THOUGHTS ON THE U.S. WEALTH DISTRIBUTION.
To quote Mark Twain: “Liars, damned liars, and statistics.” I used to study the Survey of Consumer Finance every three years (which is how often reliable data on the “wealth” distribution in the US are available). In between, I'd create estimates based on National Income Accounts data on personal income, supplementing it with Summary of Income data from income tax filings. It was great sport. The intent was to see if differences in savings rates in an age cohort explained differences in wealth distribution as the cohort aged. Unfortunately the data were too aggregated to find anything conclusive.
What I learned was to just ignore media reports on the distribution of income and especially wealth. One can't even rely on the media to know the difference between income and wealth. Heaven help them if one asked them the difference between income and cash flow. Plus, they’ll go to any source for a story regardless of whether the data is at all reliable or even well defined.
Any analysis of the issue, even by the best academics, should be taken with a big grain of salt. If one plays my game of analyzing the data, two things should stand out. The data is highly questionable, and it doesn’t support any broad conclusions. Minor differences in analytical technique, those pesky assumptions, really change the impression one gets.
If one researches “distribution of wealth in America,” the result will be lots of opinion pieces with different data and definitions. There are few actual data sources where the sources, measurement errors, or even the data are well defined. For example, an asset may be owned by one person, managed by another, while yet a third is the beneficiary of the assets value. Some often unspoken assumption has to be made in order to attribute the wealth to someone.
There are related issues arising from unfunded or underfunded assets represented by promises/entitlements. Viewed from the recipients’ perspectives, the assets have one value. Viewed from the perspective of economy (as capital stock), the assets have a different value. Which is right?
Often assumptions about issues like these are never spelled out. One has to suspect many of the “analyses” are designed with political objectives in mind, not in order to investigate the phenomena.
It is particularly interesting that in order to make data meaningful, analysts usually drop outliers from a sample. However, the 99%er crowd is largely focused on quirks created by a few outliers in a highly questionable data set. Even the Survey of Consumer Finances, which intentionally includes an over-sampling of the upper tail of the distribution, doesn’t try to pretend to know what the 99%ers purport to know.
One of my favorite mental games is to pick a few dozen stocks where ownership is concentrated in the hands of the members of the Forbes 400 wealthiest people. One then tries to guess how much the wealth distribution at the 1% level would change if some of their stocks underperformed or over performed relative to GDP. The 99%ers are reacting to supposed changes in society caused by such ephemeral issues as how a very limited set of stocks are preforming.
Now, you might ask: Why play that silly game? Well, taken at market value, Buffet, Gates, etc. look rich. When one focuses on the 1%, if they tried to sell their stock, mark-to-market would hardly be what they would get. They still are rich under mark-to-cash assumptions, but the gap between them and someone more liquid would shrink appreciably (i.e., the wealth distribution would narrow). That’s one illustration of the types of assumptions hidden in wealth distribution data.
Another more dramatic example is illustrated by one of the recent bankruptcies by a real estate tycoon. (The major owner of Simon properties, I think). Under mark-to-market he was in that 1%. Alas, when Simon had to liquidate a big portion of its real estate, conversion to cash bankrupted the company. Oops!
That’s why, although often described as a permanent plutocracy, the Forbes 400, the richest of the rich, is actually quite unstable. One study found that only 27% of America's top 400 have made the list more than once since 1994. Some of today's wealthy (very rich) become tomorrow's fallen kings. It’s very similar among the 1%. A small slice of a distribution is seldom made up of a stable population.
It may be nice to think that once the evil 1% is vanquished all will be right with the world. An evil villain is so convenient. But, like the poor, the rich will always be with us; they just won’t be the same people.
Sunday, November 6, 2011
Friday, November 4, 2011
The 99%ers: Part 1
WHO ARE THE 1%?
To quote Pogo: “We have met the enemy and he is us.” Recently, I receive this email and link. It’s good material for some serious thought. It will be the point of departure for the next few postings. Unfortunately, it’s also fodder for political, posturing often done without any thought. The postings will stick to measurement issues and try to avoid the politics.
“I understand the targeting of the 1% of the population that holds 40% of the wealth. By that standard, I would argue that the number of Americans is well over 1%. When all of Africa and Asia are added into the base, we are very well off. I would think that an annual income of $500.00 would put someone into the top 1% of the world. However, I have no data to even begin to figure out the US wealth ranking per capita. So I share this rant for your fun, and wonder what your thoughts are......
An interesting rant....”
http://blog.cagle.com/2011/10/we-are-the-one-percent/
MY THOUGHTS?
Agree. Americans who rant about the wealthy should rant into a mirror. They are the wealthy.
Even so, globally, the leveling of the wealth and the income distributions are the big events of the 21stcentury. While you point to Africa and Asia, one used to say everything outside Western Europe, Australia, and English speaking North America. However, the increases in average incomes in China, India, Southeast Asia, Eastern Europe, Latin America, etc. have narrowed the income gap. It takes a lot more than $500 today, but still much less than the US “poverty” level. My guess is someone who gets unemployment insurance for a year would be upper income in most of the world, and if they lived like a local, would end up wealthy.
Globally, inequality is decreasing. Still, all Americans except a very few are richer than most of the world’s population by order of magnitude. THE ECONOMIST MAGAZINE had an interesting supplement on this recently. The title was something catchy like: Surprise, inequality is decreasing. It pointed out that inequality is increasing in many countries, but deceasing globally because of narrowing differences between countries. It focused on income rather than wealth. So, the data aren’t directly relevant, but the discussion of issues related to international comparison is interesting and relevant.
Funny thing is, no matter how big, fast, tough, or sexy one is, there is always someone bigger, faster, tougher, or sexier. The same is true of wealth. If others’ wealth makes one envious, covetous, or resentful, welcome to a miserable life. It’s sad when Americans (and Europeans for that matter) who are the wealthy of the world, make fools of themselves this way.
It seems that envy and resentment tend to cloud people’s judgment. Also, some people think a good rant gets it off their chest and they’ll feel better: I haven’t seen that very often. Rather, it seems to make them unhappier as often as not.
A lot of Americans are thinking about the issue in terms of an exclusively American perspective. My overall thought is that the entire issue of wealth distribution in America is a smoke screen to cover-up policy failures.
Regarding the targeting of the “1%,” I’ve never been able to get into the envy and resentment thing. I don’t begrudge anyone their success. It isn’t a zero sum world. Their wealth just makes me better off.
The 99%ers as used below refers to a political posture, and 1% is used to refer to those the 99%ers think they are targeting. Here’s an interesting aspect of the international dimension of the 99%ers. The 99%ers probably think they’re making common cause with the Greek rioters. Whether they’re in the 1% is questionable, but clearly Greece is looking mainly to other Europeans to bail them out. Seems ironic that people protesting capitalism in the USA think they’re making common cause with Greeks protesting their socialist government.
So, you say: How does that relate to Americans as a gaggle of people in the 1% globally? Although one doesn’t hear much about it, the IMF is on the hook for part of the bailout, somewhere around 23% at one point. Who is the largest contributor to the IMF? You guessed it, the USA. Thus, some of the 99%ers will be bailing out other 99%ers, but look at it globally and a substantial portion of 99%ers on both sides of the Atlantic are actually the 1%.
It looks like IMF could be asked to do more. This organization, designed to help poor countries, may have to ask for contributions from low income countries in order to finance assistance to a relatively developed country. The 99%ers should look in the mirror, and shouldn’t be very proud of what’s staring back.
To quote Pogo: “We have met the enemy and he is us.” Recently, I receive this email and link. It’s good material for some serious thought. It will be the point of departure for the next few postings. Unfortunately, it’s also fodder for political, posturing often done without any thought. The postings will stick to measurement issues and try to avoid the politics.
“I understand the targeting of the 1% of the population that holds 40% of the wealth. By that standard, I would argue that the number of Americans is well over 1%. When all of Africa and Asia are added into the base, we are very well off. I would think that an annual income of $500.00 would put someone into the top 1% of the world. However, I have no data to even begin to figure out the US wealth ranking per capita. So I share this rant for your fun, and wonder what your thoughts are......
An interesting rant....”
http://blog.cagle.com/2011/10/we-are-the-one-percent/
MY THOUGHTS?
Agree. Americans who rant about the wealthy should rant into a mirror. They are the wealthy.
Even so, globally, the leveling of the wealth and the income distributions are the big events of the 21stcentury. While you point to Africa and Asia, one used to say everything outside Western Europe, Australia, and English speaking North America. However, the increases in average incomes in China, India, Southeast Asia, Eastern Europe, Latin America, etc. have narrowed the income gap. It takes a lot more than $500 today, but still much less than the US “poverty” level. My guess is someone who gets unemployment insurance for a year would be upper income in most of the world, and if they lived like a local, would end up wealthy.
Globally, inequality is decreasing. Still, all Americans except a very few are richer than most of the world’s population by order of magnitude. THE ECONOMIST MAGAZINE had an interesting supplement on this recently. The title was something catchy like: Surprise, inequality is decreasing. It pointed out that inequality is increasing in many countries, but deceasing globally because of narrowing differences between countries. It focused on income rather than wealth. So, the data aren’t directly relevant, but the discussion of issues related to international comparison is interesting and relevant.
Funny thing is, no matter how big, fast, tough, or sexy one is, there is always someone bigger, faster, tougher, or sexier. The same is true of wealth. If others’ wealth makes one envious, covetous, or resentful, welcome to a miserable life. It’s sad when Americans (and Europeans for that matter) who are the wealthy of the world, make fools of themselves this way.
It seems that envy and resentment tend to cloud people’s judgment. Also, some people think a good rant gets it off their chest and they’ll feel better: I haven’t seen that very often. Rather, it seems to make them unhappier as often as not.
A lot of Americans are thinking about the issue in terms of an exclusively American perspective. My overall thought is that the entire issue of wealth distribution in America is a smoke screen to cover-up policy failures.
Regarding the targeting of the “1%,” I’ve never been able to get into the envy and resentment thing. I don’t begrudge anyone their success. It isn’t a zero sum world. Their wealth just makes me better off.
The 99%ers as used below refers to a political posture, and 1% is used to refer to those the 99%ers think they are targeting. Here’s an interesting aspect of the international dimension of the 99%ers. The 99%ers probably think they’re making common cause with the Greek rioters. Whether they’re in the 1% is questionable, but clearly Greece is looking mainly to other Europeans to bail them out. Seems ironic that people protesting capitalism in the USA think they’re making common cause with Greeks protesting their socialist government.
So, you say: How does that relate to Americans as a gaggle of people in the 1% globally? Although one doesn’t hear much about it, the IMF is on the hook for part of the bailout, somewhere around 23% at one point. Who is the largest contributor to the IMF? You guessed it, the USA. Thus, some of the 99%ers will be bailing out other 99%ers, but look at it globally and a substantial portion of 99%ers on both sides of the Atlantic are actually the 1%.
It looks like IMF could be asked to do more. This organization, designed to help poor countries, may have to ask for contributions from low income countries in order to finance assistance to a relatively developed country. The 99%ers should look in the mirror, and shouldn’t be very proud of what’s staring back.
Thursday, November 3, 2011
Cash Flow And Balance Sheet Management: Part 2
Managing both never ends.
If you think the difference is just an issue for financial analysts, you are wrong. You’re wrong big time. Financial analysts may need a more detailed understanding than you do, but at least a passing understanding is probably more important to individuals.
“How can it possibly be more important for me than for a financial analyst?” you ask. Simple. Remember the statement from “Whose Future Is It?”: “The borrower is betting his or her future.” When the issue is an individual’s cash flow and balance sheet, it’s the entire enchilada that you are betting. One needs to understand the difference and have a passing understanding of how they interact. Any decision one makes with regard to money has both cash flow and balance sheet implications immediately, and those immediate implications will shape the future.
If you want an example of how easily errors are made when only the balance sheet is considered, it’s easy. Just envision the miser who dies from his or her self-denial despite the cash-generating potential of the accumulated wealth. That doesn’t seem to be the US’s problem.
Errors resulting from only focusing on cash flow are probably more prevalent. For some very current examples, see the discussion of the numerous errors people make when discussing the federal government budget. They are described in “Balanced Budget And Balance Budget Amendment: Dangerous Fiction.” This quote summarizes the problem: “The Federal government does its accounting on a cash flow basis…. That approach substantially increases the likelihood of errors – errors in each step and cumulative errors. To illustrate the risk on each step, both the initial Boehner and the Reid proposals to end the deadlock on the debt ceiling came up short when scored by CBO. For cumulative error, how have the forecasts of Medicare and Social Security faired?”
For discussions of balance sheet management that is more oriented toward the individual, see “Truth In Lending” and “Borrowing For Investment.” The first, “Truth,” addresses myths associated with borrowing for consumption. The second, “Borrowing,” introduced some balance sheet issues more directly. However, it ignored the fact that “debt carrying capacity also involves cash flow,” a point made in the discussion of a balanced budget. Consequently, it only introduced the issue. It is when cash flow and balanced sheet are viewed together that a financial plan becomes possible.
Back in “Investing Part 3: Setting the Volume,” the ability to anticipate cash requirements was introduced. It goes by many names from forecasting expenses to the often-dreaded budgeting. No matter the name used, without it a financial plan is close to impossible and balance sheet management a bit constrained.
The constraint seems to lead in self-contradictory directions. As mention before on this blog, some people only view assets as a way to transfer consumption between time periods. They ignore assets as an income-producing resource. It isn’t unusual for that approach to assets to be associated with an inability or unwillingness to try to project cash flow requirements. It’s what, for lack of a better term, might be called the “how long can I hold out on what I have” approach to balance sheet management. The result is an excessive focus on current market values (an obsession with mark-to-market accounting).
The contradiction is that if it’s just a transfer of consumption into some future period, why the heck does current market value matter? What matters is the value at the time when it will be translated back into consumption. The only explanation that seems to fit is a conclusion that if they can’t forecast their own behavior, they conclude that trying to forecast cash flow or future market values is hopeless or just too darn hard. Somehow no forecast is better than one that is uncertain. Perhaps their ego cannot accept the fact that their forecast will be wrong (unless they incorporate a margin of error). So, they find refuge in the “certainty” of current market value.
The unfortunate result is people ready to retire one year and planning to “have” to work forever the next year. Just as sad are people who have to accumulate great stores of low return assets before they can accept the risk of a long life, or, even worse, people who run out of money during old age, often late in old age.
At the other extreme are people who can forecast cash requirements, but can’t relate them to a balance sheet. If we’re giving these tendencies a name, let’s call it the “they’ll take care of it for me” approach. The approach totally ignores what is referred to as the “agency issue.” That’s a fancy term for the fact that the interests of the person abdicating responsibility and the interests of the person accepting the responsibility (the agent), aren’t the same. In fact, they conflict. The agent wants / needs the cost of fulfilling the responsibility to be high. The person who turned over responsibility wants / needs them to be low so that they don’t eat up all the returns.
Here’s the contradiction. The person who abdicated responsibility actually retained an even more daunting responsibility. They have to manage the financial manager. It really gets weird when the person who abdicated responsibility faults the manager with statements like “even I would have seen that (fill in the blank) was a bad investment,” or even weirder “any idiot should have known.” The strangest explanation is when they turn the responsibility over to a pension fund manager, an annuity manager, or a mutual fund management company because “Wall Street is a bunch of crooks.” Seems to me those people are Wall Street.
The unfortunate result is the proverbial angry old man, disappointed when he or she discovers that their manager didn’t quite fulfill their unrealistic expectations. They often resent the success of the person they entrusted with the responsibility. Let see, they entrusted the responsibility to the person on the assumption the person knew how to plan for the future. Why are they resentful when that the person planned for their own future? That very ability to plan was the selection criteria.
The people who manage financial institutions aren’t crooks. Generally, they are honest, hardworking, and reasonably bright people. Uncertainty is there whether you face it or pay someone else to face it for you. Turning over responsibility to someone else because it’s hard to address that responsibility doesn’t suddenly make it easier. If anything, it increases the likelihood of an error.
Why does it make it harder? Because you now have to know the incentives you’ve created for the manager and forecast how he or she will react to those incentives. Further, there is a high probability that you as the investor have created conflicting incentives. The best illustration of the conflicting incentives is when someone sets up a retirement account designed to generate cash flow at some future date, then evaluates account performance based on short-run changes in the accounts’ current market value.
By forcing the manager to focus on mark-to-market value, the person who set up the account has forced the manager into a situation where he or she has to ignore future cash flow implications in favor of current balance sheet impacts. The grantor of responsibility is creating a situation analogous to that of someone who doesn’t understand their cash flow objective. If the manager is forced or encouraged to ignore the objective, it isn’t surprising that they frequently fail to achieve it.
However, there is a conflict of interest that is so strong that the government has set up regulations to mitigate it and provide insurance as a backup when the regulations fail (of course governments exempt themselves from the regulations and insurance requirement). Specifically, it relates to defined benefits pensions (i.e., pensions that promise a specific payment – usually a percent of some reference salary or a dollar amount -- for life). Person covered, organization offering the pension, pension manager, regulator and especially those who appoint the regulator, employees’ representative (if not the individual) all have conflicting objectives. Now, lest this be misinterpreted, a fully-funded, well-managed defined benefits pension is a great hedge against some risks that are otherwise very difficult to manage. The problem is nobody involved has an incentive to fully fund a pension.
The easiest way around funding a pension applies equally well to any retirement plan. Just assume a high enough return on the investment. It instantly solves the problem. But, even if one recognizes that risk to retirement planning, there is a greater risk. Ignoring the volatility in asset returns is by far the greatest risk. However, volatility in asset return can be broken down into volatility in price (the balance sheet impact), and volatility in cash generated (cash flow impact).
Mistaken estimates of return volatility don’t just mess-up peoples’ retirement plans; they undermine their ability to simultaneously manage their cash flow and balance sheet. Mistaken volatility estimates obviously lead to mispriced assets. Clearly that leads to false conclusions about the balance sheet.
The other issue here is the pattern of the cash flow. Even if you knew the average return you would earn on your savings throughout retirement, you still can't know exactly how much lifetime income you will get. When you're drawing money from a portfolio, the pattern of returns, not the average, determines how long your savings will last. These uncertainties exist. You can’t make them go away; financial manager can’t, pension fund managers can’t, and the government can’t. The uncertainty is still there.
The key to addressing this uncertainty is understanding volatility in returns. No amount of knowledge, even prescience, regarding price volatility eliminates the uncertainty (unless all returns are generated through trading). Interestingly, for many assets, price volatility is harder to forecast than return volatility. The volatility of the non-price component of return is often much easier to forecast. Yet many people base their plans to provide for their cash flow requirements on price forecasts.
If you think the difference is just an issue for financial analysts, you are wrong. You’re wrong big time. Financial analysts may need a more detailed understanding than you do, but at least a passing understanding is probably more important to individuals.
“How can it possibly be more important for me than for a financial analyst?” you ask. Simple. Remember the statement from “Whose Future Is It?”: “The borrower is betting his or her future.” When the issue is an individual’s cash flow and balance sheet, it’s the entire enchilada that you are betting. One needs to understand the difference and have a passing understanding of how they interact. Any decision one makes with regard to money has both cash flow and balance sheet implications immediately, and those immediate implications will shape the future.
If you want an example of how easily errors are made when only the balance sheet is considered, it’s easy. Just envision the miser who dies from his or her self-denial despite the cash-generating potential of the accumulated wealth. That doesn’t seem to be the US’s problem.
Errors resulting from only focusing on cash flow are probably more prevalent. For some very current examples, see the discussion of the numerous errors people make when discussing the federal government budget. They are described in “Balanced Budget And Balance Budget Amendment: Dangerous Fiction.” This quote summarizes the problem: “The Federal government does its accounting on a cash flow basis…. That approach substantially increases the likelihood of errors – errors in each step and cumulative errors. To illustrate the risk on each step, both the initial Boehner and the Reid proposals to end the deadlock on the debt ceiling came up short when scored by CBO. For cumulative error, how have the forecasts of Medicare and Social Security faired?”
For discussions of balance sheet management that is more oriented toward the individual, see “Truth In Lending” and “Borrowing For Investment.” The first, “Truth,” addresses myths associated with borrowing for consumption. The second, “Borrowing,” introduced some balance sheet issues more directly. However, it ignored the fact that “debt carrying capacity also involves cash flow,” a point made in the discussion of a balanced budget. Consequently, it only introduced the issue. It is when cash flow and balanced sheet are viewed together that a financial plan becomes possible.
Back in “Investing Part 3: Setting the Volume,” the ability to anticipate cash requirements was introduced. It goes by many names from forecasting expenses to the often-dreaded budgeting. No matter the name used, without it a financial plan is close to impossible and balance sheet management a bit constrained.
The constraint seems to lead in self-contradictory directions. As mention before on this blog, some people only view assets as a way to transfer consumption between time periods. They ignore assets as an income-producing resource. It isn’t unusual for that approach to assets to be associated with an inability or unwillingness to try to project cash flow requirements. It’s what, for lack of a better term, might be called the “how long can I hold out on what I have” approach to balance sheet management. The result is an excessive focus on current market values (an obsession with mark-to-market accounting).
The contradiction is that if it’s just a transfer of consumption into some future period, why the heck does current market value matter? What matters is the value at the time when it will be translated back into consumption. The only explanation that seems to fit is a conclusion that if they can’t forecast their own behavior, they conclude that trying to forecast cash flow or future market values is hopeless or just too darn hard. Somehow no forecast is better than one that is uncertain. Perhaps their ego cannot accept the fact that their forecast will be wrong (unless they incorporate a margin of error). So, they find refuge in the “certainty” of current market value.
The unfortunate result is people ready to retire one year and planning to “have” to work forever the next year. Just as sad are people who have to accumulate great stores of low return assets before they can accept the risk of a long life, or, even worse, people who run out of money during old age, often late in old age.
At the other extreme are people who can forecast cash requirements, but can’t relate them to a balance sheet. If we’re giving these tendencies a name, let’s call it the “they’ll take care of it for me” approach. The approach totally ignores what is referred to as the “agency issue.” That’s a fancy term for the fact that the interests of the person abdicating responsibility and the interests of the person accepting the responsibility (the agent), aren’t the same. In fact, they conflict. The agent wants / needs the cost of fulfilling the responsibility to be high. The person who turned over responsibility wants / needs them to be low so that they don’t eat up all the returns.
Here’s the contradiction. The person who abdicated responsibility actually retained an even more daunting responsibility. They have to manage the financial manager. It really gets weird when the person who abdicated responsibility faults the manager with statements like “even I would have seen that (fill in the blank) was a bad investment,” or even weirder “any idiot should have known.” The strangest explanation is when they turn the responsibility over to a pension fund manager, an annuity manager, or a mutual fund management company because “Wall Street is a bunch of crooks.” Seems to me those people are Wall Street.
The unfortunate result is the proverbial angry old man, disappointed when he or she discovers that their manager didn’t quite fulfill their unrealistic expectations. They often resent the success of the person they entrusted with the responsibility. Let see, they entrusted the responsibility to the person on the assumption the person knew how to plan for the future. Why are they resentful when that the person planned for their own future? That very ability to plan was the selection criteria.
The people who manage financial institutions aren’t crooks. Generally, they are honest, hardworking, and reasonably bright people. Uncertainty is there whether you face it or pay someone else to face it for you. Turning over responsibility to someone else because it’s hard to address that responsibility doesn’t suddenly make it easier. If anything, it increases the likelihood of an error.
Why does it make it harder? Because you now have to know the incentives you’ve created for the manager and forecast how he or she will react to those incentives. Further, there is a high probability that you as the investor have created conflicting incentives. The best illustration of the conflicting incentives is when someone sets up a retirement account designed to generate cash flow at some future date, then evaluates account performance based on short-run changes in the accounts’ current market value.
By forcing the manager to focus on mark-to-market value, the person who set up the account has forced the manager into a situation where he or she has to ignore future cash flow implications in favor of current balance sheet impacts. The grantor of responsibility is creating a situation analogous to that of someone who doesn’t understand their cash flow objective. If the manager is forced or encouraged to ignore the objective, it isn’t surprising that they frequently fail to achieve it.
However, there is a conflict of interest that is so strong that the government has set up regulations to mitigate it and provide insurance as a backup when the regulations fail (of course governments exempt themselves from the regulations and insurance requirement). Specifically, it relates to defined benefits pensions (i.e., pensions that promise a specific payment – usually a percent of some reference salary or a dollar amount -- for life). Person covered, organization offering the pension, pension manager, regulator and especially those who appoint the regulator, employees’ representative (if not the individual) all have conflicting objectives. Now, lest this be misinterpreted, a fully-funded, well-managed defined benefits pension is a great hedge against some risks that are otherwise very difficult to manage. The problem is nobody involved has an incentive to fully fund a pension.
The easiest way around funding a pension applies equally well to any retirement plan. Just assume a high enough return on the investment. It instantly solves the problem. But, even if one recognizes that risk to retirement planning, there is a greater risk. Ignoring the volatility in asset returns is by far the greatest risk. However, volatility in asset return can be broken down into volatility in price (the balance sheet impact), and volatility in cash generated (cash flow impact).
Mistaken estimates of return volatility don’t just mess-up peoples’ retirement plans; they undermine their ability to simultaneously manage their cash flow and balance sheet. Mistaken volatility estimates obviously lead to mispriced assets. Clearly that leads to false conclusions about the balance sheet.
The other issue here is the pattern of the cash flow. Even if you knew the average return you would earn on your savings throughout retirement, you still can't know exactly how much lifetime income you will get. When you're drawing money from a portfolio, the pattern of returns, not the average, determines how long your savings will last. These uncertainties exist. You can’t make them go away; financial manager can’t, pension fund managers can’t, and the government can’t. The uncertainty is still there.
The key to addressing this uncertainty is understanding volatility in returns. No amount of knowledge, even prescience, regarding price volatility eliminates the uncertainty (unless all returns are generated through trading). Interestingly, for many assets, price volatility is harder to forecast than return volatility. The volatility of the non-price component of return is often much easier to forecast. Yet many people base their plans to provide for their cash flow requirements on price forecasts.
Wednesday, November 2, 2011
Cash Flow And Balance Sheet Management: Part 1
It may not be an elephant in the room, but it’s bigger than a bread basket.
Income and expenses are flows. Assets and liabilities are stocks. They relate, but aren’t the same. Income and expenses relate to consumption. Wealth only relates to potential consumption when it is translated into income (or expense in the case of liabilities that exceed assets). People who confuse income with wealth are ignoring the difference and not recognizing the cost associated with getting from one to the other.
There are many ways to try to equate one to the other. Market-to-market is one. Just assume perfect markets for assets and, voila, wealth equals market value. It shouldn’t be surprising that The Hedged Economist sees some problems with that approach. Numerous postings on this blog have highlighted the foolishness of the instantaneous liquidity assumption implicit in the perfect market assumption. It has been addressed directly, in terms of the consequences of changes in liquidity, and in discussions of approaches to managing one’s own liquidity needs. However, it’s only one approach, and it is a useful tool.
Another approach, often used as a retirement planning tool, is simulations, Monte Carlo being the most common. It, too, has limitations. Constructed simulations, with explicit assumptions and coefficients, share some of those limitations, but have their own set of problems. They too are useful tools.
An intriguing alternative is market-to-cash or liquidation value. It does try to envision the income the wealth would represent if converted to cash. The obvious problem is that the conversion period is arbitrary (e.g., this week, this year, the length of a bankruptcy proceeding?). The value under mark-to-cash is dependent on the time frame. The reason is mark-to-cash forces an estimate of the liquidity available. The estimate of liquidity is just that, an estimate or guess. Yet, it’s another tool.
One can use the price of an asset with a benchmark income stream. Treasury bills and treasury bonds are used extensively in financial economics as a benchmark return. They present some problems since their prices are volatile and subject to numerous risks. Theoretically, if the comparisons are instantaneous, they would yield what appear to be reliable relative comparisons. But, in fact the relative comparisons are totally dependent on how risk is being priced. An alternative benchmark income stream is to annuitize the wealth. This is another approach.
Each of these approaches yields its own estimate of the relationship between the stock (wealth) and the flow (income). Given the uncertainty associated with measuring the relationship, it is advisable to manage that relationship carefully. It makes sense to take steps to ensure that the management of each is as robust as possible. Also, it is dangerous to make too much dependent on getting the estimate of the relationship exactly right. As in everything, provide for mistakes. They’re guaranteed.
Income and expenses are flows. Assets and liabilities are stocks. They relate, but aren’t the same. Income and expenses relate to consumption. Wealth only relates to potential consumption when it is translated into income (or expense in the case of liabilities that exceed assets). People who confuse income with wealth are ignoring the difference and not recognizing the cost associated with getting from one to the other.
There are many ways to try to equate one to the other. Market-to-market is one. Just assume perfect markets for assets and, voila, wealth equals market value. It shouldn’t be surprising that The Hedged Economist sees some problems with that approach. Numerous postings on this blog have highlighted the foolishness of the instantaneous liquidity assumption implicit in the perfect market assumption. It has been addressed directly, in terms of the consequences of changes in liquidity, and in discussions of approaches to managing one’s own liquidity needs. However, it’s only one approach, and it is a useful tool.
Another approach, often used as a retirement planning tool, is simulations, Monte Carlo being the most common. It, too, has limitations. Constructed simulations, with explicit assumptions and coefficients, share some of those limitations, but have their own set of problems. They too are useful tools.
An intriguing alternative is market-to-cash or liquidation value. It does try to envision the income the wealth would represent if converted to cash. The obvious problem is that the conversion period is arbitrary (e.g., this week, this year, the length of a bankruptcy proceeding?). The value under mark-to-cash is dependent on the time frame. The reason is mark-to-cash forces an estimate of the liquidity available. The estimate of liquidity is just that, an estimate or guess. Yet, it’s another tool.
One can use the price of an asset with a benchmark income stream. Treasury bills and treasury bonds are used extensively in financial economics as a benchmark return. They present some problems since their prices are volatile and subject to numerous risks. Theoretically, if the comparisons are instantaneous, they would yield what appear to be reliable relative comparisons. But, in fact the relative comparisons are totally dependent on how risk is being priced. An alternative benchmark income stream is to annuitize the wealth. This is another approach.
Each of these approaches yields its own estimate of the relationship between the stock (wealth) and the flow (income). Given the uncertainty associated with measuring the relationship, it is advisable to manage that relationship carefully. It makes sense to take steps to ensure that the management of each is as robust as possible. Also, it is dangerous to make too much dependent on getting the estimate of the relationship exactly right. As in everything, provide for mistakes. They’re guaranteed.
Sunday, October 30, 2011
Solyndra Could Teach Us Something
But will we learn?
It seems unlikely we will learn anything from Solyndra, and that’s not a reference to the Company’s use of the 5th amendment. When there is a potentially juicy scandal or blame is in play, no one, least of all the media or politicians, is going to resist posturing. However, any scandal and who is to blame are irrelevant to the important issue.
There are two important lessons. First, the government should severely limit its use of loan guarantees. Second, development of technology firms is based more on the availability of equity than credit. They need more owners investing, not loans.
Solyndra provides plenty of material for entertainment, FOR SURE. Just for starters, Congressman Henry Waxman defending businessmen’s use of the 5th amendment to stiff Congress is a true laugh-out-loud moment. If hypocrisy were an impeachable offense, he’d be out in a moment; but then we do expect California to generate entrainment. On a serious note, we definitely need to repeal whatever law creates a punishment for Contempt of Congress. Otherwise, public polling data indicates, we’re going to have to punish the entire nation.
Unfortunately, those media that aren’t dominated by Democrats are focused on who knew what and who did what. The Treasury Department warned that the loan to solar-panel maker Solyndra LLC might be illegal. So what? We all know the Obama administration may have brushed aside warnings, prudence, and conflict of interest. Others question the administration’s quasi-religious belief in solar. However, those aren’t the important issues. The mistake isn’t that the government didn’t do its due diligence or may be tilting at windmills. Set those issues aside; just file your opinion as yours. The real issue is not what people in government did; it’s whether government should have been doing anything special at all.
The government should stop doing things it is bad at doing. It’s wise to remember that the entire Solyndra mess began with a loan guarantee. Someone needs to recognize the parallel between Solyndra, Freddie Mac, Fannie Mae, failed banks and thrifts (e.g., Indy Mac, WAMU), government-backed student loans, and the legion of government guarantee borrowers.
On July 18th, in a discussion of the tendency of the blame game to distract from productive activities (see: “More Fireworks”), this blog noted that:
“With few exceptions, The Hedged Economist doesn't like government loan guarantees as a policy. They move a liability of unknown size to the treasury. The preferred approach is the cut and dry of either making the loan or not. But, loan guarantees can make sense in a panic.”
Why? It’s very hard to determine the subsidy the guarantee implies. Basically, the government is providing a benefit of an undetermined size with a cost that is uncertain. Further, the government is lousy at assessing credit risk and default risk. Interesting thing is that the government employees at the regulatory agencies that do credit assessment for a living (e.g., bank examiners) realize how difficult credit assessment is.
There is one important exception: That’s during a legitimate panic that is creating a liquidity crisis. During a panic it gets a bit easier to determine who is insolvent as opposed to who is illiquid. The panic and its impact on liquidity are the problem, not the solvency of most firms. It’s still hard to determine solvency. In fact, it is hard enough to expect some errors, but that’s life. The object is to be right most of the time, not every time.
The unfortunate thing is that the public has a mistaken belief that a loan is a bailout rather than an investment. Thus, we may end up dependent on loan guarantees as the only option during liquidity crises. That, however, only reinforces the need to avoid using them for other reasons.
Even government loans, as opposed to guarantees, should be avoided. The reason is simple. As noted back on September 15, 2010 in “Stimulus more or less? A failure not being acknowledged. PART 3:”
“… some observers object to loans that made a profit, but applaud those that will be written off and vies-a-versa, often with no justification based on differences in benefits.”
Not only do a lot of people think loans are a bailout, many think that they should be. You’d think the mortgage bubble would have taught us that making loans that can’t be paid back isn’t sustainable.
But, you say, the government can identify good things to do: why shouldn’t it direct resources toward those good things? That’s totally irrelevant to the issue. Governments have budgets. Let them tax and spend. The issue is the false efficiency of loan guarantees and loans that aren’t paid back.
Now to the second point, loans are NOT always the right solution, although one can understand why governments that can’t balance a budget might not see that. Talk to entrepreneurs, and more than likely equity will come up. That’s especially true of entrepreneurs in new types of businesses (e.g., new business models or new technologies). It’s invariably the case with entrepreneurs who are focused on having a significant impact.
In that environment a loan is a totally inappropriate approach. From the lender’s perspective, it bares the same risk without the potential return. From the borrower’s perspective, it drains cash flow on debt service that the entrepreneur needs to grow.
The problem in start-ups isn’t credit availability as much as equity capital. The government seems incapable of recognizing the damage it does by directing excessive credit to pet fascinations (be they housing, solar, small business, etc.). These activities need equity capital not credit. Combine that with its focus on protecting equity investors from the risks inherent in start-ups, and the government has forced many entrepreneurs into relying on the wrong forms and wrong sources for cash.
If government wants more new solar technology it should focus on the obstacles it places in the way of entrepreneurs seeking equity. One obstacle was discussed from the investor’s perspective in “Investing PART 12: Angel Investing.” Specifically it noted:
“Angel investing is just one of many potentially beneficial financial behaviors the government makes difficult.”
For a broader discussion, “The discussion Congress should be having: PART 1 Angels, entrepreneurs, and diversification” addresses a number of obstacles. It is not a policy prescription. Rather, it discusses obstacles.
The key mistake and the one that is essential to understanding how Solyndra relates to the failures of our current economic policy was summarized in this blog’s first posting on entrepreneurs on April 9, 2010, “Angels, entrepreneurs, and diversification: PART 1.” After relating how the issue explained the anemic recovery and would result in continued slow growth, three points were noted:
"First, equity capital is particularly hard for entrepreneurs to access.”
“Second, equity capital and borrowed capital, like bank loans or SBA-backed funds, have differential economic implications.”
“Finally, access to angel investors and early stage equity capital has different impacts on different industries.”
The last point is particularly relevant to Solyndra. The market supports solar applications that pay for themselves. In 1978, the first solar-powered calculator appeared. Since the 1950s, solar has dominated the powering of satellites in earth orbit. In almost every state, homes that aren’t on to the grid have found it cost-effective to combine solar with diesel generation. Many decades ago The Hedged Economist invested in a solar firm with quite acceptable results. It generated hot water. That was before photovoltaic was the rage.
Solar is a big industry, with a long history and lots of expertise. The expertise and experience to figure out where solar opportunities lie is there. There is no reason to believe government can successfully outsmart an entire industry of solar experts. But, worse yet, one has to wonder at the hubris that also led them to believe government could better structure the financing than the entrepreneurs and investors involved. Clearly, they got it wrong. Solar deserves more equity, and government loan guarantees or loans are a silly substitute. They may even retard the development of viable solar applications.
Note that other than the disclosure about a previous investment, nothing said above represents anything positive or a negative about solar. Further, if Solyndra had turned out to be a roaring success, everything said above would still be equally true.
It seems unlikely we will learn anything from Solyndra, and that’s not a reference to the Company’s use of the 5th amendment. When there is a potentially juicy scandal or blame is in play, no one, least of all the media or politicians, is going to resist posturing. However, any scandal and who is to blame are irrelevant to the important issue.
There are two important lessons. First, the government should severely limit its use of loan guarantees. Second, development of technology firms is based more on the availability of equity than credit. They need more owners investing, not loans.
Solyndra provides plenty of material for entertainment, FOR SURE. Just for starters, Congressman Henry Waxman defending businessmen’s use of the 5th amendment to stiff Congress is a true laugh-out-loud moment. If hypocrisy were an impeachable offense, he’d be out in a moment; but then we do expect California to generate entrainment. On a serious note, we definitely need to repeal whatever law creates a punishment for Contempt of Congress. Otherwise, public polling data indicates, we’re going to have to punish the entire nation.
Unfortunately, those media that aren’t dominated by Democrats are focused on who knew what and who did what. The Treasury Department warned that the loan to solar-panel maker Solyndra LLC might be illegal. So what? We all know the Obama administration may have brushed aside warnings, prudence, and conflict of interest. Others question the administration’s quasi-religious belief in solar. However, those aren’t the important issues. The mistake isn’t that the government didn’t do its due diligence or may be tilting at windmills. Set those issues aside; just file your opinion as yours. The real issue is not what people in government did; it’s whether government should have been doing anything special at all.
The government should stop doing things it is bad at doing. It’s wise to remember that the entire Solyndra mess began with a loan guarantee. Someone needs to recognize the parallel between Solyndra, Freddie Mac, Fannie Mae, failed banks and thrifts (e.g., Indy Mac, WAMU), government-backed student loans, and the legion of government guarantee borrowers.
On July 18th, in a discussion of the tendency of the blame game to distract from productive activities (see: “More Fireworks”), this blog noted that:
“With few exceptions, The Hedged Economist doesn't like government loan guarantees as a policy. They move a liability of unknown size to the treasury. The preferred approach is the cut and dry of either making the loan or not. But, loan guarantees can make sense in a panic.”
Why? It’s very hard to determine the subsidy the guarantee implies. Basically, the government is providing a benefit of an undetermined size with a cost that is uncertain. Further, the government is lousy at assessing credit risk and default risk. Interesting thing is that the government employees at the regulatory agencies that do credit assessment for a living (e.g., bank examiners) realize how difficult credit assessment is.
There is one important exception: That’s during a legitimate panic that is creating a liquidity crisis. During a panic it gets a bit easier to determine who is insolvent as opposed to who is illiquid. The panic and its impact on liquidity are the problem, not the solvency of most firms. It’s still hard to determine solvency. In fact, it is hard enough to expect some errors, but that’s life. The object is to be right most of the time, not every time.
The unfortunate thing is that the public has a mistaken belief that a loan is a bailout rather than an investment. Thus, we may end up dependent on loan guarantees as the only option during liquidity crises. That, however, only reinforces the need to avoid using them for other reasons.
Even government loans, as opposed to guarantees, should be avoided. The reason is simple. As noted back on September 15, 2010 in “Stimulus more or less? A failure not being acknowledged. PART 3:”
“… some observers object to loans that made a profit, but applaud those that will be written off and vies-a-versa, often with no justification based on differences in benefits.”
Not only do a lot of people think loans are a bailout, many think that they should be. You’d think the mortgage bubble would have taught us that making loans that can’t be paid back isn’t sustainable.
But, you say, the government can identify good things to do: why shouldn’t it direct resources toward those good things? That’s totally irrelevant to the issue. Governments have budgets. Let them tax and spend. The issue is the false efficiency of loan guarantees and loans that aren’t paid back.
Now to the second point, loans are NOT always the right solution, although one can understand why governments that can’t balance a budget might not see that. Talk to entrepreneurs, and more than likely equity will come up. That’s especially true of entrepreneurs in new types of businesses (e.g., new business models or new technologies). It’s invariably the case with entrepreneurs who are focused on having a significant impact.
In that environment a loan is a totally inappropriate approach. From the lender’s perspective, it bares the same risk without the potential return. From the borrower’s perspective, it drains cash flow on debt service that the entrepreneur needs to grow.
The problem in start-ups isn’t credit availability as much as equity capital. The government seems incapable of recognizing the damage it does by directing excessive credit to pet fascinations (be they housing, solar, small business, etc.). These activities need equity capital not credit. Combine that with its focus on protecting equity investors from the risks inherent in start-ups, and the government has forced many entrepreneurs into relying on the wrong forms and wrong sources for cash.
If government wants more new solar technology it should focus on the obstacles it places in the way of entrepreneurs seeking equity. One obstacle was discussed from the investor’s perspective in “Investing PART 12: Angel Investing.” Specifically it noted:
“Angel investing is just one of many potentially beneficial financial behaviors the government makes difficult.”
For a broader discussion, “The discussion Congress should be having: PART 1 Angels, entrepreneurs, and diversification” addresses a number of obstacles. It is not a policy prescription. Rather, it discusses obstacles.
The key mistake and the one that is essential to understanding how Solyndra relates to the failures of our current economic policy was summarized in this blog’s first posting on entrepreneurs on April 9, 2010, “Angels, entrepreneurs, and diversification: PART 1.” After relating how the issue explained the anemic recovery and would result in continued slow growth, three points were noted:
"First, equity capital is particularly hard for entrepreneurs to access.”
“Second, equity capital and borrowed capital, like bank loans or SBA-backed funds, have differential economic implications.”
“Finally, access to angel investors and early stage equity capital has different impacts on different industries.”
The last point is particularly relevant to Solyndra. The market supports solar applications that pay for themselves. In 1978, the first solar-powered calculator appeared. Since the 1950s, solar has dominated the powering of satellites in earth orbit. In almost every state, homes that aren’t on to the grid have found it cost-effective to combine solar with diesel generation. Many decades ago The Hedged Economist invested in a solar firm with quite acceptable results. It generated hot water. That was before photovoltaic was the rage.
Solar is a big industry, with a long history and lots of expertise. The expertise and experience to figure out where solar opportunities lie is there. There is no reason to believe government can successfully outsmart an entire industry of solar experts. But, worse yet, one has to wonder at the hubris that also led them to believe government could better structure the financing than the entrepreneurs and investors involved. Clearly, they got it wrong. Solar deserves more equity, and government loan guarantees or loans are a silly substitute. They may even retard the development of viable solar applications.
Note that other than the disclosure about a previous investment, nothing said above represents anything positive or a negative about solar. Further, if Solyndra had turned out to be a roaring success, everything said above would still be equally true.
Monday, October 17, 2011
Stimulus Can Backfire: Monetary Policy
If Bernanke needs a break today, he should go to McDonalds like the rest of us.
The previous posting addressed how fiscal stimulus can backfire. This posting addresses monetary policy. Alan Blinder’s opinion piece, “Ben Bernanke Deserves a Break” from the WALL STREET JOURNAL September 28, 2011 is the point of departure.
The fiscal stimulus discussion, “Stimulus Can Backfire: Fiscal Policy,” and previous discussions of fiscal stimulus focused exclusively on how stimulus can fall short of, or fail to achieve, expected results. That was facilitated by the focus on the economic impact of the analysis being discussed. By contrast Blinder’s opinion piece spends a lot of time on the politics and optics surrounding monetary policy. It eventually does mention the economic aspect of operation twist. This posting will follow the same outline.
If one examines each of the pressures Blinder mentions, it is hard to see how one can seriously exempt Bernanke from some responsibility for creating the sources of most of the pressures. That is especially true of Blinder’s forays into politics and the optics. So, let’s deal with that first.
Blinder does not seem to realize that purchasing across the yield curve has always embroiled the Fed in politics. The Hedged Economist noted this cost of quantitative easing and TARP on July 19, 2011 in “A Clearer View Of The Fireworks.” As stated, “The entire issue of the Fed’s role probably could have been skipped except that it is going to explain why the Fed is going to lose any semblance of independence. Since I favor a relatively independent Fed, I consider that important.”
A number of examples of the political pressure on the Fed that are the inevitable result of trying to manage the yield curve are discussed below. They are from the period around the Fed / Treasury accommodation of the 1950’s. That period is used to confuse the partisans since many partisan roles were the opposite of today’s, although the methodological issues are often the similar.
Wall Street expectations of a twist are a curious issue. During the 1950’s they were viewed by some as a potential reason why the Fed should not buy long-dated bonds. Two concerns were 1) that bond buyers would game the Fed, and/or 2) it would reduce private sector markets for long-dated bonds. Often both arguments, although to some extent contradictory, were used by the same person. Now, Blinder views them as a pressure to implement a twist: just the opposite conclusion.
Wall Street expectations are an issue that seems totally irrelevant. What economic impact does whether Wall Street expected operation twist have? Little to none seems a reasonable answer. The most that Fed research staffs can come up with is that expectations may have a slight impact on timing. The pressure that Blinder thinks Bernanke felt due to Wall Street expectations would be totally of Bernanke’s creation.
Here’ a quote from an article: “Stocks jumped, then sank and then rose again, as investors tried to bet on whether the Federal Reserve is going to intervene again to support financial markets.” Without a reference, it could be any article (it also could have been about bond prices rather than stocks), but here’s the telling question. In what decade was it written and did the Fed act? Do a little research, and you will find it has been written in many different decades. You will also find that whether market participants’ expectations were accurate had NO relationship to future economic performance.
The real issue concerns more extensive price controls (which is what manipulating the yield curve is). The question is: Do price controls implemented through Fed purchases produce efficiency? Given the dislocations of wartime wage and price controls, this was a major issue during the 1950’s. Interestingly, in the 1950’s, justifying price controls was a major challenge for advocates because of potential adverse effects on investment. Currently that issue has been largely ignored. By contrast, some contemporary critics of purchasing longer-dated bonds point to negative impact on savers (e.g., pensions, retirees, and life insurers), an issue that could safely be acknowledged and then ignored back in the 1950’s due to the huge forced savings built up during wartime.
The divided vote among the Fed committee members is an issue where Blinder’s comments make him appear far less knowledgeable than he is (or should be). He almost certainly knows they are typical, and he has often been a party to such divisions. Let’s take one of many examples from the 1950’s where Blinder’s personal behavior isn’t at issue. Fed Chairman Martin, and the New York Fed Sproul are the best example. They are only one example, but one that was common, almost the norm.
The Martin-Sproul differences are informative currently. Two characteristics are very timely. First, the differences often originated from differences in what each individual thought should be the focus/objective of policy at the time. Yet, unlike the fictitious employment vs inflation tradeoff economists cling to despite lengthy periods of stagflation, their differences didn’t facilitate positions that were dogmatic. Blinder’s consistent advocacy of easier monetary policy wouldn’t fit into the Martin and Sproul discussions. Their differences weren’t one sided with each one always advocating the same policy.
As also exists currently, behind some of their policy differences there were significant differences in perceptions of how markets would react. Although the issues were different, the market-reactions issue is akin to the adaptive expectation-rational expectations issue. The current differences between those who rely on comparative statics verses those who believe market reactions are path dependent are also similar to the Martin-Sproul differences. There were fundamental differences in how the two parties thought markets behave.
Blinder just brushes aside the potential methodological/theoretical bases of policy differences. In an academic environment he may be more open minded. His reporting, however, leaves an impression of dogmatic refusal to question the current economic conventional wisdom. That’s unfortunate because it raises questions about whether he can actually view the policy issues objectively.
The partisan political pressure is also not new. One suspects that Blinder’s reporting it as unprecedented reflects his partisan leaning more than anything else. Democratic Senator Douglas was the highest profile congressional critic of the Fed during the 1950’s. While Douglas and the recent efforts Blinder notes represent a single chamber of Congress, surely Blinder knows that at times both chambers and the executive branch have historically pressured the Fed from time to time.
One pressure that belongs squarely with Bernanke (and those like Blinder who report and comment on the Fed) is reflected in every discussion of “bailouts.” Bernanke and maybe even Blinder understand that Fed policy represents two different issues depending upon whether the policy is designed to address a liquidity crisis, or a slow, tentative recovery. Bernanke hints at it with his “the Fed can’t do it alone” rhetoric, but he hardly helps by trying to defend current actions by referencing parallels between two very different policy imperatives.
During a liquidity crisis a central bank’s role is to add liquidity: Lend freely at usurious rates against good collateral. That will end the liquidity crisis. That was the origin of the October 2, 2010 posting, “TARP: A success not being acknowledged.” However, as the recent Republican presidential debates and the Occupy Wall Street campouts demonstrate, the Fed failed to go back and explain what they did and why.
Most of the economic pressures Blinder also notes seem like nonsense. The Fed’s role (i.e., monetary policy) is economic. Economic “pressure” is the only reason for having a Fed.
What is strange about Blinder’s argument that Bernanke deserves a break is that once he turns to economics, Blinder undermines the argument fairly effectively. He notes that all Bernanke has to offer is a “relatively weak weapon.” He goes on to say: “Any … influence of monetary policy on the economy was bound to be modest.” If any positive impact is expected to be modest, it would seem advisable to question whether the policy action should be taken. That is only reinforced by the widespread acknowledgement that the action has risks. Even Bernanke has often mentioned the risks.
That risk was mentioned even before the posting on TARP on September 15, 2010 in “Stimulus more or less? A failure not being acknowledged. PART 3.” The quote is: “One doesn't have to be terribly familiar with what is called a "barbell" portfolio strategy to understand that there is a rational way around this potential impact of having more equity on the balance sheet. Forcing banks to hold more of a conservative asset or a conservative liability can be offset by increasing the holding of an offsetting high risk item. The overall risk doesn’t change. In fact, it’s a rational response if one wants to maintain a given overall portfolio return. One just takes on a high risk, high return positions to offset the low risk, low return position; risk and return stay the same. If the reader doesn’t understand why, consult anything on portfolio theory. Or, …”
An interesting aspect of the quote was that it came up in 2010 in connection with efforts to force banks to reduce leverage and the associated risk. However, now it explains why Bernanke can’t force people into taking more risks. One can always adjust the weights across the barbell in order to maintain any given overall risk-return profile.
Between the postings “Speak Softly But Carry a Big Stick, Dr. Bernanke,” “Operation Twist, Or Is It the Logic That’s Twisted?” and “The Fed Cannot Force Investors to Shift to a Different Risk-Return Profile,” the potential that operation twist will backfire has been covered fairly thoroughly. This is not the dogma of some political figures nor a belief that the Fed or Bernanke are evil failures. Rather, it reflects the fact that TARP and the associated liquidity injections of the earlier period would succeed while operation twist will do little under current conditions. Furthermore, what it does accomplish may do more harm than good. What is worse whatever the result of operation twist, it wasn’t worth the price.
The point where Blinder’s comments get particularly telling is when he compares quantitative easing efforts. He states: “… I was a huge and enthusiastic supporter of QE1, which concentrated on MBS, but only a lukewarm supporter of QE2's Treasury purchases. (It was better than nothing.) Since then, a few scholarly studies have estimated that QE1 was indeed more powerful than QE2. So any move back toward dealing in MBS, or in other private-sector securities for that matter, is welcome."
This statement could easily be the subject of a separate posting. Just to summarize. First, the scholarly studies he cites lend no support to his conclusion about the current program. This blog has defended QE1 (and TARP) as highly effective. It defended QE2 as consistent with a reasonable interpretation of how monetary policy could contribute to economic recovery. In both cases the impact was in NO way dependent on what assets the Fed acquired. The results the studies identify are totally dependent on the economic environment at the time. (That realization has a lot to do with the dissention on current policy).
Blinder goes on to say: “Indeed, if we indulge ourselves in a bit of blue-sky thinking, we can even imagine the Fed doing QEs in corporate bonds, syndicated loans, consumer receivables and so forth.” This is perfectly consistent with my statement above: “In both cases the impact was in NO way dependent on what assets the Fed acquired. The results the studies identify are totally dependent on the economic environment at the time.” The big issue is monetary policy.
However, the hollowness of Blinder’s very argument strongly supports the contention that the Fed shouldn’t be free of supervision in deciding which types of assets it purchases. As pointed out, even purchasing across the yield curve has always embroiled the Fed in politics. That’s of questionable justification, but once the assets aren’t Treasuries, it is legitimate to argue that it should be political. It’s also why the Fed should avoid it whenever possible, and why the current operation twist, which may have no beneficial impact, isn’t worth the political cost.
The previous posting addressed how fiscal stimulus can backfire. This posting addresses monetary policy. Alan Blinder’s opinion piece, “Ben Bernanke Deserves a Break” from the WALL STREET JOURNAL September 28, 2011 is the point of departure.
The fiscal stimulus discussion, “Stimulus Can Backfire: Fiscal Policy,” and previous discussions of fiscal stimulus focused exclusively on how stimulus can fall short of, or fail to achieve, expected results. That was facilitated by the focus on the economic impact of the analysis being discussed. By contrast Blinder’s opinion piece spends a lot of time on the politics and optics surrounding monetary policy. It eventually does mention the economic aspect of operation twist. This posting will follow the same outline.
If one examines each of the pressures Blinder mentions, it is hard to see how one can seriously exempt Bernanke from some responsibility for creating the sources of most of the pressures. That is especially true of Blinder’s forays into politics and the optics. So, let’s deal with that first.
Blinder does not seem to realize that purchasing across the yield curve has always embroiled the Fed in politics. The Hedged Economist noted this cost of quantitative easing and TARP on July 19, 2011 in “A Clearer View Of The Fireworks.” As stated, “The entire issue of the Fed’s role probably could have been skipped except that it is going to explain why the Fed is going to lose any semblance of independence. Since I favor a relatively independent Fed, I consider that important.”
A number of examples of the political pressure on the Fed that are the inevitable result of trying to manage the yield curve are discussed below. They are from the period around the Fed / Treasury accommodation of the 1950’s. That period is used to confuse the partisans since many partisan roles were the opposite of today’s, although the methodological issues are often the similar.
Wall Street expectations of a twist are a curious issue. During the 1950’s they were viewed by some as a potential reason why the Fed should not buy long-dated bonds. Two concerns were 1) that bond buyers would game the Fed, and/or 2) it would reduce private sector markets for long-dated bonds. Often both arguments, although to some extent contradictory, were used by the same person. Now, Blinder views them as a pressure to implement a twist: just the opposite conclusion.
Wall Street expectations are an issue that seems totally irrelevant. What economic impact does whether Wall Street expected operation twist have? Little to none seems a reasonable answer. The most that Fed research staffs can come up with is that expectations may have a slight impact on timing. The pressure that Blinder thinks Bernanke felt due to Wall Street expectations would be totally of Bernanke’s creation.
Here’ a quote from an article: “Stocks jumped, then sank and then rose again, as investors tried to bet on whether the Federal Reserve is going to intervene again to support financial markets.” Without a reference, it could be any article (it also could have been about bond prices rather than stocks), but here’s the telling question. In what decade was it written and did the Fed act? Do a little research, and you will find it has been written in many different decades. You will also find that whether market participants’ expectations were accurate had NO relationship to future economic performance.
The real issue concerns more extensive price controls (which is what manipulating the yield curve is). The question is: Do price controls implemented through Fed purchases produce efficiency? Given the dislocations of wartime wage and price controls, this was a major issue during the 1950’s. Interestingly, in the 1950’s, justifying price controls was a major challenge for advocates because of potential adverse effects on investment. Currently that issue has been largely ignored. By contrast, some contemporary critics of purchasing longer-dated bonds point to negative impact on savers (e.g., pensions, retirees, and life insurers), an issue that could safely be acknowledged and then ignored back in the 1950’s due to the huge forced savings built up during wartime.
The divided vote among the Fed committee members is an issue where Blinder’s comments make him appear far less knowledgeable than he is (or should be). He almost certainly knows they are typical, and he has often been a party to such divisions. Let’s take one of many examples from the 1950’s where Blinder’s personal behavior isn’t at issue. Fed Chairman Martin, and the New York Fed Sproul are the best example. They are only one example, but one that was common, almost the norm.
The Martin-Sproul differences are informative currently. Two characteristics are very timely. First, the differences often originated from differences in what each individual thought should be the focus/objective of policy at the time. Yet, unlike the fictitious employment vs inflation tradeoff economists cling to despite lengthy periods of stagflation, their differences didn’t facilitate positions that were dogmatic. Blinder’s consistent advocacy of easier monetary policy wouldn’t fit into the Martin and Sproul discussions. Their differences weren’t one sided with each one always advocating the same policy.
As also exists currently, behind some of their policy differences there were significant differences in perceptions of how markets would react. Although the issues were different, the market-reactions issue is akin to the adaptive expectation-rational expectations issue. The current differences between those who rely on comparative statics verses those who believe market reactions are path dependent are also similar to the Martin-Sproul differences. There were fundamental differences in how the two parties thought markets behave.
Blinder just brushes aside the potential methodological/theoretical bases of policy differences. In an academic environment he may be more open minded. His reporting, however, leaves an impression of dogmatic refusal to question the current economic conventional wisdom. That’s unfortunate because it raises questions about whether he can actually view the policy issues objectively.
The partisan political pressure is also not new. One suspects that Blinder’s reporting it as unprecedented reflects his partisan leaning more than anything else. Democratic Senator Douglas was the highest profile congressional critic of the Fed during the 1950’s. While Douglas and the recent efforts Blinder notes represent a single chamber of Congress, surely Blinder knows that at times both chambers and the executive branch have historically pressured the Fed from time to time.
One pressure that belongs squarely with Bernanke (and those like Blinder who report and comment on the Fed) is reflected in every discussion of “bailouts.” Bernanke and maybe even Blinder understand that Fed policy represents two different issues depending upon whether the policy is designed to address a liquidity crisis, or a slow, tentative recovery. Bernanke hints at it with his “the Fed can’t do it alone” rhetoric, but he hardly helps by trying to defend current actions by referencing parallels between two very different policy imperatives.
During a liquidity crisis a central bank’s role is to add liquidity: Lend freely at usurious rates against good collateral. That will end the liquidity crisis. That was the origin of the October 2, 2010 posting, “TARP: A success not being acknowledged.” However, as the recent Republican presidential debates and the Occupy Wall Street campouts demonstrate, the Fed failed to go back and explain what they did and why.
Most of the economic pressures Blinder also notes seem like nonsense. The Fed’s role (i.e., monetary policy) is economic. Economic “pressure” is the only reason for having a Fed.
What is strange about Blinder’s argument that Bernanke deserves a break is that once he turns to economics, Blinder undermines the argument fairly effectively. He notes that all Bernanke has to offer is a “relatively weak weapon.” He goes on to say: “Any … influence of monetary policy on the economy was bound to be modest.” If any positive impact is expected to be modest, it would seem advisable to question whether the policy action should be taken. That is only reinforced by the widespread acknowledgement that the action has risks. Even Bernanke has often mentioned the risks.
That risk was mentioned even before the posting on TARP on September 15, 2010 in “Stimulus more or less? A failure not being acknowledged. PART 3.” The quote is: “One doesn't have to be terribly familiar with what is called a "barbell" portfolio strategy to understand that there is a rational way around this potential impact of having more equity on the balance sheet. Forcing banks to hold more of a conservative asset or a conservative liability can be offset by increasing the holding of an offsetting high risk item. The overall risk doesn’t change. In fact, it’s a rational response if one wants to maintain a given overall portfolio return. One just takes on a high risk, high return positions to offset the low risk, low return position; risk and return stay the same. If the reader doesn’t understand why, consult anything on portfolio theory. Or, …”
An interesting aspect of the quote was that it came up in 2010 in connection with efforts to force banks to reduce leverage and the associated risk. However, now it explains why Bernanke can’t force people into taking more risks. One can always adjust the weights across the barbell in order to maintain any given overall risk-return profile.
Between the postings “Speak Softly But Carry a Big Stick, Dr. Bernanke,” “Operation Twist, Or Is It the Logic That’s Twisted?” and “The Fed Cannot Force Investors to Shift to a Different Risk-Return Profile,” the potential that operation twist will backfire has been covered fairly thoroughly. This is not the dogma of some political figures nor a belief that the Fed or Bernanke are evil failures. Rather, it reflects the fact that TARP and the associated liquidity injections of the earlier period would succeed while operation twist will do little under current conditions. Furthermore, what it does accomplish may do more harm than good. What is worse whatever the result of operation twist, it wasn’t worth the price.
The point where Blinder’s comments get particularly telling is when he compares quantitative easing efforts. He states: “… I was a huge and enthusiastic supporter of QE1, which concentrated on MBS, but only a lukewarm supporter of QE2's Treasury purchases. (It was better than nothing.) Since then, a few scholarly studies have estimated that QE1 was indeed more powerful than QE2. So any move back toward dealing in MBS, or in other private-sector securities for that matter, is welcome."
This statement could easily be the subject of a separate posting. Just to summarize. First, the scholarly studies he cites lend no support to his conclusion about the current program. This blog has defended QE1 (and TARP) as highly effective. It defended QE2 as consistent with a reasonable interpretation of how monetary policy could contribute to economic recovery. In both cases the impact was in NO way dependent on what assets the Fed acquired. The results the studies identify are totally dependent on the economic environment at the time. (That realization has a lot to do with the dissention on current policy).
Blinder goes on to say: “Indeed, if we indulge ourselves in a bit of blue-sky thinking, we can even imagine the Fed doing QEs in corporate bonds, syndicated loans, consumer receivables and so forth.” This is perfectly consistent with my statement above: “In both cases the impact was in NO way dependent on what assets the Fed acquired. The results the studies identify are totally dependent on the economic environment at the time.” The big issue is monetary policy.
However, the hollowness of Blinder’s very argument strongly supports the contention that the Fed shouldn’t be free of supervision in deciding which types of assets it purchases. As pointed out, even purchasing across the yield curve has always embroiled the Fed in politics. That’s of questionable justification, but once the assets aren’t Treasuries, it is legitimate to argue that it should be political. It’s also why the Fed should avoid it whenever possible, and why the current operation twist, which may have no beneficial impact, isn’t worth the political cost.
Monday, October 3, 2011
Stimulus Can Backfire: Fiscal Policy
Start with the consumption multiplier
A recent posting on The Hedged Economist commented: “The public has completely out thought the Keynesians. Increase the stimulus and the public saves more in order to pay the inevitable higher taxes. Furthermore, drive down interest rates and they’ll just hold cash.”
“Liquidity trap is what economists call it when people hoard their cash. In the discussion of stimulus back in September 2010, this blog argued the multiplier wouldn’t be linear. Well, it seems the wizards in charge may have succeeded in producing a negative aggregate multiplier, a result that should be darn near impossible.” (See: “Who Killed Stimulus as a Policy Option”)
Take a step back from the generalization and one’s view about rational expectations eliminates the need for a lot of other questionable assumptions (or substitute rational responses as an assumption). To illustrate, this blog will use two items. The first will be the topic of this posting. It is a recent (September 9, 2011) piece by Mark Zandi that Moody’s Analytics (a.k.a. Economy.com) makes available (“An Analysis of the Obama Jobs Plan”). It addresses fiscal policy.
The second is an opinion piece by Alan Blinder from the September, 28, 2011 WALL STREET JOURNAL (“Ben Bernanke Deserves a Break”). It will be the subject of the next posting. It addresses issues related to monetary policy.
Zandi and Blinder are two economists whose analyses and opinions are worth knowing. They also coauthored the only analysis of the initial stimulus efforts that this blog reviewed. That review was posted in September 2010 before the actual effectiveness of the stimulus was known. “PART 3, PART 4, and PART 5 of that review all dealt with their analysis.
The above links to the relevant parts of the review are live. They contained the first cautions about some of the methodological issues that led to a stimulus that accomplished much less than expected.
Obama’s first stimulus failed by any definition including his own, and it almost certainly fell well short of the result Blinder and Zandi anticipated. Yet, it might seem naive to advocate a rational expectations assumption given the considerable evidence on irrationality developed by behavioral economists. That, however, isn’t the right question. The more appropriate question for those who need point estimates of macro responses is: Is a rational response a better assumption than the greater fool assumption implied by responses that are assumed to be fixed? Neither is going to be correct.
Interestingly, in their analysis and forecast of the impact of the initial stimulus efforts, Zandi and Blinder acknowledge that multipliers vary based on economic circumstances. They focus on capacity utilization ignoring other factors that influence the multiplier.
More recently (September 9, 2011) Mark Zandi in “An Analysis of the Obama Jobs Plan” makes a very explicit reference to changes in behavioral responses:
“Confidence normally reflects economic conditions; it does not shape them. Consumer sentiment falls when unemployment, gasoline prices or inflation rises, but this has little impact on consumer spending. Yet at times, particularly during economic turning points, cause and effect can shift. Sentiment can be so harmed that businesses, consumers and investors freeze up, turning a gloomy outlook into a self-fulfilling prophecy. This is one of those times.”
“Consumers and businesses appear frozen in place. They are not yet pulling back—that would mean recession—but a loss of faith in the economy can quickly become self-fulfilling.”
That comes very close to acknowledging a shift toward rational expectations in the following sense. If one expects bad times, the response may be to batten down the hatches in ways that ensure bad times. The difference is his assumption that there is an irrational fear motivating the loss of confidence. It could just be that the response isn’t to an irrational fear. It may be a totally rational response to previous and probable policies.
To illustrate, consider this quote from an article by another economist, Gene Epstein (BARRON’S October 1, 2011, “Big Stimulus, Little Effect):
“It [fiscal stimulus] used to be called the fiscal gas pedal. If a recession strikes, you stomp down on the accelerator to help get the economy out of the ditch, pushing the federal budget into deficit. Or more realistically, because balanced budgets have become a rarity, you make sure that this year's deficit is noticeably larger than last year's.”
It’s perfectly rational to expect continuous deficits to result in higher taxes, and to cut spending in order to prepare to accommodate the tax burden.
When discussing a new stimulus, it’s possible to argue that the failure was then: this is now. It is also extremely hard to estimate how short of expectations the initial stimulus was. However, there is an even more fundamental problem with the “that was then, this is now” argument. If unsupported, it can be used either to justify or question any stimulus.
If, however, the involuntary accumulation of debt that the first stimulus imposed on the public inhibited the effectiveness of the stimulus at all, one would expect that negative impact to be greater now. The debt, the rate at which the debt is expanding, and the focus on the debt’s implications are all greater now. Most importantly, no one, not even an ideologue, can pretend that the debt can just keep growing, although some politicians think they can convince the public someone else will have to do the paying down of the debt.
It’s important to remember the phrase “for those who need point estimates of macro responses” in the discussion above. There is a more practical approach. The reality is the “no change, stable multipliers assumption” and “the rational expectation, complete adjustment assumption” are both logical constructs that allow point estimates. However, they don’t even bound the possible. People could over-adjust to the debt and more than offset the stimulus. The practical approach is to view the potential responses as providing nothing more than a way to estimate the potential impact of stimulus.
What’s particularly dangerous about the current stimulus proposal is that it’s being proposed as being offset by taxes. If that were the case, the simulative impact is totally dependent upon a very questionable, small difference. It depends upon the positive impact on those being subsidized being greater than both the proposal’s direct negative impact on those providing the subsidy and any negative adjustment it induces among those negatively affected. While advocates of stimulus point to differences in timing as justification, it’s a weak defense in an environment where the timeframe just happens to coincide with the election cycle.
Further, it’s an election cycle that is focused on the issue central to the entire concept of government stimulus. As stated in PART 4 of the discussion of the initial stimulus efforts: “There are more basic questions about potential alternative policies. Basically, the underlying philosophy of the entire policy response should be questioned. It is not the need for a policy response, but the assumption inherent in parts of TARP and most of the fiscal stimulus that is questionable. Both are predicated on the assumption a trickle-down approach is best. In essence: give the money to a government, an investor, an automaker, etc., and just count on it to flow to the general benefit of the population.”
Current circumstances weaken Zandi’s confidence argument. If, as hypothesized above, there is a substantial portion of the population questioning the underlying philosophy of government stimulus, stimulus might actually undermine confidence. Further, the confidence issue is aggravated by differences in the resources (capital and incomes) of those who believe stimulus will help and those whose confidence would be undermined by another stimulus.
Some might consider it partisan to point out the high potential of failure of a new stimulus. The subtitle and focus of “Stimulus more or less? A failure not being acknowledged. PART 1,” was “The economic impact of fiscal stimulus isn’t a partisan issue. Nor should partisan leanings be the criteria for defining stimulus.” Beyond recommending that posting there isn’t much one can say.
Others may conclude it reflects an ideological predisposition. That’s nonsense. If people could over-adjust as individuals undermining stimulus, they are equally likely to over-adjust collectively through their democratic process. If they are the greater fool a constant multiplier implies (consumers that don’t respond to debt are foolish), then they would be equally likely to display their foolishness collectively through policy as individually as consumers. Ideological predisposition (and The Hedged Economist has his own) do not determine when stimulus is advisable or what impact it will have.
A recent posting on The Hedged Economist commented: “The public has completely out thought the Keynesians. Increase the stimulus and the public saves more in order to pay the inevitable higher taxes. Furthermore, drive down interest rates and they’ll just hold cash.”
“Liquidity trap is what economists call it when people hoard their cash. In the discussion of stimulus back in September 2010, this blog argued the multiplier wouldn’t be linear. Well, it seems the wizards in charge may have succeeded in producing a negative aggregate multiplier, a result that should be darn near impossible.” (See: “Who Killed Stimulus as a Policy Option”)
Take a step back from the generalization and one’s view about rational expectations eliminates the need for a lot of other questionable assumptions (or substitute rational responses as an assumption). To illustrate, this blog will use two items. The first will be the topic of this posting. It is a recent (September 9, 2011) piece by Mark Zandi that Moody’s Analytics (a.k.a. Economy.com) makes available (“An Analysis of the Obama Jobs Plan”). It addresses fiscal policy.
The second is an opinion piece by Alan Blinder from the September, 28, 2011 WALL STREET JOURNAL (“Ben Bernanke Deserves a Break”). It will be the subject of the next posting. It addresses issues related to monetary policy.
Zandi and Blinder are two economists whose analyses and opinions are worth knowing. They also coauthored the only analysis of the initial stimulus efforts that this blog reviewed. That review was posted in September 2010 before the actual effectiveness of the stimulus was known. “PART 3, PART 4, and PART 5 of that review all dealt with their analysis.
The above links to the relevant parts of the review are live. They contained the first cautions about some of the methodological issues that led to a stimulus that accomplished much less than expected.
Obama’s first stimulus failed by any definition including his own, and it almost certainly fell well short of the result Blinder and Zandi anticipated. Yet, it might seem naive to advocate a rational expectations assumption given the considerable evidence on irrationality developed by behavioral economists. That, however, isn’t the right question. The more appropriate question for those who need point estimates of macro responses is: Is a rational response a better assumption than the greater fool assumption implied by responses that are assumed to be fixed? Neither is going to be correct.
Interestingly, in their analysis and forecast of the impact of the initial stimulus efforts, Zandi and Blinder acknowledge that multipliers vary based on economic circumstances. They focus on capacity utilization ignoring other factors that influence the multiplier.
More recently (September 9, 2011) Mark Zandi in “An Analysis of the Obama Jobs Plan” makes a very explicit reference to changes in behavioral responses:
“Confidence normally reflects economic conditions; it does not shape them. Consumer sentiment falls when unemployment, gasoline prices or inflation rises, but this has little impact on consumer spending. Yet at times, particularly during economic turning points, cause and effect can shift. Sentiment can be so harmed that businesses, consumers and investors freeze up, turning a gloomy outlook into a self-fulfilling prophecy. This is one of those times.”
“Consumers and businesses appear frozen in place. They are not yet pulling back—that would mean recession—but a loss of faith in the economy can quickly become self-fulfilling.”
That comes very close to acknowledging a shift toward rational expectations in the following sense. If one expects bad times, the response may be to batten down the hatches in ways that ensure bad times. The difference is his assumption that there is an irrational fear motivating the loss of confidence. It could just be that the response isn’t to an irrational fear. It may be a totally rational response to previous and probable policies.
To illustrate, consider this quote from an article by another economist, Gene Epstein (BARRON’S October 1, 2011, “Big Stimulus, Little Effect):
“It [fiscal stimulus] used to be called the fiscal gas pedal. If a recession strikes, you stomp down on the accelerator to help get the economy out of the ditch, pushing the federal budget into deficit. Or more realistically, because balanced budgets have become a rarity, you make sure that this year's deficit is noticeably larger than last year's.”
It’s perfectly rational to expect continuous deficits to result in higher taxes, and to cut spending in order to prepare to accommodate the tax burden.
When discussing a new stimulus, it’s possible to argue that the failure was then: this is now. It is also extremely hard to estimate how short of expectations the initial stimulus was. However, there is an even more fundamental problem with the “that was then, this is now” argument. If unsupported, it can be used either to justify or question any stimulus.
If, however, the involuntary accumulation of debt that the first stimulus imposed on the public inhibited the effectiveness of the stimulus at all, one would expect that negative impact to be greater now. The debt, the rate at which the debt is expanding, and the focus on the debt’s implications are all greater now. Most importantly, no one, not even an ideologue, can pretend that the debt can just keep growing, although some politicians think they can convince the public someone else will have to do the paying down of the debt.
It’s important to remember the phrase “for those who need point estimates of macro responses” in the discussion above. There is a more practical approach. The reality is the “no change, stable multipliers assumption” and “the rational expectation, complete adjustment assumption” are both logical constructs that allow point estimates. However, they don’t even bound the possible. People could over-adjust to the debt and more than offset the stimulus. The practical approach is to view the potential responses as providing nothing more than a way to estimate the potential impact of stimulus.
What’s particularly dangerous about the current stimulus proposal is that it’s being proposed as being offset by taxes. If that were the case, the simulative impact is totally dependent upon a very questionable, small difference. It depends upon the positive impact on those being subsidized being greater than both the proposal’s direct negative impact on those providing the subsidy and any negative adjustment it induces among those negatively affected. While advocates of stimulus point to differences in timing as justification, it’s a weak defense in an environment where the timeframe just happens to coincide with the election cycle.
Further, it’s an election cycle that is focused on the issue central to the entire concept of government stimulus. As stated in PART 4 of the discussion of the initial stimulus efforts: “There are more basic questions about potential alternative policies. Basically, the underlying philosophy of the entire policy response should be questioned. It is not the need for a policy response, but the assumption inherent in parts of TARP and most of the fiscal stimulus that is questionable. Both are predicated on the assumption a trickle-down approach is best. In essence: give the money to a government, an investor, an automaker, etc., and just count on it to flow to the general benefit of the population.”
Current circumstances weaken Zandi’s confidence argument. If, as hypothesized above, there is a substantial portion of the population questioning the underlying philosophy of government stimulus, stimulus might actually undermine confidence. Further, the confidence issue is aggravated by differences in the resources (capital and incomes) of those who believe stimulus will help and those whose confidence would be undermined by another stimulus.
Some might consider it partisan to point out the high potential of failure of a new stimulus. The subtitle and focus of “Stimulus more or less? A failure not being acknowledged. PART 1,” was “The economic impact of fiscal stimulus isn’t a partisan issue. Nor should partisan leanings be the criteria for defining stimulus.” Beyond recommending that posting there isn’t much one can say.
Others may conclude it reflects an ideological predisposition. That’s nonsense. If people could over-adjust as individuals undermining stimulus, they are equally likely to over-adjust collectively through their democratic process. If they are the greater fool a constant multiplier implies (consumers that don’t respond to debt are foolish), then they would be equally likely to display their foolishness collectively through policy as individually as consumers. Ideological predisposition (and The Hedged Economist has his own) do not determine when stimulus is advisable or what impact it will have.
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