Posts Tagged ‘Martin Feldstein’

bailouts as concealed aid to banks

Thursday, June 23rd, 2011

Martin Wolf yesterday examined four flawed arguments for providing Greece with bailout loans. The least persuasive, he writes, is the argument that bailouts conceal government aid to the banking sector.

It is far less embarrassing to state that one is helping Greece when one is in fact helping one’s own banks. If private lenders have enough time, they can sell their loans to the public sector or write them off without capital infusions from states. ….

[This] argument was used to justify the policies of denial that gave Latin America its “lost decade” in the 1980s. It seemed immoral then and seems equally immoral now. Losses should be recognised and banks recapitalised.

Martin Wolf, “Time for common sense on Greece“, Financial Times, 22 June 2011.

Harvard economist Martin Feldstein disagrees. Feldstein worries that default by Greece “could trigger defaults by Portugal, Ireland and possibly Spain”. To prevent “a collapse of major European banks”, he wants bailouts, in order to postpone the inevitable defaults of insolvent European countries.

With time, the creditor banks and other financial institutions that hold the debt of Greece, Ireland and Portugal will be able to sell or otherwise transfer that debt to the ECB or other potential buyers and to accumulate earnings to build up their capital ratios.

When the ECB eventually determines that major creditors have reduced their holdings of the impaired debt by enough so that, in combination with their increased capital, they are able to withstand substantial debt writedowns, the ECB will allow Greece, Ireland and Portugal to have a simultaneous default in which they restructure their existing debt to levels that they can comfortably service.

This type of plan worked well for the Latin American debt in the 1980s, culminating with the substitution of Brady bonds for existing debts.

Martin Feldstein, “Postponing Greece’s inevitable default“, The A-List, 22 June 2011.

Martin Feldstein (born 1939) was President Ronald Reagan’s chief economic adviser and is former President of the National Bureau for Economic Research (NBER).

Raoul Ruparel, in a response to Mr Feldstein’s post, comes down on the side of Martin Wolf.

[B]y our estimates the EU, IMF and ECB accounted for 26 per cent of Greek debt at the start of this year. By 2014, following a second Greek bailout, this will have risen to 64 per cent, meaning that roughly two-thirds of Greek debt will be taxpayer-owned by that date. Thus Europe is setting itself up for a massive political fall-out: taxpayers in creditor countries will utterly despise having to cough up cash (as loan-guarantees are turned into outright losses), as “bankers” are let off the hook. On the other side of the coin, the second bailout plan assumes that the Greek electorate is willing and able to swallow three more years of tough austerity measures. Even with some token private sector involvement, it looks as if taxpayers across Europe would judge a second €100bn-plus bailout of Greece a massive injustice. This is a major political gamble.

Raoul Ruparel is an economist at London-based Open Europe, an influential eurosceptic think-tank.

the Greek financial crisis

Friday, May 27th, 2011

It is clear that Greece is on a path to default on (‘restructuring of’) its sovereign debt, despite denials by the Greek government, the European Commission, the International Monetary Fund (IMF) and the European Central Bank. The ECB’s former chief economist speaks with candor, however, and does not deny what is now obvious to everyone.

Greece is “not just illiquid, it is insolvent,” Otmar Issing, the European Central Bank’s former chief economist, declared at a press conference in Copenhagen today – thus contradicting completely the ECB’s official position. There were serious doubts about whether it would ever honour its debt obligations, Mr Issing added.

His comments  will no doubt be seen as unhelpful in Frankfurt. Mr Issing, 75, still commands much respect in central bank circles and, as a former Bundesbanker, was the intellectual heart of the ECB from its creation in 1998 until he stepped down in 2006. His comments will fuel financial market speculation that a Greek debt scheduling is inevitable, whatever the ECB says.

Ralph Atkins, “Issing says Greece ‘insolvent’“, Money Supply (FT blog), 26 May 2011.

Ralph Atkins is bureau chief for the Financial Times in Frankfurt am Main.

Harvard economist Martin Feldstein agrees that Greece is insolvent. Feldstein goes further, however, arguing that a massive default, even combined with fiscal austerity, will not solve the Greek crisis. The problem is that Greece also faces the challenge of prices and wages that are out of line with those of its trading partners. This lack of competitiveness shows up as a trade deficit equal to “more than 4% of its GDP, the largest trade deficit among eurozone member countries”.

Eliminating or reducing this trade gap without depressing economic activity and employment in Greece requires that the country export more and import less. That, in turn, requires making Greek goods and services more competitive relative to those of the country’s trading partners. A country with a flexible currency can achieve that by allowing the exchange rate to depreciate. But Greece’s membership in the eurozone makes that impossible.

So Greece faces the difficult task of lowering the prices of its goods and services relative to those in other countries by other means, namely a large cut in the wages and salaries of Greek private-sector employees. ….

Ever since the Greek crisis began, the country has shown that it cannot solve its problems as the IMF and the European Commission had hoped. The countries that faced similar problems in other parts of the world always combined fiscal contractions with currency devaluations, which membership in a monetary union rules out.

A temporary leave of absence from the eurozone would allow Greece to achieve a price-level decline relative to other eurozone countries, and would make it easier to adjust the relative price level if Greek wages cannot be limited. The Maastricht treaty explicitly prohibits a eurozone country from leaving the euro, but says nothing about a temporary leave of absence (and therefore doesn’t prohibit one). It is time for Greece, other eurozone members, and the European Commission to start thinking seriously about that option.

Martin Feldstein, “After the Greek Default“, Project Syndicate, 26 May 2011.

It is now abundantly clear that Greece should never have been allowed into the eurozone. But leaving the currency union is regarded as unthinkable, as this would trigger a massive run on Greek banks. Will the trick of a “temporary leave of absence” work? I suspect not, but the situation is so bad that no option should be ruled out.

I have never fully understood why workers and their unions resist cuts in nominal wages, yet easily accept cuts in real wages via currency devaluation. Part of the reason is no doubt the fact that many (not all) expenses of workers are contractual obligations that are fixed in local currency. This includes the rent and mortgage payments for housing, as well as property taxes, tuition fees and private debt. Would it not be possible for Greece to achieve an internal devaluation by sharply reducing – in a single stroke – the nominal values (in euros) of tuition, wages, rental payments, and all debts, public and private? Would this be acceptable to workers? This is just a thought … another option.

Martin Feldstein (born 1939) chaired President Ronald Reagan’s Council of Economic Advisers and is former President of the National Bureau for Economic Research (NBER).

Feldstein on ‘saving’ Social Security

Tuesday, May 3rd, 2011

Harvard University economist Martin Feldstein (1939-) in a remarkable newspaper column, proposes creation of private accounts to ‘save’ Social Security.

With a 3% payroll deduction, someone with $50,000 of real annual earnings during his working years could accumulate enough to fund an annual payout of about $22,000 after age 67, essentially doubling the current Social Security benefit. That assumes a real rate of return of 5.5%, less than the historic average return on a balanced portfolio of stock and bond mutual funds.

Martin Feldstein, “Private Accounts Can Save Social Security“, Wall Street Journal, 2 May 2011.

The current payroll deduction for “Social Security” is 12.4%. Benefits include pensions for spouses, survivors, and the disabled, as well as retirement pensions. Still, it is unbelievable that a contibution of 3% to private accounts could produce retirement benefits equal to those of Social Security.

Mark Thoma links to Feldstein’s column, but expresses scepticism by inserting 3 question marks after the title. Arnold Kling, despite solid libertarian credentials, is even more sceptical.

My skepticism runs to 4 question marks. I wrote in 2004 in an essay in favor of privatizing Social Security that what I called the “stock market scenario” is bogus.

The stock market scenario assumes that the stock prices will grow faster than the economy forever. This violates Stein’s Law, which says that anything that can’t go on forever, stops. ….

The main reason that stock prices have risen faster than GDP historically is that the price-earnings ratio was at very low levels a hundred years ago. It has risen gradually since then,although … [with] interruptions in 1929, 2000, and 2008. In any event, this ratio, too, has a limit.

This means that the growth in stock prices has an asymptote, which is the growth rate of GDP. Unless we approach the technological rapture known as the Singularity (and if we do approach the Singularity, that in itself will eliminate all worries about Social Security, Medicare, and much else), real GDP growth will be closer to 3 percent than to 5.5 percent. In which case, it would be safer to assume stock returns closer to 3 percent than closer to 5.5 percent.

Arnold Kling, “Private Accounts Can Save Social Security (????)“, 2 May 2011.

Kling’s point is important. Real GDP growth, by the way, is also the expected return on contributions in a pay-as-you-go pension scheme.

I would add that Feldstein ignores the problem of price inflation. Social Security pensions are real annuities – with benefits linked to changes in consumer prices. It is possible to purchase real annuities, but they are very expensive and generally poor value. Private savings accounts lose value when they are used to purchase lifetime annuities, especially annuities with guaranteed purchasing power.

Milton Friedman on QE2

Wednesday, December 1st, 2010

Quantitative stimulus – QE – is unconventional monetary policy used when short-term interest rates are near zero. It amounts to the central bank ‘printing money’ by purchasing long-term government bonds and other securities from financial institutions.

It is not surprising that economists on the left, such as Columbia’s Joseph Stiglitz and Princeton’s Paul Krugman are skeptical about the usefulness of monetary policy when interest rates are low, so prefer fiscal stimulus.

What is surprising is that economists and financial experts on the political right often oppose both fiscal and monetary stimulus. One example is Harvard economist Martin Feldstein (1939-), former chief economic advisor to President Ronald Reagan, who recently wrote:

The Federal Reserve’s proposed policy of quantitative easing is a dangerous gamble with only a small potential upside benefit and substantial risks of creating asset bubbles that could destabilise the global economy. Although the US economy is weak and the outlook uncertain, QE is not the right remedy. ….

What is required is action by the president and Congress: to help homeowners with negative equity and businesses that cannot get credit, to remove the threat of higher tax rates, and reduce the out-year fiscal deficits. Any QE should be limited and temporary.

Martin Feldstein, “QE2 is risky and should be limited”, Financial Times, 3 November 2010.

There has been speculation about what the famous Chicago economist Milton Friedman (1912-2006) would have said regarding Fed Chairman Ben Bernanke’s decision to embark on a second round of quantitative easing, known as ‘QE2’. Dartmouth economist Douglas Irwin (1962-) has unearthed convincing proof that Friedman would have given full support to Bernanke.

The proof comes in the form of Friedman’s response to a question from University of Western Ontario economist David Laidler in November 2000, following a keynote address at a Bank of Canada conference.

David Laidler: Many commentators are claiming that, in Japan, with short interest rates essentially at zero, monetary policy is as expansionary as it can get, but has had no stimulative effect on the economy. Do you have a view on this issue?

Milton Friedman: Yes, indeed. As far as Japan is concerned, the situation is very clear. And it’s a good example. I’m glad you brought it up, because it shows how unreliable interest rates can be as an indicator of appropriate monetary policy.

The Japanese bank has supposedly had, until very recently, a zero interest rate policy. Yet that zero interest rate policy was evidence of an extremely tight monetary policy. Essentially, you had deflation. The real interest rate was positive; it was not negative. What you needed in Japan was more liquidity. ….

In 1989, the Bank of Japan stepped on the brakes very hard and brought money supply down to negative rates for a while. The stock market broke. The economy went into a recession, and it’s been in a state of quasirecession ever since. Monetary growth has been too low. Now, the Bank of Japan’s argument is, “Oh well, we’ve got the interest rate down to zero; what more can we do?”

It’s very simple. They can buy long-term government securities, and they can keep buying them and providing high-powered money until the highpowered money starts getting the economy in an expansion. What Japan needs is a more expansive domestic monetary policy.

Milton Friedman, “Canada and Flexible Exchange Rates”, in Revisiting the Case for Flexible Exchange Rates, Proceedings of a conference held by the Bank of Canada (November 2000), pp. 420-421.

Substitute ‘US’ for ‘Japan’ and you have the situation that the Fed faces today. Texas State University economist David Beckworth, who reported this finding on his blog, adds:

Friedman’s belief that a zero policy interest rate could be contractionary and thus required the central bank to buy long-term securities shows that he understood unconventional monetary policy long before it was vogue.  He truly was a great economist.

David Beckworth, “Case Closed: Milton Friedman Would Have Supported QE2”, Macro and Other Market Musings, 29 November 2010.

HT Brad DeLong

another call for fiscal stimulus

Tuesday, October 26th, 2010

Martin Feldstein, the conservative Harvard economist who chaired Ronald Reagan’s Council of Economic Advisers, agrees that fiscal stimulus is needed to keep the US economy from falling back into recession.

This recovery has been much weaker than previous ones ….

Because [this time] the downturn was not caused by high interest rates, lowering them could not lift the economy out of recession. The Obama administration therefore turned to fiscal policy – tax cuts and a range of spending programs. Unfortunately, the fiscal stimulus was not well enough designed to get the economy onto a strong, self-sustaining growth path. And, now that those stimulus programs are coming to an end, there is a danger that the economy will slide back into slow growth or even recession. ….

If the saving rate continues to rise at the same pace in the future as it has over the past three years, the overall GDP growth rate could turn negative after a few quarters. …. A significantly higher saving rate would help the US economy in the long run, but it would be a barrier to robust growth in the next few years.

Martin Feldstein, “Why Has America’s Economic Recovery Stalled?”, Project Syndicate, 25 October 2010.

HT to Mark Thoma.

Martin Feldstein on the dollar as a reserve currency

Thursday, December 10th, 2009

Harvard economist Martin Feldstein argues that even though the US dollar is losing its status as the world’s principal “reserve currency”, it has a bright future as an “investment currency”.  The large foreign exchange holdings held by some central banks, he argues, are not reserves in the traditional sense. In reality they are investment funds, albeit “investment funds that also deter attacks by forex speculators”.

It is prudent for any country with large foreign exchange balances to diversify those funds. It is not surprising then that countries such as China and Korea are diversifying away from dollars, primarily into euros.

That diversification cuts demand for the dollar, putting pressure on its value. Market participants should see this as a natural consequence of the shift of foreign exchange balances from liquid dollar emergency reserves to longer-term multi-currency investment portfolios. But even as countries diversify away from exclusive reliance on dollars, the dollar will continue to be the main form of liquid investment for countries around the world.

As this portfolio rebalancing comes to an end, demand for dollars will stop falling. At the same time, the dollar’s reduced value will shrink the US trade deficit, reducing the annual supply of dollars. This stronger demand for dollars and reduced supply can end the dollar’s decline. What looks like a crisis of confidence in the dollar as a reserve currency is just part of the evolutionary process that will eventually halt the dollar’s decline.

Martin Feldstein, “The dollar’s fall reflects a new role for reserves”, Financial Times, 10 December 2009.

Nothing can go on forever, certainly not the decline of the dollar, but I am not confident that the process of adjustment will be so easy. The implication of Feldstein’s line of reasoning is that central banks will choose to invest only a small amount of their foreign exchange in US treasury bills. What will happen to US interest rates – and the cost of financing the massive US public debt – as Asian central banks dump US treasury bills? Big sums are involved. As Feldstein notes, Thailand holds foreign exchange assets of $100 billion, South Korea $200 billion, Taiwan $300 billion, and China more than $2,000 billion.

a proposal to reform US health care

Thursday, October 8th, 2009

Harvard economist Martin Feldstein has a plan to extend health coverage to the 45 million in the USA who are uninsured. He claims this can be done without increasing government involvement in the delivery of health care, without increasing the public debt, and without increasing taxes. Moreover, there would be no need to touch Medicare (for the disabled and elderly) or Medicaid (for families in poverty). To good to be true? Or a proposal worthy of consideration?

A good health insurance system should 1) guarantee that everyone can obtain appropriate care even when the price of that care is very high and 2) prevent the financial hardship or personal bankruptcy that can now result from large medical bills.

Private health insurance today fails to achieve these goals. ….

Here’s a better alternative. Let’s scrap the $220 billion annual health insurance tax subsidy [for purchase of employer-provided health insurance] …, and use those budget dollars to provide insurance that protects American families from health costs that exceed 15 percent of their income.

Specifically, the government would give each individual or family a voucher that would permit taxpayers to buy a policy from a private insurer that would pay all allowable health costs in excess of 15 percent of the family’s income. A typical American family with income of $50,000 would be eligible for a voucher worth about $3,500, the actuarial cost of a policy that would pay all of that family’s health bills in excess of $7,500 a year.

The family could give this $3,500 voucher to any insurance company or health maintenance organization, … [and, if desired] pay a premium to the insurance company to expand their coverage [and reduce their deductible to a lower amount].

… [T]he budget cost of providing these insurance vouchers could be more than fully financed by ending the exclusion of employer health insurance payments from income and payroll taxes.

Martin Feldstein, “A Better Way to Health Reform”, Washington Post, 8 October 2009.

According to Feldstein, only two related problems remain. First, how can we expect every family to have sufficient savings to pay for a sudden health bill equal to 15% of their annual income? Second, how can health care providers be confident that patients will be willing and able to pay the deductible amount? The solution? A government-issued health-care credit card that any family can use to charge medical bills up to the deductible amount. Its use would not be required, but it would exist as a backup to assure providers of ability to pay. Government, of course, is in a good position to obtain repayment from the cardholder.

I see a third problem. Families are free to offer their vouchers to private insurance companies, but are the insurance companies required to accept them? Feldstein envisions a system in which insurance fees – and benefits – are precisely the same for all families, except for the size of the deductible.  If some insurers end up with sick families and others with healthy families, the system will break down. In the absence of government regulation – including a mechanism to transfer voucher income from one group of insurers to another – companies with a disproportionate number of sick clients will not survive.

There is also a fourth problem. A deductible amount equal to 15% of annual income may be reasonable for a family with an income of $50,000 or more, but not for families with incomes of, say, $25,000 and less. It would be better, I believe, to set the deductible equal to a fixed percentage of family income above a poverty-line. Families living in poverty would be fully covered by insurance from their first dollar of expenditure, and for others the deductible amount, as a percentage of income, would be higher, the higher the income of the family.

Like all proposals – other than universal, single-payer systems – the devil is in the detail. Feldstein’s proposal is an interesting one, especially given the severe political constraints in the US. But the details of his proposal need to be worked out. I do not understand, for example, why such a voucher system could not replace Medicaid.

Professor Feldstein was chairman of the Council of Economic Advisers and chief economic advisor to President Ronald Reagan from 1982 to 1984.