• warning: date() [function.date]: It is not safe to rely on the system's timezone settings. You are *required* to use the date.timezone setting or the date_default_timezone_set() function. In case you used any of those methods and you are still getting this warning, you most likely misspelled the timezone identifier. We selected 'America/New_York' for 'EDT/-4.0/DST' instead in /var/www/vhosts/oregonindependent.com/httpdocs/modules/aggregator/aggregator.pages.inc on line 259.
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Updated: 31 weeks 1 day ago

Fed Watch: Froth Alert

Mon, 09/16/2013 - 2:03pm

One more from Tim Duy:

Froth Alert, by Tim Duy: Former Federal Reserve Vice-Chair Donald Kohn - suspected of being a contender for the top job at his old employer - warned about too loose monetary policy today. From the Wall Street Journal: “Very easy monetary policy often builds imbalances that may become so large that can’t be countered by regulation,” Mr. Kohn said at an event on financial stability at the Brookings Institution think tank. It would not be surprising that long-term Federal Reserve employees might now be a bit more cautious about the link between monetary policy and financial imbalances given the two recent asset bubbles. And they may even be asking themselves if another is brewing:

Net worth as a percentage of nominal GDP is approaching the highs of the internet bubble era. And that was at the end of the first quarter; US equities have made further gains since then. Now, I don't claim that I can identify the "right" level of net worth to GDP, and I doubt monetary policy makers would claim they could either. That's what make asset bubbles tricky to identify in the first place. But it is true that in the recent past, net worth near these relative levels has been followed by a certain amount of, well, let's just say "unpleasantness." I admit that we are heading into territory that makes me think more about financial imbalances, and it is tough to believe that Fed officials are not thinking the same thing. That said, is there an immediate risk? In recent history, the "unpleasantness" did not begin in earnest until the Fed inverted the yield curve, and I suspect that Federal Reserve Chairman Ben Bernanke will tell us later this week that they don't expect to even begin raising interest rates until mid-2015. So even if this another asset bubble is brewing, arguably is has a long way to run.

Paul Krugman: Give Jobs a Chance

Sun, 09/15/2013 - 11:33pm

All we are sayin', is give jobs a chance:

Give Jobs a Chance, by Paul Krugman, Commentary, NY Times: This week the Federal Reserve’s Open Market Committee ... will be holding its sixth meeting of 2013. At the meeting’s end, the committee is widely expected to announce the so-called “taper” — a slowing of the pace at which it buys long-term assets. Memo to the Fed: please don’t do it. True, the arguments for a taper are neither crazy nor stupid... But if you think about the balance of risks, this is a bad time to be doing anything that looks like a tightening of monetary policy. O.K.,... the Fed is talking about slowing the pace of these purchases, bringing them to a complete halt by sometime next year. Why? One answer is the belief that these purchases — especially purchases of government debt — are, in the end, not very effective. There’s a fair bit of evidence in support of that belief... Unfortunately, financial markets have clearly decided that the taper signals a general turn away from boosting the economy... In effect, by talking about tapering, the Fed has already tightened monetary policy quite a lot. But is that such a bad thing? ... Suppose, on one side, that the Fed were to hold off on tightening, then learn that the economy was closer to full employment than it thought. What would happen? Well, inflation would rise, although probably only modestly. ... Right now inflation is running below the Fed’s target of 2 percent, and many serious economists ... have argued for a higher target, say 4 percent. So the cost of tightening too late doesn’t look very high. Suppose, on the other side, that the Fed were to tighten early, then learn that it had moved too soon. This could damage an already weak recovery, causing hundreds of billions if not trillions of dollars in economic damage, leaving hundreds of thousands if not millions of additional workers without jobs and inflicting long-term damage as more and more of the unemployed are perceived as unemployable. The point is that while there is legitimate uncertainty about what the Fed should be doing, the costs of being too harsh vastly exceed the costs of being too lenient. To err is human; to err on the side of growth is wise. ... So my message is, don’t do it. Don’t taper, don’t tighten, until you can see the whites of inflation’s eyes. Give jobs a chance.

Fed Watch: Summers Out, Yellen In?

Sun, 09/15/2013 - 11:24pm

The first of two from Tim Duy:

Summers Out, Yellen In?, by Tim Duy: Tonight Larry Summers pulled his name from consideration to replace current Federal Reserve Chairman Ben Bernanke, ending what had become a very contentious nomination process. The Obama Administration badly miscalculated the strength of the opposition to Summers, and erred further by floating his name well before they intended to nominate him for the post, providing plenty of time for his detractors to chip away at him. Markets look to be welcoming the news, certain now that current Vice Chair Janet Yellen will get the call to fill Bernanke's shoes. Whether this is true or not remains to be seen. I still believe she is the best candidate running (putting aside names like Christina Romer and Stanley Fischer), and agree with Ezra Klein when he says the President would be petty to toss Yellen aside at this point. That said, I cannot discount that possibility. I have tended to believe in the thesis that this would be a case of mutually assured destruction for both Summers and Yellen - that Administration insiders would blame Yellen's supporters for tanking their candidate. The path for Yellen's nomination would be easier had not her supporters focused on her as the sole alternative to Summers. Even smoother still had not the Administration engaged in a whispering campaign against Yellen in the first place. The Administration is going to need to sallow some pride to nominate Yellen. Let's hope they do. The market reaction stems from the belief that Summers is a hawk and Yellen is a dove. While I understand that this is a widely held belief, I think it is insulting to both candidates to paint them with such broad strokes. I think that either candidate would be hawkish or dovish as the situation required. I also think that if you believe Yellen is an unabashed dove, you are going to be surprised by her reaction if inflation rears its head in the slightest. Indeed, I think that Brad DeLong has it right here - if you are looking for a candidate of change, Yellen isn't that candidate: One very powerful technocratic reason to prefer Summers over Yellen was that he would look at the Fed's current policy dilemmas with fresh eyes, while she is strongly invested in the belief that the policies that have produced the current outcome--1.2%/year inflation, 7.3% unemployment rate, 58.6% civilian employment-to-population ratio--are the best the Federal Reserve can do. Remember that Yellen was part of the team that cemented the Fed's inflation target in place at 2%. She has a long history of supporting inflation targets. To truly enact a regime change at the Fed, you need to find a Chair that will challenge that target and rewrite the rules. I am not sure Yellen is that person. But at the same time I also agree with Brad: That said, the other candidates on the short list are even less inclined to adopt the policies the U.S. economy needs right now. And there are powerful non-technocratic reasons--breaking glass ceilings, not making every decision a kick in the face directed at the left wing of your coalition--for choosing Yellen as well. She is the best candidate on the short list. I just think it is premature to claim that she would pursue a decidedly more dovish policy than Summers. For a more concrete example, where does Yellen sit on the tapering debate? He haven't heard from her since a speech on regulation on June 2, before Bernanke's tapering conference. But we do know her definition of "substantial" improvement in the labor market from a March 4 speech. She lays on five indicators, four from the labor market:

and general spending and growth in the economy. To be sure, she noted that unemployment and job growth were the most important. Still, if you were following these indicators, I think it is reasonable to conclude that only the unemployment rate has significantly improved since March, and only then on the back of declining labor force participation rates. Yet we are walking into the FOMC meeting this week with the general belief that the beginning of the end for asset purchases is on the table. Moreover, regardless of the outcome, the damage is done as the FOMC has clearly moved in a more hawkish direction:

Where was Yellen in all of this? Shouldn't her supposedly dovish voice have been pushing back against this hawkish turn of events? Or is she part of the status quo, largely in agreement or just not sufficiently motivated to push back? None of this is meant to challenge Yellen or her worthiness for the position, but only to challenge the assumption that she will pursue a more dovish policy that Summers. If the case against Summers was that he was not 100% committed to quantitative easing, you really need to take that into context of an current FOMC that is not 100% committed, and indeed has laid out an explicit plan to end the program without Summers on board. Bottom Line: Summers is out. Is Janet Yellen in? She should be, but we have already made the mistake once of believing she is the front-runner. Initial market reaction will be positive based on the belief that she can be caricatured as a dove. I don't think this will necessarily be so evident a year from now.

Fed Watch: FOMC Week

Sun, 09/15/2013 - 11:15pm

Here's the second from Tim Duy:

FOMC Week, by Tim Duy: You can almost smell the excitement in the air - this week we have a two-day FOMC meeting to look forward to, culminating on September 19 with not only the policy statement, but also a press conference by Federal Reserve Chairman Ben Bernanke. Does it really get any better than this? It does, because odds are that the FOMC moves forward with its plan to end asset purchases with a small, very small, reduction in the pace of asset purchases of $10-15 billion. I anticipate the cut to focus on Treasuries as the Fed will not want to risk further aggravating the mortgage market. I also anticipate a fairly dovish statement - and subsequent press conference - to make clear that an end to asset purchases does not necessarily imply an earlier beginning to rate hikes. In short the Fed will likely be taking its first step toward normalizing policy this week. At this point, the tapering question has been debated to death. On one side is the question of whether or not the evolution of the economy since Bernanke's June press conference is "broadly consistent" with the FOMC's forecasts. The drop in the unemployment rate and the upward revision in 2Q GDP both point in that direction, as does the recent inflation uptick:

To be sure, the counterargument is that even if GDP is growing faster than originally thought, it is by no means growing at a gang-buster pace, or anything likely to close the output gap in any reasonable amount of time:

(Potential GDP is the CBO estimate adjusted upward by percentage difference between the pre- and post- July 2013 GDP revisions for 2011.
Use with caution; expect additional CBO updates.)

And, although unemployment is falling, it still remains well above even short-run estimates of NAIRU:

Moreover, it remain too early to say inflation is definitely moving toward 2%:

and the Evan's rule gives us some upside leeway on that number anyway. All true, but it is likely that the FOMC will interpret these arguments as reasons to begin with a small reduction in asset purchases rather than delay the taper all together. Primarily, I believe the FOMC is increasingly biased against asset purchases in favor of forward guidance. They view asset purchases as most effective during periods of financial crisis, and less so in a more normal environment. They view their goal of achieving "stronger and sustainable" growth in labor markets as largely met given that private sector job growth did not collapse in the wake of the fiscal contraction. Moreover, I believe they are concerned about the possibility of financial market dislocations from additional asset purchases. The rapid jump in interest rates after Bernanke's press conference will be seen internally as support for those concerns. There is also the additional concern that Treasury purchases are sucking up the supply of much needed safe assets/collateral from the private sector (see here Matthew Klein and Cardiff Carcia). I don't think you would ever get the Fed to admit the latter publicly as it is essentially saying that monetary policy dramatically loses its effectiveness at the zero bound in the absence of the cooperation of the fiscal authorities who issue those safe assets. That said, Bernanke has implicitly said as much when he has admonished Congress for excessive fiscal austerity. On top of all of this, I suspect the FOMC may be moving toward an epiphany on the labor force participation rate, specifically that much of the decline is structural. See Gavyn Davies here on his changing thoughts, and review the debate in this speech by San Francisco Federal Reserve President John Williams. Honestly, I am not surprised - some worried years ago that in a protracted period of weak growth, cyclical unemployment could become structural. And the Great Recession probably accelerated the demographic changes in the labor market that were already occuring, and may have permanently damaged the outlook for younger workers as well. All doom and gloom, to be sure. The further the Fed moves in this direction, the more they will think that estimates of potential GDP are still too high and that their unemployment rate forecasts are too pessimistic. The latter creates an interesting problem for the FOMC regarding its likely dovish statement emphasizing forward guidance. That forward guidance is based on the unemployment rate, and it is difficult to see how the forecast for the unemployment rate becomes more optimistic while at the same time holding rate expectations at least constant. A solution would be to lower the unemployment threshhold to 6% from the current 6.5%, although this seems like a pretty big step and as such I am hesitant to embrace it as a primary scenario for this meeting. Instead, expect the statement and press conference to more strongly reiterate the uncertainty about the labor force participation rate, note that even if inflation is now moving in the right direction it still remains below 2%, and highlight the 50bp room above the 2% inflation target that already exists within the current forward guidance. That said, you see the obvious risk here - that over the course of the next six months, more evidence emerges to support the case that the unemployment rate remains the single best indicator of labor market tightness and that the decline in the labor force participation rate is largely structural. In such a world, the Fed could easily find itself raising interest rates soon than their own forward guidance would suggest. Other possible outcomes include the Fed does exactly nothing, or that they move forward than a bigger than expected cut to asset purchases. The argument for the former can be found above. The latter could be justified if the Fed has already largely embraced the structural story for the decline in the labor force participation rate. Moreover, there is an interesting issue regarding date- or data-based policy. In his press conference, Bernanke said they expected the unemployment rate to hit 7% by the middle of next year, and that would be an appropriate time to wrap up asset purchases. But it is reasonable to believe that the unemployment rate hits 7% by November (employment report issued in December) of this year - so if the Fed maintains a gradual pace of asset purchases, was Bernanke's guidance really data-based or was it date-based? Indeed, given the 7% trigger than Bernanke put up in June, how could they not begin asset purchases now? It leads one to wonder if the Fed understands enough about its own communications to effectively implement a forward guidance strategy. Bottom Line: This week most likely marks the beginning of the end for asset purchases.

'The Peak in World Oil Production is Yet to Come'

Sun, 09/15/2013 - 2:12pm

Jim Hamilton:

The peak in world oil production is yet to come: World oil production stagnated between 2005 and 2007, which given rapid growth in demand from emerging economies sent oil prices shooting up. Some observers suggested that production might never rise much above the levels seen in 2005. Among those who raised this possibility, two of the more thoughtful have changed their mind. Euan Mearns last month summarized what he saw as three (or four) nails in the coffin of peak oil. And Stuart Staniford, an early editor and contributor for the Oil Drum, declared a few weeks ago that the data have spoken. ...

He ends with:

Those who thought that world oil production would peak in 2005 have been proven to be wrong. But so, too, were those who thought the run-up in oil prices of the last decade would be a temporary disruption until we found a way to return to the world as it had been for a century up until that point.

Summers has Withdrawn

Sun, 09/15/2013 - 1:56pm

From Brad DeLong:

Let Me Just Say That Janet Yellen Is Now Clearly By Far the Best Technocratic Choice for Fed Chair of Those on the Short List:

BREAKING, via @WSJ: Lawrence Summers has withdrawn his name for the job of Federal Reserve chairman

— felix salmon (@felixsalmon) September 15, 2013

'The Greatest Accomplishment of our Time'

Sun, 09/15/2013 - 9:55am

Digby on Obama's Very Serious intent to cut the deficit:

The greatest accomplishment of our time, by digby: Let's party like it's 2011:

PRESIDENT BARACK OBAMA: ... my orientation here is real simple. I wanna make sure that we’ve got an economy in which Main Street’s winning. And what that requires is that we’re investing in education, early childhood, that we’re investing in transportation, that we’re investing in the things that we need to grow. If we’re gonna re– if we’re gonna continue to reduce the deficit, and I think a lot of people aren’t aware of the fact that the deficit’s been cut in half since I came into office, it’s continuing on a trend line of further reductions.

If we wanna do more deficit reduction, I’ve already– put out a budget that says, “Let’s do it.” I’m willing to reform entitlements. I’m willing to– you know, cut out additional waste that may be there. And I’m spending time, even without pressure from Congress, trying to figure out how we can cut out waste in the system.

But– I– what I also think we should be doing is eliminating– corporate tax breaks that nobody can defend– but keep on– reappearing each year in the budget. If we are serious about it, there’s no reason– that we can’t do it...

... If he can get them to take him up on his repeated offer to cut even more and especially the vital social security programs (when they actually need to be raised), he will have fulfilled his Grand Bargain agenda. He certainly seems prepared to grant that deficit reduction remains extremely important and bringing it down is one of his proudest a accomplishments. He can't wait to do more of it.

I suppose that's partly a negotiating stance but it's hard to see how any of his yammering over the past five years about the need to cut "entitlements" has bought him any political good will. In fact, this obsession with the deficit has now stuck us with sequestration which is slashing the very areas in which he insists we must invest. Kids are losing their food stamps and Head Start, the elderly are losing Meals on Wheels. There's no money for infrastructure.

But apparently we ain't done yet. According to the president we need to cut even more. So you have to assume he believes in it on the merits.

'Ronald Coase, a Pragmatic Voice for Government’s Role'

Sat, 09/14/2013 - 1:18pm

Robert Frank:

Ronald Coase, a Pragmatic Voice for Government’s Role, by Robert Frank, Commentary, NY Times: ... Nobel Memorial Prize in Economic Science [winner] ... Ronald H. Coase ... spent most of his career at the University of Chicago, where he was revered by its many free-market enthusiasts as the world’s foremost authority on ... negative externalities... He became their champion because they thought his framework provided the most cogent arguments for limiting government’s role in economic life. That belief was profoundly mistaken. In time, I predict, Mr. Coase’s framework will instead be seen as providing not only the best explanation for why governments regulate..., but also the best advice on how they might regulate more effectively. ... Mr. Coase’s work cannot be read as a case for minimal government. On the contrary, his message was more purely pragmatic: Because we can’t negotiate efficient private solutions most of the time, we must ask whether laws and other institutions can help steer us toward solutions we would have chosen if negotiation had been practical. ... Because population density has been rising, behaviors with harmful side effects have been growing steadily more important. Our continued prosperity ... will require thinking clearly about how to mitigate the resulting damage. Mr. Coase has pointed the way forward.

Stiglitz: We Created This Inequality

Sat, 09/14/2013 - 7:40am

Joe Stiglitz:

The People Who Break the Rules Have Raked in Huge Profits and Wealth and It's Sickening Our Politics, by Joe Stiglitz, Alternet [Video]: The following is taken from a transcript of Joseph Stiglitz's remarks to the AFL-CIO convention in Los Angeles on September 8. ... For too long, the hardworking and rule-abiding had seen their paychecks shrink or stay the same, while the rule-breakers raked in huge profits and wealth. It made our economy sick, and our politics sick, too. ... We have become the advanced country with the highest level of inequality... We use to pride ourselves--we were the country in which everyone was middle class. Now that middle class is shrinking and suffering. The central message ... is that ... inequality is not inevitable. ... It is not the result of the laws of nature or the laws of economics. Rather, it is something that we create, by our policies, by what we do. We created this inequality—chose it, really—with laws that weakened unions, that eroded our minimum wage to the lowest level, in real terms, since the 1950s, with laws that allowed CEO's to take a bigger slice of the corporate pie, bankruptcy laws that put Wall Street’s toxic innovations ahead of workers. We made it nearly impossible for student debt to be forgiven. We underinvested in education. We taxed gamblers in the stock market at lower rates than workers, and encouraged investment overseas rather than at home. ... It is plain that the only true and sustainable prosperity is shared prosperity..., an economy in which 95% of the growth goes to the top 1% can only be called that: sick. ... A hundred and sixty five years ago, Lincoln said, "A house divided against itself cannot stand. " We have become a house divided against itself – divided between the 99% and the 1%, between the workers, and those who would exploit them. We have to reunite the house, but it won't happen on its own. It will only happen if workers come together. If they organize. If they unite to fight for what they know is right, , in each and every workplace, in each and every community, and in each and every state capital and in Washington. We have to restore not only democracy to Washington, but to the workplace. ... The challenge facing you has seldom been greater. You are still a small fraction of America. But you are the largest group representing the vast majority of Americans who work hard and play by the rules. . You must get others to join you, to work with you, to organize with you, to fight with you. ... Together, we can grow our economy, strengthen our communities, restore the American dream, and re-establish our democracy--a government not of the 1%, for the 1%, and by the 1%, but a government of all Americans, for all Americans, and by all Americans.

I am doubtful that traditional unions can be an effective economic voice (through collective bargaining) given the threat of moving work to other states or countries, but I do think unions have an important role to play in representing workers in the political process -- unions can give workers a countervailing political voice. So I'm curious what you think about this idea:

... In contemporary America,... there is a nearly insurmountable impediment to unions’ ability to serve as a collective political voice for workers. It stems from the legal requirement that unions bundle political organization with collective bargaining, which means that in order to take advantage of the union as a form of political organization, workers must organize economically for collective bargaining purposes. This bundling of functions, an artifact of how unions formed historically, is a major problem for political organizing today. This is true most obviously because managerial opposition to collective bargaining has become pervasive. It is also true because changes in markets have made the practice of collective bargaining difficult. ... All of this has contributed to a dramatic decrease in unionization rates, which has in turn played a central role in the declining responsiveness of government. But what if we unbundle the union and allow workers to organize politically without also organizing for collective bargaining? If we shift our aim away from reviving collective bargaining and toward enabling political organizing by underrepresented groups, we would allow workers to organize “political unions” even when they don’t want to organize collective bargaining ones. It’s more straightforward than it sounds. The key is that we would make the workplace available as a site for political organization. While the law would continue to protect workers’ right to organize traditional unions, it would also protect workers’ right to organize strictly political ones. ... Employers would be prohibited from retaliating against their employees who organized politically, and if the workers did form a political union, they would be entitled — as traditional unions are — to use voluntary payroll deductions to finance their activities. But these political unions would be prohibited from collective bargaining, and no worker would ever be required to pay dues to a political union — or to be represented by one — unless she chose to be.

'Job Reallocation over Time'

Fri, 09/13/2013 - 12:43pm

Via Mark Curtis at macroblog:

Job Reallocation over Time: Decomposing the Decline: One of the primary ways an economy expands is by quickly reallocating resources to the places where they are most productive. If new and productive firms are able to quickly grow and unproductive firms can quickly shrink, then the economy as a whole will experience faster growth and the many benefits (such as lower unemployment and higher wages) that are associated with that growth. Certain individuals may experience unemployment spells from this reallocation, but economists, starting with Joseph Schumpeter, have found that reallocation is associated with economic growth and wage growth, particularly for young workers. Recently, a number of prominent economists such as John Haltiwanger have expressed concern that falling reallocation rates in the United States are a major contributor to the slow economic recovery. ...

After sorting through te evidence, the conclusion is:

... The economy is reallocating jobs at much slower rates than 20 or even 10 years ago, and this decline is, with only a few exceptions, common across states and industries. Economists are just now starting to explore the causes of this trend, and a single, compelling explanation has yet to emerge. But some explanation is clearly in order and clearly important for economic policymakers, monetary and otherwise.

The Debt Ceiling Once Again

Fri, 09/13/2013 - 10:56am

As we head for yet another political clash over government debt, one where Republicans are threatening a government shutdown and the health of the financial sector in an attempt to defund social insurance programs -- Obama care in particular -- a few things to keep in mind.

First, the long-run debt crisis is, and always was, primarily about health care costs.

Second, and importantly, it is a problem "driven in large part by increasing costs in the private-sector delivery of health care goods and services." That is, it is not a problem that is caused by the government or unique to government sponsored health care programs.

Third, the evidence suggests that Obamacare is reducing health care costs.

Fourth, the social safety net -- the very thing Republicans want to scale back substantially or eliminate -- played a key role in limiting the severity of the recession. Without these automatic stabilizers, things would have been even worse than they were.

Paul Krugman: Rich Man’s Recovery

Thu, 09/12/2013 - 11:24pm

Inequality is harmful:

Rich Man’s Recovery, by Paul Krugman, Commentary, NY Times: A few days ago, The Times published a report on a society that is being undermined by extreme inequality. This society claims to reward the best and brightest... In practice, however, the children of the wealthy benefit from opportunities and connections unavailable to children of the middle and working classes. And ... the gap between the society’s meritocratic ideology and its increasingly oligarchic reality is having a deeply demoralizing effect. The report illustrated in a nutshell why extreme inequality is destructive, why claims ring hollow that inequality of outcomes doesn’t matter as long as there is equality of opportunity. If the rich ... live in a different social and material universe, that fact in itself makes nonsense of any notion of equal opportunity. By the way, which society are we talking about? The answer is: the Harvard Business School — an elite institution, but one that is now characterized by a sharp internal division between ordinary students and a sub-elite of students from wealthy families. The point, of course, is that as the business school goes, so goes America, only even more so — a point driven home by the latest data on taxpayer incomes..., 95 percent of the gains from economic recovery since 2009 have gone to the famous 1 percent. ... Basically, while the great majority of Americans are still living in a depressed economy, the rich have recovered just about all their losses and are powering ahead. ... What’s driving these huge income gains at the top? There’s intense debate on that point,..., however, whatever is causing the growing concentration of income at the top, the effect of that concentration is to undermine all the values that define America. Year by year, we’re diverging from our ideals. Inherited privilege is crowding out equality of opportunity; the power of money is crowding out effective democracy. So what can be done? For the moment, the kind of transformation that took place under the New Deal — a transformation that created a middle-class society, not just through government programs, but by greatly increasing workers’ bargaining power — seems politically out of reach. But that doesn’t mean we should give up on smaller steps, initiatives that do at least a bit to level the playing field..., for example,... universal prekindergarten education, paid for with a small tax surcharge on those with incomes over $500,000. ... For extreme inequality is still on the rise — and it’s poisoning our society.

'Remembering Ronald Coase’s Contributions'

Thu, 09/12/2013 - 11:15am

In his post Remembering Ronald Coase’s Contributions, Robert Stavins notes a big surprise, the Wall Street Journal's editorial page being less than forthright (he is summarizing a statement in "an effective essay" by Severin Borenstein on "the effect that Coase’s thinking had decades ago on his own intellectual development"):

the Wall Street Journal in its ... tribute to Coase ... twisted the implications of his work to fit the Journal’s view of the world

Stavins goes on to discuss "The Coase Theorem and the Independence Property":

... In our article, “The Effect of Allowance Allocations on Cap-and-Trade System Performance,” Hahn and I took as our starting point a well-known result from Coase’s work, namely, that bilateral negotiation between the generator and the recipient of an externality will lead to the same efficient outcome regardless of the initial assignment of property rights, in the absence of transaction costs, income effects, and third party impacts. This result, or a variation of it, has come to be known as the Coase Theorem. We focused on an idea that is closely related to the Coase theorem, namely, that the market equilibrium in a cap-and-trade system will be cost-effective and independent of the initial allocation of tradable rights (typically referred to as permits or allowances). That is, the overall cost of achieving a given emission reduction will be minimized, and the final allocation of permits will be independent of the initial allocation, under certain conditions (conditional upon the permits being allocated freely, i.e., not auctioned). We called this the independence property. It is closely related to a core principle of general equilibrium theory (Arrow and Debreu 1954), namely, that when markets are complete, outcomes remain efficient even after lump-sum transfers among agents. The Practical Political Importance of the Independence Property ...The reason why this property is of such great relevance to ... public policy is that it allows equity and efficiency concerns to be separated. In particular, a government can set an overall cap of pollutant emissions (a pollution reduction goal) and leave it up to a legislature to construct a constituency in support of the program by allocating shares of the allowances to various interests, such as sectors and geographic regions, without affecting either the environmental performance of the system or its aggregate social costs. Indeed, this property is a key reason why cap-and-trade systems have been employed and have evolved as the preferred instrument in a variety of environmental policy settings. ...Does the Property Always Hold? ...Hahn and I ... carried out an empirical assessment of the independence property in past and current cap-and-trade systems... I hope some of may find time to read our article, but a quick summary of our assessment is that we found modest support for the independence property in the seven cases we examined (but also recognized that it would surely be useful to have more empirical research in this realm). Political Judgments That the independence property appears to be broadly validated provides support for the efficacy of past political judgments regarding constituency building through legislatures’ allowance allocations in cap-and-trade systems. Governments have repeatedly set the overall emissions cap and then left it up to the political process to allocate the available number of allowances among sources to build support for an initiative without reducing the system’s environmental performance or driving up its cost. This success with environmental cap-and-trade systems should be contrasted with many other public policy proposals for which the normal course of events is that the political bargaining that is necessary to develop support reduces the effectiveness of the policy or drives up its overall cost. So, the independence property of well-designed and implemented cap-and-trade systems is hardly something to be taken for granted. It is of real political importance and remarkable social value. It is just one of many lasting contributions of Ronald Coase.

New Research in Economics: Rational Bubbles

Thu, 09/12/2013 - 9:37am

New research on rational bubbles from George Waters:

Dear Mark,

I’d like to take you up on your offer to publicize research. I’ve spent a good chunk of my time (along with Bill Parke) over the last decade developing an asset price model with heterogeneous expectations, where agents are allowed to adopt a forecast based on a rational bubble.

The idea of a rational bubble has been around for quite a while, but there has been little effort to explain how investors would coordinate on such a forecast when there is a perfectly good alternative forecast based on fundamentals. In our model agents are not assumed to use either forecast but are allowed to switch between forecasting strategies based on past performance, according to an evolutionary game theory dynamic.

The primary theoretical point is to provide conditions where agents coordinate on the fundamental forecast in accordance with the strong version of the efficient markets hypothesis. However, it is quite possible that agents do not always coordinate on the fundamental forecast, and there are periods of time when a significant fraction of agents adopt a bubble forecast. There are obvious implications about assuming a unique rational expectation.

A more practical goal is to model the endogenous formation and collapse of bubbles. Bubbles form when there is a fortuitous correlation between some extraneous information and the fundamentals, and agents are sufficiently aggressive about switching to better performing strategies. Bubbles always collapse due to the presence of a small fraction of agents who do not abandon fundamentals, and the presence of a reflective forecast, a weighted average of the other two forecasts, that is the rational forecast in the presence of heterogeneity.

There are strong empirical implications. The asset price is not forecastable, so the weak version of the efficient markets hypothesis is satisfied. Simulated data from the model shows excess persistence and variance in the asset price and ARCH effects and long memory in the returns.

There is much more work to be done to connect the approach to the literature on the empirical detection of bubbles, and to develop models with dynamic switching between heterogeneous strategies in more sophisticated macro models.

A theoretical examination of the model is forthcoming in Macroeconomic Dynamics.

A more user friendly exposition of the model and the empirical implications is here.

An older published paper (Journal of Economic Dynamics and Control 31(7)) focuses on ARCH effects and long memory.

Dr. George Waters
Associate Professor of Economics
Illinois State University
http://www.econ.ilstu.edu/gawater/

The Rising Yuan

Wed, 09/11/2013 - 11:24pm

The yuan has made "rapid progress" as an invoicing currency:

CNY on the Rise, by Menzie Chinn: The preliminary results from the BIS triennial survey for 2013 are out. There are a lot of interesting results, but one I want to flag is that the Chinese yuan is increasingly used in forex transactions. ... The Chinese government has been quite aggressive in increasing the use of the Chinese currency, as noted in this post. The yuan is far from becoming a reserve currency [1] [2], but there are other dimensions of an international currency that the CNY could fulfill. One of these is use as an invoicing currency, and here, the CNY has made rapid progress. In a study conducted by myself and Hiro Ito (revision soon to be put online), we document the rise in CNY invoicing for Chinese exports and imports, and compare against JPY invoicing for Japanese exports and imports. ... In the study, we employ a panel time series analysis to predict invoicing, and conclude that 2010 levels of CNY invoicing of exports are below model-predicted levels, suggesting further increases in home currency invoicing are plausible.

[There are graphs showing the change over time in the original post.]