purposes. I hope to take up other issues he raises in future posts. >>>Read more
First of all, I should make it clear that despite the title, the debate is not about what money can’t buy. There is little controversy about that. Sandel correctly points out that money can buy companionship but not friendship; sex but not love; or a statuette but not the honor associated with selection as the year’s best actor. The heart of Sandel’s argument is really about what money should not buy, or more precisely, what we should not offer for sale or buy if it is offered. The book covers a lot of ground—far too much to deal with all at once. This post will address the ethics of queuing, a method of allocating scarce goods that Sandel sees as morally superior to pricing for many purposes. I hope to take up other issues he raises in future posts. >>>Read more