Saturday, April 30, 2011

Instant Balanced Budget!

Today I've read (don't ask why) some interesting assertions that not passing an increase in the debt ceiling would actually be okay, and wouldn't really spell doom for the US's economy. The crux of the argument from the "don't-believe-the-lies-about-the-debt-ceiling" crowd seems to be that payments to all creditors could still be made (thus ensuring that the US avoids technical default) so long as government spending on goods and services is immediately cut by a sufficient amount to balance the budget. Since we can't get the politicians to agree, we let the debt ceiling force spending to be equal to revenues and presto, instant spending cuts and balanced budget!

Actually, yes, there's some sort of point there; I suppose it might be possible to continue to make interest payments on the debt even if the debt ceiling isn't raised, because revenue inflows are sufficient to cover those interest payments -- so long as you can instantly cut federal spending by $1.3 tr. annually.

Just for fun, let's imagine that we can simply stop sending out checks for $1.3 tr. worth of government purchases without actually getting into the situation where the US government isn't paying someone what they're legally owed. Let's imagine what that would do to the US economy.

A cut in spending translates into an initial fall in economic activity by an equal amount; cut $1.3 tr in government spending, cut economic output by $1.3 tr. (There's no crowding in effect when interest rates are at the zero lower bound, after all.) So overnight the US economy suddenly shrinks by about 10%. For reference, during the recent recession the US economy only shrank by 3%. Oh, and then over the coming months a couple of different multiplier effects would kick in, causing output to drop further.

If economic activity has fallen by 10% or more, it's reasonable to think that employment will fall by roughly the same amount. So we can expect about 10 million people to lose their jobs in very short order, bringing the unemployment rate to close to 20% of the US population. And then it would probably rise from there as the multiplier effects do their thing. For reference, during the recession the unemployment rate peaked at a lowly 10%.

Ah, interesting; we could all have the experience of living through the Great Depression, only this time it would have been caused intentionally...

UPDATE: text edited slightly for clarity.

Friday, April 29, 2011

Where are the Grownups?

When it comes to economic policy, the grownups among politicians in Washington DC have gone missing. (Brad Delong clearly needs to resume his occasional series, "Grownup Republican Watch".) And in today's world where uninformed, discredited, and illogical economic policies seem to be eagerly accepted as gospel by legislators, the grownups have gone quiet on both sides of the aisle:
Debt ceiling: More Democrats threaten to vote against raising borrowing limit

A growing number of Democrats are threatening to defy the White House over the national debt, joining Republican calls for deficit cuts as a requirement for consenting to lift the country’s borrowing limit.

The tension is the latest illustration of how the tea-party-infused GOP is driving the debate in Washington over federal spending.
So the dangerous game in which the possibility of US government default is a bargaining chip does not seem to be over, and in fact seems to be getting new players.

And then there's the real and destructive impact of the growing threats against the Fed's independence.

Thinking more about how effective those threats from inflationistas in Washington have been in shaping current monetary policy, I came across this piece from last fall by Kenneth Silber (at David Frum's website):
The Fed and The GOP Weren’t Always Enemies

The Fed chairman was testifying before the House banking committee. When he explained the central bank’s planned course of action, the members reacted with fury. Rep. Frank Annunzio (D-Ill.) shouted: “Your course of action is wrong.” Rep. George Hansen (R-Idaho) railed that the Fed was “destroying middle America.” Rep. Henry Gonzalez (D-Texas) called for the chairman’s impeachment.

That was in July 1981. The Fed chairman was Paul Volcker and the course of action the members were decrying was a further tightening of monetary policy. As the economy fell into recession, public outrage toward the Fed grew. Volcker’s mail included bricks from contractors to symbolize the houses they couldn’t build, and keys from car dealers for cars they couldn’t sell.

Yet the Fed stuck to its guns and ultimately won widespread plaudits for taming inflation. An underappreciated aspect of this episode is that President Ronald Reagan not only refrained from jumping on the anti-Fed bandwagon but also defended the institution and its independent role in making monetary policy. “This administration will always support the political independence of the Federal Reserve Board,” he said in a February 1982 press conference in the midst of recession.
As in so many policy arenas, the grownups in the Repuiblican party used to be willing to speak up. But not today. As a result, the US's monetary policy is being influenced by extreme political rhetoric and bizaare economic theories to a worrying degree.

Okay, I admit it: when fringe elements in Washington (mainly on the right, but partly on the left as well) began making noise about reducing the Fed's independence over the past year or two, I discounted it. Given how important central bank independence is to long-run monetary policy, and given how difficult it is to regain such independence once it is lost, I never thought that such yapping would ever be allowed to have any significant impact on how the US conducts its monetary policy.

But I now think I was wrong. I now think that the current threats to the Fed's independence may be a serious danger to the long-term economic prospects of the US economy -- certainly a far more serious danger than any government budget deficit you care to imagine. I now think that Ron Paul and his supporters actually have more power, and are more dangerous, than I ever could have imagined possible.

And where are the Fed's defenders? Sure, plenty of economists have gone on the record affirming the importance of keeping the Fed insulated from political pressure. But where are the politicians who are willing to do the same? And why are so many elected officials today willing to risk serious and possibly irrevocable damage to the US economy, whether it be by threatening to force the US government to default or by threatening to curb the Fed's independence? Where are the grownups?

Thursday, April 28, 2011

How the Inflationistas Have Shaped Fed Policy

Ben Bernanke's press conference yesterday seems to have left observers with one crucial take-away. As noted by Tim Duy:
The most interesting comments came in response to questions about whether the Fed should do more to lower unemployment and if QE2 is effective, shouldn’t the program continue? Here was a more hawkish Bernanke. As I noted earlier, growth forecasts returned to the pre-QE2 range, which should be a red flag. Unemployment remains high, with only moderate job creation. Core-inflation remains low, while the impulse from commodity prices on headline inflation is expected to be temporary. ...So why not do more? Because the Fed needs “to pay attention to both sides of the mandate” and the “tradeoffs are less attractive.”

Apparently the threat of headline deflation off the table, Bernanke is not inclined to pursue sustained easing despite low core inflation and high unemployment.
Numerous observers (see e.g. Mark Thoma, Brad DeLong) have noted that any concern about inflation by the Fed right now is a bit ridiculous. In fact, the more "hawkish" Bernanke on the topic of further expansionary actions by the Fed seems at odds with the Fed's own data and projections. Most significantly to me, it also seems at odds with Bernanke's remarkably detailed and perceptive explanation of exactly why he finds the long-term unemployment problem to be so very "distressing":
BERNANKE: You're absolutely right. Long-term unemployment in the current economy is the worst, really, the worst it's been in the post-war period. Currently, something like 45 percent of all the unemployed have been unemployed for six months or longer. And we know the consequences of that can be very distressing, because people who are out of work for a long time, their skills tend to atrophy; they lose contacts with -- with the labor market, with their other people working, the networks that they have built up. Very concerning.
These are not the remarks of someone who doesn't care about the plight of the unemployed. And this not is the sort of detailed description of the permanent harm that unemployment wreaks on individuals that we would typically expect from someone who's principally worried about inflation. So why the talk about the potential dangers of inflation?

I believe that Bernanke's references to the Fed's "dual mandate", and most importantly, the hard reality confirmed in this press conference that there will be no further easing by the Fed, are the direct result of politics, not economics.

The noise that has been generated about the Fed's expansionary actions over the past 3 years is substantial, and has only gotten louder in recent months. This has not gone unnnoticed within the Fed. Some loud voices in the business press, as well as many prominent politicians (mostly Republican), have been squawking incessantly about the awful dangers (imaginary though they may be) of the Fed's expansionary policies. And I think that this, unfortunately, has had a direct impact on Fed policy. I think that there are genuine concerns at the Fed about its reputation and its independence, and that protecting both of those has forced Bernanke into the position of acknowledging the concerns of the Fed's critics, even though from a purely economic perspective they are absolutely misguided.

In short, I believe that we are seeing a Fed that is sensitive to the political winds swirling around its actions, and that the inflationistas out there have had a real impact on Fed policy -- not because they have good economic arguments, but because they have a frightening amount of political power. And perhaps that should be the most concerning thing of all.

Wednesday, April 27, 2011

The Fed's First Press Conference

Bernanke will hold the Fed's first press conference today. It's kind of a big deal - after the President of the United States, there may be no public utterances more carefully watched than those of the Chairman of the Federal Reserve Board.

The Fed has its enemies, many of whom seem to have no understanding of what the mission of the Fed actually is or how they accomplish it.

In unrelated news, Ron Paul was on the Colbert Report the other day:

The Colbert ReportMon - Thurs 11:30pm / 10:30c
Ron Paul
Colbert Report Full EpisodesPolitical Humor & Satire BlogVideo Archive

Enjoy the press conference.

Friday, April 22, 2011

Greek Default: Starting to Look Inevitable

The Economist notes a change in tone this week regarding Greece:
Latin lessons

AT FIRST sight, Greece’s debt crisis has taken another turn for the worse. Yields on its government bonds have soared, rising above 20% on two-year paper on April 18th. But what seems to be bad news may in fact be good.

Greek bond yields are spiking because European policymakers now seem to be acknowledging what this newspaper has long argued was inevitable: Greece’s debt will need to be restructured. Even Wolfgang Schäuble, Germany’s finance minister, appears to be open to the idea. The official line, admittedly, remains that restructuring is not an option; and the European Central Bank still has its head firmly in the sand. But the debate in Europe is finally shifting from how to avoid a Greek restructuring to how to do it (see article).
Managing a sovereign default is always horrendously difficult, of course, but as this leader points out, there are useful precedents and restructuring models (mostly from Latin America) that can be used for guidance. It won't be the end of the world for Greece, and it won't necessarily mean disaster for the European banking system, if it's handled properly and doesn't spread to other countries.

However, significant questions arise when considering the consequences of default. The four that seem of most interest are:
  1. Will Greece leave the euro?
  2. What will happen to creditors (i.e. large European banks) and the European banking system?
  3. What does default mean for people in Greece?
  4. Will a Greek default spread to other euro countries (i.e. will we see contagion)?
Yesterday I shared my thoughts regarding the question of whether Greece will leave the euro. I haven't seen a lot of writing specifically addressing the other three questions, however, and would welcome tips. Regardless, I'll be thinking through some answers to those questions myself over the coming days.

Thursday, April 21, 2011

Can Greece Default and Keep the Euro?

Felix Salmon notes the following:
Greece is going to restructure its debts — and it’s going to do so before mid-2013. That’s the clear message sent by the latest Reuters poll of 55 economists from across Europe: 46 of them saw a restructuring in the next two years, with four saying it would happen in the next three months.

This is a major development. The markets haven’t believed Greece for a while — but now they don’t believe the European Union, either.
Count me with the majority of the economists surveyed here; I've been suggesting for quite a while that default is going to prove to be the least bad option for Greece. (For a cogent counter-argument, however, see this post by Rebecca Wilder.)

The reason that default seems increasingly likely is summed up in this picture from Deutsche Bank. It illustrates that the Greek government will have to run a primary budget surplus of more than 10% of GDP in order to simply stabilize its level of debt. How likely do you think that is? To me it seems frankly impossible. The only alternative is for German and French taxpayers to send Greece additional and ongoing chunks of money to make up that shortfall, and we seem to have reached the end of their willingness to do that.

But if default (I suppose we can use the polite term, "restructuring") happens, there are some interesting technical issues that bear thinking through. The most interesting of them, to me, is what this means for Greece's continued use of the euro as its currency. Does default mean that Greece must necessarily drop the euro?

I think the answer is that Greece won't necessarily have to drop the euro... but that the pressures to create a local Greek currency will be tremendous, and that it will probably turn out to be the least bad option.

The problem is the banking system. As debt restructuring seems increasingly likely, and certainly if and when restructuring actually happens, depositors in Greek banks will rush to withdraw their savings in order to place them in non-Greek banks. To some degree, this process has already started, but this will become a full-fledged bank run once debt restructuring becomes imminent. (Oh, but wait: bank runs are supposed to be forestalled by deposit insurance, and deposits in Greece are guaranteed... by the Greek government. Oops.)

I don't think there's much uncertainty about this part of the story. But now the Greek government has a choice. Do they:
  1. Simply allow the bank run to happen, let banks in Greece collapse, and let Greek depositors lose all their savings; or
  2. Freeze bank assets and forbid people from withdrawing their savings, at least for the time being, thereby preserving the amount of their deposits.
My guess is that they will choose option 2. As I've noted before, my preferred analogy to this situation is Argentina in 2001, and this is exactly what Argentina did by establishing the corralito in late 2001. I suppose in this case we could call the freeze on Greek bank deposits the mantríto (from what I believe is the Greek word for corral).

Okay, so now we have an incipient bank run prevented by a freeze on bank deposits, a Greek government that has defaulted and can not borrow externally (though they may be receiving some hand-outs from the EU or IMF), and a financial sector that has completely seized up, with no borrowing or lending in Greece. What next?

The problem the Greek government now faces is how to create a financial sector again - how to get borrowing and lending to recommence, so that the economy can start to get moving. And this is where a new, local currency would be very, very welcome.

The Greek government will therefore face a second choice. Do they:
  1. Continue to rely only on the euro as a currency, but keep the mantríto in place to preserve depositors' bank balances while rendering them untouchable, with the result that the banking sector is effectively frozen and Greece becomes a cash-only economy;
  2. Start issuing New Drachmas (as well as accepting them as a legitimate form of payment for tax liabilities), provide banks with a tranche of start-up capital in New Drachmas in exchange for Greek government bonds so they can start lending and creating the new money, allow people to retain their euro savings, but keep the mantríto to prevent massive capital flight; or
  3. Start issuing New Drachmas but also forcibly convert depositors' savings in Greek banks from euros into New Drachmas, thereby effectively shrinking the Greek public's savings balances significantly, and then allow the mantríto to gradually wind down as the danger of bank runs disappears.
My guess is that they will pick either option 2 or option 3. (For reference, Argentina picked option 3 in 2001-02.) Note that the euro wouldn't have to be completely abandoned -- it's easy to imagine two currencies operating side-by-side, at least for a while. (There are many examples of countries operating with parallel or complementary currencies.) But if they create a new currency (which will rapidly depreciate against the euro), then in addition to unfreezing the banking sector it would have the huge added benefit of quickly improving Greece's competitive position, and putting the country in a position to resume economic growth.

This is all very speculative, of course, and there are various decision points in the story I've outlined here where things could go the other way. But this story makes sense to me, and seems likelier than the alternatives. So my short answer to the central question posed here is: yes, Greece can keep the euro if it defaults, but it won't.

Tuesday, April 19, 2011

Why US Multinationals Expand Abroad

Mark Thoma points us to an article by David Wessel, who points out that new data from the BEA indicates that US-based multinational corporations (MNCs) decreased employment in the US while increasing employment outside the US:
Big U.S. Firms Shift Hiring Abroad
U.S. multinational corporations, the big brand-name companies that employ a fifth of all American workers, have been hiring abroad while cutting back at home, sharpening the debate over globalization's effect on the U.S. economy.
I would like to sound a note of extreme caution when interpreting such data. It's easy to jump to the conclusion that this data indicates that MNCs are shifting jobs overseas, and that foreign employment growth is coming at the expense of jobs in the US. However, that is probably not what's going on here.

The vast majority of employment and sales by the foreign affiliates of US-based MNCs are serving the local market. When GE, or Microsoft, or Coca-Cola, or American Express expand their operations overseas, it is almost always with the primary goal of satisfying local demand, rather than replacing workers in the US. Yes, of course some offshore outsourcing does happen (though much less over the past few years than happened in the early 2000s), but really that's not what's driving the dramatic difference in employment patterns of US MNCs within the US compared to outside the US.

The following table shows employment changes and sales growth between 1999 and 2008 by major region. (Source: BEA data.) As you can see, employment of US-based MNCs did indeed fall by about 8% in the US during the period, while employment by those same MNCs rose elsewhere in the world by about 30%. In fact, US-based MNCs increased employment in the Asia-Pacific region by almost 75% over the period.

However, this reflects the fact that sales grew much faster for MNCs in countries other than the US. For example, the US branches of US-based MNCs sold only about 46% more in the US market in 2008 than they did in 1999. Meanwhile, the affiliates of US MNCs located in Europe increased their sales (excluding to the US) by 122%, while affiliates in the Asia-Pacific region increased their sales to markets other than the US by 177%. In other words, US-based MNCs expanded their operations outside the US dramatically during the period, but not primarily in order to produce stuff to be shipped to the US; rather, that overseas expansion was to serve overseas markets, which were booming for them.

The next table provides another perspective on this phenomenon, looking at absolute values of sales. In 2008, for example, the US branches of US-based MNCs sold approximately $8.7 trillion to the US market, while selling about $550 billion to non-US markets (i.e. exports). Meanwhile, the affiliates of US-based MNCs in Canada sold about $108 bn to the US but about $485 bn to markets outside the US (presumably most of that within Canada itself). And affiliates in Asia shipped only about 5% of their production back to the US -- the other 95% of sales by those affiliates of US-based MNCs were to markets outside the US (again, probably mostly in the Asia-Pacific region itself).

The point is not to argue that offshoring never happens. It does. But the pattern of international trade, particularly when it comes to the activity of MNCs, is much more complex and nuanced than that. And the clearest implication of this data is that the primary motivation for MNCs to expand their operations outside the US is not to produce stuff more cheaply there to be sold to the US. Rather, MNCs expand overseas mainly to service overseas markets.

UPDATE: I fixed a calculation error in the tables and modified the text to match.

No, there is too much. Let me sum up.

I have to put up one more post about yesterday's news that S&P has changed their "ratings outlook" for US government debt. I wrote briefly about this development yesterday, but there are just sooooo many reasons why it should be treated as a silly irrelevance (a point that some members of the press, as well as many politicians, don't seem to understand) that I can't leave it at that.

Let me count the ways in which S&P's announcement should be deemed irrelevant, as noted by a host of other writers yesterday:

1. It's impossible to imagine how the US could ever default on its debt, since all of its debt is in dollars and the US can create as many dollars as necessary:
Yves Smith: The United States is simply not at risk of default. Default is impossible for a sovereign currency issuer.

2. The ratings agencies have a proven track record of incompetence, at best:
L. Randall Wray: A decade ago Moody’s downgraded Japan to Aaa3, generating a sharp reaction from the government. The raters back-tracked and said they were not rating ability to pay, but rather the prospects for inflation and currency depreciation. After 10 more years of running deficits, Japan’s debt-to-gross-domestic-product ratio is 200 percent, it borrows at nearly zero interest rates, it makes every payment that comes due, its yen remains strong and deflation reigns.

3. Or corruption, at worst:
Barry Ritholtz: If ever there was an organization more corrupt, incompetent, and less capable of issuing an intelligent analysis on debt than S&P, I am unaware of them. Why do I write this? A huge part of the reason the US is in its awful financial position is due to the fine work of S&P... the “negative outlook” of US debt has come about because the inability of Standard & Poor’s to have performed their jobs rating mortgage backed securities. Ultimately, this enabled the entire crisis, financial collapse, enormous budget deficit and now political over the debt ceiling. Of course there is a negative future outlook. Its in large part the work product of S&P and Moody’s.

4. The ratings agencies have access to no information that is not public already. Hence their announcement adds nothing other than the opinion of a few analysts, and should be treated the same way as a warning by analysts at any other Wall Street firm:
Ryan Avent: This is "news" in the sense that S&P said something and lots and lots of news organisations have opted to write about it. But is it news? No, it isn't. Neither the American fiscal position or its political dysfunction will come as a surprise to anyone who's been paying attention. S&P has not struck out boldly in fretting about American borrowing; that's practically the national pasttime.

5. The US budget outlook is not actually a cause for concern right now, at least not for several years. As a long-term matter, yes, the US has a significant imbalance between revenues and spending. But the current frenzied anxiety over the US budget deficit is primarily the result of the recession, which makes deficit projections look much worse that they are likely to be in the medium term. It's myopic to think that large deficits today, or the difficulties politicians have had in reaching a budget agreement in Washington this year, mean that large deficits and budget stalemates are now perpetual.

6. And last but not least: What is a "ratings outlook", anyway? I know that it's meant to convey their assessment that at some point in the future they will foresee the possibility of default by the US government (stifle laugh here). But how exactly is that different from foreseeing the possibility of default right now?

Okay, now that I've gotten that out of my system I think I'm now ready to consign this news to the trash-heap of intellectual irrelevance, where it belongs.

Monday, April 18, 2011

Fear-Mongering Over the US Budget Deficit

Cross-posted at Angry Bear.

Absurd news today from S&P's credit rating analysts, who have apparently been drinking liberally from the Deficit Crisis Kool-Aid:
NEW YORK (MarketWatch) — Standard & Poor’s cut its ratings outlook on the U.S. to negative from stable on Monday, lighting a fire under Washington’s deficit-reduction debate and sending stock markets sharply lower.

The rating agency effectively gave Washington a two-year deadline to enact meaningful change, just days after House Budget Committee Chairman Paul Ryan and President Barack Obama each outlined their plans for slashing debt. S&P nonetheless kept its highest rating, AAA, on the U.S.
US debt is still rated as AAA, which effectively means that S&P's rating analysts believe there is a zero percent chance of the US government not making payments on its debt. However, this new "ratings outlook" indicates that they now believe that there's a reasonable chance that some time within the next two years they will change their mind, and start to believe that there's a chance -- albeit a remote one -- of the US government defaulting on its debts.

(If you had a hard time following the "logic" of saying that they still think there's zero chance of default, but that there is some chance that they might change their mind in the near future, don't worry - it's a rather mysterious distinction to me, too.)

For perspective, the following chart shows the OECD's forecast for the burden of debt payments in the US and the world's other largest developed economies. Net interest payments both this year and next year will be lower than any other major OECD country with the exception of Japan.

Ah, but no doubt S&P is worried about what will happen to that debt burden beyond 2012. After all, there are alarming predictions that the currently large budget deficits will continue to be unduly large after 2012, even as the economy recovers.

But deficit projections are notoriously slow to catch up with the business cycle. When the economy is doing well and deficits are small, forecasters tend to look in the rearview mirror and make very rosy projections into the future. And when the economy is doing poorly and deficits are large, forecasters also tend to project doom and gloom going forward.

So let me put up this reminder about how bad, and backward-looking, medium-term deficit forecasts can be. It shows the US government budget balance as forecast by the CBO in 1993 and 1995, and compares those forecasts with what actually happened.

I don't want to argue that the US has no long-term deficit problems. It does. And steps will need to be taken -- when the economy is in good shape -- to bring revenues more in line with spending. But the current fear-mongering over the US's budget deficit is just that: fear-mongering. And today S&P played a shameful role in it.

That Sinking Feeling

The sovereign debt crisis in Europe continues to deepen. Unsurprisingly, the advocates for Greece to restructure its debt (i.e. to partially default) are growing louder:
Furious Greeks press for country to default on debt

A growing chorus of voices is urging the Greek government to restructure its debt as fears grow that a €110bn bailout has failed to rescue the country from the financial abyss and is forcing ordinary people into an era of futile austerity.

"It's better to have a restructuring now … since the situation is going nowhere," said Vasso Papandreou, whose views might be easier to discount were she not head of the Greek parliament's economic affairs committee.

Other members of prime minister George Papandreou's party have said that Greece is locked in a "vicious cycle", unable to dig itself out of crisis with policies that can only deepen recession.
As a result, investors are pushing up interest rates and credit default swap ("CDS") spreads on the debt of the most vulnerable euro countries. Based on this morning's CDS spreads, investors are now predicting a roughly 25% chance of total default by Greece on its sovereign debt either this year or next. If you believe that a partial default is more likely than a total default (e.g. if bondholders are given maybe 50 cents on the dollar for their Greek bonds), then this means that the market is betting that there is a better than even chance that Greece will decide that some sort of debt restructuring is less awful than the alternatives.

As always, though, the big question is this: is Spain really at risk in this contagious debt crisis? An auction of Spanish government bonds this morning was rather troubling -- interest rates on 1-year notes jumped almost 60 basis points. Not good.

Monday, April 11, 2011

Questions About the Euro Debt Crisis

I've been thinking a lot about Europe lately. In particular, the debt crisis among certain euro countries -- namely the PIIGS (Portugal, Ireland, Italy, Greece, Spain) -- has been on my mind. Here's the picture:

A few questions keep coming to my mind when I look at this picture and ponder the tremendous risk premia (defined as the spread over German bond yields) that have been applied to the sovereign debt of several euro countries over the past 2 years or so. Those questions include:

  1. Does this experience fit with our understanding of financial contagion, such as from the currency crisis literature?
  2. Are these risk premia the result of fears of default, devaluation (i.e. dropping the euro), or both?
  3. Should we think about this as a currency crisis, a debt crisis, or both?
  4. Why has the crisis hit the PIIGS, but not other euro countries?
  5. Is Spain really vulnerable? Italy?
  6. Where will it end?
  7. Is austerity the right response?
  8. How large does the bailout fund need to be, and will it work?
Can you think of any other significant questions about this subject that we don't already know the answers to?

I'm working on a theoretical framework that is helping me to think about some of these questions. I hope to share it with you soon. In the meantime, though, I have pulled together a bit of data with which to fuel the speculation...

I find it interesting to note that the initial stock of net government debt seems to have no bearing on whether a country was hit by the debt crisis - it's all about the government budget deficit in 2009 (and presumably 2010 as well, though Eurostat doesn't have 2010 budget deficit data up yet). It's also interesting to note that France had similar debt and deficit numbers as Portugal through 2009, yet has been one of the countries least affected by the debt crisis. Clearly political and financial considerations other than simple macroeconomics do matter here, and the financial ties between France and Germany are perceived to be such that a French default (or abandonment of the euro) is seen as extremely unlikely.

I know it might seem a bit unfair that I just put up a bunch of questions with no answers, but I'll be sure to get the definitive answers to you soon. (Yes, tongue is planted firmly in cheek.)

Tuesday, April 05, 2011

The Return of the Myth that Competition will Fix Medicare

Well, it seems as if Congressional Republicans are going to propose a complete refashioning of the Medicare program. Specifically, they are going to recommend scrapping Medicare as a provider of health insurance to seniors, and instead replace it with a system that will provide subsidies to individuals who will then buy health insurance from private insurance companies. In other words, they want to get the federal government completely out of the health insurance business for senior citizens.
GOP 2012: overhauls on entitlements and taxes, $6.2 trillion in cuts over decade

House Republicans plan to propose Tuesday historic changes to Medicare, Medicaid and other popular programs that pour federal money into Americans’ lives, arguing that a sacrifice now will keep those programs solvent for the future.

...On Medicare, Ryan will propose altering the plan so that the federal government no longer acts as a health insurer for seniors. Instead, he would create what’s called a “premium support plan.” Seniors would pick from a list of private insurance plans, and Medicare would subsidize their coverage.

The idea, again, is to use market competition to create a system with lower costs. Ryan’s plan would not apply to Americans age 55 and older, for whom Medicare would remain under the current system.
The notion that Medicare costs have been rising because it is a government-run health insurance program, or because it is not a "competitive" health insurance program, is odd. Theoretically, economists can list a number of very specific ways in which the markets for health care and health insurance are characterized by market failures. And for those of you who have forgotten your Econ 101 lessons, please recall that economic theory clearly predicts that when there are market failures there is no reason to necessarily expect that competition (i.e. the free market solution) will provide a good outcome.

Providing yet another example when economic theory actually matches what we see in the real world quite well, we find that there is absolutely no evidence that competition among private health insurance companies leads to lower costs. The Kaiser Family Foundation conducts a survey of employer-sponsored health insurance programs every year to estimate private health insurance premiums. Health insurance premiums for workers in large companies -- those employing 200 people or more, which encompasses about 65% of all workers covered by private, competitive, employer-sponsored health insurance plans -- rose by 135% over the ten year period 1999 to 2009.

Meanwhile, Medicare spending per person rose by about 103% over the same period. (Note that to get this figure I simply divided total Medicare costs from the CBO (pdf) by the number of Medicare enrollees as provided by Census (pdf).)

Given this, I'm really baffled by this repetition of the assertion that more competition in the market for health insurance is the answer. There's no theoretical justification for it, and no empirical evidence for it. The fact is that people in the US consume more health care services every year. So every year we pay more.

Friday, April 01, 2011

The Economist Gets Tough

The Economist is not mincing words in one of this week's leaders:

Stop the play-acting

Both sides must shoulder some of the blame for the steadily worsening atmosphere on Capitol Hill. The Democrats have failed repeatedly, most recently with Mr Obama’s dishonest budget for the next fiscal year, to indicate how they intend to repair the nation’s finances. Yet even set against that miserable standard, it is the Republicans who deserve most criticism. While extracting many concessions from the Democrats, they have made precious few themselves. And while spinelessly failing to explain how the deficit might be controlled in the medium term, conservatives have vaingloriously demanded more cuts in the short term than should be inflicted on an economy as weak as America’s now is.
Miserable... spineless... vainglorious... Wow, well put.