Month: April 2013

How much do high schoolers know about economics? The National Assessment of Educational Progress did its first economics test in 2006, and the U.S. Department of Education has now released the results of the 2012 follow-up test in \”Economics 2012: National Assessment of Educational Progress at Grade 12.\” NAEP tests are carried out for a nationally representative sample of high school students.

I\’ve never read the actual questions for an NAEP economics test. The report explains that the questions are categorized in three overlapping ways. There are three main content areas: the  market economy, the national economy, and the international economy.  The questions are also divided into three \”cognitive\” categories: knowing, applying and reasoning. And the questions are divided into three assessment contexts: individual and household questions on topics related to earning, spending, saving, borrowing, and investing; business questions related to entrepreneurs, workers, producers, and investors; and public policy questions on domestic and international issues.

The results are not especially encouraging. About one-fifth of 12th-graders are \”below basic,\” and the median score is \”basic\” rather than \”proficient.\” Here\’s the overall performance in 2006 and 2012.

The modest gains from 2006 to 2012 are mainly at the lower end of the test score distribution.

However, performance on the economics test follows a pattern that is common across subjects: those with more educated parents tend to perform considerably better. I won\’t enter here into the disputes over the extent to which these differences reflect family or social influences or differences in school performance. I\’ll just note that children from families where the parents have lower levels of education are especially in need of a basic understanding of how the economy works at a personal and social level. Also, whatever the cause, education level is clearly one of the ways that families with higher socioeconomic status pass that advantage on to their children.

For those who want more detail on high school classes in economics, here\’s a post from October 2012 on \”High School Classes in Economics and Personal Finance.\”

Since Japan\’s bubble economy burst in the early 1990s, large budget deficits are one policy that the government has used in an attempt to stimulate the moribund economy. Japan\’s budget deficits have been at least 5% of GDP since the late 1990s, and more like 9-10% of GDP in the last five years. The OECD discusses Japan\’s budget deficits, and the rest of its economic situation, in the just-published OECD Economic Surveys JAPAN.  The \”Overview\” for the study is available here; the entire report can be read for free via a clunky on-line browser here.

In terms of gross government debt, Japan is the world leader. This chart shows the five countries with largest ratios of gross debt/GDP. Japan has been the clear leader since about 2000, although Greece has been making a run at the top spot in the last few years.

However, most economists tend to focus on net government debt, which subtracts out debt that the government owes to itself. (For example, in the U.S. context, net debt doesn\’t count debt held by the Social Security trust fund.) Thus, net debt focuses on how much the government has borrowed in global capital markets. By this measure, Italy was the world debt leader through the 1990s and into the early 2000s, but since then, Japan and Greece have been battling it out for the lead.

Japan\’s enormous debt poses a challenge both to those who advocate larger budget deficits, and for those who do not.  For those who advocate larger budget deficits, the challenge is that Japan\’s enormous rise in debt over about two decades has clearly not been sufficient to restore Japan\’s economy to robust health. Of course, one can object that a number of other complementary policies are also needed, and the OECD report discusses monetary policy, deregulation, energy policy, education, labor market policies, and more. But if the truly extraordinary increase in Japan\’s government debt has not been sufficient to stimulate its economy, it suggests that these other policies are of considerable importance.

On the other side, for those who advocate smaller deficits, Japan\’s enormous rise in government debt over two decades, with net debt reaching 150% of GDP,  has clearly not led to a financial crisis either.

The OECD report straddles the fence here. It warns that Japan\’s debt is far too high, and calls this the country\’s \”paramount policy challenge.\” But it also argues that immediate attempts to bring down this debt could keep Japan\’s economy sluggish, and so argues that a \”flexible fiscal policy\” is needed.

Here is the OECD report, dancing: \”The public debt ratio has risen steadily for two decades, to over 200% of GDP. Strong and protracted consolidation is therefore necessary to restore fiscal sustainability, which is Japan\’s paramount policy challenge. … Stopping and reversing the rise in the debt-to-GDP ratio is crucial. Stabilising the public debt ratio by 2020 may require, depending on the evolution of GDP and interest rates, an improvement of the primary fiscal balance from a deficit of 9% of GDP in 2012 to a surplus as high as 4% by 2020. Controlling expenditures, particularly for social security in the face of rapid population ageing, is key. Substantial tax increases will be needed as well, although this will also have a negative impact on growth. Given the size and duration of fiscal consolidation, Japan faces the risk of a marked rise in interest rates, threatening a banking system that is highly exposed to Japanese government debt.\”

Contemplate that for a moment: the recommendation is for moving from a deficit of 9% of GDP in 2012 to a surplus of 4% of GDP by 2020–that is, a swing in the government budget balance position of 13% of GDP in just 8 years. 

The U.S. debt situation differs from that of Japan in two ways: 1) the U.S. debt/GDP ratio is far smaller; and 2) domestic savings in Japan are high enough that the country can finance its government borrowing from domestic sources. In contrast, the U.S. government has depended for years on inflows of foreign investment capital to finance its debts. Thus, Japan\’s government needs to be concerned that its domestic savers will start looking elsewhere for higher rates of return, while the U.S. government needs to be concerned as to whether international investors will continue to put their money in Treasury bonds.

I remember when I was a high school debater back in the 1970s, and the oil price shocks led to arguments over the prospects for solar, wind, geothermal, and other kinds of power.  Here we are more than three decades later, and carbon-based fuels continue to rule. The International Energy Administration surveys the global situation in \”Tracking Clean Energy Progress 2013.\” 

Here is the Energy Sector Carbon Intensity Index. As the IEA report explains: \”The IEA Energy Sector Carbon Intensity Index (ESCII) tracks how many tonnes of CO2 are emitted for each unit of energy supplied. It shows that the global aggregate impact of all changes in supply technologies since 1970 has been minimal. Responses to the oil shocks of the 1970s made the energy supply 6% cleaner from 1971 to 1990. Since 1990, however, the ESCII has remained essentially static, changing by less than 1% …\”

(For the record, I edited this figure from the version in report by cutting off the projections for the future,and stopping with the present.)

Just to be clear, the IEA is a cheerleader for clean energy. Not that there\’s anything wrong with that! The report advocates \”at least\” tripling R&D budgets for clean energy. I\’m typically supportive of most R&D efforts, but it\’s important to remember that the U.S. government has spent about $150 billion (in 2012 dollars) on energy R&D since the 1970s, without much effect on moving away from carbon-based energy. R&D spending doesn\’t guarantee effective commercialization. But the report also offers a useful reminder that cleaner energy is about a lot more than trying to force-feed solar and wind power companies. For example:

Greater efficiency in energy consumption. \”Industrial energy consumption could be reduced by around 20% in the medium to long term by using best available technologies (BAT).\” Nearly half of global energy consumption is for either heating or cooling, two activities where efficiency gains are often possible.  The IEA calculates that nearly half of its desired gains in reduction of carbon emissions by 2020 can be achieved by greater energy efficiency.

Deal with Coal. The report notes: \”Coal technologies continue to dominate growth in power generation. This is a major reason why the amount of CO2 emitted for each unit of energy supplied
has fallen by less than 1% since 1990… Coal-fired generation, which rose by an estimated 6% from 2010 to 2012, continues to grow faster than non-fossil energy sources on an absolute basis. Around half of coal-fired power plants built in 2011 use inefficient technologies. … Coal plants are
large point sources of CO2 emissions, so concerted efforts to improve their efficiency can
significantly reduce coal consumption and lower emissions.\” TThus, one step is to make burning coal, where that is going to happen, more efficient.  In addition, natural gas can play a substantial role to lower emissions of carbon and various pollutants by offering a practical alternative to coal-fired electricity generation.

Push Carbon Capture and Storage. Maria van der Hoeven writes in her Foreword: \”I am particularly worried about the lack of progress in developing policies to drive carbon
capture and storage (CCS) deployment.\” The report notes: \”While 13 large-scale carbon capture and storage (CCS) demonstration projects are in operation or under construction, progress is far too slow to achieve the widespread commercial deployment envisioned …\”
 
Smarter electrical grids. Smart grids can operate in a number of ways. They can allow charging higher prices at times of peak loads, to encourage shifting demand. They can be programmed so that heating or cooling can be automatically adjusted when demand is especially high. They are going to be a necessity if the electrical grid is to be based on a wider range of energy sources, some of which may vary with sun and wind.



Those who express concern over consequences of high energy use–from conventional pollutants to the risks of climate change to effects of price fluctuations and geopolitical issues–are sometimes a little too quick to offer a policy prescription that involves waving a magic wand of R&D spending over solar or wind or biofuels. I\’d be delighted if that magic wand actually produced a commercially viable and vast source of clean energy, and maybe it will. But in the meantime, sensible policy-makers need to focus on cobbling together a range of less glamorous but perhaps more practical alternatives.

If skill level is so important in the U.S. economy, then why are the share of low-skilled jobs in labor force rising? The answer lies with the phenomenon of job \”polarization,\” a decades-long pattern in which the share of of medium-skill jobs is falling, while the share of both high-skill and low-skill jobs is rising. Didem Tüzemen and Jonathan Willis examine some aspects of this phenomenon in \”The Vanishing Middle:Job Polarization and Workers’ Response to the Decline in Middle-Skill Jobs,\” published in the First Quarter 2013 issue of the Economic Review from the Federal Reserve Bank of Kansas City.

Tüzemen and Willis describe the underlying dynamics in this way. Workers in high-skill occupations \”are typically highly educated and can perform tasks requiring anallytical ability, problem solving, and creativity. They work at managerial,professional, and technical occupations, such as engineering, finance,management, and medicine.\” In contrast, workers in low-skill occupations, typically have no

Of course, the polarized labor market also means a more polarized income distribution. Intriguingly, they offer a chart of median wages that suggests that it isn\’t the pay of those at different skill levels that has diverged, but rather the number of people working at jobs at these skill levels.

The authors document a number of patterns about job polarization in the last three decades. For example:

\”Given the sharp decline in manufacturing employment in the past three decades, this sector might appear to have been the main driver of job polarization. However, empirical evidence reveals that job polarization has been primarily due to shifts in the skill-composition of jobs within sectors as opposed to the shifts in employment between sectors in the economy. All sectors have experienced declines in the within-sector share of workers in middle-skill jobs. …  This distinction is important for labor market policy as it suggests that the impact of job polarization has been widespread across the economy rather than concentrated in a single sector, such as manufacturing. …\”

\”Job polarization has affected male and female workers differently. In response to the decline in the employment share of middle-skill occupations, employment of women has skewed toward high-skill occupations, while employment of men has shifted proportionally toward low- and high-skill occupations. …\”

\”From 1983 to 2012, the employment share of workers age 55 and older in high-skill occupations increased. This shift was related to the aging of the labor force and the delay in retirement of workers in higest demand – those with higher levels of education. In contrast, among workers ages 16 to 24 the largest increase was in the employment share of workers in low-skill occupations. Compared to the 1980s, younger people have been staying in school longer and postponing their entry into the labor force. These developments have shifted the composition of workers in the labor force and suggest that the retirement of the baby boom workers over the next decade may reduce the supply of highly-skilled workers.\”

For a global perspective on military expenditures, my go-to source is the Stockholm International Peace Research Institute. In their recent \”Fact Sheet,\”  Sam Perlo-Freeman, Elisabeth Sköns, Carina Solmirano and Helén Wilandh review \”Trends in World Military Expenditure, 2012.\”

One theme of the report is that global military spending dropped by half of 1% or so in 2012. But at least to my eye, the recent leveling out of military spending in a time of considerable economic stress around the world catches my eye less than how global military spending sagged from the late 1980s to the late 1990s, and the rebounded over the following decade. Some of this recent rise , of course, is higher U.S. military spending in the aftermath of the terrorist attacks of September 11, 2001. But in a more global perspective, it\’s also a rise in Chinese and Russian military spending.

The U.S accounts for 39% of global military expenditures, by far the highest of any country. The list below of the top 15 countries for military spending includes about 80% of all global military spending. U.S. military spending is about as much as the next 10 countries on the list, combined. In addition, while countries around the world on average spent 2.5% of GDP on the military in 2012, the U.S. military spending in 2012 was 4.4% of GDP.

But look at some of the countries in the top 15 in military spending: China at #2, Russia at #3, Japan at #5, Saudi Arabia at #7, India at #8, Brazil at #11. The regional patterns of military spending do seem to be shifting, albeit slowly. In the last few years, military spending is down in North American and western Europe, but up in many other regions. Military spending in Asia overtook that of western and central Europe a few years ago, and the gap is widening.

As I have confessed before on this blog, I have no particular expertise in global military and geopolitical issues. When political candidates argue over whether the U.S. should strive for a capability to fight two wars at a time, one-and-a-half wars at a time, or one war at a time, and what level of spending is appropriate in each case, I am out of my depth. But I can read a trendline.
After the disintegration of the Soviet Union in the early 1990s, the U.S. Was by far the preeminent military power in the world, but as countries like China, India, and Brazil continue their rapid economic growth, this U.S. military advantage will surely diminish. Moreover, while the ability of the U.S. military to win a set battle remains largely unchallenged, the ability of the U.S. to achieve its broader geo-strategic goals through a strategy based heavily on military force is certainly in question.

I was struck some commentsw that Henry Kissinger, no shrinking violet when it came to the application of force, gave in an interview last fall. Kissinger said:

\”I have seen and been involved in four wars that we started with great enthusiasm, and which turned into a debate about the speed of withdrawal—with no other outcome. We must develop a policy where, if we engage ourselves, we prevail. This means a revision of our military strategy, which has so far been based on physically stopping aggression by overwhelming it. It got us into a position where the enemy could control the pace of operations, and the length of the war. We have to develop a peripheral strategy. When the British fought Napoleon, they did not go into the continent of Europe. The strategy in Spain drained France without putting Britain into a position where it was risking its cohesion and its capabilities. I think we need a strategic concept of that nature.\”

Something tells me that my own sense of appropriate U.S. geo-strategic goals would not necessarily align closely with those of Henry Kissinger. But the idea of \”peripheral strategy,\” in which potential conflicts are shaped and managed and defused by methods that do not require \”physically stopping aggression by overwhelming it,\” seems important to pursue. 

Not that long ago, it seemed as if there was an emerging consensus among economists and central bankers that the goal of monetary policy should be \”inflation targeting\”–that is, aiming at a low and steady inflation rate in range of about 2% per year. In the aftermath of the Great Recession, this consensus has, if not shattered, at least taken a severe hit. In an e-book  Lucrezia Reichlin and Richard Baldwin have just edited an e-book called \”Is inflation targeting dead? Central Banking After the Crisis,\” published by VoxEU, with 14 short and readable essays on the question. 

In their introduction, Reichlin and Baldwin point out that when it comes to talking about the Great Recession, \”inflation targeting is cast alternatively as perpetrator, innocent bystander, or saviour.
• Perpetrator: Inflation targeting made monetary policy too easy before the Crisis and
insufficiently so since. It helped build the Crisis in the 2000s and today hinders the
clean-up.
• Bystander: The regime was like a coastal schooner finding itself in the path of Hurricane
Sandy. Inflation targeting was developed during ‘the Great Moderation’. No
one ever claimed it was robust enough to deal with a five-year sequence of once-in-a-
lifetime crises.
• Saviour: Things would have been much worse without inflation targeting’s anchoring
of expectations.\”

They argue that while inflation targeting in a narrow sense was clearly abandoned in 2008, a broader notion of inflation targeting  has an important role to play going forward, because it offers a clear framework for limiting the temptation of politicians to print money. They write:

\”Inflation targeting is alive and well. It is needed now more than ever. Inflation expectations will need to be kept anchored while the advanced economies work the debt-laden economic malaise. The debt creates temptations for governments to bail out debtors with unexpected inflation. Inflation targets and central-bank independence are the conventional ways of keeping politicians away from the printing presses. Central banks’ balance-sheet expansion and even permanent money creation are all options that can be used and considered but if there is any chance they will succeed, the credibility
of the commitment to a medium-run inflation target should not be lost. The questions remain on the effectiveness of such policies and, given their quasi-fiscal nature, on how to deal with the challenge they represent to central bank independence.\”

The eminent Michael Woodford contributes an essay called: \”Inflation targeting: Fix it, don’t scrap it.\” He writes:

\”It is important, first of all, to recognise that proponents of inflation targeting do not actually have in mind a commitment by the central bank to base policy decisions purely on their consequences for inflation, and to act so as to keep the inflation rate as close as possible to the target rate at all times. Mervyn King (1997) memorably referred to this as the ‘inflation nutter’ position, and distinguished the ‘flexible’ inflation targeting that he advocated from it …  And the theoretical case for inflation targeting has never rested on an assertion that a single-minded focus on inflation stabilisation would achieve the best outcome … Quantitative investigations of optimal monetary policy in a variety of structural models and under varying assumptions about parameters and shocks have instead found as a much more robust conclusion that optimal monetary policies involve a low long-run average rate of inflation, and fluctuations in the inflation rate that are not too persistent …

And indeed, there are important advantages for real stabilisation objectives of maintaining confidence that the medium-run inflation outlook is not changed much when shocks occur. For example, …if changes in the rate of inflation were expected to be highly persistent, it would be much more difficult for monetary policy to have an effect on real variables as opposed to simply affecting inflation. …

I thus believe that it would be possible to avoid the problems with inflation targeting as currently practised, that have been the focus of recent criticism of inflation targeting as such, while retaining the essential features of an inflation targeting regime: not only a public commitment to a fixed numerical target for the medium-run rate of inflation, and a commitment to regularly explain how policy decisions are consistent with that commitment, but the use of a forecast-targeting procedure as the basis both for monetary-policy deliberations and for communication with the public about the bank’s decisions and their justification. And I believe that it would be desirable to retain these
features of inflation targeting as it has developed over the past two decades.\”

I can\’t do justice to the volume in a blog post, but one theme that comes up in several of the papers is that some of the arguments for  inflation-targeting seem to assume that it has slowed down and limited the responses of central banks, and that an alternative monetary framework like targeting nominal GDP would have justified an even more aggressive monetary policy with more powerful results. Several of the authors are skeptical of this claim. Adam Posen makes the point that if the nontraditional tools of monetary policy (like quantitative easing and a \”forward guidance\” policy of announcing that interest rates will remain low for several years) are not effective, then it doesn\’t matter what framework you claim to be using. Posen writes:

\”Talk about alternatives to inflation targeting is, to me, a result of frustration – the lack of recovery despite massive monetary-policy shifts. But to my mind, the frustration is misdirected. Sifting a central bank’s target from inflation to nominal GDP in no way changes the effectiveness of policy instruments. Either quantitative easing works through the channel of promoting confidence, promoting asset prices, promoting aggregate demand and reallocation of the riskier assets, like all monetary policy, or it does not. If it does not do that, then it does not do that for nominal GDP any more than it does for inflation. The fact is we could have pursued more aggressive monetary policy, achieved better goals and been totally consistent with the current inflation target. There is no need to incur all the risks, dangers, and confusion of switching regimes – especially not to a regime like nominal-GDP targeting, which lacks inflation targeting’s robustness.\”

To me, one of the biggest surprises about the policies of the Federal Reserve since 2008 or so is how little effect they have had in stimulating nominal GDP growth–whether inflationary or real.

The ZIP code turns 50 this year, and the U.S. Postal Service Office of Inspector General has published a research paper (RARC-WP-13-006) to tell \”The Untold Story of the ZIP Code.\”

The ZIP code greatly helped the automation and efficiency of mail delivery: before the code, a typical piece of mail needed to sorted and handled by 8-10 pairs of hands. But  in addition, the ZIP code is an open source product for organizing data by geography. The report notes:

\”The ZIP Code was established as an open use product publicly accessible from the outset. In fact, the Postal Service only filed a trademark for the “ZIP Code” name in 1973 The openness of the ZIP Code as a platform for economic activity is part of the reason for its immense success far beyond its initial conception. Unlike most commodities, the ZIP Code is not rivalrous; use by one party does not exclude its use by any other. The Post Office took no steps to make the ZIP Code exclusive but rather provided it as a public good for use by any party, free of charge. … \”

\”Other organizations and businesses soon realized the ZIP Code possessed an elegant simplicity for efficiently organizing data by geography. The U.S. Census Bureau, for example, uses the ZIP Code to organize its statistics. Other industries, like real estate and target marketing companies, redefined the way they do business by basing their informational structure on the ZIP Code. The ZIP Code is solicited or used in a variety of transactions, such as buying gas with a credit card at an automated pump. Today, a ZIP Code and physical mailing address are widely recognized attributes of an individual’s identity.\”

The study estimates an economic value on the ZIP code of about $10  billion per year. The summary chart looks like this:

 How might the ZIP code be extended in the future? The report offers two main suggestions. One is that ZIP codes could be linked with geocodes. \”Geocoding is the process of associating precise geographic latitude and longitude coordinates with physical addresses, including street addresses and ZIP Code boundaries.\” This is already done in the UK. Adding geocodes would help the Post Office to plan faster and more efficient delivery patterns–and would also help private sector firms that do lots of shipping and deliveries. In addition, detailed geocoding of zip codes could include local features of terrain, or be used to track weather or disease. The other main change would be to link ZIP codes with demographic data. The report envisions that people could opt into a system where they provide data to the post office, which would allow better targeting of advertising. But in addition, one suspects that if geocodes and demographic information were linked with ZIP codes, clever innovators would find ways to use that data in ways that are beyond our current imagination.

Finally, the report suggests in comments here and there that the development of ZIP codes might also assist economic development around the world. The report notes: \”Current estimates show as many as 4 billion people worldwide are unaddressed and approximately sixty Universal Postal Union countries have no postal code system. …  There is strong evidence that implementing addressing systems in impoverished neighborhoods can actually increase the overall quality of life by allowing basic infrastructure, such as electricity, water, communication, and government services to be delivered to the area. This was seen in the slums of Calcutta, for example, where spray-painting unique addressing numbers on houses yielded significant positive effects on overall quality of life in the city’s neighborhoods. This effort has allowed the local government to organize the delivery of water and electrical utilities to the slums and residents now have the legal identities required to apply for bank accounts and jobs.\”

Mr. Zip, who was introduced as a symbol of the postal service at the same time as the ZIP code, has also turned 50.

Back in 2008 and 2009, I believe that there was a genuine risk of an international economic meltdown that could have been far worse than the grievous recess that actually occurred. (For some graphs that vividly illustrate the financial crisis, see here and here.) The nontraditional policies of the Federal Reserve and other central banks around that time–not just the reduction in the federal funds interest rate to near-zero, but also setting up a wide array of short-term lending facilities and the \”quantitative easing\” policy of buying financial assets–may well have limited the economic crisis from getting much worse. But that said, the recession ended back in June 2009, and I have my doubts that central banks should be continuing to maintain rock-bottom interest rates and continuing to buy financial assets for years into the future.  The question \”Do Central Bank Policies Since the Crisis Carry Risks to Financial Stability?\” is investigated in the Chapter 3 of the April 2013 issue of the Global Financial Stability Report, published by the IMF. Here\’s their summary:

\”[T]he interest rate and unconventional policies conducted by the central banks of four major regions (the euro area, Japan, the United Kingdom, and the United States) appear indeed to have lessened vulnerabilities in the domestic banking sector and contributed to financial stability in the short term. Th e prolonged period of low interest rates and central bank asset purchases has improved some indicators of bank soundness. Central bank intervention mitigated dysfunction in targeted markets, and large-scale purchases of government bonds have in general not harmed market liquidity. Policymakers should be alert to the possibility, however, that financial stability risks may be shifting to other parts of the financial system, such as shadow banks, pension funds, and insurance companies. … Despite their positive short-term effects for banks, these central bank policies are associated with financial risks that are likely to increase the longer the policies are maintained. The current environment shows signs of delaying balance sheet repair in banks and could raise credit risk over the medium term. … Central banks also face challenges in eventually exiting markets in which they have intervened heavily, including the interbank market; policy missteps during an exit could affect participants’ expectations and market functioning, possibly leading to sharp price changes.\”

One example of these potential stresses involves the money market mutual fund industry. Rock-bottom interest rates make these funds less attractive to investors, so the funds are shrinking. As a result, some of these funds are testing the limits of what regulators will allow by trying to take greater risk. A gradual reduction in the assets in money market funds is not a macroeconomic problem, but if shrinking funds and higher risks metamorphosize into a run on these funds, it could be a problem. Here\’s the report:

\”With interest rates remaining near zero in the maturities at which MMMFs [money market mutual funds] are permitted to invest, these institutions are experiencing very low (in some cases zero or negative) returns that in many cases fail to cover the costs of fund management. As a consequence, U.S. MMMFs have raised credit risk modestly (within the confines of regulatory restrictions), engaged in more overnight securities lending, granted fee waivers, and turned away new money. The fundamental problem is that to become profitable the MMMF industry needs to shrink further, and the risk is that it may do so in a disorderly fashion. For example, another run on MMMFs may occur if downside credit risks materialize or securities lending suddenly halts, fueling investors’ fear of MMMFs “breaking the buck” (that is, failing to maintain the expected stable net asset value).\”

As investors leave money market mutual funds in a \”search for  yield,\” risks arise in other  markets.

\”Credit easing, quantitative easing, and commitments to prolonged low policy interest rates may trigger flows into other mature asset markets (corporate bonds, equities, commodities, secondary currencies, and even housing). While encouraging a certain degree of risk taking is indeed the purpose of many MP-plus [monetary policy-plus] policies, they could unintentionally lead to pockets of excessive search for yield by investors and to exuberant price developments in certain markets, with the potential  for bubbles. … The sharp rise in investor\\demand for credit products, combined with constrained supply, is supporting a substantial decline in corporate borrowing costs. In turn, investors are accommodating higher corporate leverage and weaker underwriting standards to enhance yield. Some components of the credit market, such as loans with relaxed covenants, are experiencing more robust growth than in the last credit cycle …\”

The lower interest rates have helped the banking sector in the last few years, but they also raise risks for the future. The report points out: \”There is some evidence that unconventional central bank
measures may be supporting a delay in balance sheet cleanup in some banks …  The current
environment may also be encouraging banks to evergreen loans rather than recognize them as nonperforming … The volume and efficiency of interbank lending may adjust to new, lower levels based … With many banks now relying to a significant extent on central bank liquidity and banks withdrawing resources and skills from interbank lending activities, it may be difficult to restart these markets.\”

 Finally, there is the question of how central banks will eventually unwind their very large purchases of financial securities, both in private markets and in public debt. If this unwinding is done in a gradual and preannounced way, it\’s certainly possible to draw up scenarios where it doesn\’t ruffle markets. But it\’s also possible to draw up scenarios where the unwinding of these financial positions become an undesired source of disruption in these markets and in the banks and other financial institutions that hold many of these assets.

\”During 2009 and the first half of 2010, the Federal Reserve purchased close to $1 trillion in mortgage-backed securities (MBS) to support the U.S. housing market and alleviate pressures on the balance sheets of U.S. banks. It made a new commitment to buy MBS in September 2012 in an effort to lower mortgage interest rates further and spur credit extension … In two purchase programs, the ECB [European Central Bank] bought a total nominal amount of €76.4 billion of covered bonds, and the BOE [Bank of England] bought up to £1.5 billion in corporate bonds. The BOJ [Bank of Japan] also maintains a limited program to purchase corporate bonds, real estate investment trusts (J-REITs), and exchange-traded funds (corporate stocks). …

\”Central banks have become substantial holders of government bonds, too. The increasing share of government bonds held by central banks may present risks to financial stability.The Federal Reserve and the BOJ now each hold some 10 percent of their respective governments’ debt, the BOE holds 25 percent, and the ECB holds an estimated 5 percent to 6 percent of the outstanding sovereign debt of Italy and Spain. The shares of Federal Reserve and BOE holdings of longer-dated sovereign bonds are even higher at more than 30 percent.\”

The IMF recommended policy answer to these kinds of concerns is essentially technocratic: that is, keep monetary policy very expansionary until a recovery is well-established, and use financial regulatory policies like well-constructed capital standards, liquidity requirements, and other approaches to limit negative outcomes. Announce all policy changes well in advance, so that surprises are minimized, and slowly phase in all changes to avoid disrupting markets. It\’s all very sensible and prudent at some level. But the belief that well-informed and well-intentioned regulators financial risks will perceive the risks that arising because of the long-extended extreme expansionary monetary policies, and will respond in exquisitely calibrated ways to manage these risks, seems troublesome to me. 

However, those interested in an alternative view might check out this accessible recent speech from Ben Bernanke, in which he discusses \”Long-Term Interest Rates,\” the reasons why they are so low, and the case for keeping them low awhile longer.

Looking at trade between regions of the world reveals some intriguing patterns of the ties across the global economy. Here\’s a table based on data from the World Trade Organization, which splits the world into seven regions. The rows of the table are the regions where trade originates; the columns of the table are the regions that are destinations. CIS stands for \”Commonwealth of Independent States,\” which is loosely speaking the set of countries that used to be part of the old Soviet Union. For context, total world trade in 2011 was $17.8 trillion.

 Here are some patterns that jump out at me:

1) Trade in the global economy is still dominated by trade within regions. For example, by far the biggest entries in the table are from Europe/to Europe and from Asia/to Asia.

2) When looking at international trade within regions, remember that the amount is strongly influenced by the size of countries and how many countries are in a region. Trade between U.S. states is not counted as \”international trade\” in this table, but trade between, say, Belgium and Netherlands is counted as international trade. In this sense, the U.S. economy with its massive domestic market is much less exposed to globalization than most other countries of the world.

3) For the economy of North America, our biggest regional trading partner is still North America. But the countries of North America are a destination for almost almost as much in exports from the countries of Asia as they are from other countries in North America. but a nearly equivalent amount of exports from the region also go to Asia. Exports from North America to Asia are about double exports from North America to Europe. And the countries of North America export more to Asia than they do to Europe.

4) It\’s intriguing to wander through the table and look for patterns (and yes, that\’s the kind of person I am). Some regions of the world are nearly disconnected from each other in any direct economic sense. The countries in the Commonwealth of Independent States receive only de minimus amounts of trade that originates from North America,  South and Central America, Africa, or the Middle East. The nations of Africa send more trade to North America, to Europe, and to Asia than they do to other nations of Africa. The Middle East and Africa, although they are contiguous, barely trade.

This table is part of the process of producing a third edition of my own Principles of Economics textbook.  Of course, I encourage those looking for a well-explained and reasonably priced book to go to the Textbook Media website and check it out. Thanks to Dianna Amasino for putting together the table for this edition. The source is International Trade Statistics 2012: World trade developments: Key developments in 2011. from the World Trade Organization.  

In the lingo of government budgets, a \”tax expenditure\” is a provision of the tax code that looks like government spending: that is, it takes tax money that the government would otherwise have collected and directs it toward some social priority. Each year, the Analytical Perspectives volume that is published with the president\’s proposed budget has a chapter on tax expenditures.

Here\’s a list of the most expensive tax expenditures, although you probably need to expand the picture to read it. The provisions are ranked by the amount that they will reduce government revenues over the next five years. It includes all provisions that are projected to reduce tax revenue by at least $10 billion in 2014.

Here are some reactions:

1) The monetary amounts here are large. Any analysis of tax expenditures is always sprinkled with warnings that you can\’t just add up the revenue costs, because a number of these provisions interact with each other in different ways. With that warning duly noted, I\’ll just point out that individual and corporate income taxes are expected to collect about $1.7 trillion in 2014, and the list of items here would add up to about $1 trillion in 2014.

2) It is not a coincidence that certain areas of the economy that get enormous tax expenditures have also been trouble spots. For example, surely one reason that health costs have risen so far, so fast, relates to the top item on this list, the fact that employer contributions to health insurance and medical care costs are not taxed as income. If they were taxed as income, and the government collected an additional $212 billion in revenue, my guess is that such plans would be less lucrative. Similarly, one of the reasons that Americans spend so much on housing is the second item on the list, that mortgage interest on owner-occupied housing is deductible from taxes. Without this deductibility, the housing price bubble of the mid-2000s would have been less likely to inflate. Just for the record, I have nothing personal against either health care or home-ownership! Indeed, it\’s easy to come up with plausible justifications for many of the items on this list.  But when activities get special tax treatment, there are consequences.

3) Most of these tax expenditure provisions have their greatest effect for those with higher levels of income. For example, those with lower income levels who don\’t itemize deductions on their taxes get no benefit from the deductibility of mortgage interest or charitable contributions or state and local taxes. Those who live in more expensive houses, and occupy higher income tax brackets, get more benefit from the deductibility of mortgage interest. Those in higher tax brackets also get more benefit when employer-paid health and pension benefits are not counted as income.

4) These tax expenditures offer one possible mechanism to ease America\’s budget and economic woes, as I have argued on this blog before (for example,  here and here). Cut a deal to scale back on tax expenditures. Use the funds raised for some combination of lower marginal tax rates and deficit reduction. Such a deal could be beneficial for addressing the budget deficit, encouraging economic growth, raising tax revenues collected from those with high income levels, and reducing tax-induced distortions in the economy You may say I\’m a dreamer, but I\’m not the only one. After all, a bipartisan deal to broaden the tax base and cut marginal rates was passed in 1986, when the president and the Senate were led by one party while the House of Representatives was led by the other party.