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After the news broke of his firm’s (now $3 billion) loss on a hedge gone awry, Jamie Dimon quipped: “just because we’re stupid doesn’t mean everybody else was.”  Stupidity, however, is beside the point. Jan Kregel has pointed out how a lot of the discussion surrounding this episode is designed to give the impression that this was just a matter of personal folly and bad judgment.  Get rid of a few people, tweak a model, and everything should be fine.  But there’s far more to this story, says Kregel in a new policy note.  First, the fact that management appeared not to recognize what was going on in a unit that reported directly to them suggests that JPMorgan was too big to manage.  And if it’s too big to manage, it’s too big for regulators to supervise effectively. But simply making banks smaller won’t solve the problem either, according to Kregel—not if they’re allowed to engage in the same kinds of trades on the same kinds of assets.  Here he captures the “heads they win, tails we lose” dynamic of the post-Gramm-Leach-Bliley banking world: [S]ince the passage of the Gramm-Leach-Bliley Act in 1999, the major activity of banks is to profit from changes in the prices of the assets held in its trading portfolio—and for JPMorgan Chase, in its hedging… Read More

You wonder what will happen when markets finally start working. How about, for example, a market that changes prices and wages quickly in response to fluctuations in demand? In a mixed economy with a government that tries to provide fiscal stimulus as needed, will it be of help to move toward such fast-adjusting markets? The two interactive diagrams in this post are based on figures 9a, 9b, 10a, and 10b in a Levy Institute working paper of mine called “Fiscal Policy, Unemployment Insurance, and Financial Crises in a Model of Growth and Distribution,” which was issued just this month and posted on the Institute’s site (math content somewhat crucial). Each of the two figures shows one pathway followed by an imaginary economy. The pathways are computed by simulating a heterodox model, using a set of parameters as well as a starting point for each of the following variables: capacity utilization, public (government) production, the markup on labor costs used by businesses to calculate their prices, and the size of the labor force. As I explain in the paper, my parameter choices are not based on econometric estimates, but rather on a rough sense of what might be reasonable for a developed economy. In a moment, a new technology will give you a chance to see the impact of varying one… Read More

News sections are littered with shortcuts for explaining what’s going on in the eurozone, often featuring easy, morally sodden narratives. But the real problem here is not that narratives and other shortcuts are being employed—after all, sometimes the data need a little help.  The real problem is that they’re using the wrong narratives. We’re told more often than not that the reason peripheral countries like Spain are in trouble is that their governments engaged in an irresponsible spending binge and are now reaping the consequences.  But in 2007 Spain’s debt-to-GDP ratio was low—a quaint 27 percent of GDP—and had been falling for some time.  Likewise, by contrast with the Aesop-flavored conventional wisdom, German ants work 690 fewer hours per year compared to their Greek grasshopper counterparts.  But this doesn’t mean morality has no place in an assessment of Europe’s economic woes.  Today, for instance, the imposition of austerity and the waste of human potential this is generating—even as austerity fails to summon the “confidence” and growth that was promised and fails to make a significant dent in debt-to-GDP ratios—begs for moral judgement. And while a technical analysis of the basic setup of the EU and all the imbalances it has generated can get you most of the way toward explaining what’s going on (take a look at the private debt… Read More

A little while back the Wall Street Journal observed that if there were as many people employed by government today as there were in the last month of George W. Bush’s tenure, the unemployment rate would be around 7.1 percent.  Job creation policy, in other words, can sometimes be quite simple.  Step One:  stop firing so many people. Reuters’ Edward Hadas picks up Pavlina Tcherneva’s research on the reorientation of fiscal policy and points us in the direction of a Step Two:  offer a job to anyone who wants to work but can’t find paid employment.  Tcherneva’s research reveals that the standard way of doing fiscal stimulus,  trying to boost economic growth with traditional pump-priming and hoping that the jobs follow, has it backwards.  Instead of the traditional “trickle-down Keynesian” approach, Tcherneva suggests that targeting the unemployed with direct job creation policies that run throughout the business cycle would be far more efficient. Tcherneva envisions a direct job creation program that would function as a more effective automatic stabilizer, expanding in recessions and contracting in booms. She argues that this “bottom up” approach is not only closer to what Keynes actually advocated, but that it is also more likely to bring us back to full employment—while being less inflationary and more equitable.  Although expanding government payrolls for projects fulfilling various… Read More

Whether or not you already know what a “repo” is, Public Citizen’s new report on repurchase agreements, which played a part in the recent financial crisis (as well as the collapse of MF Global), is well worth reading.  Here’s their introduction: In the run-up to the 2008 financial crisis, banks depended increasingly on an unreliable method of funding their activities, called “repurchase agreements,” or repos. Repos may look like relatively safe borrowing agreements, but they can quickly create widespread instability in the financial system. The dangers of repos stem from a legal fiction: despite being the functional equivalent of secured loans, repo agreements are legally defined as sales. Dressing up repo loans as sales can lead to sloppy lending practices, followed by sudden decisions by lenders to end their risky lending agreements and market panics. Repos also permit financial institutions to cover up shortcomings on their balance sheets. The problems in the repo market were exposed as the 2008 financial crisis unfolded, yet the risks posed by repos remain largely unaddressed. Without reform, the financial system will remain susceptible to the sudden and severe shocks that repos can cause. Micah Hauptman and Taylor Lincoln have also written a blog post that runs down some of the basics. In their report, Public Citizen uses data from the Financial Stability Oversight Council… Read More

There is no shortage of viable economic solutions for the eurozone.  But as Martin Wolf points out in his FT column, once you strike all of the solutions that have been declared politically unacceptable (eurobonds, a stronger EU-level fiscal authority), there aren’t too many policy levers left to pull.  One possibility Wolf mentions is to encourage faster adjustment within the eurozone by allowing higher inflation in the core (Germany) than in the periphery—but Germany is unlikely to accept that either. Instead, we’re left with trying to achieve adjustment through internal devaluation (declining wages in the periphery).  How’s that going?  C. J. Polychroniou checks in on the progress in his latest one-pager: The “internal devaluation” policy pursued by Germany, the European Central Bank, and the European Commission can be summed up in a few words: great pain, no gain. The irony of this seems not to have escaped the attention of the Brussels bureaucrats: the Commission’s spring economic forecast, released just a few days ago, observes that “wages in the business sector have been falling in recent quarters but at a pace that was insufficient to help recover competitiveness.” Still, the report injects a note of optimism by stating that “the recent labour market measures are expected to contribute to further significant reductions in labour costs over the next two years.”… Read More

Yanis Varoufakis and Stuart Holland have updated their “Modest Proposal” for overcoming the eurozone crisis (they call it version 3.0).  They took on the challenge of coming up with proposals for addressing the eurozone’s tripartite crisis (sovereign debt, banking, and underinvestment) in a way that avoids any treaty changes or the creation of new EU institutions.  So although turning the eurozone into a “United States of Europe,” with an empowered federal (which is to say EU)-level fiscal authority and a central bank willing and ready to act as a buyer of last resort for government debt might be an ideal solution, there are serious institutional and political obstacles that stand in the way. These are the three constraints Varoufakis and Holland accepted as fixed elements of the EU’s policymaking landscape: (a) The ECB will not be allowed to monetise sovereigns directly (i.e. no ECB guarantees of debt issues by member-states, no ECB purchases of government bonds in the primary market, no ECB leveraging of the EFSF-ESM in order to buy sovereign debt either from the primary or the secondary markets) (b) Surplus countries will not consent to the issue of jointly and severally guaranteed Eurobonds, and deficit countries will not consent to the loss of sovereignty that will be demanded on them without a properly functioning Federal Europe (c) Crisis… Read More

In an interview with Helen Artopoulou that was posted on Capital.gr, Levy Institute president Dimitri Papadimitriou discusses the failure of the austerity policies imposed on Greece and the uncertain future of the euro project. Q. The political impasse in Greece, largely the outcome of the recent elections, had led to some reconsideration of the austerity policy measures being currently implemented in the indebted countries of the Eurozone. In fact, it seems that a number of public officials have shifted their position, calling now for a growth-oriented economic policy. Given the reality of Greece, how easy is to stir economic growth, and why didn’t the EU follow the growth path to economic recovery in the first place but relied instead on fiscal consolidation and draconian austerity measures? Economic growth is dependent on public policy aiming at deploying the resources available, that is, labor and capital. Presently, in Greece, there is an abundance of labor, but no capital from either the private or public sectors. It will be some time before the economy becomes friendlier to private investment, markets offering increasing liquidity, and for the private sector to gain confidence in the country’s economic stability. The time horizon for these things to happen will be long so, the responsibility falls on the public sector to do the investing in the key sectors of… Read More

Mark Thoma has posted the English transcripts of a three–part interview of James Galbraith by the German website NachDenkSeiten. In the first interview there is a brief exchange with Roger Strassburg in which Galbraith discusses the idea that the 1986 tax reforms, which followed the “lower the rates, broaden the base” mantra that we’re still hearing from lawmakers, may have contributed to dramatic increases in executive salaries: JG: In the U.S. In the 1980’s, the progressive reform which was developed by Bill Bradley and Dick Gephardt in Congress was to reduce the top tax rates by extending the base, because the system of very high marginal rates was so riddled with loopholes and exemptions that top earners by and large didn’t pay it unless they were of a very peculiar type, for example a celebrity athlete like Bill Bradley himself or Jack Kemp, who was also in the Congress at the time. They paid very high rates on that sort of straight salary income that they had. But if you were in any kind of business activity, you had a depletion allowance or timber allowance or some other damn thing that got you out of that. RS: That seems to kind of be the way that things always run, though, that wages and salaries end up getting taxed higher than… Read More

Congressman Ron Paul held a subcommittee hearing on reform of the Federal Reserve system a couple days ago that featured testimony from Senior Scholar James Galbraith, Alice Rivlin, John Taylor, Jeffrey Herbener, and Peter Klein.  There were a wide variety of topics addressed, including the size of the Fed’s balance sheet, proposals to make the Fed an arm of the Treasury, and changes to FOMC governance. Also raised was the question of whether to (formally) drop the employment side of the Fed’s dual mandate (because with unemployment at the dangerously low level of 8 percent and inflation sky high around 2 percent, clearly we’d be better off if the Fed were more like the ECB …).  As Galbraith recounts, he himself was part of the team that drafted the Humphrey-Hawkins Act (“at a time of acute theoretical conflict in economics,” he points out), and he offers his defense of the dual mandate here: As for the decided and observable tilt toward the price stability arm of the dual mandate, Galbraith collaborated on a working paper a few years back that identified the “real reaction function” of the Fed:  an aversion to full employment (“after 1983 the Federal Reserve largely ceased reacting to inflation or high unemployment, but continued to react when unemployment fell ‘too low.’”).  Although the working paper only… Read More

The recent Greek elections, which did not produce a party (or a viable coalition) with a majority in Parliament, have occasioned  a lot of excited speculation about Greece either leaving the eurozone or being nudged out.  Dimitri Papadimitriou comments today in a CNN Money piece about this possibility and offers a slightly more sober assessment, suggesting there are signs that European leaders may give Greece more leeway.  Read it here.

“In late 2007,” writes Peter Orszag, “the midpoint of the range that the Fed projected for real gross-domestic-product growth in 2008 was more than 2 percent.”  Most analysts were still expecting the fallout from the subprime crisis to be largely contained because, as Orszag puts it, their models “had at best a very rudimentary financial sector built into them.”  What would it have looked like to have taken finance more seriously?  In late 2007, Jan Kregel wrote the following in a Levy working paper: The stage is set for a typical Minsky debt deflation in which position has to be sold to make position—that is, the underlying assets have to be sold in order to repay investors. This will take place in illiquid markets, which means that price declines and, thus, the negative impact on present value will be even more rapid. In this environment, declining short-term interest rates can have little impact. . . . The damage from a debt deflation will be widespread—borrowers who lose their homes, hedge funds that fail, pensions that are reduced—so the net overall impact will be across a number of different sectors. However, in difference to what Alan Greenspan argued in defense of financial engineering to produce more complete markets—that it provided for a better distribution of risk across those who are willing… Read More