The Price of Inequality: How Today's Divided Society Endangers Our Future (64 page)

50.
There is a standard argument among conservatives against deficit spending, that the anticipation of increased tax liabilities in the future so increases savings, as workers today prepare for those future tax burdens, that aggregate demand is unaffected. The argument is called the Barro-Ricardian equivalence theorem, after the Harvard professor Robert Barro, who discussed it in his paper “On the Determination of the Public Debt,”
Journal of Political Economy
87, no. 5 (1979): 940–71. But subsequent work, such as my paper “On the Relevance or Irrelevance of Public Financial Policy,” in
The Economics of Public Debt: Proceedings of a Conference Held by the International Economic Association at Stanford, California
(London: Macmillan Press, 1988), pp. 4–76, explains that the result holds true only on very peculiar conditions, e.g., perfect capital markets and perfect altruism across generations. In fact, when Bush lowered his taxes on the rich and the deficit soared, household savings rates
fell
, moving in just the opposite direction predicted by Barro’s theory.

Chapter Nine
A M
ACROECONOMIC
P
OLICY
AND A
C
ENTRAL
B
ANK BY AND FOR THE
1 P
ERCENT

1.
Inflation hawks—monetary policymakers who seem to have an obsession with even the slightest increase in inflation—maintain that the economy sits on a precipice; even the slightest increase in inflation can set the economy down the wayward path of higher and higher inflation. There is no statistical support for this view, as the 1997
Economic Report of the President
pointed out.

2.
Critics will say that it’s all well and good to point this out
after
the crisis—our understandings are always better in twenty-twenty hindsight. But the fact of the matter is that I and others who raised these concerns about the obsessive focus on inflation pointed out these risks well before the crisis.

3.
This is partly because, with interest rates so low, their cost of capital is very low; partly because the high unemployment has put downward pressure on labor costs; and partly because large American firms earn much of their profits overseas, including in the emerging markets, which quickly recovered from the Great Recession and have been doing very well. Some may claim that the very wealthy suffered a great deal from the crash of the stock market—that they lost more than those at the bottom and in the middle ever hoped to have had. But the statistics given earlier on the losses in net wealth of Hispanics and African Americans (and even of the
median
white American) show how devastating the crisis was for them.

4.
See Jason Furman and Joseph E. Stiglitz, “Economic Consequences of Income Inequality,” in
Income Inequality: Issues and Policy Options: A Symposium
([Kansas City]: Federal Reserve Bank of Kansas City, 1998), pp. 221–63, available at
http://www.kc.frb.org/publicat/sympos/1998/s98stiglitz.pdf
(accessed March 30, 2012).

5.
“In the U.S. non-farm business sector, real median hourly wages rose at an average annual rate of 0.33 per cent between 1980 and 2005, while labour productivity increased at an average annual rate of 1.73 per cent over the same period.” Peter Harrison, “Median Wages and Productivity Growth in Study of Living, Canada and the Unites States,” Center for Study of Living Standards Research Note 2009-2, July 2009. There are large cumulative effects. Looking only at the period between 1989 and 2011, while productivity (private sector plus state and local government) was up more than 60 percent, wages over the same period were up only 20 percent. See Heidi Shierholz and Lawrence Mishel, “Sustained, High Joblessness Causes Lasting Damage to Wages, Benefits, Income, and Wealth,” Economic Policy Institute, August 31, 2011. Shierholz and Mishel provide a more complete description of what has happened to wages in “The Sad But True Story of Wages in America,” Economic Policy Institute, Issue Brief no. 297, March 14, 2011.

6.
Median hourly wages (all occupations), adjusted for inflation, were lower in 2007 than in 2001 (based on calculations from Bureau of Labor Statistics data).

7.
For minimum wage history, see the U.S. Department of Labor website,
http://www.dol.gov/whd/minwage/chart.htm
.

8.
On average, outside of recessions, when benefits are temporarily increased (often with a contentious congressional fight), only 25 percent of unemployed workers receive unemployment assistance, and their assistance replaces, on average, less than half of the lost income. (Center on Budget and Policy Priorities, “Introduction to Unemployment Insurance,” April 16, 2010.) The United States provides much poorer unemployment insurance than do many other advanced industrial countries. For instance, while (outside of periods of high unemployment) the United States provides for six months unemployment insurance, only Italy and the Czech Republic provide less; France provides for 23 months, Germany 12, and Denmark 48 (from OECD Employment Outlook, 2006, p. 60). In terms of replacement rate (the fraction of normal income that unemployment insurance replaces), the United States is also low: during the first year of an unemployment spell, France’s replacement rate is 67.3 percent, Germany’s, 64.9 percent, Denmark’s , 72.6 percent, and the United States’ only 44.9 percent (from OECD Employment Outlook, 2011, p. 40).

9.
See, e.g., Gretchen Morgenson, “0.2% interest? You Bet We’ll Complain,”
New York Times
, March 4, 2012, available at
http://www.nytimes.com/2012/03/04/business/low-rates-for-savers-are-reason-for-complaint-fair-game.html
(accessed March 5, 2012).

10.
Some economists—such as the Columbia economist Michael Woodford; see “Bernanke Needs Inflation for QE2 to Set Sail,”
Financial Times
,
October 11, 2010, available at
http://www.ft.com/intl/cms/s/0/4d54e574-d57a-11df-8e86-00144feabdc0.html#axzz1oHWZWjKv
(accessed March 5, 2012)—have suggested that the Fed commit itself to a maintaining inflation at a given level. With inflation of, say, 4 percent and interest rates of 0 percent, the real interest rate would be minus 4 percent. What is impeding economic recovery (in this view) is the “zero lower bound” to interest rates. I find this approach unpersuasive—putting aside the difficulty of the Fed’s credibly committing itself to a high inflation rate. The analysis just presented explains why a very low real interest rate may actually reduce aggregate demand. The situation in the United States today is markedly different from that in the Great Depression, when rapidly falling prices meant that real interest rates were very high. Real interest rates are already negative, and these negative real interest rates have not elicited the hoped-for response. Those who advocate such policies (and other related policies, like nominal GDP targeting) typically put excessive focus on the role of real T-bill rates in determining the level of economic activity. Equally or more important is credit availability and the terms at which credit is made available to firms. See Bruce Greenwald and J. E. Stiglitz,
Towards a New Paradigm in Monetary Economics
(Cambridge: Cambridge University Press, 2003).

11.
The consumption of the poor and middle is, as we have noted, often constrained by their resources, but this is not so true of those at the top, which is why increasing temporarily their capacity to consume today is not likely to have much effect on consumption levels.

12.
I am indebted to Miguel Morin for his analysis of this and his insights on this issue.

13.
It does involve some risk—that the long-term bond will decrease in value—but with the government systematically socializing losses, the risk is borne at least partially by taxpayers.

14.
Bloomberg
calculated more conservatively that easy access to the Federal Reserve amounted to a gift to the banks of $13 billion,
Bloomberg Markets Magazine
reports in its January 2012 issue. See Bob Ivry, Bradley Keoun, and Phil Kuntz, “Secret Fed Loans Gave Banks $13 Billion Undisclosed to Congress,” available at
http://mobile.bloomberg.com/news/2011-11-28/secret-fed-loans-undisclosed-to-congress-gave-banks-13-billion-in-income
(accessed March 5, 2012). The claim that the government had been repaid on the money that it had given to the banks was nothing but a shell game: the Fed in effect gave the banks the money that they then passed on to the government.

15.
Banks have long had a reserve requirement—a minimum proportion of liquid funds that they are required to maintain. The Federal Reserve’s explanation for why, in 2008, it had chosen to pay interest on excess reserves deposited with Reserve Banks is posted on its website: “The inability to pay interest on balances held to satisfy reserve requirements essentially imposes a tax on depository institutions equal to the interest that might otherwise have been earned by investing those balances in an interest-bearing asset. Paying interest on required reserve balances effectively eliminates this tax. . . . Paying interest on excess balances should help to establish a lower bound on the federal funds rate by lessening the incentive for institutions to trade balances in the market at rates much below the rate paid on excess balances. Paying interest on excess balances will permit the Federal Reserve to provide sufficient liquidity to support financial stability while implementing the monetary policy that is appropriate in light of the System’s macroeconomic objectives of maximum employment and price stability.” See
http://www.federalreserve.gov/monetarypolicy/ior_faqs.htm#4
(accessed March 5, 2012). The price tag for the Fed’s 0.25 percent interest rate paid on the current amount of excess reserves deposited with Reserve Banks—about $1.5 trillion—is likely almost $4 billion dollars a year. See, for excess reserves amount, the website of the Federal Reserve Bank of St. Louis Fed,
http://research.stlouisfed.org/fred2/series/EXCRESNS
(accessed March 5, 2012).

16.
Bruce Greenwald and I have argued, in
Towards a New Paradigm in Monetary Economics
, that the role of interest rates has been greatly exaggerated by central banks; equally, and in some cases more, important is the availability of credit. Paying banks on their reserves held at the central bank both raises the interest rates that banks will charge customers and reduces the credit they make available. Through both channels, the policy has adverse consequences. But the Federal Reserve evidently shunted these concerns aside, as it focused on its more immediate business of transferring money to the banks. It might defend these actions as helping recapitalize the banks, and bank recapitalization would, it was hoped, lead eventually to more lending. But there were better ways of recapitalizing the banks.

17.
Chapter 6 provides a description of the battle over perceptions in the bank bailout—did we have to do what we did in order to save the entire economy?

18.
For a breakdown of where the money went, see
http://projects.propublica.org/bailout/list/index
.

19.
Between 2009 and February 2012, 398 went bankrupt. See
http://www.fdic.gov/bank/individual/failed/banklist.html
.

20.
As of September 30, 2011 (the most recent data available), the FDIC’s “Problem List” had 844 institutions with assets of $339 billion. See FDIC Quarterly Banking Profile and Federal Deposit Insurance Corporation, Failed Bank List, available at
http://www2.fdic.gov/qbp/2011sep/qbp.pdf
(accessed February 24, 2012).

21.
Probably the most important deregulatory measure was the repeal in 1999, under President Clinton, of part of the Glass-Steagall Act of 1933 which separated investment banks (responsible for managing wealthy individuals’ and corporations’ money) and commercial banks. The repeal is also known as the Citigroup Relief Act because it legalized a merger of Citibank with securities and insurance services that had occurred in 1998. During debate in the House of Representatives, Representative John Dingell argued that the bill would lead banks to become “too big to fail,” and that this would lead to a bailout by the federal government. As chairman of the Council of Economic Advisers from 1995 to 1997, I had opposed (successfully) the repeal, on those grounds, as well as because of the risk of conflicts of interests (between the role of the issuer of new securities, by an investment bank, and providing operating funds, as a commercial bank) and because of the danger that the risk-taking culture of investment banks would contaminate the rightly more conservative culture of commericial banks. All three worries proved justified. Had Greenspan opposed the repeal, it is unlikely it would have been passed. The role of the Fed chairman and the secretary of Treasury in opposing regulation of derivatives is well documented. See J. E. Stiglitz,
Freefall
(New York: W. W. Norton, 2010), and Stiglitz,
The Roaring Nineties
(New York: W. W. Norton, 2003), and the references cited there.

22.
See, e.g., Alan Greenspan, speech at Credit Union National Association 2004 Governmental Affairs Conference, Washington, DC, February 23, 2004, though, after forcefully pointing out that those who had taken out variable-rate mortgages did much better than those who had taken out fixed-rate mortgages, he did issue some warnings that things could have turned out differently, i.e., that there was still risk.

23.
Dean Baker and Travis McArthur have estimated that the difference between the interest rates at which too-big-to-fail banks can raise capital and the rate smaller banks have access to increased from 0.29 percentage points—where it had been for about seven years before the crisis—to 0.78 percentage points in a matter of months after the bailouts. This, they argue, shows that markets recognized that too-big-to-fail banks had become “official government policy,” and implied “a government subsidy of $34.1 billion a year to the 18 bank holding companies with more than $100 billion in assets in the first quarter of 2009.” Baker and McArthur, “The Value of the ‘Too Big to Fail’ Big Bank Subsidy,” Center for Economic and Policy Research, September 2009, available at
http://www.cepr.net/documents/publications/too-big-to-fail-2009-09.pdf
(accessed March 5, 2012). In January 2010 Obama discussed the possibility of imposing a tax to offset this advantage. He didn’t pursue this, in face of the opposition from the banks (and perhaps even those within the administration).