John Taylor and John Williams have recently written an interesting paper on the “black swan” of the money market and the effectiveness of the new term auction facility. Here is the abstract:
At the center of the financial market crisis of 2007-2008 was a highly unusual jump in spreads between the overnight inter-bank lending rate and term London inter-bank offer rates (Libor). Because many private loans are linked to Libor rates, the sharp increase in these spreads raised the cost of borrowing and interfered with monetary policy. The widening spreads became a major focus of the Federal Reserve, which took several actions—including the introduction of a new term auction facility (TAF)—to reduce them. This paper documents these developments and, using a no-arbitrage model of the term structure, tests various explanations, including increased risk and greater liquidity
demands, while controlling for expectations of future interest rates. We show that increased counterparty risk between banks contributed to the rise in spreads and find no empirical evidence that the TAF has reduced spreads. The results have implications for monetary policy and financial economics.
…and a non-gated link.
Tyler Cowen has written an excellent piece in the New York Times about the food crisis. Here is the conclusion:
Lately, it’s become fashionable to assert that, in this time of financial market turmoil, the market-oriented teachings of Milton Friedman belong more to the past than to the future. The sadder truth is that when it comes to food production — arguably the most important of all human activities — Mr. Friedman’s free-trade ideas still haven’t seen the light of day.
Read the whole thing.
Nicholas Kristof on the desirability of the proposed free trade agreement with Colombia.
Today’s pictures are different. “This is a silent tsunami,” says Josette Sheeran of the World Food Programme, a United Nations agency. A wave of food-price inflation is moving through the world, leaving riots and shaken governments in its wake. For the first time in 30 years, food protests are erupting in many places at once. Bangladesh is in turmoil (see article); even China is worried (see article).
So begins the story in The Economist. Of course, this has led to outrageous claims that food “doesn’t spontaneously show up on grocery store shelves.” It does, however, when the market is allowed to operate. In reality, it is the fact that governments around the world have subsidized biofuels and established protectionist regimes to prevent the cheaper, foreign competition thereby pushing prices above the levels of affordability for many in the developing world.
There is little doubt that the market will continue to get the blame, while governments scramble to demagogue markets and offer solutions that involve more government involvement. The solution is quite simple. As Sean Corrigan explains, “Feed the world? — Then free the market!”
Our friend David Beckworth is doing some interesting work on religiosity and the business cycle. Here is an excerpt:
The first thing economic theory says is that the cost of being religious can change over the business cycle. During an economic boom individuals may find increased opportunities for higher earnings. The potential for higher earnings, in turn, make time-intensive religious activities like church attendance costly for these individuals. Consider, for example, a Southern Baptist from a low-income family being offered the opportunity of getting overtime pay to work at a retail store on Sunday morning. For this Southern Baptist, going to church suddenly becomes a lot more costly and thus, increases the likelihood of him opting for work instead of church. On the other hand, during an economic downturn, time-intensive religious activities become less costly as opportunities for earnings decline. Here, the overtime opportunity for the Southern Baptist disappears and church attendance suddenly becomes more affordable. This idea that higher earnings lead individuals to substitute out of leisure activities, like going to church, into more work and vice versa is called the substitution effect. It implies there should be a countercyclical component to religiosity.
Here is a non-gated version of the paper.
On a side note, I recommend reading David’s blog for a unique and insightful perspective on macroeconomics.
Our friend Don Boudreaux offers his thoughts on Earth Day.
J.M. Keynes on inflation in The Economic Consequences of the Peace (p. 235-6):
“Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become ‘profiteers,’ who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.”
Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”
HT: Robert Higgs
In every electoral cycle, candidates parade about explaining why their tax policies will either stimulate rapid economic growth or, in the case of a tax increase, have no effect on economic activity other than to increase government revenue. For example, during last night’s Democratic debate, Sen. Clinton espoused the following view in response to raising taxes on those making over $250,000:
Yes. And here’s why: Number one, I do not believe that it will detrimentally affect the economy by doing that. As I recall, you know, we used that tool during the 1990s to very good effect and I think we can do so again.
I am not a public finance guy and I really cannot tell you the magnitude of the impact these tax increases, but I do not think that you can claim that it was the reason for the growth during the Clinton years (which I am assuming is what she meant by “very good effect”).
We seem to get to wrapped up in the tax policy of the candidates and the implications for growth when many of their proposals are only going to have effects at the margin. What often gets overlooked by the talking heads (and obviously the candidates themselves) is that the 1990s was a period of rapid productivity growth. In this light, I am reminded of a quote from Brad DeLong:
This story of positive structural changes in the American economy – the very rapid growth of potential output – is the big story about the economy during the past four years. It’s important both at the macro level – why is output-per-man-hour 20 percent higher than it was five years ago? – and at the micro level – how are people today doing their jobs and being 30 percent more productive than their predecessors of a decade ago? The news media aren’t covering this well. Yet it’s the really big story about the economy in the Twenty-First century.
Indeed the story in terms of economic growth of the last 15 or so years has been the story of productivity, not one of ingenious tinkering with tax policy.
I try to avoid discussions of specific policies when teaching (after all, I don’t teach public finance), however, I will often remind students that the most important question to ask regarding policy is “and then what?” The tendency to look at policies in a static framework masks the long-run implications of policy.
In the current campaign for president, economic populism is all the rage. For example, our friend Jimmy P. recently summarized Sen. John McCain’s big economic speech in which he proposed a summer suspension of the federal gas tax. This seems like a great idea on the surface. It is a tax cut that favors those closer to the bottom of the income scale and it provides relief at the pump. However, in actuality, the reduction in the gas tax would lower the price of gasoline thereby increasing the demand for gasoline and, consequently, the price. Certainly, I suppose, one could make a normative judgement that it removes money from the hands of the government. However, it would do little to relieve the stress on one’s pocketbook.
The Wall Street Journal reports:
Inflation is back.
I wasn’t aware it had ever left.
UPDATE: Apparently, I am not alone.