Blogging on macro readings

A lot of bad things have been said about economics lately.  It can be argued — with plenty of evidence to support the argument — that a large portion of economic theory as it exists is an ideological rationalization of the interest of capital, a rationalization that disguises itself behind the veil of mathematical modeling.  As of late, Paul Krugman has argued that economists have been led astray by their mistaking mathematical beauty for truth.

I’m not going to disagree with this.  But, where I come from, you don’t make such a sweeping generalization about a body of ideas as complex as modern economic theory without a prior, critical digestion — both logical and factual — of the material.  Since in any case, due to my work, I need to read and re-read textbooks and articles on economic theory, I plan to — time and other obligations permitting — use this blog to publish my raw thoughts on stuff I read.

I’m going to start with a few chapters from Maurice Obstfeld and Kenneth Rogoff’s (1998) Foundations of International Macroeconomics, Cambridge: MIT Press.  This textbook continues to be used in second-year macroeconomics courses at  many doctoral programs.  From me, readers should expect something rather choppy and idiosyncratic.  Nothing systematic.

Neither should readers expect any judgment about the overall value or validity of the material in this book.  If at all, that judgment will follow my grappling with most of its chapters.

I can only engage with the material I read by reference to my own personal, intellectual trajectory.  Thus, a lot of my musings will result from — as David Harvey puts it — “rubbing” my understanding of Karl Marx’s theoretical work, which I hold in high regard, with the material I read.

Some logistics: I will need to type some math here.  For that,  I will use LaTeX.  Readers wishing to follow the math will have to use some online compiler to convert my script into something viewable.

Here’s a “Hello World!” script that people may use to test their ability to compile LaTeX files online.  Highlight it, copy it, and paste it inside of the white box of the online compiler (click on the English flag to view the page in English).  (In script that contains equations, the blank lines in between must be removed.)  After compiling it, scroll down, and request to view the output as a pdf file.

\documentclass[12pt]{article}

\usepackage{fullpage}

\textheight=9.0in

\setlength{\tabcolsep}{0in}

\begin{document} Hello World!

\end{document}

Again, on my plan

About a year ago, I sketched a plan to get the banks back into health.  Its principle was simple:  Instead of handing out massive amounts of cash to the banks with tons of toxic assets clogging their balance sheets, in the hope that that they restart lending, hand the money directly to the so-called “subprime” borrowers so that they continue to service their mortgages.   At the time, it sounded utopian, even silly — because the political clout to push for it, let alone to force its implementation was non-existent.  Even now, the political force that is required to place this plan in the agenda is still in its embryonic stages, but I believe it is gradually building up.

In this post (in my otherwise neglected blog), I just want to report that — aside from Joseph Stiglitz — there’s another reputed economist just coming around to my approach: Steve Keen.   The neat thing is that, unlike me, who only enunciated a principle and sketched the idea, Keen has taken the trouble to model and calibrate carefully the effects of the alternative plan.

And, in regards to the build up of the political force referred above, I will refer you to Arianna Huffington’s review of Michael Moore’s new movie, Capitalism: A Love Story.

[Image borrowed from The Black Commentator: http://www.blackcommentator.com.]

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Making Obama do it

Arthur Schlesinger, Jr. tells the story of FDR approached by people who wanted the U.S. to increase its involvement in confronting Hitler in Europe.  FDR replied to them:

“I agree with you, I want to do it, now make me do it.”

This is how the president tacitly assigned to them the task of bringing their case directly to the U.S. people, at the time hesitant about taking a bigger part in the European conflict.  If the national attitude towards the conflict shifted, FDR would “follow” suit.

If we check our hopes and illusions at the door, it is far from clear at this point the extent to which Obama is truly committed to promoting a progressive agenda in the U.S. and the globe.  The opportunity is definitely there.  But, consider — for example — his choice of economic cabinet.   The people he’s recruited are, to put it mildly, not known as strong reformers.  In the management of the economy, people like Austan Goolsbee, Tim Geithner, Larry Summers, and — in the background — Robert Rubin, people who have advocated the type of policies associated with the lead to the current economic disaster, have been tapped and are actively shaping up Obama’s economic plan.

Others, like Joseph Stiglitz, Paul Krugman, James Galbraith, and Dean Baker, have been largely ignored, in spite of the fact that they were critical of the policy climate that led to the current crisis, and that they have been forceful advocating measures to fight the crisis that place the broader public interest, the interest of working- and middle-class people, at the center of these policies.

In today’s New York Times, Paul Krugman continues to speak his mind about the timidity of Obama’s plans, in stark contrast with the urgency of his words.  Basic arithmetic indicates that, in the current conditions, a less than 1 trillion dollar “stimulus” is insufficient to move a 15-trillion dollar economy and tax cuts (especially tax cuts for large businesses) are largely wasted resources, because their “bang for the buck” is significantly smaller than that of a dollar directly spent.  (Apparently, even strongly pro-establishment Democrats of the Nancy Pelosi type oppose Obama’s intention of not phasing out the tax cuts for the rich that W. Bush passed!)  Yes, there’s uncertainty, but — precisely — the nature of economic uncertainty during a crisis is such that timidity in the response is the greater evil.

The excuse, as Krugman suggests, seems to be political.  Like Krugman, I’m deeply skeptical of Obama’s alleged approach.  It seems, for what we know, that Obama wants to have a large majority behind his actions, including a solid support in Congress, which requires compromising with staunch Republicans.  By temperament — the press has been telling us — Obama prefers a pragmatic focus on solutions, rather than political confrontation.

That is fine as long as the interest of the majority of working- Americans is truly the top priority.  As a tactical stance at this point, there’s nothing wrong in principle with opening the tent to more people.  But, if history is any guide, the special interests that oppose the economic security of working Americans, the reform of our disfunctional health care system, the reform of our foreign policy, etc. won’t be pacified with friendly gestures.

If Obama begins to compromise to them, always at our expense, they will only confirm that stiffening their opposition works.  Just like in economics, tax incidence is avoided by those more willing to walk away from a market deal, and falls on those forced to take it; in politics, the stubborn prevails and the compromising paints himself into a corner.  This is not an argument in favor of partisanship for partisanship’s sake.  It’s an argument in favor of partisanship to advance the public interest.

Ultimately, it is not an ideological disagreement, but the clash of their vested interests against the needs and interests of the majority of Americans which makes the right wingers so stubborn that only the effective derailment of the popular effort that gave Obama his victory, can pacify them.

Obama has said that he’ll listen to the people.  During his campaign, he emphasized that his election was not about him, but about us, rank-and-file Americans.  We need to test his claim continuously, from the get-go.  Let’s press on.  After all, we’re fired up and ready to go.  So, let’s bring the discussion to our relatives, friends, neighbors, coworkers, and everybody willing to engage in a conversation with us.  Let’s use all means at hand to impress upon the new administration that we’re stubborn in demanding satisfaction to our needs as working- and middle-class Americans.

Let’s make him do it!

[UPDATE 1/10/2009: Christina Romer and Jared Bernstein, from Obama's economic team, have estimated the impact of Obama's plan (AARP) on employment.  Since they admit that the impact of the plan as presented is rather underwhelming, they seem to be asking us to make them do more.]

[UPDATE 1/13/2009: John Nichols, a The Nation correspondent, has followed Obama closely.  Here's his view on how to push him to the left: http://www.commondreams.org/view/2009/01/12-9]

Minneapolis vs. Boston

In an October 2008 paper, V.V. Chari, Lawrence Christiano, and Patrick J. Kehoe (Fed Minneapolis, CCK) found no evidence of a crunch affecting interbank credit or borrowing by Main Street.  They argue that Main Street’s cost of borrowing is not as high as a quick look at spreads would suggest; that we should look at the levels instead.

In a November 2008 paper, Ethan Cohen-Cole, Burcu Duygan-Bump, Jose Fillat, and Judit Montoriol-Garriga (Fed Boston, CDFM) replied in detail to the arguments in the CCK paper and concluded that Main Street is indeed being hit by a credit crunch.  I am just starting to read the latter, but I didn’t find the CCK view convincing to begin with.  I’ll say why below.

My sixth sense tells me that the political implications of what CCK are arguing are relevant.  What they are really suggesting with their paper is that large public efforts to get the economy moving are not called for, especially those directed to support employment.  It’s the old let-the-markets-sort-things-out shibboleth.

From my standpoint, the main issue is the net (dynamic) distributional effect of the measures taken and to be taken (by the new administration) with the alleged aim of shoring up the financial and non-financial sectors of the economy.   Among the different possible ways in which the financial sector can be rescued, I believe that, on equity as well as on efficiency grounds, it can be argued that the best approach is the direct relief to working- and middle-class borrowers via methods that put the public interest first at the expense of the captains of finance that drove us into the ditch.

I’ll just say, to be more specific, that I favor the outright nationalization of, at least, the weakest banks, followed by the re-negotiation and direct extension of new loans to lower income individuals and small businesses by the nationalized banks.  With Fannie and Freedie re-nationalized, the mortgage market can be fixed and revived provided the political will is there.

Following Michael Moore, I also favor a similar type of nationalization of troubled industries, like car making, and the realignment of priorities  of those companies to serve the public interest, particularly in the areas of environmental sustainability and workers’ interests.

Having said that about the politics of the issue, I now return to the empirical debate mentioned above.

In the CCK paper, I find one argument utterly unconvincing, namely that spreads (the difference between the interest rates at which banks, business, or people borrow and the baseline interest rates, those of assets deemed relatively risk-free by the markets, like the federal funds rate or LIBOR) are not informative of the existence of a credit crunch.

It seems to me that  the exact opposite is true. I expect all rate levels to be dragged down to some extent by the monetary policy reactions to the crisis: lower federal funds rate and discount (the latter being the rate at which U.S. banks can borrow from the Fed). The issue is how the risk, term, liquidity, and information structures of the interest rate react to monetary policy moves.  And, at that, the spreads tell the story.  And spreads for the credit instruments available on Main Street have gone through the roof.  The flight to quality (i.e. the flight to Treasuries) is the credit crunch!

A credit crunch doesn’t mean that liquid wealth (money) won’t find any parking spot at all.  It simply means that all regular parking spots are suddenly deemed unbearable by lenders and that the hurdle rates at those spots vis-a-vis the seemingly riskless rate increase accordingly.  Parked in Treasuries, wealth will earn the baseline interest as small as it may be now.   So, it’ll be like cash (not entirely, because it’s not fully liquid, but almost), except that it will earn some token interest.

On the other hand, loaning wealth to yours truly would be an act of unbelievable foolishness.  Evidence of the credit crunch is not that the overall rate at which I’d be borrowing now is relatively low (assuming that the market where I can borrow exists, a rather heroic assumption nowadays), but the difference between what I’d have to pay in interest and what the federal government does pay in interest.

In any case, if the tons of base money (the additional reserves the Fed loans to banks via discount window or that end up in the banks whenever the Fed buys Treasuries in the open market) that the Fed has been injecting into the banking system as of late had already translated into streams of credit to average Joes like me, then we’d be observing them in the data on deposits or measures of the money stock (M1 or M2).  Here, I only see a minuscule jump in deposits, M1 and M2 in September and October.

http://www.federalreserve.gov/releases/h8/current/

http://www.federalreserve.gov/releases/h6/Current/

On the other hand,  take a look at what happened to bank reserves:

http://www.federalreserve.gov/releases/h3/Current/

In words, in September and October 2008, bank reserves went straight up.  More specifically, they more than doubled and more than tripled, respectively.  On the other hand, total deposits and M measures in the same periods only experienced a tiny increase.  Up to the latest data point available, reserves have been building up much faster than total deposits or Ms have gone up.   That does it for me.

I understand that businesses have other ways to raise cash than issuing commercial paper or knocking on a banks’ door.  But these aggregate data show clearly, to my lights, that banks have not been lending at anything near the pace at which they have expanded their reserves.  Have other forms of cash raising picked up the slack left by debt?  The state of the stock markets in the last few months doesn’t suggest that.  So, chances are, Main Street businesses are under strife while banks have frozen lots of new credit lines, and recalled old ones, as fast as they have been able to, and now sit on a bunch of idle base money.

How can this be?  Don’t banks lose the “risk-free” federal funds rate by holding reserves beyond what they are required to hold, since reserves are just electronic credits recorded on the Fed banks?  Well, a zero interest rate still beats the negative returns that banks fear if they were to loosen their purse.

To translate into new deposits (money in the economy), the base money injected by the Fed needs to be loaned, thus expanding total deposits and the Ms via the multiplier mechanism. It didn’t happen. It’s not happening.  The money multiplier has dropped.  And since credit is the lifeblood of the “real” economy nowadays, this situation must be having “real” effects as documented by the press on real time.

Conclusion: There was, back in the fall of 2008, and — although it’s eased a bit since the fall — there continues to be a credit crunch.