Corporate tax cuts use in one graph

So it seems that a good chunk of the GOP/Trump tax cuts will go to buybacks, and to fuel the bubble in the stock market, according to Robin Wigglesworth in the FT (subscription required). Bad news for those that think that higher earnings lead to higher investment (meaning gross formation of capital). My impression is that if you want tax cuts to be stimulative, you should target consumption, in particular for lower income groups, which tend to spend a higher proportion of their income.

The Forgotten Bubble

Over the years I've heard of a new story about the 1920s. Mostly in class comments or in the papers of my undergraduate students. First in Utah, now here at Bucknell. The notion is that the 1920-21 recession was solved by laissez-faire policies. This fits the revisionist view about the Great Depression defended by Amity Shlaes and others. In other words, the depression was prolonged by the New Deal policies (I discussed those here).

A new book by James Grant, The Forgotten Depression, suggests exactly that the recovery in 1922 was the result of the lack of government intervention. The notion is that there was no fiscal stimulus, and yet the economy recovered. By the way, the book also suggests that the cause of the recession was the Fed's policy. I guess it was the first Fed caused crisis in this view, in line with Friedman's explanation of the Depression as the Great Contraction.

There is a relatively well-know and established story about the 1920s recovery and boom, which does not suggest that laissez-faire is a good idea. It suggests that it was a consumption boom associated to a bubble, and, hence, unsustainable leading to a collapse. The 1920s is when debt-driven consumption of mass produced goods became the norm, and when a whole set of new goods were available for the middle class (e..g cars, refrigerators, radios, etc.). A good description of that story can be found in Livingstone here (subscription required). In other words, in spite of wage stagnation, worsening income distribution, and lack of government stimulus the roaring twenties were possible as a result of private debt accumulation. And you know how well that ended.

There was also a housing bubble. Ahmad Borazan, who is working on these topics at the University of Utah, pointed out to me the paper by Eugene White on national housing bubble that bursted in 1926. In that respect it is worth noticing that bubbles and speculation on land were central for almost all booms and busts in the 19th century, as seen in the figure below.

Note that there were financial crashes in 1819, 1837 and 1857, often associated to higher rates of interest in the UK, the main financial center back then, and to the collapse of commodity and asset prices. Housing bubbles seem to be the modern version of land speculation, when the frontier has vanished, and they seem to have played a role in the Great Depression and the last crisis.

PS: Figure above comes from Reynolds Nelson's A Nation of Deadbeats.

Cheap Talk at the Fed

By Dean Baker

Federal Reserve Board Chair Janet Yellen made waves in her Congressional testimony last week when she argued that social media and biotech stocks were over-valued. She also said that the price of junk bonds was out of line with historic experience. By making these assertions in a highly visible public forum, Yellen was using the power of the Fed’s megaphone to stem the growth of incipient bubbles. This is an approach that some of us have advocated for close to twenty years. Before examining the merits of this approach, it is worth noting the remarkable transformation in the Fed’s view on its role in containing bubbles. Just a decade ago, then Fed Chair Alan Greenspan told an adoring audience at the American Economic Association that the best thing the Fed could do with bubbles was to let them run their course and then pick up the pieces after they burst. He argued that the Fed’s approach to the stock bubble vindicated this route. Apparently it did not bother him, or most of the people in the audience, that the economy was at the time experiencing its longest period without net job growth since the Great Depression.

Read rest here.

CEPR: Latin American Growth in the 21st Century - The 'Commodities Boom' That Wasn't

By David Rosnick and Mark Weisbrot

This paper looks at whether the data support such a conclusion. It finds that there is no statistically significant relationship between the increase in the terms of trade (TOT) for Latin American countries and their GDP growth. There is, however, a positive relationship between the TOT increase and an improvement in the current account balance. It may be that this allowed countries to avoid balance of payments crises or constraints.

Read rest here.

Dean Baker: Bond Bubbles? Silly Season at the Fed

By Dean Baker

Throughout this [so-called] 'recovery' there have been a number of economists and policy types expressing concern about a “bond bubble.” This is the idea that bonds are overpriced and could take a sudden tumble giving financial markets and the economy the same sort of hits we saw from the collapse of the housing and stock bubbles. This is seriously misguided thinking from any conceivable perspective. At the most basic level the concern is misplaced because there is nowhere near as much money at stake. Former Fed economist Andrew Flowers put the amount of money at stake in the bond market as $40 trillion in a recent FiveThirtyEight column. This compares to a stock market valued at around $28 trillion and housing market at a bit over $20 trillion. While that may make the bond market seem more important, the $40 trillion number is hugely misleading. The $40 trillion figure refers to total debt, much of which is short-term. This is important because short-term debt doesn’t lose much value when interest rates rise. If we restrict our focus to debt that stands to lose substantial value when interest rates rise – remaining duration of five years or more – the volume of debt would be well under $20 trillion.

Read rest here.

Inequality for All: comparing the Great Depression and the Great Recession

A short clip from Robert Reich's Inequality for All. Overall is fine. Mind you Reich uses the supply side fiction that education (skills) generates jobs, rather than demand. A very conventional neoclassical labor market story with an implicit Say's law argument. And he calls Alan Simpson, of the infamous Bowles-Simpson's National Commission on Fiscal Responsibility and Reform (which favors cutting entitlement spending, besides higher taxes), a lefty. But still a progressive guy with good intentions, and lots of relevant data and information.

The Economist thinks bubbles are rational

Or at least is what they suggest in the popular blog Free Exchange. They bring back Peter Garber's research on the Tulipmania, and more recent research by Earl Thompson, which suggests that "the market for tulips was an efficient response to changing financial regulation." They conclude by arguing that:

"It is easy to claim that bubbles are irrational. They seem to represent a deviation of prices from fundamental values—and they contradict basic economic theory. But there has been little attempt to understand how speculation actually works. The example of tulipmania shows the importance of doing that—rather than relying on lazy quips about 'animal spirits' or irrationality."

The notion is related to the idea of the Arrow-Debreu models in which short term prices (they don't have long term prices associated with a uniform rate of profit) do reflect the fundamental values associated to the preferences of agents and the given technology and factor endowments. In this context, the efficient market hypothesis (EMH) suggests that the prices of financial assets reflect all market information, and as a result those prices would not deviate from their fundamentals. In other words, according to the EMH, bubbles do not exist.

Rational bubbles assume that rational behavior may still be associated with deviations of asset prices away from their fundamental values. In general, a self-confirming belief that asset prices depend on a variable that is intrinsically irrelevant, that is, not part of market fundamentals, is assumed. Much discussion goes into the behavioral assumptions that would make rational bubbles possible. Justin Fox's The Myth of the Rational Market, which I reviewed here (subscription required) provides an accessible introduction.

John Eatwell (here; subscription required) noted that a more relevant question than the rationality or not of bubbles is whether they are useful or not. Railroads were built on bubbles, and the dot.com bubble even left some infrastructure in terms of telecommunications that has been useful. Other bubbles, like the one associated with the subprime, are less obviously useful.

Finally, note that the old capital debates are still important to understand the limitations of much of this literature. Garegnani and Petri have noted that even the short run Arrow-Debreu models must bring investment to equality to full employment savings, and as a result some notion of a natural rate of interest is implicitly needed. And then all the problems of the aggregative model apply. So it is not possible to show that long term prices do reflect fundamentals associated with preferences, technology and endowments.

PS: On the related topic of whether the Bubble Act (financial regulation), that followed the South Sea Bubble, led to lower rates of growth see here. For the capital debates go here.