Comment on Delong commenting on Bernanke and “Summers”
In this rather long post Brad (who writes faster than most people can read causing potentially inefficient fixed pixel formation) Brad spends an odd amount of time critiquing some neo-Austrian and Singer the inflation truther.
But then he discusses the thoughts Bernanke and Summers, which are well worth discussing.
Ben Bernanke says that there is a:
risk… that rates will remain low…. [For] in an environment of persistently low returns, incentives may grow for some investors to engage in an unsafe ‘reach for yield’…. [The alternative risk that] rates will rise sharply…. The two risks may very well be mutually reinforcing…
Here I think it is important (in the context of the rest of the post) that when Bernanke writes “investors” he is thinking of financiers not people who engage in Physical investment as defined in the national income and product accounts. Basically he is worried about bankers and pension fund managers. I agree with Brad that
It seems to be very clear that prudential regulation rather than interest-rate manipulation is overwhelmingly the proper tool to deal with Ponzi finance, irrational or near-rational, and with systemic risk created by too much “reaching for yield”.
But fools and agents with incentive contracts written by fools reaching for yield by picking up pennies in front of a steam roller have created problems. The incentives created by fools can include that it isn’t good enough to maximize this years profits if the maximum is less than zero, so if the expected value of profits must be zero, gamble because its the only way to have a chance to keep your job.
So Bernanke (and Jeremy Stein et al) have a bit of a point.
Then we move to “Larry Summers” who is paraphrased.
And Larry Summers will say that if the problem is the collapse of the credit channel–the inability of a market in which participants have impaired balance sheets to properly mobilize the risk-bearing capacity of society in order to finance enterprise–the first-best answer cannot be pushing down the long-run rate of interest and so providing extraordinary incentives to invest in long-duration projects. That would produce an economy with (a) too-few risky short- and medium-term enterprises, (b) a too-high duration capital stock, and (c) too-much near-rational Ponzi finance. Much better to either (a) fix the balance-sheet problems and restore the risk-bearing capacity mobilizing power of the credit channel, or (b) failing that using the government as a financial intermediary to mobilize the taxpayers’ risk-bearing capacity when private finance cannot mobilize investors’.
I hesitate to dare to consider correcting Brad’s English, but I think the use of the future indicative “will” rather than “would” might give the ignorant the impression that Brad knows what “Summers” “will” write, because Brad ghost writes for Summers. I don’t think Brad is ghost writing. I think he is paraphrasing and the best expression is “Summers has written stuff which I won’t bother to look up along the lines of”. I vaguely remember Summers doing so, although I won’t bother to look it up either.
The future indicative “will” is also unfortunate as this analysis is a reasonable analysis of the past not the present let alone the future. And hey indeed Summers wrote that stuff (which Brad and I won’t google)* in the past.
Which participants have impaired balance sheets ? A period of extremely high profits and low investment has caused extraordinary levels of corporate sector financial assets. The low return uses of those assets are share buy backs. A large fraction of those profits have been earned by the financial sector, so banks with impaired balance sheets probably have impaired managers, so we don’t want to channel credit anywhere near them.
and what’s with an impaired ability “to finance enterprise.” “enterprise” is investing at a normal level. The low investment is almost entirely due to low housing investment. Also monetary policy mainly works through housing (Krugman calls this the “one of the dirty little secrets of monetary policy.” (some unsuccessful googling convinces me that monetary policy sure has a lot of dirty little secrets).
I really can’t tell a plausible* story about a collapsed channel from savers to home buyers which doesn’t imply an unusually large differential between the mortgage interest rate and the long term Treasury security interest rate. Currently this differential is extraordinarily low.
I just don’t see a problem with financial intermediation in this graph.
*I can tell a story — I can always tell a story — this one has a sharp divide between clearly credit worthy home buyers who are paying low interest rates and iffy credity maybe worther home buyers who often get loans are getting turned away by loan officers — but the story is sillier even than my usual models).
p.s. and I complained about Brad’s verbosity ! Have I no shame ? Actually I have shame, but I don’t have any willingness to edit this post down to a decent size. I just use the “more” button.
** update:punctuation added.
I think Delong being from a school near silicon valley may have some to do with his dealing with neo-Austrians a lot.
But I am bit confused by your huh? at the end. Do you think the paraphrasing of Summers is inaccurate or Summer’s pseudo-Austrian story doesn’t make sense, or both. I have no idea by the way, what a “too-high duration capital stock” is. (That too many of us are living in stone houses and not enough in tents?) Does he mean that depreciation is going to be too low in future? I also don’t understand what “near rational Ponzi scheme’s are” either – rational for whom?
P.S. By the way, my view of a liquidity trap is that it comes from too much domestic investment in spite of low returns, which implies an overvalued currency. How you can square the circle of that with the case of Japan is a big empirical problem with this idea. But I think that can be explained by the extraordinary reluctance of the Japanese themselves to invest overseas, rather than just bidding up domestic assets (read land and bonds) to extraordinary levels. I almost think sometimes, we would be better off just banning high leverage real estate purchases.
I made a big error in the above comment – I don’t mean too much real domestic investment I mean too much domestic FINANCIAL investment – quite a different thing. Low returns should drive the exchange rate down. If it doesn’t you can end up in a liquidity trap. The international financial system basically doesn’t work as advertised – it should push investment returns world wide together – it doesn’t.