Thursday, December 20, 2012

Chaining Social Security

It seems that Social Security's Cost of Living Adjustments (COLA) are going from a regular CPI to a chained CPI calculation. The upshot is that it social security payments would go up by less each year, thus reducing the benefit gradually over time.

Social Security plays a small, but I think still important, counter cyclical role in fiscal policy. A bad economy increases social security roles more quickly, as those nearing retirement might accelerate their exit from the work force instead of looking for a new position if they get laid off. This is very indirect, of course, compared to unemployment benefits which directly exert a counter cyclical fiscal moment.

I don't know if SS is too generous or too stingy right now, but I do think that it encourages bright, productive people, who have the benefit of years of experience, to exit the workforce too quickly

Thursday, December 13, 2012

Koo goes cuckoo

 Apologies for the silly title.

Richard Koo was one of the commentators who got many elements of the US Recession correct. In particular, he referred to it as a "balance sheet recession" and consistently pointed to the lesson of Japan, where a property bust lead to protracted stagnation, and no inflation despite low interest rates and high deficits. Koo argued that Japanese households were trying to repair their balance sheets, and the usual mechanic of lower interest rates encouraging people to take on more loans, was not going to work.

Hard to figure out this latest position then:
But nightmare scenario awaits when private loan demand recovers. The problem is what happens when private loan demand recovers. Loan books could grow more than tenfold in the US and five fold in Japan and Europe if bank reserves remain at current levels, triggering inflation rates of 500% to over 1,000%.

To avoid this outcome, central banks will have to mop up excessive reserves by raising the statutory reserve ratio, raising the interest rate paid on reserves, and selling government bonds. All of these measures will serve to lift interest rates, sending bond yields sharply higher and triggering a possible crash in the bond markets.
Unlikely. If private loan demand recovers, it means that the balance sheet repair is over and households are ready to begin re-leveraging. If horizontal money create generates too many dollars chasing too few goods, we could have inflation, but changing reserve ratios or interest pair on reserves will do nothing to deal with this problem. Banks lending is not reserve constrained, it is capital constrained, so trying to manage the size of a bank's balance sheet via reserve manipulation is climbing a tree to catch a fish.

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