Saturday, January 31, 2009

Government Failure: Starting a New Trade War?

Mankiw sounds the alarm on the risks of new populist and protectionist measures that are about to be enacted by the Congress, as explained in this article in the Washington Post. According to the Wall Street Journal:

In Washington, President Barack Obama faces an early test as international concern mounts over moves in Congress to bar foreign suppliers from winning business on most projects funded by a new economic-stimulus package. ...

Some world leaders, as well as U.S. business groups including the U.S. Chamber of Commerce, have begun to cry foul over the proposed "Buy America" provisions in the new U.S. stimulus legislation, saying they could violate international trade rules and trigger a protectionist backlash. Officials within the European Union, as well as in Canada and Australia, have warned Congress and the administration against approving the provisions.

If the new administration doesn't act fast to firmly stop this trend, it will repeat the same mistakes that led to the Smoot-Hawley Tariff Act economic disaster. According to Mankiw:
I hope President Obama and his economists strongly oppose these first shots in a new trade war of protectionism.

Saturday, January 24, 2009

Caplan on Parenting

Caplan talks about parenting in this article in the Chronicle (HT Carden). One of his conclusions, although somewhat evident to me, tends to go against public discourse on the subject:

According to a study by a team of scholars led by the Nobel Prize-winning psychologist Daniel Kahneman, mothers enjoy child care just a little more than housework, and a lot less than watching television. As an economist, I have to suspect that a major reason for parents' lack of enthusiasm for their role is simply diminishing marginal utility: Average enjoyment of parenting is low because parents are overdoing it.

You might respond, "Yes, but at least parental attention makes the children happier." It's striking, then, that even kids don't seem to want all this parental attention. One notable study by Ellen Galinsky of the Families and Work Institute found that while most parents believe their children want more face time, only a tiny minority of children actually do. In contrast, about a third of children wish their parents were less stressed and tired. What kids seem to want from their parents isn't more time; it's a better attitude.

Friday, January 23, 2009

Barro on the New Voodoo Economics

Barro discusses fiscal policy in this excellent article in the WSJ (HT Selva). Here's an intellectually stimulating passage:

As we all know, we are in the middle of what will likely be the worst U.S. economic contraction since the 1930s. In this context and from the history of the Great Depression, I can understand various attempts to prop up the financial system. These efforts, akin to avoiding bank runs in prior periods, recognize that the social consequences of credit-market decisions extend well beyond the individuals and businesses making the decisions.

But, in terms of fiscal-stimulus proposals, it would be unfortunate if the best Team Obama can offer is an unvarnished version of Keynes's 1936 "General Theory of Employment, Interest and Money." The financial crisis and possible depression do not invalidate everything we have learned about macroeconomics since 1936.

Much more focus should be on incentives for people and businesses to invest, produce and work. On the tax side, we should avoid programs that throw money at people and emphasize instead reductions in marginal income-tax rates -- especially where these rates are already high and fall on capital income. Eliminating the federal corporate income tax would be brilliant. On the spending side, the main point is that we should not be considering massive public-works programs that do not pass muster from the perspective of cost-benefit analysis. Just as in the 1980s, when extreme supply-side views on tax cuts were unjustified, it is wrong now to think that added government spending is free.

Barro hits the bull's-eye by emphasizing that incentives matter.

Entire Interview Available in Breno's Blog

Here's my entire interview (in Portuguese) with Breno Baldrati on the financial crisis, available on his blog Hotel Terra, hosted by Brazilian newspaper Gazeta do Povo. Thanks Breno!

Wednesday, January 21, 2009

Interview with Newspaper Gazeta do Povo

In this article (in Portuguese), published in the Brazilian newspaper Gazeta do Povo yesterday, Breno Baldrati interviews me (among other economists) on the economics behind the fiscal stimulus package. Breno did a great job summarizing different perspectives and making them accessible to Brazilian readers.

Questions for Tim Geithner

The NYT published an interesting article where experts in finance and economics pose important questions to Tim Geithner, Obama's nominee for heading the Treasury Department (HT Mankiw). Here are some of the most relevant:

The Treasury and Federal Reserve have been selecting which companies in American industry and finance will get taxpayer money. What criteria do you use to decide?

Do you believe raising taxes on savings and investment, as would occur if the Bush tax cuts expire in 2010, will help or hurt our economy?

President Obama supports the estate tax. Why should a person who leaves his money to his children pay more in taxes than another person with the same lifetime income who spends all his money on himself?

Should large financial institutions incur higher reserve requirements or other regulatory penalties when they become “too big to fail”?

Saturday, January 17, 2009

The Group of Thirty's Report

The Group of Thirty’s “Financial Reform: A Framework for Financial Stability” report led by Paul Volcker was published on January 15. The report makes many strict recommendations to avoid that a financial crisis like the current one happens again. The magazine The Economist summarizes the findings of the report, here's the segment on the role of central banks:

Central banks should have a stronger role in policing such things ["shadow" banking, hedge funds, money-market funds, etc.], the authors argue, and need to be especially vigilant in good times, when credit is expanding quickly. They should also be more involved in supervising bank safety and soundness—although, to safeguard central-bank integrity, the role of chief firefighter is best played by others once trouble ignites. Central bankers “need to be more concerned about financial stability, but less involved in crises,” says Tommaso Padoa-Schioppa, one of the G30.

This reminds me that I once served as the Central Bank of Brazil liaison for Mr. Padoa-Schioppa in Rio during his visit to the Central Bank. It was a great opportunity to learn about the transition to the euro and the resulting changes in European banking.

Wednesday, January 14, 2009

Fed's Plosser on New Monetary Policy Challenges

Philadelphia Fed President Plosser warns of a new set of risks that will have to be faced by monetary policy makers. The first risk regards the unconstrained growth of the Fed's balance sheet:

In the current environment, with the targeted funds rate effectively at zero, it cannot serve as a nominal anchor. On the other hand, quantitative measures — such as the stock of money, reserves, or the monetary base — have a long and venerable tradition in monetary theory and policy. Indeed, many countries have used quantitative targets quite successfully over the years, including Germany and Switzerland. However, these metrics do not assess the distribution of Federal Reserve assets across its lending programs, a focus of credit policy.

Nonetheless, while traditional measures of money may not be the best metrics for policy in this zero interest rate environment, the size of the balance sheet does offer a possible nominal anchor for monitoring the volume of our liquidity provisions. While attention is currently focused on credit policy, ignoring or failing to take into account the consequences of unconstrained growth in our balance sheet could be costly down the road in terms of our ability to ensure price stability or support a credible commitment to that goal.

The second risk is associated with the creation of the special lending facilities:

As I have indicated, some of our new lending facilities were created to replace impaired or poorly functioning private credit markets. We must consider the possibility that our presence in these credit markets will deter private-sector participants from returning to and restoring these markets. To prevent our policies from having these perverse effects, we should consider a gradual increase in the cost of borrowing from these facilities to discourage their use and encourage other participants to return to these markets. This should be an important element of our exit strategy.

Unfortunately, simply terminating the special lending programs is not enough to avoid some knotty problems. The mere act of creating the programs has created moral hazard. To the extent that market participants now feel more comfortable asking for the central bank’s support when they get into trouble, they may be inclined to take on more risk than would otherwise be prudent — thus sowing the seeds for the next crisis. In exiting such programs, it will be important for the Fed to develop clear objectives and boundaries for lending that we can commit to follow in the future. Clarifying the criteria under which we will intervene in markets or extend credit, including defining what constitutes the “unusual and exigent” circumstances that form the legal basis for the Fed’s nontraditional lending, will be essential if we are to mitigate the moral hazard we have created.

Tuesday, January 13, 2009

Atlas Shrugged and the Crisis

In this recent post I talked about the connection between rock band Rush and Ayn Rand's ideas. Coincidentally, the Wall Street Journal published an excellent article by Stephen Moore a few days ago where he uses insights from Rand's Atlas Shrugged, first published 52 years ago, to interpret the current crisis. Here's one relevant passage:
The current economic strategy is right out of "Atlas Shrugged": The more incompetent you are in business, the more handouts the politicians will bestow on you. That's the justification for the $2 trillion of subsidies doled out already to keep afloat distressed insurance companies, banks, Wall Street investment houses, and auto companies -- while standing next in line for their share of the booty are real-estate developers, the steel industry, chemical companies, airlines, ethanol producers, construction firms and even catfish farmers. With each successive bailout to "calm the markets," another trillion of national wealth is subsequently lost. Yet, as "Atlas" grimly foretold, we now treat the incompetent who wreck their companies as victims, while those resourceful business owners who manage to make a profit are portrayed as recipients of illegitimate "windfalls."
Ayn Rand predicted our current troubles well. This is the biggest problem with the handling of this crisis. Monetary and fiscal policies evidently should be used skillfully and to their full extent, but the crisis should not be used as an excuse to eliminate correct economic incentives that have always worked fine. It should always be kept in mind that incentives matter. To disrespect this basic principle of economics will not help us to get out of this crisis, it'll only postpone its solution.

7th Art: Shaun of the Dead (2004)

"Shaun of the Dead" (2004) is a pretty funny spoof of zombie movies, British style. If you're a fan of the genre, don't miss it!

Rush and Ayn Rand

Rush has always been one of my favorite rock bands. I had a chance to reevaluate their songs recently after my oldest son dug up some of my old CDs. Suddenly it came to my mind that 2112 sounded pretty Randian...

Well, I was not wrong. It doesn't only sound Randian, it is heavily inspired by Ayn Rand's Anthem! Here's a passage:
...'The massive grey walls of the Temples rise from the heart of every Federation city. I have always been awed by them, to think that every single facet of every life is regulated and directed from within! Our books, our music, our work and play are all looked after by the benevolent wisdom of the priests...'
We've taken care of everything
The words you hear, the songs you sing
The pictures that give pleasure to your eyes
It's one for all and all for one
We work together, common sons
Never need to wonder how or why
We are the Priests of the Temples of Syrinx
Our great computers fill the hallowed halls
We are the Priests, of the Temples of Syrinx
All the gifts of life are held within our walls
Look around at this world we've made
Equality our stock in trade
Come and join the Brotherhood of Man
Oh, what a nice, contented world
Let the banners be unfurled
Hold the Red Star proudly high in hand
A pretty good depiction of a world under totalitarian rule. Here's a cool video of the song:

Saturday, January 10, 2009

Stuff I've Read Today

The Economist on the rising US unemployment.
The Economist: Bank of England cuts the base rate to 1.5%.
The Economist: historic low bond yields in America.
The Economist: 2008 was the second-worst year since 1825 for America's stock markets.
The Economist: how the rich were affected by the crisis.
The Economist on the Blagojevich imbroglio and other embarrassments for the new administration.
The Economist on Obama and Castro.
The Economist on the Commerzbank bailout by the German government.

Friday, January 9, 2009

Fed Considers Inflation Targeting

According to this Wall Street Journal article, risk of deflation could help to accelerate the introduction of a new monetary regime. Here's how it could fix some of the problems faced by Bernanke:

Reinhart explained that Bernanke faces two problems now that the Fed has effectively shifted from interest rates to quantitative easing as a means to stimulate the economy: communication and governance. The former involves how to explain the purpose of the Fed’s myriad credit programs and resulting expansion of bank reserves. The latter involves the division of responsibilities between the Washington-based Fed Board and the Federal Open Market Committee that includes regional bank presidents.

Inflation targets address both.

When official interest rates are as near zero as they are now, the Fed can’t offset deflationary forces with interest rate cuts to keep inflation-adjusted private borrowing costs down. But an inflation target would convey to the public that officials will use other means, like the Fed’s balance sheet, to prevent prices from falling and also keep inflation expectations from falling too low.

A target might also ease concerns that expansionary fiscal and monetary policy now will sow the seeds of an inflationary outbreak later, and would provide officials a framework with which to eventually unwind their credit programs and rate reductions.

Targets might also head off any friction between the Board of Governors and FOMC. According to Tuesday’s minutes, a “few” FOMC participants wanted the Fed to consider reserve targets to better coordinate between the Board — which sets new lending facilities — and the FOMC, which controls open market operations.

Thursday, January 8, 2009

Bob McTeer on Central Bank Transparency

Here's the link to his interesting post. He puts it in verse:
Transparency is currently a central banker cause
But it reminds me too much of sausages and laws
I think translucence, like my shower door, is a good compromise
It lets in the light but keeps out the flies

Wednesday, January 7, 2009

Bob Lucas on the Best Stimulus Plan: Monetary Policy

The Wall Street Journal has an article written by Bob Lucas (HT Selva Brasilis) that discusses the role of monetary policy during the current recession and supports the stance of Fed Chairman Bernanke. Here's the main point of the article:
There are many ways to stimulate spending, and many of these methods are now under serious consideration. How could it be otherwise? But monetary policy as Mr. Bernanke implements it has been the most helpful counter-recession action taken to date, in my opinion, and it will continue to have many advantages in future months. It is fast and flexible. There is no other way that so much cash could have been put into the system as fast as this $600 billion was, and if necessary it can be taken out just as quickly. The cash comes in the form of loans. It entails no new government enterprises, no government equity positions in private enterprises, no price fixing or other controls on the operation of individual businesses, and no government role in the allocation of capital across different activities. These seem to me important virtues.

Ed Glaeser on the Fiscal Stimulus Package

Ed Glaeser wrote a nice piece on the risks and opportunities with a fiscal stimulus package. Here's one of his suggentions:
The best way to make sure that a vast stimulus package doesn't turn into a federal boondoggle bonanza is for that money to go directly to private citizens and local governments. Reducing payroll taxes for middle- and lower-income people harkens back to the Jacksonian idea of small-government egalitarianism. Shoring up the balance sheets of state and local governments would help ensure that those governments don't make the downturn worse by cutting spending during a recession.

Friday, January 2, 2009

Central Bank Communication & Monetary Policy

An interesting survey article by Blinder, Ehrmann, Fratzscher, De Haan and Jansen that appeared in the Journal of Economic Literature of December 2008 talks about how central bank communication has been shown to be an important component of the monetary policy toolbox:
Over the last two decades, communication has become an increasingly important aspect of monetary policy. These real-world developments have spawned a huge new scholarly literature on central bank communication—mostly empirical, and almost all of it written in this decade. We survey this ever-growing literature. The evidence suggests that communication can be an important and powerful part of the central bank’s toolkit since it has the ability to move financial markets, to enhance the predictability of monetary policy decisions, and potentially to help achieve central banks’ macroeconomic objectives. However, the large variation in communication strategies across central banks suggests that a consensus has yet to emerge on what constitutes an optimal communication strategy.