The Causes of Economic Crisis

This week's story is Cyprus- another European periphery country in economic crisis, requiring a bailout from the ECB or someone.  Natually this caused my right wingnut email correspondent to fire off a missive about Cyprus's fiscal profligacy and the Doom that awaits the US if we don't solve our deficit problem.



But why did Cyprus's banking industry implode?  Should we blame it on liberal government spending?

No.

OK, I admit it, I knew nothing about Cyprus.  Now I know next-to-nothing about Cyprus.  But I'm reading up online a little.  And the story isn't complicated- it's nearly the same as the Irish story and the Iceland story, with a few twists.  Banking sectors become incredibly large, investing lots of leveraged money poorly (in this case, I guess they invested in Greek government bonds- OOPS!).  In Cyprus, they had lots of money to invest because they were a banking haven where wealthy Russians could go to avoid taxes. (In Ireland and Iceland, the banks attracted investors from Germany and UK especially).  In all three places, the banks were about to go bust, and so the government had to step in, but the numbers were too massive for such small countries to fund the bailouts, so they were screwed.

But where does government incompetence and overspending come in?  Sorry, wingnuts, it doesn't.  Yes, yes, that story plays in Greece, and it plays to a lesser extent in Italy, but not here.  Not in Spain and Ireland, which were running budget surpluses before 2008.

 

When you're a hammer, everything looks like a nail.  For people who have decided that government deficits will be the death of us all, every problem can be explained by deficits if the shoehorn is flexible enough.  But when a country goes in the tank because the banking industry fails, where does the blame actually lie?  With the banking industry!  And with the governments' failure to adequately regulate the industry.  That's the real message.

 

I guess my critics will say I'm just a regulation-guy hammer, so regulation is the answer to everything.  But at least my argument follows a logical progression from problem back to cause.

 

And there's another reason that Cyprus is totally screwed: they don't print their own money, so they can't devalue, they can't increase the money supply, they can't cause inflation to rise.  The European monetary system is controlled by Germany, and is run for the benefit of the German economy and nobody else. 

Macro Economics is Complicated!

Scattergraph- showing the correlation between austerity and
GDP growth- from Krugman's blog

Although my readers who don't share my political philosophy may find this hard to believe, I actually think a lot about how to analyze the economy in a way that's objective and which filters out my confirmation bias.  In one sense this is a futile exercise for anyone who is passionate about politics and has a strong point of view- I'm drawn to arguments that bolster my pre-existing opinions, which is a natural human modus operandi.  But I'm trying.

So one way I try to hold myself intellectually accountable is to make predictions about the future and then see if events bear them out.  I want to try to be ready to change my views if events prove me wrong.

But this game is getting really hard these days, because so much is going on.  We can hang the whole economy on President Obama, and judge "liberal" policies based on how the economy responds to his leadership.  But now we have the Sequester- a clear win for the conservative fiscal hawks.  So I've predicted some economic slowdown because of the Sequester- but from what baseline?  If the economy keeps limping along but not crashing (which is my prediction), do we blame Obama and his liberal policies, or do we blame spending cuts of 2013?  For that matter, do we blame the tax increases that kicked in during January?

 

Now if the economy goes into recession and the bottom really falls out, conservatives will of course blame the president, and liberals will of course blame the austerity policies of the Republicans.  Here I think liberals have a better case- if conservatives are going to crow that they won the latest round of the Budget Wars, which they did, then they really need to own the results.

 

But to be fair, that means that if the economy takes off and has a surprisingly strong period of growth, conservatives get to own that too.  I'll want to crow about Obama's deft handling of things, but that won't really be fair, given that I just said he "lost" the 2013 Budget Battle.

 

So barring some new twist in these wars, I guess I'm saying this: we're testing out austerity budgeting now, in 2013.  Not the severe austerity of the UK or Spain, but relative austerity compared to the policies of 2009-2012.  Keynesian economics says that should mean slowed growth; conservatives say we'll have "expansionary austerity".  Let's see who's right!

You've Gotta Be Kidding Me...

I got this from Kevin Drum today.  A Democratic Senator is mad at the Republicans for continuing to filibuster even after the deal reached early in the year.  Jeff Merkley of Oregon says:

“Senate Republicans have demonstrated that they have absolutely no intention of ending their assault on the ability of the U.S. Senate to function,” Merkley told TPM, saying he had hoped the bipartisan rules change would ease gridlock. “Many of my colleagues are absolutely beside themselves with frustration, and that frustration is rapidly turning to fury.”
 

Now I guess Merkley is one of the Good Guys, who wanted filibuster reform to mean something.  But that any Democratic senator would be surprised that Republicans have continued to filibuster all business, including court nominees, just makes me want to scream.

As I've said before, Republicans are going to immediately change the filibuster rule as soon as they're in control of the Senate.  They're not going to put up with Democrats gumming up their agenda just because it's tradition.  And those oldtimer Democratic senators will howl in fury again; but they'll really have only themselves to blame.  They're just criminally naive.

Obama is a Very Bad Nerd

At President Obama's press conference last week, he said the following:

Now I am outraged that I voted twice for a president who doesn't know the difference between Star Wars and Star Trek.  As everyone knows, the Jedi do a "mind trick"

whereas the "Mind Meld" is done only by Vulcans

I'm just disgusted.

UPDATE: Of course I'm not exactly the first to pick up on this http://www.theatlanticwire.com/entertainment/2013/03/obama-jedi-mind-meld/62672/

The Sequester is Implemented- Small Government Conservatives Rejoice

As predicted, no deal has been reached on the Sequester, and it will now go into effect.  This means that discretionary spending, including the military, will be cut very heavily- there will be furloughs, layoffs, contracts cancelled, and government bureaucracies unable to operate at full capacity.

But one way to look at this is a big win for fiscal conservatives, particularly for those who sneer at Keynesian economics and see the path to prosperity paved only with balanced budgets.  Liberal economists universally note that this will be bad for the economy as a whole in the short term, as it is fundamentally anti-stimulative.

So we have the beginnings of a natural experiment here.  If Freshwater Economists are right, then the recovery should continue apace and even accelerate now that government spending is down so much.  And if Saltwater Economists are right, then this will drag down growth.  Of course there are so many factors in economies, and we'll probably end up somewhere in the middle, but maybe not.  Certainly a big boom in the next year with the Sequester in place would have to make fools of the Keynesians. 

Another point here is who gets the credit/blame for the economy now.  I know the Republicans will continue to try to pin continued slow growth solely on Barack Obama, but fiscally they've just gotten what they want- austerity policies including no tax hikes.  The fact that half those cuts were to the military, which most Republicans don't like, is immaterial in terms of economic growth.  If the US is successfully invaded by a foreign country due to our weakened military, we can blame liberals.  But if unemployment ticks north of its current position in the next year, we need to acknowledge that it's because of conservative fiscal policies.

Sequestration and the Centrists

So it's looking like there won't be a deal to avert sequestration by March 1, though this is always subject to change, as the nature of "chicken" type negotiation is to wait until the last second to make concessions.  Still, in comparison to the Fiscal Cliff and Debt Ceiling standoffs, we're not hearing the same kinds of forecasts of Doom if sequestration happens, so the stakes don't seem as high.

And the prospects for compromise just don't look very good.  The Republican party continues its absolutist No New Taxes stance.  So all their offers are just to replace the cuts to defense and discretionary spending with..... even more cuts to discretionary spending and less to defense.  For liberals, these offers are worse than the sequester itself.  And of course Democrats' offers are all based on more revenue one way or another, and Republicans see that as worse than the sequester too.

Now in the past when the parties have been caught with no compromise to be made, the circle is squared by just increasing the deficit.  But now we have lots of people in the political center and on the right who would go bonkers if we did that, so it's not an option.  So we're left with the sequester ready to kick in.

Jonathan Chait has a wonderful framing of the problems in the political center, based on an awful David Brooks NYT column from last week. Brooks in his column blames both parties for the failure to reach a deal, and accuses the President of refusing to make a serious proposal, even though he has done so numerous times.  Ezra Klein follows up with an interview with Brooks in which he takes him down beautifully:

EK: On that point, one theme in your column, and in a lot of columns these days, is this idea that the president should, on the one hand, be putting forward centrist policies, and on the other hand, that if he’s putting forward policies that the Republican Party won’t agree to, those policies don’t count, as they’re nothing more than political ploys. But while I agree that some level of political realism should enter into any White House’s calculations, it seems a bit dangerous and strange to say the boundaries of the discussion should be set by the agenda that lost the last election.

 

DB: In my ideal world, the Obama administration would do something Clintonesque: They’d govern from the center; they’d have a budget policy that looked a lot more like what Robert Rubin would describe, and if the Republicans rejected that, moderates like me would say that’s awful, the White House really did come out with a centrist plan.

EK: But I’ve read Robert Rubin’s tax plan. He wants $1.8 trillion in new revenues. The White House, these days, is down to $1.2 trillion. I’m with Rubin on this one, but given our two political parties, the White House’s offer seems more centrist. And you see this a lot. People say the White House should do something centrist like Simpson-Bowles, even though their plan has less in tax hikes and less in defense cuts. So it often seems like a no-win for them.
 

He's polite to Brooks.  Many are more blunt: Brooks and other centrists keep complaining that somenone just needs to lead with a serious mix of revenue increases and entitlement cuts, but nobody will do this.  Meanwhile, President Obama keeps proposing exactly what the Centrists are begging for, and Republicans are turning him down. So why are "both sides" getting blamed?  Brooks, to his credit, actually publishes a postscript to his original column, something I've never seen in the NYT for a regular column (you see it plenty in blog posts, but not in op-eds):

The above column was written in a mood of justified frustration over the fiscal idiocy that is about to envelop the nation. But in at least one respect I let my frustration get the better of me. It is true, as the director of the Congressional Budget Office has testified, that the administration has not proposed a specific anti-sequester proposal that can be scored or passed into law. It is not fair to suggest, as I did, that tax hikes for the rich is the sole content of the president’s approach. The White House has proposed various constructive changes to spending levels and entitlement programs. These changes are not nearly adequate in my view, but they do exist, and I should have acknowledged the balanced and tough-minded elements in the president’s approach.

Weak tea, not an admissiont that the whole premise of the column is bogus, but I guess it's something.  Matt Yglesias has a good post on what he calls "BipartisanThink" too, if you want more of this.  Centrists are just so bought in to the "both sides need to come together" narrative, that they can't change their frame and see what's right in front of their faces: the real problem in US politics is that the Republican party has become extremely radical and rejects all compromise.  It's a very partisan statement, but it's true.

One more thing from Ezra Klein on this here.

Minimum Wage Arguments

So a friend sent me a few pieces on the minimum wage, arguing from a conservative perspective that we shouldn't have one at all, or at least should keep it low.  This is in response to the President's call to raise the minimum wage to $9 an hour, which has been backed on the blogosphere by citations of studies that show (surprisingly) that moderate increases in the minimum apparently don't increase unemployment, as classical economics says it should.  After all, it's pretty basic to argue that if we artificially increase the price of labor, we will necessarily have less demand for that labor, as the "natural" price of it may be lower than the minimum wage.  But the studies linked above show that this effect doesn't seem to bear out in the real world for some reason, and therefore raising the minimum wouldn't really have a downside for the poor.

My friend thus sent me this by a writer named Don Boudreau:

Commenting on my recent open letter to Barack Obama – in which I asked, if government-mandated higher prices for imports discourage the purchase of imports, why do government-mandated higher prices for low-skilled labor not discourage the hiring of low-skilled labor? – John Burger writes that “there is ample evidence that increases in tariffs affect imports of said items,” but less-conclusive evidence that increases in the legislated minimum-wage affect employment rates.
Question: how many studies have been devoted to testing empirically the proposition that higher protective tariffs reduce imports? I’m not asking for studies that explore the question of how much an x-percent hike in protective tariffs lowers imports. Instead, I’m asking for studies that admit as reasonable the proposition that higher protective tariffs might in fact not reduce imports at all (or only by amounts too minuscule to detect). Put differently, I’m asking for pointers to studies whose authors begin by saying something like “Contrary to popular, textbook presumptions that rises in the prices of imports reduce the quantities demanded of imports, let’s look at the actual evidence to test this presumption scientifically. Perhaps it’s untrue.”
I know of no such studies, although perhaps they’re out there.
The evidence, to which Mr. Burger refers, on tariffs’ depressing effects on imports, seems to me to be established mostly from history and from common sense rather than from the sort of narrowly focused and tightly empirically controlled tests that are the stuff of minimum-wage studies. (History suggests to me that the minimum-wage hurts unskilled workers: look at the trend over the past 70 years in teenage unemployment, and especially that of the unemployment of black teenagers in America.)
The fact is that no one seriously doubts – and no one has it in his or her material interest to question – the proposition that higher protective tariffs reduce the quantities of imports demanded by domestic buyers. This straightforward proposition about the effects of government-mandated higher prices on the quantities demanded of imports is simply too obviously true to be the object of much controlled empirical testing. (If this proposition weren’t generally true, much – perhaps all – of the corpus of neoclassical economics would have to be discarded.)
Moreover, if someone did do a test and found that a higher protective tariff imposed by Uncle Sam on, say, fast-frozen french-fries imported from Canada over the years 2003-2007 in fact was followed by more imports of fast-frozen french-fries from Canada during this time span, I doubt that anyone would seize upon that finding as establishing a “new economics” of trade in which modest increases in protective tariffs have either no effect on imports or have even positive effects on imports. Everyone of sense would either question the study’s method or recognize that the ceteris in this particular historical instance wasn’t paribus. A handful of other studies reaching the same empirical result wouldn’t change matters.
...And yet, human labor somehow is exempt from this general attitude. Of all valuable goods and services bought and sold in markets, human labor is one of the few in which many people seriously believe that the law of demand – the proposition that, ceteris paribus, the higher is the cost of acquiring a unit of some given good or service, the fewer will be the units of that good or service sought to be acquired per period of time – does not necessarily apply.
 

I find this amazing- Boudreau seems to be saying that for economic questions to which he finds the answer obviously self-evident, we shouldn't pay attention to empirical studies!

Look, if well-designed studies showed that increasing a tariff modestly for fast-frozen french fries had no effect on imports, that would be very interesting, and maybe it would make economists question some of their bedrock assumptions about their discipline. At least, economists who aren't hacks would have to question things.

When confronted with an empirical study that runs contrary to conventional wisdom, such as the minimum wage studies, the response of economists should be to posit explanations and then test them. To intentionally ignore them seems, well, hackish. I'm ready to believe that those studies are flawed somehow, or leave out an important factor. But I'm also ready to believe that small increases in the minimum wage have only insignificant affects on employment. It's not a hard case to make theoretically: maybe it's just that other factors are much more important in determining employment, and a $2/hr increase in wages is insignificant in comparison.

 

But my friend wasn't done- next he sent me this, by Mark Perry at AEI:

1. Opponents of the minimum wage law generally support no minimum wage, i.e. a minimum wage of $0.00 per hour. To support a minimum wage of $0.00 per hour, the opponents can rely on economic theory, economic logic, scientific thinking, empirical evidence and cost-benefit analysis to support their position, which might be summarized as follows:
Increases in the minimum wage generate certain benefits (higher wages) for some workers, but generate costs (fewer entry-level jobs, fewer hours, fewer benefits, less-on-the-job training, reduced opportunities to acquire work skills, etc.) that outweigh the benefits, making unskilled workers as a group worse off on net from increases in the minimum wage. Further, a minimum wage of $0.00 per hour requires no regulatory mechanism and therefore no enforcement costs.
Bottom Line: A minimum wage of $0.00 is optimal because it generates net benefits to society that are greater than the net benefits of a mandated, artificially high minimum wage.
2. Proponents of the minimum wage law support periodic increases of the minimum wage, e.g. to $9.00 per hour, but never seem to provide any justification or analysis that would support a position that $9.00 per hour is somehow optimal for society. That is, why $9.00 per hour and not $9.25 or $8.75 per hour? Why not $8, $10 or $18 per hour? Why not $90 or $900? In other words, what is special or optimal about $9 per hour that justifies that hourly wage for unskilled workers? What theory, analysis, logic or rationale justifies $9 per hour over all other alternatives?
Bottom Line: If there is no economic theory or logic or cost-benefit analysis that justifies $9.00 per hour as an optimal wage for unskilled, entry-level workers, which seems to be the case, then a $9.00 minimum wage is exposed as being totally arbitrary and random. Unless and until Obama and other proponents of a $9 per hour minimum wage can provide some analysis to show that $9 is optimal and maximizes the net benefits to unskilled workers, then it’s a policy that really can’t be taken seriously. Further, the minimum wage requires a costly regulatory mechanism that administers and enforces the government-mandated wage, which is a cost that needs to be considered.
 

So here we have the opposite argument from the previous one. Whereas Boudreau studiously ignores empirical studies that challenge his assumptions, Perry essentially says that without empirical backup there can be no discussion of any minimum wage above $0.00.

But of course just because empirical information is difficult to come by at numbers above zero doesn't mean we should throw up our hands and give up. So economists have actually tried to put together studies about what happens when minimum wage is raised in one place and not in another, comparing results. That seems to show that at numbers in the $6-7 range in the '00s on the NJ-PA border, the effect is negligible.

Here's what we do know empirically: the American people are generally supportive of the current minimum wage according to polls, and even support by a majority, a higher wage. So whatever the negative job effects currently (if any), Americans are OK with those in favor of being guaranteed a bare livable wage if they're working. Now the president proposes returning that wage to have similar purchasing power to what it had when it was passed years ago, and to index it to inflation so we can stop having these battles (which help Democrats by the way, as raising the minimum wage is popular).

And once the minimum is raised to $9, economists like these guys can launch their empirical studies and see what effect it really has. Obviously we can't study a minimum wage that doesn't yet exist!