How things have changed

The Crimson reports:

When Harvard’s future dean of admissions and financial aid was applying to the College in 1962, the first two teachers he asked for letters of recommendation refused.

“They wouldn’t write for Harvard because they thought it was a bunch of Communists, a bunch of atheists, a bunch of rich snobs, and if you went there you’d flunk out and you’d lose your soul,” said William R. Fitzsimmons ’67.

Today at Harvard, it is almost impossible to flunk out.

Summers on the GSEs

Larry opines on Fannie and Freddie:

These institutions’ viability with anything like their current operating model depends on the implicit federal guarantee of their several trillion dollars of liabilities. It is appropriate at a time of crisis in the mortgage markets that they become, as their regulator put it last week, the “lender of first, last and every resort”.

It is not appropriate that their shareholders’ “heads I win, tails you lose” bet with the taxpayer be expanded for this purpose. Given their past and prospective losses, their regulator – supported by the Treasury, the Fed and, if necessary, Congress – should insist that they stop paying dividends and raise capital promptly and substantially as they expand their lending.

Blinder on the Mortgage Mess

Alan explains and endorses the Frank-Dodd plan.

Such stuff as dreams are made on

From Webloggistics:

I wake up, groggy, bed-headed, pajamaed. Lying next to me, fully dressed on top of the bed is Gregory Mankiw, the economist. "You're Greg Mankiw," I intelligently remark.

He springs out of bed and stands up. "Would you like to discuss consumer surplus and tariffs?"

"Why are you here?" I ask.

"Don't you remember the Make-a-Wish Foundation?"

Hypocrisy Indeed

A friend recommends today's Washington Post column by Steve Pearlstein. It starts as follows:

Well, isn't this rich: Max Baucus of Montana and Chuck Grassley of Iowa, chairman and ranking member, respectively, of the Senate Finance Committee are suddenly in a lather that taxpayer funds might be implicated in the Federal Reserve's rescue of Bear Stearns. Would that be the same Max Baucus and Chuck Grassley who have made careers out of protecting and enhancing the lavish system of import restrictions, price supports and other subsidies that have transformed American farming and ranching into a vast socialist enterprise?

Continue reading here.

Glaeser on Galbraith

A young fogey reflects on an old turk.

The Rising Return on Junk

Source.

No grade inflation here

How would you grade the Fed's recent policy moves? Here's an answer from the eminent economist and Federal Reserve historian Allan Meltzer:

I would give the Federal Reserve either a C or C-, reflecting an average of one good grade and one poor grade.

The Fed has two responsibilities. Monetary policy should be conducted to maintain economic and price stability. That calls for well-timed changes in short-term interest rates. Credit or lender-of-last-resort actions should maintain the payment and settlement system. This requires the Fed to lend reserves to the market when it lacks liquid assets that can be used to settle claims.

Monetary policy is too lax at present. The Fed has done too much to prevent a possible recession and too little to prevent another round of inflation. Its mistake comes from responding to pressure from Congress and the financial markets. The Fed has sacrificed its independence by yielding to that pressure. As a result, real short-term interest rates are negative. Borrowers are being paid to borrow. Negative real rates were a cause of the current problem; they are not a cure. The Fed must raise interest rates in order to prevent inflation.

On the other hand, the Fed’s credit policy has been good. It has been alert to problems in the payment and settlement system. Banks and financial institutions are uncertain about the solvency of other institutions, so they prefer to hold cash rather than to lend it. The traditional way to solve problems of this kind is to provide as much cash as the market wants. And indeed, the Fed has invented new ways of pumping reserves and liquid assets (Treasury bills) into the market. This has helped to prevent a genuine market crisis—at least so far. The Fed did not “bail out” Bear Stearns. It arranged a sale that wiped out the equity and replaced the management without closing the firm.

The Fed’s only mistake was to guarantee $30 billion of Bear’s portfolio. This action transferred potential losses from the market to the taxpayers. I do not believe the present system can remain if the bankers make the profits and the taxpayers share the losses.

Jeff Sachs on The Daily Show

Note: Jeff will be speaking at Harvard on April 14.

Obama: No fan of retirement saving

A key feature of the U.S. tax system is the option to put some income into tax-deferred savings accounts, such as IRAs and 401(k) plans. These accounts make the tax system a bit like a consumption tax rather than a true income tax in the sense that some part of saving gets exempt from taxation until it is later withdrawn and consumed. Many economists believe that consumption taxes are better than income taxes because they do not distort the intertemporal margin between consumption today and consumption in the future. Many financial advisers encourage people to put as much as they can into these retirement accounts.

I was surprised to see that Senator Obama has, for some reason, decided not to use this opportunity. His recently released tax returns show significant Schedule C income from book royalties (about half a million dollars in the most recent year). I am not a tax accountant, but I believe he could have put a substantial part of these earnings ($44,000) into a SEP-IRA and deferred taxes on it until withdrawal. Line 28 on his tax return, however, is completely blank.

Why? I don't know. Maybe he is getting bad tax advice. Or maybe he is expecting vastly higher tax rates in the future when the accumulated savings will need to be withdrawn and taxed. As Obama economic adviser Austan Goolsbee has written, "Future increases in tax rates potentially threaten to significantly reduce the value of your retirement savings and may even mean that you should not save in 401(k) accounts at all."

Update: Here.

Hold the Hysteria

Says Robert Samuelson.

The Latest Fed Stimulus

Via Onion Radio News.

Thanks to Eddy Elfenbein for the pointer.

McCain vs Obama: Bailouts

The NY Times reports:

Drawing a sharp distinction between himself and the two Democratic presidential candidates, Senator John McCain of Arizona warned Tuesday against vigorous government action to solve the deepening mortgage crisis and the market turmoil it has caused, saying that “it is not the duty of government to bail out and reward those who act irresponsibly, whether they are big banks or small borrowers.”

Mr. McCain’s comments came a day after Senator Hillary Rodham Clinton of New York called for direct federal intervention to help affected homeowners, including a $30 billion fund for states and communities to assist those at risk of foreclosure. Mrs. Clinton’s Democratic opponent, Senator Barack Obama of Illinois, has similarly called for greater federal involvement, including creation of a $10 billion relief package to prevent foreclosures.

Feld$tein

Marty on dollar non-policy.

Volatility at 70-year high

Reuters reports:

Volatility in the Standard & Poor's 500 stock index .SPX, the most widely-used barometer of the U.S. stock market, is at a 70-year high, according to an analysis released on Wednesday by Standard & Poor's. Measured by daily changes of at least 1 percent in the index, volatility has soared since credit concerns became a critical issue in the summer of 2007, S&P said.The number of significant daily market moves was 12.9 percent in the first half of 2007, but rose to 38.6 percent in the second half of last year as concerns grew. The number of such daily moves has increased to 51.9 percent in 2008, a level not seen since 1938.

Cowen on the Credit Crisis

Tyler's take on recent events.

Христос воскрес!

2008 = 1929?

It has become fashionable lately to see parallels between the current financial turmoil and what happened during the Great Depression. See, for example, Paul Krugman's latest column.

Let me remind everyone of one important difference: Deflation was a large part of the story of the 1930s, and that does not seem like a significant risk today. Here is a relevant passage from my favorite intermediate macro textbook (sorry, I cannot post the referenced figure):

The Money Hypothesis Again: The Effects of Falling Prices

From 1929 to 1933 the price level fell 25 percent. Many economists blame this deflation for the severity of the Great Depression. They argue that the deflation may have turned what in 1931 was a typical economic downturn into an unprecedented period of high unemployment and depressed income. If correct, this argument gives new life to the money hypothesis. Because the falling money supply was, plausibly, responsible for the falling price level, it could have been responsible for the severity of the Depression. To evaluate this argument, we must discuss how changes in the price level affect income in the IS‑LM model.

The Stabilizing Effects of Deflation

In the IS‑LM model we have developed so far, falling prices raise income. For any given supply of money M, a lower price level implies higher real money balances M/P. An increase in real money balances causes an expansionary shift in the LM curve, which leads to higher income.

Another channel through which falling prices expand income is called the Pigou effect. Arthur Pigou, a prominent classical economist in the 1930s, pointed out that real money balances are part of households' wealth. As prices fall and real money balances rise, consumers should feel wealthier and spend more. This increase in consumer spending should cause an expansionary shift in the IS curve, also leading to higher income.

These two reasons led some economists in the 1930s to believe that falling prices would help stabilize the economy. That is, they thought that a decline in the price level would automatically push the economy back toward full employment. Yet other economists were less confident in the economy's ability to correct itself. They pointed to other effects of falling prices, to which we now turn.

The Destabilizing Effects of Deflation

Economists have proposed two theories to explain how falling prices could depress income rather than raise it. The first, called the debt‑deflation theory, describes the effects of unexpected falls in the price level. The second explains the effects of expected deflation.

The debt‑deflation theory begins with an observation from Chapter 4: unanticipated changes in the price level redistribute wealth between debtors and creditors. If a debtor owes a creditor $1,000, then the real amount of this debt is $1,000/P, where P is the price level. A fall in the price level raises the real amount of this debt‑‑the amount of purchasing power the debtor must repay the creditor. Therefore, an unexpected deflation enriches creditors and impoverishes debtors.

The debt‑deflation theory then posits that this redistribution of wealth affects spending on goods and services. In response to the redistribution from debtors to creditors, debtors spend less and creditors spend more. If these two groups have equal spending propensities, there is no aggregate impact. But it seems reasonable to assume that debtors have higher propensities to spend than creditors‑‑perhaps that is why the debtors are in debt in the first place. In this case, debtors reduce their spending by more than creditors raise theirs. The net effect is a reduction in spending, a contractionary shift in the IS curve, and lower national income.

To understand how expected changes in prices can affect income, we need to add a new variable to the IS‑LM model. Our discussion of the model so far has not distinguished between the nominal and real interest rates. Yet we know from previous chapters that investment depends on the real interest rate and that money demand depends on the nominal interest rate. If i is the nominal interest rate and πe is expected inflation, then the ex ante real interest rate is i - πe. We can now write the IS‑LM model as

IS: Y = C(Y - T) + I(i - πe) + G
LM: M/P = L(i, Y)

Expected inflation enters as a variable in the IS curve. Thus, changes in expected inflation shift the IS curve.

Let's use this extended IS‑LM model to examine how changes in expected inflation influence the level of income. We begin by assuming that everyone expects the price level to remain the same. In this case, there is no expected inflation (πe = 0), and these two equations produce the familiar IS‑LM model. Figure 11-8 depicts this initial situation with the LM curve and the IS curve labeled IS1. The intersection of these two curves determines the nominal and real interest rates, which for now are the same.

Now suppose that everyone suddenly expects that the price level will fall in the future, so that πe becomes negative. The real interest rate is now higher at any given nominal interest rate. This increase in the real interest rate depresses planned investment spending, shifting the IS curve from IS1 to IS2. (The vertical distance of the downward shift exactly equals the expected deflation.) Thus, an expected deflation leads to a reduction in national income from Y1 to Y2. The nominal interest rate falls from i1 to i2, while the real interest rate rises from r1 to r2.

Here is the story behind this figure. When firms come to expect deflation, they become reluctant to borrow to buy investment goods because they believe they will have to repay these loans later in more valuable dollars. The fall in investment depresses planned expenditure, which in turn depresses income. The fall in income reduces the demand for money, and this reduces the nominal interest rate that equilibrates the money market. The nominal interest rate falls by less than the expected deflation, so the real interest rate rises.

Note that there is a common thread in these two stories of destabilizing deflation. In both, falling prices depress national income by causing a contractionary shift in the IS curve. Because a deflation of the size observed from 1929 to 1933 is unlikely except in the presence of a major contraction in the money supply, these two explanations give some of the responsibility for the Depression‑‑especially its severity‑‑to the Fed. In other words, if falling prices are destabilizing, then a contraction in the money supply can lead to a fall in income, even without a decrease in real money balances or a rise in nominal interest rates.

Could the Depression Happen Again?

Economists study the Depression both because of its intrinsic interest as a major economic event and to provide guidance to policymakers so that it will not happen again. To state with confidence whether this event could recur, we would need to know why it happened. Because there is not yet agreement on the causes of the Great Depression, it is impossible to rule out with certainty another depression of this magnitude.

Yet most economists believe that the mistakes that led to the Great Depression are unlikely to be repeated. The Fed seems unlikely to allow the money supply to fall by one-fourth. Many economists believe that the deflation of the early 1930s was responsible for the depth and length of the Depression. And it seems likely that such a prolonged deflation was possible only in the presence of a falling money supply.

Jeremy Siegel comments...

...on Bear Stearns, the Fed rate cuts, and inflation risks.

Congratulations, Steve

The WSJ reports that my friend Steve Cecchetti, now an econ prof at Brandeis, is going to the Bank for International Settlements to head its monetary and economic department.

Meanwhile, Steve teaches a journalist about how to infer expected inflation from the TIPS market.

A Solution of Sorts

Here is an intriguing pair of articles I ran across this morning. Jeff Frankel argues that the high prices of commodities like oil are being driven by low real interest rates. Anil Kashyap and Hyun Song Shin say that with oil prices so high, Middle Eastern sovereign wealth funds should come to the rescue of Wall Street.

Put together, they suggest a new piece of the monetary transmission mechanism: The Fed's monetary expansion reduces interest rates, low interest rates drive up commodity prices, high commodity prices make OPEC rich, and finally OPEC uses its new wealth to recapitalize our struggling financial institutions.

Harvard vs MIT

It is now the time of year when the next generation of economists is deciding where to attend graduate school. Those with the best undergraduate records will typically choose either Harvard and MIT. There are several reasons for this:

1. Each school has a great economics department.
2. Each school is only a couple of miles away from another great economics department.
3. Each school is close to the NBER, a preeminent economics think tank.
4. Each school is in Cambridge, which is a cool place to be a grad student.

As a result, it is rare for a student who gets into either school's PhD program to turn it down, unless he or she is attending the other.

Every year, I meet a number of highly promising students who were accepted by both schools and are having trouble choosing between them. Here is my advice:

1. Don't sweat it. You will get a great education at either place.
2. Look up your favorite ranking of economists' productivity and look at which school has more faculty near the top. Those are the profs you want to hang around and learn to emulate.

For example, if you use this standard ranking and look at the top 50, you will learn that MIT has 3 and Harvard has 12.

That should settle the question.

Sam Zell on the Credit Crisis

Click here and then again on the picture to hear his latest new year's greeting in song.

Phelps, Meltzer, and Eichengreen...

...are interviewed at Bloomberg radio.

Blinder on the Credit Crisis

Alan wants action.

On the Treasury Secretary, he writes:

On Sunday, Treasury Secretary Henry Paulson, who has been eerily silent as this crisis unfolded, made the rounds of the morning talk shows. It was not reassuring to see this former titan of Wall Street recite his talking points. Wolf Blitzer asked him five times, "Why did you bail out Bear Stearns?" He never got an answer.

I think Alan is being unfair to Paulson. Here is what Paulson was probably thinking:

"We are not bailing out Bear Stearns. We are in effect organizing an orderly liquidation of the firm. JP Morgan will take it over at a price not much above zero, so Bear's equity holders will leave with close to nothing. But that resolution of the situation is not going to be announced until later in the day. Now, on Sunday morning, I cannot say much. I will stick with broad generalities, knowing the specifics will be revealed shortly."

Fed Funds

Markets are expecting a big interest rate cut from the Fed later this week. The target for the Federal Funds rate, now at 3 percent, is expected to come down by at least 50 basis points. According to options data analyzed by the Cleveland Fed (click on the graph above to enlarge), even a cut of a full percentage point is given about a one in four chance.

Meanwhile, the past president of the Cleveland Fed chastises his former colleagues:

The Fed needs to quit chasing declining GDP growth and instead focus on curbing inflation and anchoring inflation expectations. Recent allusions to the stagflation of the 1970s are appropriate.

Do the inflation hawks still on the FOMC (Charlie Plosser perhaps) have a similar view? Will they dissent and perhaps even become openly critical of Fed policy if large interest rate cuts continue? It is a particularly fascinating time to be a Fed watcher.

Common Wealth: Economics for a Crowded Planet

My erstwhile Harvard colleague Jeff Sachs has a new book.

Tyler Cowen's reaction:

this book never gave me the feeling that I had access to the mind of Jeffrey Sachs. It doesn't even read like a popularization. Imagine a smart and diligent but not insightful or self-reflective person doing a "color by numbers" version of what a Jeffrey Sachs book should read like.

Update: More from Tyler on Jeff's book.

Greenspan on the Credit Crisis

From the Maestro himself.

Economists with Attitude

A video skit by two grad students at the University of Michigan.

Really?!?

A comment on another blog:

Mankiw is a Krugman-esque liberal who gets muddled by his socialist ideology at times.

That is odd: I always thought of myself as a Friedman-esque classical liberal who gets muddled by my new-Keynesian theorizing at times.

The Trade Debate

My new article in the NY Times.

To compare the candidates on trade policy, Brookings and Cato offer useful background information.

The BS Bailout

I don't know enough about the details of what has been going on at Bear Stearns to have a firm opinion about the latest Fed actions. But as I am an advocate of free markets and limited government, my knee-jerk reaction is to be deeply disturbed whenever the government comes to the aid of reckless rich guys. So this quotation from today's paper resonated with me:

“For the government to print money at the expense of taxpayers as opposed to requiring or going about a receivership and wind-down of any insolvent institutions should be troubling to taxpayers and regulators alike,” said Josh Rosner, an analyst at Graham Fisher & Company and an expert on mortgage securities. “The Fed has now crossed the line in a very clear way on ‘moral hazard,’ because they have opened the door to the view that they are required to save almost any institution through non-recourse loans — except the government doesn’t have the money and it destroys the U.S.’s reputation as the broadest, deepest, most transparent and properly regulated capital market in the world.”

The key is to find some way to accomplish the Fed's goal of reducing financial contagion without risking taxpayer money to help some of the least needy members of society--an action that sacrifices both the goal of efficiency (via moral hazard) and the goal of equality.

A few days ago, the Wall Street Journal reported a suggestion from economist Myron Scholes about structuring bailouts of financial institutions:

there's a conundrum. If the government guarantees or buys debt from the bank, it makes the equity holders better off. If it buys equity and dilutes existing shareholders, it makes debt holders better off.

Mr. Scholes's solution: Let government invest both in debt senior to existing debt and in preferred stock senior to existing shares. Neither is advantaged versus the other. The bank doesn't dump assets and expands lending. If all goes well, the government gets out with a profit.

Here is another off-the-wall idea that someone proposed to me: Why not make senior management personally guarantee the loans made in any such bailout? (I presume they have significant assets beyond their equity stake in the firm.) Given the sums involved, that won't offer the taxpayer a lot of protection. But at least it will make some of the guys responsible for the mess squirm just a little bit more.

Update: A reader more knowledgable than I am tells me:

the Fed action is like spraying foam on the runways -- the plane is still going to crash and not fly again, but the people on board will hopefully walk away with just bruises. Or in english, having Bear collapse in a day would have led to problems with people who rely on them for clearing trades. The Fed action won't save Bear but will avoid fallout that disrupts markets by even more.

This analysis is turning out to be right: The WSJ now reports that JP Morgan will buy Bear Stearns for $2 a share, compared with $30 at Friday's close and about $100 a few months ago.

This paragraph from the WSJ story, however, is worrisome:

To help facilitate the deal, the Federal Reserve is taking the extraordinary step of providing as much as $30 billion in financing for Bear Stearns's less-liquid assets, such as mortgage securities that the firm has been unable to sell, in what is believed to be the largest Fed advance on record to a single company. Fed officials wouldn't describe the exact financing terms or assets involved. But if those assets decline in value, the Fed would bear any loss, not J.P. Morgan.

Someone (I forget who) recently called the Fed "the pawnbroker of last resort."

The Economics of Charitable Giving

Via Leonhardt. The article includes a nice introduction to the mind of John List, with whom I had the pleasure to work while I was at the CEA.

Subprime Mortgage Blues

Thanks to Calculated Risk for the pointer.

Marty is scared

Reuters reports:

The United States is in a recession that could be "substantially more severe" than recent ones, National Bureau of Economic Research President Martin Feldstein said on Friday. "The situation is very bad, the situation is getting worse, and the risks are that it could get very bad."...

Feldstein said the downturn could be the worst in the United States since World War Two.

Phelps on Current Uncertainties

Nobelist Ned offers his perspective on the economy.

The Coming Tax Hike

Intrade now lets people bet on future marginal tax rates. The top marginal tax rate for the federal income tax, which is now 35 percent, is expected to rise. Here are the current probabilities for the top rate in 2011:

P(top rate equals or exceeds 38 percent) = .87
P(top rate equals or exceeds 40 percent) = .33
P(top rate equals or exceeds 42 percent) = .18

Notice that there is a one in three chance the rate will exceed the level that prevailed under President Clinton.

Rogoff on Inflation Risks

My Harvard colleague Ken Rogoff is concerned:

Many central bankers and economists argue that today's rising global inflation is just a temporary aberration, driven by soaring prices for food, fuel, and other commodities.

True, prices for many key commodities are up 25 percent to 50 percent since the start of the year. But if central bankers think that today's inflation is simply the product of short-term resource scarcities as opposed to lax monetary policy, they are mistaken.

The fact is that around most of the world, inflation ― and eventually inflation expectations ― will keep climbing unless central banks start tightening their monetary policies.

The U.S. is now ground zero for global inflation. Faced with a vicious combination of collapsing housing prices and imploding credit markets, the Fed has been aggressively cutting interest rates to try to stave off a recession.

But even if the Fed does not admit it in its forecasts, the price of this "insurance policy" will almost certainly be higher inflation down the road, and perhaps for several years.

Economic Advisers

Who are McCain, Obama, and Clinton listening to?

Another Member

Ernesto Zedillo, director of Yale's Center for the Study of Globalization and former president of Mexico, joins the Pigou Club:

Frankly, a Kyoto-type framework--one with global quantitative emissions targets allocated among countries--that meets the above conditions is not feasible. The only approach that will fulfill the conditions and relieve countries' apprehensions regarding sovereignty and free riding is one in which all countries agree to penalize their carbon emissions in such a way that, over time, an internationally harmonized carbon price prevails. Consequently, the negotiation's focus would not be on emissions quotas but on the harmonized carbon-price trajectory.

Of course, carbon taxes (on burning fossil fuels) would provide the easiest way for countries to comply with the system, and each country could then decide what to do with the tax revenue. Some might make their carbon tax revenue-neutral by reducing other taxes. The regime would allow countries (or associations of countries such as the EU) to comply with the internationally agreed-upon carbon price by means of their own national cap-and-trade systems. It would also let poor countries move toward the agreed trajectory of carbon prices more slowly than rich countries.

If you're worried about climate change but don't like carbon taxes, think about the messy or even impossible alternatives!

A Slice of Life

From the joshing gnome:

This morning I was on the same train at the same time. The girl next to me was reading Wittgenstein in the original German, with no notes and no dictionary. The girl on my other side was reading a Korean translation of Mankiw’s Principles of Economics.

The Gains from Trade

Thanks to Westminster College econ prof David Cushman for the link.

The Fed vs the ECB

From Sebastian Mallaby:

The divergence in approaches on either side of the Atlantic is likely to stoke tensions. Americans resent Europeans for not sharing the burden of stimulating the world economy, forcing them into unilateral action. Europeans resent Americans for blundering foolishly ahead, exacerbating inflation.

Immigration and the Median Worker

From economist Brad Schiller:

The supposed decline of the poor and middle class is exaggerated even more by the dynamics of population growth. When people look at the "poor" in any two years, they think they're looking at the same people. That's rarely true, especially over longer periods of time.

Since 1998, the U.S. population has increased by over 20 million. Nearly half of that growth has come from immigration, legal and illegal. Overwhelmingly, these immigrants enter at the lowest rungs on the income ladder. Statistically, this immigrant surge not only reduces the income of the "average" household, but also changes the occupants of the lowest income classes.

To understand what's happening here, envision a line of people queued up for March Madness tickets. Individuals move up the line as tickets are purchased. But new people keep coming. So the line never gets shorter, even though individuals are advancing.

Something similar happens with the distribution of income. People keep entering the distribution line from the bottom. Even though individuals are moving up the line, the middle of the line never seems to move. Hence, an unchanged -- or even receding -- median marker could co-exist with individual advancement.

Unintended Consequences

What do ethanol and the subprime mortgage meltdown have in common?

Whatever happened to inflation targeting?

(Click on the graph to enlarge.)

The Cleveland Fed calls this measure "a good estimate of the market's estimate of future inflation." It is derived from the 10-year yields on nominal and real bonds. The recent increase to 3.4 percent should have monetary policymakers worried.

Update on Sunday morning: Unfortunately, the link above no longer delivers what it is supposed to, I trust only temporarily. Whenever I try to access the Cleveland Fed's "inflation central" features, I am told the system "has experienced an unexpected error."

The irony: That is precisely what some market participants are starting to worry about. I hope the problem is fixed soon.

My Whereabouts Today

Eastern Economic Association. I will be giving the luncheon talk.

If I am assassinated before then, I presume my vice presidential running mate will assume the responsibility. Click on the link and scroll down to see who that would be.

More on NAFTA

Economist Phil Levy defends the trade agreement.

Feldstein on the Mortgage Crisis

Marty has a plan.

Lonely Council Meetings

Put this in the "Washington is broken" file:

Democrats Tie Up Bush on Economy

President Bush is working to prevent a recession, but the group of advisers meant to help him achieve this vital goal is woefully understaffed. In fact, the three-member Council of Economic Advisers is limping by with just a single adviser.

The reason: a lingering impasse between Senate Democrats and the Bush administration regarding the choice of nominees....

With the deadlock now dragging into March, the administration's chances of being able to fully staff the current CEA are dwindling. Already, one of Mr. Bush's nominees, Dennis Carlton of the University of Chicago, has taken his name out of the running. He had been waiting since August to be considered by the Senate.

Subprime Primer

Confused about what has been happening in credit markets? A student brings to my attention a Subprime Primer, which explains all the key issues. Current ec 10 students will recognize the story told in this cartoon slideshow as similar to that told by John Campbell in his guest lecture last week.

Warning: Some of the language is not suitable for small children.

Real interest rates are now negative

Click on the graph to enlarge and see better an unusual phenomenon: inflation-adjusted interest rates below zero.

Nothing in economic theory precludes negative real interest rates, or even suggests they should be anomalous. Nominal interest rates cannot be negative, because people would just hold cash instead of bonds,* but real interest rates can be negative. If real interest rates were very negative, investors could start investing in inventories of goods, but this arbitrage is not easy. Storing goods is costly, and many things in the CPI basket, such as services, are not storable at all.

In standard models of asset pricing, negative real interest rates are most likely to arise if growth expectations are particularly low or if uncertainty is particularly high. Low growth expectations encourage households to save, which drives down equilibrium rates of return. High uncertainty drives up risk premiums, which in turn drives down the return on safe assets, perhaps below zero. Both forces seem to be working now.

*Clarification: A reader points out, correctly, that nominal interest can be slightly negative if there are costs to holding cash.

Sowell on the Rust Belt

Hint: NAFTA is not the problem.

Landsburg's Latest

Steve Landsburg makes the case for home foreclosures.

Remember: This is from the guy who defended Ebenezer Scrooge.

Bhagwati on the Dems

International economist Jagdish Bhagwati explains why he thinks Barack Obama would be better for free trade than Hillary Clinton would be. One reason:

whereas Mr Obama’s economist is Austan Goolsbee, a brilliant Massachusetts Institute of Technology PhD at Chicago Business School and a valuable source of free-trade advice over almost a decade, Mrs Clinton’s campaign boasts of no professional economist of high repute. Instead, her trade advisers are reputed to be largely from the pro-union, anti-globalisation Economic Policy Institute and the AFL-CIO union federation.

Case Study: The Effect of Wages on Labor Supply and Unemployment

From a student email:

I am an Ec 1010b student and proud alumnus of Ec 10. In fact, I enjoyed Ec 10 so much that in addition to concentrating in economics, I have chosen to tutor the course. That's where the story begins.

Last term, the Bureau of Study Counsel paid $12/hour for one-on-one peer tutoring. They were short on tutors (particularly in Ec10) and made frequent pleas to former Ec10 students to tutor the course. When they have a tutoring job, they send out the offer over an e-mail list to those signed up to tutor. It sometimes took a long time to assign tutors to students due to the lack of interested tutors.

This term, they raised the pay rate to $14/hour and all tutoring jobs are snapped up in minutes. I myself am hoping to tutor a student or two, but I have not replied to any of the e-mails quickly enough; I guess you could say that I'm unemployed. Just thought it was interesting to see how one of the basic Ec10 ideas (raising the minimum wage creates unemployment) is at work right here on campus.

Obviously, they have gone a little too high with their pay raise. Maybe they should have run the change by an economist before taking action.

Update: Another student email me an alternative hypothesis:

As a former Ec10 and 1010 alumnus (and current ec1545 student) myself, I have to respond to email that the student sent you on your blog. Put briefly, first we should consider other variables - perhaps the tutors enjoy macro more as a whole, and therefore the supply of macro tutors is greater; also, since it is still near to the beginning of the term, there have been seemingly fewer requests for ec 10 tutors than last semester (though I admittedly have not kept track). I think the unmet demand of last semester was most noticeable during reading period, actually, when both the demand for tutoring increases and the supply decreases. The student probably remembers these pleas the most, but during the first half of the semester, I think the market cleared pretty well.

Besides, we would predict that tutors of all subjects would respond to the pay raise similarly. I notice that physical sciences tutoring jobs and a certain intro-math tutoring jobs still take some time to clear, and often they need to be re-posted. This may support my previous hypothesis - these classes have had midterms recently, so the demand for these tutors has likely been higher.

All said, I don't view the tutoring jobs as employment or unemployment, or $2 more or $2 less. I just want to teach. But perhaps some people respond to the wage raise differently from me.

Tax Rates by Income Quintile

From CBO data via Kruse Kronicle. Click on the graph to enlarge.

Glaeser on Cities

My Harvard colleague Ed Glaeser worries that cities are disadvantaged because they have more than their share of the poor and because the suburbs do more than their share of emitting carbon.

A carbon tax with revenues rebated via a lump-sum demogrant would address both concerns.

Shiller on Bubbles

The Yale prof writes in today's NY Times.

Weirdness in the Muni Market

From the WSJ.