Essential Holiday Reading on Economics

Happy holidays! Every year as I range across the web in search of news and ideas I come across a few articles that stand out as exceptionally worth reading. Today I want to share some of the articles on economic issues I personally found most interesting.

As the debate over whether to extend the Bush tax cuts came to a head—and with unemployment still at almost 10%—some of the most interesting discussion in economic circles was about economic inequality in America. In his series “The Great Divergence” (Slate, September 3),Timothy Noah shows just how wide the gap between the rich and the poor has grown in the U.S. and examines some of the factors that might be causing the gap to grow. In the end, he attributes the widening gap to some combination of government policy, international trade, and an explosion in compensation for top media figures, bankers, and executives.

During the late 1980s and the late 1990s, the United States experienced two unprecedentedly long periods of sustained economic growth—the “seven fat years” and the “long boom.” Yet from 1980 to 2005, more than 80 percent of total increase in Americans’ income went to the top 1 percent. Economic growth was more sluggish in the aughts, but the decade saw productivity increase by about 20 percent. Yet virtually none of the increase translated into wage growth at middle and lower incomes, an outcome that left many economists scratching their heads.

In “The Inequality That Matters” (The American Interest, January-February 2011), Tyler Cowen examines the same issue. Cowen argues that in one sense the gap between the middle class and the very rich isn’t as great as it seems, because even ordinary Americans have access to pretty good food, housing, and health care. Nor is it clear that having more money would really make many of them much happier. That’s why many Americans don’t begrudge the rich they money they earn. But, Cowen says, the truth is that income inequality in America is a product of a financial system in which the public effectively guarantees the gains of banks like Goldman Sachs. Inequality is not the problem, in other words, but rather a symptom of the fact that big banks have “learned how to game the American (and UK-based) system of state capitalism.”

It’s as if the major banks have tapped a hole in the social till and they are drinking from it with a straw. In any given year this practice may seem tolerable—didn’t the bank earn the money fair and square by a series of fairly normal looking trades? Yet over time this situation will corrode productivity, because what the banks do bears almost no resemblance to a process of getting capital into the hands of those who can make most efficient use of it. And it leads to periodic explosions. That, in short, is the real problem of income inequality we face today. It’s what causes the inequality at the very top of the earning pyramid that has dangerous implications for the economy as a whole.

In “End This Fed” (Naked Capitalism, December 1) Matt Stoller, who worked as a senior policy advisor for recently defeated Rep. Alan Grayson (D-FL), makes the case for reforming the Federal Reserve—an idea that has growing support among both progressives and movement conservatives. Stoller blames the Fed for declining wages, corrupt capital markets, a struggling industrial sector, and the recent financial crises. He points out that we still don’t know what was discussed during the meetings setting monetary policy at the height of the mortgage boom, and argues that in practice the “political independence” of the Fed simply provides cover for backroom dealing.

The link between the Federal Reserve and the ‘real economy’ is broken. When banks were the main conduit between the financial world and economic activity, translating savings into investment, the Fed could manipulate the economy by manipulating the banking sector. But now that shadow banks dominate our credit markets, and the Fed has allowed hot money to take over monetary policy, the Fed’s tools just don’t work. That’s why quantitative easing is foolish. We must dispatch with the ridiculous notion that pushing hundreds of billions of dollars into a broken banking system will have useful consequences.