Draghi Acts, the Market Reacts

I'm not going to beat a dead horse and repeat my same analysis of the Eurozone monetary crisis, NGDP, ect. But take a look at this, so it feels like Eurozone economic recovery is so close.

http://www.reuters.com/article/2012/07/27/markets-bonds-euro-idUSL6E8IRC1R20120727

"You Didn't Build That"

I haven't delved much into the political cycle of the United States, and won't. And let me preface this post by saying I support public investment projects that have a rate of return higher than the interest rate on the bonds needed to fund them. But there's been a lot of discussion in the Presidential race about the role of government vs business, ect. I'll comment on this from time to time, sometimes on one side sometimes the other. So here goes round one.

The fact is that the potency of the public sector depends on that of the private sector, not the other way around. If the government "builds" a bridge it contracts the construction work to a private firm; the quality and cost of the bridge will be a function of the capital, labor, and technology that firm can devote to the project. The government effectively just moved money from taxpayers to the contracting firm.

Moreover, this pattern holds through history; The Federal government, in effect, didn't win the Civil War; Colt and Winchester, the textile mills of New England, and the iron forges of Pennsylvannia did. At times, goverment has directed these private resources to (very) productive ends, such as the Interstate Highway System or the internet.

Today, Microsoft, IBM, Lockheed Martin, Boeing, Arcelor Mittal, et al. allow Uncle Sam to conduct his business, both here and abroad. I guess the message is that it's private productivity that leads to high quality public projects, not the other way around.

As An Aside, Welcome Back "Breaking Bad"

I happen to love this show. And the premier was delightfully satisfying. So here's a tribute.

And for some economic analyis, it IS about a guy who evenually corners the market for methanphetamines in the Southwest, whether he's the producer or the wholesaler. That means his cost and revenue curves look like this (at least).

So Walt will produce at quantity MR = MC, but charge at whichever P he is producing at MR. This allows him to capture some economic rent, without escaping the economic realities of the substitution effect (at some point blow is cheaper) and the income effect (I can't afford it anymore!). In any event, it's a damn good show. 

Happy Bastille Day!

Now if we could just get the French people to be one-fifth as passionate about changing the policies of the ECB as they were about the policies of King Louis XVI. Oh well.

Treasury Rates Falling on My Head, In Real Time

Not just theory. Real rates are low, and continue to fall. This has implicaitons for fiscal and monetary policy; but the relevant instituions (the US Congress and the Federal Reserve) continue to sit on their hands, and should be held responsbile for doing so.

http://www.businessweek.com/news/2012-07-11/treasuries-rise-after-record-low-yield-at-10-year-note-sale

What's a Good Indicator of the Stance of Fiscal Policy? (part 2)

So we have seen that while the Federal deficit has grown rapidly since 2008, the real interest rate on the corresponding debt has actually dipped negative recently. To state the obvious, this indicates that Federal borrowing has not driven up the price of loanable funds so as to make credit conditions less conducive to private investment, which is the channel that is supposed to translate Federal deficits into economic stagnation.

But why, exactly, have Federal deficits not driven up interest rates? Cue this handy graph:

As you can see, private saving has increase substanitally relative to private investment since 2008 (for background check out my previous recent post on the Savings = Investment identity). Since private borrowers have not been absorbing those private savings, they have flowed into Treasury securities in a large enough volume to more than absorb the torrent of bonds coming out of Washington. 

What this all means is that we need to take a more hollistic perspective on the stance of fiscal policy. Just as changes the monetary base are not enough to tell you the stance of monetary policy, changes in the Federal debt are not enough to tell you if fiscal policy is "expansionary" or not. Instead, deficits need to be evaluated in relation to conditions in the broader market for savings; for depending on those conditions, Federal deficits can either "crowd out" private investment OR allow for private savings that would otherwise not take place.

The lesson is that in fiscal policy, as in all things in economics, prices, not just quantities, matter. And when the price of fiscal expansion (the real interest rate on new government debt) is negative, its a different ballgame than most pundits would have you believe. 

What's a Good Indicator of the Stance of Fiscal Policy? (part 1)

Scott Sumner makes a big deal over the idea that neither the size of the monetary base nor the nominal/ real interest rate are good indicators of the stance of monetary policy. Lately I was thinking if a corrollary might not be true of fiscal policy; is it possible that focusing on the flow of deficits or the stock of debt might not be misleading as to the stance of fiscal policy?

This has been bothering me for several years as the Federal deficit and debt (and future projections of each) continually expand, will at every turn interest rates on that debt fall instead of rising. Its something of a pastime for conservatives to claim that rates are about the spike (we're the next Greece! Also my ass is on fire! plus zombies!) as they proceed to fall.

For backgroud, lets see why the Federal deficit is supposed to negatively affect the economy anyways. When the Federal government runs a deficit, it sells bonds that are purchased by private savers (both foreign and domestic). As the supply of bonds in the bond market increases, their price falls and their interest rate rise accordingly. At higher market interest rates, less investment projects are profitable private capital accumulation slows. The key here is that the MECHANISM through which the deficit affects the broader economy is tremendously important; it has to raise the real interest rate to have an effect.

So how have rates fared in relation to the real interest rate on the debt? Lets see, since 2008. We see the deficit rises as rates plunge. This complicates the economic narrative considerably, as we'll see subsequently.

Alexander Hamilton is no Guide for Europe (part 2)

Last post I mentioned how fiscal unification in Europe would lead to tensions between member states as disagreements over taxation, spending, regulation, labor policy, ect. inevitably arose. But more to the point, the circumstances under which Hamilton proposed Federal assumption of the state's debt beres little resemblance to the present situation in Europe.

Lets investigate why. Alexander Hamilton made his proposal in First Report on the Public Credit in order to create a system that would build the credit record of the new country. By proving the Federal government could borrow and repay international and domestic creditors, future borrowing would be possible on better terms for both the government and private borrowers. The debt burden at the time (equivalent to about $4.1 trillion in todays dollars) which the United States had no problem servicing at an interest rate of 4%.

Contrast these circumstances with those faced by Europe. All the European nations have long and established credit histories (some of which are good, some bad, all of which the bond market considers). They've got nothing to prove. Their issue is not to demonstrate their capacity to service debt at face value, but to services a nominal stock of debt that has become unsustainable given the decrease in NGDP growth (and hence nominal government revenues) since 2008. So basically the European periphery + France (I have no doubt Britain will opt out) can cede fiscal independence to Germany in a pact that will lead to tensions and pan-national resentments, or the ECB can do it's job.

Your move Draghi.

Alexander Hamilton is no Guide for Europe (part 1)

Oh dear. I came across this today (http://www.businessweek.com/news/2012-07-06/europe-recalls-hamilton-as-desperation-turns-on-the-debt ) and thought it needed an immediate commentary. It seems that some European policymakers/ deep thinkers are trying to use the plan Alexander Hamilton created to unify the 13 former colonies into the United States as a way to solve Europe's debt crisis.

This is fatally flawed plan, for several reasons.

Let me start by saying Alexander Hamilton is my favorite Founding Father, by far. His vision of the United States as a strong, unified nation that earned it's income from commerce and manufacturing, with the whole economy bolstered by a strong public sector and robust financial system, is the vision that we have fulfilled (as oppossed to Jefferson's ideal of an agrarian republic). And his plan in 1789 that the Federal government would assume the debt of the individual states in return for the states' granting the Federal government more power of their affairs was undoubtedly crucial for the development of the US and was a visionary plan.

But a modern corrollary is an inappropriate step for the Eurozone. For the individual nations of Europe to cede power to some kind of Federal institution as yet to be created in return for German money to meet their debt obligations will end in ruination. Here's why the plan is doomed to fail, in several sections.

1. The path to unification is a rocky road. Think I'm wrong? How did it work for the United States? The Federal government began legislating for all the states in 1787, after the Constitution was ratified. Immediatley, disagreements between north and south emerged over tariffs, taxes, military spending, and shall we say.. labor policy, among other things. The whole "disagreement" lasted about 70 years and eventually devolved in a bit of a tiff featuring guys who looked like this:

Can you imagine Germany having similar disagreements with Italy, Spain, et al? Because I sure as hell can. Think it wouldn't devolve into a civil war? Its unlikely, but then again such outcomes always seem to be. 

Scott Sumner on what macroeconomists have wanted all along...

... They just didn't know it. In this new blog post ( http://www.themoneyillusion.com/?p=15208 ) Scott Sumner makes the point that NGDP targeting is in fact what economists who focus on maco issues have ALL been advocating for the past half-century, even if they did not realize it. The crux of his argument is based on our friend MV=PY; that the focus of all stabilization-policy debates has been how to stablize PY, which is in fact nominal GDP. And I think he's dead right.

"Now that we've figured out how to tame the business cycle, anyone want to get a drink?"

The Borne-Out Identity: Savings and Investment

One of the most well-known and oft troted out identities in economics is the identity that says savings = investment. This identity can be derived in a simple manner as J.M. Keynes did in the second chapter of the General Theory:

Income = Consumption + Investment 

Savings = Income - Consumption 

Therefore Savings = Investment

For fun, I ran gross private savings in the US against gross private investment. 

Notice that at times private savings exceeds investment, and other times vice-versa. This is because there are other types of saving and investment other than "private." Government budget surpluses are public savings and deficits are public dissavings, while foreign capital inflows (or outflows) allow for private investment to exceed (or under-exceed) private savings. 

By looking at discerepencies between these two lines, we can see patterns in these trends for the US; notice how private savings exceeds investment in in the early 90's but falls below at the end of the 90's, when the budget surplus added public savings. 

Keynes Celebrates the End of the Gold Standard: First Video Post