Morning Bulletin: The Group of 30 Has Lost Its Collective Mind... - Grasping Reality with Both Hands
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Grasping Reality with Both Hands The Semi-Daily Journal of Economist J. Bradford DeLong: Fair, Balanced, Reality-Based, and Even-Handed Department of Economics, U.C. Berkeley #3880, Berkeley, CA 94720-3880; 925 708 0467; delong@econ.berkeley.edu.
Economics 210a Weblog Archives DeLong Hot on Google DeLong Hot on Google Blogsearch May 28, 2010
Morning Bulletin: The Group of 30 Has Lost Its Collective Mind... Paul Krugman blogs: Martin Wolf Is Not A Serious Person : And neither am I. Wolf writes: I have now lost faith in the view that giving the markets what we think they may want in future – even though they show little sign of insisting on it now – should be the ruling idea in policy. Amen. Yet most of the men in the room where I’m now sitting believe the contrary. With a few exceptions, everyone is calling for fiscal austerity everywhere, right now. Awesome. As Ricardo Caballero says, the big problem right now is that the world economy has too little safe high-quality financial assets, and thus excess demand for them is, by Walras's Law, producing excess supply of goods and services: It’s the general equilibrium, stupid: [T]he fundamental problem... is a shortage of safe “AAA” assets. The world seems to need more US Treasury-like instruments than are available.... The demand for these assets has expanded as a result of the fear triggered by the crisis.... But this time the private sector industry created to supply these safe assets – the securitisation and complex-assets production industry – is severely damaged. Much of what we see that confuses us today is the equilibrium consequence of living in an environment with this shortage. There is enormous asset price volatility, especially as assets transit out of the safe assets category... the recent difficulties in the Eurozone can be seen in this light, with Greece and others dropping from the potential safe-asset producers list. This shortage also leads to chronically low safe real interest rates.... These however, are the consequences, not the source. The US Congress and the Bank for International Settlements’ knee-jerk reactions are (mostly) bound to reallocate the malady, rather than cure it.... [A] more effective goal would be to focus on expanding the real supply of AAA assets... two basic ways of achieving this in the short run... governments in safe-asset-producing countries [could] produce a lot more of them [by running fiscal deficits]... the private sector create the AAA assets and for the governments (at a fair price) to absorb only that part of the risk the private sector cannot handle.... [F]unding fiscal deficits is very inexpensive these days... as long as one remains within the safeasset-producer category... In short, expansionary fiscal policy (credit-worthy governments print up a huge honking tranche of AAA assets, and then use the money to buy goods and services) or expansionary monetary policy (credit-worthy central banks take on duration and interest rate risk by buying securities for cash, and by increasing the money stock increase the supply of the most AAA of AAA assets) or expansionary banking policy (Treasuries and central banks turn leaden risky assets into golden safe ones by offering guarantees of one sort or another). The hope is that, by Walras's Law which tells us that excess demands across all markets must sum to zero, that relieving excess demand for AAA assets will produce as a consequence the relief of excess supply and full-employment balance in the markets for goods, services, and labor as well. This is the line of policy that was recommended by John Stuart Mill in the aftermath of the very first industrial business cycle-the 1825 crash of Britain's canal bubble: John Stuart Mill: It must, undoubtedly, be admitted that there cannot be an excess [supply] of all other commodities, and an excess [supply] of [AAA assets] at the same time. But those who have, at periods such as we have described, affirmed that there was an excess of all commodities, never pretended that [AAA assets] was one of these commodities; they held that there was not an excess, but a deficiency of [AAA assets]. What they called a general superabundance, was not a superabundance of commodities relatively to commodities, but a superabundance of all commodities relatively to [AAA assets]. What it amounted to was, that persons in general, at that particular time, from a general expectation of being called upon to meet sudden demands, liked better to possess [AAA assets] than any other commodity. [AAA assets], consequently, was in request, and all other commodities were in comparative disrepute. In extreme cases, [AAA assets] is collected in masses, and hoarded; in the milder cases, people merely defer parting with their [AAA assets], or coming under http://delong.typepad.com/sdj/2010/05/morning-bulletin-the-group-of-30-has-lost-its-collective-mind.html
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collected in masses, and hoarded; in the milder cases, people merely defer parting with their [AAA assets], or coming under any new engagements to part with it. But the result is, that all commodities fall in price, or become unsaleable... And that had in fact been carried out by the Bank of England in 1825-1826. Let me turn the microphone over to Walter Bagehot: The way in which the panic of 1825 was stopped by advancing money has been described in so broad and graphic a way that the passage has become classical. 'We lent it,' said Mr. Harman... [one of the Directors] of the Bank of England: by every possible means and in modes we had never adopted before; we took in stock on security, we purchased Exchequer bills, we made advances on Exchequer bills, we not only discounted outright, but we made advances on the deposit of bills of exchange to an immense amount, in short, by every possible means consistent with the safety of the Bank, and we were not on some occasions over-nice. Seeing the dreadful state in which the public were, we rendered every assistance in our power... This is the line of policy that, broadly, the world has been following since the subprime crash started in mid-2007 and excess demand for AAA assets first became grossly apparent. And this is the line of policy that the Group of 30 now wishes to reverse-without putting anything in its place. Now it is certainly the case that the government budget constraint holds in the long run--that governments cannot keep running deficits and raising their debt and taking on tail risk forever without cracking the AAA status of their own debt and so not relieving but instead aggravating the excess demand for AAA assets which is the Walras's Law balancing entry to excess supply in the markets for goods and services and high unemployment. As Ricardo writes: [W]ere we to continue along this path, at some point it will make sense to decouple fiscal deficits from asset production-lest we find ourselves cast in an epic Greek tragedy. The US Treasury would have to start buying riskier private assets rather than running fiscal deficits as the counterpart for its supply of Treasuries.... [In the medium term] the second, private-public approach is probably... sounder.... The private sector is much more efficient than the government in producing micro-AAA assets, but the opposite is true for macro-AAA asset production. Issuing public debt leaves the government in charge of bundling and producing both the micro- and the macro-AAA assets. Instead, if the government only provides an explicit insurance against systemic events... we could have a significant expansion in the supply of safe assets without the corresponding expansion of public debt... But we are extremely far from cracking the U.S. government's status as the supplier of AAA assets to the global economy right now. When we see signs that further issues of Treasury bonds or loan guarantees by the U.S. government are starting to erode the AAA status of U.S. government debt, then will be the time to back off of expansionary U.S. fiscal, monetary, and banking policy. Then--not now. Brad DeLong on May 28, 2010 at 10:06 AM in Economics, Economics: Macro | Permalink Favorite
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Comments Neal said... (quote) U.S. Debt Shock May Hit In 2018, Maybe As Soon As 2013: Moody's By JED GRAHAM, INVESTOR'S BUSINESS DAILY Posted 05/05/2010 07:56 PM ET ....The great uncertainty about how much debt is too much has tended to make fiscal discipline seem less urgent, rather than more. There is no obvious threshold beyond which investors will demand higher real yields for holding U.S. debt. Vague warnings from ratings agencies about the loss of America's 'AAA' status haven't added much clarity — until recently. In the wake of the financial crisis and recession, Moody's Investors Service has brought new transparency to its sovereign ratings analysis — so much so that 2018 lights up as the year the U.S. could be in line for a downgrade if Congressional Budget Office projections hold. The key data point in Moody's view is the size of federal interest payments on the public debt as a percentage of tax revenue. For the U.S., debt service of 18%-20% of federal revenue is the outer limit of AAA-territory, Moody's managing director Pierre Cailleteau confirmed in an e-mail. Under the Obama budget, interest would top 18% of revenue in 2018 and 20% in 2020, CBO projects. But under more adverse scenarios than the CBO considered, including higher interest rates, Moody's projects that debt service could hit 22.4% of revenue by 2013.... http://delong.typepad.com/sdj/2010/05/morning-bulletin-the-group-of-30-has-lost-its-collective-mind.html
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could hit 22.4% of revenue by 2013.... (end quote) The clock is ticking. Now is the time to get things moving. Wait and see is not an option. Get a plan--act on it. Reply May 28, 2010 at 10:27 AM John Howard Brown said... As others have noted, no one involved in making policy knows anyone who is unemployed, or even knows anyone who knows someone who is unemployed. There appear to be a LOT more than six degrees of separation between policy makers and those who are suffering due to the Great Recession. The only solution is to make a lot of policy makers unemployed. This is not very appealing in the US at least since the alternative is the wing-nut and Teabagger dominated Republican party whose policy views are even more absurd. (That's a very kind characterization.) Reply May 28, 2010 at 10:58 AM Pithlord said... Noah's fire department. PS. Sorry to be pedantic, but 1844 (when Mill wrote those words, mutatis mutandis) is hardly the aftermath of a crisis 18 years earlier. Reply May 28, 2010 at 11:01 AM Brad DeLong said in reply to Pithlord... I think he actually wrote the piece around 1830 or so, but kept it in his desk drawer until 1844... I may be wrong, however.., Yours, Brad DeLong Reply May 28, 2010 at 11:03 AM Jeff V said... Quick question; Why didn't high unemployement hold down inflation in the 70's; i.e., how did we get stagflation back then? I assume the answer would be something along the lines of it being a different kind of recession, i.e., not driven by bank runs, but that is just a guess - I really don't know... - Jeff V Reply May 28, 2010 at 11:28 AM Anon said... I don't know any group of individuals that understands the future well enough to create safe assets. Reply May 28, 2010 at 11:43 AM csissoko said... There is a very serious problem with replacing JS Mill's use of the word 'money' with 'AAA assets' in the quote. It is precisely the failure of the economics profession to deal with both the similarity and the differences between money and assets that got us to where we are today (i.e. the decision to put finance and monetary economics into separate disciplines). Obfuscating the differences between the two is not going to help. On the other hand, carefully setting out why you think your substitution is okay and why the differences don't matter so much in this case, might help. Reply May 28, 2010 at 11:57 AM A said in reply to Jeff V... "in the 70's..." we had the oil price shocks. And also a Federal Reserve denouncing government deficits (before Regan, who could maintain his 'fiscal responsibility' posture while amassing huge deficits [by that time's standard], and thus bring about, by Keynesian deficit spending, a 'Morning in America'). Reply May 28, 2010 at 12:17 PM Maynard Handley said... So let me get this straight. There is a demand for AAA assets, a demand that "the government" should fulfill. How much is this demand worth to those who demand it (which does NOT include me, the homeless guy on the street, and 95%+ of the US electorate)? Because I, for one, am pretty fscking pissed off at hearing how terrible it is that the government "steal" the income of the rich and in return offer them so little. It might be nice to have an actual dollar value tied to this little favor being done to the rich this time round. We had an episode a year or two ago --- remember that? --- when some of us pointed out that it might be worth the nonplutocracy getting what THEY wanted (decent finreg including, eg, transaction taxes, leverage caps, and a new personal taxation model for those in finance). But no, we were told, more important to give the rich what they wanted and, in gratitude, they would surely give us what we wanted after the crisis has passed. Well we all know how that turned out. Yesterday we get congress telling us that hedge fund billionaires do such a fine job of steering our economy that we need to give them a preferential tax rate. http://delong.typepad.com/sdj/2010/05/morning-bulletin-the-group-of-30-has-lost-its-collective-mind.html
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preferential tax rate. I'm sorry, but now ANYONE whose response to any economic crisis starts with "let's FIRST rescue the plutocracy and THEN we'll rewrite the legislation" rather than the reverse order strikes me as not serious. Reply May 28, 2010 at 12:48 PM robert said... The fact that there is a shortage of safe AAA assets doesn't help if by issuing more of these assets, they start to lose their AAA status. Reply May 28, 2010 at 12:53 PM Brad DeLong said in reply to robert... Robert Horrocks wrote: The fact that there is a shortage of safe AAA assets doesnt help if by issuing more of these assets, they start to lose their AAA status. Indeed. But unless and until that happens, and the long run in which the government budget constraint binds tightly arrives suddenly, you can put a lot more people to work making useful stuff... Reply May 28, 2010 at 01:51 PM Omega Centauri said... Brad, shouldn't the concern be what will happen if we do happen to approach the limit? Will we be able to make a seemless transition to better finances? Or will we suffer an American version of the current Europanic? I'm not reassured that we collectively will be able to identify the signs in time, that wasn't the experience with private debt, or real estate bubbles. It isn't the case with impending peakoil problems. When the decision to see the looming problem involves politics, it seems that denialism wins the day. Reply May 28, 2010 at 03:47 PM csissoko said... You set me off on a role: http://bit.ly/cfX7Zl. Reply May 28, 2010 at 05:11 PM Ben Ross said... When you've got us back in 1825, please don't say "As Ricardo writes..." Reply May 28, 2010 at 05:13 PM malcolm said... I am confused by terminology. Is the bond market in equilibrium? If the bond market is in equilibrium, then there is no excess demand which Walras law suggests should be matched by an excess supply. The rhetoric is clever...but is it empty? Reply May 28, 2010 at 11:28 PM GA said... So far as I can tell, there is very little discussion now of the nature of the government deficit, and tilting it towards investment. When the first stimulus was enacted, the key phrase was 'shovel ready' projects. It is an embarrassment that the last 18 months or so have not been used to prepare the pipeline of investment projects. Government spending is always treated as an outright expenditure - but there are government expenses (bridges, airports, roads, water plants, sewage plants, government buildings, schools, hospitals, some types of power plants, etc) that are really investments. Older stuff needs to be replaced, newer stuff will need to be built in a few years. It's a no-brainer to move government's investment/replacement forward to now. To the extent some of this can be replacement of less efficient stuff with more efficient, it may even reduce some longer-term expenditures. Many/most of these investments would be made in future years, and hence the path to future deficit reduction - we stop building new stuff - would be clear to the Masters of the Bond Universe. Maybe even Moody's would get it. And yes, in some cases it will result in somewhat less efficient outcomes - refurbishment of an airport before it would otherwise be necessary, replacement of cooling unit 'A' with today's technology when A-prime technology is about to come out - but this has to be measured against tax and employment losses/expenditures now. I repeat: it is an embarrassment that the last year has not been used to prepare and identify projects that could be shovel-ready today. And that the polity is not discussing this. There is room for investment in different stuff than monster houses. Reply May 28, 2010 at 11:56 PM Nicholas Gruen said... Yes, I got confused by references to 'Ricardo'. Reply May 29, 2010 at 08:02 AM OrganicGeorge said... Basically it was the oil shocks of the 70's, price of oil skyrocketed overnight, economy went into the tank but the higher oil prices triggered inflation. There was a lot more economic factors that just the oil prices for stagflation, however the spike in oil served as the catalyst. Reply May 29, 2010 at 08:39 AM http://delong.typepad.com/sdj/2010/05/morning-bulletin-the-group-of-30-has-lost-its-collective-mind.html
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Nick Rowe said... I think Walras' Law is wrong (or, at the very least, highly misleading). It's wrong because: it ignores monetary exchange, and so only speaks of one excess demand for money; it ignores the effect of quantity constraints in disequilibrium. For example, suppose rent controls create a permanent excess demand for apartments. Does that mean there must be an equal excess supply for other goods? No. Unable to rent extra apartments with their income, people re-compute their optimal expenditure plans, taking that additional constraint into account, as well as their budget constraint, and spend their income on something else instead. In other words, there may be a "notional" excess supply of other goods, but not a "constrained" excess supply of other goods (Clower/Barro/Grossman, etc.). The apartment market has an excess demand for apartments matched by an excess supply of money; all other markets can be in equilibrium. Walras' Law only includes one excess demand/supply for money. But in a monetary exchange economy, there are as many excess demands/supplies for money as there are non-money goods. For "apartments" read "bonds" instead. If the argument doesn't work for apartments, it shouldn't work for bonds either. The excess demand for bonds/apartments will only create a general glut of other goods if it spills over into an excess demand for money. Money (as medium of exchange) is special. There are always two ways for an individual to satisfy an excess demand for money: sell more stuff; buy less stuff. In a general glut, individuals cannot sell more stuff; but they can buy less stuff. That's because the short side of the market determines quantity exchanged. So each individual tries to get hold of more money by buying less stuff. Each individual can succeed, but in aggregate they fail (given fixed total supply of money). The "Paradox of Thrift" is really a Paradox of Hoarding. Thrift alone (excess demand for bonds) cannot cause a general glut. Hoarding (excess demand for the medium of exchange) can. Reply May 29, 2010 at 10:53 AM Bernard said... it just seems to me that looking at the short term vs the long term is what the focus needs to be about. in the short term we need to rebuild American infrastructure. since Government is the only "mover" capable of doing this, due to the vast sums of money and projects involved, this would be a short term investment with a long term future. re-investing would employ more Americans who would spend and increase tax revenues, which could be used to pay down the long term and present deficit. but politics always gets in the way of fiscal reality, now that the Rich own America. i doubt we shall see any sense of investment, long or short term anytime soon, until the bubble of the Corporatist Congress/Military/Industrial complex. and being an Empire the focus will remain with those that have the power. stupid as most wars are, we will bankrupt ourselves, not the rich thought, and then we will have a chance to start anew. until then, all this dialogue is empty rhetoric Reply May 29, 2010 at 03:36 PM Comment below or sign in with TypePad
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Galbraith: The danger posed by the deficit 'is zero'
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Washington Post (blog) - May 12, 2010 ... as demonstrated by both economic history and public knowledge of Ben's opposition to higher inflation rats(google Brad DeLong and 3% inflation target). ... Related Articles » « Previous Next »
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