Year: 2013

When I think of John Maynard Keynes as an investor, a few images and thoughts run through my mind. 

One image is an insouciant and self-satisfied global citizen, making global investments while sipping tea in bed. In his 1919 essay, The Economic Consequences of the Peace, Keynes painted a picture of what the world economy looked like before 1914. He wrote:

\”The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery upon his doorstep; he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprises of any quarter of the world, and share, without exertion or trouble, in their prospective fruits and advantages; or he could decide to couple the security of his fortunes with the good faith of the townspeople of any substantial municipality in any continent that fancy or information might recommend.\”

A second thought is how very difficult it is to make money in the stock market, because you are essentially trying to pick the stock today that other people think will want to buy at a higher price tomorrow. In the General Theory, Keynes offers a famous metaphor:

\”[P]rofessional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole, not those faces which he himself finds prettiest, but those which he thinks likeliest to match the fancy of the other competitors, all of whom are looking at the problem from the same point of view.\”

 Finally, I also think of Keynes as a legendarily successful investor, and in particular how he grew the endowment of King\’s College.  I don\’t think he did all of it sipping tea in bed, nor by thinking about investing as a beauty contest. In fact, I had no real idea how Keynes succeeded as an investor until reading the article by David Chambers and Elroy Dimson, \”Retrospectives: John Maynard Keynes, Investment Innovator,\” in the most recent issue of the Journal of Economic Perspectives. (Like all articles appearing in  JEP, it is freely available on-line courtesy of the American Economic Association. Full disclosure: I\’m the managing editor of the journal.) Here are a few insights from their article (as always, with citations and notes omitted for readability):

Over the entire time period, Keynes was wildly successful as an investor.
\”When John Maynard Keynes managed the endowment of King’s College at Cambridge University, the actively managed part of his portfolio beat the performance of the British common stock index by an average of 8 percentage points per year from 1921 to 1946.\”

Keynes was one of the first institutional investors to move heavily into stocks. 
\”Keynes was among the first institutional managers to allocate the majority of his portfolio to the then-alternative asset class of equities. In contrast, most British (and American) long-term institutional investors of a century ago regarded ordinary shares or common stocks as unacceptably risky and shunned this asset class in favor of fixed income and real estate. … To our knowledge, no other Oxbridge colleges made a substantial allocation to equities until the second half of the twentieth century. In the United States, the largest university endowments allocated less than 10 percent to
common stock in the 1920s (on a historical cost-weighted basis), and this total only rose above 20 percent in the late 1930s.\”
However, Keynes performed poorly as an investor for the first eight years or so. 
\”The year-by-year results also show that Keynes underperformed [a comparable market index] in only six out of the 25 financial years and that four of those years occurred in the first eight years of his management of the Discretionary Portfolio. By August 1929, he was lagging the UK equity market by a cumulative 17.2 percent since inception. In addition, he failed to foresee the sharp fall in the market the following month.\”

Keynes dramatically shifted his investment philosophy around 1930, switching from a market-timing macroeconomic approach to becoming one of the first \”value\” investors. 
\”Keynes independently championed value investing in the United Kingdom at around the same time as Benjamin Graham was doing so in the United States. Both Keynes’ public statements and his economic theorizing strongly suggest that he did not believe that “prices of securities must be good indicators of value” (Fama 1976). Beginning as a top-down portfolio manager, seeking to time his allocation to stocks, bonds, and cash according to macroeconomic indicators, he evolved into a bottom-up investor from the early 1930s onwards, picking stocks trading at a discount to their “intrinsic value”—terminology he himself employed. Subsequently, his equity investments began to
outperform the market on a consistent basis.\”

Keynes\’ overall portfolio was far from an index fund: he concentrated on a relatively small number small and medium-sized firms in certain industries. 
\”[T]he majority of his UK equity holdings were concentrated in just two sectors, metal mining—tin mining stocks in the 1920s and gold mining stocks in the following decade—and commercial and industrial firms …  Banking carried an index weight of 20 percent, and Keynes had little or no exposure in this sector. … Keynes’ substantial weighting in commercial and industrial stocks began in the early and mid-1920s with a diversified portfolio of industrial names. However, soon thereafter he concentrated his exposure in this sector on the two leading British automobile stocks, Austin Motors and Leyland Motors. In the context of the time, these would have been viewed as “technology” stocks. In terms of firm size, Keynes had a decided tilt towards mid-cap and small-cap stocks.\”

When a timetable for putting the euro in place was annouced by the Delors Commission back in 1988, I didn\’t believe it would ever happen. Germany was going to give up the deutsche mark? Really? Europe was already reaping gains from a more-free flow of goods, services, labor, and capital across borders, as well as from economic cooperation in other areas. Would a single currency increase those economic gains by much? Of course, the euro somehow managed to disregard my personal doubts and proceed to be implemented on schedule. But as the euro-zone has done a zombie stagger for the last few years, I\’ve been feeling more vindicated in my earlier doubts. The most recent Summer 2013 issue of the Journal of Economic Perspectives contains four articles putting what has happened in the euro-zone in perspective. (Courtesy of the American Economic Association, all articles in the JEP are freely available on-line going back to the first issue in 1987. Full disclosure: I am predisposed to think that JEP articles are worth reading because I\’ve been the managing editor since 1987.) Here\’s my own narrative of what has happened with the euro, drawing on those articles.

To set the stage for what needs explaining here, consider some patterns of unemployment. When the euro went into full effect early in 2002, unemployment dropped across the euro zone, but since early in 2008 it has been on the rise, now at about 12%. Notice that unemployment in the euro-zone, shown by the light line, has been higher and has risen faster than unemployment for the euro area as a whole.

Moreover, if one goes beyond the overall euro-average and looks at specific countries, the unemployment rates become even more disturbing. Unemployment in Greece and Spain, the two countries to the far right of the graph, are agonizingly high at above 26%.

So what explains the pattern of unemployment first falling when the euro came into effect in 200s, and then 2002, and then rising?  In their JEP paper, Jesús Fernández-Villaverde,  Luis Garicano, and Tano Santos offer a couple of striking graphs looking at borrowing patterns. Before the euro, countries in the periphery of Europe like Greece, Spain, Ireland, and Portugal had to pay higher interest rates than Germany. But with the advent of the euro, international capital lender  apparently decided that all countries borrowing in euros posed the same risk, and interest rates across these countries converged.

As the countries of the periphery experienced this sharp drop in interest rates, they went on something of a borrowing binge. In Greece and Portugal, the binge involved large government deficits. In Ireland and Spain, it involved large borrowing to finance an unsustainable housing bubble. But in all of these countries, their indebtedness to foreign investment rose dramatically. Meanwhile, much of this inflow of foriegn investment was coming from Germany, where foreign assets were piling up.

The rise in borrowing in the periphery countries was unsustainable, and the rubber hit the road when the recession hit in 2008. These economies had been living high on inflows of international capital. Average wages had risen substantially for workers. Governments had made lots of promises about spending for pensions and other areas. One hope of the euro had been that it would force countries on the periphery of Europe to run more sensible macroeconomic policies: after all, the plan was that they would hand over their central banking to the professionals at the European Central Bank, and various euro-wide rules would limit government borrowing. But instead, countries on the periphery of Europe were deluged with easy money in the form of unsustainable inflows of foreign capital. Now, those explicit and implicit promises of prosperity have fallen apart.

The current hope is that it may be possible to cobble together some set of arrangements that can sustain the euro. For example, there is talk of a unified banking system across Europe, with common deposit insurance, bank regulation, and rules for closing down insolvent banks. There is talk of swapping some of the debt of countries for debt that would be repaid by the euro area as a whole, to avoid the \”sovereign-debt doom loop\”  that arises when banks in a country mainly own the government debt of that country. In that situation, problems of bank bailouts turn into large increases in government debt (as in Ireland) and problems of government debt turn into sick banks–which in turn makes the economy worse. In their JEP article, Stephanie Schmitt-Grohé and Martin Uribe discuss how price inflation of perhaps 20%, spread over 4-5 years, could serve to reduce real wages in the countries with high unemployment and thus make them economically more competitive. There are even whispers of a hint of a shadow of a possibility of steps like a shared unemployment insurance fund across Europe.

But while I\’m sure it\’s possible to cobble together a series of bailouts and steps like these to keep the euro going awhile longer, the economic case that the euro may not be able to function very well remains.  The economic case against the euro is based on the \”optimal currency area\” literature associated with the work of Robert Mundell back in the 1960s.  (Mundell won the Nobel prize in 1999, and their website has a nice overview of his main contributions here.)

To understand the guts of the argument, consider a situation where one region of the U.S. economy performs well with rapid productivity and output growth, while another region does not. What happens? Well, substantial numbers of people migrate from the area with fewer jobs to the area with more jobs. Prices of nontraded goods like land and housing adjust, so that they are cheaper in the area that is performing less well and more expensive in the area that is performing better. Eventually, firms will see potential profits in these lower-cost areas and expand there. The U.S. tax code and spending programs reallocate some resources, too, because a progressive tax code will collect a greater share of the rising income in the area that is relatively better off, while a range of safety net programs and other spending will tend to favor the area that is relatively worse off. In short, when the modern U.S. economy has a situation where growth differs across regions, those differences are ameliorated to some extent by other economic shifts and policy choices. With these preconditions in place, a single currency works fairly well across the U.S. economy.

But what would happen if the two areas of the U.S. were not connected in these ways? What if one area performed well, another performed poorly, but there was very little movement of people, relatively little adjustment of wages and prices, no central government cushioning the differences of regional performance, and no eventual movement of business to the lower-cost region. In this case, the low-performance economic region could remain a depressed regional economy with high unemployment for a long, long time. In this situation, without the other offsetting economic changes, it would be useful for the two areas to have different currencies. Then the currency of the low-performance area could depreciate, which would make its workers and goods more attractive, and help the region to climb out of its slump.

When you look at Germany and Greece, you don\’t see tens of thousands of Greek workers heading to Germany for jobs. You don\’t see German firms setting up shop in Greece to take advantage of lower-priced land and labor. The European Union government has quite a small budget relative to national economies, and does very little to offset cross-country economic differences. Back before the euro, when areas of Europe differed in their economic performance, adjustments in the exchange rate–which in effect change the prices of all labor and goods from that economy on world markets–could ease the adjustment process. But for countries in the euro-zone, adjusting the exchange rate is no longer possible, and the other possible economic adjustments are not very strong.

In this situation, the economic outcome is sometimes called an \”internal devaluation.\” When countries like Greece, Spain, Portugal, and Ireland on the periphery of Europe can\’t cut their exchange rate and can\’t adjust in other ways, all that\’s left is the prospect of a long, miserable period where unemployment stays high and wages remain stagnant. In reviewing these kinds of economic dynamics, Kevin H. O\’Rourke and Alan M. Taylor write in their JEP article: 

\”So where the eurozone needs to go in the long run, we argue, is towards a genuine banking union; a eurozone-wide safe bond to break the sovereign-bank doom loop; a central bank that is more flfl exible and willing to act as a true lender of last resort against such bonds and other assets as necessary; and a fiscal union at least sufficient to support the above. But the short-run problems facing countries in the periphery of Europe are now so great that politicians may never get a chance to solve these long-run problems because the eurozone may well have collapsed in the
meantime.\”

The ultimate question here, perhaps, involves the desired destination of the euro-zone. In his article in the JEP symposium, Enrico Spolaore looks at the arguments of the \”intergovernmentalists,\” who see European integration as a process in which national governments look to cooperate for mutual benefit, while remaining ultimately in charge, and the \”functionalists,\” who see European integration as a long march toward a United States of Europe. Many Europeans seem to ambiguous on this choice, sometimes leaning one way, sometimes the other. As Spolaore writes: \”This same ambiguity is present in the conflicting views about the euro among its supporters: is it a currency without a state yet, or is it a currency without a state ever?\”

It\’s no secret that advertising has migrated on-line to the internet. But the rapidity of the change is nonetheless remarkable. Here\’s the growth in internet advertising as shown in an April 2013 report from the Internet Advertising Bureau. The annual growth rate for this advertising has been nearly 20% per year since 2003. 

 
In contrast, here\’s a figure showing the change in newspaper advertising, taken from the Pew Media Center\’s State of the News Media 2013, from the section on newspapers written by Rick Edmonds, Emily Guskin, Amy Mitchell and Mark Jurkowitz.  The blue bars show print advertising; the green bars show the still-small digital advertising revenue that newspapers receive.

 

 With that drop in revenue, the drop in newsroom employees at newspapers is no big surprise. Newspapers had about 55,000 newsroom employees through the late 1980s and much of the 1990s, but that number is now down around 40,000.
 

The State of the News Media 2013 also has a section on digital media, written by  Jane Sasseen, Kenny Olmstead and Amy Mitchell. 

To put these advertising numbers in the context, Kantar Media estimates that the total U.S. advertising market in 2012 was about $140 billion. Here is their figure showing that fewer people are getting their news from TV, radio, and newspapers, while more are getting it from online or digital sources.
 

Many more people report getting connected to their news from social media sites like Facebook and Twitter. Overall, it may well be that people are consuming more stories related to the news, but in a digital world people have a much wider range of choices for the source of their news, and thus much greater control over the type of stories they want to see in terms of subject area, emphasis, and political slant.

Hat tip: David Warsh discusses the comparison between newspaper and internet advertising, along with some thoughts about the future of the newspaper business,in his August 12 column at his \”Economic Principals\” website.

On the principle that you can never have too many supply and demand stories at hand, contemplate the market for lobsters. In recent years, supply has climbed dramatically. For a time, demand climbed as well, especially with additional global demand from China and elsewhere. But the price/pound received by lobster fishermen peaked back in 2005, and now has fallen to a multi-decade low.

From the State of Maine Department of Marine Resources, here\’s a graph showing the size of the lobster catch and total value of the catch.The total quantity of Maine lobsters caught doubled from 2007 to 2012. It nearly quintupled from 1990 to 2012. In recent decades, the rules for assuring that the lobster catch is sustainable have been tightened, so this doesn\’t seem to be a case of aggressive overfishing. Instead, it seems that the water temperature off the Maine coast has been rising in a way that increases the lobster catch. Here\’s a useful overview from the Financial Times ( Neil Munshi, \”Lobster industry squeezed by oversupply,\” August 7).

Given total quantity of lobsters and total value of the catch, both shown in the graph above, one can infer the price. At the bottom of this post I\’ll append a table of lobster data from the Maine state government: total quantity of Maine lobsters caught, total price, and then average price per pound.

The graphs shows that as the lobster catch started rising in the late 1980s and into the 1990s, the total value of the catch rose just as fast, or even a little faster, suggesting that nominal prices for lobsters were rising. There is price spike around 2005, which seems related to a rise in global demand. But the quantity just keeps rising. Nominal prices received by lobster fishermen fell from a peak of $4.63/pound in 2005 to $2.69/pound in 2012.

Because of inflation over the decades, it took about $2.56 in 2012 to purchase what $1 would buy back in 1981 (based on the Consumer Price Index). Thus, lobster fishermen were receiving $2.09 per pound for lobster back in 1981, but if you multiply by 2.5 to adjust for inflation, the equivalent price in 2012 would have been about $5.22/pound.

Lobster-fishing is a competitive industry, with many small producers and a few relatively large ones. As long as the fishermen are following the guidelines for assuring that the catch is biologically sustainable, there\’s no reason to expect that a cartel will form to hold down supply. Thus, the main hope for beleaguered lobster fishermen is a surge in  demand, perhaps as the US economy recovers or as lobster becomes more widely used in ways that have not been traditional outside of New England. Lobster mac-and-cheese? Lobster pizza? 

Here\’s the Maine data on quantity, total value,  and price/pound received by Maine lobster fishermen.

The Summer 2013 Issue of the Journal of Economic Perspectives is now available on-line. Like all issues of JEP back to the first issues in Summer 1987, it is freely available courtesy of the American Economic Association. I\’ve been the managing editor of JEP since that first issue, so for me, it\’s issue #105.

The issue has two main symposia: one has six papers with various perspectives on the top 1% of the income distribution; the other has four papers on what has happened with the euro. There\’s also a paper at the end about the legacy of John Maynard Keynes as a highly successful institutional investor, and my own \”Recommendations for Further Reading\” column. I\’ll post more about specific papers next week. For now, here are abstracts of the articles, with the article titles in boldface, and weblinks.

Symposium: The Top 1 Percent
 

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\”The Top 1 Percent in International and Historical Perspective,\” by Facundo Alvaredo, Anthony B. Atkinson, Thomas Piketty and Emmanuel Saez
The top 1 percent income share has more than doubled in the United States over the last 30 years, drawing much public attention in recent years. While other English-speaking countries have also experienced sharp increases in the top 1 percent income share, many high-income countries such as Japan, France, or Germany have seen much less increase in top income shares. Hence, the explanation cannot rely solely on forces common to advanced countries, such as the impact of new technologies and globalization on the supply and demand for skills. Moreover, the explanations have to accommodate the falls in top income shares earlier in the twentieth century experienced in virtually all high-income countries. We highlight four main factors. The first is the impact of tax policy, which has varied over time and differs across countries. Top tax rates have moved in the opposite direction from top income shares. The effects of top rate cuts can operate in conjunction with other mechanisms. The second factor is a richer view of the labor market, where we contrast the standard supply-side model with one where pay is determined by bargaining and the reactions to top rate cuts may lead simply to a redistribution of surplus. Indeed, top rate cuts may lead managerial energies to be diverted to increasing their remuneration at the expense of enterprise growth and employment. The third factor is capital income. Overall, private wealth (relative to income) has followed a U-shaped path over time, particularly in Europe, where inherited wealth is, in Europe if not in the United States, making a return. The fourth, little investigated, element is the correlation between earned income and capital income, which has substantially increased in recent decades in the United States.
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\”Defending the One Percent,\” by N. Gregory Mankiw
 Imagine a society with perfect economic equality. Then, one day, this egalitarian utopia is disturbed by an entrepreneur with an idea for a new product. Think of the entrepreneur as Steve Jobs as he develops the iPod, J. K. Rowling as she writes her Harry Potter books, or Steven Spielberg as he directs his blockbuster movies. The new product makes the entrepreneur much richer than everyone else. How should the entrepreneurial disturbance in this formerly egalitarian outcome alter public policy? Should public policy remain the same, because the situation was initially acceptable and the entrepreneur improved it for everyone? Or should government policymakers deplore the resulting inequality and use their powers to tax and transfer to spread the gains more equally? In my view, this thought experiment captures, in an extreme and stylized way, what has happened to US society over the past several decades. Since the 1970s, average incomes have grown, but the growth has not been uniform across the income distribution. The incomes at the top, especially in the top 1 percent, have grown much faster than average. These high earners have made significant economic contributions, but they have also reaped large gains. The question for public policy is what, if anything, to do about it.
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\”It\’s the Market: The Broad-Based Rise in the Return to Top Talent,\” Steven N. Kaplan and Joshua Rauh
One explanation that has been proposed for rising inequality is that technical change allows highly talented individuals, or \”superstars\” to manage or perform on a larger scale, applying their talent to greater pools of resources and reaching larger numbers of people, thus becoming more productive and higher paid. Others argue that managerial power has increased in a way that allows those at the top to receive higher pay, that social norms against higher pay levels have broken down, or that tax policy affects the distribution of surpluses between employers and employees. We offer evidence bearing on the different theories explaining the rise in inequality in the United States over recent decades. First we look the increase in pay at the highest income levels across occupations. We consider the income share of the top 1 percent over time. And we turn to evidence on inequality of wealth at the top. In looking at the wealthiest Americans, we find that those in the Forbes 400 are less likely to have inherited their wealth or to have grown up wealthy. The Forbes 400 of today also are those who were able to access education while young and apply their skills to the most scalable industries: technology, finance, and mass retail. We believe that the US evidence on income and wealth shares for the top 1 percent is most consistent with a \”superstar\”-style explanation rooted in the importance of scale and skill-biased technological change. It is less consistent with an argument that the gains to the top 1 percent are rooted in greater managerial power or changes in social norms about what managers should earn.
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\”The Pay of Corporate Executives and Financial Professionals as Evidence of Rents in Top 1 Percent Incomes,\” by Josh Bivens and Lawrence Mishel

The debate over the extent and causes of rising inequality of American incomes and wages has now raged for at least two decades. In this paper, we will make four arguments. First, the increase in the incomes and wages of the top 1 percent over the last three decades should be interpreted as driven largely by the creation and/or redistribution of economic rents, and not simply as the outcome of well-functioning competitive markets rewarding skills or productivity based on marginal differences. This rise in rents accruing to the top 1 percent could be the result of increased opportunities for rentshifting, increased incentives for rent-shifting, or a combination of both. Second, this rise in incomes at the very top has been the primary impediment to having growth in living standards for low- and moderate-income households approach the growth rate of economy-wide productivity. Third, because this rise in top incomes is largely driven by rents, there is the potential for checking (or even reversing) this rise through policy measures with little to no adverse impact on overall economic growth. Lastly, this analysis suggests two complementary approaches for policymakers wishing to reverse the rise in the top 1 percent\’s share of income: dismantling the institutional sources of their increased ability to channel rents their way and/or reducing the return to this rent-seeking by significantly increasing marginal rates of taxation on high incomes.
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\”Income Inequality, Equality of Opportunity, and Intergenerational Mobility,\” Miles Corak
My focus is on the degree to which increasing inequality in the high-income countries, particularly in the United States, is likely to limit economic mobility for the next generation of young adults. I discuss the underlying drivers of opportunity that generate the relationship between inequality and intergenerational mobility. The goal is to explain why America differs from other countries, how intergenerational mobility will change in an era of higher inequality, and how the process is different for the top 1 percent. I begin by presenting evidence that countries with more inequality at one point in time also experience less earnings mobility across the generations, a relationship that has been called \”The Great Gatsby Curve.\” The interaction between families, labor markets, and public policies all structure a child\’s opportunities and determine the extent to which adult earnings are related to family background — but they do so in different ways across national contexts. Both cross-country comparisons and the underlying trends suggest that these drivers are all configured most likely to lower, or at least not raise, the degree of intergenerational earnings mobility for the next generation of Americans coming of age in a more polarized labor market. This trend will likely continue unless there are changes in public policy that promote the human capital of children in a way that offers relatively greater benefits to the relatively disadvantaged.
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\”Why Hasn\’t Democracy Slowed Rising Inequality?\” by Adam Bonica, Nolan McCarty, Keith T. Poole and Howard Rosenthal
During the past two generations, democratic forms have coexisted with massive increases in economic inequality in the United States and many other advanced democracies. Moreover, these new inequalities have primarily benefited the top 1 percent and even the top .01 percent. These groups seem sufficiently small that economic inequality could be held in check by political equality in the form of \”one person, one vote.\” In this paper, we explore five possible reasons why the US political system has failed to counterbalance rising inequality. First, both Republicans and many Democrats have experienced an ideological shift toward acceptance of a form of free market capitalism that offers less support for government provision of transfers, lower marginal tax rates for those with high incomes, and deregulation of a number of industries. Second, immigration and low turnout of the poor have combined to make the distribution of voters more weighted to high incomes than is the distribution of households. Third, rising real income and wealth has made a larger fraction of the population less attracted to turning to government for social insurance. Fourth, the rich have been able to use their resources to influence electoral, legislative, and regulatory processes through campaign contributions, lobbying, and revolving door employment of politicians and bureaucrats. Fifth, the political process is distorted by institutions that reduce the accountability of elected officials to the majority and hampered by institutions that combine with political polarization to create policy gridlock.
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Symposium: The Euro

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\”What Is European Integration Really About? A Political Guide for Economists,\” by Enrico Spolaore
Europe\’s monetary union is part of a broader process of integration that started in the aftermath of World War II. In this \”political guide for economists,\” we look at the creation of the euro within the bigger picture of European integration. How and why were European institutions established? What is European integration really about? We address these questions from a political-economy perspective, building on ideas and results from the economic literature on the formation of states and political unions. Specifically, we look at the motivations, assumptions, and limitations of the European strategy initiated by Jean Monnet and his collaborators of partially integrating policy functions in a few areas with the expectation that more integration will follow in other areas in a sort of chain reaction toward an \”ever-closer union.\” The euro with its current problems is a child of that strategy and its limits.
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\”Political Credit Cycles: The Case of the Eurozone,\” by Jesús Fernández-Villaverde, Luis Garicano and Tano Santos
We study the mechanisms through which the entry into the euro delayed, rather than advanced, key economic reforms in the eurozone periphery and led to the deterioration of important institutions in these countries. We show that the abandonment of the reform process and the institutional deterioration, in turn, not only reduced their growth prospects but also fed back into financial conditions, prolonging the credit boom and delaying the response to the bubble when the speculative nature of the cycle was already evident. We analyze empirically the interrelation between the financial boom and the reform process in Greece, Spain, Ireland, and Portugal and, by way of contrast, in Germany, a country that did experience a reform process after the creation of the euro.
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\”Cross of Euros,\” Kevin H. O\’Rourke and Alan M. Taylor
The eurozone currently confronts severe short-run macroeconomic adjustment problems and a deficient institutional architecture that has to be reformed in the longer run. Europe\’s efforts at economic and monetary union are historically unprecedented. However, the gold standard provides lessons regarding what will and won\’t work, macroeconomically and politically, in the short run, while US history provides long-run lessons regarding appropriate institutional structures. The latter also suggests that institutional reform only happens at times of great crisis, and that it cannot be taken for granted. The eurozone\’s leaders may therefore ultimately have to take heed of the lessons of history regarding currency union breakups.
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\”Downward Nominal Wage Rigidity and the Case for Temporary Inflation in the Eurozone,\” by Stephanie Schmitt-Grohé and Martin Uribe
Since the onset of the Great Recession in peripheral Europe, nominal hourly wages have not fallen from the high levels they had reached during the boom years — this in spite of widespread increases in unemployment. This observation evokes a well-known narrative in which nominal downward wage rigidity is at the center of the current unemployment problem. We embed downward nominal wage rigidity into a small open economy with tradable and nontradable goods and a fixed exchange-rate regime. In this model, negative external shocks cause involuntary unemployment. We analyze a number of national and supranational policy options for alleviating the unemployment problem caused by the combination of downward nominal wage rigidity and a fixed exchange-rate regime. We argue that, in spite of the existence of a battery of domestic policies that could be effective in solving the unemployment problem, it is unlikely that a solution will come from within national borders. This leaves supranational monetary stimulus as the most compelling avenue out of the crisis. Our model predicts that full employment in peripheral Europe could be restored by raising the euro area annual rate of inflation to about 4 percent for the next five years.
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Features

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\”Retrospectives: John Maynard Keynes, Investment Innovator,\” by David Chambers and Elroy Dimson
John Maynard Keynes made a major contribution to the development of professional investment management. Based on detailed archival research at King\’s College, Cambridge, we describe Keynes\’ investment philosophy, his investment performance, and the evolution of his investment approach as the manager of a large educational endowment. His portfolios were actively managed and unconventional. He was an investment innovator both in making a substantial allocation to the then new institutional asset class of common stocks as well as in championing value investing.
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\”Recommendations for Further Reading,\” by Timothy Taylor
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Notes and Errata

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\”Under this plan, quotas for hunting of whales would be traded in global markets. But again, and unlike most “catch share” programs in fisheries, the whale conservation market would not restrict participation in the market; both pro- and antiwhaling interests could own and trade quotas. The maximum potential harvest for any hunted species in any given year would be established in a conservative manner that ensures sustainability of the marketed species (that is, harvest levels would be established that would not permit taking more individuals than can be replaced) and maintains their functional roles in the ecosystem. The actual harvest, however, would depend on who owns the quotas. Conservation groups, for example, could choose to buy whale shares in order to protect populations that are currently threatened; they could also buy shares to protect populations that are not presently at risk but that conservationists fear might become threatened in the future.\”

\”Despite the widely acknowledged failure of the IWC [International Whaling Commission] moratorium to curtail unsustainable whaling, the whale conservation market idea has proved to be wildly controversial within conservation and antiwhaling circles. Concerns have been raised about how the system would be established (for example, under what guidelines would the original shares be allocated?) and how it would play out over time (for example, would a legal market lead to increased whaling?). Many critics of the idea are also plainly not comfortable with the ethics of putting a price on such iconic species—that is, with using contingent market methods for what they believe should be a categorical ethical obligation to preserve whales. On the other hand, the negotiation failures surrounding the global management of whales underscore the need for a realistic and pragmatic discussion about available policy alternatives. Indeed, the vulnerable status of many whale populations and the failure of the traditional regulatory response to halt unsustainable harvests call for a more innovative and experimental approach to whale policy, including considering unconventional proposals, such as the whale conservation market.\”

My own sense, trained as I am into economic ways of thinking, is that if ethics are to be meaningful, they need to engage with pragmatic realities. The moratorium on commercial whaling is not, in fact, protecting a biologically sufficient number of whales. The arguments that whales should not be hunted, whatever their merits, have not been winning where it counts–that is, as measured by the size of the whale population. Arguments about the ethics whaling have even not brought us to a biologically sustainable situation, much less to the far more stringent limits on whaling that many environmentalists would prefer. In that situation, real-world ethical behavior calls for looking at alternatives.

The migration puzzle is that while Americans tend to think of themselves as a country where migration is commonplace, the actual rate of migration has been falling since about 1980. Raven Molloy, Christopher L. Smith, and Abigail Wozniak provide a nice overview of the changes in \”Internal Migration in the United States\” in the Summer 2011 issue of the  Journal of Economic Perspectives. (Full disclosure: I\’ve been holding down the Managing Editor job at JEP since the tail end of the Reagan administration. I posted about the Molloy, Smith, and Wozniak article here, soon after it was published. ) Since then, there are a couple of recent developments: some new evidence that the migration rate may be turning up a bit, and some new explanations for why it declined.

William Frey presents some recent evidence on the within-the-U.S. migration rate in a short overview article in the Milken Institute Review, July 2013. He writes: \”In 2011-12, 14 states (most of
them in the Sun Belt) showed bigger gains than the previous year. Phoenix picked up 37,000 intranational migrants, compared with just 4,000 the year before. At the same time, 27 states, most in the Snow Belt, were losing migrants at an accelerated pace. Metro New York, for example, lost 128,000, compared to 99,000 in the prior 12 months. To be sure, Snow Belt to Sun Belt flows are
not close to their peaks, or even to normal levels. In 2005-6 New York lost 290,000 migrants,
while Phoenix gained a tad less than 100,000. But there is clearly a thaw.\”

Explaining the decline in within-U.S. migration since the late 1980s or early 1990s migration has proven difficult. It\’s easy to suggest possible reasons. For example, perhaps as the average age of America\’s population rises, people become less likely to move. Or perhaps the increase in two-earner couples makes people less likely to move. But these kinds of explanations can easily be tested against the data: for example, by looking at areas that have more or less elderly people, or areas that have bigger or smaller shares of two-earner couples, and comparing mobility rates. As Malloy, Smith and Wozniak pointed out in their 2011 JEP article: \”Migration rates have fallen for most distances, demographic and socioeconomic groups, and geographic areas. The widespread nature of the decrease suggests that the drop in mobility is not related to demographics, income, employment, labor force participation, or homeownership.\”

However, Greg Kaplan and Sam Schulhofer-Wohl have written \”Understanding the Long-Run Decline in Interstate Migration ,\” published as Working Paper 697 by the Minneapolis Federal Reserve. Their paper is technical research economics, and thus not an easy read for the uninitiated, but the basic findings can be explained easily enough. They write: 

\”We show that micro data rule out many popular explanations for this change [of lower migration rates], such as aging of the population or changes in the number of two-earner households. But the data do support two novel theories. The rst theory is that labor markets around the country have become more similar in the returns they o er to particular skills, so workers need not move to a particular place to maximize the return on their idiosyncratic abilities. The second theory is that better information–due to both information technology and falling travel costs–has made locations less of an experience good, reducing the need for young people to experiment with living in di erent places. We build a model that makes these ideas precise and show that a plausibly calibrated version is consistent with cross-sectional and time-series patterns.\” 

As Kaplan and Schulhofer-Wohl readily admit, just how much of the change in migration is explained by these factors is not yet clear: it could be as little as one-third, or as much as all of it. I\’m sure future research will try to narrow this down. They also provide a useful compact explanation of why the level of migration, and the reasons why it slowed down, matter for labor markets and policy-makers (in what follows, citations are omitted).

\”Many policymakers have worried that the decline in migration heralds a less-flexible economy where workers cannot move to places with good jobs. In such an economy, the labor market might adjust more slowly to shocks, potentially prolonging recessions and reducing growth. Low migration has thus been proposed as an explanation for the slow recovery from the 2007-\’08 financial crisis. But the causes of decreased migration that we identify suggest that the economy may not be less flexible after all. Rather, low migration means that workers either do not need to move to obtain good jobs or have better information about their opportunities. In either case, the appropriate policy response may diff er from the appropriate response to a decrease in workers\’ ability to move. Thus, understanding the causes of the decline in gross migration is an important goal for economists.\”

Three years ago, the Wall Street Reform and Consumer Protection Act, commonly known as the Dodd-Frank act, was signed into law by President Obama. The legislation took a peculiar form: rather than Congress actually writing a new set of rules and regulations, the law involved a massive set of requirements that regulatory agencies write new rules.

The law firm of Davis Polk and Wardwell has been publishing regular progress reports on how the rule-making is proceeding. By their count, the legislation involved 398 new rule-making requirements. According to the third-anniversary report, the deadlines for writing 279 of those rules have been reached, but only 107 rules have been completed. Of the 172  rules where deadlines have now been missed, regulators have not yet submitted proposals for 64 of them. By their count, so far there are 15 million words worth of regulations to implement the 898-page legislation, and the count is rising.

In some sense, this slow pace of producing final rules is no surprise, as I\’ve discussed earlier here. Writing a rule involves a legally defined process of proposals, comments, revised proposals, and so on. Writing several dozen new major rules to govern financial institutions and markets would be a major undertaking: writing several hundred new rules is a gargantuan task. Of course, each rule is contested between those of differing views. In a real sense, Dodd-Frank was not actually about Congress enacting financial reform, but rather about admitting that Congress doesn\’t have enough knowledge to enact financial reform–and handing off the task to others.
That said, how are the reforms proceeding? Daniel Tarullo of the Fed Board of Governors gave a talk on the subject in May. Here\’s how he listed the positives, and what remains to be done. On the positive side:

\”First, the basic prudential framework for banking organizations is being considerably strengthened, both internationally and domestically. Central to this effort are the Basel III changes to capital standards, which create a new requirement for a minimum common equity capital ratio…. Second, a series of reforms have been targeted at the larger financial firms that are more likely to be of systemic importance. … The governing principle for this new set of rules is that larger institutions should be subject to more exacting regulatory and supervisory requirements, which should become progressively stricter as the systemic importance of a firm increases. … A third set of reforms has been aimed at strengthening financial markets generally, without regard to the status of relevant market actors as regulated or systemically important. The greatest focus … has been on making derivatives markets safer through requiring central clearing for derivatives that can be standardized and creating margin requirements for derivatives that continue to be written and traded outside of central clearing facilities.\”

As Tarullo points out, a number of these rules are still being implemented. On the other side, here are his limitations and shortcomings. For example, he writes that the new capital standards for banks are lower than he would prefer, and do not fully address the \”too-big-to-fail\” problem. He also emphasizes: \”Most importantly, relatively little has been done to change the structure of wholesale funding markets so as to make them less susceptible to damaging runs. … [S]ignificant continuing vulnerability remains, particularly in those funding channels that can be grouped under the heading of securities financing transactions.\” In particular, Tarullo mentions \”[r]epo, reverse repo, securities lending and borrowing, and securities margin lending.\” 

For a more detailed discussion of shortcomings of Dodd-Frank, I recommend \”Financial Stability Monitoring\” by Tobias Adrian, Daniel Covitz, and Nellie Liang at the Fed, written as Finance and Economics Discussion Series 2013-21. For example, when Congress requires that rules are written for tighter regulation of depository institutions, they create incentives for larger parts of the financial sector to move out of the regulated sector and to what is often known as the \”shadow banking\” sector. These are financial entities that accept investments that can be withdrawn in the short-run, but often invest in financial securities that pay off over the long run–which as we have learned can set the stage for a financial crisis if many investors try to sell off these investments at the same time. As another example, when Congress attempts to set rules that limit what regulators can do when a financial institution is in trouble, it risks making a future financial crisis even more severe. They also emphasize Tarullo\’s point that the Dodd-Frank Act \”does not address structural problems in wholesale short-term funding markets, such as the susceptibility of money market funds to investor runs or the inherent fragility of repo markets.\”

It is remarkable and depressing to me that three years after the passage of this legislation, and more than four years after U.S. financial markets nearly melted down in late 2008 and early 2009, the issues of how to reform the financial sector remain so fluid and unresolved.

From time to time, I\’ve posted figures to help illustrate the sharpness and severity of the financial and economic shocks that hit the U.S. economy starting in 2007 and lasting into 2009. Some examples (here and here) included interest rate spreads, net lending by the financial sector, the housing price bubble, inflows of international capital, and the like. But here\’s an offbeat measure: in the transcripts of the meetings of the Federal Open Market Committee, which is at the center of making decisions about monetary policy, how many times does the transcript note that laughter occurred?

During the tail end of the Greenspan years, 10-30 laughs per meeting was about the norm. (Just to be clear, this humor is typically the sort of thing that would only provide chuckles to aficionados of monetary policy who are shut in a room together.) When Bernanke arrives, the laughter level rises up into the range of 70-80 laughs per meeting. But when the first stirrings of the financial crisis hit in late 2007, there are a few meetings with no almost no laughter at all.

The data only go through early 2008, because minutes of FOMC meetings are only released after a five-year lag. The figure is taken from a briefing book put together by the Stanford Institute for Economic Policy Research for their annual \”summit\” meeting last spring, and is based on data from Bianco Research. 

The rate at which health care costs are rising had slowed down in recent years, and perhaps not unexpectedly, Obama\’s economic advisers have sought to draw the link that \”As ACA Implementation Continues, Consumer Health Care Cost Growth Has Slowed.\” But an array of evidence suggests that something beyond that legislation–which after all, is mostly not yet implemented–is the cause.

1) The slowdown in the rise of health care spending was already being noted in newspaper articles back in early 2012. Writing in the New England Journal of Medicine in August 2012, Charles Roehrig, Ani Turner, Paul Hughes-Cromwick, and George Miller trace the timing and causes of the slowdown in \”When the Cost Curve Bent — Pre-Recession Moderation in Health Care Spending.\”
They measured the extent to which the rise in national health care spending exceeded growth of \”potential GDP: (that is, GDP adjusted to take out the effects of recessions and booms).  They find that the slowdown in health care spending started around 2003, and has been lower since 2005. Here\’s one of their figures:

They write: \”Spending for physician and clinical services has grown particularly slowly since the curve bent in 2005. In the pre-recession period, we trace this slowdown to slow growth in physician-payment rates relative to overall prices in the economy. In the post-recession period, payment-rate increases have remained low and the growth in the utilization of physician services has diminished.\” The authors acknowledge that the recession may also have contributed to a slower rise in health care spending, but they believe earlier structural factors–not yet well-understood–played a bigger role.

3) There\’s some reason to be dubious as to whether the slower rate of growth in health care spending will persist. Only a year ago, government actuaries were predicting that the rise in health care costs would pick up again as the economy accelerated, and total health care spending would rise from $17.8% of GDP in 2009 to nearly 20% of GDP by 2021.

In short, the case that the 2010 U.S. health financing reform legislation is already playing a substantial role in holding down health care costs seems weak. It seems clear that the recession held down the rise in health care costs both in the U.S. and in many other countries. And there\’s some reason to believe that the rise in U.S. health care costs may be slowing–although the evidence remains preliminary.

If the rise in health care costs is slowing down, and the health care cost curve is indeed bending, it would be huge news. For households, \”Health Care Costs are Eating Your Pay Raise,\” as I posted back in January 2012. For government, rising health care costs for current employees, for the poor, and for retirees are the major drivers of why budget deficits are projected to become so very large in the next few decades.