Randall Wray joined Suzi Weissman for radio KPFK’s Beneath the Surface to discuss monetary policy, financial fraud, and a number of other issues.  The interview kicked off with Wray explaining his skepticism of the effectiveness of monetary policy, and in particular of quantitative easing, under current conditions, touching also on the question of why this long-term bias in favor of monetary over fiscal policy has developed.  The interview turned to LIBOR and the long string of recent financial scandals and outright fraud, with Wray tying it all to a broader (and growing) financialization of the economy.  Elaborating on the dominance of the FIRE sector in our economy, he discussed the increasingly fuzzy boundaries between, say, finance and industry.

Listen to the interview here.

In his recent commentary on the LIBOR scandal, Jan Kregel elaborates on a distinction that is crucial to understanding this story.  The scandal centers around revelations that financial institutions had been manipulating their LIBOR rate submissions to the British Bankers’ Association (BBA).  Questions have subsequently been raised as to whether regulators were aware of and condoned, or actively encouraged, these manipulations.  But as Kregel explains, there were two very different types of manipulation that were going on, and the distinction between the two is acutely relevant to evaluating attempts to pin a major share of the blame for this scandal on regulators and central bank officials.  (LIBOR is a proprietary index put out by the BBA that is supposed to represent an average of the rate at which banks are able to borrow from each other short term.  It is composed of rate submissions from banks selected for a panel who are asked to give the rate at which they have borrowed or could hypothetically borrow.  The highest and lowest 25 percent of the submissions are thrown out.  LIBOR sets the benchmark for things like mortgages, student loans, credit cards, etc.  See Kregel’s piece for a more detailed explanation.)

Prior to the most recent financial crisis, LIBOR was rigged by banks in an attempt to benefit their trading positions (the banks had made bets whose payoffs depended in part on what was happening to LIBOR).  The investigative reports from the Financial Services Authority in the UK and the Commodity Futures Trading Commission and Department of Justice in the US point to evidence of such manipulation as far back as 2005.

But during the heart of the financial crisis there was a different type of misreporting going on, this time driven by the collapse of interbank lending.  While regulators appeared to have been aware of the latter misreporting, the evidence does not suggest they were aware of the former, more nakedly venal, pre-crisis manipulation.  A lot of the controversy on this question stems from a confused reading of the 2012 testimonies of Paul Tucker (currently deputy governor of the Bank of England) and Robert Diamond, the former head of Barclays Capital, before a House of Commons committee.  The testimonies are being read as providing the smoking gun evidence that the Bank of England was aware of the scandal from the beginning and failed to stop it—but this interpretation only works, as Kregel demonstrates, if you confuse or fuse together the two varieties of LIBOR manipulation.  And there are good reasons to keep them separate in our analyses. continue reading…

We end the week with news of only modest economic growth, but also with a set of revised data that does not seriously worsen the economic outlook. Today the Bureau of Economic Analysis announced the release of an advanced estimate of 2^nd quarter GDP, as well as revised data for 2009Q1 through 2012Q1. Their press release notes that:

“Real gross domestic product—the output of goods and services produced by labor and property located in the United States—increased at an annual rate of 1.5 percent in the second quarter of 2012, (that is, from the first quarter to the second quarter), according to the “advance” estimate released by the Bureau of Economic Analysis. In the first quarter, real GDP increased 2.0 percent.”

An article from the FT  points out that consumption grew by 1.5 percent, while government spending at all levels of government fell by 1.4 percent. Leaving the drop in government spending out of the calculation would raise the overall growth rate to 1.8 percent per year, or .3 percent higher than the actual figure released today.

Here is a graphical comparison of the old and new data series:

As the figure shows, the new data series implies that the fall in real GDP during the 2007–09 recession was not as deep as previously believed, though this difference is rather small. (Note: This earlier FT article mentions some of the reasons the GDP series needs to be revised, and well as some of the anticipated policy implications of today’s data release.)

Also, the revisions make only a slight difference in an estimated trend line for all the data, as seen in the figure below, where the blue line is hidden behind the red one. However, these trend lines are much different from a similar estimate constructed using prerecession data (1947Q1–2007Q3) only, which is also seen below.

The continuing weakness of the actual GDP data compared to the prerecession trend line provides further support to the notion that the economy has a lot of extra room to grow. In other words, such a sharp drop in economic activity relative to an existing trend is an indication that private-sector output can recover to a great extent without straining supplies of labor and most other resources. Hence, economic stimulus designed to increase aggregate demand is in order, as we have argued for some time. The reported decline in government spending is of some concern indeed.

These numbers of course do not constitute a good measure of national well-being, but at their recent levels, they are symptomatic of an economy experiencing a prolonged period of high unemployment rates, which can contribute to many other social and economic problems.

Postscript, July 27: Interesting, same-day posts by New York Times bloggers  point out that the revised data reveal a shrinking government sector and analyze the effects of the revisions.

The cliff approaches, and politicians and pundits in Washington are pondering how to deal with it. For those who have forgotten, recent nontechnical summaries of the legislative issues and amounts of money at stake can be found here , here, and in this old post. But essentially, the term “fiscal cliff” refers to a massive group of tax increases and spending cuts due to take effect on or around January 1 of next year. President Obama and some Congressional Democrats are seeking to take a stand for distributional fairness and deficit reduction at the same time by pushing for a renewal of the Bush tax cuts, but only for those with incomes less than perhaps $250,000 for a couple. On the other hand, some long-time fiscal conservatives are seeking to cushion the blow by delaying the impact of the spending cuts and tax increases and by seeking a less indiscriminate choice of program cuts. They emphasize that in any case, draconian measures must in their view be taken eventually and committed to now.

From the point of view of Keynesian macroeconomics, what the fiscal conservatives fail to understand is that the economy requires even more fiscal ease than they have been willing to contemplate so far; otherwise, like Spain and many other European nations (see the FT and the WSJ on the European austerity debate), this country will experience such weak economic performance that even the goal of reducing the deficit will be elusive—let alone feeding the hungry, keeping states and localities from going broke, maintaining an adequate defense, or funding scientific research.

The automatic spending cuts (known also as sequesters) due to take effect soon are designed to hit almost every discretionary defense and nondefense spending item—to the tune of 10- to 15-percent cuts in what the federal government spends each day on average on these items. continue reading…

Martin Essex of the Wall Street Journal flags Dimitri Papadimitriou and Randall Wray’s recent Policy Note on the eurozone, “Euroland’s Original Sin.”  The Note traces the root cause of the eurozone’s struggles, including the solvency issues and bank runs in the periphery, to a fundamental design flaw in its setup:  national governments gave up currency sovereignty by adopting the euro but retained responsibility for their own fiscal policy.

Essex chooses to focus on a footnote that quotes some early predictions by those associated with the Levy Institute, which is fine.  But it’s important to note a couple of things here.  First, the point is not that the euro project was predicted to run into trouble in general, but that in these quotations the problems were predicted to flow from a particular structural flaw:  the separation between fiscal policy and monetary sovereignty.  And this is important for reasons that go beyond a prescience contest.  The predictions serve as a useful guide for figuring out what needs to be done to save the euro project.

Getting it right isn’t about being able to say “I told you so,” but about having the credibility to say “here’s what should happen next.”  In this case, in the context of addressing the bank runs afflicting the periphery, Papadimitriou and Wray argue for the necessity of eurozone-wide deposit insurance backed by the creation of a serious EU-level Treasury.  Getting the diagnosis right also allows you to see which solutions won’t work:  using the EFSF/ESM to bail out banks, which was part of the plan emerging from the June summit, won’t solve the problem, the authors argue, since those bodies don’t have the unlimited firepower of a sovereign currency issuer.

If you think the eurozone is in trouble primarily because of the fiscal profligacy of lazy spendthrifts in the periphery, you will have a very different idea of what needs to happen next.  But if the fundamental problem in the eurozone is the divorce between fiscal and monetary sovereignty, then until this design flaw is fixed, “solvency” issues are bound to arise—even for a national government running a fiscal surplus (which is precisely what happened to Spain).

Essex cites a number of other economists who predicted trouble for the eurozone early on, and he invites his readers to come up with some other examples.  One example he doesn’t mention is featured in Papadimitriou and Wray’s Note: continue reading…

There’s a sad truth about the fate of financial regulation: It’s almost certain to be outmoded by the time it’s introduced. This was as true of Glass-Steagall in 1933 as it is of Dodd-Frank today.

This month we begin the third year since the Dodd-Frank Wall Street reform act passed, with the struggle over its shape ongoing. It’s a still-unmolded toddler, and already on the fast track to fossilization. Does the most ambitious finance legislation in decades carry the DNA to successfully cope with the next crisis? In a word, no.

The take-away from this challenge doesn’t have to be cynicism, inaction, or laissez-faire tirades. To be ready for the next shock rather than the last one, though, we need to reset our thinking.

Dodd-Frank is based on the idea that financial markets are normally stable, with the exception of the occasional alarming “event.” The New Deal’s Glass-Steagall Act and the Clinton-era Gramm-Leach-Bliley “Modernization” shared those assumptions. All of these efforts were conceived as system-wide overhauls. In reality, though, they were designed only to remedy random, ad hoc crises; shocks like the 2008 meltdown, sometimes called “Minsky Moments.”

Ironically, the late economist Hyman Minsky actually believed that these “moments” were anything but. At the Levy Institute, we share his view that instability is central to the genome of modern finance.

In other words, it’s normal for the boat to keep rocking. The increasingly risky practices that fuel danger and instability are still being rewarded, and the absence of penalties for losses continues. The shocks will keep coming.

And each new threat to stability is destined to be different than the last. Dodd-Frank aims to identify the most vulnerable institutions and practices. That approach is too brittle to contain the disastrous effects of risks that are always morphing. Even constructive aspects of the Act could have perverse consequences, unless the rules are subject to sophisticated re-examination as the finance world develops. continue reading…

With yesterday’s quarterly BLS data release on “usual weekly earnings” out, I have once again constructed some “alternative” measures of real wages, based on price indexes for food commodities at the wholesale level. The commodity-based indexes are depicted in the figure above with lines in various colors. Compared to the more typical measure of real, or inflation-adjusted, earnings, which is seen in black, the food-commodity wages may be of interest in different contexts: for consumers who spend relatively large portions of their budgets on food, for example, or to those following the debate over the unfortunate SNAP (food stamp) cuts in the farm bills recently passed by the Senate and the House Agriculture Committee (see this earlier post). Inflation at the wholesale level is sometimes a harbinger of similar trends in prices paid by consumers at retail stores, so the series shown above may be most helpful as indicators of possible future trends in the standard of living.  Along these lines, the Financial Times reports that prices for food commodities will be higher this decade than last, according to two major forecasters.  The cited reasons for the expected rise in food-commodity prices include an expected upward trend in the price of oil, climate-related crop failures, and demand from emerging economies.

It is best, given that the data are not seasonally adjusted, to look at changes compared to the second quarter in another year. Also, since the commodity-price indexes are rather volatile, changes over fairly long periods are most informative. The second-quarter “real” wage results, relative to the second quarter of 2010, are: in terms of a broad BLS price index, -1.5 percent; fresh and dry vegetables, +10.6 percent; fresh and dry vegetables, +24.0 percent; grains, -38.6 percent; slaughter livestock, -16.0 percent; slaughter poultry, -3.2 percent; raw milk, -4.6 percent; chicken eggs, -14.5 percent; and hay, hayseeds, and oilseeds, -33.1 percent.  The results for the past year have been a bit better, with five of the eight commodity-wages rising, along with the BLS’s broad real measure, which has risen .3 percent over its second quarter 2011 level.

Update, July 20: I forgot to point out that the run-up in grain prices that I mentioned in Spring and Fall 2011 posts appears to have ended (see purple line) in the data shown in the figure; meanwhile however, certain grain prices are in fact rising rapidly again. As a matter of fact, the Financial Times reported again on commodity prices today, this time on its front page. In a report noting that soybean and corn prices reached record highs in commodities markets yesterday, it observes that the world is facing a new “food crisis,” owing largely to the drought currently affecting crop yields in the United States.

Correlation is not causation, of course, but I’m beginning to suspect that there might be some operational relationship between the frequency with which you hear people complaining about the crippling burden of government debt, and a fall in the cost of government borrowing.

Last week the Financial Times reported that investors had accepted “the lowest yields ever for 10-year paper in a US Treasury auction.”  Right on schedule, the Washington Post announced yesterday that a shiny new campaign, organized by former politicians and business leaders, has been put together to tackle the clear and present dangers of government debt, advocating “a far-reaching plan to raise taxes, cut popular retirement programs and tame the national debt.”

To be fair, it seems there is always a new campaign being announced for taming the national debt (this particular initiative features some plucky newcomers named Erskine Bowles and Alan Simpson).  But there are problems with the projections underlying these arguments about the long-term unsustainability of federal debt.  And in the short run, it’s becoming increasingly difficult to understand what problem is supposed to be solved by decreasing government borrowing.

Thankfully, the conventional wisdom is beginning to solidify around the belief that we need to avoid the “fiscal cliff,” but this justified fear of the huge fiscal contraction scheduled for 2013 has so far not translated into equal concern for the smaller-scale budget austerity we’re already imposing (or for what would seem like a logical extension of that fear of fiscal contraction:  namely, a push for expansionary fiscal policy).

With negative real interest rates being “paid” on 10-year government debt, one runs out of ways of explaining how foolish it is that, for example, spending by state and local governments on public infrastructure is at its lowest levels in seven years.  We’ve covered the sarcastic approach in the first sentence, so let’s set the question up in as dull and uncontroversial a manner as possible: continue reading…

Local government officials in San Bernardino county have apparently heard enough about how the overhang of mortgage debt is holding back the recovery, and they’re considering taking matters into their own hands.  Reuters‘ Matthew Goldstein and Jennifer Ablan report on the background discussions leading up to a proposal that is being considered by officials in San Bernardino, California—a county where almost half of all mortgages are “underwater.”  The general idea is to use eminent domain as a kind of mortgage debt forgiveness program:  principal reduction would be achieved by forcing the sale of mortgages that have been packaged into securities; the mortgages would then be restructured on more favorable terms.  Homeowners with underwater mortgages who are current on their payments would be able to participate.

Randall Wray and Paul McCulley are quoted in the piece, with the latter describing the program as “[a] legal system-midwifed, modern-day jubilee.”  Read the article here.

From the announcement of a new joint research project by Mariana Mazzucato and the Levy Institute’s Randall Wray (“Financing Innovation: an Application of a Keynes-Schumpeter-Minsky Synthesis”):

The purpose of this project is to integrate two research paradigms that have strong policy relevance in understanding the degree to which financial markets can be reformed in order to nurture value creation and ‘capital development’, rather than value extraction, and destruction.  The first one might be called the Keynes-Minsky vision that puts effective demand front and center of economic analysis, and the second is the Schumpeter-Minsky vision that places innovation at the center of competition theory, rather than relegated to the periphery of imperfect competition. The project will bring the two visions together to provide rigorous analysis of competition in the financial sphere and how it interacts with competition in the industrial sphere. The new framework will help us better understand the difference between creative destruction and destructive creation, and its applicability to new periods of economic growth such as that which will hopefully result from the green technology revolution.