Why Are Interest Rates So Low?

Ben Bernanke's first blog after leaving his job as the Chairman of the Federal Reserve, is a response to those who criticized the Fed for keeping interest rates too low.  He presents a good description of the determinants of interest rates and what the Fed does to influence those rates.  The Fed attempts to bring interest rates as close as it can to the equilibrium interest rate consistent with full employment and its inflation target.  The market plays a dominant role in this process.  When the expected rate of return on investment is high, the demand for investment loans will be high, and that will cause interest rates to rise.  The opposite will happen when the expected return on capital investment is low.  Interest rates are low primarily because the demand for investment funds in global economy is low.  Fiscal policy also plays a role in the process.  When governments borrow to fund deficits it absorbs more of the supply of savings which tends to increase interest rates.  The Fed, and other central banks, can affect the supply of money and short term interest rates through monetary policy but its actions are limited by the expectations that business has on the expected return on capital.

The Fed struggles to determine what the equilibrium rate is at any point in the business cycle.  That is the subject of much of the debate among members of the FOMC which recommends monetary policy actions.  If it too aggressive it can accelerate price inflation which drives interest rates higher.  If it is not aggressive enough, it will not satisfy its full employment of resources goal.  The primary reason for low global interest rates is that the expected return on capital investments is low.

Indiana's Religious Freedom Law And GOP Politics

Indiana passed a religious freedom law that has nothing to do with religious freedom.  Everyone in Indiana, and elsewhere, is free to practice whichever religion they prefer.  The law enables businesses to refuse services to individuals whose sexual practices violate their religious beliefs by protecting them from lawsuits.  Mike Spence, the Governor of Indiana, defended the law on national TV by claiming that it "empowers people".  Perhaps the real intent of the law is to empower the religious far right to vote for Republicans.  Nineteen other states have so called religious freedom laws.  Republican politicians are not concerned about religious freedom.  These laws are intended to strengthen their hold over "values voters" who have become the base of their Party.  They also provide another example of how the Republican Party has bastardized the concept of freedom.  This law provides legal freedom to one group so that it can take away the freedom of others to purchase products and services.  Jeb Bush, who has become the leading candidate for the GOP nomination in 2016, certainly understands the politics of the GOP base.  He has defended the Indiana law.  David Brooks also understands the values wedge that has been used by his party in election campaigns.  He attempts to make the religious freedom law credible by separating it from GOP politics.  He suggests that we should be tolerant of "minorities" who have strong values.  He means that we should be tolerant of the GOP's exploitation of the values held by a substantial portion of its base.  His job is to make GOP policies more tolerable to the better educated audience who reads his op-eds.

Seven Excellent Panel Discussions About Economics And Society

The New York Review Of Books has been one of the premier intellectual publications in the US for a long time.  It recently invited a stellar group of economists, social scientists and other intelligent observers of of our economic world to discuss the economics profession, its relationship to other academic professions and to society.  I think that each of these discussions are provocative and informative.  Many of us have been campaigning to have the video's released.  Thankfully, the NYRB has provided a public service by making them available at no cost to the general public.

Keynes On The Euthanasia Of The Rentier

Few of Keynes' critics have read his General Theory but some his critics have read Keynes very carefully and they have rejected his theory because it is incompatible with their political economy.  The General Theory is not easy read but Brad DeLong has posted some its most powerful arguments.  For those who have not read or understood Keynes, his posts may help you to better understand his political economy.  You will also understand why there is so much opposition to his political economy.

The General Theory was written in troubled times.  The world economy was depressed and many wondered whether there were superior alternatives to capitalism.  The General Theory made a case for a more enlightened capitalism that could provide for full employment, and maintain some of the positive features of capitalism that were superior to totalitarian economic systems.  Keynes saw functionless investors, or the rentier class, as an obstacle to a full employment economy.  Moreover, the maldistribution of wealth and income, that characterized the interests of the rentier class, was seen as an impediment to the growth of capital.  Keynes argued that a more progressive tax system would facilitate economic growth by redistributing income from those who saved much of their income to those who spent most of their income.  He believed that progressive taxation was a better alternative than revolution.  In other words, euthanasia was better than the warfare against the rentier class.

Keynes was also familiar with the arguments against progressive taxation.  Clearly, it would inspire tax evasion schemes, but it also might diminish the motivation for risk taking, and it might reduce the level of savings that were consistent with a full employment level of investment.  We should be familiar with these criticisms because they are still with us today.  Ronald Reagan made the same arguments in defense of his tax policies which rolled back the progressive tax policies that were legislated during the New Deal.  Reagan claimed that we needed a higher level of savings to stimulate investment, and that progressive taxes were a disincentive to risk taking and hard work.  In other words, a properly functioning capitalist system is dependent upon a high level of savings that could only be obtained from the rentier class.  Keynes believed that retained earnings provided enough capital to maintain business investment.  That is pretty clear in our current economy.  Corporations are only investing a small portion of their retained earnings.  They are using the majority of their retained earnings to provide dividends to shareholders, and to repurchase their own stock.  Keynes also believed that we needed an incentive system to reward hard work and risk taking.  He felt, however, that the system would operate just fine with a less substantial reward system.  Keynes could not even imagine the reward system available to corporate executives in our current era. 

Keynes also believed that the rentier class preferred high interest rates on their savings as well as high dividends.  Of course, high interest rates encourage savings, and they retard investment.  He believed that recessions occur when the pool of savings are greater than the level of business investment. He favored lower interest rates to encourage investment and to reduce the incentive to save.  Implicit in his analysis is the idea that there is an interest rate that is consistent with a full employment economy.  Ordinarily, monetary policy can be used to maintain a full employment economy.  The exception, of course, is when interest rates are close to zero and cannot be reduced far enough to stimulate investment and consumption.  Under those conditions, fiscal policy has more leverage than monetary policy.



  

Keynes On The Trade Cycle

Brad DeLong provides us with a description of the trade cycle (or business cycle) that is provided in Chapter 22 of the General Theory.  He then condenses it into a small number of bullet points.  Its pretty clear that the level of business investment, which is dependent upon the expected return on investment, is the critical factor in his theory.  Interest rates, and the relative scarcity of capital, play a role in the business cycle but they are less important than the expected return on new capital.  Downturns in the business cycle are steeper than recoveries because business pessimism and business optimism have different cycles.  Keynes, of course, was concerned with problem of overcoming pessimism and restoring optimism about the return on new capital.   The Great Depression was a case in point.  Business pessimism became self reinforcing during the Depression and Keynes looked to government investment as a means to reverse the business cycle.

When I look at the US economy today it seems different to me than it might have been in the 1930's.  We have deindustrialized and have become a services economy.  Healthcare services represent 17% of GDP and educational services are also major component of GDP.  Most of our households include two wage earners.  That has stimulated demand for daycare services and other services that satisfy the needs of two wage earner families. Financial services are also a larger part of the economy.  I could go on but my point is that the services industries are not as capital intensive as the industries that they have replaced.  Business investment, and the US business cycle, used to be heavily dependent upon the automobile sales cycle.  When Detroit had a good year the economy had a good year.  That is less true today.  A good share of the parts and finished products are produced elsewhere.  Buick sells more cars in China than it does in the US but the capital investment required to service that market does not occur in the US.  It makes sense for Buick to invest in China because the automobile market in China is now larger than the US market.  Capital investment will usually flow in the direction of the market.  The market for tradable products has become global and so has capital investment.

The real estate market is a capital intensive market and the investment required to satisfy the demand for real estate is local.  It is also an interest rate sensitive market since most of the development is financed with mortgages.  If we look at the business cycle in the US it is highly correlated with the availability and cost of mortgage finance.  The Fed has been able to use interest rates to expand and contract the huge real estate market and the US economy which is heavily dependent upon real estate investment.  It also eased regulations so that mortgage securitization enabled more credit to flow into the real estate market and expand access to mortgage finance by less credit worthy consumers.  To a large extent, capital investment in the US and the business cycle has been influenced by real estate investment and by monetary policy.  It is not surprising that the collapse of the real estate market, along with the debt hangover, has played such a huge role in the US business cycle. 

Given the changes in the US economy, and the globalization of capital investment, the US business cycle is more complex than it might have been when the economy was more capital intensive and most on the capital investment was domestic.  It may have become more dependent upon the flow of business activity that is triggered by new business ventures.

GOP Plan For Reducing Inequality Is A Plan For Increasing Inequality

Many Americans have become concerned about rising inequality.  Therefore, it makes sense for politicians to claim that have a plan for reducing inequality.  Even Republicans have jumped on this bandwagon.  Most Americans do not read the details of their proposals but those who do study their plans for reducing inequality have concluded that they will actually increase inequality.  This short article by John Cassidy points out a few of the ways in which GOP budget proposals will actually increase inequality.  We can't expect a leopard to change its spots.

Paul Ryan's plan to end the estate tax is one of the more egregious proposals made by the leopards who refuse to change their spots.  Ryan argues that the estate tax hurts small business people and farmers.  He gets away with this because most Americans don't know that the first $5.4 million of taxable assets for married couples is excluded from the estate tax.  Ryan's plan only benefits the wealthiest households in America.  Of course, Ryan knows about the $5.4 million exclusion, and so do most households that benefit from the exclusion.  Ryan gets away with his charade only because most Americans are not aware of the exclusion.   They also don't know that stocks, which have appreciated in value, can be passed on to heirs tax free.  That is, they do not have to pay a tax on the capital gain.  They inherit the stocks at their current market value and only have to pay a future tax on the gains over that value when they are sold.

Many Americans, including most Republicans, believe that social mobility and access to higher education are correlated.  Access to higher education, however, is also correlated with the cost of higher education.  That is why the Pell Grant program, which provides subsidies to low income Americans, was passed into law.  The Republican budget proposal reduces the subsidy from the Pell Grant program.  This is consistent with the behavior of Republican governors who have been cutting back state contributions to their state university systems.  That passes on more of the cost for higher education to students and their families.  That is one of the reasons why student debt in America exceeds the debt owed on credit cards or auto loans.  Mortgage debt is the only category of debt that exceeds the debt on student loans. 

It is difficult to make substantial changes in the ways that market incomes are determined.  Market income inequality has been growing in most western economies.  The major difference between the US and other western nations is that spending on social welfare programs in the US is much lower than it is in other rich countries.  Consequently, net income inequality, which reflects the contributions of social welfare programs, is substantially higher in the US than it is in other rich nations.  Consequently, one would expect that the Republican Party, given its new concern about income inequality, would want to bring spending on social welfare programs in the US closer to those in other rich nations.  The Republican Party has not changed its spots.  Over two thirds of the spending cuts in their budget proposal are realized by cuts in social welfare programs.

Rich nations are very different from poor nations.  Income inequality is typically much lower in rich nations because their citizens are better educated and their governments are less corrupted than those in most poor nations.  One could make a similar comparison between states in the US.  The low income states in the US have higher income inequality,  weaker educational systems, and more corrupt state governments.  They are also the states that are dominated by the Republican Party.  There is a reason why the leopard does not change its spots, and why the chances that the US moves closer to the ways in which first world nations function is a growing concern to the rest of the nation and even to our partners in other rich countries.

Economic Impact Of Strong US Dollar

Currency volatility has been one of the more significant factors in the global economic outlook.  This article from Fidelity describes the impact of the strengthening US dollar for the global economy and investors.

Why The US Should Bomb Iran????

John Bolton served in the Bush Administration where he took the position that Iraq was developing weapons of mass destruction and that only a military attack would keep that from happening.  Today he is arguing that we should bomb Iran to prevent it from developing nuclear weapons.  Bolton refuses to admit that he was wrong about Iraq's efforts to develop weapons of mass destruction and that the war would be quick and inexpensive.  Bolton is a Senior Fellow at the conservative American Enterprise Institute.  The AEI link includes Bolton's frequent comments on Fox News.  His status at AEI provide him with a platform at the Wall Street Jourmal as well as the liberal New York Times.  His dismal record in the Bush Administration has not tarnished his image as a foreign policy expert and as critic of every policy introduced by the Obama Administration.  He is anxiously preparing for the GOP attack on Hillary Clinton if she wins the Democratic nomination for 2016.

Media Capture In Britain

The British media have done of poor job of describing fiscal issues to the public.  They have basically echoed the messages that the conservative government has been promoting in its election campaign.  The public is being told that Britain will become the next Greece unless it makes large cuts in public spending.  In fact, the government was forced to increase spending in order to prevent the economy from sliding into recession.  The administration, with help from the media, is telling the public that its austerity program has bolstered the economy.  The majority of economists in Britain, outside of those employed by the finance industry, have been critical of the rationale for the government's focus on austerity, and tragedies that would follow, if over spending by government were to continue.

Media capture is always a problem in a democracy.  Governments and vested commercial interests have a powerful incentive to influence public opinion through the media.  They also have the means at their disposal.  The US is not immune from this problem.  We went through a similar news cycle in which the public was told that we would be the next Greece if we did not make drastic cutbacks to entitlement programs.  Fortunately, the economics profession did a decent job of debating this issue with the help of our more responsible media outlets.  However, media capture is an enduring problem in a democracy and a free press cannot be taken for granted.

What's Wrong With Republican Budget Proposals?

The answer to the above question is simple.  The modern Republican Party depends upon fraud to win elections and transfer money from the poor to the rich.  The budget proposals from the House and the Senate are being advertised as an effort to balance the federal budget.  To balance the budget they propose huge cuts in social welfare programs.  They also cut taxes for the rich.  They can't explain how their proposals will balance the budget so they use asterisks in key areas of the budget which depend upon dynamic scoring assumptions that they make.  That is, the economy will grow faster than trend because of their proposed tax cuts.  That will increase tax revenues and pay for the tax cuts.

Cutting social welfare programs and cutting taxes for the rich may not be very popular with the typical household.  It can only be sold to the public as a way to balance the budget.  In order to balance the budget they are forced to make assumptions about economic growth which they cannot explain without the use of unexplained asterisks.

The Intangible Corporation

Corporations used to have a physical presence in a community and a commitment to the community.  This article describes the intangible corporation that consists primarily of intangible assets such as patents, brand value, copyrights etc.  They are also committed to shareholders who have no commitment to any particular community or to any future generation.  The less tangible the corporation the more footloose and fancy free it is.  A corporation named WhatsApp, with no physical assets, no profits and only a few employees was just purchased for $22 billion.  It may be the model for the modern intangible corporation.  The following quote provides a good description of the modern intangible corporation.

From entities with persistent ownership beholden to their nation states, corporations have transitioned into organizations with investors with no commitment to any particular nation or generation other than the present. The result is that the interests of the corporation have progressively diverged from those of the societies within which they operate.

Shareholder Capitalism Is Working Just Fine

Robert Samuelson defends our current system of shareholder capitalism in which 90% of corporate profits are used to buyback shares, or payout dividends to shareholders.  He argues that corporate managers would invest the profits if they could find profitable new investments.  They can't find profitable new investments because the economy has not recovered fully from the recession.  It would not be sensible for corporations to invest in unprofitable projects just to stimulate the economy.  Samuelson has conducted the trial and decided that the system is working just fine.  The trial that Samuelson held might have been more interesting if he had called some witnesses to the stand that were more critical of the shareholder value myth. 

Curiously, Samuelson has also opposed the use of fiscal policy to stimulate an economy in recession.  He favors cuts in government spending in order to balance the federal budget.  He assumes that business confidence would increase if there were less government borrowing and that would stimulate the economy.  That has not worked where it has been tried out in Europe.  Moreover, if business investment has been constrained by a lack of demand, as he argues, and aggressive monetary policy has not ended the recession, fiscal policy may be the only weapon remaining.  Cuts in government investment in order to balance the budget, paired with a low level of business investment, is not what is needed to restore the economy.

A New Film About The Selling Of Climate Change Denial

The Merchants of Doubt has just been released.  It is a documentary which features one of the marketeers who has been hired to create doubt about the human contribution to climate change.  The featured marketeer, who had previously worked for Rush Limbaugh, and the senator from Oklahoma who represents the oil interests in his state,  is very good at his job.  He understands his role and he has been successful at creating doubt within a substantial segment of of the polity.  He has been helped by the media which provides a platform for climate science denialists under the assumption that both sides of the story are reasonable.  The producer of the documentary does not believe that his film will change the opinions of those who belong to the "flat earth society".  His audience is the large segment of Americans have been confused by the marketeers who lie to them.  The lying is pretty apparent in the documentary and the producer believes that the confused segment of the population will be less confused after viewing the film.

What's Good For GM Is Only Good For Shareholders

The CEO of GM once claimed that what was good for GM was good for America.  In some sense he was correct.  GM's market success was good for its employees and also for its suppliers.  GM has recovered from its near death experience thanks to support from the US government.  It recently, announced that it will buyback $5 billion of its stock.  It made this decision in response to four hedge funds that want to cash in on their investment in GM.  Stock buybacks will reduce the number of shares outstanding and make the remaining shares more valuable.  Four hedge funds, which hold 2% of GM shares, have the power to force GM to buyback its shares instead of investing those funds in its business.  What's good for GM is not necessarily good for its employees or for its suppliers.  GM joins the legions of other large US corporations who have used share buybacks and dividend payments to return 90% of their profits to their shareholders.  Investing in the longer term future of the corporation is not in the interest of shareholders who are primarily concerned with the current share price.   

The Exploding US Welfare State Is A Fiction

Paul Krugman provides us with a simple graph that tells the story about the "exploding" welfare state.  Employment security increased during the financial crisis but it has fallen back to trend along with the recovery.  Social Security is also back on its long run trend.  Healthcare is a long run problem but that is due to the rising cost of healthcare.  The good news is that the rate of growth in healthcare costs has been reduced.  We have a very inefficient system and there is plenty of room for improvement.

Actually, this story is not new.  Many of us understood that our biggest challenge has been to improve the efficiency of the healthcare system.  The exploding welfare system in the US is a figment of the conservative imagination.  

David Brooks Tells Hillary Clinton To Be Ronald Reagan

David Brooks feigns concerns over Hillary Clinton's strategy for winning the Democratic nomination for 2016.  He suggests that she might be tempted to stress a populist agenda in order to attract primary voters who are generally more radical than voters in the general election.  He concludes his op-ed by arguing that voters in the general election respond better to uplifting messages than they do to negative messages.  If Brooks had his way, Clinton would follow Ronald Reagan's strategy by presenting her own "Morning in America" message.

Brooks, of course, is not interested in helping Hillary Clinton win the presidency.  He is more concerned with countering a trend among some Democrats that concerns him.  He is worried that they will abandon their traditional support for "human capital progressivism" for "redistributive progressivism" which is a form of populism that shifts the focus from improving educational opportunities to the problem of income inequality.  The implication is that Democrats must oppose human capital progressivism in order to pursue policies that deal more directly with growing income inequality.  Nothing could be further from the truth.  There is no reason why Democrats have to abandon their traditional interest in expanding educational opportunities in order to deal with the problem of income inequality.  Human capital formation has a positive impact on worker productivity and economic growth.  However, educational inequality is not the primary cause of rising income inequality.  It will have to be dealt with by reversing many of the changes in our political economy that had their origin in Ronald Reagan's "Morning in America".  The rising share of income that has been going to the top 1% is totally unrelated to educational achievement.  They are not any smarter than were when the gains from productivity were more equally shared.  Part of David Brooks mission is to shift attention away from the top 1% and focus our attention more broadly on the income differences that have always existed between the better educated and the educationally disadvantaged.

If David Brooks were really concerned about educational opportunity he should address his concerns to the Republican governors who have been reducing their funding for higher education.  That increases the cost of higher education and reduces opportunity for low income families.  The GOP governor of Wisconsin has proposed a $300 million cut in the higher education budget.  He is running for the GOP nomination and he believes that this will help him to win GOP primaries.  He is not misreading the GOP electorate.  They don't want to support higher education if it means that they have to pay for it with taxes.

Larry Summers Tells Us What To Do About Rising Inequality

Larry Summers is probably the most influential economist within the Democratic Party elite.  He was asked to clarify some of the comments that he had made in a speech at the Brookings Institute when he argued that education was not the solution to rising inequality.  His clarifications are reported in this post.  He understands that this is complex issue and his analysis goes to the heart the interactive issues that need to be teased apart.  His framework for looking at these issues ought to be a starting place for those interested in the intersections between education, technology and rising income income inequality.  He also provides some approaches that will be required to address the forces that are underway today, and which will be even more pronounced in the future as the global economy continues to evolve.

The Wisdom Of Warren Buffet And Charlie Munger

Warren Buffet celebrated the 50th anniversary of Berkshire Hathaway by describing what he has learned from his mistakes and successes, and from his experiences on the boards of numerous large corporations.  His colleague, and partner Charles Munger, also provided a description of the critical factors that have contributed to the outstanding performance of Berkshire Hathaway over the last fifty years.  Anyone who is interested in business or investing can learn more from the two letters they provided than any other source that I have encountered in my experience as a professor and a business consultant.  A deep understanding of the wisdom that they have provided in two short letters is superior to what is covered in most MBA programs.  They redefine the concept of shareholder value, and they help us to understand the mistakes that CEO's make when they pay too much attention to the advice that they receive from Wall Street or from their CFO.