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The Post had a very nice lead front page story, too bad its editors probably won’t see it.
The Post had a very nice lead front page story, too bad its editors probably won’t see it.
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Dylan Matthews has an interesting column discussing former M.I.T. professor Stanley Fischer’s career in the context of the possibility of him replacing Ben Bernanke as Fed chair in the fall. There are a couple of important items that are not mentioned in this discussion.
First, Matthews notes the central role that Fischer played in the I.M.F.’s resolution of the East Asian financial crisis. While this discussion might lead readers to believe the resolution was a success, this crisis actually marked a turning point that led to the major imbalances of the next decade.
Prior to the crisis there were substantial capital flows from rich countries to poor countries, as textbook economics would predict. However as an outcome of the crisis developing countries began to accumulate massive amounts of foreign exchanges reserves, presumably to avoid ever having to be in the same situation as the East Asian countries were placed when they had to deal with the I.M.F. in the crisis.
This led to a huge rise in the value of the dollar and large trade deficits. The gap in demand created by the trade deficit with developing countries was filled in the United States by the housing bubble. The predictable outcome of this situation was the collapse in 2007-09, which is likely to cost the country close to $10 trillion in lost output before the economy fully recovers.
This raises the more general point that Fischer is one of the pillars of the school of thought that central banks should target 2.0 percent inflation and otherwise do nothing. If it is in principle possible for an economic theory to be refuted by evidence, this view of the optimal monetary policy has been decisively discredited.
These items may affect how people would view Stanley Fischer’s qualifications as a candidate for Fed chair.
The piece also gets one other important item wrong. It contrasts the ability of Israel (where Fischer now runs the central bank) as a small country to devalue its currency with the United States, as the holder of the world’s reserve currency.
“If Bernanke halved the value of the dollar relative to, say, the Chinese yuan, that would dramatically increase U.S. exports and probably economic growth, too, but it would also wreak havoc with the global financial system. Every dollar-denominated asset in the world, including all manner of bonds, would plummet in value.”
Actually this is very far from being the case. Most holders of dollar denominated assets are not hugely interested in the value of their assets measured in yuan. (Quick, how many yuan is your 401(k) worth?) While the repercussions of a large fall in the value of the dollar against one or more major currencies are certainly greater than the fall of the Israeli shekel, it is certainly not obvious that a major reduction in its value would have disastrous consequences. In fact, over time it is virtually inevitable.
Dylan Matthews has an interesting column discussing former M.I.T. professor Stanley Fischer’s career in the context of the possibility of him replacing Ben Bernanke as Fed chair in the fall. There are a couple of important items that are not mentioned in this discussion.
First, Matthews notes the central role that Fischer played in the I.M.F.’s resolution of the East Asian financial crisis. While this discussion might lead readers to believe the resolution was a success, this crisis actually marked a turning point that led to the major imbalances of the next decade.
Prior to the crisis there were substantial capital flows from rich countries to poor countries, as textbook economics would predict. However as an outcome of the crisis developing countries began to accumulate massive amounts of foreign exchanges reserves, presumably to avoid ever having to be in the same situation as the East Asian countries were placed when they had to deal with the I.M.F. in the crisis.
This led to a huge rise in the value of the dollar and large trade deficits. The gap in demand created by the trade deficit with developing countries was filled in the United States by the housing bubble. The predictable outcome of this situation was the collapse in 2007-09, which is likely to cost the country close to $10 trillion in lost output before the economy fully recovers.
This raises the more general point that Fischer is one of the pillars of the school of thought that central banks should target 2.0 percent inflation and otherwise do nothing. If it is in principle possible for an economic theory to be refuted by evidence, this view of the optimal monetary policy has been decisively discredited.
These items may affect how people would view Stanley Fischer’s qualifications as a candidate for Fed chair.
The piece also gets one other important item wrong. It contrasts the ability of Israel (where Fischer now runs the central bank) as a small country to devalue its currency with the United States, as the holder of the world’s reserve currency.
“If Bernanke halved the value of the dollar relative to, say, the Chinese yuan, that would dramatically increase U.S. exports and probably economic growth, too, but it would also wreak havoc with the global financial system. Every dollar-denominated asset in the world, including all manner of bonds, would plummet in value.”
Actually this is very far from being the case. Most holders of dollar denominated assets are not hugely interested in the value of their assets measured in yuan. (Quick, how many yuan is your 401(k) worth?) While the repercussions of a large fall in the value of the dollar against one or more major currencies are certainly greater than the fall of the Israeli shekel, it is certainly not obvious that a major reduction in its value would have disastrous consequences. In fact, over time it is virtually inevitable.
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He may well be right. His story is that the yield on junk bonds is currently lower than the earnings yield on stock. Irwin tells readers:
“The stock market’s earnings yield is 6.6 percent, which is actually higher than the 6.1 percent that junk bonds are yielding. Buyers of junk bonds are tolerating lots of risk and not even being compensated. That suggests a market that is somehow out of whack. And there’s a quite plausible case that the Federal Reserve’s quantitative easing policies are part of the story. With the Fed buying billions of Treasury bonds and mortgage backed securities, those who would normally buy those assets have to buy something else. But it’s easy to imagine that this doesn’t affect all assets equally. Investors normally inclined to buy bonds may not be willing to move that money into stocks, but will buy junk bonds, even if the prices seem unfavorable.”
The big story here is that last sentence:
“Investors normally inclined to buy bonds may not be willing to move that money into stocks, but will buy junk bonds, even if the prices seem unfavorable.”
Okay, so we have people controlling funds with billions or even tens of billions of dollars who can’t figure out that they should move from junk bonds to stocks even when current prices suggest that the stocks provide a much better risk/return trade-off. Given that almost all of these people were buying into the stock market in the late nineties, when price to earnings ratios crossed 30, and that almost none of them saw the housing bubble in the last decade, Irwin’s observation is entirely plausible.
This does raise the question as to why the people who manage money funds earn many hundreds of thousands of dollars a year and often many million? If a fund manager just holds bonds rather than stocks out of habit then this person clearly has few skills. Rather than paying someone millions of dollars to cost a fund big bucks in virtually guaranteed losses isn’t it possible to find some high school kid who could be paid the minimum wage. After all, if we don’t expect people who manage funds to have any investment skills why are the jobs so highly paid?
He may well be right. His story is that the yield on junk bonds is currently lower than the earnings yield on stock. Irwin tells readers:
“The stock market’s earnings yield is 6.6 percent, which is actually higher than the 6.1 percent that junk bonds are yielding. Buyers of junk bonds are tolerating lots of risk and not even being compensated. That suggests a market that is somehow out of whack. And there’s a quite plausible case that the Federal Reserve’s quantitative easing policies are part of the story. With the Fed buying billions of Treasury bonds and mortgage backed securities, those who would normally buy those assets have to buy something else. But it’s easy to imagine that this doesn’t affect all assets equally. Investors normally inclined to buy bonds may not be willing to move that money into stocks, but will buy junk bonds, even if the prices seem unfavorable.”
The big story here is that last sentence:
“Investors normally inclined to buy bonds may not be willing to move that money into stocks, but will buy junk bonds, even if the prices seem unfavorable.”
Okay, so we have people controlling funds with billions or even tens of billions of dollars who can’t figure out that they should move from junk bonds to stocks even when current prices suggest that the stocks provide a much better risk/return trade-off. Given that almost all of these people were buying into the stock market in the late nineties, when price to earnings ratios crossed 30, and that almost none of them saw the housing bubble in the last decade, Irwin’s observation is entirely plausible.
This does raise the question as to why the people who manage money funds earn many hundreds of thousands of dollars a year and often many million? If a fund manager just holds bonds rather than stocks out of habit then this person clearly has few skills. Rather than paying someone millions of dollars to cost a fund big bucks in virtually guaranteed losses isn’t it possible to find some high school kid who could be paid the minimum wage. After all, if we don’t expect people who manage funds to have any investment skills why are the jobs so highly paid?
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Okay, I made up that number, but suppose that I did calculate the amount of money that average holder of government bonds gets in interest each year and compared it to what we spent on children. According to the logic that they use at the Urban Institute (as recounted by Ezra Klein) I would have demonstrated a tendency for our government to favor bondholders at the expense of our nation’s children.
The sophisticates out there would surely point out that bondholders paid for their bonds and therefore are entitled to the interest they get on these bonds. Bravo!
Now if anyone with the same level of sophistication entered the halls of the Urban Institute they could point out that we run a old age, survivors and disability insurance program through the government (Social Security) as well as a senior health insurance program (Medicare). The fact that people collect benefits from these programs reflects the fact that they paid premiums during their working lifetimes — just like bondholders get interest because they paid for their bonds.
In fact, as the Urban Institute has shown, on average Social Security beneficiaries will get slightly less back in benefits than what they paid into the program in premiums. Medicare beneficiaries will get more back, but this is because we pay way more money to our doctors, drug companies and other health care providers than any other people on the planet. In other words, the big gainers here are the providers, not our seniors.
Anyhow, the comparison of payments to seniors with payments to children makes as much sense as comparing payments to bondholders with payments to children. It is understandable that people who want to cut Social Security and Medicare would make such comparisons (or cut interest payments to bondholders), but it is hard to see why anyone engaged in honest policy debate would take such comparisons seriously.
Okay, I made up that number, but suppose that I did calculate the amount of money that average holder of government bonds gets in interest each year and compared it to what we spent on children. According to the logic that they use at the Urban Institute (as recounted by Ezra Klein) I would have demonstrated a tendency for our government to favor bondholders at the expense of our nation’s children.
The sophisticates out there would surely point out that bondholders paid for their bonds and therefore are entitled to the interest they get on these bonds. Bravo!
Now if anyone with the same level of sophistication entered the halls of the Urban Institute they could point out that we run a old age, survivors and disability insurance program through the government (Social Security) as well as a senior health insurance program (Medicare). The fact that people collect benefits from these programs reflects the fact that they paid premiums during their working lifetimes — just like bondholders get interest because they paid for their bonds.
In fact, as the Urban Institute has shown, on average Social Security beneficiaries will get slightly less back in benefits than what they paid into the program in premiums. Medicare beneficiaries will get more back, but this is because we pay way more money to our doctors, drug companies and other health care providers than any other people on the planet. In other words, the big gainers here are the providers, not our seniors.
Anyhow, the comparison of payments to seniors with payments to children makes as much sense as comparing payments to bondholders with payments to children. It is understandable that people who want to cut Social Security and Medicare would make such comparisons (or cut interest payments to bondholders), but it is hard to see why anyone engaged in honest policy debate would take such comparisons seriously.
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Robert Rubin is best known as the man who pocketed more than $100 million as a top Citigroup honcho as it played a central role in pumping up the housing bubble that sank the economy. However, because of the incompetence (corruption?) of the Washington media, he is much better known as a great hero of economic policy.
Ezra Klein helps to feed this myth when he tells us of the great virtue of deficit reduction in the Clinton years.
“Back in the 1990s, we knew why we feared deficits. They raised interest rates and “crowded out” private borrowing. This wasn’t an abstract concern. In 1991, the interest rate on 10-year Treasurys was 7.86 percent. That meant the interest rate for private borrowing was, for the most part, much higher, choking off investment and economic growth.
“Enter Clintonomics. The theory was simple: Bring down deficits, and you’d bring down interest rates. Bring down interest rates, and you’d make it easier for the private sector to invest and grow. Make it easier for the private sector to invest and grow, and the economy would boom.
“The theory was correct. By the end of Clinton’s term, the interest rate on 10-year Treasurys had fallen to 5.26 percent — lower than it had been in 30 years. And the economy was, indeed, booming. ‘The deficit reduction increased confidence, helped bring interest rates down, and that, in turn, helped generate and sustain the economic recovery, which, in turn, reduced the deficit further,’ Treasury Secretary Robert Rubin said in 1998.”
Okay, fans of intro economics know that it is the real interest — the difference between the nominal interest rate and the inflation rate — that matters for investment, not the nominal interest rate. The inflation rate in the first half of 1991 was over 5.0 percent. This means that the real interest rate — the rate that all economists understand is relevant for growth — around 2.5 percent.
Is that bad? If we take the last half year of the Clinton administration (and not some cherry picked low-point) the interest rate on 10-year Treasury bonds averaged around 5.7 percent. The inflation rate for the second half of 2000 averaged around 3.5 percent. This gives us a a real interest rate of 2.2 percent (5.7 percent minus 3.5 percent equals 2.2 percent).
So we are supposed to believe that the difference between the 2.5 percent real interest rate in the high deficit pre-Clinton years and the 2.2 percent real interest rate at the end of the Clinton years is the difference between the road to hell and the path to prosperity? This is the sort of nonsense that you tell to children. It might past muster with DC pundits, but serious people need not waste their time.
The story of the boom of the Clinton years was an unsustainable stock bubble. This led to a surge in junk investment like Pets.com. It led to an even larger surge in consumption. People spent based on their stock wealth, pushing the saving rate to a then record low of 2.0 percent (compared to an average of 8.0 percent in the pre-bubble decades).
Robert Rubin acolytes may not like it, but the deficit reduction was a minor actor in the growth of the 1990s. The bubble was the real story. That may not be a smart thing to say if you’re looking for a job in the Obama administration, but it happens to be the truth. You have to really torture the data to get a different conclusion.
Robert Rubin is best known as the man who pocketed more than $100 million as a top Citigroup honcho as it played a central role in pumping up the housing bubble that sank the economy. However, because of the incompetence (corruption?) of the Washington media, he is much better known as a great hero of economic policy.
Ezra Klein helps to feed this myth when he tells us of the great virtue of deficit reduction in the Clinton years.
“Back in the 1990s, we knew why we feared deficits. They raised interest rates and “crowded out” private borrowing. This wasn’t an abstract concern. In 1991, the interest rate on 10-year Treasurys was 7.86 percent. That meant the interest rate for private borrowing was, for the most part, much higher, choking off investment and economic growth.
“Enter Clintonomics. The theory was simple: Bring down deficits, and you’d bring down interest rates. Bring down interest rates, and you’d make it easier for the private sector to invest and grow. Make it easier for the private sector to invest and grow, and the economy would boom.
“The theory was correct. By the end of Clinton’s term, the interest rate on 10-year Treasurys had fallen to 5.26 percent — lower than it had been in 30 years. And the economy was, indeed, booming. ‘The deficit reduction increased confidence, helped bring interest rates down, and that, in turn, helped generate and sustain the economic recovery, which, in turn, reduced the deficit further,’ Treasury Secretary Robert Rubin said in 1998.”
Okay, fans of intro economics know that it is the real interest — the difference between the nominal interest rate and the inflation rate — that matters for investment, not the nominal interest rate. The inflation rate in the first half of 1991 was over 5.0 percent. This means that the real interest rate — the rate that all economists understand is relevant for growth — around 2.5 percent.
Is that bad? If we take the last half year of the Clinton administration (and not some cherry picked low-point) the interest rate on 10-year Treasury bonds averaged around 5.7 percent. The inflation rate for the second half of 2000 averaged around 3.5 percent. This gives us a a real interest rate of 2.2 percent (5.7 percent minus 3.5 percent equals 2.2 percent).
So we are supposed to believe that the difference between the 2.5 percent real interest rate in the high deficit pre-Clinton years and the 2.2 percent real interest rate at the end of the Clinton years is the difference between the road to hell and the path to prosperity? This is the sort of nonsense that you tell to children. It might past muster with DC pundits, but serious people need not waste their time.
The story of the boom of the Clinton years was an unsustainable stock bubble. This led to a surge in junk investment like Pets.com. It led to an even larger surge in consumption. People spent based on their stock wealth, pushing the saving rate to a then record low of 2.0 percent (compared to an average of 8.0 percent in the pre-bubble decades).
Robert Rubin acolytes may not like it, but the deficit reduction was a minor actor in the growth of the 1990s. The bubble was the real story. That may not be a smart thing to say if you’re looking for a job in the Obama administration, but it happens to be the truth. You have to really torture the data to get a different conclusion.
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Economists usually believe that companies try to make as much money as possible. This is why readers of an NYT article on plans to reduce Medicare payments for drugs might have been surprised to see the comment:
“Some have speculated that other consumers could end up paying for the cost savings if drug makers raise their prices to account for the lost revenue. ‘That money has to come from somewhere,’ said Douglas Holtz-Eakin.”
This statement implies that drug companies have a group of customers from whom they could now be making more money, but for some reason are choosing not to. This is not consistent with how economists think the economy works. It is difficult to imagine that Pfizer, Merck or any of the other big drug companies are voluntarily choosing to forgo profits. If it is possible for drug companies to get more money by raising prices, then it would be expected that they would have already raised prices.
The piece also includes speculation on why the Medicare drug benefit cost less than had been projected. The main reason is that drug costs in general have risen much less rapidly than had been projected.
Economists usually believe that companies try to make as much money as possible. This is why readers of an NYT article on plans to reduce Medicare payments for drugs might have been surprised to see the comment:
“Some have speculated that other consumers could end up paying for the cost savings if drug makers raise their prices to account for the lost revenue. ‘That money has to come from somewhere,’ said Douglas Holtz-Eakin.”
This statement implies that drug companies have a group of customers from whom they could now be making more money, but for some reason are choosing not to. This is not consistent with how economists think the economy works. It is difficult to imagine that Pfizer, Merck or any of the other big drug companies are voluntarily choosing to forgo profits. If it is possible for drug companies to get more money by raising prices, then it would be expected that they would have already raised prices.
The piece also includes speculation on why the Medicare drug benefit cost less than had been projected. The main reason is that drug costs in general have risen much less rapidly than had been projected.
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Allan Sloan used his column today to explain a simple but often overlooked point, when interest rates rise, bond prices fall. This means that if long-term interest rates rise substantially in a few years, as the Congressional Budget Office predicts, then the bonds issued at very low interest rates today will be selling at large discounts.
The implication of this fact is that in 2015 or 2016, the Treasury would be able to purchase back much of the debt issued today at substantial discounts. This would allow it to drastically reduce the government’s debt at no cost. For example, if it bought back debt with a face value of $4 trillion at an average discount of 20 percent, it could instantly eliminate $800 billion in debt, reducing the debt to GDP ratio by almost 5 percentage points.
This step would be pointless from either an economic or financial standpoint since it would not change the interest burden facing the country, but it should make many of the deficit cultists happy. Since these cultists, who largely control the economic debate in the United States, assign some mystical power to specific debt to GDP ratios, they should be pacified by the knowledge that we can buy bonds back at a discount to keep the debt burden under their magic number. This route is much simpler than raising taxes or cutting spending.
Allan Sloan used his column today to explain a simple but often overlooked point, when interest rates rise, bond prices fall. This means that if long-term interest rates rise substantially in a few years, as the Congressional Budget Office predicts, then the bonds issued at very low interest rates today will be selling at large discounts.
The implication of this fact is that in 2015 or 2016, the Treasury would be able to purchase back much of the debt issued today at substantial discounts. This would allow it to drastically reduce the government’s debt at no cost. For example, if it bought back debt with a face value of $4 trillion at an average discount of 20 percent, it could instantly eliminate $800 billion in debt, reducing the debt to GDP ratio by almost 5 percentage points.
This step would be pointless from either an economic or financial standpoint since it would not change the interest burden facing the country, but it should make many of the deficit cultists happy. Since these cultists, who largely control the economic debate in the United States, assign some mystical power to specific debt to GDP ratios, they should be pacified by the knowledge that we can buy bonds back at a discount to keep the debt burden under their magic number. This route is much simpler than raising taxes or cutting spending.
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For some reason the NYT keeps using the official German unemployment rate in its coverage of Germany’s economy rather than the OECD harmonized rate. The official German rate includes workers who are involuntarily working part-time. By contrast, the OECD essentially uses the same methodology as the United States.
Therefore the NYT badly misled readers when it reported that Germany’s unemployment rate is 7.4 percent. The OECD harmonized unemployment rate in Germany is 5.3 percent.
For some reason the NYT keeps using the official German unemployment rate in its coverage of Germany’s economy rather than the OECD harmonized rate. The official German rate includes workers who are involuntarily working part-time. By contrast, the OECD essentially uses the same methodology as the United States.
Therefore the NYT badly misled readers when it reported that Germany’s unemployment rate is 7.4 percent. The OECD harmonized unemployment rate in Germany is 5.3 percent.
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That’s what readers of this NYT piece hyping a European-U.S. trade agreement should be asking. It begins by telling readers:
“President Obama’s call for a free-trade agreement between the United States and the European Union has unleashed a wave of optimism on both sides that a breakthrough can be achieved that would lift trans-Atlantic fortunes, not just economically but politically.’
Really? How much of an economic boost should be anticipated from this deal? Will it make up for the impact of the sequester and the end of the payroll tax cut?
That’s not very likely. We don’t know what a final deal will look like, but a couple of months ago David Ignatius was touting the prospect of a deal in a Washington Post column. He cited a study that projected that the complete elimination of all tariff barriers would raise GDP in the U.S. by about 0.9 percent.
Note that this 0.9 boost to GDP is a one-time gain and not an increase to the growth rate. The provisions in these deals are typically phased in over a period of years and it also takes the economy time to adjust to a reduction in tariff rates. If we assume that the effects of an agreement are seen over ten years, we would expect to see an increase in the growth rate of 0.09 percentage points, if the projections from this model prove accurate. Of course since we are unlikely to see the complete elimination of tariff barriers, the actual impact on growth will almost certainly be less than 0.09 percentage points annually.
The point is that this deal is not a serious way to boost the economy in the sense of providing an alternative to stimulus. The deal may well be beneficial to the economies of both the U.S. and the EU, however portraying it as a way to move these economies back to full employment badly misleads readers.
This piece uses the term “free-trade” to describe the proposed pact five times. Many of the provisions of the pact will likely have nothing to do with reducing barriers to trade and some, such as increased patent and copyright protection, may actually increase them. It would therefore be more accurate to simply refer to the pact as a “trade agreement.”
That’s what readers of this NYT piece hyping a European-U.S. trade agreement should be asking. It begins by telling readers:
“President Obama’s call for a free-trade agreement between the United States and the European Union has unleashed a wave of optimism on both sides that a breakthrough can be achieved that would lift trans-Atlantic fortunes, not just economically but politically.’
Really? How much of an economic boost should be anticipated from this deal? Will it make up for the impact of the sequester and the end of the payroll tax cut?
That’s not very likely. We don’t know what a final deal will look like, but a couple of months ago David Ignatius was touting the prospect of a deal in a Washington Post column. He cited a study that projected that the complete elimination of all tariff barriers would raise GDP in the U.S. by about 0.9 percent.
Note that this 0.9 boost to GDP is a one-time gain and not an increase to the growth rate. The provisions in these deals are typically phased in over a period of years and it also takes the economy time to adjust to a reduction in tariff rates. If we assume that the effects of an agreement are seen over ten years, we would expect to see an increase in the growth rate of 0.09 percentage points, if the projections from this model prove accurate. Of course since we are unlikely to see the complete elimination of tariff barriers, the actual impact on growth will almost certainly be less than 0.09 percentage points annually.
The point is that this deal is not a serious way to boost the economy in the sense of providing an alternative to stimulus. The deal may well be beneficial to the economies of both the U.S. and the EU, however portraying it as a way to move these economies back to full employment badly misleads readers.
This piece uses the term “free-trade” to describe the proposed pact five times. Many of the provisions of the pact will likely have nothing to do with reducing barriers to trade and some, such as increased patent and copyright protection, may actually increase them. It would therefore be more accurate to simply refer to the pact as a “trade agreement.”
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