Euro Fetters?

Although it can be alarming how relevant the Great Depression sometimes seems today, it is reassuring that the policy response has reflected the lessons learned (at least in the US). Monetary policy has been very aggressive, partly because Ben Bernanke understands those lessons as well as anyone, and because the Fed is not limited by gold standard the way central banks were in the 1930's.

However, the Euro may be playing a role similar to the gold standard in constraining Ireland from responding appropriately to its very sharp recession, according to Ambrose Evans-Pritchard:

If Ireland still controlled the levers of economic policy, it would have slashed interest rates to near zero to prevent a property collapse from destroying the banking system.

The Irish central bank would be a founder member of the "money printing" club, leading the way towards quantitative easing a l'outrance.

Irish bond yields would not be soaring into the stratosphere. The central bank would be crushing the yields with a sledge-hammer, just as the Fed and the Bank of England are crushing yields on US Treasuries and gilts.

Dublin would be smiling quietly as the Irish exchange rate fell a third to reflect the reality of trade ties to Sterling and the dollar zone.

It would not be tossing away its low-tax Celtic model to scrape together a few tax farthings – supposedly to stop the budget deficit exploding to 13pc of GDP this year, or 18pc says Barclays Capital. If the tax raises were designed to placate rating agencies, they made no difference. Fitch promptly booted Ireland from the AAA club anyway.

Above all, Ireland would not be the lone member of the OECD club to compound its disaster by slashing child benefit and youth unemployment along with everything else in last week's "budget from Hell".

Depression buffs will note the parallel with Britain's infamous budget in September 1931, when Phillip Snowden cut the dole and child allowance to uphold the deflation orthodoxies of the Gold Standard – though in that case the flinty Pennine rather liked hair-shirts for their own sake.

Though few had any inkling at the time, Snowden's austerity drive would soon push British society over the edge. It set off a mutiny – a Royal Navy mutiny at Invergordon over pay cuts, in turn triggering a run on sterling. The pound was forced off Gold within days. Irish deliverance from EMU will not be so easy.

Brian Lenihan, Ireland's finance minister, said the economy would contract 8pc this year on top of the terrifying 7.1pc drop in the final quarter of last year.

But what caught my ear was his throw-away comment that prices would fall 4pc, which is to admit that Ireland is spiralling into the most extreme deflation in any country since the early 1930s. Or put another way, "real" interest rates are rocketing.

This is torture for a debtors' economy. You can survive deflation; you can survive debt; but Irving Fisher taught us in his 1933 treatise "Debt Deflation causes of Great Depressions" that the two together will eat you alive.

The downside of membership in a common currency like the Euro is giving up monetary policy independence. For economies which tend to move together, a common monetary policy would work reasonably well. That is, an "optimum currency area" would exist. Evans-Pritchard is essentially making the case that Ireland and Germany (the largest Euro economy) are not an optimum currency area. He argues that the Irish boom was inflated by the European Central Bank keeping rates low earlier in the decade when the German economy was sluggish:

[Ireland] was betrayed again by the European Central Bank, which opened the monetary floodgates early this decade to nurse Germany through a slump, holding rates at 2pc until late 2005, despite flagrant breach of the ECB's own M3 money targets. Fast-growing Ireland and the Club Med over-heaters were sacrificed to help Germany. They were left to cope with credit bubbles as best they could.

And now, when the boom collapses, it is forced into overly-tight monetary and fiscal policies, which only make matters worse.

Abandoning the Euro would be very costly, but it this crisis is revealing that the costs of membership are higher than many realized.

About That Scary Trade Graph

At Vox, Barry Eichengreen and Kevin O'Rourke have some scary graphs showing that, over the past year, some economic data looks as bad as or worse than during the first year of the Great Depression. (As further evidence of the burgeoning popularity of scary graphs, their pictures have been picked up by Paul Krugman, Ezra Klein, Yves Smith and David Beckworth).

One of them is the decline in world trade volumes: I would suggest that things aren't quite as scary they seem, because a growing proportion of world trade is in intermediate goods, and this leads to some double counting in the trade statistics.

For example, consider an iPod which is worth $150 when it leaves China, and includes a $70 hard drive made in the Philippines (this is a simplified from Hal Varian's article about the global production of the iPod). If China exports 1 less iPod, its exports decrease by $150, and the Philippines' exports decrease by $70. The total decline in world trade is $220, which is greater than the value of the iPod itself because the hard drive gets counted twice.

This "vertical specialization" where different parts of the production process occur in different countries is much more prevalent today than in the 1930's, and it provides one reason why the decline in trade appears so much more dramatic now.

Update (4/24): Mea culpa. I realize (thanks to Paul Krugman (!)) that I was thinking about this incorrectly... while intermediate goods trade does lead to double counting, which would make the decrease in the amount of trade appear excessively large, the double counting also affects the base from which the decline occurs, so the percentage change is not exaggerated.

Say It Isn't So (Bad as 1982)

Time's Justin Fox has been among those holding the "not quite as bad as 1982" line, but with the latest employment report, he capitulates, and posts this scary chart: Indeed, this recession has really been a maneater, and that is also true if one looks at the change in the unemployment rate (relative to the 'local minima' around the business cycle peak dates): Nonetheless, I can't go for that, because (as I've discussed previously) the horrors of the early-1980's economy can only be appreciated by looking at the 1980 and 1981-82 recessions in tandem. While Fox's chart shows that payroll employment did recover in late 1980, the unemployment rate really didn't, and the combined increase in the unemployment rate was still somewhat worse than what we've seen so far: And if we do match that total 4.9 point rise in the unemployment rate, it would take us to 9.6%, which is still considerably short of the 10.8% level reached at the end of 1982 (because we started from a low point of 4.7% in Nov. 2007, vs. 5.9% in Nov. 1979).

Economix has a useful "F.A.Q." on the unemployment data.

The Japan Precedent

Much of the debate over how well - or poorly - the administration and Fed are dealing with the financial crisis centers on comparisons to the Japanese crisis of the 1990's. In the latest iteration of that debate, The Economist's Free Exchange frets that we are repeating Japan's mistakes (as does Krugman), but James Surowiecki continues to think the comparison is strained.

The Geithner Plan

The administration's plan to shore up banks sector by lending money to funds that will buy some of their sketchy securities and atrocious assets continues to get mixed reviews.... Joe Stiglitz does not like it, but Martin Feldstein thinks its a good start.

Keynes on "Wasteful" Spending

With a bit of a lag, I have been following along with Marginal Revolution's intermittent "book club" discussion of Keynes' General Theory. Tyler Cowen does not like chapter 10; but I do, partly because it reminds us how funny - and prescient - Keynes could be. The last section contains the famous example about burying money. Keynes, who refers to deficit-financed government spending as "loan expenditure," makes a point that is quite relevant amid the current obsession with finding examples of "wasteful" spending in the administration's proposals:

When involuntary unemployment exists, the marginal disutility of labour is necessarily less than the utility of the marginal product. Indeed it may be much less. For a man who has been long unemployed some measure of labour, instead of involving disutility, may have a positive utility. If this is accepted, the above reasoning shows how "wasteful" loan expenditure may nevertheless enrich the community on balance. Pyramid-building, earthquakes, even wars may serve to increase wealth, if the education of our statesmen on the principles of the classical economics stands in the way of anything better.

It is curious how common sense, wriggling for an escape from absurd conclusions, has been apt to reach a preference for wholly "wasteful" forms of loan expenditure rather than for partly wasteful forms, which, because they are not wholly wasteful, tend to be judged on strict "business" principles. For example, unemployment relief financed by loans is more readily accepted than the financing of improvements at a charge below the current rate of interest; whilst the form of digging holes in the ground known as gold-mining, which not only adds nothing whatever to the real wealth of the world but involves the disutility of labour, is the most acceptable of all solutions.

If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.

The analogy between this expedient and the goldmines of the real world is complete. At periods when gold is available at suitable depths experience shows that the real wealth of the world increases rapidly; and when but little of it is so available our wealth suffers stagnation or decline. Thus gold-mines are of the greatest value and importance to civilisation. Just as wars have been the only form of large-scale loan expenditure which statesmen have thought justifiable, so gold-mining is the only pretext for digging holes in the ground which has recommended itself to bankers as sound finance.

Another more sensible loan expenditure would be volcano monitoring, as we were recently reminded.

Dis-Endowed Chairs

There's no Herman Miller Aeron chair in my future, and, apparently, that's front-page news:According to the story:

In what usually is a routine request, Miami wanted to spend $166,648 for office chairs in the new Farmer School of Business building, which opens next fall. But because some of the chairs cost $522 each, the board charged with considering state spending requests rejected the request 6-1.

Miami asked the board to approve 333 chairs for the new business building - 245 office chairs at $522 each, 78 conference room chairs for $446 each and 10 other chairs for $397 each. They were to come from APG Office Furnishings of Cincinnati.

Controlling board members objected to the highest-priced chairs and noted that the same company offers office chairs for $400 or less.

Before any torch-bearing, pitchfork-wielding mob comes for me, I do want to say, that had I been given such a chair, I would have been willing to return it voluntarily.

(As a factual matter, it is worth noting that a large portion of the money being spent on the new building was raised from donors).

Hmm... perhaps metal folding chairs would make faculty meetings more entertaining, and quicker.

Update (3/29): From University VP David Creamer's response:

In the case of these chairs, we used our four standard criteria for purchasing furnishings and equipment: ergonomics, life of the product, price, and appearance, in that order. When all factors were considered, the chair that was selected – the Aeron – with an estimated life of 15 years and a 12-year full warranty, offered the lowest long-term cost and best value. It is a widely used chair in every public four year university in Ohio.

This chair is on the state’s list of eligible items for $693. Miami could have purchased from that list without the approval of the controlling board. Instead, we solicited bids in order to purchase at the lowest possible price, leading to potential savings of $171 per chair over the state listed price.

Mikey Likes It!

The markets liked the Treasury plan. As Jonathan Chait reminds us, this doesn't necessarily mean much; the anxious fretting over market reactions to policy announcements reminds me of this:



However, Free Exchange argues there is a placebo effect:

It isn't clear to me why markets are up some 6% today. Or rather, it's clear to me that they're up because of the Treasury plan, but it's not clear why they're up because of the Treasury plan. It's also not clear to me that it matters. Tonight, every newscaster in America will say, more or less, the following words: markets were up strongly today on expectations that the Treasury's banking plan will succeed. Who cares what Mr Geithner was saying on CNBC this afternoon when the Dow added 500 points on the news?

If people become convinced that a plan will work, they'll begin to make bets based on expectations that the plan will work, which will make the plan work regardless of what the plan is. I don't know whether the rally will stick or not, and the broader economy will follow its slow path toward eventual recovery in any case, but this certainly has the potential to change the psychological dynamic that had prevailed, of lost confidence in Mr Geithner and in the banking system. And that would have to be considered a big win for the Obama administration.

Or, we might say there are multiple equilibria, and the new "confidence" shifts us to a better one.

Still, I am more concerned with Paul Krugman's reaction, and he doesn't like it. But Brad DeLong is more hopeful, as is Steven Pearlstein.

Secretary Geithner explained the plan in the WSJ, and there is more at the Treasury's web site.

Whose Tax Cuts?

Last week, the Congressional Budget Office forecast much bigger deficits over the next ten years from the Obama budget proposal than the administration had projected. A large part of that difference is attributable to more pessimistic assumptions about economic growth (the OMB director responds).

EconomistMom makes an important point about the deficit: a significant part of it is attributable to Obama's planned continuation of most of the 2001 and 2003 tax cuts. She writes:

So the biggest single proposal in the Obama budget contributing to the deterioration in the 10-year budget outlook is, contrary to public perception, not big spending on bailouts or stimulus or even longer-term health care reform, and not temporary tax cuts that are designed to provide immediate stimulus to the economy at only near-term cost, but rather permanent extension of most of the Bush (2001 and 2003) tax cuts–with costs that grow dramatically over time. It explains why the Obama budget (according to CBO projections) will not only fail to make trillion-dollar-plus deficits an extraordinary and temporary phenomenon (with the 2019 deficit climbing back to $1.2 trillion), but will fail to stabilize the public debt as a share of GDP (with the ratio exceeding 80 percent by 2019).

President Obama doesn’t have to feel “stuck with” the Bush tax cuts. In fact, Congress will have to write and pass new legislation, which President Obama will have to sign, in order to keep any of the “Bush tax cuts” beyond December 31, 2010. So now that they’re so clearly a central part of the Obama budget, it’s probably time we stop calling them the “Bush tax cuts” and start calling them the ($2 trillion in deficit-financed) “Obama tax cuts.” But we’re still not “stuck with” them.

Under current law, income tax rates would revert to their pre-2001 levels in 2011. The 10% would be folded back into the 15% bracket, the marginal rates on the current 25%, 28% and 33% brackets would rise to 28%, 31% and 36% respectively, and the top rate goes up to 39.6%. While the administration proposes letting the rates rise as scheduled on incomes over $250,ooo, it would make permanent the rest of the current bracket structure, and add a number of other breaks that would apply mainly to low- and middle-income households.

One purpose of the administration's tax proposals is to lean against the trend of widening income inequality and stagnating middle-class incomes by raising taxes on the rich and cutting them for the middle class. In doing so, they seem to have taken a very narrow definition of rich: median US household income is roughly $50,000, so the administration is only allowing income taxes to rise on households making more than 5 times the median (this is a conservative calculation, since "taxable income" is considerably less than income). The administration is also making permanent the "patch" of the alternative minimum tax, which also mainly benefits households that are relatively well-to-do (if not truly wealthy). Moreover, even though incomes have ballooned at the very, very top of the distribution, the administration is not proposing a still higher rate on multimillion-dollar income levels.

Not really soaking the rich, just moistening them a bit...

Update: See also Howard Gleckman's summary of the Tax Policy Center's examination of the tax side of the Obama budget.

Colbert on New Deal Denialism

Stephen Colbert and Jonathan Chait discuss the argument the New Deal worsened the depression:

The Colbert ReportMon - Thurs 11:30pm / 10:30c

The New Deal - Jonathan Chait

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Mark Sanford
NASA Name Contest

Chait's New Republic article: "Wasting Away in Hooverville."