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The Gulf Between Keynesians and Austrians

On April 6, 2011, in Economy, Housing, by Tim

The broad disagreement between Keynesian and Austrian economists on the subject of “liquidity traps” is discussed in this item over at The Freeman blog. It’s kind of an important question as it is fundamental to where the global economy finds itself today and whether the disease and the cure (i.e., excessive debt) can really be the same.

Under the Keynesian paradigm, if monetary authorities cannot stimulate private spending by forcing down interest rates, then the only other avenue is for the government to borrow and create new money, and spend on its own projects. If the first option does not work, the second, by definition, must.
…
(Murray) Rothbard (in The Great Depression) continued that the very things Keynesians claim will worsen an economic downturn – including falling wages and prices and liquidation of capital – actually are necessary to speed up the readjustment. The Austrian-Keynesian divide is fundamental on this point; Austrians not only reject the liquidity-trap paradigm, but also hold that the problem is boom-induced malinvested capital rather than idle capital.

The distinction is important because Austrians say the economy cannot recover until the malinvested capital is transferred to other uses, liquidated, or abandoned altogether. Keynesians, on the other hand, claim that if government can spend enough money, the same capital that Austrians say is malinvested will be returned to full employment.

I suppose that if you were trained as a Keynesian economist – having invested years of your life academically and then finding yourself surrounded by the same sort of thinking professionally – it’s the path of least resistance to just dismiss the Austrian viewpoint about malinvestment out of hand. But, for anyone who doesn’t have that bias already instilled, it’s hard to argue against the Austrian viewpoint since taking a contrary position would imply that what we’ve seen over the last decade was not malinvestment.

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Soaring Inflation, Dipping ECRI Weekly Index

On March 28, 2011, in Economy, by Tim

The cost of David Rosenberg’s daily missives from Gluskin Sheff will rise infinitely in price in just two days (i.e., from zero to $1,000 a year – not the sort of thing you’d expect from someone whose been pitching the de-flation story), so, today seemed like a good opportunity to grab a chart while they can still be had, this one of the ECRI Weekly Index.

Recall that this index was cause for much gnashing of teeth last spring when it began to exhibit rather large and unprecented year-over-year changes that many thought foretold a new economic slowdown (or much worse). Well, that never came to pass as the 2010 summer lull turned into a veritable economic revival when Ben Bernanke and crew started talking about printing up another half trillion dollars or so for the greater good.

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Interest Rates and Home Equity Extraction

On March 24, 2011, in Housing, by Tim

You don’t hear too much about equity cushions anymore, that term popularized by the Greenspan Fed five or six years ago as they marveled at the rapid increase in housing prices and wondered (just a little bit) what a reversal might lead to. Back around the middle of the last decade, the  consensus within the central bank was that homeowners had sufficient equity in their homes to prevent anything really bad from happening.

Obviously, they were wrong, and the debate continues about who should be blamed for the near collapse of the global financial system, central bank economists still denying any part played by low interest rates. While most economists dare not criticize the Fed for fear of a stunted career (an act akin to underlings criticizing the Pope), others have been pointing to low short-term interest rates as one of the proximate causes for our current troubles, the latest being this article by Heleen Mees about how interest rates factored into the home equity “extraction” craze that was all the rage here in the U.S. just a few short years ago.

In recent research (Mees 2011), I show that the Fed’s easy monetary policy, rather than the housing boom, as asserted by Taylor (2007), sparked the refinancing boom. While mortgages for purchase do not respond significantly to changes in the fed funds rate but instead to changes in long-term interest rates, I find that mortgages for refinance are significantly responsive to both changes in the fed funds rate and changes in long-term interest rates, especially so in the period 2000 – 2008. Between Q1 2003 and Q2 2004, the time when the FOMC held the fed funds rate steady at 1%, two-thirds of all mortgage originations were for home refinance.

Spending money that had been raised through home equity extraction – or remortgaging – amounted to more than 4% of GDP in 2005. From the FOMC transcripts in 2003 and 2004, it emerges that the FOMC in general looked favourably upon home equity extraction as a source of personal consumption expenditure. In his 2005 Sandridge lecture, Bernanke boasted of the depth and sophistication of the country’s financial markets that allowed households easy access to rising housing wealth. The possibility that the housing boom could one day turn to bust, leaving many homeowners in negative equity, seems not to have set off any alarm bells at the Federal Reserve.

Mees goes on to make a number of other points and provides a few charts in support, all of which seem to make a good deal of sense. When you could take out a HELOC and pay, say, $50 a month to service an extraction of $50,000, this can act on a powerful drug  to those who thought they’d never really have to ever pay the money back, a good number of these types taking that home equity and using it to go out and buy a second home, or a third.

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Robert Shiller and the Fed’s “Credibility Trap”

On March 16, 2011, in Asia, Economy, Housing, Stocks, by Tim

On perusing US Dollar, FOMC, and the Japan Crisis: The Dog That Didn’t Bark at Jesse’s Cafe earlier today, there were two items of interest that seemed worth sharing here, the first being more ominous warnings from Yale economist Robert Shiller, he being one of those rare dismal thinkers who can actually spot asset bubbles in real time.

Shiller recently noted, “the housing bubble was the largest asset bubble in US economic history, since at least 1895″ which is as far back as his records could go and, anyone wanting more details on this subject might want to have a look at this YouTube video of Shiller where talks about some of the housing data he’s collected.

In a Bloomberg interview, Shiller warned about winding down Fannie Mae and Freddie Mac since, basically, they are the mortgage market today as commercial banks are still in something of a mortgage funk, only moderately interested in originating mortgages to earn a fee but showing little desire to carry them on their books.

In a CNBC interview on Monday, Shiller suggested that the Japan quake and tsunami could have a huge negative impact on the current stock market rally, one that he’s long thought was not squarely based on fundamentals. He pointed to a big plunge in the Japanese stock market one full week after the Kobe earthquake in 1995, suggesting that an event such as this takes some time to register with investors and traders and that we could see a similar development later this week.

As for the other item in the title above – the Fed’s “Credibility Trap” – that’s a phrase that I just read for the first time this morning (though others seem to be talking about it too these days), an idea that is particularly relevant after yesterday’s soothing words from the central bank that “subdued inflation trends and stable inflation expectations are likely to warrant exceptionally low levels for the federal funds rate for an extended period”.

After this morning’s surge in producer prices – up at an annual rate of 10 percent over the last six months – and what could be a surprising report on consumer prices tomorrow, that would be an interesting phrase to watch on Google Trends. The phrase  liquidity trap sprang to life there just a couple of years ago, but, so far “credibility trap” doesn’t register.

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Balance Sheet Recessions Explained

On March 13, 2011, in Debt, Economy, by Tim

This video has popped up in a number of places recently – Richard Koo explains what a balance sheet recessions is, how we got into one, and why QE1, QE2, QEx are not helping.

Like many other areas of contemporary economic thought, what bugs me most about this “juicy rationalization” of our current predicament is that, it as if the world’s economists woke up one day only to discover that everyone had borrowed and spent too much money, just like, in October of 1929, the stock market crashed, and thus the trouble began.

Reckless expansion of money and credit rarely ends well, something that far too few policymakers and dismal scientists seem to acknowledge as the root cause of the worst two financial market and economic disasters of the last century.

Perhaps Jeremy Grantham put it best not long ago after being asked how he would remedy the world’s economic ills when he quipped, “Well, I wouldn’t start from here”.

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Economists Still Defend the Fed

On February 22, 2011, in Economy, WTF?, by Tim

Obviously, with a name such as the one that adorns my blog, I have my own notions about how the world works and the role that economists play in it, but these two graphics from the recently conducted Q1 Kaufman poll of economics bloggers (which they kindly asked me to participate in) demonstrate how the nation’s central bank still has their tentacles firmly around the economics profession in this country.

First, after many reports over the years (including, most recently, by the Financial Crisis Inquiry Commission) about how both former Fed Chief Alan Greenspan and current Fed Chief Ben Bernanke have failed the nation (though they’ve been pretty good to Wall Street banks), they are seen in a favorable light by the poll respondents.

Why might this be?

(more…)

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