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Today’s Economist: Laura D’Andrea Tyson: The Sequester and Fiscal Policy

March 8, 2013 by Leave a Comment

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Laura D’Andrea Tyson is a professor at the Haas School of Business at the University of California, Berkeley, and served as chairwoman of the Council of Economic Advisers under President Clinton.

The sequester – the large, across-the-board cuts in federal government spending that began to take effect on March 1 and are scheduled to persist through the next decade – is a product of political stalemate and ideology cloaked in the language of fiscal responsibility. Despite what some of its champions proclaim, there is no economic justification for the sequester. It is the wrong medicine for what ails the economy now and the wrong cure for its future budgetary challenges.

Today’s Economist

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As a result of a deep and lingering deficiency in aggregate demand, the United States economy is operating far below its potential. Real gross domestic product fell by 8 percent relative to its non-inflationary potential level in 2008 and has remained about 8 percent below the level consistent with its pre-recession growth rate ever since.

The gap between the actual and potential level of output means about $900 billion of forgone goods and services this year alone. This tremendous waste of productive potential is reflected in an unemployment rate of 7.9 percent, a higher rate than at any point in the 24 years before the depths of the 2008 recession, and a poverty rate of 15 percent, significantly above the average of the last 30 years.

High levels of unemployment impose substantial costs not only in terms of human suffering and forgone output now but also in terms of the economy’s productive potential in the future. The longer the economy operates below its current capacity, the slower the growth of its future capacity as a result of diminished risk-taking, forgone investment and the erosion of skills.

Besides its sheer size, what’s remarkable about the gap between actual and potential output is its persistence, despite a sustained and unprecedented effort by the Federal Reserve to boost demand and hasten the recovery. For more than five years, the Fed has held the nominal short-term interest rate near zero – its effective lower bound — with a promise to keep it there at least until the unemployment rate falls to 6.5 percent. The Fed has also been purchasing about $1 trillion of long-term government bonds annually. As a result of these actions, the nominal yield on the 10-year Treasury bond, a measure of the borrowing costs of the federal government, hovers around 2 percent, less than a third of its 40-year average, and both short-term and long-term interest rates are less than the rate of inflation.

In a speech earlier this week to the National Association of Business Economists, the Fed’s vice chairwoman, Janet Yellen, reaffirmed the Fed’s commitment to its bold accommodative policies until there is a “substantial improvement in the outlook for the labor market.”

Under current economic conditions, with significant unutilized resources, low inflation and highly accommodative monetary policy, contractionary fiscal policy has contractionary effects: spending cuts and tax increases reduce aggregate demand, choke job creation and dampen growth. In these circumstances, more deficit reduction is neither necessary nor wise; it is counterproductive. A more anemic recovery means less deficit reduction for any given set of fiscal policies.

Spending cuts at the local, state and federal levels have been powerful headwinds constraining growth during the last three years. And the headwinds are intensifying this year.

Taken together, the caps on discretionary spending imposed in 2011, the tax increases in the 2013 tax deal – especially the increase in payroll taxes that will trim household incomes by about $125 billion – and the sequester will cut about 1.5 percentage points from 2013 growth, consigning the economy to yet another year of tepid recovery and elevated unemployment. The sequester cuts alone will result in a loss of at least 700,000 jobs. And these arbitrary across-the-board cuts will inflict more damage on the economy than sensibly targeted cuts of the same magnitude.

Mr. Bernanke admonished Congress in his recent statement that monetary policy “cannot carry the entire burden of ensuring a speedier return to economic health.” Discretionary fiscal policy in the form of more debt-financed government spending is warranted and would be effective. Recent research finds that the multiplier for discretionary fiscal policy – the change in output caused by a change in discretionary government spending – is larger when interest rates are low and underutilized resources are available.

Indeed, under these conditions it is possible that increases in government spending will end up paying for themselves in the long run by speeding the recovery and stemming unnecessary losses in the economy’s future capacity. This possibility is the greatest for government spending in investment areas like research, education and infrastructure that generate sizable returns over time.
 
Mr. Bernanke also advised Congress that “not all tax and spending programs are created equal with respect to their effects on the economy,” and emphasized the importance of investments in work-force skills, research and development and infrastructure. Unfortunately, as a result of the caps on discretionary spending and the sequester, these areas will fall victim to significant cuts over the next decade.

If these policies are enforced, the Congressional Budget Office projects that discretionary spending will fall to 5.5 percent of G.D.P. by 2023, more than three percentage points below its 1973-2012 average, with nonmilitary outlays falling to 2.7 percent of G.D.P. compared with a 40-year average of 4 percent.

The economy needs less rather than more deficit reduction in the near term. But less deficit reduction also means more debt accumulation over time. Even with the sequester and the discretionary caps, federal debt held by the public is projected to recent Congressional testimony remain around 75 percent of G.D.P. during the next decade, compared with an average of about 40 percent between 1960 and the 2008 recession.

A large and growing government debt relative to the size of the economy has several negative potential consequences. Most important, when the economy is operating at capacity, it crowds out private saving and investment, reducing the capital stock, productivity and wage growth. It puts upward pressure on long-term interest rates and increases the cost of servicing the debt. It weakens investor confidence in the debt, heightens the risk of a financial crisis and reduces the government’s budgetary flexibility to address future, unexpected shocks.

The economy needs a long-run plan of revenue increases and spending cuts to put the federal budget on a sustainable path that will stabilize and reduce gradually the debt- to-G.D.P. ratio. Congress should jettison the sharp, front-loaded and arbitrary sequester cuts that will harm the recovery and work on such a plan.

Unfortunately, the political stalemate and ideology that produced the sequester appear to rule out this approach at least for now. Perhaps when the sequester’s costs become apparent, Congress will be forced back to the negotiating table.

Article source: http://economix.blogs.nytimes.com/2013/03/08/the-sequester-and-fiscal-policy/?partner=rss&emc=rss

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Political Economy: Don’t Rely on Banking Union to Solve Euro Zone Crisis

December 9, 2012 by Leave a Comment

Conventional wisdom has it that the euro zone needs a banking union to solve its crisis. This is wrong. Not only are there alternatives to an integrated regulatory structure for the zone’s 6,000 banks, but centralization will undermine national sovereignty.

The rallying cry for a banking union sounded this year when it seemed that the euro zone might break apart. Advocates of such a union said that it would break the “doom loop” connecting troubled banks and troubled governments. This week, E.U. countries will meet to discuss the terms for a single supervisor for banks, the first stage of a banking union.

There are two parts to the doom loop: when banks go bust, their governments bail them out, adding to their own debts; and when governments become over-indebted, their lenders get sucked into a vortex, as their balance sheets are full of sovereign debt.

In its fullest incarnation, a European banking union would break the first part of this loop. There would be a central mechanism to recapitalize troubled banks or close them down. There would also be a single deposit guarantee scheme. The cost of dealing with banking crises would, therefore, be borne by the whole euro zone rather than by national governments.

The other half of the loop — the way ailing governments infect banks — would be left intact. This is worrisome given that banks in peripheral countries have doubled lending to their own governments to €700 billion, or more than $900 billion, in the past five years, according to the research organization Bruegel.

The current proposal does not even address the first part of the loop, as politicians are focusing on supervision. Although leaders did agree in June to let the euro zone directly recapitalize banks, Germany subsequently insisted that this would not apply to “legacy” assets, meaning that the promise was of no help to countries already hit by a banking crisis, like Greece, Ireland or Spain.

Moreover, E.U. countries are finding it hard to agree on how a single supervisor should work. Germany does not want its savings banks covered, for instance, an exemption that other countries think would be unfair. Germany is also worried that the European Central Bank, which will take over the supervision, could be diverted from its main role of fighting inflation if it felt the best way to prevent a banking blowup was to keep interest rates artificially low.

There are also difficulties that come with trying to satisfy the interests of countries that are part of the European Union but that are not in the euro zone. Some, like Poland, might want to join the banking union but complain that they do not have a say at the E.C.B.

Meanwhile, Britain does not want to join the banking union but is worried that the E.C.B. will make decisions that will be detrimental to London. Last week, Christian Noyer, governor of the Banque de France, fanned those fears when he told The Financial Times that there was “no rationale” for letting the euro zone’s financial hub be “offshore,” a reference to the fact London is not in the euro zone.

There is an alternative way of breaking the doom loop. First, banks should be required to hold a large chunk of capital that can be used to absorb losses if they go into a tailspin. This cushion, which could be in equity or in bonds, should amount to 15 percent to 20 percent of their “risk-weighted” assets, roughly double the equity-only cushion that new regulations demand. With such a big buffer, there would be less risk that governments would need to bail out their banks. Although the European Commission has bought into this concept, it has not quantified the buffer. It should do so.

Second, banks should be required to diversify their holdings of government debt. Greek banks would not hold little other than Greek bonds and Spanish lenders would not own almost only Spanish debt. Instead, all banks would have a mixture of bonds from across the euro zone, making them less vulnerable to over-indebted national governments.

With these two mechanisms in place, supervision, deposit insurance and “resolution” — the orderly wind-down of ailing banks — could be left to the national authorities. Governments would be free to devise their own policies for dealing with future bubbles, by jacking up the minimum capital ratios for banks or capping the size of mortgages, for instance.

There would still need to be coordination across the euro zone. The E.C.B. would also need to have the fortitude to refuse to act as a lender of last resort to inadequately capitalized banks. But, at the very least, even more powers would not be transferred to an unelected central bank in Frankfurt.

If the euro zone is determined to create a single banking supervisor, it should at least do so properly. That means giving the E.C.B. authority over all banks, not just the big ones. After all, the problems of recent years have been concentrated in fairly small lenders, as seen with Spanish savings banks. If the taxpayers of the euro zone have to cover failing banks, then the E.C.B. needs the authority to clean up national banking systems from top to bottom. It also needs to be more accountable.

The worst outcome would be for no institution to be in charge. Banking supervision is only the first step of a banking union, which is only the initial stage of a planned political union. If leaders of the euro zone cannot stomach the necessary transfer of sovereignty in this case, they should devise a more decentralized model for banks and for their overarching project.

Hugo Dixon is the founder and editor of Reuters Breakingviews.

Article source: http://www.nytimes.com/2012/12/10/business/global/10iht-dixon10.html?partner=rss&emc=rss

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Chesapeake to Cut Number of Gas Rigs

January 24, 2012 by Leave a Comment

The announcement was not unexpected, and it followed a trend that has been under way for several months: oil and gas companies have been transferring drilling rigs to oil fields from natural gas fields. But given that Chesapeake has been the industry’s most public champion of natural gas, its announcement of an 8 percent cut in daily production led to a substantial rally in gas prices that had fallen last week to their lowest level in a decade.

Natural gas prices have been steadily falling over the last two years because of a glut stemming from mushrooming production in shale fields like the Haynesville in Louisiana, the Barnett in Texas and the Marcellus in Pennsylvania. Warm weather so far this winter has also cut normal seasonal demand significantly.

Aubrey K. McClendon, Chesapeake’s chief executive, said in a statement, “We have committed to cut our dry gas drilling to bare minimum levels.”

The company, based in Oklahoma City, said it would reallocate its investments from natural gas drilling to fields that are rich in oil and other hydrocarbon liquids like ethane, butane and propane, which are used as feedstocks for refining gasoline, diesel, heating and petrochemicals. Those fields are mainly in Ohio, Texas, Oklahoma and Wyoming.

Oil prices have remained strong the last two years because of instability in the Middle East and North Africa and growing demand in China and other developing countries. Since natural gas is not easily exported, prices in the United States are not tied to natural gas prices in Europe and Asia, which are still high.

Chesapeake, which has been responsible for almost a tenth of national gas output, said it would cut spending on drilling gas wells to $900 million in 2012 from $3.1 billion last year. The company said it would idle half of its drilling rigs in the next several months in fields that produce gas but no oil or hydrocarbon liquids.

The announcement showed that the oil industry does not know what to do with all the gas it is able to produce in shale fields, which were considered almost useless until a decade ago when new production techniques, including horizontal drilling and hydraulic fracturing, were first employed in a major way.

“This is a sign that the low price of gas has changed expectations for at least the next three to five years,” said Michael C. Lynch, president of Strategic Energy Economic Research, a consultancy. “If they thought the price would recover in a year or so, they would keep drilling.”

The Energy Department released a report on Monday predicting that shale gas production would increase to 13.6 trillion cubic feet in 2035, or 49 percent of total domestic natural production, from 5 trillion cubic feet in 2010, or 23 percent.

Gas futures contracts on the New York Mercantile Exchange rallied by almost 8 percent on Monday. Chesapeake shares rose by $1.32 to close at $22.28.

Halliburton, a leading service provider to oil and gas producers, warned last week that the slump in natural gas drilling could cause disruptions in its first-quarter operations and earnings. But the company said it expected that the shift to oil drilling from gas would not hurt its earnings over the year.

“We are very optimistic about 2012 and fully expect that North American revenue and operating income will increase over 2011,” said Dave J. Lesar, Halliburton’s chief executive, in a conference call.

Article source: http://feeds.nytimes.com/click.phdo?i=10da312dcde9aea402d4f70be194f922

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Spine Experts Repudiate Medtronic Studies

June 29, 2011 by Leave a Comment

The repudiation, appearing in a full issue of The Spine Journal devoted to the topic, represents a watershed in the long-running debate over conflicts of interest for the sponsorship of scientific studies by makers of drugs and medical devices. It is extremely rare for researchers to publicly chastise colleagues, and editors of leading medical journals said they could not recall an instance in which a publication had dedicated an entire issue for such a singular purpose.

Medtronic, the nation’s biggest maker of medical devices, has been facing intensifying scrutiny over its promotion of Infuse, the bone growth product at the center of the controversy. The bioengineered material is used primarily in spinal fusions, a procedure in which spinal vertebrae are joined to reduce back pain.

Infuse is used in about a quarter of the estimated 432,000 spinal fusions performed in this country each year. The articles published on Tuesday charge that researchers with financial ties to Medtronic overstated Infuse’s benefits and vastly understated its risks by claiming there were none.

“It harms patients to have biased and corrupted research published,” five doctors wrote in a joint editorial that accompanied the reports. “It harms patients to have unaccountable special interests permeate medical research.”

“The spine care field is currently at a precarious intersection of professionalism, morality and public safety,” Dr. Christopher M. Bono, editor of the special edition, said in a statement. “As physicians and journal editors, we felt an obligation to present a thorough examination of this controversial issue.”

It is too early to predict how the articles will affect the financial fortunes of Medtronic, which earned an estimated $900 million from Infuse in its most recent fiscal year. But the potential consequences seem significant, and the company’s new chief executive, Omar Ishrak, decided to issue a statement in response.

Mr. Ishrak noted that the articles did not challenge the data Medtronic had submitted to the Food and Drug Administration that led to Infuse’s approval in 2002 for use in one type of spinal fusion. Separately, other company officials said Medtronic planned to retain independent experts to examine the issues raised by the publication.

“Integrity and patient safety are my highest priorities,” Mr. Ishrak said.

Medtronic officials acknowledged in interviews that it was common for them to review studies of its products before publication. However, they sought to distance themselves from the content of the published reports, and said outside researchers, not the company, had determined the significance of data and how it should be presented. At the heart of the issue are potential side effects related to Infuse’s use that emerged during patient studies conducted about a decade ago by outside researchers with significant financial ties to Medtronic.

Medtronic, as required, reported that data to the F.D.A., and the agency considered the rate of those complications significant enough in some cases to require the company to list them on Infuse’s label. But in reporting on such studies in 13 medical journal articles published during the last decade, researchers whose studies were paid for by Medtronic maintained that Infuse’s use was not tied to any complications.

In one article released Tuesday, experts said those reports played down Infuse’s risks and slanted them to favor Infuse’s performance over a bone graft, the material traditionally used in a fusion. Those experts estimated that the incidence of adverse events in connection with Infuse’s use ranged from 10 to 50 percent, depending on how it was used.

Those side effects, they said, include male sterility, infection, bone loss and unwanted bone growth. A stronger version of Infuse, called Amplify, was recently rejected for approval by the F.D.A. because of concerns about possible cancer risks.

In 2008, the agency warned the public that it had received reports of life-threatening injuries associated with the use of Infuse in the cervical portion of the spine, a use that was not approved by the agency.

Dr. Eugene J. Carragee, editor of The Spine Journal, said he believed that Infuse was a valuable product for patients who were not candidates for a bone graft. But he added that the publication had undertaken the review because he and other experts hoped to cleanse the scientific record.

Article source: http://feeds.nytimes.com/click.phdo?i=58c3c7a0187cdebb7fabb4a6221bc620

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