Dodd-Frank Under Fire

Over the weekend, Bloomberg reported:

As he prepared to sign orders designed to roll back bank regulations enacted to stop the next financial crisis, President Donald Trump said that the rules are stifling lending.

“We expect to be cutting a lot out of Dodd-Frank, because frankly I have so many people, friends of mine, that have nice businesses and they can’t borrow money,” Trump said on Friday. “They just can’t get any money because the banks just won’t let them borrow because of the rules and regulations in Dodd-Frank."

While rolling back restrictions on the financial sector seems contrary to the Trump administration's populist veneer, it is consistent with what he said he would do during the campaign.

We can expect more misleading rhetoric about "holding" capital, like this from former Goldman Sachs president Gary Cohn, who Trump has appointed director of the National Economic Council:

“Every place a bank needs to hold capital and they need to retain capital prohibits them from lending,” Cohn said in the interview. “So we’re going to attack all aspects of Dodd-Frank.”

As the article (admirably) explains:

Banks don’t actually “hold” capital. In banking, capital refers to the funding they receive from shareholders. Every penny of it can be loaned out. A 5 percent minimum capital requirement means that 5 percent of the bank’s liabilities has to be equity, while the rest can be deposits or other borrowing. The more equity a bank has, the smaller its risk of failing when losses pile up.

On their blog, Cecchetti and Schoenholtz summarize findings that higher capital not detrimental to lending.

Its not clear that Congress will undertake a full repeal of Dodd-Frank, but there are plenty of ways it can be weakened.  Brookings' Robert Pozen outlines some of the things that may happen.  At Vox, Matthew Yglesias argues that Dodd-Frank has been successful.  This paper by Martin Baily, Aaron Klein and Justin Schardin provides a more detailed assessment of its provisions.  John Cochrane has favorable views of some of the Republican alternatives, though its far from certain that there will be action on them.

The administration is also halting the Labor Department's "fiduciary rule," which requires investment advisors to act in the interest of their clients.  Cohn's defense of this action seems rather strained:

"I don't think you protect investors by limiting choices," said Cohn, who previously was Goldman Sachs' COO.

"We think it is a bad rule. It is a bad rule for consumers," Cohn told The Wall Street Journal. "This is like putting only healthy food on the menu, because unhealthy food tastes good but you still shouldn't eat it because you might die younger."

See columns by Steve Rattner, Paul Krugman and Mike Konczal.

Overall, the administration's approach to financial regulation may have short-run benefits to the financial industry, and its not surprising that financial stocks largely drove the gains in the stock market after the election.

Looser reins and more profits on Wall Street also likely mean bigger bonuses - before the crisis, financial industry compensation had been a substantial contributor to widening income inequality, and that trend seems likely to resume.

Rolling back or watering down Dodd-Frank also will increase the likelihood of another financial crisis, which we should know all too well from recent experience can have severe negative effects on the economy as a whole - from January 2008 through December 2009, nonfarm payrolls dropped by 8.6 million before beginning an agonizingly slow recovery.

Trashing the fiduciary rule and increasing the likelihood of future financial crises will also be detrimental to Americans' efforts to save for their retirements.  While there's been a short-run boost to financial shares, overall, the risk of severe losses is increased, as is the likely proportion of savings that will be eaten up by fees.  That is, Americans will be poorer and less financially secure in their old age.

Populism, indeed.

Update (2/12): CNBC's Ylan Mui reports on efforts by Jeb Hensarling, chair of the House Financial Services Cmte., to go after the CPFB.  The NYT has an op-ed by Vanguard founder John Bogle on the fiduciary rule.  Meanwhile, at the Fed, Daniel Tarullo, who has led efforts on regulation, is stepping down from the board, causing financial stocks to jump.

Economic Implications of the Immigration Order

The most troubling aspects of President Trump's immigration executive order are the moral and national security implications (the later is outside my area of expertise, but its hard to see how betraying our friends, alienating our allies and handing an easy propaganda victory to our enemies advances the stated goal of protecting America).

The economic implications are pretty bad as well.  Although the order currently applies only to people from seven countries, the spectacle of people who've jumped through all the bureaucratic hurdles to get permission to come to the US being detained and turned away at airports by a sudden, incompetently planned and implemented policy change will no doubt deter many others from wanting to come.

In the short run, making it less attractive to come to the US will hurt our tourism and education exports.  In the longer run, it will harm our productivity by diminishing our universities, science, technology and human capital.

One of Trump's stated economic concerns is the US trade deficit, which was -$499.5 billion in 2016 (2.7% of GDP), according to the BEA's advance estimate.   While the US trade balance is negative in goods (-$770.5 billion) that is partly made up for by a $271.1 billion surplus in services.

According to the ITA, the US had 77.5 million visitors in 2015, and Colorado had 461,000.

Tourism is an important part of US service exports.  2016 figures aren't available yet, but in 2015, according to the BEA, $750.9 billion in service exports included $122.4 billion in "other personal travel" (i.e., non-business travel not related to health or education). 

The order won't only deter tourists; in addition to tourism, education services are another major US export.  According to the Institute of International Education, there were just over 1 million international students enrolled in US colleges and universities last year.  In 2015, the US exported $35.8 billion of education-related travel, which includes tuition paid by international students.

In addition to contributing to US GDP and exports, international students play a vital role in US higher education.  At the undergraduate level, an important part of the experience is learning from one's peers - the presence of international students on our campuses enhances the educational opportunities for everyone.

International graduate students play a significant role in the life of our research universities, particularly in the sciences (and economics!).  The impact of the order was felt immediately by scientists (see also this story).  According to the NSF, international students earn more than half of the doctorates granted in the US in mathematics and computer science and engineering and over one third in physical and earth sciences.

The ability to attract hard-working, talented students from around the world is a source of strength for American university research and one of the reasons US institutions dominate global rankings.  US leadership in many fields also means that many of the faculty in US institutions are immigrants and green card holders.

Technology companies have spoken out about the impact of the immigration order on their workforces, but the impact will be more widespread - according to the NSF, 21% of the US science and engineering workforce is foreign born.

If the grad students, post-docs, scientists and engineers who are so vital to our universities and industries find America a less appealing place to live and work - for example, if they have to worry that if they leave to visit relatives, they risk not being able to get back in - they have other options.  The competition for talent is global, and this hands an advantage to non-US universities and businesses.

America is great, but President Trump's order will make it less so.

Mark Blyth to the Social Democrats

Jacobin magazine has Mark Blyth's thought-provoking speech to the German Social Democrats, in which he encourages them to act like social democrats:

When you ask for the content of what structural reform means, it seems to be a checklist of lower taxes, deregulate everything in sight, privatize anything not nailed down, and hope for the best. But are these policies not disturbingly American, if not Thatcherite? Indeed, isn’t this everything that the SPD is supposed to be against, and much of which the German public would never put up with?

Interesting...

"Structural reform" means lots of different things - some good and some bad - and whether "austerity" is appropriate depends on the circumstance, so I'm wary of blanket statements about either of those concepts, but I think he is broadly correct in the context of what is going on in Europe right now. The existence of the Euro, in conjunction with ECB policy, prevents necessary monetary and exchange rate adjustments that from taking place, and misguided moralism about debt may make a political settlement impossible.  It is this last point which is his target.

Trade-Related (?)

Economic theory provides a number of useful tools for thinking about tariffs, and these tend to frame economists' instincts when it comes to discussions about "free trade agreements."  However, in many cases, tariffs are already quite low (perhaps this is a rare success for economists' powers of persuasion...) and the main ingredients of trade agreements concern other things which are trickier to analyze.

One aspect of contemporary trade agreements that is coming under scrutiny in the discussions over the Transatlantic Trade and Investment Partnership (TTIP) and the Trans-Pacific Partnership (TPP) are provisions to protect foreign investors by allowing them to take disputes with governments to arbitration.  This Vox piece by Danielle Kurtzleben is a nice summary of the debate concerning these investor-state dispute settlement (ISDS) rules.

Another issue getting considerable attention in the TPP discussions is the fact that trade agreements typically do not deal with currencies.  As the Times reported, many in Congress are pushing for incorporating a provision to deal with "currency manipulation" into the TPP.

This is a tricky issue which cuts across economics' division between international trade - which uses microeconomic theory to analyze long-run equilibria - and open-economy macroeconomics, which is concerned with monetary and balance of payments issues (which are "short-run" but can have meaningfully persistent effects).  At an institutional level, trade policy is usually the purview of trade ministers (e.g., the US Trade Representative), while currency policy falls to central banks and finance ministers (i.e., the Treasury in the US).  Globally, trade has the WTO, while currencies have the IMF (which, unlike the WTO, does not have any enforcement mechanisms).

Simon Johnson and Jared Bernstein have written in favor of inserting a currency clause, while Edwin Truman argues the contrary.  Janet Yellen expressed concern about the potential for trade agreements to encroach on monetary policy, and Jeffrey Frankel noted that some of the loudest concerns about currency manipulation aimed at China (not currently a party to the TPP) are out of date.

Just the Varoufakis, Ma'am

An interesting BBC interview with Yanis Varoufakis, the finance minister of the new Greek government (interview begins at about 3:30):

If the eurozone breaks apart - and it seems we're back to worrying about that yet again - I don't think it will be because the Greeks are being unreasonable (or uncool). 

Varoufakis also spoke with Ambrose Evans-Pritchard:

Mr Varoufakis is braced for an arid meeting on Thursday with his German counterpart and long-time nemesis Wolfgang Schäuble, a man he once accused – borrowing from Tacitus - of reducing Europe to a desert and calling it peace.

“I will try to be as charming as I can in Berlin. I will tell Mr Schäuble that we may be a Left-wing riff-raff but he can count on our Syriza movement to clear away Greece’s cartels and oligarchies, and push through the deep reforms of the Greek state that governments before us refused to do,” he said.

“But I will also tell him that we are going to end the debt-deflation spiral and do what should have been done five years ago. That is not negotiable. We have a democratic mandate to challenge the whole philosophy of austerity,” he said.

In a recent blog post, Paul Krugman clarified how we should think if the conflict between Greece and the EU-ECB-IMF "troika" -

[A]t this point Greek debt, measured as a stock, is not a very meaningful number. After all, the great bulk of the debt is now officially held, the interest rate bears little relationship to market prices, and the interest payments come in part out of funds lent by the creditors. In a sense the debt is an accounting fiction; it’s whatever the governments trying to dictate terms to Greece decide to say it is.

OK, I know it’s not quite that simple — debt as a number has political and psychological importance. But I think it helps clear things up to put all of that aside for a bit and focus on the aspect of the situation that isn’t a matter of definitions: Greece’s primary surplus, the difference between what it takes in via taxes and what it spends on things other than interest. This surplus — which is a flow, not a stock — represents the amount Greece is actually paying, in the form of real resources, to its creditors, as opposed to borrowing funds to pay interest.

Greece has been running a primary surplus since 2013, and according to its agreements with the troika it’s supposed to run a surplus of 4.5 percent of GDP for many years to come. What would it mean to relax that target?

It would not mean demanding that creditors throw good money after bad; everyone has already implicitly acknowledged that the debt will never be fully paid at market rates, but Greece is making a transfer to its creditors by running a primary surplus, and we’re just arguing now about how big that transfer will be.

At Project Syndicate, Joe Stiglitz writes:

So it is not debt restructuring, but its absence, that is “immoral.” There is nothing particularly special about the dilemmas that Greece faces today; many countries have been in the same position. What makes Greece’s problems more difficult to address is the structure of the eurozone: monetary union implies that member states cannot devalue their way out of trouble, yet the modicum of European solidarity that must accompany this loss of policy flexibility simply is not there....

When companies go bankrupt, a debt-equity swap is a fair and efficient solution. The analogous approach for Greece is to convert its current bonds into GDP-linked bonds. If Greece does well, its creditors will receive more of their money; if it does not, they will get less. Both sides would then have a powerful incentive to pursue pro-growth policies.

This short paper by Marcel Fratzscher, Christoph Steffen and Malte Rieth of DIW Berlin lays out how GDP-linked debt might work.

The Greek government's proposals are along the same lines, according to Ambrose Evans-Pritchard's article:

The proposals offer a bond swap to ease the debt burden – 177pc of GDP - without demanding an explicit writedown of Greece’s foreign loans. This allows both sides to save face. The aim is to slash Greece’s primary budget surplus from the troika target of 4.5pc of GDP to around 1.5pc to pay for welfare pledges and boost investment. “This gives us a reasonable buffer. The old target is ludicrous,” Mr Varoufakis said.

Loans from the EU bailout machinery would be replaced by GDP-linked bonds, akin to Keynes’s "Bisque Bonds" in the 1930s. Money owed to the ECB would convert into “perpetual bonds”.

The Times' Eduardo Porter reminds us that economists foresaw that the euro might not work out so well:

The euro had been enshrined in a treaty but not yet come to life in the autumn of 1997, when Martin Feldstein, the influential president of the National Bureau of Economic Research, published an essay arguing that European leaders’ hopes that a monetary union would foster greater harmony and peace in a Continent repeatedly ravaged by wars were misplaced.

It “would be more likely to lead to increased conflicts,” wrote Mr. Feldstein, a former chief economic adviser to President Ronald Reagan.

War within Europe, “would be abhorrent but not impossible,” he added. “The conflicts over economic policies and interference with national sovereignty could reinforce longstanding animosities based on history, nationality and religion.”

The real difficulty is politics, not economics; as Porter writes:

Fixing this is not impossible. The most direct way would be for the creditors in Europe’s north to relax the tight conditions on debtor countries, provide them with debt relief and allow them to spend more to kick-start growth. Alternatively, they might just invest more themselves, which would lead to higher wages and prices at home, encouraging more output in their poorer neighbors.

This path presents some political complications, however. Voters in Germany and other rich northern countries have no appetite for transfering resources to the vulnerable neighbors around Europe’s edge. And, comfortably insulated by their own prosperity and conditioned by memories of hyperinflation after World War I, they still fear higher inflation. Even the direst warnings of impending doom seem unlikely to shift the public mood.

And that sets the political constraint on the other end of the field. “The right policies would defuse the political crisis in the peripheral countries at the expense of intensifying it in Germany,” Mr. De Grauwe said. “It would prevent communists taking over in the south but would fuel the extreme right in the north.”

As we've seen in the US, the right policies to deal with financial crises and depressions do not appeal to most people's moral intuition, and are thus very difficult politically.  If the euro - and the project of European unity - is to be saved, it will take some courage on the part of the leaders in Germany and other "northern" countries.

Update: the embedded video was taken down, but a shorter version is available at the link.

Cassidy on Keynes and Reagan

Econ 302 midterm question 2(a):

The fiscal policies enacted by the Reagan administration included significant cuts in taxes and increases in (military) spending. Illustrate the effects of this fiscal policy using an IS-LM diagram. 

While my students were asked to work out the results in (Keynesian) theory, the data are consistent with its prediction:

The red line (right-hand scale) is GDP growth, which is negative in 1982, but strongly positive in 1983 and 84 ('Morning in America'), and the blue line is the federal deficit as a percentage of potential GDP, which shows the effect of Reagan's fiscal policy.

Apropos of this, John Cassidy has a nice post arguing that Reagan was a closet Keynesian:

In strict terms, Reagan’s neglect of the deficit wasn’t Keynesian. Keynes himself believed in letting the deficit rise in a recession and paying down debts in the good times. In America, though, Keynesianism has always been associated with stimulus programs, big government, and deprioritizing the deficit. In all of these ways, Reagan was a Keynesian. But a word to the wise: don’t waste your time trying to tell that to anybody in the Republican Party.

On the Yellen Bandwagon

The quasi-campaign for the next Federal Reserve chair continues... Heidi Hartmann and Joyce Jacobsen (my office neighbor) have organized an open letter from economists in support of Janet Yellen, which concludes:

[W]e believe that Janet Yellen is an extremely effective leader who has demonstrated her capacity to work with the other FRB governors and to bring important perspectives of the American people to her leadership and decisions.  In our opinion, she is the best possible leader for the Federal Reserve Board at this critical time in our nation’s history.

The whole thing can be read here, and there is a link for economists who wish to add their names.

The letter has already been successful in attracting quite a few signatories, including some big names, like Michael Woodford (who Richard Clarida called "the leading monetary theorist on the planet right now" in this Bloomberg profile), Alan Blinder, Christina Romer, David Romer, Robert Shiller, Maurice Obstfeld, James Hamilton (who endorsed Yellen at Econbrowser), Mark Gertler, Menzie Chinn and Charles Engel.

In addition to having the support of economists, Yellen has also been endorsed by The Economist.

There has been quite an outpouring of commentary on this, though I don't think any of it has fundamentally changed the preference for Yellen over Summers I expressed in July after Ezra Klein's initial report that Summers was the front-runner (was that the worst trial balloon ever?).  However, Jared Bernstein, who worked with him in the White House, did argue persuasively that some of the vilification of Summers as a Wall Street stooge is off-base.  This story by Zachary Goldfarb details how and why President Obama became so enamored of Summers.  But as Steven Pearlstein argued (and so did Felix Salmon) that very closeness to the President is problematic from the standpoint of central bank independence.

One of the things I like about Yellen is that she appears to represent stylistic continuity with Bernanke, who has tried to de-personalize the making of monetary policy.  However, I think an argument could be made for a regime change in substance - a shift to a new monetary rule, like nominal GDP targeting as Christina Romer called for (and Scott Sumner persistently evangelizes for), or Laurence Ball's suggestion of a higher inflation target (which I also raised back in 2008), or Ken Rogoff's "sustained burst of moderate inflation."  A Fed chair openly advocating such a fundamental policy shift does not appear to be in the cards - certainly it would be problematic in the confirmation process, and there is no guarantee that the FOMC could be brought along anyway.  Of the options that are on the table now, Janet Yellen clearly seems the best to me.

Of Summers, Discontent

Based on conversations with "plugged-in sources", Ezra Klein reports:

The word among Federal Reserve watchers right now is that the choice is down to Janet Yellen or Larry Summers as Ben Bernanke’s replacement. I can’t find anyone who really thinks it’ll be Roger Ferguson, Tim Geithner, Alan Blinder, or some other dark horse.

People dismissed Summers’s chances a month or two ago, but he’s increasingly viewed as the leading candidate today — and opinions on this, for reasons I don’t fully understand (though I suspect have to do with a bunch of elite trial balloons going up at the same time), have really hardened in the last 72 hours.

I'd thought the persistent reports that Summers was a leading candidate represented some wishful thinking among writers in need of a more interesting story; like Matt Yglesias, I thought Yellen over Summers a no-brainer.  Yellen's qualifications are beyond doubt - she has strong academic credentials and experience at high levels of the Fed.  From a political perspective, Summers seems to have obvious drawbacks - supposedly one of the reasons Obama appointed him CEA chair rather than Treasury Secretary at the beginning of his administration was to avoid a messy confirmation fight (the CEA position does not require Senate approval).

Moreover, as Bill McBride details, "Yellen has a much better track record of correctly analyzing the economic situation, while Summers has frequently been wrong (but never in doubt)" and Cardiff Garcia's endorsement of Yellen provides further evidence on that point.  Scott Sumner is also unimpressed with Summers' views (or lack thereof) on monetary policy.

Also, as Paul Krugman notes:

[Y]ou need someone who can be effective at bringing the rest of the Fed along — but that’s a bit of a mysterious quality. Ben Bernanke has been far better at that than one might have expected from an academic. Looking forward, which is better: someone who has already demonstrated an ability to get along with her Fed colleagues, or someone who has a reputation as a tough guy but also a reputation for raising hackles? 

As Richard Grossman explains, one of Bernanke's big achievements has been to move away from the "cult of personality" style of central banking that was one of the worst aspects of the Greenspan era.  In that respect, appointing someone with a reputation for being obnoxious "strong personality" like Summers would likely be a step backward.

Up to this point, I've refrained from mentioning the fact that an appointment of Yellen would be historic because she would be the first woman to lead the Fed.  Even without taking that into consideration, its clear that she is a strong candidate, and Summers a highly problematic one.  But breaking the "glass ceiling" that still seems to exist in the monetary policy world would be no small thing.

Ezra Klein recently argued in a column that there was an undercurrent of sexism in some of the arguments being made against Yellen (e.g., "She lacks 'toughness.' She’s short on 'gravitas.' Too 'soft-spoken' or 'passive.'").  He pointed out that

An interesting wrinkle is that the current chairman of the Federal Reserve doesn’t fit the default masculine leadership model himself. Bernanke is soft-spoken and conciliatory. He doesn’t pound the table in meetings or preen at conferences. When he took the job, there were concerns about his gravitas. He’s not a social or political force around Washington in the way his predecessor, Alan Greenspan, was. He leads by consensus, with none of the high-stakes showdowns that burnished the legend of former Fed chairman Paul Volcker. Yet Bernanke has managed to pull the Federal Reserve through an extraordinarily turbulent period.

Yellen’s background bears similarities to Bernanke’s, though she’s got more Washington and Fed experience than he did at the time of his appointment. 

Klein generally seems to know what he's talking about, and I believe him when he says his reporting is well-sourced.  His story lays out the reasons Obama is apparently leaning towards Summers, none of which I find very persuasive.  I hope he's wrong on this one.

See also: Noam Scheiber, who asks "can we at least talk it over first?"

Update (8/1): There has been quite an outpouring of commentary on this in the last week.  While much of it focuses on the perceived drawbacks of Summers (e.g., Paul Krugman), James Hamilton makes a case for Yellen.  The New York Times has editorialized in favor of Yellen, and President Obama defended Summers at a meeting with congressional Democrats (he also mentioned Don Kohn as a possibility for the Fed position).  This widespread, almost campaign-like debate is little uncomfortable for those who subscribe to the view that the Fed should be somewhat removed from politics.

Ezra Klein dug further into the administration's arguments for Summers, and Brad DeLong makes a (somewhat lonely) pro-Summers case (see also his blog post).

Actual Politician for State-Contingent Fiscal Policy!

Matthew Yglesias points to Maine Senate candidate Angus King's views on the expiration of the Bush tax cuts:

I was in favor of ending the Bush-era tax cuts immediately, but after continued poor employment numbers, we need a more nuanced approach. We should consider pegging the sunset of these tax cuts to something non-arbitrary, like a certain amount of GDP growth, or a lower level of unemployment. This would avoid the unproductive brinkmanship that Congress engages in over this issue – and could prevent our fragile recovery from being further slowed down.

This is essentially what I suggested in June (HC op-ed, blog post).  Nice to see someone who might actually be in a position to do something having similar thoughts.

Richard on Gold

The inclusion of a plank supporting a commission to study a return to the gold standard in the Republican platform has prompted a number of economists to explain (again) why it is a bad idea.

In an LA Times op-ed, my Wesleyan colleague Richard Grossman writes:

History provides ample evidence that the gold standard is a bad idea. After World War I, the major industrialized nations established the gold standard, which is widely seen as having contributed to the spread and intensification of the Great Depression. The gold standard tied the hands of monetary policymakers, forcing them to maintain high interest rates in order to maintain the price of gold, thereby making a bad economic situation even worse.

See also Paul Krugman.  My version of the case against gold is in this earlier post.

Rich and Paul

From Ryan Lizza's New Yorker profile of Paul Ryan:

In 1988, Ryan went to Miami University, in Ohio, where he got to know an economics professor named William R. Hart, a fierce and outspoken libertarian in a faculty dominated by liberals. The two quickly discovered their shared fascination with Rand and Hayek. Ryan got his first introduction to movement conservatism when Hart handed him an issue of National Review. “Take this magazine—I think you’ll like it,” he said.

Rich Hart (nobody calls him "William" or "Bill") was a colleague of mine for several years when I worked at Miami.  He certainly was "outspoken" - I figured that much out on my visit to Oxford as a job candidate, when I quickly realized politics probably wasn't the safest subject. After one of his colleagues - Rich wasn't the only conservative there - described Hillary Clinton as a "communist" I changed the topic.  After getting know Rich a little better, I'm sure he wouldn't have held the fact that our political views were very different against me.  Indeed, he was always quite kind in his dealings with me and supportive of the junior faculty.

I never had a precise sense of what Rich taught in his macroeconomics class, but, while he may have reinforced the political inclinations Paul Ryan brought with him to Miami, I highly doubt he could be held responsible for Ryan's absurdly ignorant take on monetary policy:

Perhaps Ryan’s most unconventional opinion on monetary policy came in the summer of 2010, when he told Ezra Klein that the Federal Reserve should actually raise interest rates even as the U.S. economy was still struggling: “[T]here’s a lot of capital parked out there, and we need to coax it out into the markets,” he said. “I think literally that if we raised the federal funds rate by a point, it would help push money into the economy, as right now, the safest play is to stay with the federal money and federal paper.”

Maybe America has a Greek Problem After All

I was asked recently if I was worried that the US was turning into Greece.  "I'm not worried about that at all," I said.  I gave the standard economist's explanation: the crucial difference is that the US government is borrowing in its own currency, and the primary evidence that markets aren't worried is the low yield on long-term Treasuries. 

However, reading Paul Krugman's column today about Mitt Romney's taxes, I realized that the US-Greece parallel may be valid in one unfortunate respect: both countries appear to have a serious tax-avoidance problem on the part of their elites. 

Wonkblog's Brad Plumer wrote about a study of tax evasion in Greece:

A bigger question is why Greece hasn’t been able to crack down on tax evasion. The authors note that Greek officials seem to have a very good idea of who’s avoiding taxes: In 2010, the parliament took up a bill that specifically targeted doctors, dentists, lawyers, architects, engineers and so forth. As the authors note, these are precisely the groups evading the most taxes (largely because they receive much of their income in bribes). But the crackdown bill failed — possibly because, as the authors discover, these are the professions best represented within the Greek parliament.

In the US, we have a problem of illegal tax evasion - the "tax gap" - which, while significant, may not be on the same scale as Greece's.  The bigger problem in the US is the ability - and willingness - by corporations and very high-earners to legally avoid taxes. 

Though its hard to know for sure what's going on without more information, Mitt Romney's IRA might be an example. According to Krugman:

I.R.A.’s are supposed to be a tax-advantaged vehicle for middle-class savers, with annual contributions limited to a few thousand dollars a year. Yet somehow Mr. Romney ended up with an account worth between $20 million and $101 million. 

I doubt Romney did anything illegal by the letter of the law, but the complexity of our tax system provides lots of ways for people and corporations that can muster legal and accounting firepower to minimize their taxes.  Moreover, the same people and corporations who benefit from the messiness of the tax code have disproportionate influence in Washington which may help them keep their loopholes open, and perhaps get them widened a little here and there.

The obvious policy answer is a simpler, and better-enforced tax code.  But, given the political economy, that's probably not realistic.  And focusing on the tax rules may miss the real issue, both here, and perhaps in Greece, that there is not a strong enough sense that taxes are a duty (one might even say noblesse oblige) and some attempts to avoid them - even if legal - might be wrong. 

Krugman noted that, in contrast to his son, George Romney was notably transparent about his finances:

Those returns also reveal that he paid a lot of taxes — 36 percent of his income in 1960, 37 percent over the whole period. This was in part because, as one report at the time put it, he “seldom took advantage of loopholes to escape his tax obligations.” 

There probably always have been and will be "loopholes", but what matters is the willingness to take advantage of them.  That depends, in part, on how socially acceptable it is to do so.  While the details are different (and the macroeconomics is very different), the US and Greece seem to share a significant failing in the "social norms" department.

The Subordination of Economic Theory to Society

At Project Syndicate, Schlomo Ben-Ami writes:

Europe, however, has always found it difficult to come to terms with an over-confident, let alone arrogant, Germany. The current political turmoil in Europe shows that, regardless of how sensible Chancellor Angela Merkel’s austerity prescriptions for debt-ridden peripheral Europe might be in the abstract, they resemble a German Diktat. The concern for many is not just Europe’s historic “German problem,” but also that Germany could end up exporting to the rest of Europe the same ghosts of radical politics and violent nationalism that its economic success has transcended at home.

Once the crisis became a sad daily reality for millions of unemployed – particularly for what appears to be a lost generation of young, jobless Europeans – EU institutions also became a target of popular rage. Their inadequacies – embodied in a cumbersome system of governance, and in endless, inconclusive summitry – and their lack of democratic legitimacy are being repudiated by millions of voters throughout the continent.

Europe’s experience has shown that the subordination of society to economic theories is politically untenable. Social vulnerability and frustration at the political system’s failure to provide solutions are the grounds upon which radical movements have always emerged to offer facile solutions.

If "economic theories" is taken to mean the theories of economists, the "subordination of society to economic theories" is not the problem in Europe right now.

The euro project was driven by politicians and businessmen - not economists - from the outset.  In terms of economic theory, giving up autonomous monetary policy is highly problematic, especially in the absence of fiscal union and when labor mobility is limited. 

Moreover, according to economic theory, the "austerity prescriptions" are anything but "sensible."   Economic theory says that these policies are pro-cyclical (i.e., exacerbate the current economic slump) and that the adjustment of economic imbalances through "internal devaluation" is extremely painful.

The underlying motives for the push for austerity in Europe are largely political.  I cannot claim to have any insight about domestic politics in Germany, but the last several years in the United States have demonstrated that interventions grounded in basic economic ideas - counter-cyclical fiscal policy, expansionary monetary policy, and "lender of last resort" financial interventions - can be deeply unpopular.  Even though these policies can deliver what appears to be a (nearly) "free lunch," they are profoundly unappealing to the instinct and intuition of voters.  What the voters ("society") seem to want are economic policies that reward virtue and punish profligacy (last year, Stephen Gordon nicely observed a parallel between German attitudes and the US "Tea Party").

Economists and our theories are far from perfect, but the problem in Europe is not economic theories, or at least it isn't the economic theories of economists.  Europe would be doing much better right now if it was subordinated to economic theory (not the same thing as "technocrats").   The problem is that voters have their own economic theories, grounded in their perceptions of fairness and virtue, and these stand in the way of resolving the crisis.  That is, Ben-Ami has it exactly backward: what is underlying the European crisis is the subordination of economic theories to society.

Update:  Empirical evidence, tweeted by the Economist's Greg Ip:

Apparently many voters mistrust IS-LM. YouGov Economist poll: How stimulate econ? 47%=>gov't infrastructure spending; 46%=> reduce deficit.

And related thoughts in Paul Krugman's blog.

Is "Policy Uncertainty" Endogenous?

At Vox, Nicholas Bloom and Scott Baker argue "falling policy uncertainty is igniting the US recovery."

Since the idea that the economy weighted down by "uncertainty" induced by the Obama administration seems to have become a right-wing talking point, I'm instinctively skeptical.  However, the underlying premise that uncertainty could reduce investment and consumption is sensible (even if I don't think it explains much about the current slump).  So, perhaps its a worthwhile academic endeavor to try to quantify it and make an empirical study of its impact.

According to Bloom and Baker, their index of "policy uncertainty" has three components:

• The frequency of newspaper articles that reference economic uncertainty and the role of policy.
• The number of federal tax code provisions that are set to expire in coming years.
• The extent of disagreement among economic forecasters about future inflation and future government spending on goods and services.

The difficulty with this arises from the possibility that an economic downturn causes the measures of policy uncertainty to rise, rather than vice-versa.

Certainly a downturn means more news about the economy, and it also leads policymakers to try to respond.  The process of negotiating a policy response through the political system is naturally uncertain, and leads to newspaper articles which discuss the various, uncertain, policy outcomes.  In the Obama era, for the sake of "fairness," in their stories about administration proposals, the media will quote critics, many of whom like to argue that the administration is destroying the economy by creating more "policy uncertainty."  The frequent repetition of this argument causes the measure of policy uncertainty to rise, regardless of whether it has merit.

One set of policy responses to a slump involve temporary tax cuts.  This leads to expiring tax code provisions, which increase the measure of policy uncertainty.  (Though in the US case, the main uncertainty was arguably created in 2001 and 2003 when Congressional Republicans passed tax cuts that were scheduled to expire in 2010).  Furthermore, if there is uncertainty about the state of the economy - which there often is during slumps - there will also be uncertainty among forecasters about future policies.

Overall, I would expect more "policy uncertainty" as Baker and Bloom measure it, during economic downturns - but I think it is primarily a consequence of a bad economy, rather than the cause.

Bartlett: Not the Time for "Reaganomics"

At washingtonpost.com, Bruce Bartlett writes:

Judging from the [Republican] candidates’ tax proposals, they seem to believe that the most Reagan-like candidate is the one with the biggest tax cut. But as the person who drafted the 1981 Reagan tax cut, I think Republicans misunderstand the premises upon which Reagan’s economic policies were based and why those policies can’t — and shouldn’t — be replicated today.

Although I am skeptical of "supply-side economics" in general, and I don't think that it should be considered a success in the 1980's (see this post, for example) I think Bartlett makes a reasonable case that it made more sense (or at least was less non-sensical) in 1980 than today:

When comparing Reagan’s policies with Republican proposals today, several things stand out. Inflation is low now. We are not looking at “bracket creep” or sharply rising taxes, as we were in the late 1970s. The top income tax rate is 35 percent, half the rate Reagan inherited. And federal revenue is at a 60-year low of about 15 percent of GDP, compared with a post-World War II average of about 18.5 percent.

These differences are essential to understanding why Reagan’s policies worked when they did — and why they are not appropriate today.

All of the evidence tells us that the economy’s fundamental problem today is not on the supply side but the demand side.

Steve "Jobs" versus Barack "US" Jobs

Indiana Governor Mitch Daniels, Republican response to the State of the Union:

Contrary to the President's constant disparagement of people in business, it's one of the noblest of human pursuits. The late Steve Jobs - what a fitting name he had - created more of them than all those stimulus dollars the President borrowed and blew.

Perhaps he missed this, in a fascinating story about Apple in Sunday's New York Times magazine:

[A]s  Steven P. Jobs of Apple spoke, President Obama interrupted with an inquiry of his own: what would it take to make iPhones in the United States?

Not long ago, Apple boasted that its products were made in America. Today, few are. Almost all of the 70 million iPhones, 30 million iPads and 59 million other products Apple sold last year were manufactured overseas. 

Why can’t that work come home? Mr. Obama asked. 

Mr. Jobs’s reply was unambiguous. “Those jobs aren’t coming back,” he said, according to another dinner guest.

Apple employs 43,000 people in the United States and 20,000 overseas, a small fraction of the over 400,000 American workers at General Motors in the 1950s, or the hundreds of thousands at General Electric in the 1980s. Many more people work for Apple’s contractors: an additional 700,000 people engineer, build and assemble iPads, iPhones and Apple’s other products. But almost none of them work in the United States. Instead, they work for foreign companies in Asia, Europe and elsewhere, at factories that almost all electronics designers rely upon to build their wares.  

As for those dollars we "borrowed and blew," according to the Congressional Budget Office:

CBO estimates that ARRA’s policies had the following effects in the third quarter of calendar year 2011 compared with what would have occurred otherwise:

• They raised real (inflation-adjusted) gross domestic product (GDP) by between 0.3 percent and 1.9 percent,
• They lowered the unemployment rate by between 0.2 percentage points and 1.3 percentage  points,
• They increased the number of people employed by between 0.4 million and 2.4 million,

(According to the CBO's estimates, the impact of the stimulus peaked in the third quarter of 2010 at 0.7-3.6 million).

To summarize, US jobs:

• Steve Jobs' "noble pursuit": 43,000* 
• Barack Obama "borrowed and blown": 400,000-2,400,000

Maybe it would be fitting to call the President Barack "US" Jobs.

*Don't get me wrong - I'm a fan of his computers.  There's alot to think about in the Times article - see Paul Krugman and Ryan Avent. However, many of the issues raised by it, and by the President's speech, about trade, education and "industrial policy," are really about the composition of employment.  The total number of jobs at any time depends mainly on aggregate demand - and when there is a slump (particularly one the Fed can't handle), the appropriate fiscal policy response is indeed for the government to borrow some money and "blow" it.

Update (1/27): Paul Krugman noticed the same thing, and wrote a column about it.

An Inconvenient Mankiw

Food for thought for all the would-be Romney administration Kremlinologists out there:

The National Journal's Jim Tankersley has an interesting article about Mitt Romney and his economic advisors.  The gist of the article is that Greg Mankiw and Glenn Hubbard are well-respected economists, but Romney's statements on the campaign trail suggest he's not listening to them much.  Tankersley writes:

This, then, is the Romney Conundrum—for conservatives, liberals, and everyone else. Even on the economy, Romney’s signature issue, it’s hard to know where his heart lies—and how he would govern in the White House. Would the former Massachusetts governor listen to his best and brightest? Or to his party base?

“Romney’s got Glenn and Greg advising him, and they’re both top-notch economists,” said Keith Hennessey, who ran the National Economic Council for President George W. Bush. “But there’s more to economic policy than just economics.”

Of course this isn't entirely unique to Romney - politicians often fail to follow through on politically inconvenient suggestions from economists (though the universe of what is inconvenient for a Republican primary candidate to say is pretty scary these days).

The article comes to my attention from Greg Mankiw, who linked to it on his blog, without comment.  Hmmmmm...

As if to illustrate... Mankiw has a column in today's Times about tax reform.  Among his suggestions:

Consider the tax on gasoline. Driving your car is associated with various adverse side effects, which economists call externalities. These include traffic congestion, accidents, local pollution and global climate change. If the tax on gasoline were higher, people would alter their behavior to drive less. They would be more likely to take public transportation, use car pools or live closer to work. The incentives they face when deciding how much to drive would more closely match the true social costs and benefits.

Economists who have added up all the externalities associated with driving conclude that a tax exceeding $2 a gallon makes sense. That would provide substantial revenue that could be used to reduce other taxes. By taxing bad things more, we could tax good things less. 

Well, if Romney proposed that, it would probably take the attention off his tax returns!

City of Yesterday, Today

Extremists who mistakenly believe they are defending liberty have the Detroit suburb where I grew up in their vise, the New York Times reports:

In what could be a new high water mark of anti-Washington sentiment, the city of Troy, Mich., is rejecting a long-planned transportation center whose construction would have been fully financed with federal stimulus money.

The terminal, which would help Troy become a transportation node on an upgraded Detroit-to-Chicago Amtrak line, was hailed by supporters as a way to create jobs and to spur economic development. But federal money is federal money, so with the urging of the new mayor, who helped found the local Tea Party chapter, the City Council cast a 4-to-3 vote this week against granting a crucial contract, sending the project into limbo.

“There’s nothing free about government money,” Mayor Janice Daniels said in an interview. “It’s never free, and it’s crippling our way of life.” 

The street signs at the city's entrances say "City of Tomorrow, Today!" but it sounds like Mayor Daniels is leading Troy backwards, with great conviction.

A Better Analogy for the Deficit?

The recurrent "government should balance its budget like a household" trope has been one of the more infuriating aspects of recent debates over economic policy.  Its easy to see the appeal for politicians who want to appear to be talking "common sense," but the policy implications are destructive.  In the LA Times, I suggest a different analogy:

Politicians of both parties have furthered the misunderstanding by frequently drawing an analogy between the federal budget and household budgets. "Families across this country understand what it takes to manage a budget," President Obama declared in a February radio broadcast. "Well, it's time Washington acted as responsibly as our families do." While this comparison appeals to a general belief that we should "live within our means," it's also misleading.

Decisions about the federal budget are fundamentally different from those of individual households, because policymakers need to account for how their choices affect the economy as a whole. It is more appropriate to liken government budget deficits to prescription medicine. Just as medication can be helpful to a sick patient, deficits can aid a failing economy.

The debt ceiling debate showed how hard it is for the political system to deal with something that can be good in some circumstances, bad in others.  I hope this is a way of thinking of it that is simple and intuitive, but also right.

Of course, the ideal is to simultaneously have an expansionary policy now, but also a plan for a (roughly) balanced budget in the long run (i.e., after the economy has returned to health).  But the debt ceiling fight illustrated how raising the issue of long term projected imbalances starts a big fight over the ultimate size of government (which isn't what countercyclical policy is about).  With 14 million people unemployed - and interest rates very low - that is a dangerous distraction.

S&P Downgrade: Its the Institutions, Not the Debt

S&P just downgraded US government bonds from "AAA" to "AA+".  Their explanation:

We lowered our long-term rating on the U.S. because we believe that the prolonged controversy over raising the statutory debt ceiling and the related fiscal policy debate indicate that further near-term progress containing the growth in public spending, especially on entitlements, or on reaching an agreement on raising revenues is less likely than we previously assumed and will remain a contentious and fitful process. We also believe that the fiscal consolidation plan that Congress and the Administration agreed to this week falls short of the amount that we believe is necessary to stabilize the general government debt burden by the middle of the decade.

That is, the downgrade has as much to do with the US political system as it does with debt levels.  The ugly spectacle of a faction of one political party taking the economy hostage in the debt ceiling debate has trashed the rating agency's (and everyone else's) confidence in Washington's ability to make difficult compromises.