Regulate and Backstop

The shadow banking system is still unregulated.

Simon Johnson's Latest on Bernanke and Too Big to Fail by Dean Baker

Late Night with Ben Bernanke by Binyamin Appelbaum

3. Not surprisingly, Mr. Bernanke often is asked to reflect on the financial crisis. He offered something a little different than his normal response on Friday night. 

“In many ways, in retrospect, the crisis was a normal crisis,” he said. “It’s just that the intuitional framework in which it occurred was much more complex.” 

In other words, there was a panic, and a run, and a collapse – but rather than a run on bank deposits, the run was in the money markets. Improving the stability of those markets is something regulators have yet to accomplish.*

(via Thoma)

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*

Equipping the Fed for a Future Crisis by Appelbaum

5:33 p.m. | Updated to reflect alternative solutions proposed by the New York Fed chief. 

The federal government has generally responded to the financial crisis by expanding the power of regulators, most of all the Federal Reserve. But in an interesting speech this month, William C. Dudley, president of the Federal Reserve Bank of New York, argued that Congress has not gone far enough. 

Mr. Dudley’s concern is about a little-noticed piece of the 2010 Dodd-Frank Act that actually reduced the central bank’s authority in one crucial area: its ability to provide emergency funding to strapped financial firms. 

The Fed arrested the 2008 financial crisis by using this authority to create a series of unprecedented programs that offered emergency financing not just to American banks – its traditional flock – but also to foreign banks, and not just to banks but to other kinds of financial companies as well, and indeed to other kinds of companies entirely. 

Congress responded to this performance by making it difficult to repeat. Dodd-Frank imposed new restrictions on the Fed’s ability to make emergency loans, or to keep money flowing, outside the banking industry. 

One basic reason was that Congress had never really intended to give the Fed such broad power in the first place. Rather remarkably, the authority that the Fed used to save the financial system in 2008 was granted by Congress in 1991 with almost no debate or public notice, a story I first told in The Washington Post in 2009. It was quietly slipped into a broader bill by former Senator Christopher Dodd of Connecticut, at the behest of Wall Street companies including Goldman Sachs. When it was first used almost two decades later, legislators like Representative Barney Frank confessed that they didn’t know they had voted for it. 

Furthermore, everyone agreed that the 1991 law didn’t make much sense. It expanded the Fed’s safety net without expanding its regulatory authority. Banks are backstopped and, at least in theory, carefully regulated. Backstopping the rest of the financial system without regulation was an invitation to excess. There’s a reasonable argument that that contributed to the crisis. 

But rather than expanding regulation, Congress decided to pull in the net. 

This decision commanded broad support. Bailing out financial firms is not a popular spectator sport, and there is a general consensus in Washington that public policy should focus on minimizing the damage when firms fail. 

“Many – myself included – have drawn from the financial crisis the conclusion that government safety nets should be drawn tightly so that only a very few, very tightly regulated firms get as little liquidity support as possible,” Karen Shaw Petrou, a close watcher of financial regulation who drew my attention to Mr. Dudley’s speech, wrote to clients of her firm, Federal Financial Analytics. 

A more inclusive policy, she continued, “will open the safety net, wide, wide open to all sorts of actors who, smiling sweetly, will rob us blind.” 

Mr. Dudley takes the opposite view. He argued in his recent speech that it would make no sense to draw a line between banks and other kinds of financial firms if both were playing essentially the same role in the broader economy. 

Both should be regulated, and both should be backstopped. 

“If we believe that these activities provide essential credit intermediation services to the real economy that could not be easily replaced by other forms of intermediation, then the same logic that leads us to backstop commercial banking with a lender of last resort might lead us to backstop the banking activity taking place in the markets in a similar way,” he told the New York Bankers Association. 

Perhaps the most powerful argument for this view is that the absence of a broader backstop is the mechanism by which a housing crash became a financial crisis. 

The government stabilized deposit funding through the creation of the Federal Reserve, as an emergency lender to strapped banks, and the Federal Deposit Insurance Corporation, as a guarantor that depositors would get their money back. 

But banks and other financial companies increasingly draw money from sources that do not have similar backstops, including the sale of commercial paper to money market funds and complicated arrangements called “triparty repos” that basically allow financial firms to borrow money by pledging assets as collateral. 

These are short-term loans that must be renewed regularly, often daily. As a result, panic among investors can almost instantly undermine financial stability, which is exactly what began to happen in 2007: Panic spread, financing disappeared, and the global financial system came perilously close to complete collapse. 

There is broad agreement that something should be done to improve the stability of money-market funds and the triparty repo market. So far, nothing much has happened, but one can’t rule out the possibility that that will change. 

Mr. Dudley favors many of these efforts, but his broader point is that they all are insufficient. There is no substitute for the role the Fed now plays in the banking system, as a lender of last resort – and not just the emergency authority granted to the Fed in 1991, but authority to serve as a permanent backstop. 

Alternatively, he noted that regulators could instead choose to restrict the use of unstable funding sources, but that is a solution many regard as impractical. 

Perry Mehrling, an economist at Barnard College, argued in a 2011 book, “The New Lombard Street,” that it had never made sense to restrict the Fed’s backstop to the traditional banking system, because banks had always been part of a broader system, all of which required the same regulation and support. 

“The practical intertwining of money markets and capital markets is the defining institutional feature of the American system, and that feature requires a similarly integrated backstop by the central bank,” Professor Mehrling wrote. 

The only choice, he argued, was between planning carefully for the next crisis, or repeating the Fed’s ad-hoc any-tools-available response in 2008. 

Mr. Dudley appears to be in complete agreement with that view. 

“The sheer size of banking functions undertaken outside commercial banking entities – even now, after the crisis – suggests that this issue must not be ignored,” he said. “Pretending the problem doesn’t exist, or dealing with it only ex post through emergency facilities, cannot be consistent with our financial stability objectives.”

If Not For That Pesky Sequester by Tim Duy

This morning's Wall Street Journal headline on the sequester included this quote:

"If they could get this fixed, the economy is poised to take off," Bank of America Corp. Chief Executive Brian Moynihan said in an interview.

I believe this is largely correct, albeit "take off" is perhaps a bit strong. The US economy looks to have shaken off some of last year's doldrums, particularly in manufacturing and the housing recovery is set to accelerate further this year. While clearly some external headwinds remain, notably the ongoingeconomic disaster that is Europe, I tend to think these will have only a second-order impact on the US economy. The immediate concern is obviously the impact of the sequester and earlier tax hikes, especially considering the evolving views of the impact of fiscal policy. That said, while I find the timing of these policy changes unfortunate and believe they place an unnecessary speedbump in the recovery process, their impact should fade as the year progresses.

(via Thoma)

The Immorality of the Interest Rate Hawks by Krugman

Economic Conditions and Conditionality by Charles Evans

AV Clubs reviews "Comint" on "The Americans."

Greed is Good

Hidden profits, hidden rents by Steve Randy Waldman

Evan Soltas has a very good post on the explosive growth of the financial industry since the end of World War II. As a share of GDP, in terms of profits, and in terms of payroll, postwar America has been truly been a golden age for bankers, brokers, and fund managers. 

In fact, it’s even better than it looks! 

...

There are lots of good reasons to reduce our dependence on the institution of debt in favor of more equity-like arrangements. Evolving towards a smaller financial industry less capable of capturing rents is another reason. Using the power of the state to stabilize the inflation rate is a bad idea, also for lots of reasons, including that the practice encourages debt finance and powerful banks.

I knew this before it was cool. Doug Henwood's "Wall Street" is good on this.

Ben Bernanke to Congress: You’re doing it wrong by Ezra Klein

Yen Depreciation and the Scope for Expenditure Switching by Menzie Chinn

With Haruhiko Kuroda ascending to head the Bank of Japan [1], it is likely that monetary policy will remain fairly expansionary. Even without direct intervention in foreign exchange markets, the yen will likely continue to weaken as expectations of inflation rise. What is the likely impact of trade flows?

a bad negotiator you say?

White House Believes G.O.P. Will Bend as Cuts Take Hold

WASHINGTON — President Obama’s team concedes that the almost certain arrival of across-the-board budget cuts on Friday will not immediately produce the politically dramatic layoffs and airport delays that the administration has been warning about for days. 

But White House strategists say they believe that a constant drip-drip-drip of bad news will slowly emerge in Congressional districts across the country in the weeks ahead, generating negative headlines and — they hope — putting Republicans on the defensive for their refusal to raise taxes. 

Yet by accepting the inevitability of an extended Washington stalemate, the president is risking the possibility that Americans will eventually blame him — not members of Congress — for job losses, smaller paychecks, longer lines at airports, a reduction in government services and a less well-equipped military. 

He could also ultimately emerge as a kind of president-who-cried-wolf if Americans just shrug at the slow-rolling budget cuts and think the crisis atmosphere that Mr. Obama created was more hype than reality. On Tuesday, the president began admitting that the impact of the cuts “won’t be felt overnight.” 

Even so, he has aggressively used the White House political machinery to ratchet up public anxiety about the budget cuts, called sequestration. The goal, officials said, is to prepare Americans for layoffs, shrinking benefits and reduced services — and to ensure that Republicans get blamed. 

“It will be like a rolling ball,” Janet Napolitano, the secretary of homeland security, said this week, describing the impact of the budget cuts on her sprawling agency. “It will keep growing.” 

White House officials said on Wednesday that Mr. Obama had invited the Congressional leadership to a meeting on Friday, after the cuts have gone into effect — a stark indication that the administration does not expect any progress before then. 

The wait-it-out political strategy in the White House is different from the one Mr. Obama pursued in previous tax and spending standoffs with Republican lawmakers. In those clashes, the president urgently sought to reach last-minute deals with Republicans to avoid the dire fiscal and economic consequences of an impasse. 

Republicans are trying to make the case to the American public that the president and his staff are trying to frighten people by overstating how difficult it will be for government agencies to trim their spending. 

In an interview Tuesday evening, the House speaker, John A. Boehner, said the White House was trying to “play games with the American people, scare the American people,” adding, “This is not leadership.” 

Officially, White House officials say the president remains hopeful that something might happen in the next 48 hours to delay the automatic cuts, which he and the Republicans agreed to in the summer of 2011 as a way to prod agreement on how to cut the nation’s soaring deficit. 

In reality, there appear to be no attempts at last-minute negotiations. The president’s top aides said they expected Mr. Obama to have discussions with lawmakers this week, but they have repeatedly said that they do not have any planned meetings or phone calls to announce before Friday. 

“The president has been engaged and will continue to be engaged with Congressional leaders of both parties on the issue of the sequester,” Jay Carney, the president’s press secretary, told reporters aboard Air Force One on Tuesday. 

White House officials do not expect Mr. Boehner or Senator Mitch McConnell of Kentucky, the Republican leader, to suddenly agree to tax increases in the next two days. And the president has no intention of backing away from his demands for what he calls “balanced” deficit cutting that includes tax increases and spending cuts. 

As a result, the next several weeks could look very much like the present, with Mr. Obama flying to communities around the country to highlight the impact of the budget cuts. 

House Republicans, meanwhile, remain confident that their members will not give in to the president’s demands for tax increases no matter what happens after the cuts take effect. 

Strategists for Mr. Boehner believe that Republicans have been successful in branding the automatic cuts as Mr. Obama’s idea. For weeks, the speaker and others have pointed to news reports from 2011 suggesting that sequestration was initially proposed by the president’s top aides. 

Top Republicans say that their members previously made concessions to Mr. Obama only when inaction would have automatically led to a payroll tax increase or an income tax increase on all Americans. This time, they say, their inaction will lead to spending cuts, something they say Americans support. 

Mr. McConnell said in a statement on Wednesday that the meeting with the president on Friday was a chance to affirm the Republican commitment to spending cuts. 

“With a $16.6 trillion national debt, and a promise to the American people to address it, one thing is perfectly clear: we will cut Washington spending,” Mr. McConnell said. “We can either secure those reductions more intelligently, or we can do it the president’s way with across-the board cuts. But one thing Americans simply will not accept is another tax increase to replace spending reductions we already agreed to.”

Republicans didn't care about the payroll tax increase, which happened anyway. Americans don't support spending cuts as the Republicans will find out. The Teabaggers miscalculated again just as they assumed the debt ceiling clown show was feasible until their leadership explained it to them.

It takes a village

 M83 | Midnight City from DIVISION on Vimeo.

"Village of the Damned" has been running on cable lately. I didn't realize that John Carpenter, one of my favorites, had directed it. VotD is good but kind of cheesy in a mid-90s way. M83 is a French band and it's amusing to imagine intelligent French musicians watching cheesy American pop cultural products.

Stereolab has a great song titled "Exploding Head Movie" which must be named after "Scanners."

AV Club review of "Outlaw' on Justified.

I could see Shelby turn out to be Drew Peterson.

Republicans hate social insurance

The Perfect Logic of Boehner’s Crazy Sequester Strategy by Jonatahn Chait

This is just a way of saying that most Republicans are seized with apocalyptic economic terror, and cannot or will not rationally identify actual problems and work pragmatically toward their resolution. 

Indeed, their plan of forcing high-profile confrontations with Obama almost surely weakens their position in every way. Obama is much more popular than they are, Obama’s budget proposals are much more popular than theirs, and Obama has a much more advantageous platform with which to communicate. Republicans would be much better served to sit down and negotiate with Obama now. Once sequestration starts to bite, defense contractors and other businesses harmed by it will be howling for Boehner to compromise, and rational party leaders will likewise begin to panic at a reprise of the Gingrich-era government shutdown that cements the party’s image as a pack of loons. 

But Boehner can’t negotiate now. Indeed, his members were so angry at the fiscal cliff deal — even though it did not come out of negotiations with Obama — that Boehner had to promise no further secret negotiating with the president. (And, of course, secret negotiating is the only kind of political negotiating. Politicians don’t horse trade in public.) Boehner has to lead his party into a huge fight or else risk being deposed. 

Jake Sherman’s report on Boehner’s thinking contains a number of useful clues. Boehner, he reports, will cut a deal in the end: “Republicans are aiming for an eventual package that will include a hefty dose of spending cuts and reforms like a change to calculating government benefits called chained CPI and closing a few tax loopholes.” Obviously, Boehner wants the spending cuts to be as big as possible, and the higher taxes as small as possible, but cutting a deal is the endgame. 

Why not do it now? Because Boehner understands that “starting off this new session of Congress by hiking taxes again would be akin to political suicide for the Ohio Republican.” He has to show the ultras he’ll fight. If the GOP takes a major hit in the process, which it almost surely will, then he’ll have an internal rationale to compromise. Boehner is marching his party into war because the guns facing his troops are less dangerous to him than the ones pointed at his own back.

Obama shouldn't take a deal with Boehner's rump Republicans which includes chained CPI, even if it means deposing Boehner. I don't think he will. House Democrats should refuse to vote for it.

It's a Hobson's choice, more job-killing austerity or entitlement benefit cuts. But Republicans will lose over no deal.

Yglesias talks about cross-pressure. Certain prolier-than-thou Obama-hating liberals like Kervick, don't understand legislative politics. They argue Obama wants cuts.

Django Unchained: A white revenge fantasy by Noah Smith

King Schultz, you see, is a German. Whatever claim Southerners have to be the Real White People, Schultz' claim is deeper and more credible. He's got Siegfried and Brunhilde. And slavery - the institution on which the South built its civilization - is beneath him. He is contemptuous of it and the degenerate human beings who practice it. He does not view slavery as "normal" for the 1800s. He does not shed a tear when he guns slavers down. 

And gun them down he does - in droves. The supposedly mighty Southern warriors are no match for Schultz' Prussian gunnery. I see this as Tarantino giving a big fat middle finger to Southern pretensions of military manhood; one diminutive middle-aged German dude makes them look like amateurs. King Schultz, you see, is the Real Real White Guy, and one such man is worth a thousand of the chickenshit slavers who tried to usurp the mantle of the white race.

Um no. See my review. Germany had a long tradition of being on the right side of enlightenment and democracy until war, depression and fascism crushed that tradition. Goethe, Beethoven, Marx.

My paternal Grandfather's name was Siegfried. I recently learned I'm related to Lincoln's Secretary of War, Stanton.

department of huh???? sucking up to the Clinton administration veterans

Careerism

AMERICAN CONSERVATISM’S CRISIS OF IDEAS: PROJECT SYNDICATE MONARCHY, PATRIARCHY, ORTHODOXY WEBLOGGING by DeLong

The big difference between the Malthusian conservative critics of social insurance in the early nineteenth century and the Chicago critics of the 1970’s is that the Chicago critics had a point: Providing public support to the “worthy” poor, and then removing it when they began to stand on their own feet, poisoned incentives and was unlikely to lead to good outcomes. 

And so, from 1970 to 2000, a broad coalition of conservatives (who wanted to see the government stop encouraging immorality), centrists (who wanted government money spent effectively), and leftists (who wanted poverty alleviated) removed the “notches” from the social-insurance system. Presidents Jimmy Carter, Ronald Reagan, George H. W. Bush, Bill Clinton, and even George W. Bush and their supporters created the current system, in which tax rates and eligibility thresholds are not punitive disincentives to enterprise.

Clinton's welfare reform was a dismal failure. As was his deregulatory ideology which allowed an unregulated shadow banking system to arise. Doesn't matter how much incentive there is to work if there's no work to be had.

Ideological Movements Need Accurate Reporting by Yglesias

And I do think there tends to be an asymmetry here. Last night I read a great piece by James Ridgeway and Jean Casella about how prison guard unions often stand in the way of criminal justice reform and about how since the guards are often part of larger umbrella unions such as AFSME or AFGE they can punch above their weight. And I didn't read it in a libertarian magazine where it would be a natural ideological fit; I read it in Mother Jones, whose readers' instincts are going to be cross-pressured.

It's the Third Wayers who need to be cross-pressured. Welfare reform failed. Robert Rubin was a failure. Renominating Greenspan was an epic failure by Clinton. I did like how Clinton blurbed Alan Blinder's new book which is critical of him obliquely. I like how Clinton worked to help re-elect Obama. Politicians can't hold grudges. And finally at the time I failed to realize how hard it was for Clinton to work with a Republican Congress that wasn't inclined to compromise. My bad.

BERNANKE’S WELCOME LECTURE ON AUSTERITY ECONOMICS by John Cassidy

Fed Defends Stimulus in Testimony to Senate by Binyamin Appelbaum

The reception on Capitol Hill was frostier, as several Republican senators challenged Mr. Bernanke’s assertion that the purchases were producing clear economic benefits, and questioned the potential costs. Senator Bob Corker, a Tennessee Republican, drew Mr. Bernanke into an unusually sharp exchange. 

Mr. Corker, asserting that low interest rates were “throwing seniors under the bus,” by reducing returns on some kinds of investments, asked Mr. Bernanke, “Do you all ever talk about the longer-term degrading effect of these policies?” 

“One thing we talk about is unemployment,” Mr. Bernanke responded. He added that the best way to increase interest rates was to increase growth. 

Mr. Corker then accused Mr. Bernanke of insufficient concern about potential inflation, saying, “I don’t think there’s any question that you would be the biggest dove since World War II,” using the term “dove” to denote a Fed official who is more concerned about unemployment than higher inflation. 

Mr. Bernanke, clearly piqued, responded, “You call me a dove, but my inflation record is the best of any chairman in the postwar period.”

 Republicans: Fact Free Zone.

Yes Virginia the GOP is dishonest

Republicans Finally Decide That the Fiscal Cliff Deal Was a Tax Hike by David Weigel

In today's GOP leadership presser, Rep. Eric Cantor tweaked a line that Mitch McConnell has been using for weeks. The fiscal cliff deal included a tax increase. Thus, there was no more need for tax increases. "There have been four years of spending increases," said Cantor, "and now the President says we can’t have any progress on the sequester unless he gets a second tax hike in eight weeks." 

We're forgetting a sublime, ridiculous fact about that fiscal cliff deal. By law, on January 1, tax rates rose to pre-Bush levels. Later that day, when the president signed the deal, the rates "lowered" again -- only the top rate was hiked to 39.6 percent. In order to defend their tax cut bona fides, Republicans pretended that the deal amounted to a tax cut. 

This spin got around. "After more than a decade of criticizing these tax cuts,” said Rep. Dave Camp, chairman of the tax-writing Ways and Means committe, "Democrats are finally joining Republicans in making them permanent. Republicans and the American people are getting something really important, permanent tax relief." Grover Norquist, blamed and demonized by the media for holding Republicans accountable on taxes, argued that "the Bush tax cuts lapsed at midnight last night," so "every Republican voting for Senate bill is cutting taxes and keeping his/her pledge." 

But that was eight weeks ago. Now it's in Republicans' best interests to pretend that they met the president halfway and raised taxes. Forget about moving the goalposts. This is pulling a Criss Angel on the goalposts and making them disappear.

Macho Men, Social Security, and the Chained CPI by Dean Baker

department of huh? DeLong defends IMF

TUESDAY TEN YEARS AGO ON THE INTERNET: KEN ROGOFF: THE IMF STRIKES BACK by DeLong

Seems to me that the periphery of Europe (and the U.S.) recently had hot money flow in and out which cause budget problems and recession regardless of the state of the county's budget. Italy and Spain were not that bad. 

Capital controls would have helped. They're not cost free but basically they're regulations. At least have a transaction tax to help build a rainy day slush fund.

Seems like the Washington Consensus IMF view helped create the world wide housing bubble /bond bubble which was disastrous.

'Fix the Economy, Not the Deficit' by Thoma

Dean Baker:

Fix the Economy, Not the Deficit, by Dean Baker, The American Prospect: 

The next step at that point is unclear. President Obama has explicitly offered cuts in Social Security and Medicare if the Republicans will go along with higher taxes. For those who oppose cuts to these programs, the generous view of this maneuver is that he knows that the Republicans won’t budge on taxes; by offering a compromise, he is simply making them look unreasonable. The less generous view is that he is actually willing to make cuts in these programs, sharing the view of Washington Post-centrist types that seniors are living too high on the hog. 

While the odds are against a “grand bargain” that couples tax increases with cuts to Medicare, Medicaid, and Social Security, it remains a possibility. However, it’s more likely that President Obama and Congress will agree to some scaled-down version of the sequester... This will have the deficit hawks yelling and screaming, but that would be the best plausible outcome from the standpoint of the economy. ... 

My view is of the less generous variety. I think Obama is quite willing to make these cuts.

 So if he does, Thoma is right. If not he was wrong. At least he went on record.

The greatest show that ever was or will be

Enlightened is TV’s best show right now—and it needs more viewers

Except maybe for Walking Dead. AV Club reviews "I Ain't Judas." 

Or "Justified" or "The Americans." Etc.

"high demand" not "excess demand" and "reaching for yield."

READINGS FROM JÉRÉMIE COHEN-SETTON AND MARTIN KESSLER OF BRUEGEL: SAFE ASSETS, THE DOWNTURN, AND THE RECOVERY by DeLong

What is an "excess demand for money"? by Nick Rowe

(via Thoma)

What's the debate between DeLong/Beckworth and Rowe/Waldmann?

Alan Blinder spoke of a bond bubble alongside the housing bubble. What happened?

Safe assets are now in high demand. This is signified by the fact that people with money (institutional investors, China, etc.) are willing to lend money to the U.S. at zero interest rates. 

Beckworth speaks of "market segmentation." During the bond bubble, there was no segmentation as mortgage-backed-securities earned higher interest rates than they deserved. The demand for money was met even as we had a savings glut with interest rates above the zero lower bound. ???

Since there is no bond bubble, people with money don't have places to park it where it earns interest (reaching for yield). But as Waldmann correctly points out, there isn't an "excess" demand as people can buy as many Treasuries as they want. Rowe concurs. 

But people with money would pay more for safe assets if they had to and send interest rates negative. But they can't and so what do they do with the extra money? They sit on it? Excess reserves at the central bank.

DeLong writes "Brad DeLong [says]… "John Stuart Mill… saw that excess demand for some particular set of assets in financial markets was mirrored by excess supply of goods and services in product markets, which in turn generated excess supply of workers in labor markets. If you relieved the excess demand for financial assets, you also cured the shortfall of aggregate demand" [for a recent formulation of these arguments, see Ricardo Caballero and Emmanuel Farhi]."

Commenter at Rowe's blog responds: 

(I think I'll just recycle the comment that I left Robert Waldman on DeLong's original post, because I think it might apply here as well.) 

"Excess Supply (or Demand)" has more than one meaning. Those meanings are non-identical, but related. 

Waldman and you focus on the micro-economic meaning; in a single market for a homogenous good we can see whether supply for that good is greater than or less than demand when we hold prices fixed. That's a precise definition and probably the most common one. 

Macroeconomists have a related and different definition. They're comparing aggregate supply (i.e. potential output) and aggregate demand. Now, in some simple models it is possible that the two meanings correspond; aggregate demand equals aggregate supply if the aggregate price level is right. That equivalence goes away in more complicated macroeconomic models. 

I think another way of saying that last sentence is to say that "potential output" is not necessarily the same as the sum of a bunch of price-based supply functions.

Prices during and after bubble. Prices of safe assets were lower during the bubble as people were parking their money in riskier assets which paid higher interest rates. So demand of safe assets was lower. Or rather the supply of safe assets was much much higher as per Blinder's bubble many unsafe assets were treated as safe assets.

Post bubble prices of safe assets are much higher - as are the demand - as people are willing to lend to the Treasury at zero interest rates.

So Mill and DeLong are saying we need more safe assets? QE is supposed to lower the demand and price of riskier assets as the Fed buys them. Waldmann is skeptical of QE.

Economist Ignored the Financial Sector (FireDogLake)

(via Thoma)

Dean Baker and Santelli on CNBC