When people worry about the security of an asset the price usually plummets, as was the case with mortgage backed securities when the housing bubble burst. It is pretty hard to envision the opposite scenario: that because people get concerned about the security of an asset its price rises.
However this is what Ezra Klein tells us in a column today. The story is that worries over the possibility that the U.S. government is becoming dysfunctional could actually result in the price of U.S. government bonds rising.
“The paradox is that defaulting on our debt could lead to a panic so severe that, in a desperate bid for safety, markets will buy even more of our debt. ‘We are the only country in the world where a fiscal mess, rather than increasing spreads, pushes yields lower,’ El-Erian said [Mohamed El-Erian, chief executive officer of Pacific Investment Management Co.]. ‘If there was another round of debt-ceiling fight with no agreement, we might have lower 10-year Treasury yields, rather than higher.'”
The basis for the idea that uncertainty about the stability of the U.S. government will lead people to buy more U.S. government debt seems to come from the experience in the summer of 2011 when the price of U.S. Treasury bonds soared and interest rates plummeted as we came within days of hitting the debt ceiling.
The problem with this story is that there is a more obvious explanation than people rushing to buy Treasury bonds because they were worried about the instability of the U.S. government. Italy suddenly made the list of euro zone crisis countries that week. While euro zone could have almost certainly withstood a default by Greece, a default by Italy would have almost certainly meant the end of the euro.
The very real risk of the collapse of the euro gives a perfectly plausible explanation for the plunge in world stock markets and U.S. interest rates, even if Boehner and Obama were spending their afternoons having beers together and telling jokes. In other words, the history to date suggests that there is little basis for serious concern about the hostile relationship between the parties imposing a major cost in the form of higher interest rates.
I hate to spoil the efforts at building fear and panic, but this is getting more than a bit overblown. Hitting the debt ceiling would undoubtedly be bad news, but an earth-shaking disaster is pretty unlikely. Everyone will get their money, with interest, even if it is a bit late.
The annoying part of the fear story is the implication that somehow things are okay now. We are throwing $1 trillion of potential GDP in the toilet every year because Congress and the President won’t approve enough stimulus to get the economy back to full employment. And millions of lives are being ruined because people can’t get jobs and earn enough money to raise their kids properly.
The media want us to get all bent out of shape because we could cross the magic line and then suddenly have to pay a risk premium of 5-20 basis points on government debt for years into the future? Sorry, for those of us who know arithmetic that doesn’t come close to the disaster we are already seeing.
When people worry about the security of an asset the price usually plummets, as was the case with mortgage backed securities when the housing bubble burst. It is pretty hard to envision the opposite scenario: that because people get concerned about the security of an asset its price rises.
However this is what Ezra Klein tells us in a column today. The story is that worries over the possibility that the U.S. government is becoming dysfunctional could actually result in the price of U.S. government bonds rising.
“The paradox is that defaulting on our debt could lead to a panic so severe that, in a desperate bid for safety, markets will buy even more of our debt. ‘We are the only country in the world where a fiscal mess, rather than increasing spreads, pushes yields lower,’ El-Erian said [Mohamed El-Erian, chief executive officer of Pacific Investment Management Co.]. ‘If there was another round of debt-ceiling fight with no agreement, we might have lower 10-year Treasury yields, rather than higher.'”
The basis for the idea that uncertainty about the stability of the U.S. government will lead people to buy more U.S. government debt seems to come from the experience in the summer of 2011 when the price of U.S. Treasury bonds soared and interest rates plummeted as we came within days of hitting the debt ceiling.
The problem with this story is that there is a more obvious explanation than people rushing to buy Treasury bonds because they were worried about the instability of the U.S. government. Italy suddenly made the list of euro zone crisis countries that week. While euro zone could have almost certainly withstood a default by Greece, a default by Italy would have almost certainly meant the end of the euro.
The very real risk of the collapse of the euro gives a perfectly plausible explanation for the plunge in world stock markets and U.S. interest rates, even if Boehner and Obama were spending their afternoons having beers together and telling jokes. In other words, the history to date suggests that there is little basis for serious concern about the hostile relationship between the parties imposing a major cost in the form of higher interest rates.
I hate to spoil the efforts at building fear and panic, but this is getting more than a bit overblown. Hitting the debt ceiling would undoubtedly be bad news, but an earth-shaking disaster is pretty unlikely. Everyone will get their money, with interest, even if it is a bit late.
The annoying part of the fear story is the implication that somehow things are okay now. We are throwing $1 trillion of potential GDP in the toilet every year because Congress and the President won’t approve enough stimulus to get the economy back to full employment. And millions of lives are being ruined because people can’t get jobs and earn enough money to raise their kids properly.
The media want us to get all bent out of shape because we could cross the magic line and then suddenly have to pay a risk premium of 5-20 basis points on government debt for years into the future? Sorry, for those of us who know arithmetic that doesn’t come close to the disaster we are already seeing.
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Glenn Hubbard and Justin Muzinich had an interesting piece in the Post today discussing whether the Fed’s mandate should be explicitly broadened to include preserving financial stability. While I am inclined to agree with Fed governor Jeremy Stein, that attacking bubbles is already implicit in the Fed’s goal of maintaining full employment, the more interesting issue is Hubbard and Muzinch’s shyness in dealing with the problem of groupthink at the Fed and among other economic policymakers.
They write:
“This propensity to follow the herd is at the root of financial instability. In the most recent crisis, homeowners, investors and, notably, the Fed so succumbed to groupthink that we were almost unanimously blind to the risks of rising housing prices and bank leverage. So, how to create a Fed that guides its governors to be skeptical of crowd-induced financial excess?”
Their answer of course is a change in the Fed’s mandate. The more obvious solution would be to change incentives. Economists usually think it is important that it is possible to fire workers who perform their jobs badly. This gives workers the incentive to do their jobs well.
If Fed officials, along with other economists in policymaking positions, could lose their jobs and see their careers ruined by failing to stem the growth of destructive asset bubbles then they would have some real incentive not to engage in mindless groupthink. As it is, economists suffer almost no consequence for even the most momentous failures.
None of the Fed governors lost their jobs for failing to stem the growth of the housing bubble. In fact, according to administration sources, President Obama was considering two of these governors (Donald Kohn and Roger Ferguson) as possible replacements for Ben Bernanke as Fed chair.
Unless economists know that they can face real career consequences from engaging in groupthink their incentive is to go along with the herd. Resisting the herd will always carry risks, since it is possible that they will be shown wrong or at least will not be proven right before they lose their job. Given such asymmetric incentives basic economics would show that economists in policymaking positions will almost always choose to just follow the herd.
Note: Typos corrected.
Glenn Hubbard and Justin Muzinich had an interesting piece in the Post today discussing whether the Fed’s mandate should be explicitly broadened to include preserving financial stability. While I am inclined to agree with Fed governor Jeremy Stein, that attacking bubbles is already implicit in the Fed’s goal of maintaining full employment, the more interesting issue is Hubbard and Muzinch’s shyness in dealing with the problem of groupthink at the Fed and among other economic policymakers.
They write:
“This propensity to follow the herd is at the root of financial instability. In the most recent crisis, homeowners, investors and, notably, the Fed so succumbed to groupthink that we were almost unanimously blind to the risks of rising housing prices and bank leverage. So, how to create a Fed that guides its governors to be skeptical of crowd-induced financial excess?”
Their answer of course is a change in the Fed’s mandate. The more obvious solution would be to change incentives. Economists usually think it is important that it is possible to fire workers who perform their jobs badly. This gives workers the incentive to do their jobs well.
If Fed officials, along with other economists in policymaking positions, could lose their jobs and see their careers ruined by failing to stem the growth of destructive asset bubbles then they would have some real incentive not to engage in mindless groupthink. As it is, economists suffer almost no consequence for even the most momentous failures.
None of the Fed governors lost their jobs for failing to stem the growth of the housing bubble. In fact, according to administration sources, President Obama was considering two of these governors (Donald Kohn and Roger Ferguson) as possible replacements for Ben Bernanke as Fed chair.
Unless economists know that they can face real career consequences from engaging in groupthink their incentive is to go along with the herd. Resisting the herd will always carry risks, since it is possible that they will be shown wrong or at least will not be proven right before they lose their job. Given such asymmetric incentives basic economics would show that economists in policymaking positions will almost always choose to just follow the herd.
Note: Typos corrected.
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The New York Times has an excellent piece on the high cost of asthma medicines in the United States. However there is one major error in the piece. It attributes the high prices to the market. In fact the whole piece points to the opposite. It details how government granted monopolies allow drug companies to charge prices that are close to ten times as high as the price in other countries.
Without government intervention the market would lead to much lower prices. The United States is unique in having the government play such a large role in raising prices to consumers.
The New York Times has an excellent piece on the high cost of asthma medicines in the United States. However there is one major error in the piece. It attributes the high prices to the market. In fact the whole piece points to the opposite. It details how government granted monopolies allow drug companies to charge prices that are close to ten times as high as the price in other countries.
Without government intervention the market would lead to much lower prices. The United States is unique in having the government play such a large role in raising prices to consumers.
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The NYT is doing cover up work for Paul Ryan telling readers about his plan for:
“a debt ceiling increase tied to changes to Medicare and Medigap plans that would save more than enough money to ease some of the across-the-board cuts to domestic and defense programs …”
Ryan is not going to save money from changing Medicare, he will save public dollars by cutting Medicare. In other words, Ryan wants seniors to pay more money for their health care. It’s very polite of the NYT to assist Ryan in pushing his agenda by attempting to conceal its impact, but what happened to the old days when newspapers were about informing readers.
Under the Ryan’s proposals, seniors will pay more money out of pocket because Medicare benefits will be cut. That shouldn’t be too hard for a NYT article to print. Ryan can defend his proposed cuts by arguing that other priorities are more important, but people should understand what is at stake.
The NYT is doing cover up work for Paul Ryan telling readers about his plan for:
“a debt ceiling increase tied to changes to Medicare and Medigap plans that would save more than enough money to ease some of the across-the-board cuts to domestic and defense programs …”
Ryan is not going to save money from changing Medicare, he will save public dollars by cutting Medicare. In other words, Ryan wants seniors to pay more money for their health care. It’s very polite of the NYT to assist Ryan in pushing his agenda by attempting to conceal its impact, but what happened to the old days when newspapers were about informing readers.
Under the Ryan’s proposals, seniors will pay more money out of pocket because Medicare benefits will be cut. That shouldn’t be too hard for a NYT article to print. Ryan can defend his proposed cuts by arguing that other priorities are more important, but people should understand what is at stake.
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According to polling data the Republicans are taking a beating over their decision to shutdown the government and risk default on the debt to stop Obamacare. The Washington Post decided to help them out. Using their new journalism model, where there is no distinction between news and editorial views, they used the news section for this purpose.
In a front page article in the implications of missing the debt ceiling, the Post discussed a report from Moody’s which argued that the government could structure its payments so that the debt is serviced and there is no default. It therefore reasoned that the impact on financial markets would be limited. The piece discussed this assessment and then told readers:
“The memo offered a starkly different view of the consequences of breaching the debt limit than is held by the White House, many policymakers and other financial analysts. Over the weekend, economists at Goldman Sachs said the economy would take a devastating hit even if Treasury kept making payments on the debt, because the pullback in federal spending would amount to roughly $175 billion, or 4.2 percentage points of gross domestic product.”
Actually Moody’s view (as described in the Post piece) is not a “starkly different view.” Moody’s report focused on the financial market implications. It did not discuss (at least by the Post’s account — I couldn’t find the memo), the macroeconomic effects of the cuts discussed by Goldman Sachs and other economists.
It would be striking if analysts at Moody’s really did have a “starkly different view” of the economy than almost all the other analysts who follow it. However the Post did not actually produce any evidence that this is the case. It just misled readers by implying that the huge macroeconomic hit from sharp cutbacks in spending is a debatable point, as opposed to something like the shape of the earth, which serious people do not waste time disputing.
According to polling data the Republicans are taking a beating over their decision to shutdown the government and risk default on the debt to stop Obamacare. The Washington Post decided to help them out. Using their new journalism model, where there is no distinction between news and editorial views, they used the news section for this purpose.
In a front page article in the implications of missing the debt ceiling, the Post discussed a report from Moody’s which argued that the government could structure its payments so that the debt is serviced and there is no default. It therefore reasoned that the impact on financial markets would be limited. The piece discussed this assessment and then told readers:
“The memo offered a starkly different view of the consequences of breaching the debt limit than is held by the White House, many policymakers and other financial analysts. Over the weekend, economists at Goldman Sachs said the economy would take a devastating hit even if Treasury kept making payments on the debt, because the pullback in federal spending would amount to roughly $175 billion, or 4.2 percentage points of gross domestic product.”
Actually Moody’s view (as described in the Post piece) is not a “starkly different view.” Moody’s report focused on the financial market implications. It did not discuss (at least by the Post’s account — I couldn’t find the memo), the macroeconomic effects of the cuts discussed by Goldman Sachs and other economists.
It would be striking if analysts at Moody’s really did have a “starkly different view” of the economy than almost all the other analysts who follow it. However the Post did not actually produce any evidence that this is the case. It just misled readers by implying that the huge macroeconomic hit from sharp cutbacks in spending is a debatable point, as opposed to something like the shape of the earth, which serious people do not waste time disputing.
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That’s not exactly what the piece said. Rather it said that China raised concerns about the debt ceiling in discussions with Secretary of State John Kerry. It implied that such concerns may affect China’s willingness to buy and hold U.S. debt.
The purchase of U.S. government bonds is the mechanism through which China “manipulates” the value of its currency. By buying U.S. bonds it raises the price of the dollar relative to the Chinese yuan, thereby making its exports cheaper to people living in the United States.
As a matter of policy, both the Bush and Obama administration claimed to be committed to ending this “manipulation.” While the dollar has fallen against the yuan in the last decade it is still priced at a level that results in a huge U.S. trade deficit with China. The position of both administrations has been that their pressure is leading to a gradual reduction in the value of the dollar relative to yuna, however this article suggests that concerns over default may lead to much more rapid progress.
That’s not exactly what the piece said. Rather it said that China raised concerns about the debt ceiling in discussions with Secretary of State John Kerry. It implied that such concerns may affect China’s willingness to buy and hold U.S. debt.
The purchase of U.S. government bonds is the mechanism through which China “manipulates” the value of its currency. By buying U.S. bonds it raises the price of the dollar relative to the Chinese yuan, thereby making its exports cheaper to people living in the United States.
As a matter of policy, both the Bush and Obama administration claimed to be committed to ending this “manipulation.” While the dollar has fallen against the yuan in the last decade it is still priced at a level that results in a huge U.S. trade deficit with China. The position of both administrations has been that their pressure is leading to a gradual reduction in the value of the dollar relative to yuna, however this article suggests that concerns over default may lead to much more rapid progress.
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In a blog post at Econbrowser, Princeton Economist Angus Deaton complains about how his work on the impact of inequality on health outcomes was challenged by Michael Ash, an economics professor at the University of Massachusetts. He compares this challenge to the more recent challenge posed by Ash, along with Thomas Herndon and Robert Pollin to the work of Harvard professors Carmen Reinhart and Ken Rogoff. People may recall in this latter work, Herndon, Ash, and Pollin showed that the results in Reinhart and Rogoff’s original 2010 paper on the relationship between national debt and growth were due to both an Excel spreadsheet error and a peculiar method of aggregation.
Deaton joins the criticisms of the two papers:
“In our case, as in Reinhart and Rogoff, neither the coding error (in our case there was none) nor the choice of weights has any effect on the main results. … With Reinhart and Rogoff, they referred only to an early paper, ignoring updated results. But the effect is the same, to magnify a tiny or non-existent problem and claim that it threatens the whole enterprise whereas, in fact, nothing of the sort is true.”
Deaton then complained that the criticisms of Reinhart and Rogoff did not even take place in refereed journals, but rather through blog posts (yes, I’m one of those guilty) and the media.
Perhaps Deaton is unaware of the impact of Reinhart and Rogoff’s work on the debate over stimulus and deficits. Otherwise it is difficult to see how he can trivialize the importance of the criticisms from Herndon, Ash, and Pollin (HAP) to the public debate on this issue.
Contrary to what Deaton implies, Reinhart and Rogoff highlighted the idea of a cliff at a debt to GDP ratio of 90 percent from their first paper. Above this level, their earlier work showed a sharp falloff in growth. This paper had enormous impact on policy debates in Europe and the United States. In fact, it was the explicit basis for the debt targets set out by Erskine Bowles and Alan Simpson, the co-chairs of President Obama’s deficit commission.
While Reinhart and Rogoff’s later work did not provide evidence of such a cliff, this conclusion from their original paper continued to guide public debate uncorrected by Reinhart and Rogoff. The spreadsheet error uncovered by HAP managed to bring this issue into the public spotlight. When the error was corrected, any basis for claiming a large growth penalty for debt to GDP ratios in excess of 90 percent disappeared. There was in general a negative correlation between growth and debt levels, but the sharpest tradeoffs were at relatively low levels of debt (under 30 percent of GDP), not the 90 plus level highlighted by Reinhart and Rogoff.
HAP also inspired a series of papers that examined the direction of causality. All of these papers showed evidence that the causation overwhelmingly went from slow growth to debt rather than in the other direction. In other words, countries that were growing slowly tended to accumulate lots of debt, rather than the other way around.
The result is that policymakers and the general public now have a much clearer view of the potential limits posed by debt. The fact that this exchange of analysis among economists occurred outside of professional journals would seem to be a criticism of professional journals and their limited relevance for policy debates. If a side effect was that two prominent Harvard economists were publicly embarrassed, that seems a small price to pay.
Addendum:
Reinhart and Rogoff might have saved themselves and the rest of the world much grief if they had made their data publicly available in January of 2010 when their work first began to have a major impact on policy debates.
In a blog post at Econbrowser, Princeton Economist Angus Deaton complains about how his work on the impact of inequality on health outcomes was challenged by Michael Ash, an economics professor at the University of Massachusetts. He compares this challenge to the more recent challenge posed by Ash, along with Thomas Herndon and Robert Pollin to the work of Harvard professors Carmen Reinhart and Ken Rogoff. People may recall in this latter work, Herndon, Ash, and Pollin showed that the results in Reinhart and Rogoff’s original 2010 paper on the relationship between national debt and growth were due to both an Excel spreadsheet error and a peculiar method of aggregation.
Deaton joins the criticisms of the two papers:
“In our case, as in Reinhart and Rogoff, neither the coding error (in our case there was none) nor the choice of weights has any effect on the main results. … With Reinhart and Rogoff, they referred only to an early paper, ignoring updated results. But the effect is the same, to magnify a tiny or non-existent problem and claim that it threatens the whole enterprise whereas, in fact, nothing of the sort is true.”
Deaton then complained that the criticisms of Reinhart and Rogoff did not even take place in refereed journals, but rather through blog posts (yes, I’m one of those guilty) and the media.
Perhaps Deaton is unaware of the impact of Reinhart and Rogoff’s work on the debate over stimulus and deficits. Otherwise it is difficult to see how he can trivialize the importance of the criticisms from Herndon, Ash, and Pollin (HAP) to the public debate on this issue.
Contrary to what Deaton implies, Reinhart and Rogoff highlighted the idea of a cliff at a debt to GDP ratio of 90 percent from their first paper. Above this level, their earlier work showed a sharp falloff in growth. This paper had enormous impact on policy debates in Europe and the United States. In fact, it was the explicit basis for the debt targets set out by Erskine Bowles and Alan Simpson, the co-chairs of President Obama’s deficit commission.
While Reinhart and Rogoff’s later work did not provide evidence of such a cliff, this conclusion from their original paper continued to guide public debate uncorrected by Reinhart and Rogoff. The spreadsheet error uncovered by HAP managed to bring this issue into the public spotlight. When the error was corrected, any basis for claiming a large growth penalty for debt to GDP ratios in excess of 90 percent disappeared. There was in general a negative correlation between growth and debt levels, but the sharpest tradeoffs were at relatively low levels of debt (under 30 percent of GDP), not the 90 plus level highlighted by Reinhart and Rogoff.
HAP also inspired a series of papers that examined the direction of causality. All of these papers showed evidence that the causation overwhelmingly went from slow growth to debt rather than in the other direction. In other words, countries that were growing slowly tended to accumulate lots of debt, rather than the other way around.
The result is that policymakers and the general public now have a much clearer view of the potential limits posed by debt. The fact that this exchange of analysis among economists occurred outside of professional journals would seem to be a criticism of professional journals and their limited relevance for policy debates. If a side effect was that two prominent Harvard economists were publicly embarrassed, that seems a small price to pay.
Addendum:
Reinhart and Rogoff might have saved themselves and the rest of the world much grief if they had made their data publicly available in January of 2010 when their work first began to have a major impact on policy debates.
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