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A Rant Against the Use of the Word “Bubble” in the Context of the Bond Market - Washington Center for Equitable Growth
Thus I think clearer thought is obtained by eschewing applying the word “bubble” the bond market. Call them extremely richly-valued. Call them low return. Call them risky for those without the option to hold them to maturity. But if you have to use the word “bubble” apply it to other things.
I wouldn’t even say that the U.S. is currently in a monetary policy bubble. For that to be the case, it would have to be a small open economy borrowing heavily in foreign currency, or in some form of currency union with larger economic powers…
Evening Must-Read: Frances Coppola: The Failure of Macroeconomics - Washington Center for Equitable Growth
Representative agent models, flawed though they are, at least attempt to explain the behaviour of households and firms: but the behaviour of banks, and things that don’t call themselves banks but do bank-like things, stayed under the radar… made it impossible for mainstream economists to understand the significance of the build-up of credit
I Understand Where Martin Feldstein Starts: I Do Not Understand Where He Ends Up: Focus - Washington Center for Equitable Growth
Vir illustris Martin Feldstein starts by saying: downward nominal price stickiness is such a thing that we do not have to worry about deflationary spirals in consumer prices. I agree. But I do not understand where his argument ends up:
Martin Feldstein: The Deflation Bogeyman: “The world’s major central banks are currently obsessed with… raising their national inflation rates to… 2% per year….
…But is this a real problem?… Fortunately, we have relatively little experience with deflation to test the downward-spiral theory…
Morning Must-Read: James D. Hamilton, Ethan S. Harris, Jan Hatzius, and Kenneth D. West: The Equilibrium Real Funds Rate: Past, Present and Future - Washington Center for Equitable Growth
The uncertainty around the equilibrium rate argues for more ‘inertial’ monetary policy than implied by standard versions of the Taylor rule… a later but steeper normalization path for the funds rate compared with the median ‘dot’ in the FOMC’s Summary of Economic Projections.
Evening Must-Read: Stephen G Cecchetti and Enisse Kharroubi: Why Does Financial Sector Growth Crowd Out Real Economic Growth? - Washington Center for Equitable Growth
Stephen G Cecchetti and Enisse Kharroubi (2014): Why Does Financial Sector Growth Crowd Out Real Economic Growth? (Basel: BIS) http://www.bis.org/publ/work490.pdf “We… concluded that the level of financial development is good only up to a point…
…after which it becomes a drag on growth, and that a fast-growing financial sector is detrimental…. Financial sector growth benefits disproportionately high collateral/low productivity projects… the strong development in sectors like construction, where returns on projects are relatively easy to pledge as collateral but productivity (growth) is relatively low…. Where financiers employ the [most] skilled workers… productivity growth is lower than it would be had… entrepreneurs attract[ed] the [most] skilled labour…. [Thus] financial booms in which skilled labour work for the financial sector, are sub-optimal when the bargaining power of financiers is sufficiently large…. We focus on manufacturing industries and find that industries that are in competition for resources with finance are particularly damaged by financial booms… manufacturing sectors that are either R&D-intensive or dependent on external finance suffer disproportionate reductions in productivity growth when finance booms…
Morning Must-Read: Matthew Klein: Crush the Financial Sector, End the Great Stagnation? - Washington Center for Equitable Growth
Matthew Klein: Crush the Financial Sector, End the Great Stagnation?: “Productivity growth in the rich world started slowing…
…down around the same time that the financial sector’s share of economic activity started rising rapidly…. The interesting question, then, is whether this process can be put into reverse. Maybe there is a deeper wisdom behind financial regulations that appear to be (at best) pointless. Harassment that encourages an unproductive, resource-hoarding industry to get smaller might be exactly what’s needed in economies plagued by chronically slow growth.
Afternoon Must-Read: William K. Black: Foreshadowing the Three Fraud Epidemics that Drove the Crisis - Washington Center for Equitable Growth
William K. Black: Foreshadowing the Three Fraud Epidemics that Drove the Crisis: “[Piskorski, Seru, and Witkin] were not aware, however…
…of the answers to these fundamental questions [about mortgage fraud]…. ‘These misrepresentations are not instances of the classic asymmetric information problem in which the buyers know less than the seller. Rather, we contend that they are instances where, in the process of contractual disclosure by the sellers, buyers received false information on the characteristics of assets.’ The use of the word ‘classic’ indicates an important (retrograde) movement in economics. The ‘classic’ treatment of asymmetry… George Akerlof’s 1970 article on a market for ‘lemons’… all about ‘buyers receiv[ing] false information on the characteristics of assets’ in the process of ‘contractual disclosure by the sellers.’ Akerlof presented a dynamic process in which the seller makes false disclosures… to maximize the asymmetry of information…. Indeed, Akerlof emphasized the propagation of that fraudulent asymmetry through the industry as a result of what he dubbed a ‘Gresham’s’ dynamic. ‘[D]ishonest dealings tend to drive honest dealings out of the market. The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence‘ (Akerlof 1970). The fact that top economists, 40 years later, claimed that fraud does not represent a ‘classic’ pathology of asymmetrical information demonstrates how far economics has fallen…”
Confessions of a Financial Deregulator: Hoisted from the Archives from 2008 Over at Project Syndicate - Washington Center for Equitable Growth
People have been asking me about this recently, and I keep thinking it is a set of issues I should revisit, reconsider, expand, and write about at length. But I have failed to do so.
So here it is again, hoisted from the archives:
J. Bradford DeLong: Confessions of a Financial Deregulator: Back in the late 1990’s, in America at least, two schools of thought pushed for more financial deregulation–that is, for repealing the legal separation of investment banking from commercial banking, relaxing banks’ capital requirements, and encouraging more aggressive creation and use of derivatives.
The first school of thought, broadly that of the United States’ Republican Party, was that financial regulation was bad because all regulation was bad. The second, broadly that of the Democratic Party, was somewhat more complicated, and was based on four observations:
In the global economy’s industrial core, at least, it had then been more than 60 years since financial disruption had had more than a minor impact on overall levels of production and employment. While modern central banks had difficulty in dealing with inflationary shocks, it had been generations since they had seen a deflationary shock that they could not handle.
The profits of the investment-banking oligarchy (the handful of investment banks, with Goldman Sachs and Morgan Stanley preeminent) were far in excess of what any competitive market ought to deliver, owing to these banks’ deep pockets and ability to maneuver through thickets of regulations.
The long-run market-return gradient–by which those with deep pockets and the patience to take on real-estate, equity, derivative, and other risks reaped outsize returns – seemed to indicate that financial markets were awful at mobilizing society’s risk-bearing capacity.
The poorer two-thirds of America’s population appeared to be shut out of the opportunities to borrow at reasonable interest rates and to invest at high returns that the top third–especially the rich–enjoyed.
These four observations suggested that some institutional experimentation was in order. Depression-era restrictions on risk seemed less urgent, given the US Federal Reserve’s proven ability to build firewalls between financial distress and aggregate demand. New ways to borrow and to spread risk seemed to have little downside. More competition for investment-banking oligarchs from commercial bankers and insurance companies with deep pockets seemed likely to reduce the investment banking
