Means, Needs, and Federalism

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For Setting National Economic Priorities, I have been suggesting consolidating means-tested programs into a single flexible benefit. One goal is to reduce marginal tax rates. Another advantage of this approach is that the first $2000 or so of the benefit can be directed toward purchasing catastrophic health insurance.

A third advantage of this approach is that it can untangle some of the overlaps between national and state/local programs. The basic principle would be that the Federal government, with a generic flex-benefit, would offer support based on means-testing. It could leave the assessment of special household needs to state and local governments as well as charities.

Special needs would include learning-disabled children, expensive medical illness, or high-cost housing.

We can imagine the Federal government paying households flex-benefit dollars based on a simple formula–perhaps $6000 per adult and $4000 per child, minus 25 percent of the household’s (taxable income plus value of employer-provided health insurance). Those of you who have been following these posts will notice that I keep playing with different values of the parameters. Those issues are still unsettled in my mind. It only recently occurred to me that fairness in distributing the universal benefit requires including employer-provided health insurance as income for purposes of phasing out the flex-dollar benefit.

By default, this money would go into a savings account. Households would not be allowed to withdraw from the savings account until they have purchased catastrophic health insurance.

State and local governments would be able to contribute to these accounts, based on their assessment of household needs. A household with a severely disabled child might receive $5000 per year from a state. A household in an area with expensive housing might receive $4000 a year from the local government. It would be up to state and local governments to decide whether to use this mechanism for distributing benefits or use something else.

We would abolish Medicaid. Instead, we would have the Federal government pay a fixed dollar amount to states that would go toward the cost of health care for the elderly and disabled that currently are covered by Medicaid.

We would abolish the Department of Housing and Urban Development. We would get rid of Federal mortgage subsidies and instead allow households to use money from their flex-benefit savings accounts to go toward down payments.

We would abolish the Department of Education. Instead, we would retain a research department, housed in the National Science Foundation, to evaluate educational effectiveness and to fund experimental pilot programs.

Uber $17 Billion?

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The Seattle Times reports,

The funding positions the company at the front of a pack of Internet startups, at a valuation of about $17 billion, up from $3.5 billion in a financing last year.

Back in 1999, I started The Internet Bubble Monitor, a blog about that bubble. I tracked the absurd valuations of firms that had already gone public. This time around, it looks like the VCs want to front-run the public and bid firms up to absurd levels before anyone else can.

I would be curious to know what the investors think that the margins will be in the business in five years. Will Uber be able to collect $5 a ride? Fifty cents a ride? Maybe Facebook or Twitter will offer ride connections for free and hope to make a go of it on advertising revenue.

But, hey, I’m just an old man who doesn’t understand technology.

Larry Summers on Mian and Sufi

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He writes,

They argue that, rather than failing banks, the key culprits in the financial crisis were overly indebted households. Resurrecting arguments that go back at least to Irving Fisher and that were emphasised by Richard Koo in considering Japan’s stagnation, Mian and Sufi highlight how harsh leverage and debt can be – for example, when the price of a house purchased with a 10 per cent downpayment goes down by 10 per cent, all of the owner’s equity is lost. They demonstrate powerfully that spending fell much more in parts of the country where house prices fell fastest and where the most mortgage debt was attached to homes. So their story of the crisis blames excessive mortgage lending, which first inflated bubbles in the housing market and then left households with unmanageable debt burdens. These burdens in turn led to spending reductions and created an adverse economic and financial spiral that ultimately led financial institutions to the brink.

Pointer from Tyler Cowen.

Summers points out that Mian and Sufi’s suggestion that we should have bailed out homeowners is probably not correct. I feel even more strongly than Summers does about this.

Suppose that we accept the balance-sheet recession story. Some comments and questions.

1. Vernon Smith is also a proponent.

2. What was the difference between the damage to consumer wealth caused by the dotcom crash of 2000 and by the housing crash of 2007-2008? Was it solely the fact that the latter had been financed more by borrowing?

3. Suppose that there had been no debt-fueled consumer boom in 2005-2006. What would there have been instead? A sluggish economy? A more sustainable boom?

4. Suppose that we take a PSST perspective. Then the period from the late 1990s to the present is one long, painful, still-unfinished adjustment to the Internet and factor-price equalization. We happened to have a sharp boom-bust cycle in home construction in the middle of it, but even during the boom we did not have four consecutive months of gains in employment over 200,000. Then, in 2008 we had a panic about large financial institutions, leading to a big increase in government intervention, which mostly consisted of transfers of resources to less-productive businesses, such as GM, Citigroup, and Solyndra.

The Clearest Inflation Indicator

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Are prices really rising much faster than the official data show? Consider that the percent change from a year ago in the index of compensation per hour (part of the labor department data on productivity and costs) keeps running at about 2 percent. You have to believe one of the following:

1. This measure of the growth in labor costs is itself being distorted by sneaky government statisticians, and compensation is actually growing at a much higher pace.

2. With prices rising faster than official measures, real compensation costs are declining dramatically. In which case,

2a. Productivity is also declining dramatically, or

2b. Business profitability is soaring

3. The official measures of inflation are not hiding significant inflation.

My money is on (3).

Re-telling the AIG story

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Hester Peirce writes,

AIG’s securities lending program is just as critical to the story of its downfall. Through the securities lending program, AIG and its life insurance subsidiaries had massive exposure to residential mortgage-backed securities. At the height of the 2008 crisis, the program experienced a run, and AIG could not meet the massive repayment demands. The losses in the securities lending program were severe enough to imperil a number of AIG’s regulated life insurance subsidiaries. Before the bailout, AIG itself may have been insolvent.

The standard story is that all of the problems at AIG were caused by its credit default swaps. As those out-of-the-money options came closer to being in the money, their counterparties exercised rights to collateral calls, creating a liquidity crisis for AIG.

I have always accepted the standard story, and my view is that the way to handle it would have been to block the collateral calls. Make Goldman Sachs and DeutscheBank and everyone else wait to see how things play out.

Peirce says that in addition to the collateral calls on credit default swaps, AIG had exposure to mortgage securities through its regular insurance subsidiaries’ portfolios. Those securities lost market value during the crisis. For AIG, the problem became acute because of its securities-lending business. I don’t think I understand completely how this securities lending worked, but I think that the effect was to create a very significant maturity mismatch for AIG, so that it had a lot of short-term liabilities backed by long-term assets. When counterparties for a variety of reasons stopped providing short-term funding to AIG, it was faced with a need to sell long-term assets, and a lot of those assets were mortgage securities whose prices were depressed.

I came away from this analysis believing that the securities-lending program was important. However, I am less convinced that AIG was insolvent or that some of its subsidiaries were insolvent.

The Dismal Forecasting Record

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Tim Harford writes,

There were 77 countries under consideration, and 49 of them were in recession in 2009. Economists – as reflected in the averages published in a report called Consensus Forecasts – had not called a single one of these recessions by April 2008.

… Making up for lost time and satisfying the premise of an old joke, by September of 2009, the year in which the recessions actually occurred, the consensus predicted 54 out of 49 of them – that is, five more than there were. And, as an encore, there were 15 recessions in 2012. None were foreseen in the spring of 2011 and only two were predicted by September 2011.

He cites research from Prakash Loungani and Hites Amir. Some comments:

1. This underlines the fact that macroeconomists are using equations that are not verified empirically.

2. Perhaps the “target the forecast” mantra of market monetarists would not work as robustly as they might hope.

3. According to the NBER, the U.S. was already well into a recession by April 2008 and already out of recession by September of 2009.

Reform of Macroeconomics Teaching

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Simon Wren-Lewis writes,

So my first point, which I have made before, is that we can get rid of a lot of stuff that is simply out of date. Like the LM curve (and theories of money demand that go with it). And the Aggregate Demand curve which is derived from it. And Mundell Fleming which is an open economy version of it (and inconsistent with UIP to boot). And the money multiplier (which, apart from being very misleading, is unnecessary if we stop fixing the money supply).

That is fine. But he winds up with this:

So there you have it. Econ 101 with just three basic relationships: an IS curve, a Phillips curve and UIP

Pointer from Mark Thoma. UIP stands for uncovered interest parity, with the impact that a higher interest rate at home is associated with a stronger currency and reduced net exports.

Actually, I do not think that replacing the equations that have gone out of fashion with those that are currently fashionable represents an improvement. Quite possibly, it is worse. As Noah Smith points out, these equations are not empirically verified. They are merely asserted.

I think that macroeconomics ought to be taught as a combination of economic history and history of thought. In that regard, I think that my macro memoir would have some value, although other perspectives also deserve to be included.

Provocative Sentences

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From Roger Pielke:

a “carbon cap” necessarily means that a government is committing to either a cessation of economic growth or to the systematic advancement of technological innovation in energy systems on a predictable schedule, such that economic growth is not constrained. Because halting economic growth is not an option, in China or anywhere else, and because technological innovation does not occur via fiat, there is in practice no such thing as a carbon cap.

Pointer from Mark Thoma.

If you assume a Leontief production function, then this is correct. You either come up with a way to reduce the fixed coefficient of carbon/output or you reduce output.

Instead of a fixed-factor production function, assume some substitutability, in which you can produce the same output with less carbon emissions and more of some of other factor of production–labor, capital, or other forms of energy. That would mean that you can vary the carbon/output ratio with existing knowledge, so that Pielke is not correct. He might argue that the elasticity of substitution is quite small, which may plausibly be the case.

I am skeptical that a carbon cap would be implemented effectively. The more narrowly it is implemented, the more the substitution will be between two different sources of carbon emissions rather than away from overall carbon emissions. Thus, the recent announcement by the EPA that it will target the electric power industry for a 30 percent reduction in emissions over a period of decades strikes me as unwise from even the most staunch environmentalist perspective. Assuming that the policy were to stick and the reduction were to be achieved within that industry, it would most likely be the result of a shift of carbon-intensive energy sources to uses in other sectors. It is not hard to picture a scenario in which total carbon emissions actually increase as a result, because you are directing carbon-based energy sources into less efficient uses.

Regardless, the EPA announcement works well as a gesture. And politics seems to be mostly about gestures. In Hansonian terms, politics is not about policy.

Employment and ACA

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Casey Mulligan writes,

the ACA will put millions of workers in the economically extreme situation of having zero short-term financial reward (or less) to working full-time rather than part-time.

In economics jargon, this means the ACA creates marginal tax rates on labor income that exceed 100 percent.

The SNEP solution might be as follows:

1. Re-orient health financing policy toward catastrophic health insurance and health savings accounts. Create a national standard catastrophic health insurance plan that acts like true insurance and is reasonably affordable.

2. Repeal the ACA.

3. For non-elderly households with able-bodied adults, replace Medicaid and other means-tested programs with the universal benefit or flex-benefit.

4. For a household without health insurance who receives the flex-benefits, automatically allocate an amount of flexdollars toward health insurance. Perhaps the first $1500 per person in a household would go toward a combination of health insurance (which could be the national standard catastrophic plan) and a health savings account.

5. Close to half of current Medicaid spending is on the elderly and the disabled. I do not think that the flex-benefit system deals with those groups. At this point, I do not see a better approach than Medicaid in those cases.

This would create something like universal health insurance coverage, but with an emphasis on real insurance rather than Medicaid or pre-paid health plans. It also would get rid of the problem of high marginal tax rates. Thus, it would be better than the ACA in both dimensions–there would be fewer households without health insurance and fewer households facing strong disincentives to work.

Financial Stability, Regulation, and Country Size

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Lorenzo writes,

Something that is very clear, is that “de-regulation” is a term empty of explanatory power. All successful six have liberalised financial markets–Australia and New Zealand, for example, were leaders in financial “de-regulation”. If someone starts trying to blame the Global Financial Crisis (GFC) on “de-regulation”, you can stop reading, they have nothing useful to say.

Pointer from Scott Sumner.

The deregulation story amounts to saying that we know that regulation can prevent a crisis, but a crisis occurred, therefore there must have been deregulation. In fact, the risk-based capital rules that I have suggested helped cause the crisis were at the time they were enacted viewed as regulatory tightening, to correct flaws in the regime that existed at the time of the S&L crisis. The deregulation that did take place was intended to reduce bank profits by making the industry more competitive, not to increase profits or risk-taking.

Lorenzo’s post mostly beats a drum that I have been beating, which is that government tends to get worse as scale increases. He writes,

It is generally just harder to stick it to folks (either by what you do or what you don’t do) in a way that doesn’t get noticed in smaller jurisdictions. (Unless jurisdictions are so small they fly under the media radar but are big enough to be semi-anonymous–urban local government in Oz has a bit of a problem there.)