Tuesday, December 30, 2008

John Taylor Unleashed

John Taylor is not bashful about criticizing mistakes made by U.S. economic policy makers. He recently had this interesting paper where he concludes as follows:
In this paper I have provided empirical evidence that government actions and interventions caused, prolonged, and worsened the financial crisis. They caused it by deviating from historical precedents and principles for setting interest rates, which had worked well for 20 years. They prolonged it by misdiagnosing the problems in the bank credit markets and thereby responding inappropriately by focusing on liquidity rather than risk. They made it worse by providing support for certain financial institutions and their creditors but not others in an ad hoc way without a clear and understandable framework. While other factors were certainly at play, these government actions should be first on the list of answers to the question of what went wrong.
I love seeing Taylor unleashed like this--no U.S. Treasury position holding him back now. (Note to critics: in the last sentence above he acknowledges other "factors were at play", he never denied this point) Taylor continues his assault on poorly designed and executed U.S. macroeconomic policy in an interview with Tom Keene of Bloomberg. Listen to the interview here.

Update: John Taylor continues his critique of Fed policy at the AEA meeetings while Josh Hendrickson provides a nice overview of Taylor's paper.

Monday, December 29, 2008

The Hangover Debate

Do certain economic booms inevitably require economic busts? Are recessions sometimes the painful but necessary way to correct the buildup of past economic imbalances? Paul Krugman says no to this line of reasoning and calls it the "hangover theory" of the business cycle. Steven Randy Waldman replies that while not every business cycle fits the "hangover theory", some of them do. Consequently, he believes the hangover theory should not be so easily dismissed. Mike Shedlock also replies by showing in great detail how the past housing boom-bust cycle fits quite well the hangover theory. Finally, Justin Fox weighs in on the matter, but ultimately decides to ride the fence on this question.

My own view is similar to Waldman's--some but not all boom-bust cycles fit the hangover theory. I think this view can be best illustrated by the double-dip recessions of Paul Volker in the early 1980s that are now credited with (1) eliminating double digit inflation and, in turn, (2) laying the foundation for the subsequent 20+ years relative macroeconomic stability.

Sunday, December 28, 2008

What Happened to the 1,911,000 Lost Jobs?

Mark Thoma directs us to a stunning claim made by Casey Mulligan in the New York Times:
[T]he decreased employment is explained more by reductions in the supply of labor (the willingness of people to work) and less by the demand for labor (the number of workers that employers need to hire).
If true, this claim means most of the 1,911,000 jobs lost since December 2007 are the result of voluntary choices made by employees. This interpretation probably strikes most observers as ridiculous, but before we dismiss it out of hand let's take a look at the employment data. The place for data on this question is the BLS's Job Opportunity and Labor Turnover Survey (JOLTS). This survey provides data on job openings, hires, and separations, and goes back to December 2000.

Let's first take a look at the JOLTS data on "quits" and "layoffs & discharges". The quits category is defined as "employees who left voluntarily" and does not include retirees or transfers to other locations. The layoffs and discharges category is self explanatory, but here is the JOLTS definition if you are interested. I have graphed these two series below through the last data point available, October 2008 (click on figure to enlarge):

Note that the number of voluntary quits has actually declined over the past two years, indicating workers are not leaving their jobs en masse as suggested by Mulligan. So much for the labor supply contraction. Layoffs & discharges, on the other hand, show a upward trend over the past two years. The increase in layoffs & discharges, however, is quite modest and that may be surprising to some observers given the large number of lost jobs this year. The modest increase in layoffs & discharges, though, is more than made up for with the lack of new job openings and hires (definitions here) as can be seen in the figure below (click on figure to enlarge):

This last graph highlights an interesting point raised by Robert Hall: employment typically falls during a recession not because of a huge increase in job losses, but because new jobs are harder to find. Either way, weakened labor demand is the source of the employment reduction. The JOLTS data show this to be the case for the current U.S. recession.

Fiscal Policy Stimulus Smackdown

The usually reserved Tyler Cowen comes out swinging in this rebuttal to Paul Krugman and other fiscal policy stimulus proponents. He provides a number of good critiques, but this one I think is key:
Note that under standard theory neither monetary nor fiscal policy will set right the basic problems from negative real shocks and indeed the U.S. economy is undergoing a series of massive sectoral shifts. That includes a move out of construction, a move out of finance, a move out of debt-financed consumption, a move out of luxury goods, the collapse of GM, and a move out of industries which cannot compete with the internet (newspapers, Borders, etc.)

I've never seen a stimulus proponent deny this point about real shocks but I don't see them emphasizing it either. It should be the starting point for any analysis of fiscal policy but so far it is being swept under the proverbial rug.
Josh Hendrickson makes a similar point here in his discussion of what macroeconomic theory has to say about this crisis. My belief is that macroeconomic policy should aim to stabilize nominal spending while these negative real shocks are being worked out. This can be most easily accomplished through the existing policies of (1) shoring up the financial sector and (2) quantitative easing by the Fed. Note that it was the equivalent of these two policies in the 1930s the ended the Great Depression, not fiscal policy stimulus.

Saint Nick Brings Good Economic Cheer This Holiday Season

Okay, it was not really Saint Nick but Nick Rowe who gave me some economic cheer this holiday season. He did so by addressing, in part, my concern about the deterioration of the Fed's balance sheet over at Econbrowser. There, Nick reassures me that this deterioration is nothing to fear, but is the equivalent of the now-needed helicopter money drop:
Let's compare the Fed's "gamble" with helicopter money.

With a "helicopter" increase in the money supply, the Fed's balance sheet shows a new liability, and no new asset.

That is equivalent to the Fed buying an asset, with newly-printed money, and then the asset turning out to be worthless.

In other words, if you believe that a "helicopter" increase in the money supply is what is needed to get the economy out of a liquidity trap, then the destruction of the Fed's balance sheet net worth is exactly what the Fed is trying to achieve.

The only difference between helicopter money and the Fed's buying a worthless asset is in who gets the money: the person who picks it up off the ground (i.e. the one who receives the government transfer payment); or the person who sold the fed the worthless asset.

Let me put it another way: if it lost the gamble, the Fed would be forced to print money to make the same monthly transfer to Treasury, and this would be inflationary. But the expectation of future inflation is exactly what the Fed needs to create now, to escape the liquidity trap. This is a gamble the Fed wants to "lose".

This is a very interesting take on the changes in the Fed's balance sheet, one that Nick Rowe further elaborates on over at the Worthwhile Canadian Initiative. He is beginning to give me hope that maybe there is a well-thought out plan behind the deterioration of the Fed's balance sheet. What would fully bring me peace is if Nick Rowe could also explain what the Fed will do once the recovery is secured and inflationary pressures loom.

Update: See the comment section for Nick's answer to my question on inflationary pressures.

Saturday, December 27, 2008

Misery Loves Company: Recession Edition

Justin Wolfers recently reported poll data that shows the current recession is taking a steep toll on self-reported measures of well being. His posting confirms what other related studies indicate will happen over this recession: happiness will see a marked decline. But wait, Sonja Lyubomirsky writing in the NY Times tells us that happiness has not declined as much as it could and, as a result, we are still relatively happy. (ht Mark Thoma) Why? Lyubomirsky says it is because relative rather than absolute economic status that matters:
Research in psychology and economics suggests that when only your salary is cut, or when only you make a foolish investment, or when only you lose your job, you become considerably less satisfied with your life. But when everyone from autoworkers to Wall Street financiers becomes worse off, your life satisfaction remains pretty much the same.

Indeed, humans are remarkably attuned to relative position and status. As the economists David Hemenway and Sara Solnick demonstrated in a study at Harvard, many people would prefer to receive an annual salary of $50,000 when others are making $25,000 than to earn $100,000 a year when others are making $200,000.

Similarly, Daniel Zizzo and Andrew Oswald, economists in Britain, conducted a study that showed that people would give up money if doing so would cause someone else to give up a slightly larger sum. That is, we will make ourselves poorer in order to make someone else poorer, too.

Findings like these reveal an all-too-human truth. We care more about social comparison, status and rank than about the absolute value of our bank accounts or reputations.


So in a world in which just about all of us have seen our retirement savings and home values plummet, it’s no wonder that we all feel surprisingly O.K.
So while we are not happy as we were at the peak of the housing boom, we are not as miserable as we should be giving our absolute economic condition. While this interpretations seems plausible to me, I assume it only applies within certain bounds. (e.g. Would most people really prefer dire poverty for everyone just to eliminate a some variance in the standard of living?) For now, though, it provides a silver lining amidst the economic distress.

Tuesday, December 23, 2008

Macroeconomic Insights on the Current Crisis

Josh Hendrickson reviews modern macroeconomic theory and explains what it has to say about our current economic situation.

A Question for Paul Krugman, Tyler Cowen, and Felix Salmon

Paul Krugman, Tyler Cowen, and Felix Salmon are discussing the implications of the claim that "the worst of the crisis is hitting states that largely didn’t experience a housing bubble." This claim, however, is based only on recent changes in unemployment rates. If one looks at changes in NFP employment at the state level since the beginning of the recession then there is a closer connection between the housing bubble and the states being hit the hardest by the crisis. There also emerges from this data a clear geographical part of the country that appears to be relatively unscathed by the crisis.

First, take a look at the change in the BLS state-level NFP employment for the period of December 2007 - November 2007 (See here for more on the data).

Note that the two hardest-hit states in terms of employment also happened to be ones with some of the biggest increases in home prices: FL and CA. The two states who have gained the most jobs over this time also happened to miss most of the run up in home prices: OK and TX. Now these are only the extreme cases, but they do indicate that there is some relationship between regional house prices and the regional impact of the economic crisis.

Now, if one were to map out these changes in NFP employment at the state level over the last year (Nov. '07 to Nov. '08) and categorize states by those with any employment gain versus those with any employment losses you would get the following map (click to enlarge):

This map (source: St. Louis Fed GeoFred) indicates that the energy belt seems to be weathering this crisis far better than the rest of the country. This observation needs explaining. So Paul, Tyler, and Felix what is your story for this observations and does it have any implications for policy?

Monday, December 22, 2008

The Money Multiplier Again

Steve Randy Waldman has been thinking about the Fed and questions its policy of paying interest on reserves at this point in time:
[T]he core rationale for paying interest on reserves has disappeared entirely. Originally, the Fed wanted the power to pay interest on reserves so that it could expand its balance sheet to pursue "stability" goals without stoking inflation by letting the short-term interest rate fall to zero. Now the short-term interest rate has fallen to zero, and the dominant concern is that we are in a "liquidity trap". Yet we are still paying the banks 25 basis points to hold this freshly created money at the Fed. James Hamilton, towards the end of his piece, points out that this is counterproductive. I want to point out that it is also obscene.
I agree with Waldman and Hamilton and have said so before. The easy way to make the case for eliminating the interest payment on excess reserves is to simply look at the money multiplier as I did in this previous posting. There, I showed the money multiplier using MZM as the broad measure of money and the St. Louis Fed's monetary base measure. (See here for why MZM is used over M1 or M2) The data were on a bi-weekly basis. Here I have updated the figure through the week ending December 8, 2008 (Click on figure to enlarge):

Last time I posted this figure the money multiplier had declined, but still had a higher value than in most of the previous years. Now it is far below the previous years' values. This is not the picture one would want to see when conducting a program of quantitative easing.

The Business Cycle and Religiosity on CNN

Consistent with my research, CNN did a segment that shows evangelical Protestant churches grow during economic downturns:

By the way, if you looked close enough you might have seen me briefly in the video clip. Here is more from another CNN Interview:
For a more thorough discussion of why evangelical Protestants are so sensitive to swings in business cycles see here.

Update: Here is the New York Times article mentioned in the video clip.

Sunday, December 21, 2008

Michigan's Eight Year Recession

As a follow up to my last posting on employment conditions at the state level, I thought a look at Michigan might be of interest to some readers given the debate surrounding the state's auto industry. Take a look at this striking figure of Michigan's NFP employment, where the numbers in the vertical column are in the thousands:

In terms of employment, the recession did not start in 2007 for Michigan but in 2000. Now that has to be some kind of record.

Friday, December 19, 2008

Employment Conditions at the State Level

We all know had bad employment conditions have become in the United States: 533,000 jobs lost in November and 1,911,000 jobs lost since December 2007. While these numbers are ominous--the United States needs about 100,000 jobs a month just to keep up with the growth in the working age population--they mask some interesting employment patterns at the state level that help shed light on what Robert Reich calls the "new Civil War":
There's a new Civil War going on when it comes to automaking in America. Japanese, Korean, and German automakers are now building 18 auto assembly plants in the United States, none of which is unionized. Kentucky (Senate Republican Leader Mitch McConnell) already has Toyota's biggest auto assembly plant outside Japan. Tennessee (Senate Rep. Bob Corker, who came up with the "chapter 11" bailout amendment) houses Nissan's North American headquarters. Alabama (Senate Rep. Richard Shelby) hosts Mercedez Benz and several other foreign automakers.

So there's no reason to suppose the good citizens of Kentucky, Tennessee, or Alabama are particularly excited at the prospect of handing over their taxpayer money to competing firms and their workforces.
While Reich focuses on the auto industry, I show below with employment data that more broadly speaking there is no doubt that some Southern and Central states will be subsidizing other parts of the country receiving bailout money, whether for the financial or auto industry, and this may strike some taxpayers in these regions as troubling.

So what does the data show? Let's start with the two states hit hardest by the recession in terms of employment. (They also happen to be the two states with the biggest run up in house prices.) First up is Florida. The numbers on the vertical column are in thousands (Click on figure to enlarge):

Florida has lost 216,200 jobs since December 2007. Next up is California:

California has lost 147,000 jobs over the same time. So far, this story is consistent with the national view. Let's now look at the two states that have fared the best in terms of employment since December 2007. First up is Texas:

Amazingly, Texas has added 198,000 jobs over this period. Even November saw employment go up by 7,300 jobs. Next up is Oklahoma:

Oklahoma has added 16,300 jobs over this time. In fact, there are a number of states where jobs have been added during the recession. These states, therefore, with stronger economies will be paying taxes for subsidies going to other states. These so called 'fiscal transfers' are important to the smooth function of an optimum currency area, but can still be irritating to those regions paying out more in taxes than they receive in government benefits.

Here are the employment numbers for the rest of the states (Source: BLS):

(Note: state level NFP employment is estimated separately from than the national measure,)

Tuesday, December 16, 2008

Pulling Out the Big Monetary Guns

Martin Wolf discusses how the Fed can conduct monetary policy with its policy interest rate now near zero percent:
Central banks may soon resort to their most powerful weapons against deflation: the printing press and the “helicopter drop” of money. It is a time for which Ben Bernanke, chairman of the Federal Reserve, has long prepared. Will this weaponry work? Unquestionably, yes: used ruthlessly, it will eliminate deflation. But returning to normality thereafter will prove far more elusive. [This latter point is key--see my comments below]


Does [the Fed] face any constraint? Not really. As Robert Mugabe has shown, anybody can run a printing press successfully. Once the interest rate hits zero, the Fed can perform much further easing. Indeed, it can create money without limit. Imagine what would happen if an alchemist could transform lead into gold, at no cost. Gold would not be worth much. Central banks can create infinite quantities of money, at no cost. So they can reduce its value to nothing without difficulty. Curing deflation is child’s play in a “fiat money” – a man-made money – system.

So what might central banks do? They might lower longer-term interest rates by buying as many long-term government bonds as they wish or by promising to keep short rates low for a lengthy period. They might lend directly to the private sector. Indeed, they might buy any private asset, at any price and in any quantity they choose. They might also buy foreign currency assets. And they might finance the government on any scale they think necessary.

Alternatively, the fiscal authorities can run a deficit of any size they wish and then finance it by issuing short-term paper that the central bank would have to buy, to keep interest rates down. At the zero-rate boundary, fiscal and monetary policies become one. The central bank’s sole right to make monetary policy is gone. But the reverse is also true: the central bank can send money to every citizen. This is the helicopter drop proposed by the late Milton Friedman and recently discussed by Eric Lonergan on the FT’s economists’ forum.

I am confident the Fed can prevent deflation. What I am not confident about, though, is how the Fed will reverse its actions once the economy recovers. The Fed has been acquiring many questionable assets in its efforts to thaw frozen markets. As I discussed here, this has lead to a deterioration of the Fed's balance sheet and may impair it from being able to fully reign in all the expanded monetary base.

Update I: Jim Hamilton discusses the Fed's options going forward.

Update II: Justin Fox over at the Curious Capitalist talks with Marvin Goodfriend who believes the Fed's printing of money (i.e. quantitative easing) policy will work. He, however, shares my concerns:
The big issue, Goodfriend says, will be the exit strategy. At some point the animal spirits of businesses and consumers (and bankers) will return, and if the Fed doesn't act quickly to retire most of those hundreds of billions of new dollars it's been creating, the result will be inflation. But that's tomorrow's problem.
Don't get me wrong--I believe stabilizing nominal spending should be the key objective of the Fed at this point and, thus, quantitative easing makes sense. I am just wondering what we do after the recovery.

The Consequences of Paying Interest on Excess Reserves

Jeffrey Hummel has an interesting piece on the Federal Reserve paying interest on excess reserves and its unintended consequences (ht Tyler Cowen):

So again, the accumulation of excess reserves may reflect the perverse impact of central banks paying interest on them... I predict that future economic historians will look back on this change as a major blunder during the current credit tightening, making traditional monetary policy less effective.

If this policy turns out to be a major blunder, future economic historians will probably compare it to the one the Fed made in 1936-1937.

Sunday, December 14, 2008

Religiosity and the Business Cycle in the New York Times

Welcome to those who read about my research on the business cycle and religiosity in the New York Times or at Marginal Revolution. If you are interested in the paper "Praying for a Recession" go here. If you want a less technical overview on the paper see this discussion at Mark Thoma's blog. I recently gave another paper along the same lines at the Southern Economic Association that can be accessed here and was discussed here.

Thursday, December 11, 2008

James Grant Interview

James Grant discusses his new book "Mr. Market Miscalculates: The Bubble Years and Beyond" and other issues with Bloomberg's Tom Keene. You can listen to the talk here.

Wednesday, December 10, 2008

The Importance of the Fed's Balance Sheet

The Fed's balance sheet has blown up from about $900 billion in August 2007 to almost $2.2 trillion in early December, 2008. This means the monetary base--which is comprised of the liability side of the Fed's balance sheet--has also blown up. Normally, such a development would boost spending and create inflationary pressures, but not this time. The Fed has cleverly employed two strategies to "sterilize" the impact on aggregate demand from the growth of its balance sheet:(1) pay interest on excess reserves and (2) have the U.S. Treasury conduct quasi-open market operations for the Fed (i.e. the Treasury supplemental financing program where the Treasury is selling securities and parking the payments at the Fed.) Both of these operations have allowed the Fed to inject massive amounts of liquidity to the troubled parts of the financial system while keeping the pressures from the liquidity contained.

There are some big problems, though, with this strategy. First, as John Berry notes, the Fed will have to reverse all these actions once the financial crisis ends. The timing of this reversal will be key: move too soon and risk further economic fallout, move too late and watch inflation emerge. Second, the Fed's ability to reverse its liquidity injections has been compromised since its Treasury holdings have fallen almost in half. The decline in the Fed's Treasury holdings is the result of the Fed swapping its Treasuries for illiquid assets in the hope that these actions would kick start distressed asset markets. But if this strategy does not work, the Fed will be in the position of having fewer assets than liabilities. As a result, the Fed's ability to tighten would be limited.

Is there any hope for the Fed's balance sheet? Apparently, the Fed thinks there is at least one more clever solution: issue its own debt. As reported by the WSJ, the Fed is considering debt sales of its own. This would certainly give it more flexibility in managing its balance sheet, but it comes with a whole set of new problems as noted by Yves Smith and Jesse. Chris Sims has been thinking about these problems. He has a paper that outlines the some of issues. Here are some excerpts:
Should the central bank care about its balance sheet?
  • Naive answer: Of course not, since they can always “print money” to pay for anything they owe.
  • Correct answer: Yes, if the central bank is responsible for controlling inflation.
  • Open market operations to restrain inflation: Sell assets to put upward pressure on interest rates and reduce high-powered money.
  • If the CB’s stock of assets is well below the total value of its liabilities, there will be limits to how sharply it can tighten without running out of assets to sell.
  • Some CB’s in this situation (running out of assets) have issued interest bearing debt on their own account (e.g. Korea) or taken in deposits bearing market interest rates (Israel). These have non-traditional fiscal impacts — in effect an unelected body is generating potential future fiscal burdens and competing with the Treasury in the bond markets.

Rosy scenario
[for the Fed going forward]
  • The panic subsides.
  • The private assets the Fed and the Treasury have acquired prove saleable at prices better than their purchase prices.
  • The tax burden of future generations is slightly reduced.
  • The Fed goes back to its old balance sheet model; independence of monetary policy is preserved.
Bad luck: Deflationary spiral [for the Fed going forward]
  • Even the tremendous interventions of the Fed and the Treasury prove too slow and too small to stem panic.
  • Asset prices continue to drop.
  • Bankruptcies snowball.
  • Commodity price drops feed in to the general price level and deflation accelerates.
  • Deflation only makes bonds still more attractive.
  • Deflation makes Fed dollar-denominated assets rise in real value, while making more of the private loans it has acquired default — the Fed’s balance sheet deteriorates.
Bad luck: Inflationary spiral [for the Fed going forward]
  • The Fed’s asset purchases turn out to be worth little.
  • Possibly even without deflation, its balance sheet goes negative.
  • Popular revulsion against Wall Street and the Fed makes it politically impossible for the Treasury to provide backing to the Fed.
  • No new taxes” political rhetoric becomes even more popular, so that investors come to see the US as unlikely to back its suddenly larger fiscal burden with future primary surpluses.
  • So inflation spirals out of control
Bad luck: Good policy [for the Fed going forward]
  • That either or both of inflation and deflation could emerge if the assets acquired turn out to be worth little is both a frightening aspect of the situation and a key to its possible resolution.
  • Several recent studies analyzing the great depression (e.g. Eggertsson, AER) have suggested that the only successful monetary/fiscal policy combination would have been one that convinced the public that policy would deliver future inflation at some target level.
  • This would make government paper less attractive now, and thereby induce people to start spending.
Read the rest of the paper here. Until this crisis, I did not realize the composition of a central bank's balance sheet could be so important.

Update: Tyler Cowen weighs in on the Fed's proposal to issue its own debt.

Monday, December 8, 2008

Brad DeLong: the Propagation Mechanism is Key

Brad DeLong responds to Larry White's article "What Really Happened" at CATO Unbound by arguing that an understanding of the economic shocks that started the current crisis is not as important as is understanding why the shocks have been propagated into the worst global financial crisis since the Great Depression:
Thus we have an impulse — a $2 trillion increase in the default discount from the problems in the mortgage market — but the thing deserving attention is the extraordinary financial accelerator that amplified $2 trillion in actual on-the-ground losses in terms of mortgage payments that will not be made into an extra $17 trillion of lost value because global investors now want to hold less risky portfolios than they wanted two years ago.


Thus my dissatisfaction with Larry White’s piece: he talks only about the impulse, while it is the propagation mechanism — the financial accelerator — that is the important part of the story...
DeLong's point is a good one that could be leveled against me too, as I have spent most of my time writing about how we got here rather than why the fallout has been so pronounced. I do, though, disagree with DeLong's claim that the Fed had little influence on the housing boom. In evaluating the Fed's impact, he only looks at the dollar value of the Fed's open market purchases (OMP). The absolute dollar size of the OMP, however, is not important. What is important is whether these increases in liquidity were excessive relative to the demand for them. One only needs to look at the negative real federal funds rate that persisted over this period to see that these injections were excessive. (Read here and here for more on this view.) Still, DeLong's main point about the propagation mechanism is a good one. Probably the best analysis on this issue comes from Claudio Borio and others at the BIS. See here for a summary of some of their relevant research.

Update: Josh Hendrickson provides further thoughts on this discussion.

Application form for the Federal Bail Out Program

In case you have been looking for the federal bailout application form you can find it here.

Friday, December 5, 2008

If Only the Fed Had Been Targeting Nominal Income

Over at Cato Unbound, Lawrence H. White explains the reason why the Federal Reserve's monetary policy was too accommodative in the early-to-mid 2000s was that if failed to stabilize nominal spending:
How do we judge whether the Fed expanded more than it should have? One venerable norm for making fiat central bank policy as neutral as possible toward the financial market is to aim for stability (zero growth) in the volume of nominal expenditure. [2] Second-best would be a predictably low and steady growth rate of nominal expenditure. A useful measure of nominal expenditure is the dollar volume of final sales to domestic purchasers (GDP less net exports and the change in business inventories). During the two years from the start of 2001 to the end of 2002, final sales to domestic purchasers grew at a compound annual rate of 3.6 percent. During 2003, the Fed’s acceleration of credit began to show up: the growth rate jumped to 6.5 percent. For the next two years, from the start 2004 to the end of 2005, the growth rate was even higher at 7.1 percent, nearly a doubling of the initial rate. It then backed off, to 4.3 percent per annum, from the start of 2006 to the start of 2008. But the damage from an unusually rapid expansion of nominal demand had been done.
A key implication is that had there been a nominal income targeting rule, monetary policy during this time would have been more stabilizing. I am a big fan of nominal income targeting and hope some day it becomes as popular as inflation targeting has been over the past few decades. For more discussion on why a nominal income targeting rule would have made a difference in the early-to-mid 2000s see my posts here and here. Also see this classic paper on nominal income targeting for a good overview.

The Real Balance Effect During the Great Depression

Okay, one more posting on the real balance effect and the vertical AD curve during the Great Depression. Yesterday, Paul Krugman set out to demonstrate why the real balance effect did not matter during the Great Depression. His main point was that the impact from even a sharp fall in the price level would not be that consequential for aggregate demand since the monetary base itself is not that large and the wealth effect is similarly modest in size. His post, however, only raises more questions:

(1) Krugman doesn't actually look at 1930s data--which was the original point of contention--but at current data. One, therefore, cannot easily draw conclusions about the real balance effect during the Great Depression based on his posting.

(2) Why look only at the monetary base? Real money balances would at least include M1, if not M2. Since these monetary aggregates are notably larger than the monetary base, the real balance effect would be larger than Krugman shows with the monetary base.

(3) Krugman assumes a standard wealth effect elasticity of 0.05%. This estimate is usually associated with a wealth effect from stocks during normal times, but it is not clear it would be the same for real money balances during periods of intense economic distress. Consumption smoothing is the reason the the wealth effect number is less than one in normal times--individuals would not want to consume all their wealth gains presently but spread it out over time to smooth consumption--but when one's world is collapsing around them, as it was during the Great Depression, are individuals really thinking about consumption smoothing over their lifetime? During such times, individuals get myopic and think more about just making it through the day. This would imply a higher wealth effect elasticity for real money balances. A paper by Karl Case, John Quiqley, and Robert Shiller shows that wealth effects do change based on the the type of wealth. In this paper, the authors discuss some interesting findings on various wealth effects:
Differential impacts of various forms of wealth on consumption have already been demonstrated in a quasi-experimental setting. For example, increases in unexpected wealth in the form of large lottery winnings lead to large effects on short-run consumption (see Imbens, Rubin, and Sacerdote, 1999). Responses to surveys about the uses put to different forms of wealth imply strikingly different “wealth effects” (Shefrin and Thaler, 1988).
The bottom line is that not all wealth effects are the same, even in good economic times. Throw in bad economic conditions and all bets are off on the 0.05% wealth effect number used by Krugman.

So let's put points (1) - (3) to use and construct the real balance effect in 1933--the last year of the Great Contractions--following Krugman's method. First, take a look at M2, real M2, and nominal GDP for this period in the figure below: (Click on the figure to enlarge.)

Real M2 is constructed by deflating M2 with the GDP deflator. All data come from here and here. Using 1929 as the base year, real money balance wealth gains were $11.26 billion in 1933. Using Krugman's 0.05% wealth effect number times the $11.26 billion, we get $0.563 billion which is about 1% of nominal GDP ($56.4 billion) in 1933. If we assume a multiplier of 2, as did Krugman, then the real balance effect raises GDP by about $2 billion or about 2%. This non-trivial increase suggests there was at least some downward slope to the AD curve.

But wait, what if my contention that Krugman's 0.05 wealth effect elasticity is on the low side is correct? Then there would be even a larger gain to GDP. Using the same approach as above, here are some possible scenarios using slightly higher wealth effect numbers:

Again, when people are living day-to-day they are probably not thinking about consumption smoothing, but rather are spending any by any means possible, including their wealth gains. Consequently, if anything these numbers are probably on the low side. Now, this analysis, is far from complete, but at a minimum it shows that a meaningful real balance effect was possible during the 1929-1933 downturn. These results, in conjunction with Tyler Cowen's point that an infinite liquidity preference is needed here, make it hard for me to believe there was a vertical AD curve during the Great Contraction.

Update 1: ECB in the comments notes a flaw in my analysis: the real balance effect should only apply to outside money since it only--and not inside money like M2--is a net asset to the private sector. This means my analysis overstates the real balance effect. It also means Krugman was correct to use the monetary base. See here for more on this point.

Update 2: Based on the flaw mentioned in update 1, I redid the analysis using Friedman & Schwartz's monetary base numbers. Using 1929 as the base year, one finds a real money balance gain of $2.85 billion by 1933. Again, using Krugman's multiplier of 2 and allowing for different wealth effect elasticities, here are some scenarios:
To get a meaningful real balance effect then, one must allow for higher wealth effect elasticities. As argued above, such high wealth effect elasticities are entirely reasonable during times of severe economic distress.

The Future of the Euro (Part III)

Barry Eichengreen says I should stop worrying about the future of the Euro.

Wednesday, December 3, 2008

Paul Krugman and the Vertical Aggregate Demand Curve

Paul Krugman is all over Amity Shales's argument that the New Deal's high wage doctrine reduced employment and ultimately output. He blasts her here, here, and here. His main beef with Shales is that her argument assumes an downward slopping aggregate demand (AD) curve which he asserts was not possible during the early-to-mid 1930s. In his words:
[I]n normal times the AD curve slopes down, we think, because other things equal a higher price level increases the demand for money, which drives up interest rates, which reduces desired spending. (In terms of IS-LM analysis, higher P leads to lower M/P which shifts LM left.)

But in liquidity trap conditions, the interest rate isn’t affected at the margin by either the supply or the demand for money – it’s hard up against the zero bound. And as a result the usual explanation for the downward slope of the AD curve doesn’t work.
As a result, Krugman claims that instead of a downward slopping AD curve there was a vertical slopping AD curve. This, in turn, means any leftward shift of the AS curve from the high nominal wages should have no effect on output. Here is his money graph:There is a problem, however, with Krugman's story. It assumes there is no real balance (or pigou) effect and if there is one Krugman claims it is swamped by the impotency of the interest rate channel effect and the effect of debt deflation. This assumption is highly controversial. I can buy that there was some steeping of the AD curve, but to forcefully conclude that it was perfectly vertical and, thus, high nominal wages had no effect on employment and output seems too extreme. Where is the conclusive evidence?

What is really remarkable is that despite this empirically-unsupported assumption, Krugman concludes as if it is truth and, therefore, claims that those observers who think otherwise are not "thinking it through":
The key point, then, is that the reality of a liquidity trap in the 1930s has crucial implications for what we think about the effects of policies like the NIRA. People who assert that New Deal support for wages made the Depression much worse aren’t thinking it through. They’re implicitly assuming – not demonstrating – that the AD curve had a “normal” slope, even in the depths of the Depression. But it didn’t.
Krugman may be correct in his assumption about the real balance effect, but I think one can reasonably disagree with him on this point until there is conclusive evidence.

Update: Tyler Cowen also questions Krugman's vertical AD curve.

Update II: Paul Krugman explains why he dismisses the real balance effect.

Tuesday, December 2, 2008

Will the Euro Survive? (Part II)

Back in early November I noted that Desmond Lachman was arguing that the global financial crisis increased the likelihood that the Eurozone would not survive in its current form. His argument was that since the Eurozone is not an optimal currency area the stresses from the financial crisis may crack it open. Martin Feldstein is now making a similar case (ht Mark Thoma):
CAMBRIDGE – The European Economic and Monetary Union (EMU) and the euro are about to celebrate their tenth anniversary. The euro was introduced without serious problems and has since functioned well, with the European Central Bank delivering the low inflation that is its sole mandate.

But the current economic crisis may provide a severe test of the euro’s ability to survive in more troubled times. While the crisis could strengthen the institutions provided by the EMU, it could also create multiple risks, of which member countries need to be aware if they want to avoid them.

The primary problem is that conditions in individual EMU members may develop in such different ways that some national political leaders could be tempted to conclude that their countries would be better served by adopting a mix of policies different from that of the other members. The current differences in the interest rates of euro-zone government bonds show that the financial markets regard a break-up as a real possibility. Ten-year government bonds in Greece and Ireland, for example, now pay nearly a full percentage point above the rate on comparable German bonds, and Italy’s rate is almost as high.


The most obvious reason that a country might choose to withdraw is to escape from the one-size-fits-all monetary policy imposed by the single currency. A country that finds its economy very depressed during the next few years, and fears that this will be chronic, might be tempted to leave the EMU in order to ease monetary conditions and devalue its currency. Although that may or may not be economically sensible, a country in a severe economic downturn might very well take such a policy decision.
Feldstein's article prompted me to go back and look at the Intrade contract that predicts whether "any country currently using the Euro [will] announce their intention to drop it on/before 31 Dec 2010." Here is the figure from the contract (click on figure to enlarge):

Not much change since early November, but still almost 40%. As noted before, there are some great articles on the future of the Euro found here.

Has Charles Plosser Been Reading This Blog?

Real Time Economics is reporting that Federal Reserve Bank of Philadelphia President Charles Plosser gave a speech today where he said "economic growth will continue to be weak over the next several quarters before improving in the latter part of 2009..." That is exactly the timing I came up with in this recent posting. Read the post to see how I did the forecast, but here is the money graph from that entry:

Historian Eric Rauchway on the Great Depression

The latest podcast EconTalk:
Eric Rauchway of the University of California at Davis and the author of The Great Depression and the New Deal: A Very Short Introduction, talks with EconTalk host Russ Roberts about the 1920s and the lead-up to the Great Depression, Hoover's policies, and the New Deal. They discuss which policies remained after the recovery and what we might learn today from the policies of the past.
Listen to the podcast here.

Saturday, November 29, 2008

Was the American Revolution the Product of a Boom-Bust Cycle?

Ronald W. Michener and Robert W. Wright say yes. According to this article, these authors have "worked for several years on a manuscript arguing that the American Revolution was a direct result of the economic malaise that followed the French and Indian War." So how exactly does their story unfold? From the article:
For the colonists, as for us, first came the boom. During the height of the French and Indian War, which lasted from 1754 until 1763, money flooded into the colonies, especially New York, where the British Army was headquartered. At the same time, the New York Legislature issued large numbers of bills of credit.

All that cash sloshing around resulted in lavish displays of wealth — notably by British officers, whose opulent living was emulated by the locals, especially in New York.

Housing prices soared during the war. But when credit tightened afterward — thanks in no small part to a prohibition on the issuance of paper money by the colonies under the Currency Act of 1764 — real estate owners who could not pay their debts lost their land.


At the core of the Wright-Michener argument is that this confluence of nasty economic circumstances was what produced the anger that found expression in rebellion against the Stamp Act and other British taxes. In other words, the core economic culprit was a boom-bust cycle; convinced that their future was no longer in their hands, the colonists could summon the ghost of John Locke, setting the stage for the arguments of Tom Paine and the Declaration.
I wonder if Niall Ferguson included this story in his new book.

Paul Krugman Versus Christina Romer

Paul Krugman is questioning whether the Great Depression was truly a monetary phenomenon. He apparently missed Christina Romer's article "What Ended the Great Depression?" where she shows that monetary developments were key not only to the economic recovery of 1933-1936 but also for the post-1938 recovery. These developments were what I would call unconventional monetary policy: FDR's devaluing gold, gold inflows from abroad, and Treasury choosing not to sterilize them. See here for more discussion of her findings--including a striking figure that shows what would have happened had there not been these monetary developments--and how it raises questions for the World War II-ended-the-Great-Depression story.

Update: See Josh's comments below and Zubin Jelveh's take on the numbers.

Wednesday, November 26, 2008

What Corporate Bond Yield Spreads Tell Us

Recently, a number of concerned observers took note of the rising cost of corporate borrowing by looking at real interest rates on AAA-rated and BAA-rated bonds. Let me add to their concern by looking at the BAA yield minus AAA yield spread. Whenever the spread between these two securities increases the market believes there to be a higher probability of default for the riskier BAA rated bonds. The spread may also increase as a result of the BAA securities becoming less liquid, either as a result of their increased riskiness or because of stress in financial markets. Since there are a large number of firms in these measures, the spread provides a good indicator of economy-wide stress facing firms. The spread, therefore, provide some insights into the overall state of the economy. The figure below graphs the spread and the officially dated NBER recession with gray bars. The data comes from the St. Louis Fed, has a monthly frequency, and runs through 11/24/08. (click on figure to enlarge.)

The figure shows that spread is now notably higher than it was during the 1973-1975 and early 1980s recessions. Moreover, the spread indicates corporate borrowing is now as stressed as it was during the second half of the Great Depression. So what does this mean for the real economy? To answer that question I took spread data for the entire period and plugged it along with the Fed's monthly industrial production series (also from St. Louis Fed) into a Vector Autoregression (VAR) with 13 lags (enough to eliminate serial correlation). Using the estimates from this simple VAR I was able to do a dynamic forecast of industrial production through the end of 2009. The figure below shows the results of this exercise. The blue portion of the line is the actual series while the red line is the forecast. (click on figure to enlarge.)

This simple bivariate model indicates the recession will last through August 2009. This implies that if the recession began in January 2008, then it should be a 20 month recession overall. This forecast assumes, though, the spread reaches a peak this month. If this assumption proves to be incorrect then the trough would be pushed back to a later date.

Tuesday, November 25, 2008

Monetary Policy Ended the Great Depression...

and not fiscal policy, according to Christina Romer in her 1992 JEH paper. Tyler Cowen recently referenced this article--amidst the New Deal debate ragging between Alex Tabarrok, Eric Rauchway, Paul Krugman, and others--and I want to follow up by noting a few more details from its conclusions. First, Romer found that fiscal policy was inconsequential not only in the early -to-mid-1930s, but also as late as 1942. Her results call into question the traditional view that World War II-driven fiscal policy ended the Great Depression. Second, Romer shows that it was monetary developments that ended the Great Depression, both in the mid- and late-1930s. In her own words:
The money supply grew rapidly in the mid- and late 1930s because of a huge unsterilized gold inflow to the United States. Although the later gold inflow was mainly due to political developments in Europe, the largest inflow occurred immediately following the revaluation of gold mandated by the Roosevelt administration in 1934. Thus, the gold inflow was due partly to historical accident and partly to policy. The decision to let the gold inflow swell the U.S. money supply was also, at least in part, an independent policy choice. The Roosevelt administration chose not to sterilize the gold inflow because it hoped that an increase in the monetary gold stock would stimulate the depressed economy.(p. 781)
So a defacto easing of monetary policy was the source of the 1933-1937 recovery as well as the one after 1938.

To make these findings more concrete, Romer performed some counterfactuals to demonstrate what would have happened had there not been expansionary macroeconomic policies. She does this by showing the actual path of real GNP and its path under non-expansionary policies. The difference between the two series show the importance of the expansionary policy that took place during this time. First she shows the impact of fiscal policy:Note there is no meaningful difference between these series. Hence, there was no real expansionary fiscal policy, even as late as 1942. Next, she shows the effect of monetary policy:
Here there is a significant difference. Romer concludes "real GNP would have been approximately 25 percent lower in 1937 and nearly 50 percent lower in 1942 than it actually was if the money supply had continued to grow at its historical average."

So much for the World War II story. But wait, Romer does notes that World War II can still be credited in a different way for ending the Great Depression:
However, Bloomfield's and Friedman and Schwartz's analyses suggested that the U.S. money supply rose dramatically after war was declared in Europe because capital flight from countries involved in the conflict swelled the U.S. gold inflow. In this way, the war may have aided the recovery after 1938 by causing the U.S. money supply to grow rapidly. Thus, World War II may indeed have helped to end the Great Depression in the United States, but its expansionary benefits worked initially through monetary developments rather than through fiscal policy.

Once again we are reminded that monetary policy matters.

Update: To be clear, Romer does not say fiscal policy could not be effective only that it was not really tried. See Mark Thoma for more on this point.

Monday, November 24, 2008

Niall Ferguson

Niall Ferguson must never tire. He produces books so rapidly one wonders whether he ever sleeps. Ferguson's latest book is the The Ascent of Money. According to the cover, Ferguson shows that "finance is in fact the foundation of human progress. What’s more, he reveals financial history as the essential backstory behind all history." I love the implication: one cannot be a real historian unless one understands finance and economics. With such a ringing endorsement of my profession I am looking forward to getting a copy. There is also this interesting interview with Ferguson regarding his new book:

PBS will be airing a series to accompany this book in January. If you want a taste of Ferguson's writing without buying one of his books, take a look at his recent article in Vanity Fair titled "Wall Street Lays Another Egg."

More on the Business Cycle and the Church

I just presented a paper this past weekend looking at the dynamic response of religious participation and religious giving to economic shocks. This paper follows an earlier one where I found a strong countercyclical component to religious participation by evangelical Protestants and a slightly procyclical component for mainline Protestants. Economic theory provides good motivations for these results. Given my interest in this field of economics--yes, I am macroeconomist dabbling in the economics of religion--I was pleased to find the following video clip on CNN. It shows people turning to church as a means to smooth their consumption over this business cycle.

Saturday, November 22, 2008

Liquidity Premium Sign of the Times

The Cleveland Fed used to provide TIPS-based expected inflation estimates that accounted for the TIPS liquidity premium. No more. (Click on figure to enlarge)

Wednesday, November 19, 2008

Larry White on How the Fed Contributed to the Housing Boom

I have made the case here many times that the Fed's monetary policy in the early-to-mid 2000s was inordinately loose, and as a result, helped create the housing boom. Two channels through which this accommodative monetary policy affected the housing sector is that it (1) encouraged households to take on excessive leverage and (2) created a "search for yield" environment where investors looked at investment options they normally would ignore (e.g. subprime MBS). Larry H. White in this new paper adds another channel:
The Fed’s policy of lowering short-term interest rates not only fueled growth in the dollar volume of mortgage lending, but had unintended consequences for the type of mortgages written. By pushing very-short-term interest rates down so dramatically between 2001 and 2004, the Fed lowered short-term rates relative to 30-year rates. Adjustable-rate mortgages (ARMs), typically based on a one year interest rate, became increasingly cheap relative to 30-year fixed-rate mortgages. Back in 2001, non teaser ARM rates on average were 1.13 percent cheaper than 10-year fixed-mortgages (5.84 percent vs. 6.97 percent). By 2004, as a result of the ultra-low federal funds rate, the gap had grown to 1.94 percent (3.90 percent vs. 5.84 percent). Not surprisingly, increasing numbers of new mortgage borrowers were drawn away from mortgages with 30-year rates into ARMs. The share of new mortgages with adjustable rates, only one-fifth in 2001, had more than doubled by 2004. An adjustable-rate mortgage shifts the risk of refinancing at higher rates from the lender to the borrower. Many borrowers who took out ARMs implicitly (and imprudently) counted on the Fed to keep short-term rates low indefinitely. They have faced problems as their monthly payments have adjusted upward. The shift toward ARMs thus compounded the mortgage-quality problems arising from regulatory mandates and subsidies.
Read the whole paper here.

Monday, November 17, 2008

Another Economic Prophet: Peter Schiff

I have labeled Nouriel Roubini and Andy Xie as certified economic prophets for calling the financial crisis ahead of time. Let me add Peter Shiff to the list. He too warned of the looming financial crisis. What is really remarkable is that he made this call many times despite the intense ridicule he received from the naysayers. See him get scorned below:

I admire Peter Schiff's resolve. Thanks to my student Adam Alderman for the pointer.

Wednesday, November 12, 2008

Did the "Great Moderation" Contribute to the Financial Crisis?

Since the early-to-mid 1980s there has been a pronounced drop in macroeconomic volatility. This development has been called the "Great Moderation" and can be seen in the figure below. This figure shows the rolling 10-year average real GDP growth rate along with one-standard deviation bands. These standard deviation bands provide a sense of how much variation or volatility there has been around the 10-year average real GDP growth rate. The figure shows a marked decline in the real GDP volatility beginning around 1983. (Click on figure to enlarge)

Solid line = 10 year real GDP growth rate rolling average
Dashed line = 1 standard deviation

Something I have been wondering lately is whether this "Great Moderation" contributed to the financial crisis by creating complacency about macroeconomic conditions. Is it possible that policymakers, investors, and others came to believe that improvements in macroeconomic stability were a given and, as a result, let their guard down? Thomas Cooley believes this may be the case:
There is another, deeper possible link between the Great Moderation and the financial crisis that is worth thinking about, because it may help to inform the financial regulation of the future. The idea is simply that the decline in volatility led financial institutions to underestimate the amount of risk they faced and overestimate the amount of leverage they could handle, thus essentially (though unintentionally) reintroducing a large measure of volatility into the market.

Financial institutions typically manage their risk using what they call value at risk or VaR. Without getting into the technicalities of VaR (and there is a very long story to be told about the misuse of these methods), it is highly likely that the Great Moderation led many risk managers to drastically underestimate the aggregate risk in the economy. A 50% decline in aggregate risk is huge, and after 20 years, people come to count on things being the same.

Risk managers are supposed to address these problems with stress testing--computing their value at risk assuming extreme events--but they often don't. The result was that firms vastly overestimated the amount of leverage they could assume, and put themselves at great risk. Of course, the desperate search for yield had something to do with it as well, but I have a hard time believing that the managers of Lehman, Bear Stearns and others knowingly bet the firm on a systematic basis. They thought the world was less risky than it is. And so, the Great Moderation became fuel for the fire.
So as much as the Great Moderation has been praised, it may turn out to be a key contributor to the biggest financial crisis since the Great Depression.

Sunday, November 9, 2008

The Challenges Ahead

Nouriel Roubini reminds us of the challenges facing President-elect Obama over the next few years:
Obama will inherit [an] economic and financial mess worse than anything the U.S. has faced in decades: the most severe recession in 50 years; the worst financial and banking crisis since the Great Depression; a ballooning fiscal deficit that may be as high as a trillion dollar in 2009 and 2010; a huge current account deficit; a financial system that is in a severe crisis and where deleveraging is still occurring at a very rapid pace, thus causing a worsening of the credit crunch; a household sector where millions of households are insolvent, into negative equity territory and on the verge of losing their homes; a serious risk of deflation as the slack in goods, labor and commodity markets becomes deeper; the risk that we will end in a deflationary liquidity trap as the Fed is fast approaching the zero-bound constraint for the Fed Funds rate; the risk of a severe debt deflation as the real value of nominal liabilities will rise given price deflation while the value of financial assets is still plunging.


So let us not delude each other: the U.S. and global recession train has left the station; the financial and banking crisis train has left the station. This will be a long and severe and protracted two year recession regardless of the best intentions and good policies of the new U.S. administration. It will take a lot of hard work and sound policies to clean up this mess and reduce the length and severity of this economic contraction.
Expect a few more gray hairs from out next President.

Will the Euro Survive?

I was a little puzzled last week after reading Wolgang Munchau's column in the FT. He noted that some of the European countries outside the Eurozone--specifically Denmark, Hungary, Iceland--are now wishing they were members and probably will become so in the near future. Based on these developments he argued the global financial crisis should actually lead to an enlargement of the Eurozone. While his argument makes sense in the case of the few countries mentioned above, what about the broader Eurozone? Does not the global financial crisis add more stress to the viability of the Eurozone? In a reply to Munchau, Desmond Lachman says yes:
Sir, Wolfgang M√ľnchau seems to be very wide of the mark in asserting that the present global financial crisis will lead to the early expansion of the eurozone... For, as the marked widening in interest rate spreads on Italian and Spanish government bonds would suggest, the more pressing question raised by the crisis is not so much whether the eurozone will expand but rather whether or not the euro can survive in its present form.

In 1998, when the euro was launched, Milton Friedman famously warned that the euro would be truly tested by the first major global economic recession. He issued this warning in the belief that, lacking labour and product market flexibility, Europe was not an optimum currency area in the sense that was the case of the U.S. economy.

Judging by October's alarming plunge in global equity prices and the virtual freezing up in global credit markets, there can be little doubt that Europe, along with the United States, is at the start of its worst economic recession in the postwar period. And judging by the bursting of Spain's outsized housing market bubble and by the precarious state of Italy's public finances, there can be little doubt that Spain and Italy will be the two major European economies that will be put to the severest of tests as the global recession deepens.

For in order to cope with their respective problems, Spain and Italy will need low interest rates and weak currencies that continued euro membership clearly precludes.
In short, Lachman is questioning whether the Eurozone in its current form is an optimal currency area and, thus, whether it can truly survive. Apparently, so are some investors thinking this way. Over at intrade.come there is a contract on whether "any country using the Euro to announce their intention to drop it on/before December 2010." Here is the latest figure--where price equals probability-- from the contract (click figure to enlarge):

Currently the probablity of say Spain or Italy leaving the Euro is between 30-35%. Although not very high, it is a sizable increase from when the contract was introduced in early 2008. So what is the future of Euro?

Update: Here is a related post from Naked Capitalism. Here are some papers from a conference on the future of the Euro hosted by The Economist magazine and CATO.