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Policy Notes No.7
28 May 2009
“Enforced Indebtedness” and Capital Adequacy Requirements
AbstractThe capital adequacy requirements for banks, enshrined in international banking regulations, are based on a fallacy of composition—namely, the notion that an individual firm can choose the structure of its financial liabilities without affecting the financial liabilities of other firms. In practice, says author Jan Toporowski, capital adequacy regulations for banks are a way of forcing nonfinancial companies into debt. “Enforced indebtedness” then reduces the quality of credit in the economy. In an international context, the present system of capital adequacy regulation reinforces this indebtedness. Proposals for “dynamic provisioning” to increase capital requirements during an economic boom would simply accelerate the boom’s collapse. Contingent commitments to lend to governments in the event of private-sector lending withdrawals, alongside lending to foreign private-sector borrowers, are a much more viable alternative.
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Working Paper No.566
20 May 2009
Caste and Wealth Inequality in India
AbstractIn this paper, we conduct the novel exercise of analyzing the relationship between overall wealth inequality and caste divisions in India using nationally representative surveys on household wealth conducted during 1991–92 and 2002–03. According to our findings, the groups in India that are generally considered disadvantaged (known as Scheduled Castes or Scheduled Tribes) have, as one would expect, substantially lower wealth than the “forward” caste groups, while the Other Backward Classes and non-Hindus occupy positions in the middle. Using the ANOGI decomposition technique, we estimate that between-caste inequality accounted for about 13 percent of overall wealth inequality in 2002–03, in part due to the considerable heterogeneity within the broadly defined caste groups. The stratification parameters indicate that the forward caste Hindus overlap little with the other caste groups, while the latter have significantly higher degrees of overlap with one another and with the overall population. Using this method, we are also able to comment on the emergence and strengthening of a “creamy layer,” or relatively well-off group, among the disadvantaged castes, especially the Scheduled Tribes.
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Working Paper No.564
14 May 2009
New Consensus Macroeconomics: A Critical Appraisal
AbstractThis paper is concerned with the New Consensus Macroeconomics (NCM) in the case of an open economy. It outlines and explains briefly the main elements of and way of thinking about the macroeconomy from the standpoint of both its theoretical and its policy dimensions. There are a few problems with this particular theoretical framework. We focus here on two important aspects closely related to NCM: the absence of banks and monetary aggregates from this theoretical framework, and the way the notion of the “equilibrium real rate of interest” is utilized by the same framework. The analysis is critical of NCM from a Keynesian perspective.
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Working Paper No.563
13 May 2009
Whither New Consensus Macroeconomics?
AbstractIn the face of the dramatic economic events of recent months and the inability of academics and policymakers to prevent them, the New Consensus Macroeconomics (NCM) model has been the subject of several criticisms. This paper considers one of the main criticisms lodged against the NCM model, namely, the absence of any essential role for the government and fiscal policy. Given the size of the public sector and the increasing role of fiscal policy in modern economies, this simplifying assumption of the NCM model is difficult to defend. This paper maintains that conventional arguments used to support this controversial assumption—including historical reasons, theoretical propositions, and practical issues—do not have solid foundations. There is, in fact, nothing inherently monetary in the stabilization policies found in the model. Thus, fiscal policy could play a role at least as important as monetary policy in the NCM model.
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Policy Notes No.6
11 May 2009
The “Unintended Consequences” Game
AbstractA simple consideration of history tells us that each new piece of legislation contains loopholes that benefit a new class of entrepreneurs; some of these loopholes are small, but others are such that one could drive a bullion-laden truck through them. In this new Policy Note, Martin Shubik suggests creating a “war gaming group” to stress-test all major new legislation, with a first prize of $1 million to be awarded to the competing lawyer or team of lawyers who finds the most egregious loophole—a small amount relative to the potential savings.
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Working Paper No.562
08 May 2009
The Current Economic and Financial Crisis
AbstractWidespread economic recessions and protracted financial crises have been documented as setting back gender equality and other development goals in the past. In the midst of the current global crisis—often referred to as “the Great Recession”—there is grave concern that progress made in poverty reduction and women’s equality will be reversed. Indeed, for many developing countries it is particularly worrisome that, through no fault of their own, the global economic downturn has exacerbated effects from other crises manifest in food insecurity, poverty, and increasing inequality. This paper explores both well-known and less discussed paths of transmission through which crises affect women’s world of work and overall wellbeing. As demand for textile and agricultural exports decline, along with tourism, job losses are expected to rise in these female-intensive industries. In addition, the gendered nature of the world of work suggests that women will see an increase in their share among informal and vulnerable workers worldwide, and will also supply more of their labor under unpaid conditions. The latter is particularly important in the context of developing countries, where many production activities take place outside the strict boundaries of the market. The paper also makes this point: examined through the prism of gender equality, the ability of the state to implement countercyclical policies matters greatly. If policy responses at the national and international levels end up aggravating inequities, gender equality processes face many more barriers, especially among the poor.
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Working Paper No.561
06 May 2009
The Return of the State: The New Investment Paradigm
AbstractTo save America—indeed, the global economy as a whole—the private/public sector balance has to shift, and the neoliberal economic model on which the country has been based for the past 25 years has to be modified. In this new working paper, Marshall Auerback details why the role of the state needs to be reemphasized.
The abandonment of a mixed economy and corresponding diminution of the role of government was hailed as the “rebirth of individualism,” yet it caused rising inequality and the decline of median wages, and led to the widespread neglect of public goods vital to its citizens’ welfare. Meanwhile, the country ran through the public investment it had made from the 1930s to the 1970s, with few serious challenges from policymakers or mainstream economists.
The neoliberal model was also aggressively exported: the “optimal” growth strategy for all emerging economies was supposedly one that emphasized limited government, corporate governance, rule of law, and higher levels of state-owned and -influenced enterprise—in spite of significant historical evidence to the contrary. Not even the economic wreckage in Mexico, Argentina, Thailand, Indonesia, and Russia seemed sufficient to challenge, let alone overturn, the prevailing paradigm.
That is, until now: in reaction to the financial crisis, many governments—led by the United States—are enacting massive economic stimulus packages and taking a central role in promoting economic growth strategies. This reemergence of state-driven capitalism constitutes a “back to the future” investment paradigm, one that is consistent with a long and successful pattern of economic development. But once we get beyond the pothole patching and school repairing, what industries can be pushed forward using public seed capital or through Sematech-like consortiums? What must be brought to the fore is the need for a new growth path for the United States, one in which the state has a significant role. There are already indications that the private sector is beginning to adapt to this new, collaborative paradigm.
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Policy Notes No.5
09 April 2009
A Proposal for a Federal Employment Reserve Authority
AbstractThere is already considerable talk about the possible need for a massive public works program in response to the deepening recession and rising unemployment; however, an ad hoc emergency approach is going to waste billions of dollars by mismatching skills and needs. In this new Policy Note, Martin Shubik of Yale University outlines a proposal aimed directly at providing good planning consistent with maintaining market freedom and minimizing pork-barrel legislation. Rather than an emergency relief program on the order of the New Deal Works Progress Administration, Shubik proposes a permanent agency modeled on the Federal Reserve that would monitor unemployment in each state and maintain a list of potential public works projects. Financing for any project could then be set in place as soon as the unemployment level in any state exceeded the trigger value, eliminating the need for relief legislation during a crisis.
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Strategic Analysis
09 April 2009
Recent Rise in Federal Government and Federal Reserve Liabilities: Antidote to a Speculative Hangover
AbstractFederal government and Federal Reserve (Fed) liabilities rose sharply in 2008. Who holds these new liabilities, and what effects will they have on the economy? Some economists and politicians warn of impending inflation. In this new Strategic Analysis, the Levy Institute’s Macro-Modeling Team focuses on one positive effect—a badly needed improvement of private sector balance sheets—and suggest some of the reasons why it is unlikely that the surge in Fed and federal government liabilities will cause excessive inflation.
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Research Project Report
09 April 2009
New Estimates of Economic Inequality in America, 1959—2004
AbstractIn this latest LIMEW report, the authors present new evidence on the pattern of economic inequality in the United States that indicates higher inequality in 2004 than in 1959. According to the LIMEW, there was a surge in inequality between 1989 and 2000 that reflects the large increase in income from wealth for the top rungs of the economic ladder; the principal factor behind the official measures was base income (consisting mainly of labor income). The authors’ findings suggest a rather bleak picture for the lower and middle classes in terms of sharing the economic pie.
Download LIMEW Report, April 2009 PDF (434.52 KB) -
Policy Notes No.4
08 April 2009
A Crisis in Coordination and Competence
AbstractThe ad hoc emergency approach to the current economic crisis has a great chance of wasting billions of dollars by mismatching skills and needs. According to Martin Shubik of Yale University, the current deepening recession needs a “quick fix” solution now, but a longer-fix solution must be put into place along with it.
There is already considerable talk about the possible need for a large public works program to follow the massive infusion of funds into the financial and automobile sectors. But who is going to manage it? For us to weather this great economic storm we need to line up and coordinate (at least) four sets of highly different talents—political, bureaucratic, financial, and industrial. Without their coordination, economic recommendations, no matter how good they may appear to be in theory, will fail in execution.
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Public Policy Brief No.100
08 April 2009
It’s That “Vision” Thing: Why the Bailouts Aren’t Working, and Why a New Financial System Is Needed
AbstractThe Federal Reserve’s response to the current financial crisis has been praised because it introduced a zero interest rate policy more rapidly than the Bank of Japan (during the Japanese crisis of the 1990s) and embraced massive “quantitative easing.” However, despite vast capital injections, the banking system is not lending in support of the private sector.
Senior Scholar Jan Kregel compares the current situation with the Great Depression, and finds an absence of New Deal measures and institutions in the current rescue packages. The lessons of the Great Depression suggest that any successful policy requires fundamental structural reform, an understanding of how the financial system failed, and the introduction of a new financial structure (in a short space of time) that is designed to correct these failures. The current crisis could have been avoided if increased household consumption had been financed through wage increases, says Kregel, and if financial institutions had used their earnings to augment bank capital rather than bonuses.
Download Public Policy Brief No. 100, 2009 PDF (202.39 KB) -
Working Paper No.560
06 April 2009
The Social and Economic Importance of Full Employment
AbstractUnemployment was singled out by John Maynard Keynes as one of the principle faults of capitalism; the other is excessive inequality. Obviously, there is some link between these two faults: since most people living in capitalist economies must work for wages as a major source of their incomes, the inability to obtain a job means a lower income. If jobs can be provided to the unemployed, inequality and poverty will be reduced—although such policy will not directly address the problem of excessive income at the top of the distribution. Most importantly, Keynes wanted to put unemployed labor to work—not digging holes, but in socially productive ways. This would help to ensure that the additional effective demand created by government spending would not be exhausted in higher prices as it ran up against bottlenecks or other supply constraints. Further, it would help maintain public support for the government’s programs by providing useful output. And it would generate respect for, and feelings of self-worth in, the workers employed in these projects (no worker would want to spend her days digging holes that serve no useful purpose). President Roosevelt’s New Deal jobs programs (such as the Works Progress Administration and the Civilian Conservation Corps) are good examples of such targeted job-creating programs. These provided income and employment for workers, actually helped increase the nation’s productivity, and left us with public buildings, dams, trails, and even music that we still enjoy today. As our nation (and the world) collapses into deep recession, or even depression, it is worthwhile to examine Hyman P. Minsky’s comprehensive approach to resolving the unemployment problem.
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Working Paper No.559
02 April 2009
Labor-market Performance in the OECD
AbstractIn this paper we assess the evolution of labor-market performance in the Organisation for Economic Co-operation and Development (OECD) over the last decade. We provide a survey of the literature dealing with labor-market performance in the OECD, finding that, while this literature tends to conclude that institutions are a key part of the story, the survey’s results appear far less robust and uniform than is commonly believed. We then assess the robustness of the claims made in the most recent (2005) OECD follow-up study within a very similar cross-country setup, and highlight the impact of unobserved heterogeneity and outliers on the policy estimates. We find that in recent OECD cross-country data, changes in labor-market performance are consistently (and inversely) linked to its lagged level. Structural changes are also important: changes in the share of construction employees are very significant, even in the presence of various kinds of policy change indicators. As far as the latter are concerned, some consistent role seems to emerge only for active labor-market policies and (to a lesser extent) unemployment benefit reforms.
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Strategic Analysis
02 April 2009
A “People First” Strategy: Credit Cannot Flow When There Are No Creditworthy Borrowers or Profitable Projects
AbstractIn 1930, John Maynard Keynes wrote: “The world has been slow to realise that we are living this year in the shadow of one of the greatest economic catastrophes of modern history.” The same holds true today: we are in the shadow of a global catastrophe, and we need to come to grips with the crisis—fast. According to Senior Scholar James K. Galbraith, two ingrained habits are leading to our failure to do so. The first is the assumption that economies will eventually return to normal on their own—an overly hopeful view that doesn’t take into account the massive pay-down of household debt resulting from the collapse of the banks. The second bad habit is the belief that recovery runs through the banks rather than around them. But credit cannot flow when there are no creditworthy borrowers or profitable projects; banks have failed, and the failure to recognize this is a recipe for wild speculation and control fraud, compounding taxpayer losses.
Galbraith outlines a number of measures that are needed now, including realistic economic forecasts, more honest bank auditing, effective financial regulation, measures to forestall evictions and keep people in their homes, and increased public retirement benefits. We are not in a temporary economic lull, an ordinary recession, from which we will emerge to return to business as usual, says Galbraith. Rather, we are at the beginning of a long, painful, profound, and irreversible process of change—we need to start thinking and acting accordingly.
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Working Paper No.558
01 April 2009
Managing the Impact of Volatility in International Capital Markets in an Uncertain World
AbstractInternational financial flows are the propagation mechanism for transmitting financial instability across borders; they are also the source of unsustainable external debt. Managing volatility thus requires institutions that promote domestic financial stability, ensure that domestic instability is contained, and guarantee that international institutions and rules of the game are not themselves a cause of volatility. This paper analyzes proposals to increase stability in domestic markets, in international markets, and in the structure of the international financial system from the point of view of Hyman P. Minsky’s financial instability hypothesis, and outlines how each of these three channels can produce financial fragility that lays the system open to financial instability and financial crisis.
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Policy Notes No.3
27 March 2009
An Assessment of the Credit Crisis Solutions
AbstractAll of the various schemes that have been put forward to resolve the current credit crisis follow either the “business as usual” or the “good bank” model. The “business as usual” model takes different forms—insurance or guarantee of the assets or liabilities of the financial institutions, creation of a “bad bank” to buy toxic assets, temporary nationalization—and is the one favored by banks and pursued by government. It amounts to a bailout of the financial system using taxpayer money. Its drawback is that the cost may exceed by trillions the original estimate of $700 billion, and despite the mounting cost, it may not even prevent the bankruptcy of financial institutions. Moreover, it runs the risk of government insolvency, and turning an already severe recession into a depression worse than that in the 1930s.
The “good bank” solution consists of creating a new banking system from the ashes of the old one by removing the healthy assets and liabilities from the balance sheet of the old banks. It has a relatively small cost and the major advantage that credit flows will resume. Its drawback is that it lets the old banks sink or swim. But if they sink, with huge losses, these might spill over into the personal sector, and the ultimate cost may be the same as in the business-as-usual model: a catastrophic depression.
In this new Policy Note, author Elias Karakitsos of Guildhall Asset Management and the Centre for Economic and Public Policy, University of Cambridge, outlines a modified “good bank” approach, with the government either guaranteeing a large proportion of the personal sector’s assets or assuming the first loss in case the old banks fail. It has the same advantages as the original good-bank model, but it makes sure that, in the eventuality that the old banks become insolvent, the economy is shielded from falling into depression, and recovery is ultimately ensured.
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Policy Notes No.2
25 March 2009
What Role for Central Banks in View of the Current Crisis?
AbstractCentral banks have an aversion to bailing out speculators when asset bubbles burst, but ultimately, as custodians of the financial system, they have to do exactly that. Their actions are justified by the goal of protecting the economy from the bursting of bubbles; while their intention may be different, the result is the same: speculators, careless investors, and banks are bailed out.
The authors of this new Policy Note say that a far better approach is for central banks to widen their scope and target the net wealth of the personal sector. Using interest rates in both the upswing and the downswing of a (business) cycle would avoid moral hazard. A net wealth target would not impede the free functioning of the financial system, as it deals with the economic consequences of the rise and fall of asset prices rather than with asset prices (equities or houses) per se. It would also help to control liquidity and avoid future crises. The current crisis has its roots in the excessive liquidity that, beginning in the mid 1990s, financed a series of asset bubbles. This liquidity was the outcome of “bad” financial engineering that spilled over to other banks and to the personal sector through securitization, in conjunction with overly accommodating monetary policy. Hence, targeting net wealth would also help control liquidity, the authors say, without interfering with the financial engineering of banks.
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Working Paper No.557
19 March 2009
Background Considerations to a Regulation of the US Financial System
AbstractUnited States financial regulation has traditionally made functional and institutional regulation roughly equivalent. However, the gradual shift away from Glass-Steagall and the introduction of the Financial Modernization Act (FMA) generated a disorderly mix of functions and products across institutions, creating regulatory gaps that contributed to the recent crisis. An analysis of this history suggests that a return to regulation by function or product would strengthen regulation. The FMA also made a choice in favor of financial holding companies over universal banks, but without recognizing that both types of structure require specific regulatory regimes. The paper reviews the specific regime that has been used by Germany in regulating its universal banks and suggests that a similar regime adapted to holding companies should be developed.
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Public Policy Brief No.99
09 March 2009
The Return of Big Government: Policy Advice for President Obama
AbstractIn the current global financial crisis, economists and policymakers have reembraced Big Government as a means of preventing the reoccurrence of a debt-deflation depression. The danger, however, is that policy may not downsize finance and replace money manager capitalism. According to Senior Scholar L. Randall Wray, we need a permanently larger fiscal presence, with more public services. His advice to President Obama is to discard all of former Treasury Secretary Paulson’s actions. Wray believes that we can afford any necessary spending and bailouts, and that these actions will not burden our grandchildren.
Download Public Policy Brief No. 99, 2009 PDF (169.17 KB) -
Public Policy Brief No.98
19 February 2009
The Case Against Intergenerational Accounting: The Accounting Campaign Against Social Security and Medicare
AbstractThe Federal Accounting Standards Advisory Board (FASAB) has proposed subjecting the entire federal budget to “intergenerational accounting”—which purports to calculate the debt burden our generation will leave for future generations—and is soliciting comments on the recommendations of its two “exposure drafts.” The authors of this brief find that intergenerational accounting is a deeply flawed and unsound concept that should play no role in federal government budgeting, and that arguments based on this concept do not support a case for cutting Social Security or Medicare.
The FASAB exposure drafts have not made a persuasive argument about basic matters of accounting, say the authors. Federal budget accounting should not follow the same procedures adopted by households or business firms because the government operates in the public interest, with the power to tax and issue money. There is no evidence, nor any economic theory, behind the proposition that government spending needs to match receipts. Social Security and Medicare spending need not be politically constrained by tax receipts—there cannot be any “underfunding.” What matters is the overall fiscal stance of the government, not the stance attributed to one part of the budget.
Download Public Policy Brief No. 98, 2009 PDF (144.51 KB) -
Research Project Report
19 February 2009
What Are the Long-Term Trends in Intergroup Economic Disparities?
AbstractOver the last half century, government policy has had an important hand in alleviating disparities among population subgroups in the United States; for example, special tax treatment for families with children has meant an improvement in the well-being of single mothers, and Medicare and Social Security have been the driving force in improving well-being among the elderly. Thus, the measure of economic well-being used is critical in assessing changes in disparities between groups.
The Levy Institute Measure of Economic Well-Being (LIMEW) is a comprehensive measure that not only includes estimates of public consumption and household production but also factors in the long-run benefits of wealth ownership. In this report, the authors examine long-term trends in economic well-being in the United States between 1959 and 2004 within various population subgroups based on the following household characteristics: race/ethnicity, age, education, and marital status. With the exception of income from wealth, they find that the gap between nonwhite and white households narrowed between 1959 and 2004, and public consumption increasingly favored nonwhites. Relative well-being for those 65 and older improved significantly, and was 9 percent higher than the average nonelderly household in 2000 (a finding at odds with official measures of economic well-being). In contrast, the under-35 age group experienced a sizable deterioration in relative well-being, as did less educated groups relative to college graduates. The gap between families with a single, female head of household and families with a married head of household also widened further over time.
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Research Project Report
03 February 2009
Postwar Trends in Economic Well-Being in the United States,1959–2004
AbstractThe Levy Institute Measure of Economic Well-Being (LIMEW) is a more comprehensive measure than either gross money income or extended income because it includes estimates of public consumption and household production, as well as the long-run benefits from the ownership of wealth. As a result, it provides a picture of economic well-being in the United States that is very different from the official measures.
The authors find that median household well-being grew rather sluggishly over the 1959–2004 period compared to the annual growth rate of per capita GDP. They note the crucial role of net government expenditures, and therefore call for the Obama administration’s fiscal stimulus package to improve the broader economic well-being of the poor and the middle class, while also creating jobs.
Download LIMEW Report, February 2009 PDF (639.69 KB) -
Working Paper No.556
29 January 2009
Long-Term Trends in the Levy Institute Measure of Economic Well-Being (LIMEW), United States, 1959–2004
AbstractThe motivation to construct the LIMEW in lieu of relying on the official measures of well-being is to provide a more comprehensive measure of economic inequality that will also show the disparities among key demographic groups. The authors of this new working paper show that the LIMEW provides a perspective on disparities among population subgroups that differs from the official measures, as well as differing time trends. For example, according to the LIMEW, there has been an almost continuous improvement in the relative well-being of the elderly, which were 9 percent better off than the nonelderly in 2000 because of greater income from wealth. Moreover, the principle factor behind the increase in inequality over the 1959–2004 period was the rising contribution of income derived from nonhome wealth.
Download Working Paper No. 556 PDF (705.76 KB)