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J. Maynard Keynes Comments on the Current Crisis

Robert Waldmann

Non-Standard Monetary Policy

Robert Lucas on Non-Standard Monetary Policy 2008

A dead end? Not at all. The Fed can satisfy the demand for quality by using reserves — or “printing money” — to buy securities other than Treasury bills. This is the way the $600 billion got out into the private sector.

This expansion of Fed lending has not violated the constraint that “the” interest rate cannot be less than zero, nor will it do so in the future. There are thousands of different interest rates out there and the yield differences among them have grown dramatically in recent months. The yield on short-term governments is now about the same as the yield on cash: zero. But the spreads between governments and privately-issued bonds are large at all maturities. The flight to quality means exactly that many are eager to trade private paper for non-interest bearing (or low-interest bearing) reserves and with the Fed’s help they are doing so every day.

Maynard Keynes on Non Standard Monetary Policy 1937

If the monetary authority were prepared to deal both ways on specified terms in debts of all maturities, and even more so if it were prepared to deal in debts of varying degrees of risk, the relationship between the complex of rates of interest and the quantity of money would be direct. The complex of rates of interest would simply be an expression of the terms on which the banking system is prepared to acquire or part with debts; and the quantity of money would be the amount which can find a home in the possession of individuals who — after taking account of all relevant circumstances — prefer the control of liquid cash to parting with it in exchange for a debt on the terms indicated by the market rate of interest. Perhaps a complex offer by the central bank to buy and sell at stated prices gilt-edged bonds of all maturities, in place of the single bank rate for short-term bills, is the most important practical improvement which can be made in the technique of monetary management.

Ben Bernanke (2009) is following their advice.

I’d say that, when Robert Lucas and Maynard Keynes agree, they probably have a point.

Of course there is a counter-argument, based, in large part, on the key question of the Central Bank’s inability to pre-commit to the optimal policy rule (known as dynamic inconsistency)

The short-term rate of interest is easily controlled by the monetary authority, both because it is not difficult to produce a conviction that its policy will not greatly change in the very near future, and also because the possible loss is small compared with the running yield (unless it is approaching vanishing point). The the long-term rate may be more recalcitrant when once it has fallen to a level which, on the basis of past experience and present expectations of future monetary policy, is considered “unsafe” by representative opinion.


Thus a monetary policy which strikes public opinion as being experimental in character or easily liable to change may fail in its objective of greatly reducing the long-term rate of interest, because M2 [speculative demand for money not what we call M2] may tend to increase almost without limit in response to a reduction of r [the nominal interest rate] below a certain figure. The same policy, on the other hand, may prove easily successful if it appeals to public opinion as being reasonable and practicable and in the public interest, rooted in strong conviction, and promoted by an authority unlikely to be superseded.

J. Maynard Keynes 1937

And what does Prof. Lucas have to say to that ? A mere $ 1 trillion many not be enough to move long term interest rates below the rate which market participants consider normal. Lucas is making rapid progress, so he might catch up with Keynes 70 years ago some day.

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Yglesias Wants to Soak the Rich

Robert Waldmann

The Kid has dropped his mask (he’s been hinting at this for years but … 95% !!!!)

What if we had a 95 percent marginal tax rate on income over $10 million? What dire consequences would flow from this? Perhaps a certain outflow of top-flight baseball talent to Japan. But I don’t see this leading to any kind of economic calamity. Producers of certain classes of supply-constrained luxury goods would lose out as their prices go down. But my strong suspicion is that at the end of the day most of the super-rich would ultimately find it a relief to get off the treadmill of status-competition and the not-quite-so-rich would be thrilled to see their betters cut down to size.

I’m prepared to be talked out of this view if Brad DeLong or someone can really lay it out for me, but I don’t see it for myself. If anything a de facto cap on compensation would probably make firms better-managed.

OK look a 95% tax might be OK, but it is not acceptable to say that Brad DeLong is the only economist worthy of debating Matthew Yglesias (I mean the only one worth naming. I mean that shows disrespect for Paul Krugman himself).

I must object.

update: In 1936 J Maynard Keynes responded to M Yglesias

Since the end of the nineteenth century significant progress towards the removal of very great disparities of wealth and income has been achieved through the instrument of direct taxation — income tax and surtax and death duties — especially in Great Britain. Many people would wish to see this process carried much further, but they are deterred by two considerations; partly by the fear of making skilful evasions too much worth while and also of diminishing unduly the motive towards risk-taking,

Click the link to find Robert Waldmann making the same 2 arguments in the same order (but with many many more wasted words) in 2009. I promise I was not consciously following Keynes.

But first I note that another benefit is that a progressive tax punishes volatile income as in a huge bonus this year then no job because the firm is bankrupt next year. It increases risk aversion (by penalizing variance). This also means it penalizes short termism. Also a bit more risk aversion would have been nice no ?

I think the problem with 95% tax rates is not that they reduce incentives to work. I mean after the first 30 million or so, I don’t think that the point is having the money as opposed to getting the high score in the money game.

The problem is that they make tax avoidance schemes profitable. Fatcat CEOs play two games — who can get the most out of shareholders and who can pay the least to the IRS.

The second game is a total waste of time and energy.

update: Now I have a thought. Many tax avoidance schemes (not to mention tunnels that is semi legal embezzlement schemes) require fat cat managers to also be in business on their own account (for example owning a firm that owns a structure and subtracting depreciation so the firm has negative profits and then a huge capital gain when the structure, which hasn’t really depreciated, is sold). How about conflict of interest rules for the top 5 officer of publicly traded corporations which require them to have no other income other than compensation from the corporation and Tresury security interest on their wealth ? I’d say that eliminating conflict of interest is a worthy goal in itself *and* that this would make tax avoidance very difficult.

Another problem is that we really like start up entrepreneur types who take huge risks. They are motivated partly by the hope of huge rewards. They are probably about as rational as the average lottery ticket buyer, but their crazy optimism is socially useful. I wouldn’t want to tax their winnings over 1,000,000 at 95% (for one thing they would otherwise reinvest them in their promising but liquidity constrained firms).

So tax the hell out of way overpaid employees, but leave super successful small (but getting big fast) businessmen alone ? Uh Uh, I’d guess that the fat cats will redefine themselves as freelance management consultants.

The problem with taxing at 95% is that defining the tax so that it doesn’t have loopholes is impossible (if a loophole is worth millions per year per client lawyers will find one).

So, in the end, I’d support at 75% tax, but 95% seems a bit too high.

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by reader coberly


We often hear claims that the “rate of return on investment” of Social Security is less than what a person could realize by investing “in the market.” So much so that some authors claim that Social Security has created a “legacy debt” that amounts to a “backward transfer” of wealth from future generations to past generations.

This claim is as bizarre as it sounds. No future taxpayer will be giving money to his long dead grandparents. But it is also fundamentally wrong headed. Social Security is not an investment club in which returns paid to some subscribers result in less money available to earn interest to pay other subscribers. Social Security is an insurance policy, and the costs and “returns” of an insurance policy must reflect the real world costs of the insured event. They cannot be a simple expression of an arbitrarily chosen interest rate.

Calculations of “rate of return” usually leave out important complications like fees, taxes, inflation, and market variations. And they never refer to the insurance function whereby Social Security protects you from disability and your family from your early death. And no consideration whatever is given to the accidents of health or employment that could leave you unable to save enough through market investments to pay for even a marginally adequate retirement.

And finally, these comparisons always ignore the fact that as an insurance policy, there is no one “rate of return” that adequately describes the facts of Social Security. My purpose here is to make a beginning to addressing that lack of understanding. Ultimately there are too many complications for a short essay to address all the possibilities, but here is a start:

I’ll explain the method below, but here are the results.

An employee earning a below average wage of 26000 per year (adjusted for inflation and average real wage growth), in order to get the benefits Social Security will guarantee to him and his wife, would have to invest his 6.2% payroll tax and get a steady 12% return on investment per year every year above taxes and fees.

That same employee without a wife would have to get 10%.

A self employed person, investing the entire 12.4% payroll tax, would have to get 8.5% if married, 6.3 % if single.

An employee earning the average wage of 44,000 per year, adjusted, would have to get 10.4% married, 8.5% single; self employed married 6.7%, self employed single 4.5%.

An employee earning 70,000 per year, adjusted would have to get 9.2% married, 7.3% single; self employed married 5.5%, 3% single.


I assumed an average wage equal to the “average wage index” given in Table V.C1, page 98 of the 2007 Trustees Report, for each year from 1975 through 2009. This is nearly equivalent to starting at $8600 per year in 1975 and increasing 5% each year after that. For the low wage worker, I assumed 60% of the average. For the high wage worker I assumed 160% of the average. In each case I assumed an investment each year equivalent to either 6.2% of the wage for “employee” or 12.4% for the self employed.

I calculated benefits based on the average adjusted wage, which is the same as the final wage in this exercise, using the bend points in Figure V.C1, page 100 of the 2007 Trustees Report. I assumed the retiree would be able to buy an annuity using all of his savings plus return on investment calculated above. I assumed that annuity would earn 8% and pay the Social Security calculated benefit plus 3% inflation adjustment each year for a life expectancy of 15 years following retirement. I assumed that a married retiree would receive an extra 50% spouse allowance.


Since I looked at only the required 35 years for the Social Security calculation, some would argue that I neglected the money the employee would have earned, and paid taxes on, over a greater number of years. On the other hand, since early wages tend to be lower in relation to the average wage than later wages, by holding the wage constant, as a function of the average wage, I very likely overestimated the earnings from the early years, those that would have the greatest increase due to compounding. I did not count wages earned by the spouse, but neither did I count taxes and fees, possible inflation surges and market dips. Nor did I consider that actual life expectancy is even now somewhat longer than 15 years after retirement.

The largest source of contention, I suspect, would be whether or not the employer’s share of Social Security taxes would be available for the employee to invest if there was no tax. My view is that while it is reasonable to guess that they would be, obviously for the self employed, probably for high earners with bargaining power, or unionized employees with bargaining power, it is extremely unlikely they would be for low wage workers who have no bargaining power. And it is even more unlikely that if those taxes magically turned into a 6% wage hike for the low wage earner, that he would save and invest them. A worker making 400 dollars per week is not going to invest 50 dollars on the market even if you give him a 25 dollar raise. In any case according to the law, and in historical fact, the employer’s share does NOT come out of the employee’s earnings. I prefer to deal with reality rather than the woulda shoulda coulda of even the best economists’ imaginations.

And the whole point of Social Security is to provide retirement security for those workers who, for whatever reason, end up after a lifetime of work without enough money saved to pay for a retirement that includes a roof and groceries. Since this could be you… even now… if you are currently enjoying high expectations, instead of obsessing about what you “could have” earned “if only,” let me suggest you pour a glass of good wine and rejoice that you are going to at least get your money back adjusted for inflation. And all in all it is better to pay a little for insurance you don’t “need” than to not pay for insurance you end up wishing you had. In fact, if the universal mandatory automobile insurance requirements are a guide for thinking, there is some reason to suppose that it is better for you that other people have insurance, even if you yourself will never need it.


A low wage employee with a stay at home wife would have to get more than 12% “rate of return” from investing his Social Security tax to get the same retirement income that Social Security guarantees him. This is based on current tax and benefit schedules and historical data that reflect roughly a 3% inflation rate and a 2% real income growth. An unmarried, self employed, average earner would have to earn 4.5% every year on his savings of 12.4% of his income in order to get the retirement income that Social Security guarantees him. The rate of return is highly dependent on income level, with rates of return being much higher for people whose lifetime earnings fall below average. But even a single, self employed, high earner will at least get his taxes back adjusted for inflation. Social Security is insurance, not an investment, but its “rate of return” is quite competitive with real world investments.
by reader coberly

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Going into Shock

by reader Noni Mausa

Title: Going into Shock

Subhead: Some economic metaphors seem more appropriate than “tighten your belt.”

Explaining economic realities and their likely solutions can be made a lot easier with the judicial use of well-understood metaphors. Unfortunately, these tools can be also Used for Evil, or at least Confusion.

In times of economic catastrophe like these, one of the common metaphors is that, when times are bad and money is scarce, people, nations, and businesses need to “tighten their belts.” The idea is that since the ordinary household cuts back and saves money and puts off Johnny’s new bicycle to next summer, therefore it makes just as much sense for America to stop spending and put off her bicycle to next summer.

In this case, a different metaphor seems more appropriate. Compare the economic body to a human body going into shock.

A detailed description of shock [link ] makes it clear that it’s no minor ailment. Shock is a killer — not a psychological event but a string of chemical processes which lead to organ failure and death if not interrupted.

Like all biochemistry, it’s pretty complicated. The commonest form of shock is called hypovolemic shock — that is, shock due to loss of blood volume, often from serious accidental injury, stabbing, gunshot, or hemorrhage.

In sequence, the inadequate blood volume leads to loss of oxygen and nutrients to the cells. This leaves the cells trying to keep themselves going by using other energy sources which have toxic byproducts. Soon, breakdown of the cell membrane and failure of the sodium pump follows, leading to a bodily release of digestive enzymes, which releases more toxic substances into circulation. Eventually capillary damage and generalized cell death follows — that is, the patient dies of pervasive metabolic poisoning and organ failure.

It seems to me that the sudden loss of circulatory volume to the economic body is having much the same effect on the interconnected and mutually dependent nations of the world.

So, how is shock treated? By telling the patient to “snap out of it” and tighten his belt? Hell no. The article goes on:

In the early stages, shock requires immediate intervention to preserve life… The management of shock requires immediate intervention, even before a diagnosis is made. Re-establishing perfusion to the organs is the primary goal through restoring and maintaining the blood circulating volume ensuring oxygenation and blood pressure are adequate, achieving and maintaining effective cardiac function, and preventing complications….

(Sounds a bit like a stimulus package, doesn’t it?)

In hypovolemic shock, caused by bleeding, it is necessary to immediately control the bleeding and restore the casualty’s blood volume by giving infusions … Regardless of the cause, the restoration of the circulating volume is priority. As soon as the airway is maintained and oxygen administered the next step is to commence replacement of fluids via the intravenous route.

…Vasoconstrictor agents have no role in the initial treatment of hemorrhagic shock, due to their relative inefficacy in the setting of acidosis, and because the body, in the setting of hemorrhagic shock, is in an endogenously catecholaminergic state. . Definitive care and control of the hemorrhage is absolutely necessary, and should not be delayed.

Roughly this last paragraph says : “…trying to raise blood pressure by administering drugs that constrict blood vessels doesn’t help prevent the ongoing release of metabolic poisons…” (I confess I don’t have a clue as to what the “endogenously catecholaminergic state” has to do with it — or even what it is.) Anyway, to carry on:

Regardless of the cause, the restoration of the circulating volume is priority. As soon as the airway is maintained and oxygen administered the next step is to commence replacement of fluids via the intravenous route.

As I see it, capillaries are local communities, smaller businesses and civic governments, the large organs skirting failure are states, nations and large financial and business organizations, and the cells are the struggling people themselves.

Telling them to tighten their belts is to accelerate, not ameliorate the situation. Urgent action is indeed necessary, lest the toxic byproducts of social malfunction build up further, to destroy the very people and institutions that make up a healthy body politic. A transfusion and an IV drip, not a balanced budget, is the approach of choice right now.

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What else is new?

So what else is new?

In several hearings this month, members of Congress said they believed the derivatives had often been used to speculate, not to manage risk. They have expressed outrage that A.I.G.’s trading partners got 100 cents on the dollar for their money-losing trades when ordinary Americans paying for the bailout have suffered big losses in their 401K accounts and other investments.

Some have also been dismayed to learn that taxpayer money had ended up bailing out foreign banks. Some of the biggest beneficiaries of the bailout of A.I.G. were banks in Europe, including Societe Generale of France and Deutch Bank of Germany, each of which received nearly $12 billion, Barclays of Britain, which received $8.5 billion, and UBS of Switzerland, which received $5 billion.

Of course, Merrill Lynch, Goldman Sach, and JPMorgan got paid as counterparties through public funds to AIG.

Deeper yet, what did the FED, Bernake, and Paulson and Geithner know and when did they know it?

They have been playing this game for quite a while. If they are surprised, they are collectively incompetent. If they knew, they are culpable. And now Geithner wants sweeping authority over hedge funds. Hard not to be cynical here. I want to know precisely what he is going to do when the government seizes control. Specifically, let’s see some concrete guidelines for renegotiating employee contracts and counterparty contracts. Is the government going to pay off those counterparty contracts? Deep six those contracts, I say.

And while we are asking questions, how does the Geithner plan handle credit default swaps? We have talk of toxic assets; no talk of credit default swaps. And if private investors are going to buy toxic assets, will they shoulder any real risk risk? Or is the FDIC going to insure that the real risk is its?

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Miami Vice

Reality (h/t Dr. Black):

In certain ZIP codes in places like Homestead and Florida City, around 25 percent of the homes are in one stage of foreclosure or another. Countless others were built by developers and sit vacant in ghostly subdivisions, with not a buyer in sight.

In the days after Andrew, then-Dade County Emergency Management Director Kate Hale famously said on national TV: ”Where the hell is the cavalry on this one?”

The same could be asked now, in this new disaster. People in south Miami-Dade — just like people in foreclosure-strewn cities across the nation — are wondering: How did we get here?

Fantasy (via The Sports Law Blog):

The stadium did undergo some renovations in 1999 to make it more baseball-friendly, but the Marlins have been drawing low attendance figures. The Marlins averaged 16,688 fans last year, their third straight season averaging under 17,000 per home contest.

As Marc Edelman notes at the link above:

Last year, the Marlins team payroll was just $22 million…by far the lowest in the league. Rather than investing in their own team, Marlins President David Samson often used the threat of keeping a low payroll as part of his strategy in demanding public subsidies.

Miami-Dsde officials, as those from Montreal know well, must be really stupid if they think Jeffrey Loria is going to invest in making the team competitive just because they just wrote him a Very Large Check. Then again, maybe they figure one more vacant property won’t make a difference.

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Dear Brad and Mark (et al.)

This is why we don’t believe the bailout will work the way you think it will (i.e., to increase lending):

Recently, securities rated AAA have changed hands for roughly 30 cents on the dollar, and most of the buyers have been hedge funds acting opportunistically on a bet that prices will rise over time. However, sources said Citi and BofA have trumped those bids.

Instead of using the bailout monies to lend, or even make their balance sheets more creditworthy, the firms have been doubling-down on the assumption that they will be fellated by Timmeh and Larry. (At least Bill Gross and PIMCO (h/t Robert) did it when there was still a chance of sane monetary policy.)

I take back part of what I said earlier: this isn’t comparable to hitting on 17 because you’re drunk; it’s hitting on 19 because you’re desperate and insane. As Barry R. closes:

If anything, this argues against bailouts and in favor of nationalization, firing management, wiping out S/Hs, zeroing out debt, haircutting bond holders, etc.

Some economists may need to spend less time reviewing brilliant analysis from Barry Eichengreen (link is to PDF) and more reviewing Friedman and Savage (link is to PDF) in the context of principal-agent problems.

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By Spencer

The updated fourth quarter real GDP revisions really did not have much interesting information.

But maybe the most important data was the release of fourth quarter profits, especially for financial corporations. From the fourth quarter of 2007 to the fourth quarter of 2008 financial corporation profits fell from $370.3 billion to $122.4 billion, or about 66% while total profits only fell 21.5%.

Since their peak in 2002 financial corporations profits have fallen from 41.2% of corporations domestic profits to 26.5% in 2008. But in the fourth quarter of 2008 the share was only 14.1%, back where it was in 1959.

During this bear market financial stocks have fallen from some 22% of the S&P 500 capitalization to 9.8% at the end of February. Since write off are such a large share of the drop in financial corporations profits does financials share of the S&P falling under 10% signal a buying opportunity as it did for tech stocks at the end of the tech wreck?

Challenging question.

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Conservatives for Conservators

Robert Waldmann

The USSR (Union of Serious Socialist Republicans or House GOP caucus) just came out in favor of nationalizing banks.

From their alternative non budget

[O]ur plan supports a process to address insolvent institutions that stops throwing good money after bad into failing institutions and places insolvent ones into temporary receivership. … For insolvent firms, either the FDIC or a Resolution Trust Corporation-type entity would restructure these firms in receivership by selling off their assets and liabilities, reappointing private management, while protecting depositors — a process that builds off Washington Mutual’s arranged sale last year.

via Elana Schor

Now, if an when the Obama administration gets around to actually nationalizing, they will denounce it as socialist revolution. It won’t be anything new for them to contradict themselves. Still good news as far as it goes.

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