•In Obama Tax Plan, Boost for Job Creation –

In Obama Tax Plan, Boost for Job Creation – A year ago, President Obama and the Democrats made the mistake of assuming that an economic recovery was under way. This week’s deal to extend the Bush tax cuts shows that the White House’s top priority is avoiding the same mistake again — even if it has to upset many fellow Democrats in the process.  Mr. Obama effectively traded tax cuts for the affluent, which Republicans were demanding, for a second stimulus bill that seemed improbable a few weeks ago. Mr. Obama yielded to Republicans on extending the high-end Bush tax cuts and on cutting the estate tax below its scheduled level. In exchange, Republicans agreed to extend unemployment benefits, cut payroll taxes and business taxes, and extend a grab bag of tax credits for college tuition and other items.  Congressional Democrats have reacted with a mix of wariness and anger, and some said Mr. Obama should have put up a fight on the high-end tax cuts. Yet once the Democrats bungled this issue — failing to deal with it before the midterm elections — their choices were extremely limited. If they stood firm on the high-end tax cuts and Republicans stood firm as well, all of the Bush tax cuts, not just those on income above $250,000, would have expired Dec. 31.

Tea Partiers gripe at the tax cut deal –While Democrats argue about whether Obama’s tax cut deal is better than could be expected, given the circumstances, or less painful "than a poke in the eye with a sharp stick," or the first step in the road to gutting Social Security or one of the most "extraordinary hypocrisies in the history of American politics" since Lyndon Johnson escalated the war in Vietnam, some Republicans are also letting loose with their own murmurs of discontent. The Hill quotes House Tea Party Caucus chairwoman Michele Bachmann (R-Minn.):  "I don’t know that Republicans would necessarily go along with that vote. That would be a very hard vote to take," Bachmann said on conservative commentator Sean Hannity’s radio show. In Michele Bachmann’s world, a tax cut "compromise" means only going so far as to keep all the Bush tax cuts temporary, instead of making them permanent.

House Republicans Continue Drumbeat Against Fed – Top members of the incoming Republican majority in the U.S. House of Representatives continued to level broadsides against the Federal Reserve Tuesday, questioning its proper role in shaping U.S. economic policy. Reps. Paul Ryan of Wisconsin and Indiana’s Mike Pence both repeated calls for an end to the central bank’s dual mandate to promote both jobs and maintain price stability. Members of Congress aren’t trying to encroach on the Fed’s independence, Pence said, but may have to take legislative action to change the Fed’s responsibilities. “It’s time that the Fed focus solely on price stability and the dollar,” Pence said. He said the Fed’s plan to buy $600 billion in Treasury securities to goose the economy — generally known as “QE2″ — is an example of the central bank overstepping its bounds. “QE2 is an example of what happens when the Fed involves itself too much in macroeconomic meddling,”

 The reason why governments always say they will not negotiate with hostage takers is that, if they won’t negotiate, there is no incentive to take them in the first place.  But, once hostages have been taken, the government has a strong incentive to negotiate because they don’t want to be responsible for the hostages getting killed.  And the problem is that the would-be hostage takers understand this, and therefore do not believe the government will follow its announced policy of not negotiating. That example may not work next semester, if my future students saw President Obama’s press conference: I’ve said before that I felt that the middle-class tax cuts were being held hostage to the high-end tax cuts.  I think it’s tempting not to negotiate with hostage-takers, unless the hostage gets harmed.  Then people will question the wisdom of that strategy.  In this case, the hostage was the American people and I was not willing to see them get harmed.  

In November, the Fed started its new “quantitative easing programme”. The Fed will buy up to $600 billion in long-term government bonds, putting $600 billion of extra money in the economy. Defenders think this is the key to reducing unemployment and breaking the economy out of its doldrums. Though the Fed’s motives were initially unclear, Chairman Ben Bernanke’s 5 December interview on CBS 60 minutes made it clear that fighting unemployment is a crucial motivation. Critics think this is the first step to out-of-control inflation, dollar devaluation, and a trade war. This column argues that now is not the time to be buying back long-term debt. Given exceptionally low long-term rates, the US government should be issuing it instead.

The Correlation between Money Base Growth and Inflation – I’ve been reading through undergraduate textbooks, trying to figure out where the idea that money base expansion must necessarily manifest itself in higher inflation. In Stephen Williamson‘s macro textbook, he argues that fears of inflation are motivated by the view that eventually, money base expansion will feed into money expansion (box on pp. 432), despite the fact that there is no obvious contemporaneous correlation between the two variables. I would’ve agreed with that assertion in a world where no interest was paid on reserves (see here for a primer). However, even the M2 to inflation link is less than entirely convincing of a money-inflation link at the short horizon. [1] In any case, here are some scatterplots. First, 3 month changes (in log terms):These are overlapping observations. The observations in the lower left hand side quadrant pertain to period of quantitative easing. The next two graphs eliminate overlapping changes, and then the post-Lehman observations.

Flying With Faulty Indicators –Rising equity prices haven’t inspired corporate investment because companies don’t believe what the market signals. …what if consumption doesn’t match up to what asset prices are telling firms? The risk is that additional investment could create overcapacity. Reluctant to invest their capital, they’re sitting on an ever bigger pile of cash. Everyone knows the Federal Reserve has inflated asset prices. Because that’s what the Fed explicitly set out to do. At some point, the Fed won’ be able to prop up this Potemkin edifice of ebullient asset prices set in front of a heavily overleveraged and deeply distorted economy. The Fed’s key measure for how the economy is performing is unemployment. At near 10% it is too high and isn’t expected to revert to a normal range of between 5% and 6% for years, according to Fed chairman Ben Bernanke. The implication is rates will stay at near zero until the jobless rate reaches those levels. President Obama’s tax compromise qualifies as another major fiscal stimulus–threatens to become the sort of debt monetization that destroys currencies. So investors chase assets and seek protection, not knowing if they’re facing stall speed or the point at which the financial structure starts to break apart.

Economists React: Pros and Cons of Tax Deal –Economists and others weigh in on the agreement between the White House and congressional Republicans on a broad tax package.–The proposed temporary tax cuts and spending increases will provide a substantial boost to growth in 2011. Instead of another year expanding at no more than the U.S. economy’s potential growth rate — with job gains of 1.2 million and unemployment hovering near 10% — real GDP growth will accelerate to 4%, job gains will pick up to 2.8 million, and the unemployment rate will decline to around 8.5% by year’s end. In all likelihood, the recovery would have made it through next year without backtracking into recession, but this deal improves those odds significantly. It also reduces the pressure on the Federal Reserve to engage in more aggressive monetary easing, a possibility even the central bank’s most ardent supporters aren’t happy about. –Mark Zandi, Moody’s Analytics (6 others)

Did Barack Obama lose a political battle but win a war – The number crunchers have had their first stab at Monday’s tax deal and the economic impact is impressive. Goldman Sachs now thinks the economy will grow 0.5 to 1 percentage points faster next year than its current forecast of 2.7%, which was bumped up from 2% only a week ago. JPMorgan has raised its 2011 forecast (fourth quarter compared to a year earlier) to 3.5% from 3%. Moody’s Economy.com sees growth next year at 4%. All of these forecasts imply some decline in the unemployment rate. … The initial reaction, in particular among liberal commentators, was that this was a political loss for Barack Obama, since he gave up more than the Republicans. I initially shared that view, but a colleague notes that this constitutes a loss only by narrow Beltway-based accounting. What will ultimately matter in 2012 is how the economy performs, not whose policies are responsible for that performance. If the economy is booming a year from now, Mr Obama may be seen to have lost the battle but won the war. …

Trend of Unemployment Claims as % of Continuing Unemployment; US Population vs. Employment, vs. Labor Force, vs. Continued Unemployed – Inquiring minds might be interested in a pair of charts courtesy of reader Tim Wallace. Click on either chart to see a sharper image.Note the trendline of new unemployment claims as a percentage of continuing unemployment. Over time, the chart suggests it takes longer and longer to find a job. There was a brief respite in the Clinton years, no doubt because of the internet boom, not because Clinton did anything particularly special. The trend is unbroken all the way back to 1967. It just was not noticeable before because overall unemployment was lower. The recent spike in continued unemployed is especially aggravating given the flat growth in employment.

Servicer Distrust as an Obstacle to Mortgage Mods – Yves Smith – Before we get the usual objections to mortgage modifications, I need to remind readers that in the old fashioned days of banking, when bank kept the loans they made, it would be unthinkable NOT to modify a mortgage or any other loan when a borrower got in trouble, assuming the borrower was viable. “Viable” means that the borrower still has enough income to pay enough that the bank still comes out ahead by modifying the loan rather than other recovery strategies, which for a mortgage loan means foreclosure. This isn’t charity, it’s good business sense.  Many commentators have pointed out that mortgage servicers are the big reason mods aren’t happening. Most mortgages in recent years were securitized, and the servicers are not the investors. With loss severities at 70% and higher on a foreclosure, a principal mod in the 30% to 50% range is a clear win-win.  But servicers have lots of reasons not to go there. First, they get lots of fees upon foreclosure and have organized streamlined processes to make it a profitable activity for them. Second, they are obligated to keep advancing principal and interest when borrowers default.. So they also are driven to foreclose to recover P&I advances. Third, they are just not set up to do mods. Not only do their contracts not allow for them to collect fees to do mods, but for a mod to have any hopes of success, you need to do some borrower assessment. Servicers are factories, highly routinized, so doing anything on a one-to-one basis is difficult given their operating parameters.

Keep calm and muddle on – It was a technical meeting, they said – not a time for big new ideas. And that was probably just as well – because right now there do not appear to be any big new ideas which all of Europe’s finance ministers can support. Even before the meeting began, Germany had shot down the idea of a common European bond, which might make it easier for weak economies to borrow, and make European bond markets more liquid, among other things, but could also lock Germany into guaranteeing other countries’ debts (see yesterday’s post European bonds: For and against).  At a press conference last night, after the dinner of euro group ministers, Jean-Claude Juncker stuck to his view that the E-bond idea was "intellectually attractive". But he also accepted that it’s time had not yet come. If ministers rejected a diluted version of the common bond proposal, when the markets had a gun to their heads in early May, it’s hard to see why they would accept the full-strength version now.
Chart of the day: California taxes – I pulled table D1 (Californian GDP) and table M13 (Californian state tax collection) from the California statistical abstract. That only gives data from 1967 to 2007, unfortunately, and the GDP series changes slightly in 1997. But in any case, here’s the result: It seems to me that tax revenues have been floating pretty steadily around roughly 5.5% of GDP since the mid-70s, with a brief blip up to a high of 6.8% during the dot-com bubble. I’m sure that the recession has brought the ratio down of late. But what I’m not seeing is any indication that the decline of federal tax revenues is made up for by a concomitant increase in state tax revenues.
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