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Kocherlakota loose money and deflation

Robert Waldmann

Minneapolis Fed President and famous economist Narayan Kocherlakota made my jaw drop with this argument

Long-run monetary neutrality is an uncontroversial, simple, but nonetheless profound proposition. In particular, it implies that if the FOMC maintains the fed funds rate at its current level of 0-25 basis points for too long, both anticipated and actual inflation have to become negative. Why? It’s simple arithmetic. Let’s say that the real rate of return on safe investments is 1 percent and we need to add an amount of anticipated inflation that will result in a fed funds rate of 0.25 percent. The only way to get that is to add a negative number—in this case, –0.75 percent.

Kocherlakota asserts that expansionary monetary policy will eventually cause deflation. This is very odd. My honest opinion is that he wants to argue for a higher target federal funds rate and he’s decided to present every argument that supports that proposal even if it is half baked, unbaked or negabaked (frozen ?). However, I can’t resist trying to make sense of the argument (after the jump I try and fail).

First, as noted by Andy Harless, Kocherlakota is asserting super-neutrality – not just that the level of the money supply doesn’t affect real variables in the long run but also that the rate of growth of money doesn’t affect real variables in the long run. Kocherlakota is right that this claim is not controversial – it is uncontroversially false as argued in, say, much of Kocherlakota’s academic work. Weird.

Second, Kocherlakota does not say anything about economic agents and their objectives. For there to be deflation firms must lower prices. Kocherlakota does not discuss why firms might do that. This is very strange coming from an economist who was, until recently, chairman of the Minnesota economics department.

update: This is not as unoriginal and pointless as the rest of the post.

Immediately above the quoted passage Kocherlakota wrote

As I said, the FOMC meets eight times a year. Its decisions are always influenced by fairly recent economic data. But, at the same time, its decision-making has to be shaped by long-run considerations. In that vein, let me close by offering some thoughts about long-run inflation—or really, long-run deflation. I mentioned earlier that inflation has been near 1 percent recently. These data have led some observers to worry about the possibility of a multiyear period of falling prices—that is, persistent deflation. I don’t see this possibility as likely. It would require the FOMC to make the surprising mistake of ignoring the long run in its desire to fix the short run.

He notes that there is a long run equilibrium in which the Fed funds rate is very low and inflation is negative. He strongly suggests that this would be a bad thing. In Kocherlakota’s academic work, he asserts that optimal policy implies an euqilibrium with deflation and a very low nominal interest rate (optimally 0). This is called the Friedman rule. So why would reaching such an equilibrium require a mistake. The argument about the equilibrium real interest rate is an argument about the real interest rate which corresponds to unemployment equal to the natural rate. The problem with deflation is that it can cause real interest rates to be higher than that rate. Kockerlakota assumes that there is no problem caused by deflation in his warning that loose money might lead to deflation.

[intemperate outburst deleted]

end of update.

Further up in the speech, Kocherlakota notes that it makes no sense to consider a policy of keeping the federal funds rate at 0.25 percent from now until T= infinity, since the question at hand is the target rate for the next month and a half. He then just says this doesn’t matter (1.5 is approximately equal to infinity). I think that to the man in the street, this is stranger than deciding micro foundations are optimal and that neutrality implies super neutrality.

However, I find it comprehensible. When one attempts to deal with difficult mathematical models, the temptation to consider steady states is almost irresistible. Furthermore Fresh water economists have been saying “that may be true in the short fun but not in the long run” for decades. In fact, economists have been dodging questions by talking only about the long run since before Keynes wrote “in the long run we’ll all be dead” to respond to exactly that invalid argument.

Another key point is the immense power of “if.” Kocherlakota discusses the irrelevant question of sticking to 0.25% target forever (he doesn’t consider sticking to it for a mere million years). He thus implicitly assumes that the Fed can keep the Fed funds rate at 0.25 from now to infinity without interruption. I think that is impossible and it certainly won’t happen if the Fed follows the policy opposed by Kocherlakota.

The Fed has been keeping the Fed funds rate that low via open market operations in which it issues high powered money in exchange for other assets. Such an approach might fail to achieve the target because it leads to inflation. It is easy to see how a policy of trying to keep the federal funds rate below the equilibrium real interest rate would cause high inflation until the Fed would lose its ability to drive short term interest rates down because the real value of new high powered money issued would be too small – that is the amount of money they create doesn’t matter if no one wants it.

I not sure that it’s even possible to write down a model in which such a policy succeeds in keeping the Fed funds rate 0.25% for the long run and leads to an equilibrium with deflation. Certainly no such model currently exists.

The Fed could achieve 0.25% starting in around 2020 and lasting forever by reducing and reducing the money supply, however that would imply very high nominal interest rates in the near future (this isn’t theory it is an empirical observation) and it is not the proposal which Kockerlakota opposes.

I guess I have wasted your time. I started with no clue about Kocherlakota’s mental processes and and I still have no clue.

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Not Replacing 1970’s Military Equipment

by reader Ilsm

Misspent Tax Dollars for Profits, Not Replacing 1970’s Military Equipment

US outlays for military programs are wasted through mismanagement and neglect: these must not be spared in spending cuts. 20% of US government outlays are for the Defense Department. Something that needs to be to considered while reading the report is that the sum of Research and Procurement appropriations in DoD 2011 proposed budget is $214B ($189B baseline with an additional $25B for overseas contingencies).

According to GAO 09-326SP Assessment of Selected Weapons Programs (8mb pdf!), the largest weapon projects, the “portfolio” of 96 major programs with commitments for spending on revised acquisition “baselines” has grown to $1.6T, averaging a 19% increase since each program started, with 42% (40 programs) of the reviewed programs rising in cost more than 25% since inception. At 25% increase the Sec Def is required to justify to congress why the department will continue with the program.

There not only is room to cut, there is screaming need to cut. It will take 8 to 10 years’ at current 2011 budget levels to work through these commitments assuming cost increases stop, schedules are met, technical performance is delivered, and the US doesn’t “go broke” trying. The $1.6T is the tip of the DoD acquisition iceberg, for these are the largest systems mismanaged at reviews by the highest level, an Undersecretary of Defense led panel. There are a lot of other urgent requirements against the research and investment budgets, which were not reviewed in this assessment.

There will be a huge logistics burden for these systems. Acquisition costs are a fraction of DoD’s total weapon system commitments, each system requires two to three times acquisition costs over the planned 20 year life to train and maintain “capability” for fictitious wars and entanglements. This bow wave of future logistics for the major programs is $3 to 5 Trillion in support costs spread over 20 years. (Operations and Maintenance 2011 with OCO $317B, about $200B base budget)

Cutting most of this $7T unfunded liability will encourage national security, and reduce deficits. What good is it to be “bankrupted” for the wrong weapons, whose untested specifications are watered down to limit the obscene cost overruns, years after promised?

These commitments scream to be reviewed and many cancelled. They represent gross mismanagement, waste, nothing but dividends to companies who profit.

GAO released 10-388SP in March 2010, however it does not have “rolled up data” due to “lack of complete Selected Acquisition Report data for 2009”.

Footnote: GAO Acquisition Cost: All cost information is presented in fiscal year 2009 dollars using Office of the Secretary of Defense approved deflators to eliminate the effects of inflation. We have depicted only the program’s main elements of acquisition cost—research and development and procurement. GAO 09-326SP, App I, Pg. 168 (175/190 .pdf)

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6% of GDP…so what!

Lifted from an e-mail from Dale Coberly regarding Social Security and the dangers of increasing ‘costs’ of helping our old folk live a bit above a level of destitution:

…that while SS will eventually cost 6% of GDP, this is not a lot of money for the basic needs of 25% of the population. Moreover, they will have paid for it themselves.

And that is what it is going to cost “us” in any case, however the money is arranged… that is what the old people will “eat.” And the bread will be baked by “us.” You can fool yourself with financial transactions, or you can take the money directly via a payroll “tax.” At the end of the day…in terms of distribution of goods and services to the elderly vs the “young,” it will come out exactly the same.

You would have to show that laundering the money through the financial markets will result in more production or a fairer distribution, and while the first is an article of religious faith with some people, there has been no evidence whatsoever to support it for the past eighty years. I suspect it has something to do with the maturation of capitalism, but I am no economist. Merely an observer of what is.

To put it in terms any might understand: Granny is going to consume 6% of what “we” produce. So what? (She produced a hell of a lot of what we consumed in her prime time.)

(Rdan…lightly edited for readability)

Angry Bear front page author Bruce Webb has kept the numbers straight and well covered, and Dales’s Northwest Plan offers an especially workable answer to the possible problems in the money stream for workers, but sometimes you just gotta say it out loud and in real family terms many of us actually believe about the over 65 group. Thanks for working hard.

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Considering the ill-advisedness of favoring capital income

by Linda Beale
crossposted with Ataxingmatter

Dealing with the Sunset of the Bush Tax Cuts (Part III in a series)–considering the ill-advisedness of favoring capital income

During the Bush administration a number of significant reductions in revenue were enacted, especially in the 2001 and 2003 tax bills, but with a sunsetting provision that (extended in some cases) generally will mean that the pre-existing provision will be reinstated after 2010. Both individual and corporate taxes were reduced. Many of the corporate and business provisions involved accelerated expensing provisions, allowing businesses to write off purchases much faster than the economic depreciation of the asset would require and thus amount to a significant tax reduction for businesses. Rates on capital gains were reduced, and dividends, which have traditionally been treated just like interest income and taxable at ordinary rates to individuals, were temporarily made subject to the preferential capital gains rates. The estate tax was phased down and then completely eliminated for the 2010 tax year. As a result of these and other changes, capital income is especially favored under the temporary provisions, and the wealthiest 1% who own a substantial portion of the financial assets received significant benefits.

Much of the argument in favor of reducing taxation on the income from capital is spurious. It is a claim that by taxing returns from capital less heavily than returns from labor, those who receive those returns will invest them in new businesses, spurring entrepreneurship. The returns from capital that are favored, however, are not closely correlated with reinvestments in businesses. Most of the returns are those gained merely from secondary market trading and those increases in capital do not go to businesses but to other investors or financial institutions. There is a special provision that taxes initial issuance corporate stock gains more favorably, but that is only a small piece of the capital gains preference.

In terms of the economy, it is highly likely that tax cuts for lower income taxpayers will be spent domestically and thus provide important impetus to economic growth at this point in the recession. Tax cuts for the wealthy and owners of financial assets at the top of the distribution are much less likely to spur economic development–the wealthy are well known for utilizing tax shelters (legitimate and not so legitimate) and for moving assets offshore into tax haven jurisdictions (sometimes through illegitimate use of foreign banking secrecy laws to evade US taxation). The wealthy may reinvest their gains in new businesses (or private equity funds that spend some part of their accumulated assets in funding new businesses), but they are also likely to invest much of those gains abroad or to put them into the shadow banking system, which played a role in the financial crisis (that developed into a full blown recession) by creating a huge amount of leverage and interconnectedness.

Those with considerable amounts of financial assets also tend to be the ones who make possible the riskier types of investments. Yes, we want some adventuresomeness, but the appetite for risk and high returns that led to the financial crisis and recession was problematically high. Higher taxes on capital income would tend to temper that appetite for risk.

Further, concentrations of wealth create problems for democratic societies, especially at a time when at least 8 million Americans find themselves out of work and many out of their homes at the same time. Wealth concentrations lead to gated communities and the isolation of the wealthy from the mainstream of society. The ability to understand problems and to understand the distribution of benefits and burdens diminishes. When there is a group of people so well off that they are simply not “in the same boat” as everybody else, society is negatively impacted. Tax policy cannot cure the problem, but it can address it and ameliorate the worst of the consequences of concentrated wealth accumulation.

These are concepts that Congress should bear in mind as it considers whether or not to enact new tax cuts that will extend the Bush tax cuts longer.

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HEALTH CARE thoughts: Resident Rights versus Caregiver Rights

by Tom aka Rusty Rustbelt

HEALTH CARE: Resident Rights versus Caregiver Rights

In 1987 the federal government passed a comprehensive “bill of rights” for nursing home patients. Most states followed.

The law gives nursing home residents wide protection, including (when mentally able) the ability to refuse care, meals and just about anything else they please.

Resident care preferences regularly create all sorts of difficult issues though, including:

Can white residents refuse care from black nurses and nurse aides? ( a common problem)

Can female residents refuse care from male caregivers? (the courts say yes on privacy grounds)

Can residents request care from specific employees (a latino requesting a latino)?

Can residents request care from specific employees just because they like the employee?

Mrs. Rustbelt has dealt with all of these issues (recently) and many more. Her first comment was “I only have to do 12 hours work in 8 hours, of course I need to referee a unit full of adult children. Grrrrr.”

According to a recent federal court in an Indiana case, if a white resident requests “no blacks” and the facility accommodates (according to Indiana law) the facility has discriminated against the employee.

Keeping in mind the average nursing home resident is about 78 years old with multiple physical problems and some level of mental and emotional impairment, this creates just a great big mess, and the facility loses in every scenario.

The unintended consequences of government regulation. Everyone suffers except the bureaucrats, and the lawyer who profit. Anyone got any solutions?

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Household leverage: what does the US have that the UK does not?

Earlier this week I compared household saving rates across the US, UK, Canada, and Germany. My conclusion was pretty simple:

So generally, this simple analysis would suggest that Menzie Chinn’s skepticism of a “status quo” of US consumer imports is worthy. But with the status quo firmly in place in Germany, the household saving data paint a foreboding picture – certainly for the Eurozone, but possibly for the global economy as well.

The financial circumstances of US and UK households are very similar despite their diverging saving rates over the last two quarters (see saving rate chart here): leverage is high.

The chart above illustrates the total stock of household loans/debt (including non-profit organizations, which is small relative to the “household”) as a share of personal disposable income.

In the UK, household leverage peaked above that of the US at 161% of personal disposable income in Q1 2008, having fallen to 149% by Q1 2010. Furthermore, recent deleveraging by UK households has occurred through income gains, rather than paying down debt: spanning the period Q2 2009 to Q1 2010, the UK household stock of loans increased 1.2%, while disposable income grew 3.1% (you can download the data here).

Given the remaining leverage on balance, the divergence in household saving rates across the US and UK is probably not sustainable. The UK household saving rate is likely to increase, or at the very minimum, hold steady.

The problem is: that according to the sectoral balances approach, it’s impossible for the government and the private sector to increase saving simultaneously unless the UK is running epic current account surpluses (it’s not). Therefore, the £6.2billion in public “savings” may push UK households farther into the red. However, the more likely outcome is that UK public deficits rise amid shrinking aggregate demand (and with it, tax revenue) and the increasing household desire to save.

The punchline: the US household has something that the UK household does not: (still) expansionary fiscal policy ($26 billion in state aid and extending unemployment benefits, for example).

Rebecca Wilder

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Prices as virtuous

Yves Smith, excerpted from her post Boston Fed’s New Excuse for Missing the Housing Bubble: NoneOfUscouddanode. This part caught my eye in addition to the critique:

The problem is that mainstream economics sees prices as a virtuous. Everything can be solved by price. If there is some unbalance in the economy, it merely means prices need to rise or fall, the impediment must be stickiness or some other inefficiency that is preventing the magic price setting mechanism to do its magic work. Mainstream economists also believe that price mechanisms lead to optimal outcomes from a social welfare standpoint. There is a reason that this line of thinking. aka neoclassical economics, became dominant (and Keynsianism is merely a branch; Keynes himself believed economies were fundamentally unstable, while the neoclassical types believe that markets are always and every self correcting). It’s very favorable to the business community. (Note this is a simplification; ECONNED provides a long form treatment of this topic).

Second, some very unfashionable schools of economics, namely the Austrians and the Marxists, both recognized the imbalances in the economy prior to the bust. It wasn’t just housing; the negative personal savings rate and the widening trade deficit with China were red flags.

Third is the through-the-looking glass logic: “Well, it took those (supposed) few who saw the bubble a long time to be proven right!”

Yves here. Now there are other measures that regulators can use to attack bubbles, since the ones that are most damaging involve borrowed funds. They can take measures to restrict the gearing used in the markets that are superheating. But Macfarlane’s comment about the resistance to intervening rings true. Just imagine the howling you would have heard from homebuilders, realtors, bankers, home decorators, land speculators, you name it, had the authorities been able to severely restrict no-doc loans and had required a minimum downpayment, say, of 10% for non FHA loans. It isn’t yet clear we have the political will to take on the people who win short term from borrowing binges.

WSJ article is here

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Dealing with the Sunset of the Bush Tax Cuts (Part II in a series)

by Linda Beale
crossposted with Ataxingmatter

Dealing with the Sunset of the Bush Tax Cuts (Part II in a series)

The Congressional Budget Office has published a report with its views on the economic impact of enacting legislation to extent some of the Bush tax cuts. The full report and summary are available here.

The report provides 10-year projections–all with the caveat that forecasting economics is “subject to considerable uncertainty.” It projects a relatively slow recovery from the recession, as is typical with financial crises, with unemployment staying relatively high until about 2014. The slow growth means lower revenues, though the CBO expects revenues to begin to recover in 2010–with a total of $2.1 trillion or 14.6% of GDP. But spending will be about $3.5 trillion (24% of GDP). That means a projected deficit for 2010 of $1.3 trillion, second only to 2009’s deficit as a percentage of GDP (9.1% compared to 2009’s 9.9%). That’s using as a benchmark the tax laws as written–i.e., no additional “patch” for the alternative minimum tax (AMT) and no changes to the Bush tax cut sunset provisions, so that the Bush cuts expire as slated at the end of 2010. If those policies were not continued (i.e., if a further tax cut similar to the Bush cuts were enactetd and an AMT patch were put in place, and the discretionary budget remained about the same as in past years as a proportion of overall spending, the deficit in 2020 would be about 8% of GDP and the public debt about 100% of GDP.

That’s a significant cost to enact tax cuts. Should we do so? Wouldn’t the economy get more of a boost if we allowed the cuts to expire as slated and used the additional revenues in programs that are likely to build jobs?

There is certainly an argument for increasing economic stimulus now, if possible. That might spur some further job creation and permit more of those on the brink of economic disaster to retain their homes. While tax cuts are likely not the best means of providing a stimulus, it might be more possible to attain a Congressional vote compared to direct government programs, such as infrastructure spending.

But the utility of tax cuts as a stimulus likely wanes fairly rapidly as income levels increase. A person with 30 thousand of income will find ready spending needs for a few hundred dollars of tax savings. A person with 30 million of income would not need the extra tax savings and might simply purchase more financial assets with any extra cash. The purchase might add liquidity to the US markets–or it might be equities in China or India and have no useful impact in the US. Purchases in the secondary market, at any rate, will not put new funding in the hands of corporate businesses. So the argument in favor of a new tax cut does not well support an across-the-board cut. Cut taxes for those at the lower income levels, but retain rates for those at the top. Obama’s line-drawing is nothing magical, but increasing taxes for individuals making more than $200,000 shouldn’t be a big problem.

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75 years of unqualified success

Prof. Barkley Rosser at Econospeak, lifted from comments here:

We really should pause for a minute or so to appreciate the 75 years of this program, which has been an unqualified success, providing social security for millions of people extremely efficiently and without a single scandal that I am aware of in its entire history. That people of either party are going after it is really the scandal.

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Progress Report

by Mike Kimel

Cross-posted at the Presimetrics blog.
Progress Report

Getting a book out when you’re a complete unknown is tough. Presimetrics shipped a couple of weeks ago, and we’re doing what we can to get the word out but its slow going. We had a lucky break a few weeks ago when Parade Magazine featured a quiz based on the book. A week ago I had an interview with US News & World Report which I understand will appear in their on-line edition in mid-September.

Meanwhile, I’ve heard that among major bricks & mortar stores, the book is being carried by Borders. According to the publisher, Barnes & Noble ordered copies too, but the local store isn’t carrying it and I’ve heard from people in other locations that they haven’t seen it at B&N locations near them either. Online, its easiest to watch the rankings bounce around on Amazon; they’ve been everywhere between 5,000 (right after the Parade Magazine quiz) and 150,000 in the past couple of weeks. Nobody has put up a review on Amazon yet. (Actually, I don’t think I’ve seen the book reviewed anywhere in the media or in blogs yet.)

The publisher is continuing to try to book us with national media (they were the ones who hooked us up with Parade and USN&WR) but there’s a chicken and egg factor; a certain amount of fame/notoriety/recognition is needed to be featured on many media venues, and being picked up by the media is needed for the book’s existence to become known.

On a more local level, over the past week and a half I’ve been extremely busy with my outside life, but this week I plan to get in touch with local tv & radio shows, and also to look into local book signings. We will also begin going after the academic market, focusing on poli sci/government/recent American history rather than economics; this is a book about governance, after all, and economics is only a component of the book, after all.

Anecdotally, people who are reading the book seem very enthusiastic about it. I suspect word of mouth will lead to the biggest slice of sales for this book in the long run, but that takes a while to build up. The biggest problem, so far, I think, is us – the authors. We’re both low key guys who aren’t hugely comfortable tooting our own horns in a world where marketing beats product. But we’re trying to change our ways.

So that’s where we are. And I’m interested in your feedback. Have you read the book? If so, what do you think about it? If not, does it seem like something you would read? Why or why not? Also, any ideas on marketing are welcome.


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