Depression Economics in a Nutshell by Brad DeLong

Historically, we have had three types of excess demand for finance that have produced big downturns in economies.

In 2002 there was an excess demand for bonds and so logically there was less demand for currently produced goods and services. Brad doesn't say it, but that was in the aftermath of the Tech Bubble crash. He writes that in 2008 there wasn't excess demand for bonds because they are still cheap. They would be expensive if there was an increased demand.

Second is excess demand for liquid cash money.

It is possible to tell when there is monetarist downturn: since everybody is trying to build up their stocks of liquid cash money, everybody is selling their other financial assets and thus their prices--stocks, bonds, whatever--and all their prices are low. That is not the kind of downturn we have today: today the prices of some financial assets--the liabilities of credit-worthy governments, for example--are very high.

Third is an excess demand for safety after the housing bubble popped and the ensuing panic.

We conclude that the excess demand in financial markets right now on the part of investors is an excess demand for safety: for high quality AAA-rated assets for people that hold in their portfolios. Prices of risky financial assets are low--there is no excess demand for them. Prices of safe financial assets are high--there is an excess demand for them.

Thus businesses and households have cut back on their spending on currently-produced goods and services as they all have concluded: "We don’t have enough safe assets in our portfolios. We need to stop spending so much until we build up our holdings of safe assets to a higher level." And the fact that they cannot do so because there is a shortage of safe assets in the economy is what is keeping us wedged in this current situation of high unemployment and low capacity utilization.

Where did this excess demand for safe assets come from?

It came as a consequence of the deregulation of finance and of the securitization of mortgages, from the housing bubble and the crash, from the fact that then it turned out that investment banks that had created brand new derivative securities based on mortgages had not originated-and-distributed them but had, to a remarkable and astonishing degree, originated and kept them. They were supposed to sell off all the pieces o[f] real estate risk in small bundles to savers all over the world. They did not.

Financial Crisis Inquiry Panel to delay report until the end of January.

Federal Reserve Bank defends QE2.  by Sewell Chan

The Republicans who signed the letter were the Senate minority leader, Mitch McConnell of Kentucky; Senator Jon Kyl of Arizona; Representative John A. Boehner of Ohio, who is in line to become the House speaker in January; and Representative Eric Cantor of Virginia, the No. 2 House Republican. They emphasized that the Fed should be insulated from political pressure but also said the central bank "should be open to receiving input and data from a wide range of sources."

However, the letter was more moderate in tone than recent complaints voiced by other Republican critics, like Representatives Mike Pence of Indiana, the chairman of the House Republican Conference, and Kevin Brady of Texas, who is in line to lead a subcommittee on trade.

By contrast, in the Fed’s corner on Wednesday was Thomas J. Donohue, president of the United States Chamber of Commerce, which poured money into the midterm campaigns to defeat Democrats.

"The Fed has over many, many, many years been particularly helpful to this government and to this country in dealing with financial crises, and by the way, they always make money on it," Mr. Donohue told reporters, referring to the fact that the Fed each year turns over to the government the profit it makes as a byproduct of its investments. "We’re hopeful that the Fed’s judgments turn out to be very positive for job creation and economic expansion."

Mr. Donohue suggested that some of the criticism of Mr. Bernanke had gone too far, praising Mr. Bernanke as a scholar of the Depression and saying, "We must maintain the independence of the Fed and be very, very careful not to louse that up on Capitol Hill:"

The Beatings Will Continue Until Morale Improves

Irish Officials Acknowledge Need for Aid in Debt Crisis.

Ireland: a Textbook Example of the Dangers of Balanced Budgets and Fiscal Responsibility by Dean Baker

OECD sees global recovery slowing

January 7th panel in Denver at the AEA Annual Meeting

Panel Moderator: John Quiggin (University of Queensland, Australia) 

Brad DeLong (University of California-Berkeley) Lessons for Keynesians 

Tyler Cowen (George Mason University) Lessons for Libertarians 

Scott Sumner (Bentley University) A defense of the Efficent Markets Hypothesis 

James K. Galbraith (University of Texas-Austin) Mainstream economics after the crisis

Wikipedia entry on "duel" and dueling.

Isaac Asimov relates a joke in his Treasury of Humor (1971) that claims that Otto von Bismarck challenged Rudolf Virchow to a duel. As the challenged party had the choice of weapons, Virchow chose two sausages, one of which had been infected with cholera. Bismarck is said to have called off the duel at once.

One Way to Trim Deficit: Cultivate Growth by David Leonhardt

Krugman blogs:

As Catherine Rampell points out, this is the lowest level of core inflation ever.

But I have a question here: why do economic forecasters keep predicting a near-time rise in core inflation, even though they are also predicting high unemployment? The Survey of Professional Forecasters now predicts average unemployment of 8.7 percent in 2012, which would seem to be a recipe for continuing disinflation and quite possibly deflation; but the same forecasters predict a noticeable rise in core inflation over the next two years:

 

I don’t really understand this, except as a fundamental unwillingness to face up to the Nipponization of the US economy.

Meanwhile in Europe, the debt crisis resurfaces. Dean Baker blogs:

Ireland is in the headlines these days as its government struggles with insolvency. Remarkably, none of the news stories remember to point out that Ireland was a model of fiscal responsibility in the years leading up to its current disaster. Not only did it balance its budget, Ireland ran large budget surpluses in the 5 years preceding its collapse in 2008. Its peak surplus in 2006 was 2.9 percent of GDP, the equivalent of a surplus of roughly $420 billion in the United States.

Like the deficit hawks in the United States, Ireland's political leaders ignored the country's massive housing bubble, the collapse of which sank its economy. It is interesting to note that, while Ireland's background to the deficit crisis is generally ignored, news reports on Greece's financial difficulties routinely referred to its large budget deficits in the years leading up to the crisis.

And yet here we are in the US talking about deficits and the Catfood Commission.

Generation Why? by Zadie Smith

Philly Fed revises downwards. I bet the economy does better than this but it's just a hunch.

(via DeLong, via Atrios)


Under Attack, Fed Officials Defend Buying of Bonds by Sewell Chan

Bernanke and the Fed have been attacked by China, Germany etc., Greenspan and conservative letter writing economists.

Yglesias directs us to this by Greg Mankiw. He didn't sign the letter, nor did Mark Zandi. Both have gone up in my book. Greenspan seems to have reverted to form after admitting he was wrong about self-regulating banks.

Tim Duy writes:

Bottom Line: In general, the retail sales report was good news, as it is another indicator that drives a stake into the heart of the double-dip story. But keep in mind that the data continues to illustrate the good cop, bad cop conflict in the economy. Policymakers should be concerned about the distance between new trends and old, lest they risk falling into the trap of diminished expectations, believing that 9% unemployment should be the new normal. Market participants, however, may simply be content with confirmation that the foundation for ongoing corporate revenue growth remains secure.

(via Mark Thoma)

Krugman responds to fellow columnist David Brooks:

So David Brooks claims that

The economic approach embraced by the most prominent liberals over the past few years is mostly mechanical. The economy is treated like a big machine; the people in it like rational, utility maximizing cogs. The performance of the economic machine can be predicted with quantitative macroeconomic models.

I protest, on several grounds.

First, it’s conservative economists who insist that people are always rational and utility-maximizing; liberal economists are the ones willing to invoke bounded rationality, animal spirits, etc.. The whole salt-water fresh-water split was about which you were going to believe: the assumption of perfect maximization, or your own lying eyes. And the Keynesians were the ones who preferred to believe their eyes.

Second, David would have us believe that the Obama people were misled by their excessive faith in models. But we actually know what happened when the stimulus was being discussed: the modelers, who said that we needed something much bigger, were dismissed in favor of gut feelings about market psychology.

The truth is that we would have been much better off if Obama et al had relied on old-fashioned hydraulic Keynesianism.

David Brooks: Math is Hard, Just Give Money to Rich People by Dean Baker

Brooks is a member of my "rogues gallery."