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I-9 Audits and Immigration Policy Failure July 16, 2011

Posted by Afflatus in Economics, immigration, Politics.
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Last week in the New York Times, there was an article about how the Obama Administration’s immigration policies are affecting small businesses around the country. It explains that while the Bush Administration focused on headline-making raids that resulted in arrests of immigrant workers, the Obama Administration has gone after employers with Immigration and Customs Enforcement’s I-9 audits.” These audits consist of requiring employers to verify the eligibility to work in the United States of all its employees. The theory behind the policy is that employers who hire undocumented workers create the demand that produces the influx of illegal immigrants.

While I certainly applaud the Obama Administration for halting the inhumane practices of raids and deportation of immigrant workers, I don’t think I-9 auditing is a good approach to solving our country’s immigration problem. The article details how burdensome and detrimental to production these requirements are on small businesses. Businesses are forced to fire good employees they otherwise would not fire. Business are also required to complete onerous paperwork.  Many even hire lawyers, further increasing their costs. One business owner said he had reduced his 2011 sales goals by 15% after the disruption caused by ICE’s I-9 audit.

Now, I understand that this “onerous paperwork” is attempting to ensure compliance with the law. It is illegal to hire workers that are ineligible to work in the United States, and the Justice Department should enforce the law. But the program is a abject failure. It’s goal – reducing employer demand for illegal workers – is not being achieved, and long-term progress towards the achievement of this goal seems far-fetched. It’s quite clear from the article that the illegal workers whom ICE requires businesses to fire have found other willing employers to give them jobs. So what is really being achieved besides burdensome regulations that hamper economic growth? Demand for undocumented workers is only reduced marginally, while economic growth is reduced substantially.

To me the I-9 audit program seems like a political tool employed by the Obama Administration to provide itself with cover for its support of immigrant-friendly policies such as the DREAM act. Whether this suspicion is true or not, the I-9 audits are yet another example of how our failure to address immigration reform in a comprehensive and smart way weakens America’s economy.

Debt Ceiling Debate – Politics and Policies July 11, 2011

Posted by Afflatus in Economics, Politics.
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A number of people have engaged me in a discussion about the ongoing debt ceiling negotiations with a great sense of anxiety. While a failure to raise the debt ceiling would be catastrophic for the United States (and the world), it is not yet time to start worrying. In fact, it would be strange if the negotiating parties, which effectively consist of the House Republican leadership and President Obama, reach a compromise deal before the final hour. For the next 10-14 days, the two sides will continue jockeying – through media outlets and face-to-face – in order to improve their respective negotiating positions.

Treasury Secretary Tim Geithner has said August 2 is the final day after which the Treasury can no longer use accounting tricks to avoid defaulting on some of its debt. Yesterday, the President said a deal needs to be agreed upon in 10 days in order to allow time for legislation to pass both houses of Congress to raise the debt limit in time. However, now is not the time to start worrying. In theory, one should not expect either side to compromise until it believes its negotiating position is at its peak strength relative to the other side. Unless one side comes to the humble conclusion that its negotiating position will only weaken in the future, do not expect to see a deal until the final hour. Despite this, I’m optimistic about a compromise deal occurring. Both sides consist of patriots who understand the devastating consequences America would suffer if they failed to raise the debt ceiling. Moreover, neither side wants to suffer the political blame for ruining the country’s financial dominance.

Many of my fellow Democrats have expressed exasperation that the debate has largely been happening on Republican terms. With the exception of the recent and marginal success Democrats have had in pushing the policy idea of closing tax loopholes on jets and yachts, the negotiations have largely taken place on Republican terms. This is especially true if you take a longer view and consider the Fiscal Year 2011 budget debate which culminated in early April. The reason for this right-leaning negotiation is that the Republican House majority, largely unified and highly disciplined, can credibly threaten that they will actually shut the government down (in April) or let the Treasury default on its maturing debt (now). In neither case could the President, or Democrats in Congress, credibly threaten to do the same. Why can the the Republican Party do this? Because it has been content to shirk the responsibilities of governing.

Since January the Republicans have proposed literally only one policy idea to help the fledgling economy: cut spending. Not only does this proposal fail on its own terms (they refuse to cut Defense spending, or subsidies for big businesses), but it is also economically fallacious. Current Republican arguments upend the foundation of modern macroeconomics, Keynesianism, which argues that counter-cyclical spending is required for a healthy economy. Put simply, this means that in times of economic boom (1990’s for example), government spending should be curtailed. In times of economic bust (2007-2009) government spending should be increased. This is based on the fact that during a recession three components of GDP (investment, consumer spending, and net exports) will almost certainly decrease. It follows that the fourth and final component of GDP should be increased. That’s called stimulus. It’s such a mainstream idea that even George W. Bush supported it.

This morning Moody’s Analytics details how government spending (stimulus and unemployment compensation) was crucial throughout the recession to keep the economy on its feet. Now, as it dries up, Moody’s is warning of a weakening of the economy. The June jobs report was poor – only 18,000 jobs were added to the economy. What’s striking is that the public sector lost 39,000 jobs! These are the direct result of federal, state and local budget cuts. Without these budget cuts forced upon government, the jobs situation would not look nearly as bad. Republicans insist on cutting government spending, and then when budget cuts lead to bad jobs reports, they bemoan the lack of jobs. Not only is this economically nonsensical, it is morally wrong. While refusing that rich people pay their fair share of the burden, they insist on cuts which disproportionally affect the poor. This is regressive and wrong. And it’s not the type of society in which I want to live.

So it is not yet time to worry about a the lack of a debt ceiling compromise. However, outrage over Republican economic ideology is long overdue.

RSA Animate: Crisis of Capitalism? June 18, 2011

Posted by Afflatus in Economics, Politics, World Affairs.
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In this RSA Animate series entitled “Crisis of Capitalism,” sociologist David Harvey lays out the standard analyses of what went wrong in the 2007-2009 Financial Crisis, and then then offers a Marxist interpretation of his own. The categories he lays out at the beginning  are instructive, and he presents some important facts about wage stagnation, wealth accumulation at the top, and the dominance of capital over labor. The video is thought-provoking and worth-watching, however his ultimate conclusions are unpersuasive.

Harvey argues that capitalism “never solves its crisis problems,” instead “it moves them around geographically.” He asserts that this is exactly what has happened: the US is recovering from its financial crisis, but Greece is experiencing a sovereign debt crisis. While both of these things are happening, Harvey makes no attempt to provide a causal link between the US recovery and the crisis in Greece. Without strong contrary evidence, I’m inclined to believe that the US recovery has little to do with the Greek sovereign debt crisis. Greece’s fiscal problems and economic stagnation date back decades, and why would US economic production cause Greece to be unable to repay maturing debt? Harvey doesn’t say.

Finally, Harvey concludes on a revolutionary note arguing that “any sensible person right now would join an anti-capitalist organization.” This is an overstatement. There is clearly room to solve the problems that led to the financial crisis within a capitalist system. In America, Dodd-Frank was a start. We still need more consumer protection safeguards and regulatory reform in the financial sector. I do like how Harvey concludes by suggesting that we need a broader discussion to solve these problems. A more inclusive dialogue will help bring about an economic system that is more responsible, just, and humane. However, it will be a capitalist system, and it should be.

Georgia Immigration on My Mind May 18, 2011

Posted by Afflatus in Economics, immigration, Politics.
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For the superstitious among us, Friday the 13th has always been a dark day. But this past Friday the 13th was a particularly bad day for all Americans, but especially for Georgians. On Friday May 13th, Georgia Governor Nathan Deal signed into law H.B. 87, the Illegal Immigration Reform and Enforcement Act of 2011. The law, which was modeled on similar legislation in Arizona and Utah, gives police the authority to verify the immigration status of suspected criminal offenders. This power will surely lead to widespread racial profiling. The law also requires many private employers, and all public employers, to check the immigration status of newly hired workers on a federal database called E-Verify, a highly burdensome regulation. Beyond that, the law is full of ambiguous language, making it likely law enforcement officers will abuse their newfound power with impunity. Just to ensure the law was sufficiently damaging, Georgia Republicans threw in some unfunded mandates with which county governments and state agencies must comply.

Perhaps one of the most outrageous provisions of the law is the creation of a new crime, “aggravated identity fraud,” for which one can be charged for using a fake ID in order to obtain employment. If found in violation one would be sentenced to state prison for up to 15 years and face up to a $250,000 fine. For comparison, the punishment in Georgia for having sex with a 16 year old is only five years jail time. With the stroke of a pen Georgia has become extremely hostile to undocumented workers, illegal immigrants, and, likely, Hispanic-looking people in general. This new law will cause serious economic and cultural damage to the state of Georgia. Moreover, it represents a growing hostility to immigrants in the United States. This growing trend in America is self-defeating and will hasten American decline.

The new law is almost certain to result in the moral injustice of racial profiling. This is not only wrong, but also contrary to American values, which is one of our country’s greatest strengths. Additionally, the law will significantly hamper the economic growth of several important industries in Georgia. Tourism will suffer greatly, as it has in Arizona where 40 conventions were canceled amid economic boycotts costing the state an estimated $141 million. In only its first seven months, Arizona’s immigration law cost the state a whopping 2,761 jobs and $9.4 million in tax revenue. Georgia’s leading industry is agriculture, which generates $65 billion annually toward the State’s economy and employs one out of every seven residents. Many of these workers are undocumented immigrants, without whom the agriculture industry would come to a grinding halt. This law will undoubtedly hurt Georgia’s economy at a time when it is struggling to revive itself.

The conventional wisdom is that undocumented workers are a huge drain on the state’s economic resources, paying no taxes and consuming vast amounts of government resources. In fact, the opposite is true. According to the Georgia Budget and Policy Institute, in 2006 undocumented immigrants in Georgia contributed between $215.6 million and $252.5 million in aggregated sales, income, and property tax to state and local government coffers. In addition, research by the Immigration Policy Center indicates that Georgia would lose more than $21.3 billion in economic activity if all undocumented immigrants were removed from the state and that immigrant owned businesses had sales and receipts of more than $12.2 billion and employed more than 74000 people in 2002. These are their contributions to the state; what about their costs? Undocumented immigrants are banned from using almost all government-provided social programs with two notable exceptions: K-12 public education and emergency health care. While it’s hard to have sufficient data on the exact net effects, it’s clear the conventional wisdom is wrong: undocumented immigrants contribute greatly to economic activity and government revenue in positive ways.

Moreover, one of America’s unique strengths, especially compared to other developed countries, is its open borders. Perhaps the biggest problem facing Western European countries, Russia, and Japan is their aging and contracting populations. An older and smaller workforce is a recipe for economic stagnation. The US Census Bureau projects that the American population will grow 49% over the next four decades, a fact largely due to immigration. The US has always been a country of immigrants and it will continue to be one. Immigrants will help America remain the most dynamic and powerful economy in the world. This pluralism is essential, and it, coupled with America’s unique creativity in innovation, will counteract other forces of American decline.

America must strive to remain an attractive place to live and work, and a place where all are welcomed equally. However, by targeting immigrants and Hispanics Georgia’s new law does just the opposite. The law is unequal as written and will be even more unjust in application. America’s trend of unchecked hostility towards immigrants, as Georgia’s new law so clearly embodies, will severely weaken America’s economic strength. Moreover, the trend, if it continues, will undermine America’s claim to be a place of equality and opportunity for all people. America’s greatest strength is its ideals. Let’s not abandon them.

US Debt and Reason for Optimism April 20, 2011

Posted by Afflatus in Economics, Politics, World Affairs.
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On Monday morning, April 18, the ratings agency Standard & Poor lowered its outlook on American debt from “stable” to “negative.” The change in S&P’s outlook on America’s credit worthiness signals that there is a one in three chance S&P will downgrade America’s credit rating (currently AAA) by 2013. The pundits, news anchors, and politicians went almost haywire over the announcement. The markets? They hardly budged. The Economist reports: “The market reaction has been about as benign as one could hope for; relative to the Friday close, equities are higher, bond yields are lower, and the dollar is basically flat. Markets shrugged.”

In a fantastic piece on the reality of America’s debt crisis, “American Government Debt: What, US Worry?”, The Economist’s Free Exchange blog provides logic and level-headedness throughout. The article clearly shows that America has a debt problem, but not an absurdly bad one. “America’s ratio of gross government debt to GDP currently stands at about 99%. That’s not an absurdly high level for a rich country at the present time. It’s about 24% above Germany’s ratio and 20% above Britain’s. It’s 82% of Italy’s debt ratio, 66% of Greece’s, and less than half of Japan’s.”

The problem is that America’s debt-to-GDP ratio is projected to continue growing for the foreseeable future, whereas many of those large European countries are expected to have falling debt-to-GDP ratios by 2013.

However, there are some truly optimistic signs of hope when one seriously looks at America’s debt situation. America’s projected economic growth is strong; by 2016 the IMF believes America will grow at twice the pace of the German economy. America has better demographics than countries in Europe or Japan. America’s population is generally younger and immigration flows are higher (Immigration is good for long-term growth!) Additionally, America issues the world’s dominant reserve currency and the most plentiful safe asset. This means the dollar will remain strong and America will be able to continue borrowing at low interest rates.

Additionally, the article points out that there are clear routes forward to solve its fiscal situation, both on the taxing side and the spending side. The Economist supports low taxes but still recommends comprehensive tax reform which would marginally raise taxes on all individuals while broadening the tax base substantially. This is common sense and it is what President Obama has proposed.

Further on the optimistic front: “it was scarcely a decade ago that America was running actual surpluses and not long before that that bitterly opposed politicians were cutting deals that made those surpluses possible.”

Without question, America requires action on fiscal matters. But it’s delusive for two reasons to suggest that America must make imminent budget cuts to discretionary spending programs to solve its long-term debt problem. One: the problem is not an imminent crisis. Two: cuts to discretionary programs mathematically cannot solve the debt problem.

In fact, the cuts made in the FY2011 budget compromise made last week will hurt the economy. Unfortunately, politicians on both sides of the aisle grandstand as if deficit reduction has begun in order to capitalize on the country’s budget-cutting mood. Meanwhile, objective economists on both sides of the aisle state that the economy will suffer as a result of these cuts. Consumer spending will decrease, and some jobs will be destroyed or not created.

To solve America’s long-term debt problem, maturity and cool heads must prevail in Congress. Bipartisanship has always taken place in the past, and it will take place in the future. While America’s political system is at times maddening, it was designed to produce compromise. During the course of America’s history, congressional leaders and presidents have generally risen to the challenge when crises were in fact imminent. If America’s debt problem becomes a crisis, it can be resolved. Until then, America should focus on rebuilding its economy, and structuring it to compete successfully in the future.

What I learned from UNRWA November 20, 2010

Posted by Afflatus in Economics, Politics.
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On Tuesday, I got the chance to see John Ging speak. He is the Director of the United Nations Relief and Works Agency (UNRWA), which operates the UN’s humanitarian mission in Gaza. His 2010 budget is $450 million and he has a staff of 10,000. Here is a summary of what he said:

After the flotilla incident, Israel changed its Gaza blockade from a list of approved items to a list of prohibited items making almost all general consumer goods available for purchase in shops. The people of Gaza were already able to get these goods, but they acquired them on the black market after they had been smuggled through the tunnels on Gaza’s Egyptian border. Anything that goes through these tunnels is taxed by Hamas agents, and the criminal traffickers are able to extract a higher price than market value in return for their services. As a result, Mr. Ging said this policy shift was extremely wise because it prevents Hamas and these traffickers from profiting off this illegal commercial activity, while it improves the access and reliability of these goods for regular Palestinians living within Gaza. It also enriches the legitimate business enterprises operating in Gaza to provide these goods. Ging said since this policy shift there has been an 80% reduction in commercial activity through tunnels.

Still, Ging reported that 80% of Gaza’s population is dependent on food aid, and they cue for rationing daily. This food comes from the UN. 95% of the water in Gaza is undrinkable, but construction of new water facilities is prevented under the construction limitations imposed under the blockade. 84,000 m3 of raw partially treated sewage gets dumped into the Mediterranean Sea every day!

Currently Gaza’s schools operate a double shift daily (one set of students attends 8am-2pm, then another attends from 3pm-9pm) Still, however, its schools are jam-packed and unable to accommodate everyone who wants to enroll. One reason there aren’t more schools are the construction limitations under the blockade. UNWRA builds schools, but its pace cannot keep up with the demand for school facilities.

Ging understands the legitimate security concerns Israel has in relation to Gaza. He advocated for a legal and secure route for cement and building materials to enter Gaza. For example, he mentioned an idea that is often floated whereby a secure sea-lane would be established between Ashdod port and Gaza port. Israeli customs agents could thoroughly inspect the goods, and IDF ships could escort the commercial boats from Ashdod to Gaza after their inspection.

Ging also mentioned the Summer Games Program, which is a 10 week summer program meant to fill the void of boredom and frustration that many students in Gaza feel during their two and half month break from school. The kids participate in camp-like games and activities, and apparently the beach program is especially popular. This past year 250,000 participated. In comparison, Ging estimates that about 14,000 students spent their summer months in militant training camps. Not too long ago, said Ging, around 100,000 kids used to attend Hamas’ militant training programs, and he was proud this number has been reduced so substantially. Still, it is 14,000 too high. Mr. Ging was frustrated that the Summer Games Program could not expand further because of a lack of resources. They have to turn kids away from the program every year.

Ging ended on a high note, saying that all hope is not lost in Gaza. Over half of the population is under the age of 18, and not necessarily prone to follow the violence advocated by Hamas.

One thing that became clear to me during the talk was that Israel needs to facilitate more humanitarian assistance to Gaza if it wishes to defeat Hamas. Hamas has historically attracted followers not through its militancy towards Israel, but through its charitable provision of social services to Palestinians. Israel can best undermine Hamas by providing large amounts of humanitarian assistance combined with an information campaign explaining how Hamas is harming the interests of everyday Palestinians. Israel’s blockade of Gaza serves a short-term security interest for the state of Israel. But while the construction ban might prevent attacks in the short-term, it also prevents economic development from occurring which exacerbates Israel’s long-term security problem. The blockade one of the main inhibitors to true social and economic development which is the only way for Israel to ultimately defeat Hamas, and normalize relations with its neighbors.

Redrado is Right: Fernandez’ Actions Will Do Lasting Damage March 9, 2010

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On December 14, 2009, President Cristina Fernandez de Kirchner of Argentina issued a presidential decree of necessity and urgency to establish a bicentennial fund for debt service, which would be stocked with $6.569 billion of the central bank’s foreign currency reserves. Martin Redrado, the president of the central bank challenged the decree and refused to transfer his bank’s reserves into the bicentennial fund. After Redrado refused to resign, President Fernandez issued a second decree ordering the removal of Redrado. A political scandal ensued, the judiciary stepped in and ruled that the Senate must approve of President Fernandez’ proposed use of the reserves. Feeling he had sufficiently stood up for his economic principles, Mr. Redrado agreed to resign in late January.

Mr. Redrado defended two fundamental economic principles concerning the central bank. The first was that a central bank must remain independent; the second that reserves should be used strictly to ensure monetary and financial stability. He was right to do this and it is unfortunate he lost his job. President Fernandez’ attempted seizure of the central bank’s reserves will likely produce grave consequences for Argentina’s economy. President Fernandez has substantially weakened the central bank’s balance sheet. She has established two harmful institutional precedents: compromising the central banks’ independence and encouraging fiscal irresponsibility. President Fernandez’ ultimate goal of repaying government debt is commendable, however her means for achieving that goal are illegitimate. Rather than slashing spending before looming elections, the President has chosen to indulge her political base, and reject sound economic policies. Mr. Redrado did the right thing.

One of the key principles that Martin Redrado defended was the importance of maintaining an independent central bank. This principle is founded on the economic axiom that in the short-term there is a trade-off between inflation and growth. If politicians control monetary policy, they will likely pursue an expansionary monetary policy, particularly in the run up to elections; typically in a politically sensitive time, governments prefer more employment over less inflation. If non-politicized figures control monetary policy over the long-term, this trade-off need not occur. For this reason Mr. Redrado and most other economists believe a central bank’s independence to be sacrosanct. President Fernandez has breached this inviolable divide.

The second belief that Mr. Redrado upheld was that central bank reserves should be used strictly to ensure monetary and financial stability. Mr. Redrado believes that central banks should serve as an independent institution striving to manage inflationary pressures, maintain a stable currency, and promote a healthy economic environment. Mr. Redrado believes that without these reserves, the central bank’s ability to defend its currency is considerably handicapped. A corollary to this argument is that government debts must instead be paid through instruments within the government’s prerogative such as solid fiscal surpluses.

President Fernandez’ attempt to gain access to Argentina’s foreign currency reserves in order to retire government debt presents severe problems in both the short- and long-term. Most immediately, Fernandez’ actions significantly weaken the central bank’s balance sheet. In exchange for its international currency reserves, which are liquid and high-quality assets, the bank will receive a highly illiquid asset (a non-transferable government bond) and it must absorb a considerable loss to its reserves. As Mr. Redrado has stated, this weakens the central bank’s ability to defend its currency.

The central bank of Argentina currently has $47.8 billion in foreign currency reserves; so the $6.6 billion the President is taking is 14% of the bank’s reserves (Benson, 2009). President Fernandez argues that the reserves she will acquire are “excess” reserves, because the central bank currently holds more reserves than the monetary base. This is the same argument Hugo Chavez used to take more than $20 billion from the central bank of Venezuela since 2005. Economists disagree over the necessary amount of reserves. Many, like Redrado, believe that in a highly dollarized emerging economy like Argentina’s, it is important to have an abundance of U.S. Treasury bonds.

The correct level of “excess” reserves is debatable, but larger, more serious, concerns trump this issue. More significantly, the precedents President Fernandez’ actions set, the likely degradation of Argentina’s financial and governmental institutions, and the illegitimate manner President Fernandez attempted to seize the bank’s currency reserves will be long lasting.

In addition to weakening the bank’s balance sheet, President Fernandez’ actions cause other, more serious long-term problems for Argentina’s political economy. First, President Fernandez has set a precedent which compromises the central bank’s independence from the government. President Fernandez has made clear that the executive branch can remove a central banker who opposes the government’s wishes. “The bank’s independence has disappeared,” Abel Viglione, an economist with the Foundation for Latin American Economic Research (FIEL), told BusinessWeek (Raszewski, 2010). In the future, the President of the central bank will understand this precedent and may consider the political and personal implications of monetary policy (i.e. losing one’s job, as Redrado did). A central banker that weighs political ramifications in his or her decision-making process is less likely to produce sound monetary policy. Or, on the flip side, a president who directly influences the central bank’s monetary policy is less likely to attract international investments.

Second, President Fernandez has weakened the incentive for future fiscal responsibility. Anytime a government is in a budgetary bind, it will now be easier for that government to dip into the central bank to stay afloat. This possibility will lead governments to put off tough decisions like cutting expensive, but politically popular programs. Indeed, the postponement of politically thorny decisions is one reason many analysts believe President Fernandez has made this decision. In this way, President Fernandez can pay back maturing bonds, while maintaining her unsustainable spending and indulging her political base.

Third, the manner in which President Fernandez has attempted to seize the central bank’s reserves is dubious and arguably unconstitutional. The central bank’s charter stipulates that if the President wishes to remove a central bank chief, he or she must ask lawmakers for a prior, non-binding recommendation. Ms. Fernandez ignored this specification, and instead tried to fire Mr. Redrado by decree of necessity and urgency. Not only did President Fernandez disregard the central bank’s charter, but also it is unclear if this moment truly merits a decree of necessity and urgency. In fact, Judge María José Sarmiento, the initial appeals judge to hear the dispute, determined in her ruling that it was neither necessary nor urgent to create the Bicentennial Fund with central bank reserves. Moreover, some opposition parties have filed injunctions requesting the courts to rule that President Fernandez’ actions were unconstitutional (Haskel, 2010). To say the least, the legitimacy of President Fernandez’ two decrees are in serious question. While her ostensible goal of paying back bond debts is laudable, her methods are dubious. The end does not justify the means.

Veto player theory applies to President Fernandez’ recent actions as well. Veto player theory argues,  “a higher number of veto players lowers the likelihood of change” (Scartascini, 2008). In the case of Argentina’s central bank dispute, Mr. Redrado acted as a veto player: his consent was necessary in order for the government to access the central bank’s reserves. Now that the main veto player, Mr. Redrado, has been removed, it is significantly more likely President Fernandez will be able to use the central bank’s reserves to pay down its debt to bondholders. Congress, consisting of some veto players itself, must still approve President Fernandez’ proposal in a debate next month.

With a key veto player in Mr. Redrado eliminated, President Fernandez has named Mercedes Marcó del Ponte to be his replacement. She is a staunch supporter of the Kirchners, and certainly would not act as a veto player on this issue. As a lawmaker in 2007, Ms. Marcó del Ponte sponsored a bill to change the central bank’s charter. Though her bill failed, the proposed changes would have expanded the central bank’s prerogative to help facilitate growth and job creation (Weber, 2010). This philosophy indicates that Ms. Marcó del Ponte would likely acquiesce to further incursions into the central bank’s reserves. The elimination of veto players regarding monetary policy makes those policies less resolute. This change sends bad signals to investors looking for a stable financial climate.

It appears that President Fernandez has chosen to sacrifice sound economic policy for political gain. It is quite possible that President Fernandez has established control over the central bank in order to monetize her budget deficits, and fund a spending spree before presidential elections in 2011 (Weber, 2010). Luis María Corsiglia, a former director at the central bank of Argentina, also speculated that President Fernandez wants to use the reserves for current spending (Weber, 2010). The problems with this policy are profound; it will weaken the central bank, weaken the Argentine peso, and lead to a spike in inflation. In fact, official inflation in January reached a 22-month high of 1.1%; however private estimates believe the real number is 2% (Brandimarte, 2010). According to the Financial Times, many economists expect inflation to reach 20% this year (Weber, 2010). With the new central bank president a loyal political ally, it seems unlikely that the central bank will raise interest rates in order to combat inflation. This all will have severely detrimental effects on the economy.

Mr. Redrado rightly defended the importance of an independent central bank. He also championed the idea that central bank reserves should be used strictly for maintaining monetary and financial stability. President Fernandez’ actions weaken the central bank’s balance sheet, decreasing its ability to defend its currency. In the long-term, the independence of Argentina’s central bank has been reduced, and will remain a concern for investors. President Fernandez’ actions also weaken the incentive for her and her successors to maintain a balanced budget; the reserves will be there to bail them out. The method which President Fernandez has pursued to repay debt and regain access to international capital markets will likely backfire. Investors’ anxiety will likely continue due to three factors: improvident spending, a compromised central bank, and high inflation. President Fernandez would be more likely to gain investors’ confidence (as well as voters) if she were to restore the bank’s independence, respect Argentine institutions, and repay debt through fiscal surpluses.

Stagflation June 23, 2009

Posted by presto21 in Economics.
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I was recently having a conversation with a friend when he asked me, “what is so bad about inflation?” Well the truth is we had at least one awful period of inflation in this county – the 1970’s.

Inflation is not such a bad thing if it can be kept to within 1-3% – the figure which today is almost universally aimed for by the central banks of developed countries. In fact it can be a good thing at those levels because it helps maintain fluidity in the credit markets. When inflation rises above that level however, it does have negative impacts. It discourages venture capital as well as complicating mortgages and other long-term loans because people can’t be assured that the long-term returns on their investments will hold up against inflation.

One of the most elementary propositions in economics is that people will not invest if they cannot keep the fruits of their investment. The effects on the engine of private sector growth and job creation, which require some degree of stability so that wages and prices can find an equilibrium, can be destructive.

Stagflation is an economic situation in which inflation and economic stagnation occur simultaneously and remain unchecked for a period of time. Stagflation presents a policy dilemma because most actions to assist with fighting inflation worsen economic stagnation and vice versa. Both stagnation and inflation can result from inappropriate macroeconomic policies. For example, central banks can cause inflation by permitting excessive growth of the money supply and the government can cause stagnation by excessive regulation of goods markets and labor markets; together, these factors can cause stagflation. Both types of explanations are offered in analysis of the global stagflation of the 1970s: it began with a huge rise in oil prices, but then continued as central banks used excessively stimulative monetary policy to counteract the resulting recession, causing a runaway wage-price spiral.

In macroeconomics, the price/wage spiral represents a vicious circle process in which different sides of the wage bargain try to keep up with inflation to protect real incomes. Thus, this process is one possible result of inflation. In the early 1970s, inflation had been much higher than in previous decades, getting above 6% briefly in 1970 and persisting above 4% in 1971. U.S. President Richard Nixon imposed price controls on August 15, 1971. This was a move widely applauded by the public and some number of (but by no means all) economists, especially Keynesian. The 90-day freeze was unprecedented in peacetime, but such drastic measures were thought necessary. Also motivating the controls, it should be noted that on the same date that the controls were imposed, 15 August 1971, Nixon also suspended the convertibility of the dollar into gold, which was the beginning of the end of the Bretton Woods System of international currency management established after World War II. It was quite well known at the time that this would likely lead to an immediate inflationary impulse (because the depreciation of the dollar that would follow would boost the demand for exports and increase the cost of imports). The controls aimed to stop that impulse. The fact that the election of 1972 was on the horizon likely contributed to both Nixon’s application of controls and his ending of the convertibility of the dollar.

The 90-day freeze became nearly 1,000 days of measures known as Phases One, Two, Three, and Four, ending in 1973. In these phases, the controls were applied almost entirely to the biggest corporations and labor unions, which were seen as having price-setting power. 93% of requested price increases were granted and seen as necessary to meet costs.With such monopoly power, some economists saw controls as possibly working effectively (though they are usually skeptical on the issue of controls). Because controls of this sort can calm inflationary expectations, this was seen as a serious blow against stagflation. The controls helped Nixon to re-election, but afterward were seen to be a total failure; meat disappeared from grocery store shelves and Americans protested wage controls that didn’t match up to inflation.

Finally, a man named Paul Volcker (whom some of you may recognize as a current economic adviser to President Obama) decided he was going to clamp down hard on inflation. As a talented economist he knew about the short-term pain his policy would bring to the economy. But he also believed that unless stringent fiscal discipline, a steady money supply and higher interest rates could be brought to bear against stagflation, it would continue indefinitely. Paul Volcker was a Democrat and was appointed Chairman of the Federal Reserve in August 1979 by President Jimmy Carter and reappointed in 1983 by President Ronald Reagan. Volcker’s Fed is widely credited with ending the United States’ stagflation crisis of the 1970s. Inflation, which peaked at 13.5% (insane) in 1981, was successfully lowered to 3.2% by 1983. The federal funds rate (AKA the interest rate), which had averaged 11.2% in 1979, was raised by Volcker to a peak of 20% in June 1981. The prime rate rose to 21.5% in ’81 as well. This was extremely unpopular at the time, but President Reagan stood by Volcker’s policies even as the economy convulsed. The recession worsened for a while, but by 1982 a strong recovery was underway. Unfortunately Reagan cut taxes so deeply while greatly expanding defense expenditures that he wound up running large deficits towards the end of his presidency (deficits George H. W. Bush would be left to deal with) and making it unclear whether he was ever really  committed to real fiscal discipline even though he consistently campaigned on it. But that’s another story…