Commentary

(Updated) Here’s what’s new from yesterday’s FOMC statement and Bernanke’s press conference:  the Fed has indicated that asset purchases (QE) will end when unemployment hits 7 percent.  (Note that that’s different from the point at which the Fed will begin considering raising short-term interest rates — previously linked to a threshold of 6.5 percent unemployment.) Commentators have pointed out that the Fed seems to be basing its expectations — that asset purchases will begin “tapering” this year and end by next year — on some fairly optimistic economic forecasts (this is a recurring issue).  There are also a lot of questions as to what’s motivating these signals of a less expansionary stance, given that inflation is too low by the Fed’s own measure.  “Frankly,” Yves Smith writes, “the real issue seems to be that the Fed has gotten itchy about ending QE.  Who knows why. It may be 1937 redux, that they’ve gotten impatient with the length of time they’ve been engaged in extraordinary measures.” Somewhat related to this post on the Fed’s historic “reaction function,” here’s Tim Duy’s analysis: Bernanke continued to deflect attention from the low inflation numbers, describing them as largely transitory, identifying the impact of the sequester on medical payments as a factor.  Here is what I think is going on:  Overall, the Fed has basically…more

Remember last summer? The London Whale, that blockbuster adventure thriller, triggered one chill after another as the high-risk action at JPMorgan Chase was revealed. Today, the threats posed by megabanks remain just below the surface — no crisis at the moment — but they’re equally dangerous. A major sequel this year cannot be ruled out. Dodd-Frank, the law designed to reform the financial system, had already been on the books for two years when JPMorgan’s troubles surfaced. In an effort to figure out how it failed to prevent massive losses by one of the world’s largest banks, a Senate subcommittee investigated. This spring, it issued its report on the outsize positions taken by the bank’s Chief Investment Office (CIO) — with a lead trader known as ‘the London Whale’ — and the department’s subsequent six billion dollar crash. The committee detailed a list of concealed high-risk activities, and determined that the CIO’s so-called ‘hedging’ activities were really just disguised propriety trading, that is, volatile, high-profit trades on behalf of the bank itself, rather than on behalf of its customers in return for commissions. Levy Economics Institute Senior Scholar Jan Kregel has taken these conclusions a step further, after analyzing the evidence. In a new research paper he makes the case that the primary cause of the bank’s difficulties was not…more

Last week, James Galbraith was supposed to be interviewed by ERT, the public broadcaster in Greece.  Events intervened when the Greek government ordered that ERT be shut down, and so instead of sitting for the interview, Galbraith delivered this speech in Thessaloniki in front of a large gathering assembled in response to the closure (ERT defied the directive and continued broadcasting on the internet; yesterday, a Greek court ordered that ERT be put temporarily back on the air).  After noting that the Greek crisis has been going on for five years now, with no sign of progress, Galbraith suggested that it might be time to start reconsidering the policy approach:  “After a certain amount of time, even an economist ought to reconsider their ideas. Most other people would so much more quickly, but we are a very patient and stubborn profession.”

We have been advocates of the theory that fiscal tightening is threatening economic recovery (last week, for example). John Taylor objects to the view that fiscal tightness has been the key to the slowness of growth in the recovery. In his blog, he states, “As a matter of national income and product accounting, it is true that cuts in state and local government purchases subtract from GDP, but these cuts are mainly an endogenous consequence not an exogenous cause of the weak recovery.” Taylor’s reasoning is that state and local government spending has been constrained by weak tax revenues. This is certainly true. However, Taylor’s argument seems to imply and rely upon another false dichotomy—variables are either exogenous causes or endogenous outcomes. Is it not more reasonable to say that these reductions in spending at the state and local level are “mainly an endogenous consequence and endogenous cause of the weak recovery”? (Note for further reading: This scheme of cumulative causation or positive feedback is part of the fiscal trap thesis advanced in a brief I wrote with Dimitri Papadimitriou last summer and fall: especially in a non-sovereign-currency system, spending cuts and slow growth can be part of a vicious cycle or downward spiral. This 2010 Levy Institute brief, among other publications, assessed the extent to which fiscal stimulus of various…more

A new book by the Levy Institute’s Randall Wray and Éric Tymoigne (release date July 31): The Rise and Fall of Money Manager Capitalism: Minsky’s half century from World War Two to the Great Recession The book studies the trends that led to the worst financial crisis since the Great Depression, as well as the unfolding of the crisis, in order to provide policy recommendations to improve financial stability. The book starts with changes in monetary policy and income distribution from the 1970s. These changes profoundly modified the foundations of economic growth in the US by destroying the commitment banking model and by decreasing the earning power of households whose consumption has been at the core of the growth process. The main themes of the book are the changes in the financial structure and income distribution, the collapse of the Ponzi process in 2007, and actual and prospective policy responses. The objective is to show that Minsky’s approach can be used to understand the making and unfolding of the crisis and to draw some policy implications to improve financial stability.

Boston Fed’s Eric Rosengren on the risk of financial runs and the implications for financial stability*  22nd Annual Minsky Conference (video) *(Link has changed:  see below the fold of this post for Rosengren video) Paying Paul and Robbing No One: An Eminent Domain Solution for Underwater Mortgage Debt  New York Fed ‘Financialization’ as a Cause of Economic Malaise  NY Times The Cash and I  J. W. Mason A Blogospheric Taxonomy of the Fiscalist vs Monetarist Debate  FT The Biggest Economic Mystery of 2013: What’s Up With Inflation?  Atlantic How Schlubs Get Taken By Wall Street Pros  Forbes Fiscal Implications of the ECB’s Bond-buying Program VoxEU

In the context of the IMF’s latest release in its mea culpa series, this time on the problems with the Greek bailout plan (pdf), Dimitri Papadimitriou appeared on Skai TV to discuss the worsening crisis in Greece, the failure of austerity, and the need to renegotiate the bailout deal.  Segment (in Greek) begins at 9:35 mark:

I used a figure like the one above in a talk that I gave at the Eastern Economic Association 39th Annual Conference last month on the topic “Heterodox Shocks.” (The diagram above incorporates data released at the end of last month.) Total government spending in the US, shown in red, continues to fall as a percentage of GDP. Similarly, federal spending is trending downward following a 2009Q2 peak. The effects of the spending sequester, which technically went into effect on March 1, have probably not been fully felt yet in the Q1 data. My talk was intended only to be a thought-provoking discussion of the concept of shocks in macroeconomics (including policy shocks) and does not contain, say, a complete new economic model. It began with two concrete examples from recent data, including the one above, which may be of some interest to readers who have followed the Institute’s work on the recent move to austerity in US fiscal policy, in this blog and elsewhere on our website. For those interested, a revised working paper version of the conference paper just went online and is available at this link. Finally, this Powerpoint file may be of interest to readers looking for an outline-style summary of the talk and paper, though it contains some additional visual examples and could be described…more

Ryan Avent wonders why, with unemployment too high and inflation too low — even by the Federal Reserve’s own previously articulated standards — there is so much talk of “tapering” coming from members of the Open Market Committee (talk of slowly drawing down the Fed’s asset purchases). Avent mentions the possibility that considerations other than inflation and employment are guiding policymakers’ decisions:  in this case, the concern that the current monetary policy stance is generating financial instability (by blowing up asset bubbles, according to the theory).  Narayana Kocherlakota, head of the Minneapolis Fed, has occasionally been associated with this view, but if his April speech is any indication, his position has much more nuance to it. For what it’s worth, a paper by James Galbraith, Olivier Giovannoni, and Ann Russo looked back at the Fed’s behavior from 1969 to 2003 to determine what really drives changes in Fed policy.  The paper made waves by revealing an apparent partisan bias in monetary policy during election years, but the main findings were, if anything, more disturbing.  In addition to Fed policy playing a causal role in increasing inequality, the authors found an important behavioral change after 1983: … contrary to official claims, the Federal Reserve does not target inflation or react to “inflation signals.” Rather, the Fed reacts to the very “real”…more

Today in the Guardian, Philip Pilkington notices the British Labour party potentially inching away from their scaled-down proposal for a “job guarantee,” an idea fleshed out by Hyman Minsky: Minsky’s theories of financial instability suggested that capitalist economies were prone to serious downturns in which huge amounts of the labour force would find themselves unemployed. What’s more, this would lead to large shortfalls in demand for goods and services which would further exacerbate such downturns. The result was a vicious circle that would become worse and worse as the financial system evolved into an increasingly fragile entity and households and businesses became increasingly mired in debt. … While progressive taxation and unemployment benefits went some way toward both protecting workers and propping up demand during downturns, it did not, according to Minsky and his followers, go nearly far enough. They believed that governments should offer a job to anyone willing and able to work and then pay for these jobs by engaging in increased deficit spending … Read the whole thing.  Pilkington notes that the original Labour proposal differed from Minsky’s “employer of last resort” in both its scope (limited to the long-term unemployed) and its compulsory nature (the ELR is meant to be voluntary, in Minsky’s original formulation), but the proposal did at least represent a departure from the…more

The US Senate investigation of JPMorgan Chase’s Chief Investment Office (CIO), and more specifically of the operations of its Synthetic Credit Portfolio (SCP) unit — otherwise known as the “London Whale” trades — concluded with the release of their full report in March.   The report alleges that the CIO operated without a clear mandate and that its hedging activities were inappropriate.  Neither of these claims, says Jan Kregel, gets to the real problem with the London Whale episode: The problem arose when JPMorgan Chase created the equivalent of a shadow bank that funded the SCP’s short positions through what was in effect a Ponzi scheme. Further, while proprietary trading was involved in the losses, the real problem was that the bank was allowed to operate across all aspects of finance and the difficulties that this creates for efficient macro hedging. If we are to reduce systemic risk, not only must banks provide regulators with more detailed information on their balance sheet hedging, but it is also necessary to rethink the 1999 Financial Services Modernization Act, as it has led to banks that are too big to fail, manage, or regulate. Read the rest here.

Annie Lowrey recently renewed the ongoing discussion over whether the Federal Reserve’s attempts at reviving the economy through quantitative easing (QE) are exacerbating inequality.  The abbreviated version of the argument is that QE operates mainly through boosting asset prices, leading to gains in stocks and housing that largely benefit those at the top.  If that’s the case (Lowrey quotes Josh Bivens suggesting that one would also have to weigh any potential reductions in the unemployment rate from the Fed’s easing), it’s bad news for those who care about inequality, because for the next three years, monetary stimulus is the only game in town (it will be interesting to see whether Republicans continue to be skeptical of fiscal stimulus if they win the White House in 2016). Turning to fiscal policy, Ajit Zacharias, Tom Masterson, and Kijong Kim did a preliminary estimate (pdf) of the likely distributional impacts of the American Recovery and Reinvestment Act (ARRA).  They found that the Recovery Act would have a positive impact on employment (largely “palliative,” given the rapid rate of job loss at the time) and little overall effect on inequality.  A fiscal stimulus skewed more toward expenditure and less dominated by tax cuts than the Recovery Act could have a greater positive impact for low-income households and individuals. This is particularly the case if…more