Sep 18

Romney Thinks Half of Americans Are Lazy (In his own words!)

Mother Jones has released what is apparently leaked video from a Romney fundraiser.  It’s quite revealing that he claims about half of the country is lazy and dependent on government.  See for yourself…

Sep 15

The Fed’s Action and IS-LM

Since I have done a couple posts explaining the IS-LM macroeconomic model and a post on quantitative easing, this will be a quick post discussing this week’s Federal Reserve actions in light of the IS-LM model.  If you need a refresher on IS-LM or how bonds and the Fed work, check out these:

IS-LM Part 1

IS-LM Part 2

Bond and Quantitative Easing Overview

What the Fed has done this week is announce that it will buy $40 million worth of mortgage securities per month until unemployment significantly improves.  A mortgage security is similar to a bond in that if you own it you receive a regular fixed payment.  With a mortgage security, many individual mortgage loans are lumped together and sold by banks, so all the interest that was originally to go to the bank now goes to investors who buy them.  Mortgage securities are also called mortgage bonds.

So what happens when the Fed buys a lot of mortgage bonds?  The price of the bonds increases since demand for them has increased.  Since the interest rate payment is fixed an increased price means a lower yield.  So if a mortgage bond was originally worth $100 and paid 5% interest, the interest payment would be $5.  But if the price increases to $120, then the return on the investment is still $5, giving a lower yield of 4.17%.  Since this is happening on a large scale, the lower yields on mortgage bonds will lead to lower interest rates on mortgages.  Ideally, that will make it easier for home buyers to afford a loan and stimulate the housing market. (As an aside, Slate has a great article from 2008 describing how mortgage securities related to the larger financial crisis.)

Additionally, by buying these bonds, the Fed is injecting large amount of cash into the economy.  Investors who held bonds now have more money they can invest in the economy.  What effect does the IS-LM model predict this will have?   First, that the increased money supply will decrease interest rates.  Since the Fed has been keeping interest rates close to zero anyway, there’s little effect this can have in today’s economy.

MS =Money Supply  MD = Money Demand

The impact of increased money supply will only have benefit if it can increase GDP.  In this case, it can potentially increase GDP by lowering barriers to home buyers by lowering mortgage rates.  However, it can only do so to the degree that there is sufficient demand for housing.  This is a debatable point, but let’s assume that there is sufficient demand and the housing market will improve, increasing GDP.  This means there be an increase in investment in the goods market (the IS curve).  Investment will increase, shifting the IS curve to the right. For reasons explained in part 2 of my IS-LM overview, the LM curve is currently flat since interest rates are basically 0%.  I’ve added to the chart from Paul Krugman’s blog to show what this would look like.

Note the new equilibrium point between the goods and financial markets is at a higher GDP and higher interest rate.  Unfortunately, no one really expects investment to increase beyond the point where the LM curve is flat.  One reason is that since interest rates are already very low, the Fed can’t make it much easier for people to borrow money, which is it’s usual tool for stimulus.  Second, demand for goods and services has to increase to really get GDP going.  Lowering the costs of a mortgage certainly helps, but it does so at the margins, not really affecting aggregate demand in any significant measure.  If Obama wins the election, one can imagine some type of new fiscal stimulus which would have a much greater impact on demand.  As one indicator, consumer confidence is still well below pre-2008 levels.  Consumer confidence is a measurement of how optimistic consumers are about the state of the economy.  So the broad lesson is that the economy could still really use a stimulus from the government.


Sep 14

Focusing on Free Speech in Muslim World Misses the Point

With much of the Islamic world protesting what is rightly seen as an anti-Islamic movie, a lot of attention has been given to a perceived cultural divide between the West and Islam, a view which sees Muslims as not understanding what freedom of speech really means.  This may or may not have merit, but before the recent protests there was already a great deal of resentment towards the US and the West that needed only a small spark to ignite.  It seems much more appropriate to focus on this resentment than murky issues about free speech.  It does not excuse the violence of extremists or say that the protesters are factually correct, but it is important to address the underlying issues.

A 2011 Gallup poll of majority Muslim countries found a correlation (.669) between “Approval of the Leadership of the US’ and “how positively countries view Muslim-West relations.”  Gallup used what they call the Muslim-West Perceptions Index (MWPI), in which a higher index indicated a more positive view of the relations with the West.  Despite the “clash of civilization” theory, religion is actually not a major factor in how Muslims perceive relations with the West. As the poll report states,

“In general, those in majority-Muslim countries who say religion is important rank
higher on the MWPI than those in majority-Muslim countries who say religion is
not important. In the West, this is reversed, with people who see religion as important
occupying a lower position on the MWPI, and people who do not see religion as
important occupying a higher position.”

So if US leadership is a key factor about Muslim views of the West, what are their concerns?  In 2010 the Brookings Institute did a poll  in Egypt, Jordan, Lebanon, Morocco, Saudi Arabia, and the United Arab Emirates (the 2011 version is not functioning on their site or at least not on my computer so 2010 will have to do). When asked “What two steps by the United States would improve your views of the United States the most?” the the answers were as follows:

Israel-Palestine peace agreement: 54%

Withdrawal from Iraq: 45%

Stopping Aid to Israel: 43%

Withdrawal from the Arabian Peninsula: 35%

“Protecting Israel” and “Controlling Oil” were the top two reasons given as what was “driving American policy in the Middle East” at 49% and 45%, respectively.  Tied for third at 33% were “Weakening the Muslim World” and “Preserving Regional and Global Dominance.”  By enormous margins, Israel and the United States are viewed as the “biggest threats to you” at 88% and 77%.

Surely Islamic extremism takes advantage of the concerns of the Muslim public, just as white supremacists take advantage of white poverty in the US.  I should add that there are no doubt grievances internal to many Muslim countries, especially since the Arab Spring has altered the political context of the Middle East.  However, we in the US should address our share of their grievances, since they are very real.   It is not enough to address Islamic extremism, just as arresting violent white supremacists does not get rid of the ideology.  Police and/or military action can be necessary in both cases, but we must also address the underlying problems.

I can hardly due justice to those grievances here, except to mention a few points.  It is unrealistic to expect the Muslim world to not have a negative view of the US when it arms Israel to the teeth and will not push for any kind of settlement freeze.  How can the US possibly be seen as an honest broker when it is arming one side?  Let’s also consider recent history.   The US invaded Iraq and Afghanistan and with Israel has threatened Iran, which is right between the two countries.  Put aside any arguments about whether those wars were justified and just look at it from the point view of the average Arab.  Can we really expect them to not be angry at the US?  Are they supposed to welcome the military ventures of the most powerful military in the world and its number one recipient of military aid?  However grotesquely these observations can be distorted by Islamic radicals, I don’t think it is hard to understand why the Arab world harbors resentment towards the US and the broader West.  We are missing the crux of the issue (as are the Muslim protesters for that matter) if we only focus on issues of free speech.

See my previous post for data from the 2011 Brookings Institute poll.

Sep 10

Three Quick Counter-Examples to Free Market Fantasy

It is quite astounding how the role of government in the economy is vastly underrated.  This is especially true of many conservatives who cling to a free market fantasy, but it is often overlooked by liberals as well.  Here are a few snippets of the government role in the US economy:

These are only three examples, but they provide the infrastructure for today’s economy.  Government involvement in their creation was not just incidental, but absolutely fundamental.

Sep 09

Brief Thoughts on Obama’s Speech

To start with what Obama did well, he did make his policy preferences clear on many issues, even though he did not commit to many specific policies.  The exceptions are that Obama did state he wanted to raise taxes on those making more than $250,000 per year, create 1 million manufacturing jobs in four years, and hire 100,000 new teachers by 2020.   Otherwise, it was rather broad, expressing support for things such as addressing global warming, equality for gays, strengthening Social Security, and investing in renewable energy.  While it would be nice to hear more specific policy proposals on these issues, I can’t blame for not doing so.  After all, mainstream Republicans call global warming a hoax, oppose gay rights, want to privatize Social Security, and have never indicated any interest in renewable energy.

There were two specific parts of his speech, though, where I think Obama was sending signals that people wanted to hear, but were very unrealistic.  First, Obama’s goal of 1 million manufacturing jobs and doubling exports are nice hopes, but there are so many factors in play here that he can’t possibly commit to making that happen.  Massively expanding US exports won’t happen unless Europe gets its house in order and that could be a long way off, especially since Germany, the strongest Euro country, is starting to see some worries about future economic decline.  A huge export-led growth based on manufacturing would lead push wages up in this sector, making it hard to keep jobs in the US.  By talking this up Obama did present a good idea, but it was clearly not something he can promise to deliver if reelected.

The second part of his speech that was pure popular appeal was his providing a false sense of empowerment to those who voted for him.  He said the 2008 election was not about him, but about “you.”  He then went on to list policy accomplishments with each followed by “You did that.”  Really?  The population was responsible for the Affordable Care Act, stopping deportation of the children of illegal immigrants, ending the US war in Iraq?  It was one of those statements that is in some broad way true (they wouldn’t have happened if people had not voted for him), but overstates the case completely.  The population was responsible for these accomplishments in the same way they were responsible for Clinton surplus, since he was elected by them too.  This part of the speech presented a false image of Obama as a leader of a social movement, implying that we can be part of a great march of progress if we vote for him.  Obama clearly did have some good accomplishments and maybe there will be progress if he is reelected, but by saying “You did this,” he made people feel like participants when they were mostly spectators.

Sep 05

Obama Is Not The Answer

I was reminded recently of a great song by the punk band Bad Religion called “The Answer” and it reminded me of the fact that we shouldn’t think of Obama as the answer to our problems.  I encourage everyone to listen to the full lyrics, but my point is simply this.  While it is absolutely imperative to elect Obama over Romney and recognize that Republicans are hell-bent on class warfare, we should not think that Obama is some kind of savior.  I hear many people say that Obama does his best, but is limited by Republicans.  This is partially true, for sure, but if you look at his policies, Obama is basically a centrist Democrat.  Remember the Occupy movement?  Obama was able to say that he understood the movement’s frustration, but he certainly did not do or say anything once the evictions started.  Perhaps he would have lost credibility among the powers that be and have not been able to get anything else done.  But this is all the more reason that the US population needs to set a new threshold that allows for more radical changes.  Remember the slogan “Yes We Can!”?  It was clear then and it is clear now that meant we could vote for Obama and then he would do all these great things for the population.  But we should take his saying that “We are the ones we are waiting for” more seriously, re-elect him and continue to push for greater reforms in our society.  Reviving Occupy is one possibility.  Another possibility that I think offers the best long-term promise is the somewhat hidden, but growing movement of worker-owned cooperatives.  Visit the US Federation of Worker Cooperatives for more. As a leftist, I am not calling for radical revolution overnight, but for simply giving people more control of their daily productive lives.

Sep 04

Empowering Work for All

Since it’s Labor Day, I wanted to put out an idea that I have had for a long time, but honestly haven’t thought about in a while.  Why do we think it is ok to have an economy where finding a job often means doing menial work that is not under your own control?  Forget the low pay.  What if work could be something that helped you fulfill yourself?  Such fulfillment can come from something simple like mastering a craft, such as carpentry, bricklaying etc.

But the reality is that a huge portion of the jobs are offered by corporations that place the bottom line above all else (as they are required by law to do) and treat their employees more or less like replaceable parts.  Of course you can do a good job, become a manager and acquire more empowering work that way.  But why does empowering work have to be a scarce resource?

Michael Albert and Robin Hahnel have done excellent work on an idea called Participatory Economics, which includes the idea of a “balanced job complex.”  Think of each job as a list of tasks.  Under our present system, some people have jobs where the list of tasks is empowering (decision-making, creating, collaborating) and other jobs have lists of tasks that are disempowering (restocking shelves, sweeping, taking the trash out).  If you gave every task a rating based on empowerment, the average rating for some jobs would be much higher than others.  The idea of a balanced job complex is that everybody has roughly the same average rating.  So if I worked at a bookstore, sometimes I would be stocking shelves, but other times I could be leading a book discussion or deciding which books to order.  Or if I worked at a restaurant, sometimes I would be wiping grime from the floor and other times I would be trying out new recipes.

To me the case for balanced job complexes is such common sense that I have not heard an objection to it, on both pragmatic and moral grounds, that I don’t think can be overcome.

Sep 03

A Basic Macroeconomic Model Tutorial: IS-LM Part 2

This is part 2 of an overview of the IS-LM economic model and how we can use it to understand today’s economy.  Read part 1 here.

In my last post, I described the IS (Investment-Saving) part of the IS-LM model.  Remember that the IS-LM model demonstrates the relationship between the interest rate and GDP.  The main point to draw from that was that as the interest rate rises GDP declines, because companies are less inclined to borrow money for investment.  Now onto the LM side…

What is LM?

LM stands for Liquidity-Money.  This refers to the financial market, i.e. the demand for money.  More specifically, it refers to the bond market.  (See my post on the Fed for an overview of how bonds work.)  If the economy is not doing well, there will be low demand for money by businesses for investment.  They will use their excess money to  buy bonds so that their money can earn interest rather than be idle.   (Bonds are primarily held by the federal government, but there are municipal bonds and corporate bonds.  For our purposes, I will refer only to US government bonds).  This is where liquidity comes in.  Liquidity simply means that money can be spent for various purposes (the same way a liquid can move around easily).  So if the the economy is bad and money is stored in bonds, liquidity is low.  On the other hand, if the economy is doing really well, liquidity is high because there is a high demand for money, meaning a low demand for bonds.

As we did with the IS aspect of the model, we need to examine the role of the interest rate.  If the demand for money is high and everyone is selling bonds, the government will increase interest rates to give banks and businesses more incentive to store money in bonds.  (The Fed also does this to keep inflation low.)  Let’s lay this out in more detail as an events chain, bringing in GDP.  GDP can increase by a variety of forms, but let’s imagine the economy improves and businesses increase their level of investment:

investment increases –> GDP increases –> increased demand for money –> decreased demand for bonds –> increase in the interest rate

And of course the opposite is true (and more relevant for our current economy)

investment decreases –> GDP decreases –> decreased demand for money –> increased demand for bonds –> decrease in the interest rate

In this last example, why does the interest rate decrease?  Because more businesses are seeking to store their wealth in bonds, so  the government can decrease the amount it pays on those bonds.  Just as it has to offer a higher interest rate as an incentive if demand for bonds is low, it can reduce this incentive when the demand for bonds is high.

Absolutely Key Point: As GDP increases, so does the interest rate.  As GDP decreases, so does the interest rate.

But if we remember the IS part of the model,the interest rate and GDP are inversely proportional.   How do we reconcile this with the fact that in the financial market (LM) the interest rate and GDP are positively correlated?  Just like supply and demand, we need to find an equilibrium rate of interest and level of GDP.  In other words, we need to find both an interest rate and GDP level where the market for goods and services is in equilibrium with the market for money.

Let’s look at some visuals to spell this out more.  Leaving aside GDP for the moment, the chart below shows how the interest rate is determined by the interplay of the supply and demand for money.

In the short run, the money supply is considered to be fixed, hence it is a vertical line.  If demand for money is high, then the interest rate will be low and vice versa.  The letter “i” indicates the equilibrium interest rate in the financial market.  Let’s chart out one of the events chain from above:

investment increases –> GDP increases –> increased demand for money –> decreased demand for bonds –> increase in the interest rate

The economy is growing leading businesses to increased demand for money for investment.  This will cause the money demand curve to shift rightward.  The government will raises the interest rate to offer an incentive to hold bonds, leading to new interest rate i2.  Notice that i2 is the equilibrium rate balancing the supply and demand of money.

Now let’s take GDP into account to make our LM curve.  Remember that MD1 and MD2 correspond to two different GDP levels and two different interest rates.  At the intersections of i1 and GDP1 and i2 and GDP2 we have are two points to draw our LM curve.

Combining the IS and LM Curves

We saw previously that the interest rate and GDP are inversely proportional in the IS part of the model.  So let’s add that to our chart above on the right.  Note i(e) and GDP(e) are the equilibrium interest rate and equilibrium GDP level, balancing both the goods market and financial market.

How can we explain today’s economy?

Let’s start with the financial crisis in 2008.  It was obviously a very complicated affair that this model can only address at the simplest level.  But it gives a good overview of the basics.  I’m actually going to go past the immediate crisis to the subsequent decline in GDP that was most pronounced in 2009.  Here are some event chains with corresponding graphs that culminate in an IS-LM chart.

investment decreased  —> GDP decreased

For any given interest rate, the amount of money businesses were willing to invest dropped off significantly, leading to a GDP decrease.

This spilled over into the financial market…

GDP decreased –> demand for money decreased –> interest rate decreased

MS = money supply, which is fixed in the short run

Then the Federal Reserve lowered the interest rate close to zero.  This is where we have to keep in mind that there is more than one actual interest rate, but market forces keep them in the same ballpark.  In this case, the Fed reduced the rate it lent money to banks, to encourage banks to lend out more freely for investment.  This is essentially the IS side of things, i.e. reduce interest rates so it costs businesses less to invest.

At the same time, the interest rate on bonds decreased, because higher demand for bonds –> increased bond prices –> decreased yields.  In any case, the Fed wanted bond interest rates to be low to encourage businesses to spend money instead of storing it in bonds.

But the real crux, and what makes our current economic situation so unique, is that interest rates have been reduced to almost zero and the demand for money (to invest) is not increasing.  What this also means is that if the Fed were to increase the interest rate, investment would go down even more since the cost of borrowing would be higher andit would hardly increase the demand for bonds since that is where businesses are storing their money anyway.  Even if the demand for bonds did increase, the price of bonds would increase more, bringing the yields back down close to 0%.

So what this means is that the LM curve is flat at zero and will only rise (as normal) when GDP is higher.  But for the IS and LM curves to be in equilibrium at an interest rate above zero, the IS curve needs to shift far to the right.  This is demonstrated by a graph from Paul Krugman’s blog:

So what can get the IS curve to the right?  Increasing the money supply through buying of bonds (quantitative easing) will do very little, if anything, to shift IS right.  Investment will increase if businesses have more opportunities to make a good rate of return.  Such opportunities can be created by increasing consumer spending or government spending or decreasing taxes on both consumers and businesses.  Conservatives claim it’s taxes and excessive regulation that keep investment down, but are taxes or regulation significantly higher than before the crisis?  Of course not.  But if the government increases short-term spending to boost the economy, that will begin a cycle that will increase investment.

Perhaps an even more important lesson of this model is to think about what austerity measures do.  Let’s say conservatives get their way and government spending is cut to try to reduce the deficit.  The IS curve will shift to the left and, in all likelihood, the decline in tax revenues due to smaller GDP can increase the deficit. Worse yet, it will take that much more effort to shift the IS curve back to the right.

Government spending now will restart the economy and when the IS and LM curves intersect near full employment, the government can then reduce expenditures since the private sector will be willing to invest again.  It is intuitive to fear increasing the debt even more now, but as Paul Krugman points out in his recounting of the Washington D.C. babysitting co-op, if everyone saves at the same time the economy goes nowhere.

For those interested in learning more about the IS-LM model, check out Krugman’s blog post about it.  If you have the patience, there is an excellent  youtube tutorial series by a professor at the University of South Africa.

Sep 01

A Basic Macroeconomic Model Tutorial: IS-LM Part 1

I am going to present a standard macroeconomic model called IS-LM to give us some perspective on the current economic situation.  This post is part 1, which will cover the IS part of the model and over the next couple days I will post part 2 on the LM part and how the IS and LM interact.  (As a disclaimer, I should say that I first heard about IS-LM through Paul Krugman, but I honestly had a little trouble understanding his post on it, so I thought I’d write one for the lay audience now that I have studied it more.  But you can certainly check out Krugman’s explanation too.)

Before starting, you will need to understand how bonds work to understand the IS-LM model.  For a quick overview see my previous post on bonds and quantitative easing.

On to IS-LM!…

What is IS-LM?

IS-LM is a model that helps think about the economy as a whole and find out how the market for goods and services interacts with the money market (bonds essentially).  IS stands for Investment-Saving and LM for Liquidity-Money.  It should be stated at the start that like any model, this makes simplifying assumptions to get a basic grasp of what is going on in the economy and is not a magic tool that can scientifically calculate to the nth degree.  Nonetheless, it allows us to make some basic predictions and see if they are true.

What IS-LM shows is the approximate interest rate in the economy and the level of GDP.  Different interest rates will have different effects on the level of GDP.  Likewise, a change in GDP can change the interest rate.  If you are unsure what exactly I mean by “interest rate,” since I’m speaking rather generally, read on and you will see what it means.

IS (Investment-Saving)

The IS part of the model has to do with the market for goods and services, i.e. cars, doctor visits, IPods, and so on for everything in the economy.  Specifically, we want to look at it from a company’s point of view.    A company will only invest in a project if it can get a reasonable return on its investment.  So let’s take an imaginary company, Company X,  and four projects it is thinking of funding:

Project A: Company X expects to get a 10% return on its investment, i.e. for every $100 invested it will make a profit of $10.

Project B: 8% return expected

Project C: 6% return expected

Project D: 4% return expected

Company X then needs to borrow money from a bank or other lender to fund its project.  Once it makes a profit it can pay back the bank with some profit still intact.  As Company X looks for a loan it finds the going interest rate is 7%.  (In reality, there is no one single interest rate, since every bank can loan at what interest rate it wants.  But market forces cause interest rates to more or less be in the same ballpark.  For simplicity’s sake, we are assuming that there is one interest rate).

Company X sees that Project A will make a 10% profit, so it can pay back the 7% interest and still make a profit.  The same is true of Project B.  But Projects C and D both have investment returns of less than 7%, so if Company X purses these investments it will lose money.  So Company X funds Projects A and B.

The important point is that if the interest rate had been lower, say 3%, then all four projects would be funded.  If the interest rate had been ridiculously high, say 11%, then none of the projects would be funded.  In the big picture then, as interest rates on loans increase, investment (and thus GDP) decreases.  As interest rates on loans decrease, investment (and thus GDP) increases.  GDP is really what we are after.

We can represent this graphically with interest rate on the y-axis and GDP on the x-axis:

What does this have to do with the current economy?

Right now, interest rates are incredibly low.  The Federal Reserve has the federal funds rate, which is the rate it loans money to banks, at around .25%, so banks likewise have low rates.  So why aren’t companies investing in the economy if the interest rate is virtually zero?  Because they don’t think they can get a worthwhile return on their investment.  Conservatives claim this is due to excessive regulation and taxation on profits, which I find hard to buy, but that’s another story.  I think a more realistic argument is that there is not enough consumer demand, so companies just don’t see enough customers purchasing their product.  High unemployment means people are spending less.

I have left a lot to explain, specifically the LM part of this model and how the IS and LM curves interact.  See part 2 for that.

Aug 30

Greenwald Shows How Political Campaigns Are Lacking Substance

Glenn Greenwald has an excellent piece today that shows the inauthentic nature of the presidential campaigns.  He also shows the ridiculous level to which CNN has sunk in what it thinks is journalism.  The title of Greenwald’s article is a little deceptive since he goes after both Ryan and Obama.  I addressed the same topic in a previous post, discussing some public opinion polls that show how misinformed voters across the political spectrum are.

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