Monthly Archives: March 2009

People Respond to Incentives

I normally don’t do politics, but I found this comment from President Obama during his recent press conference particularly irksome:

People are still going to be able to make charitable contributions. It just means if you give $100 and you’re in this tax bracket, at a certain point, instead of being able to write off 36 (percent) or 39 percent, you’re writing off 28 percent. Now, if it’s really a charitable contribution, I’m assuming that that shouldn’t be the determining factor as to whether you’re giving that hundred dollars to the homeless shelter down the street.

Two comments:

1. People respond to incentives.

2. The fundamental point is not about the decision to give or not to give, but rather how much to give. In other words, people think at the margin. So while they might not decide to abstain from giving to the homeless shelter, they might give less than they would have otherwise.

Bernanke pushes the accelerator

From the FOMC statement:

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months. The Federal Reserve has launched the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses and anticipates that the range of eligible collateral for this facility is likely to be expanded to include other financial assets. The Committee will continue to carefully monitor the size and composition of the Federal Reserve’s balance sheet in light of evolving financial and economic developments.

[Emphasis added.]


A couple people asked my opinion on AIG, so I thought I would post something. Basically, my thoughts are mostly summarized by Andrew Ross Sorkin:

Everyone from President Obama down seems outraged by this. The president suggested on Monday that we just tear up those bonus contracts. He told the Treasury secretary, Timothy F. Geithner, to use every legal means to recoup taxpayers’ money. Hard to argue there.

“This isn’t just a matter of dollars and cents,” he said. “It’s about our fundamental values.”

On that last issue, lawyers, Wall Street types and compensation consultants agree with the president. But from their point of view, the “fundamental value” in question here is the sanctity of contracts.

That may strike many people as a bit of convenient legalese, but maybe there is something to it. If you think this economy is a mess now, imagine what it would look like if the business community started to worry that the government would start abrogating contracts left and right.

The Obama administration clearly knows this as Larry Summers has indicated that they aren’t going to start abrogating contracts, but they will have to maintain the faux outrage.

Tyler Cowen adds:

The real lesson is that this is another reason not to nationalize banks. It means politicizing every decision which ends up in the newspaper.


Tournament Time

You can fill out a NCAA tournament bracket and compete against me, James Hamilton, and others by joining the Econbrowser group on ESPN.

Also, given that it is tournament time, the discussions of lost productivity will be in full force. For those interested in why those studies are nonsense, you can read my old article from TCS Daily or the article in which I was quoted in the USA Today.

Keynesian Versus New Keynesian Multipliers

A new paper from Cogan, Cwik, Taylor and Wieland suggests that the estimated multipliers are inflated:

Renewed interest in fiscal policy has increased the use of quantitative models to evaluate policy. Because of modelling uncertainty, it is essential that policy evaluations be robust to alternative assumptions. We find that models currently being used in practice to evaluate fiscal policy stimulus proposals are not robust. Government spending multipliers in an alternative empirically-estimated and widely-cited new Keynesian model are much smaller than in these old Keynesian models; the estimated stimulus is extremely small with GDP and employment effects only one-sixth as large and with private sector employment impacts likely to be even smaller.

Here is the non-gated link.

The Tone

The tone of the debate is growing more and more contentious. This time Greg Mankiw is noticeably cantankerous — and rightfully so. Paul Krugman recently challenged Mankiw’s skepticism that the administration’s forecast for growth is optimistic by dismissing him out of hand despite the fact that Mankiw has actually contributed to the line of research to which Krugman refers. Mankiw responds:

Paul Krugman suggests that my skepticism about the administration’s growth forecast over the next few years is somehow “evil.” Well, Paul, if you are so confident in this forecast, would you like to place a wager on it and take advantage of my wickedness?

There is more. Read the whole post.

The Macro Battle Continues

Willem Buiter of LSE is writing for the Financial Times. His latest post is a “takedown” of modern macroeconomics. David Andolfatto critiques modern New Keynesian (NK) models and then unloads on Buiter:

My beef with the NK paradigm is this in a nutshell. It is a model that ignores money and typically, financial markets too. It embeds unexplained “frictions,” like sticky prices. It embeds conceptually vacuous “shocks” like “mark-up shocks” or “inflation shocks.” It focusses on the policy problem of “stabilizing” the economy in the face of these little itty-bitty shocks. It is not a model designed to understand financial crisis. It is a model designed to legitimize what central bankers always believed they should be doing in the first place: adjust the short-term interest rate to stablize the economy around a predetermined long-run trend. This is why the NK model is the dominant paradigm; and this is why those that promote this view land all the cushy consulting jobs. Among those that promote this view include our very own Herr Buiter. Here are some links to the courses he teaches on the subjects: see here. Good job, Willem. One can easily see how your students (and yourself) were well-prepared to deal with the current financial market crisis with your “very useful ad hoc models” of the economy.

Will Ambrosini gets into the foray as well:

Google scholar and a minimal knowledge of the DSGE literature allows one to refute Buiter’s claims in less than 10 minutes. Someone should really give him a quick lesson on Google scholar.

Estimating the Multiplier

As many of you know, I have expressed skepticism that the stimulus package will work. At the heart of the debate is whether the multiplier associated with government spending is greater than one. Some recent literature should allow us to do some back-of-the-envelope calculations of the multiplier.

A recent paper by Matthew Shapiro and Joel Slemrod (non-gated link) uses survey data to determine the effects of the 2008 stimulus package in which individuals received tax rebates. They find that 20% of those interviewed suggested that they would “mostly spend” the rebate. 32% would mostly save the check and the remaining 48% would mostly pay down their debt. At first glance, this would seem to suggest that the fraction of the population likely to increase their consumption is 20%. The authors, however, note that there is a difference between “save” and “mostly save”. Thus, they estimate the marginal propensity to consume (MPC) to be roughly .3.

In Mankiw-Campbell land, this roughly translates to the idea that the fraction of consumers that are rule-of-thumb consumers (those that live paycheck-to-paycheck) is about .3. We can then use this measure of the number of rule-of-thumb consumers to estimate the multiplier based on a recent study by Jordi Gali, et. al (HT: Ambrosini).

The paper by Gali, et. al provides two ways to estimate the multiplier based on the fraction of rule-of-thumb consumers. First, with competitive labor markets, the fraction of rule-of-thumb consumers would have to be roughly .65 to generate a multiplier of 1. Clearly, this is well above the estimate provided above. Second, with non-competitive labor markets, the fraction of rule-of-thumb consumers would have to be .25 to generate a multiplier of 1. Further, a rule-of-thumb fraction of .3 implies a multiplier greater than 1, but less than the administration’s estimate of 1.5.

Naturally, this raises the question as to whether the labor market in the United States is competitive. Gali et. al define a non-competitive labor market as that in which unions set the wage and employment is determined by the labor demand curve. The idea that the wage is determined by labor demand is certainly a reasonable assumption, especially given the current circumstances (Thanks Will). Thus, based on the work presented, the multiplier may be slightly above 1.

(A BRIEF NOTE: The paper by Shapiro and Slemrod examines the impact of a temporary government stimulus. The current stimulus package contains both temporary and permanent aspects. Nevertheless, I think that their estimates provide a meaningful guide. The current stimulus provides permanent tax cuts through the “making work pay” rebate. It also includes temporary spending provisions such as infrastructure spending etc. In addition, some of the spending side is likely to be permanent. Thus, the increase in consumption is likely to be greater than that estimated by Shapiro and Slemrod because the tax cut is permanent. However, this effect might be offset by the permanent increases in government spending in the package, which will crowd out private investment. Also, the package has been sold as a temporary stimulus to the American people and thus treating the entire thing as temporary when evaluating the behavior of consumers is likely a good first-approximation. Finally, these are merely back-of-the-envelope calculations and should be taken with a grain of salt.)

A Random Thought

If money can’t buy happiness, can it buy confidence?

Calling Dow 6800

Reviewing that analysis, the cyclical, technical and economic reasons for a potential market collapse from Dow 12k to 6800 is still worth reading today.

But the timing? Not so much . . .

That is our friend Barry Ritholtz on his famous (infamous) 6800 call in 2006. I’d say better late than never, but I assume that some readers may not take too kindly to such congratulations given the state of their 401(k)s.