Overview of the Fed and Quantitative Easing

Federal Reserve Chairman Ben Bernanke seems close to having the central bank engage in “Quantitative Easing.” A lot of people may wonder what in the world that means.  Normally I post things more opinionated, but I thought this would be a good tutorial. For the benefit of everyone, I’m going to discuss what bonds are and the role of the Federal Reserve before getting to quantitative easing, or QE, as it’s called.

What Are Bonds?

If you buy a US Treasury Bond the government is promising to pay you a fixed amount over a period of time, which can range from weeks to decades. Let’s imagine you bought a 30-year bond for $100 that pays at 5%. This means you will get $5 per year from the government for 30 years. (There are bonds that protect against inflation but that gets more complicated). You have loaned the government money and they are paying you interest.

What’s different about a bond from a normal loan is that the price of the bond can change, but your interest payment stays the same, in this case $5. The price of a bond is determined by supply and demand.  Say a lot of people wants to invest their money in bonds, so the demand increases.  You can sell your bond on the open market at say $120 instead of the original price $100.  But if I buy your bond, I still only get $5 per year, even though I had to pay more.  This means the rate of return on the bond (called the yield) will be about 4.17%   The price of the bond has gone up and the interest rate (yield) has gone down.  Likewise, if the price of a bond goes up, the interest rate (yield) goes down.  They are always in an opposite relationship.

Interest Rates

One major role of the Federal Reserve System (called the Fed for short) is to set interest rates on government bonds.  If interest rates on government bonds are really high, then people will rather keep their money in bonds than investing in the economy.  This may be good for individual portfolios, but it can slow down the economy.  So the Fed may reduce interest rates to give an incentive for businesses to invest that money rather than let it accumulate interest.  Likewise, if the economy is really booming and there are concerns about inflation (prices increasing), then the Fed may increase interest rates to give an incentive to buy bonds instead of investing money.

Quantitative Easing

At a basic level, the Fed controls the amount of money that circulates in the US economy. It does this through what are called Open Market Operations where it either buys or sells government bonds.  The Fed often does this, but Quantitative Easing (called QE for short) is when it is done on a larger scale in a major economic downturn.  For example, during QE the Fed is more likely to buy long-term bonds, while it usually only buys short-term ones.

What is most important is that during QE the Fed buys a huge number of government bonds from the public.  Banks own a huge amount of bonds, so after QE banks will now have money they can use instead of it being stored in a bond.  When the Fed buys a lots of bonds, the increased demand leads to an increased bond price, meaning interest rates (yields) decrease.  However, right now because of the poor state of the economy the Fed has already cut rates to close to 0%.  So by buying lots of bonds the Fed is not seeking to lower interest rates.  Rather it is effectively putting cash into the vaults of banks (it is all done electronically now of course), with the hope that since banks have more money on hand, they will be more willing to give out loans.  Those loans will lead to increased investments by businesses, which will hopefully get the economy going again.   Ideally, when the economy is in better shape the Fed will sell those bonds again, restoring a more normal money supply.

Republicans seem to enjoy trashing the Fed, such as Rick Perry’s somewhat famous accusation of QE being treasonous.

In any case, I hope this is helpful for people.

Unemployment Rate and Murder Rate Partially Linked

After the latest shooting today in NYC, I started wondering if the bad economy might have anything to do with the recent number of mass shootings.   What I did can hardly be called a full analysis, and as the WSJ shows the correlation-cause relationship is hard to pin.  But I found two things.  First, that there is a positive correlation between the US unemployment rate and the homicide rate for every year between 1948 and 2006.  The r-squared is 29.5% with p < .0001.  (For the non-statistically inclined, that means that 29.5% of the variation in the homicide rate is explained by variation in the unemployment rate.  The p value means that the probability of this relationship being due to chance is less than .01%)

What was also interesting is that there is a stronger relationship between the unemployment rate of the previous year and a given year’s homicide rate.  So the unemployment rate of 2004 is a better predictor of the murder rate in 2005 than 2005′s unemployment rate.   In this case for the years 1949-2005, the r-squared was 36.6%.

I don’t see how there could be a one-to-one connection here, because it would almost seem like the homicide rate drops before the unemployment rate.  But especially in the 70′s and 80′s they seem to change together.  This is fascinating. I’d love to know more about what is behind this relationship.

Charts with sources and more info below:

Unemployment Rate and Homicide Rate 1948-2006 (Homicide Rate per 100,000 people, Unemployment Rate as Percentage)

Same Year’s Unemployment (x-axis) and Murder Rates (y-axis)

Homicide Rate on y-axis, Unemployment Rate on x-axis
Homicide Rate is per 100,000 people, Unemployment is percentage;
Unemployment Source: Bureau of Labor Statistics
Murder Rate Source: Bureau of Justice Statistics

 

Previous Year’s Unemployment (x-axis) and Murder Rates (y-axis)

Homicide Rate on y-axis, Unemployment Rate on x-axis
Homicide Rate is per 100,000 people, Unemployment is percentage;
Unemployment Source: Bureau of Labor Statistics
Murder Rate Source: Bureau of Justice Statistics

 

 

The Basics on Growth and Deficits

[Update: Paul Krugman raised an important point today (which he actually got from Dave Weigel), which is that the Republican response to the Congressional Budget Office's report on the "fiscal cliff" of Bush tax cuts' potential expiration and new spending cuts contradicts their concerns about the deficit.  If the deficit was the main problem with our economy right now, then the "fiscal cliff" should be welcomed for its balanced budget effects.  But Republicans want all the spending cuts and none of the taxes.  After all, they want government in a bathtub.]

The economy is a complicated place, but sometimes the basics are not complicated.  All the concern about deficits and the debt ignores some basic facts about our current situation.  First, if we look at government outlays (what it spends) versus receipts (when it takes in) and compare it to the GDP growth rate, it becomes obvious that receipts go down and outlays go up when GDP growth is smaller than usual.  Or in the current situation, when the GDP growth becomes anemic.

Look at the following two charts and you’ll see this is true for the financial crisis and subsequent plunge in GDP growth.  But it is also true for other periods when GDP was growing, but at a slower pace, such as 2000-2003, when it was under 5%.  Receipts start going back up in 2004-2007, when GDP was 5% or higher.

What is clear is that the primary way to achieve balance in the deficit is to grow the economy.  How do you grow the economy?  The government can either cut taxes or increase spending.  Cutting taxes can help some, but in the current economy demand is so low that people will (understandably) save a good chunk of that, not helping growth much.  But if you increase government spending the tax base is broadened and unemployment insurance and other transfer payments decrease.  As a side benefit, government stimulus can promote moderate inflation, decreasing the burden of private debt among the population, which will increase consumer spending.

The most important point, though, is that deficits did not cause our economic problems.  Even if we were to magically have a balanced budget tomorrow, our economy wouldn’t necessarily get better.

 

We Should Have Supported Mubarak? Seriously?

The recent forced retirement of several Egyptian generals by President Morsi brings to light some commentary on the Egyptian situation that is quite mind-boggling.  As a case in point, Charles Rowley, professor emeritus at George Mason University, blames President Obama for supporting the ouster of Mubarak when it risked bringing Islamist militants into power.  Rowley writes of the removal of the generals:

If President Morsi’s counter-coup holds, the follow-up issue is whether The Islamic Brotherhood will then impose its own dictatorship over the Egyptian population.  If so the Coptic Christians had better run for the borders, together with the leaders of Mubarak’s former military junta.

All these issues were clearly on the table when President Obama supported the internal coup against President Hosni Mubarak, a loyal ally of the United States, during the Arab Spring.   I doubt that President Obama will find President Morsi supportive of any of his expressed goals, most especially that of preserving Israel from military attacks in the Middle East.  On the other hand, perhaps that expressed commitment  is not seriously on President Obama’s  real agenda.

Congratulations once again, Mr. President!”

First, to call the overthrow of Mubarak a “coup” is misleading.  It was not as if there was simply a power struggle between different branches of the government.  The overthrow of Mubarak was due to the courageous, awe-inspiring protests of the Egyptian people.  It is also misleading to say that Obama supported the coup.   When it first broke out in January 2011, Secretary of State Hillary Clinton said:

Our assessment is that the Egyptian government is stable and is looking for ways to respond to the legitimate needs and interests of the Egyptian people.”

This was clearly a statement of support for Mubarak, especially given the ludicrous statement regarding Mubarak’s regime looking to respond to the needs and interests of the Egyptian people.  As Amnesty International stated in a condemnation of the government’s crackdown on peaceful protests in 2011,

Undue restrictions and sweeping measures under the nearly 30 years of state of emergency have routinely been used by the Egyptian authorities to quash the legitimate exercise of the rights to peaceful protest and assembly.”

Clinton also made it clear that the US was not looking for Mubarak to leave, talking vaguely about transition to a “real democracy.”

The Obama administration later looked for a way to get Mubarak out of power when it was evident that the regime wasn’t stable after all, but the administration was hardly an enthusiastic supporter of his overthrow.  Hillary Clinton was actually greeted by protesters on her recent trip to Egypt.

So why does Rowley blame Obama?  The only plausible interpretation is that Rowley believes Obama should have done everything in his power to keep a dictatorial regime in place, because it allegedly served US interests.  This is not only profoundly anti-democratic, but rather shocking when the record of Mubarak’s record on torture and other human rights abuses is recalled.  If there is another way to interpret his post, I would love to hear it.

 

The Under(and Over)Estimation of Catastrophe

Reuters has a piece today called “Are Israelis tough enough for a long war with Iran?” Some shocking points emerge out of it. One is the following quote from Defense Minister Ehud Barak:

“Defense Minister Ehud Barak estimates 500 Israelis would die should a strike on Iran, which denies seeking to develop nuclear weaponry, turn into a regional exchange of fire.”

I’m assuming that refers only to immediate military deaths, because if war broke out with Iran, Israel would likely face another war with Hezbollah, and attacks from Hamas and other armed Palestinian groups. Violence could spill over into Shiite Iraq.  It would be a boon to al-Qaeda like groups. So we’re talking about a lot more than 500 Israeli deaths. Of course, the deaths of non-Israelis would be disastrous as well, and probably far greater in number.

A second point that is Netanyahu sees a “second Holocaust” on the horizon. Does anyone really believe that Iran is going to be so suicidal as to drop a bomb on Israel so they can go down in flames but at least being able to claim they killed all the Jews? That’s certainly not how the military sees it, as evidenced by Defense Intelligence Agency Director General Ronald Burgess’ 2010 testimony before Congress: (see the conclusion)

Iran seeks to increase its regional power by countering Western influence, expanding ties with its neighbors, and seeking a leadership role in the Islamic world. Diplomacy, economic leverage, and active sponsorship of terrorist and paramilitary groups are the tools Iran uses to drive its aggressive foreign policy. Nevertheless, internal security remains the regime’s primary focus. While it is unlikely to initiate a conflict intentionally or launch a pre-emptive attack, Iran uses its military forces to defend against both external and internal threats. (Italics mine)

Whatever threat Iran may be, it is not a genocidal, maniacal state. It is certainly a dangerous one to its own people, sharing the company of most Middle Eastern states. What does the Middle Eastern public think of Iran’s nuclear ambitions? As I noted in an earlier blog post, a Brookings Institute poll of the Arab public found that 64% thought Iran had the right to pursue a nuclear program, even though a 35% plurality thought it would have a negative impact on the Middle East. When asked what two countries were the greatest threat, 71% said Israel, 59% said the US, while 18% said Iran.

Increasing the threat level is going to drive Arab opinion even further against Israel and in favor of Iran, ultimately leading to greater violence between Iran and the Arab World and Israel. Israel will not be safe as long as it continues to exist as a Spartan island. On this point, the same poll discussed above also showed 67% of the Arab public was ready for peace with Israel if it returned to the 1967 borders.

The real potential catastrophe is what will happen to the Middle East if Israel goes after Iran. While no one should want Iran to have a bomb, a second Holocaust is just fear mongering.

Democracy Now on Paul Ryan

Ryan’s policies are scrutinized quite thoroughly here…

Mainstream Economics Anyone?

Mainstream economics tells us (quite logically I believe) that the multiplier effect of government spending is greater than that of tax cuts. That is to say an increase in government spending increases GDP more than a tax cut of the same amount. Why? Because if I have a tax cut, I am likely to save some of that money. The government can inject money directly into the economy. That obviously doesn’t mean there should be extremely high taxes and only government spending. But it does make us ask what will happen to the economy under Ryan’s budget, since he wants to massively reduce government spending.  That may not be the best idea.

 

Political Theater Is Absurd

 

Much has already been said about Romney’s pick of Paul Ryan as the VP candidate. While it isn’t even hidden that Ryan’s plan will cut services to the poor, while decreasing taxes on the wealthy, that is not what I want to focus on here. What gets me is how orchestrated these political campaigns are for public relations effect. Introducing Paul Ryan in front of a battleship? The inspirational music that keys in as he approaches the podium? It is all so phony and fake with absolutely zero political content.

Not to put this all on Republicans. When Obama introduced Joe Biden in 2008 in what was so clearly aimed at making Biden appear as a working class guy. Obama referred to Biden as a “Scrappy kid from Scranton.” Joe Biden came out to Bruce Springsteen’s “The Rising” (go to 12:50 of this video).

My concern is not just that this is corny and cheesy, which is obviously the case. What really gets me is that politics has become like any other kind of marketing, where campaigns follow the polls and say the right things at the right time and play the right kind of music, so that someone will be more likable. Trying to reach people on an emotional level like this devoids politics of content and real debate.

The reality is that the debate is complicated. For example, I have a hard time understanding all the different aspects of economic policy, whether presented by Democrats or Republicans. But we should learn about them and discuss them. Not distract ourselves with petty showmanship. This partially explains the results of a December 2010 study by World Public Opinion. 56% of voters in the November national elections said they had “encountered information that seemed misleading or false.” What’s worse is that people were misinformed on the issues. 40% thought TARP was initiated under Obama, not George W. Bush. Liberals had their own misinformation, believing that the US Chamber of Commerce was using large amounts of foreign money to fund campaigns.

The part of the study we should be most concerned about is that people who watched less news were less likely to be misinformed!!! The mass media is terrible on political theatrics, buying right into it. They will discuss image and personality until the cows come home. What if they asked candidates, “Is it really necessary to make political events so theatrical?” They could be far better gatekeepers for the public. Perfect example of terrible media coverage right here.

 

Welfare Reform, Race and Oversimplification in Politics

I’d like to look at some issues related to one of Mitt Romney’s recent campaign ads in three parts.i First is the narrative and background in which this type of political discourse takes place. It is not new and has it’s roots in Reagan’s so-called “War on Drugs” and “colorblind” rhetoric used during his presidential campaigns. Second, I want to look at possible reasons why one would be opposed to Clinton’s 1996 welfare reform act regardless of Obama’s particular reasons for his opposition. Lastly, I will look at exactly what aspect of the welfare reform act Obama amended.

To discover the roots of this type of political discourse we need to look back to the presidential campaign of Reagan. According to Michelle Alexander in her book “The New Jim Crow”, during his run for president Reagan “built on the success of earlier conservatives who developed a strategy of exploiting racial hostility or resentment for political gain without making explicit references to race. Condemning ‘welfare queens’ and criminal ‘predators’, he rode into office with the strong support of disaffected whites – poor and working-class whites who felt betrayed by the Democratic Party’s embrace of the civil rights agenda.”ii The genius of this strategy was its plausible deniability. Due to the use of “colorblind” language there were no explicit references to race but the message was there. If not understood consciously by the voting public it worked on prejudices; unconscious or otherwise. Republicans were not the only ones guilty of this. In addition to “getting tough on crime”, Clinton also attacked welfare which, according to Alexander, became part of his “grand strategy articulated by the ‘new Democrats’ to appeal to the elusive white swing voters.”iii There were claims that welfare reform was fueled by “the desire to end big government and slash budget deficits”iv but in reality there was no reduction in government money being spent on the urban poor; just a restructuring of where it went. Loïc Wacquant, in the article “Class, Race & Hyperincarceration in Revanchist America,” says in truth

“the upsizing of the carceral function of government has been rigorously proportional to the downsizing of its welfare role. In 1980, the country spent three times as much on its two main assistance programs ($11 billion for Aid to Families with Dependent Children [AFDC] and $10 billion for food stamps) than on corrections ($7 billion). By 1996, when ‘welfare reform’ replaced the right to public assistance by the obligation to accept insecure employment as a condition of support, the carceral budget came to double the sums allocated to either AFDC or food stamps ($54 billion compared to $20 billion and $27 billion, respectively). Similarly, during the 1990s alone, Washington cut funding for public housing by $17 billion (a reduction of 61 percent) and boosted corrections by $19 billion (an increase of 171 percent), effectively making the construction of prisons the nation’s main housing program for the poor. ”v

Getting tough on crime and getting rid of lazy welfare recipients who only want to live off the hard work of others were themes not invented by Reagan or the ‘new Democrats’. After slavery there was Jim Crow followed by today’s penal system. As Wacquant puts it: “The single greatest political transformation of the post-civil rights era in America is the joint rolling back of the stingy social state and rolling out of the gargantuan penal state that have remade the country’s stratification, cities, and civic culture, and are recasting the very character of ‘blackness’ itself. ”vi These not-so-subtle attacks on state welfare programs are not new. They are part of a conscious program to appeal to working-class and poor whites in order to gain their vote and this is what’s behind Romney’s ad; consciously or not.

Clinton’s 1996 “historic welfare reform” act was entitled “Personal Responsibility and Work Opportunity Reconciliation Act” and replaced “Aid to Families with Dependent Children” with “Temporary Assistance to Needy Families (TANF).” TANF imposed a 5-year limit on welfare assistance and, as Alexander reports, a “lifetime ban on eligibility for welfare and food stamps for anyone convicted of a felony drug offense – including simple possession of marijuana.”vii This additional condition excluding people with felony convictions condemns those under the control of our criminal justice system to a life a poverty and legalized discrimination. Not only are they ineligible for welfare benefits but many states carry a “felony conviction” check box on employment applications. Potential employers are legally allowed to disregard an employment application merely based on a prior felony conviction. Given the racist nature of Reagan’s “war on drugs”, and the disproportionate number of black males either incarcerated or under the control of the criminal justice system due to drug related crimes,viii acts such as TANF serve to legalize discrimination of a vulnerable segment of America’s new underclass; in affect they become part of the new Jim Crow.

Often people released from jail carry a large debt due to costs associated with their incarceration. If they are legally discriminated from employment and denied welfare assistance how are they supposed to get back on their feet? Who will be surprised when they return to jail? It seems this system is set up to make those who have served their sentence fail.

Romney’s ad attacks Obama for the comment he was “not a huge supporter of the federal plan that was signed in 1996.” Yet if we look at this so-called “welfare reform” maybe there are good reasons to be opposed to it? Yes, getting people to work and off government subsidies is important and this message should be echoed the loudest across Wall Street. But the trivialization and oversimplification of a complex social issue down to “a bill that requires people on welfare to work, instead of just collecting a check” should not go unchecked in a society as open as our.

On July 12th the Administration for Children and Families’ Office of Family Assistance issued a memorandum stating “the Department of Health and Human Services will use its statutory authority to consider waiver requests that strengthen the Temporary Assistance for Needy Families (TANF) program.” The purpose of this was to provide TANF participants with the “flexibility to innovate in the TANF program with the goal of helping more families find jobs and move toward self-sufficiency.” After meeting with TANF recipients the Administration for Children and Families “heard concerns that some TANF rules stifle innovation and focus attention on paperwork rather than helping parents find jobs.” The crucial language here is “waver requests” which is quite different from what the language of Romney’s ad is meant to imply; that lazy people are living off your hard earned money. The memorandum goes on to say “states that apply for a waiver must identify interim performance targets that will be used to hold states accountable for improving outcomes for families” and Department of Health and Human Services are “only interested in approving waivers if the state can explain in a compelling fashion why the proposed approach may be a more efficient or effective means to promote employment entry, retention, advancement, or access to jobs that offer opportunities for earnings and advancement that will allow participants to avoid dependence on government benefits.”ix

Rules and laws are passed with the provision they may be amended for a reason. Karl Poppers’ distinction between “utopian social engineering” and “piecemeal social engineering”x are helpful for those seeking means of social and political progress. We should look at social reform as a scientist looks at the progress in their field. The is no utopian plan or master blueprint of how to proceed in science and a good deal of progress occurs through trial and error. In the same way when laws are passed the consequences can not be completely foretold; there must be room for future amendment and changes. The Obama administration’s decision, as stated in the Administration for Children and Families’ Office of Family Assistance’s memorandum, to direct federal agencies “to work closely with state, local, and tribal governments to identify administrative, regulatory, and legislative barriers in Federally funded programs that currently prevent states, localities, and tribes, from efficiently using tax dollars to achieve the best results for their constituents”xi sounds a lot different than Romney’s characterization. The irony is Romney would support Obama’s efforts to spend federal money more effectively; that is, if we can take the moral authority’s statements about fiscal responsibility and balancing the budget seriously.xii

This trivialization of complexity in our culture is not limited to politics. It can be seen in science, philosophy, religion, etc. But it is particularly shameless when used as a tool to manipulate people with legitimate concerns and worries into blaming their problems on a less privileged group. Simply saying “a bill that requires people on welfare to work, instead of just collecting a check” is such a gross fabrication that Romney’s only hope must be people won’t really look into the issue. Here he is right; most people do not have time to research these things. Perhaps in a country with a functioning media though these issues would be exposed. If not the media whose job is it to investigate the claims made by our elected officials; especially ones that perpetuate the suffering of others?

i. Romney For President, “The Rise and Fall of Welfare Reform,” https://www.youtube.com/watch?v=Gf_TjkvcWZY
ii. Michelle Alexander, The New Jim Crow: Mass Incarceration in the Age of Colorblindness (New York, NY: The New Press), 48
iii. Ibid., 56
iv. Ibid., 57
v. Loïc Wacquant, “Class, Race & Hyperincarceration in Revanchist America,” Daedalus, Summer 2010, 76
vi. Ibid., 74.
vii. Michelle Alexander, The New Jim Crow: Mass Incarceration in the Age of Colorblindness (New York, NY: The New Press), 57
viii. Department of Health and Human Services, “Temporary Assistance for Needy Families Information Memorandum,”

http://www.acf.hhs.gov/programs/ofa/policy/im-ofa/2012/im201203/im201203.html

ix. Karl Popper, The Open Society and Its Enemies Volume One: The Spell of Plato (London and New York: Routledge Classics), 166-167
x. Department of Health and Human Services, “Temporary Assistance for Needy Families Information Memorandum”
xi. Romney for President, “Fiscal Responsibility,” http://www.mittromney.com/issues/fiscal-responsibility

It’s Not The Wealthy That Are The Problem, It’s Those Welfare Queens…

This is truly sad.  Romney can’t dispel his image of being an out of touch rich guy, so he tries to say Obama is in favor of  keeping lazy people on welfare.  Are we supposed to believe people from Romney’s class aren’t the problem, it’s lazy welfare recipients and their dependency-loving ally in the White House?  It doesn’t surprise me that Romney put an ad like this out.  What get me is that people may actually believe it and vote for him because they think we have way too many lazy poor people.  This is class warfare at its finest.  Sorry this post isn’t as research-based as most of them, but this kind of stuff just gets to me.  I’m curious to hear who people think this ad is targeted at?  How many people might it actually sway?  Let me know what you think…