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Friday, September 30, 2005

Marginal Utility on Consumption Taxes

Tom Bozzo at Marginal Utility explains why he is not sold on the consumption tax:

Marginal Utility: Coming At You From The Econoverse (Maybe): The Consumption Tax: ...A consumption tax has been a darling of long standing for some economists. The main idea, as articulated by Alan Greenspan here, is that taxing consumption as opposed to income — thereby deferring tax on saved income until it's consumed — increases saving (by lowering the price of future consumption relative to present consumption) and, by extension, investment and economic growth. ... One idea with more than a little currency is to replace the income tax system entirely with a "progressive consumption tax." This is often presented as a simplification of the income tax system in that you just subtract (net) saving off of income to obtain "consumption," probably further subtract some personal exemptions, hit the result against a tax table, and voilà, a tax return in ten lines or less. While some forms of consumption taxes are "regressive" in that they disproportionately fall on the not-rich who have little choice but to consume ... their income in order to live, the rates in a "progressive consumption tax" ... can be set to ensure that the rich pay their fair share ...  Moreover, the top tax rates would specifically discourage some of the conspicuous consumption ... which drives portions of the non-rich classes to the poor house, making some forms of consumption taxation amenable ... to ... economists like Mark Thoma and Cornell's Robert Frank (author of Luxury Fever).(*)

You might ask, if this is such a damn great idea, why wasn't it implemented yesterday? There are a few candidate answers:

  1. Just wait. The tax reform commission launched earlier this year is due to report its findings soon, notwithstanding the various preoccupations of the Bushist "policy" shop. Given that promoting savings and growth are explicitly listed elements of its remit, its quite conceivable that consumption taxation in some form will be among the recommendations.
  2. There are big transition issues (also cited by Greenspan), particularly relating to the treatment of assets acquired under the income tax system. Really, any material tax reform will have some sort of transition problem, since even if the system were designed to be as distributionally neutral as possible, someone's oxen will be gored and the Flying Spaghetti Monster help the politicians who do it.
  3. As a replacement for income taxation, consumption taxes aren't obviously so great after all.

---------------------------
I'll make some of the case for #3... One problem is that the simplicity argument in favor of a consumption-tax replacement for the income tax can be a chimera: The simpler the consumption tax in the length-of-the-tax-form sense, the less clear it is that its economic distortions are smaller than those from a well-designed income tax. ... That measuring net savings is potentially complex is well-enough known that it's mentioned in pro-consumption tax sources like this EconLib article. The solution proffered by the article's author — a sort of unlimited IRA, ... amounts to little more than a wave of a magic wand. ... Under a consumption tax, it becomes necessary to track and net out all contributions and distributions from every possible savings vehicle. This doesn't bother me, but then again I can figure out my AMT on my own if I have to. I would predict a bonanza for tax preparers and tax software providers.

There also arises an issue of just where does consumption end and saving begin. It's not so simple. ... Nor is it necessarily easy to measure economic consumption. ... consumer "durable" goods like appliances, cars, and (in some respects) houses account for large shares of expenditures and are mostly consumed in tax periods other than the year of purchase. If the consumption tax is essentially a cash-flow tax (i.e., simpler from an accounting perspective), then it will tend to overtax durables in the year(s) of purchase, and then undertax them once they're paid off ... This could be seen variously as excessively discouraging durable goods acquisition ... Did I mention that for a given level of revenue, consumption tax rates would need to be much higher than income tax rates, other things equal, given that consumption represents a smaller tax base than income? The more economically efficient alternative of gradually taxing durable goods consumption would itself be a colossal administrative undertaking, ... Again, this is not necessarily so simple. As for the necessity argument, since a consumption tax system eliminates tax distortions affecting savings returns at the cost of increasing them (via higher tax rates) in various goods markets, the net benefits would appear to be ambiguous...

So I'm not especially inclined to buy. I'd prefer a simplified progressive income tax that traded off some of the present mess of deductions, credits, and tax-preferenced forms of income for as low a set of rates, applied to a broad income base, as will approximately balance the federal budget along 'trend' growth. (That'll require a lot more revenue than is presently being raised, in the absence of a reversion to fiscal discipline...) To be sold, I'd need convincing that any feasible consumption tax will outperform that counterfactual.


(*) ...Frank's article ... proposes an untraditional mechanism by which the consumption tax might promote savings. The progressive rate structure would tend to reduce consumption inequality which ... pushes people to spend themselves into oblivion to try to keep up with higher-income, higher-consuming peers who ratchet up general expectations of what constitutes a reasonable lifestyle. Social acceptance of financially modest consumption is, then, a collective good that's under-provided by the "market." ...Mark Thoma doesn't completely buy the collective good argument , and I'd certainly view the need for a tax remedy to the "problem" with extreme suspicion, but I'm not inclined to dismiss the relevance of the social context of consumption.

Good points.

    Posted by on Friday, September 30, 2005 at 01:35 AM in Budget Deficit, Economics, Income Distribution, Taxes | Permalink  TrackBack (0)  Comments (23)


    Santomero: The Fed Needs to Keep Raising Rates

    Anthony Santomero, president of the Philadelphia Federal Reserve makes his position clear.  He, like other Fed officials we have heard from in recent days, thinks interest rates should continue to go up.  He also says "The Fed ha[s] a dual mandate, to oversee price stability and potential growth 'in that order'":

    Fed official expects rebound after hurricanes, by Andrew Balls, Financial Times: The Federal Reserve needs to continue raising rates in order to remove unnecessarily accommodative monetary conditions but also to demonstrate its "unwavering commitment" to maintaining stable inflation, a top Federal Reserve official said. Anthony Santomero, president of the Philadelphia Federal Reserve, said the economy was likely to bounce back after ... hurricanes Katrina and Rita, with stronger-than-expected growth next year on a boost from reconstruction and government spending. High oil prices would boost headline inflation, and contribute to higher core inflation, he said. ... "The challenge for us as a central bank is to maintain price stability and maintain our commitment to price stability so that people recognise that this is an adjustment in the price level of an important commodity, but it is not an adjustment in the inflation rate," he said.

    The Fed had a dual mandate, he said: to oversee price stability and potential growth "in that order". ... Mr Santomero said the economy was growing at a healthy pace before the hurricanes ... Katrina and Rita would contribute to slightly weaker growth in the second half of this year,... but ... the drop in consumer confidence after those storms should be swiftly reversed, based on past experience. Mr Santomero said he expected a post-hurricane rebound for 2006 "as the rebuilding and increased spending builds its own expectations of further good times". He remained confident healthy growth would continue next year ... above the economy's long-term trend rate of slightly less than 3½ per cent.

    The impact of high energy prices on consumer spending was a key uncertainty, he said, adding that to date income and employment growth had allowed consumers to increase spending in spite of higher energy costs. Another key question was the consumer response as the housing market cooled. Mr Santomero said that, while he remained confident ... judging the underlying strength of the economy could remain difficult for the Fed at a time when the incoming data would be distorted by the disruption on the Gulf coast, making the central bank's job very difficult. Information about the US economy during the weeks between last week's FOMC decision and the next would become “fuzzier rather than clearer”, he said, "because of the disturbance affecting the data". He said that the committee would make decisions meeting by meeting and did not have a preordained path of rate increases in mind.

    His statement that "The challenge for us .. is to maintain price stability and ... our commitment to price stability so that people recognise that this is an adjustment in the price level of an important commodity, but it is not an adjustment in the inflation rate" suggests he is worried about increases in inflationary expectations.  To prevent this, the Fed needs to demonstrate its "unwavering commitment" to price stability.

      Posted by on Friday, September 30, 2005 at 01:25 AM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (1)


      New Economist on Barro and the Equity Premium Puzzle

      New Economist wonders if Barro has solved the equity premium puzzle:

      New Economist: Has Barro solved the equity premium puzzle?: It's not quite the holy grail of financial economics, but certainly one of the longest running debates has been over what is known as the equity premium puzzle - or why US stock returns are so much higher than returns on Treasury bonds. The seminal paper was by Rajnish Mehra and Edward C.Prescott's in 1985: "The Equity Premium: A Puzzle" (PDF) in the Journal of Monetary Economics. Mehra and Prescott showed it was difficult to reconcile empirical facts about equity and debt returns with reasonable assumptions about the relative rate of risk aversion and the pure rate of time preference, posing difficulties for the capital asset pricing model. A new paper by Robert Barro to this year's Minnesota Workshop in Macroeconomic Theory attempts to answer the puzzle: Rare Events and the Equity Premium (PDF). Barro's paper builds upon Thomas Rietz 1988 JME article "The equity premium: A solution", which argued that the premium could be explained by infrequent but very large falls in consumption (i.e. wars, depressions or disasters), if the intertemporal elasticity of substitution of consumption is low. Or as Brad DeLong recently put it:

      Rietz's (1988) answer to the equity premium puzzle was this: a long, fat lower tail to the return distribution. A small probability of very bad things happening to stock returns could support both (a) a relatively small sample variance of returns, and (b) rational aversion to large-scale stock ownership large enough to produce the observed equity premium. The question that Rietz was unable to answer was: "What exactly are these very bad things?"

      Mehra & Prescott immediately dismissed the Rietz arguments in a 1988 JME article (PDF), concluding:

      Are Rietz's disaster scenarios reasonable? They are undoubtedly extreme. That such extreme assumptions are needed to account for the average returns on debt and equity we interpret as supporting our contention that standard theory still faces an unsolved puzzle.

      Barro explained his 2005 paper's origins in an interview in the September 2005 issue of the Minneapolis' Fed's journal, The Region:

      Mehra and Prescott were extremely critical of the Rietz analysis, and I think they managed to convince most people that low-probability disasters were not the key to the equity premium puzzle. But, although I highly value the insights in their original 1985 paper (which Mehra and Prescott like to point out was actually written in 1979), I think the arguments in their 1988 comment on Rietz were incorrect.

      I had not thought much about this issue until a few months back—it's not an area that I've worked in. But when I began to study it, it seemed that low-probability disasters could be quite important. And then I found Rietz's paper, which I thought was a great insight, and I have been building on it. Frankly, I think this idea explains a lot. Of course, there is a good deal more to work out, to think about further, but I think his basic insight is correct.

      Continue reading "New Economist on Barro and the Equity Premium Puzzle" »

        Posted by on Friday, September 30, 2005 at 01:16 AM in Academic Papers, Economics, Financial System | Permalink  TrackBack (0)  Comments (0)


        Thursday, September 29, 2005

        Will the Dollar Lose Its Position as the Dominant Reserve Currency?

        The Economist asks whether the U.S. dollar is losing, or about to lose, its position as the dominant reserve currency:

        How the dollar might lose its status as the world's main reserve currency, The Economist:  Once a decade or so, economists ask whether the dollar's reign as the world's number one reserve currency might be at the start of a slow decline. ... In the past 30 years, the dollar has had four bouts of marked depreciation. ... Even so, 66% of the world's official foreign-exchange holdings are still in dollars, compared with 25% in euros, 4% in yen and 3% in pounds... And yet dollar sceptics note that this time the dollar's crown is, if not wobbly, at least skewed. America's current-account deficit, at 6% of GDP, is its highest on record; its net foreign liabilities, at 22% of GDP, are also close to an all-time high. Foreign central banks seem to have reduced their purchases of American Treasuries ... If this trend continues, other currencies could one day challenge the dollar's dominance.

        History offers perhaps only one true example of a reserve-currency shift, from the British pound to the dollar. The pound was king during the era of the gold standard. But in the years after 1914, Britain switched from net creditor to net debtor, and by the 1920s the dollar was the only currency convertible to gold ... Two costly wars and two episodes of currency devaluation in Britain later, the dollar was unchallenged as the world's chief reserve currency. The likeliest pretender to the dollar's crown is the euro. Reserve currencies need to have a home economy with a large share of global output, trade and finance. ... The euro area's total trade with the rest of the world is about as big as America's; about half of this trade is invoiced in euros. The financial market of the reserve currency country must also be deep, open and well developed. America leads the euro area by most measures, but the creation of the single currency has helped to integrate Europe's financial markets.

        Confidence in the value of the currency is also an important requirement, and this is where critics of the dollar have mostly taken aim. Barry Eichengreen, of the University of California at Berkeley, argues in a recent paper* that whether the dollar retains its reserve-currency role depends mostly on America's own policies. If America allows its large current-account deficit to persist and its net foreign liabilities to rise, foreigners will become less willing to hold more dollars. ... In another recent study, Menzie Chinn, of the University of Wisconsin, and Jeffrey Frankel, of Harvard, ... use ... estimates to predict whether the euro could overtake the dollar as the world's main reserve currency. It could, but not soon. ... they reckon, the euro could become the top currency by 2024. If in addition Britain, Sweden, Denmark and all the central and eastern European countries that joined the European Union last year adopted the euro, it would supersede the dollar by 2019...

        Another view, offered by Mr Eichengreen, is that the world might eventually have more than one main reserve currency. The dollar could share its status if other currencies become more attractive. ... This process, thinks Mr Eichengreen, favours the euro. He is doubtful about other candidates, notably the yuan. He argues that both Europe and America “have strong institutions, respect for property rights, and sound macroeconomic policies relative to the rest of the world.” In China, by contrast, capital controls, financial markets that are neither very liquid nor transparent, and uncertainty about property rights make the yuan an unlikely contender for decades to come...


        *“Sterling's Past, Dollar's Future: Historical Perspectives on Reserve Currency Competition”. NBER Working Paper No. 11336: www.nber.org/papers/w11336
        “Will the Euro Eventually Surpass the Dollar as Leading International Reserve Currency?” NBER Working Paper No. 11510: www.nber.org/papers/w11510

          Posted by on Thursday, September 29, 2005 at 04:08 PM in Economics, International Finance | Permalink  TrackBack (0)  Comments (1)


          What is Debt Monetization? When is it Automatic? Is it a Risk?

          What is debt monetization and how does it work?  How can constant interest rate rules make debt monetization automatic?  Why is this a worry and how does it relate to the choice of a new Fed chair?

          What it is and how it works

          1.  Suppose the government runs a deficit.  As an example, let government spending on goods and services be $10,000.  For simplicity, all transactions are in cash.  Let net taxes from all sources be $9,000 so there is a $1,000 deficit.

          2.  The government has $9,000 in cash from taxes, but needs to spend $10,000.  Somehow (print money, borrow money, raise taxes, or lower spending) it must get $1,000 more.

          3.  Suppose it decides to borrow – issue new debt.  Then the Treasury sells a government bond to someone in the private sector for $1,000.  The person gives $1,000 in cash to the government and in return gets an IOU (perhaps for, say, $1,100 in one year).

          4.  The government now has $9,000 in cash from taxes and $1,000 it has borrowed from the public so it can now purchase $10,000 in goods and services.

          5.  Now let’s do the monetization step.  This can happen automatically, as explained below, but for now let’s have the Fed conduct a $1,000 open market operation to increase the money supply.  To do this, it cranks up the press, loads in some paper and green ink, and prints a brand new $1,000 bill.  It takes the $1,000 bill and purchases a bond from the public, for simplicity make it the same bond the Treasury just issued.  Then the money supply goes up by $1,000 (and may go up more through multiple deposit expansion) and government debt in the hands of the public goes down by $1,000 since the Fed now holds the bond.  The increase in the money supply is inflationary.

          6.  What has happened?  When all paper has ceased changing hands, the $10,000 in goods and services is paid for by the collection $9,000 in taxes and by printing $1,000 in new currency.  The government debt simply moves from the Treasury to the Fed (in the U.S., the Fed pays for its operations from its earnings on these bonds and remits the remainder to the Treasury; I believe the remittance is weekly, but I’m not positive on that).

          How can constant interest rate rules potentially cause debt monetization to occur automatically?

          Suppose the Fed follows a constant interest rate rule.  Further suppose an increase in government spending increases the interest rate (see here for a paper on this by Benjamin Friedman posted at the NBER site today).  That is, when the government issues new debt, the supply of bonds increases lowering the price and raising the interest rate. Under these assumptions what will happen when there is deficit spending?

          1.  Deficit spending financed by borrowing from the private sector causes the interest rate to go up.  Thus, initially two things happen, bonds held by the public (debt) increase and interest rate increases as well.

          2.  But the Fed is following a constant interest rate rule.  Seeing the interest rate rising, what should it do?  It should increase the money supply and to do so it prints money, as above, and uses it to buy bonds from the public.  In order to return the interest rate to where it started, all of the debt issued in step one must be purchased with newly printed money (can you smell the fresh ink?).

          3.  In the end, what happens?  It’s just as above, the entire deficit is financed by printing money and the debt issued by the Treasury ends up in the hands of the Fed.

          This is one reason why the Fed has made so much noise lately about letting interest rates rise in the face of budget deficits.  The Fed is sending a signal to fiscal authorities that it would rather let interest rates rise than monetize the debt and suffer the inflation that debt monetization brings about.  So far we have been lucky in this regard.  Long-term interest rates have remained low while budget deficits have increased.  But if your read what Janet Yellen said yesterday, echoing remarks by other Fed officials, she is clearly concerned that this may not persist and that interest rates could rise quickly.  The Fed is signaling that if the increase in interest rates is caused by budget deficits, the Fed is unlikely to intervene due to the inflationary consequences of monetization.  It will allow interest rates to rise.

          Is this a risk?

          For me, this is one of the important considerations for the new Fed chair.  I will be interested to hear the commitment of the new chair to fighting inflation even if it’s not a direct commitment to an explicit inflation target.  There is every incentive for both parties to choose someone who will allow the debt to be at least partially monetized by allowing inflation to increase because this relieves congress of the responsibility for raising taxes or cutting programs.  With debt monetization, government debt disappears and inflation takes its place.  While the public moans at the Fed over high inflation, fiscal authorities, because the debt is monetized, are absolved of responsibility.  The Fed is signaling it does not intend to monetize the deficit and I hope the choice for a new chair will maintain that commitment.

            Posted by on Thursday, September 29, 2005 at 02:22 AM in Budget Deficit, Economics, Inflation, Monetary Policy, Policy | Permalink  TrackBack (0)  Comments (43)


            The Endangered Species Act is Endangered

            The environment surrounding The Endangered Species Act is becoming less hospitable:

            Threatened and endangered, Editorial, The Oregonian: After 30 tumultuous years, the Endangered Species Act sorely needs a thoughtful, rational rewrite ...Instead, the U.S. House is bulling ahead on an ill-considered reform plan, rushing to a vote Thursday on a bill crafted largely by Rep. Richard Pombo, R-Calif., the leading critic in Congress of the Endangered Species Act. The act is "broken," Pombo says, noting that only 10 of roughly 1,300 species have recovered enough to be removed from federal protections. But ... at least all but a handful of them still exist. Only nine species have gone extinct since the act was adopted in 1973. Either way, Pombo's bill is ... ultimately ... about reducing the power of federal wildlife agencies and lifting the burden of species protections from private landowners and those who log, mine and drill in public lands. Pombo and other co-sponsors of the House bill, including Rep. Greg Walden, R-Ore., look at the existing law and see red tape, disputed science, unfair burdens on landowners and slow, imperious federal wildlife agencies. ... the House bill seeks to fix them by cutting into the heart of the act. Instead of targeted incentives to fairly compensate landowners who protect wildlife, the House bill would allow landowners to demand massive payments for lost profits from forgone uses of their land. Such a law would encourage developers to go looking for environmentally sensitive areas to propose projects and seek compensation. The bill also would ban wildlife agencies from designating "critical habitat," lands considered crucial to the recovery of the species. At least one major study has shown that endangered species with protected habitat are more than twice as likely to be recovering as species without it. Walden's views ... understandably hardened during the Klamath crisis in 2000, when irrigation water was abruptly cut off to protect endangered suckers. Anger from the Klamath incident is still driving debate over the act, even though it is hard to look at the Klamath Basin today and see a triumph of species protection over property rights. The ... Pombo bill ... is certain to pass in the Republican-controlled House. It will then fall to the Senate to negotiate a more careful reform of the Endangered Species Act, one that holds true to the act's original intent, preventing human development from jeopardizing species.

            This editorial from Japan provides contrasting view to that of the House majority:

            Flight of the storks, asahi.com:  The release into the wild on Saturday of five Oriental white storks captured our imagination. The birds, designated by the government as special natural treasures, soared into the sky in a most impressive fashion. The last wild one of the birds died in Japan 34 years ago. But thanks to an artificial breeding program in Toyooka, Hyogo Prefecture, these graceful birds are returning to our environment. It is like a dream come true. ... The Oriental white stork is a large migratory bird that is distinguished by its white body, black wings and a thick beak. In the Edo Era (1603-1867), these storks inhabited many parts of Japan. In their heyday before World War II, about 100 storks lived in and around Toyooka. But the birds began disappearing in the era of rapid economic growth. This was because the natural environment underwent a drastic change in the postwar period. Pine groves, where the birds nest, were destroyed. Loach and frogs, on which the storks fed, vanished when farmers began draining excess water in their paddy fields early in summer or just before harvest time in the fall. Agricultural chemicals used by farmers also affected the birds' breeding ability. Returning artificially bred storks into the wild required not only advanced breeding technology but also a reinvigorated natural environment. Farmers had to abandon intensive farming methods that relied on agricultural chemicals and fertilizers to produce high annual crop yields. They even had to ensure there was water in their fallow paddy fields in winter to sustain all living creatures. Rivers also had to be cleaned and natural woodlands near populated areas had to be managed properly. Power transmission lines had to be buried underground. All these efforts require the willing participation of local inhabitants.

            Some people worried that the storks would harm the rice crop. But this mind-set gradually reversed itself as people began to place greater stock in food safety and agricultural products that are free of chemicals. The rice paddies where storks feed offered proof that farmers valued the natural environment. ... The only downside might be that harvests are slightly smaller. There was even a move to cultivate rice as from farmland that welcomed back the storks. We applaud this move and think it should be emulated around the country-assuming that storks will settle all over the land. ... We believe that municipalities across the country should take a leaf out of Toyooka's book and adopt similar preservation methods to create a natural environment that is also comfortable to humans. If the five storks that flew off into the wild can adapt themselves to their new environment and pair off, we may see juvenile storks leave their nest early next summer. It is said that it takes several generations for such breeding programs to become totally successful. We truly hope that such persistent efforts will bear fruit. Storks travel far. They may appear in the area where you live. If they do, please don't disturb them. We hope you will enjoy just having them in the neighborhood.

              Posted by on Thursday, September 29, 2005 at 01:20 AM in Economics, Environment, Policy | Permalink  TrackBack (0)  Comments (8)


              Australian Reserve Bank Governor: Global Imbalances not Caused by U.S.

              This is a discussion by I.J. Macfarlane, Governor of the Reserve bank of Australia, on global trade imbalances. What's different about this discussion? He does not believe global imbalances are caused by developments within U.S. He also has five key developments (empirical facts) that any theory of the current account imbalance must explain. His contention is that a story with the U.S. as the cause of global imbalances cannot explain all five of these developments. At the end he asks, and answers, the question of whether he lets the U.S. off too easily. Finally, he is dismissive of excess liquidity stories.  It's a bit long, but not quite as long as it appears as it includes graphs, footnotes, and references:

              What are the Global Imbalances?, I.J. Macfarlane, Governor, Talk to Economic Society of Australia Dinner, Melbourne - 28 September 2005:

              I was told to remove this speech by the media office of the Reserve Bank of Australia (RBA).  I am used to policies such as these:

              Unless otherwise specified on this web site, reproduction         of any Federal Reserve Bank of San Francisco Information contained herein may be made without limitation as to number, provided however, that it is not distributed for the purpose of private gain and it is appropriately credited to the Federal Reserve Bank of San Francisco.

              Unfortunately, the RBA is more restrictive. Apologies to readers - the speech is still available in the link above.

                Posted by on Thursday, September 29, 2005 at 01:19 AM in Budget Deficit, China, Economics, International Finance, Saving | Permalink  TrackBack (2)  Comments (2)


                Benjamin M. Friedman: Deficits and Debt in the Short and Long Run

                Since I cited this paper by Benjamin Frieman on deficits here, I decided to post the link and abstract:

                Benjamin M. Friedman, Deficits and Debt in the Short and Long Run, NBER WP 11630, October 2005Abstract This paper begins by examining the persistence of movements in the U.S. Government’s budget posture. Deficits display considerable persistence, and debt levels (relative to GDP) even more so. Further, the degree of persistence depends on what gives rise to budget deficits in the first place. Deficits resulting from shocks to defense spending exhibit the greatest persistence and those from shocks to nondefense spending the least; deficits resulting from shocks to revenues fall in the middle. The paper next reviews recent evidence on the impact of changes in government debt levels (again, relative to GDP) on interest rates. The recent literature, focusing on expected future debt levels and expected real interest rates, indicates impacts that are large in the context of actual movements in debt levels: for example, an increase of 94 basis points due to the rise in the debt-to-GDP ratio during 1981-93, and a decline of 65 basis point due to the decline in the debt-to-GDP ratio during 1993-2001. The paper next asks why deficits would exhibit the observed negative correlation with key elements of investment. One answer, following the analysis presented earlier, is that deficits are persistent and therefore lead to changes in expected future debt levels, which in turn affect real interest rates. A different reason, however, revolves around the need for markets to absorb the increased issuance of Government securities in a setting of costly portfolio adjustment. The paper concludes with some reflections on “the Perverse Corollary of Stein’s Law”: that is, the view that in the presence of large government deficits nothing need be done because something will be done.

                  Posted by on Thursday, September 29, 2005 at 12:27 AM in Academic Papers, Budget Deficit, Economics | Permalink  TrackBack (0)  Comments (1)


                  Wednesday, September 28, 2005

                  A Haven For Rent-Seeking Behavior

                  Is this rent seeking behavior, or do lobbyists help to direct government spending towards a more efficient allocation of resources by providing useful information?:

                  Lobbies Line Up For Relief Riches, by Jeffrey H. Birnbaum, Washington Post: With Congress dangling as much as $200 billion in hurricane related aid, lobbyists for oil companies, airlines, manufacturers and others are clamoring to get their share. ... Lawmakers are receptive to many of these requests, congressional aides said. For example, House Energy and Commerce Committee Chairman Joe Barton (R-Tex.) is moving legislation this week, much of it recommended by lobbyists, that would waive regulations to help oil companies build new refineries. ... The oil lobbyists, like so many others, are using the storms as an excuse to win long-sought legislation, even when their plans relate only tangentially to the hurricanes. Earlier this week groups as diverse as the American Institute of Architects and the American Petroleum Institute were freshening their requests for tax breaks and other favors. ... The troubled airline industry has been particularly active on the hurricane front. ... Insurers have been using Katrina as an argument for ... an extension of the Terrorism Reinsurance Act (TRIA), which provides for the government to pay a portion of the damage caused by a foreign terrorist attack over certain thresholds. ... Farmers, even those outside the disaster zone, are begging for hurricane cash. "It is important to remember that the economic impact of Hurricane Katrina is harming much more of U.S. agriculture than producers in those three states," ... The nation's for-profit hospitals are trying to persuade Congress to carve an exception into a ... law specifying that only nonprofit institutions qualify for grants from the Federal Emergency Management Agency to rebuild critical facilities after a natural calamity. ...

                  Who will legislators rely on for industry knowledge with so many different types of expenditures to be made so quickly?

                  Wikipedia: ...Collusion between firms and the government agencies tasked to regulate them can be a haven for rent-seeking behavior, especially when the government agency must rely on the firms for knowledge about the market...

                  I say it's rent-seeking.  And it seems to pay pretty well.

                    Posted by on Wednesday, September 28, 2005 at 02:30 AM in Economics, Market Failure, Policy, Politics | Permalink  TrackBack (0)  Comments (1)


                    Yellen: There is a Bubble But Don’t Pop It With Monetary Policy

                    As noted here and more recently here, Alan Greenspan does not believe monetary policy should be used to deflate bubbles. Janet Yellen, president of the San Francisco Fed agrees. She believes that fundamentals do not fully explain the increase in housing prices so that there is a bubble component to housing price increases, and that the bubble poses a risk to the economy. But since the effects of a deflated bubble would be small, since the effects occur slowly giving monetary policy time to intervene after the collapse, and since there are potentially better tools such as regulation, there is no need for monetary policy to pinpoint bubbles except to the extent that the bubbles impact overall inflation:

                    Presentation to the members of Parliament at the Conference on US Monetary Policy, by Janet L. Yellen, President of the Federal Reserve Bank of San Francisco, The U.S Economy and Monetary Policy: ... I want to focus my remarks today on another longer-term issue, namely, the housing market ... The question is: ...Is there a house-price "bubble" that might collapse, and if so, what would that mean for the U.S. economy? To answer this question, let me begin by clarifying what I mean by the term "bubble." A bubble does not just mean that prices are rising rapidly—it's more complicated than that. Instead, a bubble means that the price of an asset—in this case, housing—is significantly higher than its fundamental value.

                    One common way of thinking about housing's fundamental value is to consider the ratio of housing prices to rents. ... Currently, the ratio for the U.S. is higher than at any time since data became available in 1970 ... Higher than normal ratios do not necessarily prove that there's a house-price bubble. House prices could be high for some good, fundamental reasons. ... Probably the most obvious candidate for a fundamental factor ... is low mortgage interest rates. ... While the fundamentals I've mentioned do play a role, the consensus seems to be that much of the unusually high price-to-rent ratio for housing remains unexplained. Moreover, with controversy over exactly why long-term interest rates have remained so low, we can't rule out the possibility that they would rise to a more normal relationship with short-term rates, and this obviously might take some of the "oomph" out of the housing market. So, while I'm certainly not predicting anything about future house price movements, I think it's obvious that the housing sector represents a risk to the U.S. outlook.

                    This brings me to the debate about how monetary policy should react to unusually high prices of houses—or other assets, for that matter. ... As a starting point, the issue is not whether policy should react at all; I believe there is quite general agreement that policy should be calibrated to the wealth effects of house prices on output and inflation. The debate lies in determining when, if ever, policy should be focused on deflating the asset price bubble itself. In my view, the ... decision to deflate an asset price bubble rests on positive answers to three questions. First, if the bubble were to collapse on its own, would the effect on the economy be exceedingly large? Second, is it unlikely that the Fed could mitigate the consequences? Third, is monetary policy the best tool to use to deflate a house-price bubble?

                    My answers to these questions in the shortest possible form are, "no," "no," and "no." ... In answer to the first question on the size of the effect, it could be large enough to feel like a good-sized bump in the road, but the economy would likely to be able to absorb the shock... In answer to the second question on timing, the spending slowdown that would ensue is likely to kick in gradually... That would give the Fed time to cushion the impact with an easier policy. In answer to the third question on whether monetary policy is the best tool to deflate a house-price bubble, ... For one thing, no one can predict exactly how much tightening would be needed, or by exactly how much the bubble should be reduced. Beyond that, a tighter policy to deflate a housing bubble could impose substantial costs on other sectors of the economy that would lead to equally unwelcome imbalances. Finally, it's possible that other strategies, such as tighter supervision or changes in financial regulation, would not only be more tailored to the problem, but also less costly to the economy. Taking all of these points into consideration, it seems that the arguments against trying to deflate a bubble outweigh those in favor of it. ... But let me stress that the debate surrounding these issues is still very much alive.

                      Posted by on Wednesday, September 28, 2005 at 02:07 AM in Economics, Housing, Monetary Policy | Permalink  TrackBack (0)  Comments (7)


                      The New $10 Bill and Money Flops of the Past

                      The new $10 bill will be unveiled today - Update: Here it is:

                      Colorful $10 bill coming, CNN/Money: A new $10 bill featuring color, new art and enhanced security will be unveiled Wednesday, and the government hopes it will take hold quickly as other new designs. The Department of the Treasury, Federal Reserve and U.S. Secret Service will jointly announce the bill, which they expect will enter circulation in early 2006. The redesigned $10 note -- which will still feature a picture of the nation's first Treasury Secretary, Alexander Hamilton -- is the third denomination in a new currency series that incorporates background colors and improved security features. A new $20 note was issued in October 2003, followed by a new $50 note in September 2004.

                      CNN/Money ran this story about currency flops of the past before the release of the new $20 in 2003:

                      Currency flops through the ages, by Gordon T. Anderson, CNN/Money: Remember the Susan B. Anthony dollar? It was the first U.S. currency to feature an historical female figure since the 19th century, when Martha Washington adorned a silver-backed note. Citing the cost-saving and efficiency benefits of coins over bills, the Treasury Department promoted it as "the dollar of the future." Amid great fanfare, the U.S. Mint produced nearly one billion of them between 1979 and 1981 (as well as a smaller re-minting in 1999).

                      The piece itself was supposed to have looked and felt different from other change. Instead, it seemed like a quarter with that funny hendecagon (an 11-sided polygon) on its face. As for the great suffragist it honored, well, more than a few wags joked about her striking resemblance to George Washington. Vast national indifference soon rendered the Anthony dollar as another quaint relic of the Seventies, like the Ford administration's WIN ("Whip Inflation Now") buttons or the AMC Pacer.

                      Unlike the Anthony dollar, Americans will be forced to use the new bills. So public reaction, whether vibrant or muted, really won't matter. For example, many griped when the last rollout of new bills -- the fat-head series, you might call it -- came in the 1990s. "We all pooh-poohed it, but we use it," said Stephen L. Bobbitt, a spokesman for the American Numismatic Association in Colorado Springs. "What other choice do we have?"

                      Money woes: a history

                      Over the years, America's moneymakers have had their share of disappointments and failures. Here are just a few of them:

                      Sacagawea dollar: In 1999, Treasury announced it would take another stab at a dollar coin. This time, it honored the Shoshone woman with the difficult name, who helped guide Lewis and Clark across the West. To distinguish it from other coins, the piece has a brass-colored coating – which rubs off with even minimal handling. Three years after its introduction, a General Accounting Office poll found that 97 percent of the nation had not used the coin within the past month, and that 74 percent could not remember ever using one.

                      The 2-dollar bill: The note honors Thomas Jefferson on its front, and the signers of his Declaration of Independence on the back.

                      The bill is so obscure that the Treasury Department's Web site contains an explanation to remind us that it is official U.S. currency, which had another series printed during the Clinton administration. "It's very popular at dog tracks and horse races," says Bobbitt. "The only thing it's good for is making a two-dollar bet."

                      Bare-breasted woman (part 1): In the 1890s, an "education series" of notes sought to teach Americans about science and history. An imprint about electricity, however, reminded many about the birds and the bees: the exposed left breast of a stylized goddess appeared on the bill. Outcry forced the notes to be recalled and reprinted with a model wearing clothing.

                      Bare-breasted woman (part 2): Long before the dollar-coin fiasco, Treasury officials apparently believed that no mistake is ever so great that it can't be made twice. The Liberty quarter, issued during World War I, also proved too risque in its first edition. This time, however, it was the right breast that saw the light of day. Again, the national decency brigade forced an expensive recall.

                      Another technicolor production

                      Of course, many Treasury Department innovations have been successes. The use of green on the currency, for example, was a happy historical occurrence, born during the Civil War years. At the time, the new science of photography had some treacherous implications. Since color photographic inks had not been invented, green was added to notes to foil counterfeiters trying to use photography to reproduce notes.

                      The new twenty-dollar note is also not the first time Treasury has issued multi-colored bills. In the early part of the twentieth century, the twenty bore George Washington's picture. Today, it's known by collectors as the "technicolor note," for its striking assortment of hues. The front contains yellow, red, green and black inks, and the back features a bright gold design. The technicolor was always popular, and it still is. You can buy one on eBay -- for about thirty times the face value.

                        Posted by on Wednesday, September 28, 2005 at 01:38 AM in Economics | Permalink  TrackBack (0)  Comments (3)


                        Yellen, Bernanke, and Greenspan

                        The Fed continues to give strong signals that its primary concern is inflation as these comments from San Francisco Fed president Janet Yellen illustrate. She is also worried about the current account and budget deficits, saying in particular that budget deficits could send the economy on an unsustainable (inflationary) upward path. Finally she notes, as she has before, that monetary policy is not as good as fiscal policy at attenuating the impact of regional economic events:

                        Presentation to the members of Parliament at the Conference on US Monetary Policy, by Janet L. Yellen, President of the Federal Reserve Bank of San Francisco, The U.S Economy and Monetary Policy: ...Obviously, at the forefront of everyone's mind are the two huge hurricanes that recently struck the U.S. Gulf Coast. The human tragedy following Katrina is enormous. ... The economic consequences for the region, of course, also are enormous. ... Staring into the face of such disasters, it is natural at first to want to use every tool at hand to try to help, including monetary policy. However, it seems clear that where monetary policy can make its greatest contribution is in keeping the national economy on an even keel. ... Instead, it's appropriate to use the tools of fiscal policy—especially government spending and transfers—to address the immediate crisis.

                        When Hurricane Katrina hit at the end of August, the economy was actually doing reasonably well. ... above-trend growth and diminishing slack [let] the FOMC ... lift its foot off the accelerator bit by bit, gradually removing the policy accommodation ... looking ahead ... Heading my list of risks to the economy in both the near and medium-term is energy prices. ... In addition to energy prices, the huge and unsustainable current account deficit and the budget deficit pose longer-term risks to the U.S. economic outlook. Indeed, the latter is even more of an issue now, with the massive rebuilding plans for the Gulf Coast. ... Higher energy prices put U.S. monetary policy on the horns of a dilemma. On one side, the negative impact of higher energy prices on spending tends to damp economic activity, which calls for a more accommodative policy, although in this case, the rebuilding effort will provide some offset. On the other side, it adds to inflationary pressures, which calls for a tighter policy. Although the effects of Katrina and Rita will remain uncertain for some time, it appears that the most likely outcome is a significant dip in growth in this quarter and the next, ... followed by a rebound in the first half of next year as the region rebuilds. ... Going forward, the Committee will certainly continue to monitor developments closely and weigh the options carefully. One option that is clearly not on the table is allowing an unacceptable rise in inflation. It has taken many years of consistent performance for the Federal Reserve to earn the public's confidence in its commitment to price stability. ... to maintain its credibility, the Federal Reserve must deliver—again and again–on its commitment to price stability.

                        Next, Alan Greenspan reissues his warning about not being fooled by recent financial market stability into underestimating risks, but he also makes an interesting statement about monetary policy. He believes that the economy is largely self-correcting, even more so in recent years, and that monetary and fiscal policy have often made things worse rather than better. This implies he believes that monetary policymakers should not try and anticipate and counteract short-run or medium-run movements in output through movements in the target federal funds rate, but should instead be focused on long-run output stability through price stabilization. He also believes that self-correction works best when the economy is competitive and free of government interference in domestic or foreign markets:

                        Exuberance always leads to asset drops-Greenspan, by Tim Ahmann , Reuters: Asset bubbles fueled by "market exuberance" invariably burst and policy-makers cannot safely pierce them, Federal Reserve Chairman Alan Greenspan said ... In a speech in which he once again defended the Fed's decision not to deflate the late-1990s stock market bubble, Greenspan said a successful monetary policy can be a victim of its own success -- by reducing economic volatility that in turn fosters greater risk-taking. He warned that protracted bouts of big risk-taking by investors are always followed by asset-price declines ...

                        "That greater tendency toward self-correction has made the cyclical stability of the economy less dependent on the actions of macroeconomic policymakers, whose responses often have come too late or have been misguided," he said." "It is important to remember that most adjustment of a market imbalance is well under way before the imbalance becomes widely identified as a problem," Greenspan added.

                        ...[Greenspan] said "fostering an environment of maximum competition" was the best way to ensure economic flexibility. In that regard, he said it was important to ward off misguided efforts to try to protect jobs through trade protectionism and other competition-inhibiting policies. "Protectionism in all its guises, both domestic and international, does not contribute to the welfare of American workers," Greenspan said. "At best, it is a short-term fix at a cost of lower standards of living for the nation as a whole."

                        Finally, for the second day in a row saying much the same thing, Ben Bernanke, a former Fed Governor and now Chief White House Economic Adviser says what you would expect, things will turn down a bit in the short-run, but be fine in the long-run:

                        Impact of oil price still small: Bernanke, Reuters: High energy prices are a burden on households and could ultimately restrain economic growth but so far the impact has been modest, a top White House economic adviser said on Tuesday. "The U.S. economy is in the midst of a strong and sustainable economic expansion," Ben Bernanke.. said ... "The resilience of the economy ... is helping it to absorb the shocks to energy and transportation from the hurricanes," ... The short-term economic outlook remains dominated by Hurricane Katrina ... Bernanke said, joining other forecasters in looking for a hit to national rates of job creation and growth in the current quarter. Beyond that "recovery and rebuilding should ultimately increase growth rates and rates of job creation, perhaps by the fourth quarter and certainly in the first half...

                        UPDATE:  Make that the third day in a row, White House´s Bernanke: no big risk of recession.

                          Posted by on Wednesday, September 28, 2005 at 12:45 AM in Budget Deficit, Economics, Inflation, Monetary Policy | Permalink  TrackBack (0)  Comments (0)


                          Tuesday, September 27, 2005

                          Tiptoe Through the Rebalancing Mine Field

                          The Economist has advice for the U.S., China, and Europe on how to achieve rebalancing, with the U.S. budget deficit high on the list of places to start.  This complements Greenspan's remarks and concerns on deficits and on rebalancing both internally and externally.  However, Greenspan expresses more concern than this article over the risks of the rebalancing process and the title of this post was chosen to emphasize the risks that rebalancing brings about:

                          Rebalancing Act: How to tame the thrift shift, The Economist: If the first step towards finding a solution is to agree on the problem, the world's policymakers are still a long way from solving the global imbalances. European politicians blame American profligacy, urging Mr Bush's government to cut its budget deficit. Chinese politicians echo those sentiments. Yet for American lawmakers on Capitol Hill, there is only one villain: China and its undervalued currency. The analysis in the White House is more sophisticated, but still tends to Mr Bernanke's view that America's current-account deficit is not “made in the USA”. ... All of this misses the bigger picture. The current pattern of global imbalances is the result both of thrift shifts abroad and of American actions. ... America's current rate of borrowing is excessive. Despite the advantages of having the world's reserve currency, an enviable rate of productivity growth and the world's most liquid capital markets, America cannot continue to borrow at an accelerating pace forever. More important, ... Most of that foreign money is going into consumption and housing rather than boosting investment in productive American assets. Building houses does not raise long-term economic growth in the way that equipping a factory does. And the current rate of consumption, fuelled by housing wealth, leaves many indebted consumers at risk... Unfortunately, there is little sign that anything will change very quickly...

                          What, then, needs to be done? For a start, recognise who has to be involved. Given the size of their saving surpluses, oil-exporting countries should be at the centre of the discussion. Yet they are rarely even invited to G8 summits and other global policy pow-wows. The rich countries have understood the importance of including China in their gatherings. ... But when politicians are discussing global imbalances, they will have to broaden the guest list further. More important, their “to do” list needs to be revised. Reducing China's saving surplus is about more than simply calling for a stronger yuan. It means creating the conditions that encourage more efficient investment and reduce the need to save quite so much. That requires more emphasis on corporate and financial reform ... It also means persuading China's government to spend more on social safety nets. ... Higher public spending—on hospitals, schools and helping the poor—will itself reduce China's national saving rate, and creating better health, education and pension systems will reduce the incentive to save so much. Japan's example suggests that there is no particular Asian propensity for thrift... Europe, too, would do well to adopt ... policy stimulus. The European Central Bank remains too reluctant to cut interest rates. Europe does not need, and cannot afford, a fiscal binge of American proportions, but the recent lesson from Japan is that if economies stagnate, government debts spiral.

                          If the rest of the world could do with a less puritan take on thrift, America needs to be reminded of its virtues. ... less government borrowing is still the most certain route to higher national saving. ... Convincing the American people to save more is trickier. ... There are plenty of reasons for America to carry on borrowing from abroad. It has better demographic prospects than the rest of the rich world, and indeed than many Asian emerging markets. It has nimble and productive firms. ... But the present deficit is excessive and dangerous. Left alone, it could end in a global recession, rampant protectionism, and even a disastrous financial crash. That is why policymakers need to act soon. With his “saving glut” speech, Mr Bernanke focused attention on the scale of the global thrift shift. Now, as one of Mr Bush's top economic advisers, he should persuade his boss of the importance of making the thrift shift safe.

                          [Note: The original article has a different picture.]

                          UPDATE:  Guest blogger Menzie Chinn discusses current account deficits at Econbrowser. 

                            Posted by on Tuesday, September 27, 2005 at 01:51 AM in Budget Deficit, China, Economics, International Finance, Monetary Policy | Permalink  TrackBack (1)  Comments (9)


                            Greenspan, Bernanke, Bies, and Moskow

                            Alan Greenspan discusses the consequences of a leveling or decline in the housing sector, perhaps through higher interest rates.  Though it’s wrapped in cautionary language, he sees benefits from higher interest rates in addition to the usual arguments about fighting inflation and anchored expectations.  He believes higher rates make it less likely that consumers at the margin will take on risky debt, that the current account will fall, and that personal saving will increase:

                            Greenspan Say Speculation Adds to Home-Price Surge, Bloomberg: Federal Reserve Chairman Alan Greenspan said speculative buying may be driving housing prices and creating a risk for the U.S. economy because so many Americans rely on home appreciation to support their spending... The abundance of interest-only loans and ''exotic'' variable-rate mortgages ''are developments that bear close scrutiny,'' he said. The unconventional mortgages are letting buyers who barely qualify purchase homes at inflated prices, ... ''In the event of a widespread cooling in house prices, these borrowers, and the institutions that service them, could be exposed to significant losses,'' Greenspan said. Any retraction in sales or refinancing raises the risk of an ''adjustment'' in overall spending. How much is an ''open question,'' he said… Sales of vacation houses, or homes that aren't always occupied by owners, are ''arguably at historically unprecedented levels,'' ... ''This suggests that speculative activity may have had a greater role in generating the recent price increases than ... in the past.''… Greenspan said if home purchases or refinancing declined, consumption would probably retrench and the saving rate would rise. This would also point to larger adjustments in the U.S. economy, he noted. ''Imports of consumer goods would surely decline as would those imported intermediate products that support them,'' he said. ''And one would assume that the U.S. trade and current- account deficits would shrink as well, all else being equal.''...

                            The Bloomberg story, however, omits this important qualifier:

                            Greenspan says gains offer a cushion, Reuters: …Though mortgage debt is rising, most Americans have built up so much equity in their homes that they could weather a price drop without serious harm, ... "The vast majority of homeowners have a sizable equity cushion with which to absorb a potential decline in house prices," Greenspan told the American Bankers Association. … he said some regions may be seeing unsustainable price gains. But he said that, at mid-2005, fewer than 5 percent of homeowners were highly leveraged -- which would make them vulnerable if prices fell -- on their loans.

                            See also Calculated Risk here on Greg Ip’s WSJ article on Greenspan's remarks and here for more on the Reuters and Bloomberg reports.  Greenspan’s research paper supporting his remarks is here.

                            Next, Ben Bernanke, a former Fed Governor and now Chief White House Economic Adviser, on the economy after the hurricanes.  Note that he says the Fed does not have to raise rates “violently,” not that rates shouldn’t go up:

                            Energy prices risk to US economy-Bernanke, Washington Post: High energy prices in the wake of Hurricanes Rita and Katrina pose a risk to U.S. economic growth, but inflation expectations remain well-contained, a top White House economic adviser said on Sunday. "The high energy prices are certainly burdening consumer budgets, … and certainly continued increases in energy prices are a risk for economic growth going forward," … But Bernanke … said low inflation expectations gave the Fed more flexibility than in past energy crises. "A very important factor is the fact that inflation expectations are well-controlled and well-contained, which means that the Federal Reserve, unlike the 70s, doesn't have to react violently in terms of raising interest rates to contain the second- and third-round inflationary impacts. So I remain pretty optimistic about the economy," …Bernanke said the energy markets had been in the process of recovering from Hurricane Katrina when Rita hit… "I remain optimistic that the impact on energy from these two events will be limited." ... but warned that job losses in September would be heavy and that the unemployment rate would climb a couple of tenths of a percentage point. … "(But) as the economy begins to recover, as jobs are returned and as the rebuilding process continues and strengthens over next two years or so, the effects on national GDP growth and job creation will actually be positive," he said. "Basically, I'm going to be very optimistic today about the ability of the U.S. economy to absorb these body blows, and my reason for that is that I think this is an extraordinary resilient and flexible economy."

                            Last, but lately by no means least, here’s Chicago Fed president Moskow and Fed Governor Bies who spoke at separate events.  Both see a strong economy:

                            U.S. Treasuries Decline; Fed's Bies, Moskow Say Economy Strong, Bloomberg: U.S. Treasuries fell as two Federal Reserve officials said the economy remains strong after two hurricanes struck the Gulf Coast, bolstering views the central bank will keep raising interest rates. … Chicago Fed President Michael Moskow said ''the fundamentals of the economy are strong,'' and Fed Governor Susan Bies said there is ''underlying core resilience.'' A drop in crude oil to a two-week low after Hurricane Rita caused only minor disruptions at Houston-area refineries kicked off the declines in Treasuries in overnight trading. … ''It's early to see the results of Rita, but I think the fundamentals of the economy are strong,'' Moskow said  … ''All of the rebuilding that's going to be required is also going to show up in the economic numbers once we get through the initial impact,'' Bies said to reporters...

                            UPDATE: Federal Reserve Bank of Kansas City President Thomas Hoenig signals concern over inflation:

                            Fed's Hoenig says must be wary of inflation, Reuters: Federal Reserve Bank of Kansas City President Thomas Hoenig said on Monday that the U.S. economy can shake off the damage of hurricanes Katrina and Rita and the Fed must focus on its primary mission of keeping inflation at bay to ensure sustainable growth. "I believe it is also important for the Federal Reserve to stay focused on its primary mission for maintaining a neutral monetary policy that is both able to contain inflationary pressures and still-balanced growth," he told a Kansas City Fed economic forum here. Hoenig noted that the consumer price index has already pushed up significantly from a year ago, thanks to high energy prices, while unit labor costs were rising and economic capacity was being absorbed by the strong U.S. economy. "When you see all three coming together you must be alert," he said. "The mission of the Fed is to be sensitive to these pressures. … Hoenig said the U.S. central bank was not ignoring the human and economic tragedy along the Gulf Coast. But monetary policy acts on the national, not regional level, and no one would thank the Fed for taking its eye off the ball and allowing inflation to get out of control. "You can end up increasing inflationary pressures that could undermine the recovery if you are not careful," he said.

                            There isn't much ambiguity in that statement. 

                              Posted by on Tuesday, September 27, 2005 at 01:48 AM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (12)


                              Time Varying Structural Vector Autoregressions and Monetary Policy

                              One or two of you may be interested in this paper.  The introduction is in the continuation frame:

                              Primiceri, Giorgio E., "Time Varying Structural Vector Autoregressions and Monetary Policy". Review of Economic Studies, Vol. 72, No. 3, pp. 821-852, July 2005 (SSRN link, July 2004 version on author website) Abstract: Monetary policy and the private sector behaviour of the U.S. economy are modelled as a time varying structural vector autoregression, where the sources of time variation are both the coefficients and the variance covariance matrix of the innovations. The paper develops a new, simple modelling strategy for the law of motion of the variance covariance matrix and proposes an efficient Markov chain Monte Carlo algorithm for the model likelihood/posterior numerical evaluation. The main empirical conclusions are: (1) both systematic and non-systematic monetary policy have changed during the last 40 years - in particular, systematic responses of the interest rate to inflation and unemployment exhibit a trend toward a more aggressive behaviour, despite remarkable oscillations; (2) this has had a negligible effect on the rest of the economy. The role played by exogenous non-policy shocks seems more important than interest rate policy in explaining the high inflation and unemployment episodes in recent U.S. economic history.

                              Continue reading "Time Varying Structural Vector Autoregressions and Monetary Policy" »

                                Posted by on Tuesday, September 27, 2005 at 01:46 AM in Academic Papers, Economics, Methodology, Monetary Policy | Permalink  TrackBack (0)  Comments (2)


                                Monday, September 26, 2005

                                Paul Krugman: Find the Brownie

                                Paul Krugman has new games for you to play:

                                Find the Brownie, by Paul Krugman, Commentary, NY Times: For the politically curious seeking entertainment, I'd like to propose two new trivia games: "Find the Brownie" and "Two Degrees of Jack Abramoff."

                                The objective in Find the Brownie is to find an obscure but important government job held by someone whose only apparent qualifications for that job are political loyalty and personal connections. It's inspired by President Bush's praise, four days after Katrina hit, for the hapless Michael Brown, the director of the Federal Emergency Management Agency: "Brownie, you're doing a heck of a job." I guess it depends on the meaning of the word heck.

                                There are a lot of Brownies. As Time magazine puts it in its latest issue, "Bush has gone further than most presidents to put political stalwarts in some of the most important government jobs you've never heard of." Time offers a couple of fresh examples, such as the former editor of a Wall Street medical-industry newsletter who now holds a crucial position at the Food and Drug Administration.

                                A tipster urged me to look for Brownies among regional administrators for the General Services Administration, which oversees federal property and leases. There are several potential ways a position at G.S.A. could be abused. For example, an official might give a particular businessman an inside track in the purchase of government property - the charge against David Safavian, who was recently arrested - or give a particular landlord an inside track in renting space to federal agencies.

                                Some of the regional administrators at G.S.A. are longtime professionals. But the regional administrator for the Northeast and Caribbean region, which includes New York, has no obvious qualifications other than being the daughter of the chairman of the Conservative Party of New York State. The regional administrator for the Southwest, appointed in 2002 after a failed bid for his father's Congressional seat, is Scott Armey, the son of Dick Armey, the former House majority leader.

                                You get the idea. Go ahead, see what - or rather who - you can come up with.

                                Jack Abramoff is a lobbyist who was paid huge sums by clients such as casino-owning Indian tribes and sweatshop operators on Saipan. Two Degrees of Jack Abramoff is inspired by the remarkable centrality of Mr. Abramoff, who was indicted last month on charges of fraud, in Washington's power structure.

                                The goal isn't to find important political players who were chummy with Mr. Abramoff - that's too easy. Instead, you have to find people linked by employment. One degree of Jack Abramoff is someone who actually worked for the lobbyist. Two degrees is a powerful Washington figure who hired someone who formerly worked for Mr. Abramoff, or who had one of his own former employees go to work for Mr. Abramoff.

                                Grover Norquist, the powerful antitax lobbyist, is a one-degree man. Mr. Norquist was Mr. Abramoff's campaign manager when he ran for chairman of the College Republican National Committee, then became his executive director. And don't dismiss this as kid stuff: as Franklin Foer explains in The New Republic, the college Republican organization pays serious salaries and has been a steppingstone for the likes of Lee Atwater and Karl Rove.

                                Mr. Rove, by the way, is a two-degree man. He hired Susan Ralston, Mr. Abramoff's personal assistant, as his own personal assistant. For those unfamiliar with what that means, Ms. Ralston became Mr. Rove's gatekeeper - the person who determined who got to see the great man.

                                Tom DeLay, the House majority leader, is also a two-degree man. Tony Rudy, who worked for Mr. DeLay in several capacities, left to work for Mr. Abramoff.

                                Finally, somebody should be considered a two-degree man on account of the recently arrested Mr. Safavian, who worked for both Mr. Abramoff and Mr. Norquist, then went first to the G.S.A. and on to the White House Office of Management and Budget, where he oversaw procurement policy. But I'm not sure who gets credit for hiring Mr. Safavian.

                                O.K., enough joking. The point of my games - which are actually research programs for enterprising journalists - is that all the scandals now surfacing are linked. Something is rotten in the state of the U.S. government. And the lesson of Hurricane Katrina is that a culture of cronyism and corruption can have lethal consequences.

                                  Posted by on Monday, September 26, 2005 at 12:15 AM in Economics, Politics | Permalink  TrackBack (0)  Comments (0)


                                  Fed Watch: Dejá Not

                                  Tim Duy, recently known as Mr. Contrarian for his call1 that the Fed would continue to raise rates even after Katrina, has his latest Fed Watch:

                                  Thankfully, Hurricane Rita proved not to be as destructive as feared and largely spared critical refinery capacity. We can be sure the Fed breathed a sigh of relief as well – one supply shock to the nation’s infrastructure is enough for the year.

                                  The Fed’s last statement was widely parsed, with the general feeling that Katrina left the Fed feeling more hawkish than widely expected (see Mark Thoma’s roundup of commentators). Many noted that the Fed still believes monetary policy to be accommodative, that, in addition to energy, “other costs” are now fueling inflationary pressures, and inflation expectations are now just “contained,” not “well” contained. And, of course, that the Fed expects Katrina to have minimal lasting impacts on demand.

                                  Many, I believe, expected the Fed to be more concerned about growth prospects, especially in light of a rather sharp drop in consumer confidence. With this in mind, reread this paragraph from the FOMC statement:

                                  The Committee perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. With underlying inflation expected to be contained, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.”

                                  Note the subtle but important shift from the beginning to the end of this paragraph. The FOMC believes that with measured removal of monetary accommodation will help meet the twin goals of sustainable growth and price stability. As always, of course, they remain data dependent. If economic prospects change, they will act to ensure price stability, not sustainable growth.

                                  Of course, the two goals are the same if the economy is subjected to demand shocks. Supply shocks, however, are a different matter entirely. This is where I believe many have missed a key element of Fed thinking. They do not view the Katrina induced energy disruptions as a demand disturbance. They view Katrina more as a 70’s-style supply shock, with the possibility of triggering both inflation and weak – or even recessionary – growth. And I believe the Fed is explicitly saying that in such a stagflationary situation, they will choose price stability. The short run blow to growth is less important than keeping long run inflation expectations in check. Or, in other words, they believe additional tightening now will extend the length of the recovery by keeping inflation in check and avoiding more painful hikes in the future. Of course, not everyone agrees with the Fed’s position – be sure to read James Hamilton’s critique of recent policy.

                                  Regarding data dependence, the FOMC clearly believes that Katrina will have little demand impact in the long run. That implies they will discount any negative numbers that appear to have been distorted by Katrina, with the exception of inflation numbers, a statistic the Fed is clearly nervous about. I suspect this will frustrate many analysts to no end.

                                  More evidence of the Fed’s increasingly hawkish stance can be found in this curious report from Reuters. I wonder how much play it will get; in my mind it is important. Repeating part of what Mark Thoma posted earlier:

                                  U.S. Federal Reserve Chairman Alan Greenspan told France's Finance Minister Thierry Breton the United States has "lost control" of its budget deficit... "'We have lost control,' that was his expression," Breton told reporters after a bilateral meeting with Greenspan. "The United States has lost control of their budget at a time when racking up deficits has been authorized without any control (from Congress)," Breton said. "… Breton said: "The situation that is creating tension today on the currency market ... is clearly the American deficit." ... Breton added that after hearing Greenspan talk about inflation: "One has the feeling -- though he didn't say so -- that interest rates will probably continue to rise slightly until his departure."...

                                  On the surface, this is a stunning breach of etiquette. These are private conversations for internal use, not for public dissemination. In fact, it is such a breach that one wonders if Greenspan asked that his thoughts be leaked to the press in effort to make a signal he doesn’t feel he can make directly. In any event, we should likely take Breton at face value and assume he is accurately reporting his conversation with Greenspan. And the message is the clear intention to keep tightening in the face of inflationary pressures. I interpret “continue to rise slightly” as additional 25bp pops.

                                  One of those pressures is fiscal deficit spending, with Katrina driving the latest round of profligacy (I suspect that those impacted by Rita will want their share too). It is not out of the question that Greenspan is sending a warning to Congress that he will not let the Fed be pulled into monetizing the deficit. Recall that we saw similar comments by Dallas Fed President Richard Fisher. There is a real possibility that the Fed is gearing up to lean against the wind of fiscal spending.

                                  I continue to think that Greenspan & Co. are sending increasingly not-so-subtle messages that the days of low interest rates and easy policy are at their end. This is a message for Congress and the Administration, not just the financial markets. Indeed, something unexpected may be happening – a concerted effort to end any sense of a Greenspan-put in the markets or the economy as a whole. It will undoubtedly be interesting to watch this chapter in Fed history play out.

                                  UPDATE (by Mark Thoma):  With Greenspan's comments on the deficit over the weekend, the recent concern expressed by Dallas Fed President Richard Fisher, and this today from Chicago Fed president Michael Moskow, it is clear that the Fed is becoming increasingly concerned about the fiscal deficit.  I hope to post more about this later, but here's a quick update for now:

                                  Moskow: Fed still has room to tighten, MarketWatch:  The Federal Reserve has more room to raise interest rates, the president of the bank's Chicago branch said Monday. Michael Moskow said excess capacity in the nation's economy makes removing borrowing accomodation necessary. ... Moskow said the impact from the storms in holding down output and pushing up prices probably was temporary. He will continue to monitor, in particular, government spending that came in response to Katrina. A pledge for increased outlays from President Bush and Congress led many private-sector economists to stick with or increase their 2006 economic-growth projections, despite the many uncertainties still posed by Katrina and, to a lesser degree, Hurricane Rita…

                                  And there was also this from Fed Governor Susan Bies:

                                  Fed's Bies warns about energy prices, MarketWatch:  Higher energy prices are threatening to have a ripple effect on the prices of other goods, Federal Reserve Governor Susan Bies said Monday. "The longer the prices stay higher, the more likely there will be an impact on prices in general," Bies told reporters following an international bankers conference. Bies also said she was relieved that Hurricane Rita didn't wreak as much havoc as feared. … The Fed policymaker said she was particularly heartened that the storm didn't take a major toll on Gulf Coast energy infrastructure. … Although the impact of both hurricanes Rita and Katrina will wallop local economies for weeks or perhaps months to come, the effect on the U.S. economy should be minor, Bies said. "At this point, we're still seeing an underlying resilience in the economy," she said…


                                  1Tim's Fed Watches between Hurricane Katrina and the most recent FOMC meeting are at 9/18, 9/13, 9/5, and 8/30.

                                    Posted by on Monday, September 26, 2005 at 12:04 AM in Budget Deficit, Economics, Fed Watch, Monetary Policy | Permalink  TrackBack (1)  Comments (5)


                                    Will Changes in Consumption, Investment, the Social Safety Net, or the Exchange Rate Reduce Saving in China Anytime Soon?

                                    The Economist reports on China's high saving rate, nerly 50% of GDP, and the prospects for change in the near future.  While saving has slowed recently, investment has slowed even faster leading to a more rapid accumulation of saving.  There are solutions to the saving imbalance in China, Chinese consumers could increase consumption and reduce saving, domestic investment could pick up, social safety nets could be improved, or the yuan could be revalued, but according to this analysis, the prospects for a quick adjustment in any of these factors do not look promising:

                                    The frugal giant, by Minton Beddoes, The Economist: ...[T]he world ... is still waiting for a big Chinese consumption boom. ... the Chinese are spending a lot more than they used to. ... But Chinese saving is growing even more rapidly. Since 2000, the country's overall saving rate-already the world's highest by far-has risen sharply, to nearly 50% of GDP (see chart). Even though China is investing at the staggering rate of 46% of GDP, it is still running a net saving surplus, and that surplus is still growing... and shows no signs of stopping.


                                     

                                    ...China's capacity for thrift has long perplexed economists... What is going on? Household saving is the easiest to make sense of. First, Chinese households have not changed their consumption patterns fast enough to keep up with the huge rise in their incomes. ... a large part of China's growing income has been going to the relatively small share of the population living in coastal areas. Richer people save more than poorer ones. ... Moreover, the one-child policy has made it harder for people to rely on their children as a source of support in old age, further encouraging thrift. ...  A further incentive to saving is the weakness of social safety nets. Under the old economic regime many Chinese workers could count on health and pension benefits from state enterprises (the "iron rice bowl"). No longer. ... Pension coverage is low ... Health care is also getting more expensive. ... Education, too, requires deep pockets ... The relative lack of credit is another factor... consumer credit is still in its infancy. ... Like the Japanese in the 1960s, the Chinese need to save a lot because they find it hard to borrow.

                                           

                                    And save a lot they do. Chinese household saving, at around 25% of disposable income, is astonishingly high ... But ... they were not responsible for the sharp rise in national thrift since 2000. ...China's household saving rate has been more or less steady since 2000 (see chart). The recent rise in national saving was led by ... the corporate sector. ... China's firms are now bigger savers than its households. But unlike their peers in the rest of the world, they are investing their surpluses... That splurge may well prove unsustainable. Profit growth has slowed sharply over the past year ... Slower profit growth means less corporate saving, but investment seems to be slowing even faster ... the pace of China's investment is likely to fall over the medium term...

                                    What happens to China's national saving surplus will depend on whether China's households will save less and spend more, thus becoming the engine of the domestic economy. The example of Japan is sobering. Although Japanese households now save much less than they used to, their country never really made the shift from export-led to consumer-led growth. ... China, however, is different in important ways. Its economy is already much more open than Japan's ever was. ... And ... China seems to be shifting away from an undervalued currency far more quickly than Japan did. ... but this is likely to take several years. Although American policymakers may be clamouring for a rapid rise in the yuan, there is no sign in Beijing that the government plans anything of the sort. ... A government that depends on rapid economic growth to legitimise itself will not want to risk instability with a sudden rise in the currency, so a much stronger yuan seems an unlikely route to a quick reduction in China's saving surpluses. ... Redirecting an economy as big as China's towards domestic consumption takes time. China's saving surpluses will not last forever, but nor will they disappear overnight. And trying to move too fast can be disastrous, as the mess in Asia's other emerging markets shows.

                                      Posted by on Monday, September 26, 2005 at 12:03 AM in China, Economics, International Finance, Saving | Permalink  TrackBack (0)  Comments (0)


                                      Larry Summers or Robert Rubin for Fed Chair?

                                      Caroline Baum is suggesting Larry Summers as a possible replacement for Greenspan.  While I agree there’s a good chance the choice will surprise us, that is not my main interest in the column.  She reports that 11 percent of 104 market professionals chose Robert Rubin as their best guess of Bush’s choice for the next Fed chair.  I would want to know more about the survey design before making too much of this, but what message is sent with the choice of Rubin?  I want to jump to the conclusion that it reflects the out of control deficit, but this is the Fed chair, not the Treasury Secretary.  It does signal a desire for a familiar and experienced face and, for many, a desire for a background in business:

                                      Those Clinton Years Are Looking Better Every Day, Caroline Baum, Bloomberg:  While the Bush administration has been … mum on the subject of a successor to … Alan Greenspan, investors are already voicing their picks. A survey of 104 market professionals … put Ben Bernanke … in first place with 38 percent. … Martin Feldstein came in second, with 31 percent of the vote. In third place, with 11 percent, was (gulp) Robert Rubin, Clinton administration Treasury secretary par excellence… What are we supposed to make of investors' more-than-zero odds of an iconic, across-the-aisle choice? … The survey specifically asked who would be President George W. Bush's choice to succeed Alan Greenspan... It would be out of character for Republican tax-cutter Bush to appoint Democratic deficit hawk Rubin to a key economic post. For starters, Rubin stands for something. … [and his] image may be just what the Bush administration needs… Are investors onto something in imagining Bush could tap Rubin for Fed chairman? ... ''Someone who thought he could appoint … Wolfowitz to the World Bank is not going to cross the aisle to go to a Democrat.'' … My guess is that Bush will reject an academic like Bernanke for … someone with more real-world, market experience. Someone who isn't on anybody's short (and stale) list. Someone who isn't on the radar of the investors ... Someone, in short, like Bob Rubin. Calling Larry Summers? The Harvard University president and former Treasury secretary has an added appeal, having already alienated the politically correct Left.

                                        Posted by on Monday, September 26, 2005 at 12:01 AM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (7)


                                        Sunday, September 25, 2005

                                        Reducing Government Spending to Pay for Hurricane Relief Also Reduces GDP

                                        The main thrust of this article is that Democrat Tom Harkin and Republican Charles Grassley, both of Iowa, disagree on how to pay for Katrina, but I didn’t think it was news that a Democrat and a Republican disagree on this point. Instead, it’s time to correct something. It’s said again and again, and this is the latest example, that we can’t raise taxes because that might hurt the economy’s recovery from Katrina and now Rita, so we will have to cut programs to pay for the spending instead. How is it that cutting government spending doesn’t reduce aggregate demand and GDP and hurt the economy in the same way as raising taxes?

                                        Lawmakers differ on how to pay for relief efforts, by Aimee Tabor, The Hawk Eye: ...Grassley said he doesn't feel a tax increase is the solution for the Katrina relief. "If you raise taxes enough to pay for Katrina you'd probably add to the negative ripple effect that Katrina is having on the economy," Grassley said. "We don't want to compound that by an irresponsible increase in taxes." Congress then has two choices — it can either continue to borrow or cut spending, Grassley said...

                                        First, during the recovery period itself, there is no need to do either, something Grassley seems to implicitly acknowledge elsewhere in his remarks. If the goal is to stimulate the economy during this period, then deficit spending (borrowing) is needed. Offsetting spending on hurricane relief with reduced spending elsewhere or increasing taxes does not provide any short-run stimulus. Arguments about long-run economic growth and tax rates are being mixed up with arguments about the level of GDP in the short-run.  Once the economy has recovered, then it’s time to pay the bills. At that point either an increase in taxes or decrease in spending can be used in theory since both reduce the deficit, though in reality tax increases will be needed since spending cuts alone cannot solve our deficit problem. This is where growth considerations come into play and, though there are certainly pockets of fat in government, cuts in spending large enough to dent the deficit will reduce essential spending on infrastructure and social insurance programs and harm rather than enhance our long-run growth prospects and economic security.

                                          Posted by on Sunday, September 25, 2005 at 02:47 AM in Budget Deficit, Economics, Politics, Taxes | Permalink  TrackBack (1)  Comments (6)


                                          The Growing Education Gap

                                          David Brooks says:

                                          The Education Gap, By David Brooks, NY Times: Especially in these days after Katrina, everybody laments poverty and inequality. But what are you doing about it? For example, let's say you work at a university or a college. You are a cog in the one of the great inequality  producing machines this country has known. What are you doing to change that?

                                          Let me defend universities against the implied notion that colleges aren't doing anything to address these problems. I apologize that this post is a bit "me" oriented, but Brooks struck a nerve. First, there are whole offices devoted to this problem, e.g. see here, but that by no means exhausts the available resources. On another front, I am currently Chair of the University's Scholastic Review Committee and an elected member of The Undergraduate Council. Both committees are concerned with these issues, but let me back up to the many years I chaired the University's Scholarship Committee, the committee responsible for allocating the entire pool of University scholarship money. As Chair, I had the committee reexamine each step in our process to try and identify hidden bias in the award of scholarship money. As an example, one part of our evaluation process used the number of AP courses a student completed as a measure of academic quality. However, there is a wide disparity in the number of AP courses across high schools and it varies with both the size of the high school and its demographic characteristics. To overcome this, we changed the standard to something along the lines of "The student takes full advantage of available educational opportunities" and distributed a list identifying the number of AP courses available at each high school. Some schools offered no AP courses at all and those students were no longer penalized for not having AP courses on their transcripts. In Oregon, there are a few large cities with large, high average income high schools and lot of smaller and less affluent schools spread out across the state. Subsequent data indicated that this change was successful in, as we saw it, more fairly distributing scholarship money according to merit across high schools with such varied demographics. This is not all we did, at the evaluation orientation each year we discussed these issues with regard to the evaluation process, e.g. when looking at a student's extra-curricular activities to be sure and account for circumstance and we would cite examples of how that might work, and the committee has members to specifically represent the interests of the students Brooks is writing about. The extra-curricular expectations for a single mom or an older sibling with imposed child care responsibilities are different from those of a student without such time or resource constraints. In any case, from my experience on this and other committees, I resent the implication that we do not care, are not sensitive to, or are not taking action to address these problems. We are.

                                          Brooks goes on:

                                          As you doubtless know, as the information age matures, a new sort of stratification is setting in, between those with higher education and those without. College graduates earn nearly twice as much as high school graduates, and people with professional degrees earn nearly twice as much as those with college degrees. But worse, this economic stratification is translating into social stratification. ... The most damning indictment of our university system is that these poorer kids are graduating from high school in greater numbers. It's when they get to college that they begin failing and dropping out...

                                          Why is this an indictment of the university system and not our under funded primary and secondary education systems? I have no idea when assigning grades to the 50-300 people in a course what a student's economic circumstances are. I can only assign the grade the multiple choice or essay test supports and if a student fails, I can't pass them on some other basis. They need to come to college prepared and that starts long before they get to universities. Having done the University's grade inflation study and having examined high school grades as part of that process, I have my own ideas about why high school graduation rates might be rising. Take a look at the pressures and incentives current education policy gives primary and secondary schools for a start, and I've already mentioned funding issues. In any case, that we get more under privileged students coming through our doors but many fail along the way is something we do our best to address, but students need to arrive prepared and that is a social problem that extends far beyond the reach of our universities. Finally,

                                          ...I'm going to come back to this subject and write about what some colleges are doing to help these students and how most colleges are neglecting them. But let me conclude with the thought that while we have big political debates in this country about equality of results, all those on the left and right say they believe in equality of opportunity. This is where America is failing most.

                                          I'll agree with that, equality of opportunity is essential, but I'm guessing we will disagree about the source of and solution to this problem.

                                          UPDATEArnold Kling comments on this post and writes:

                                          In my view, the issue is larger than universities' policies concerning admissions and financial aid. It concerns how universities are financed, and how this affects the distribution of income. First, consider state subsidies for universities. These are almost certainly regressive. Much of the subsidy goes to raise the rents earned by administrators and professors. Much of the rest goes to affluent students. The taxes that pay for the subsidies come from all economic classes. Second, consider university endowments. Again, they serve to increase rents of employees and to subsidize those students who attend the most elite institutions--a student population that is disproportionately affluent. Imagine instead what might happen if state funds and alumni donations  funded vouchers for student tuition. Compared with reforming university finances, tinkering with admissions and scholarship policies is beside the point. It may "show that you care," but has little practical significance.

                                          A couple of quick notes.  First, I was answering the question Brooks posed, what have I done personally.  If I controlled state taxes and expenditures, my approach would be different!  Second, I disagree it is of little practical significance.  That's not what our numbers told us, that's not what the people on the committee that work with students tell us, and if you are one of the students who gets a scholarship, it is of huge significance.  Sure, we need to work on the issues Arnold identifies, but is he implying we shouldn't do this too? 

                                          One final note, we are a state institution, but our "subsidy" is 13 cents per dollar, down from around 30 cents fifteen years ago.  The impact of this is that we have increased tuition to make up the difference at a rate far greater than the rate of inflation and this has reduced access.  A lot of our work internally has been to counter the trends in enrollment the changes in state funding have caused and scholarships are one part of that strategy. The changes have not been insignificant. Some figures:

                                          1990:  Tuition was 23% of budget, state funded 32% of budget
                                          2004:  Tuition was 33% of budget, state funded 13% of budget

                                          That's a big change in funding over the last 15 years and this is common across universities.  The disinvestment you hear about is real and it has harmed educational access.

                                            Posted by on Sunday, September 25, 2005 at 01:28 AM in Economics, Income Distribution, Oregon, Press, Universities, University of Oregon | Permalink  TrackBack (2)  Comments (9)


                                            Greenspan Says US Budget Deficit is Out of Control

                                            Alan Greenspan told France’s Finance Minister that the United States has lost control of the deficit.  The Finance Minister also says that after talking to Greenspan and hearing his concerns over inflation he believes, though Greenspan did not say so explicitly, that there will be further increases in the target federal funds rate:

                                            Greenspan to French Financial Minister:US lost deficit control, Reuters: U.S. Federal Reserve Chairman Alan Greenspan told France's Finance Minister Thierry Breton the United States has "lost control" of its budget deficit... "'We have lost control,' that was his expression," Breton told reporters after a bilateral meeting with Greenspan. "The United States has lost control of their budget at a time when racking up deficits has been authorized without any control (from Congress)," Breton said. "We were both disappointed that the management of debt is not a political priority today," he added. Ministers from the Group of Seven rich nations on Friday called for vigorous action around the world to curb rising imbalances in international trade and investment accounts. A decrease in the U.S. budget deficit were cited by the G7 as one way to ease those imbalances. ... Breton spoke as International Monetary Fund Managing Director Rodrigo Rato said U.S. plans to cut its government expenditures now looked ambitious in the light of huge reconstruction costs to be borne in the wake of Hurricane Katrina. Breton said: "The situation that is creating tension today on the currency market ... is clearly the American deficit." ... Breton added that after hearing Greenspan talk about inflation: "One has the feeling -- though he didn't say so -- that interest rates will probably continue to rise slightly until his departure."...

                                            There was no indication that Greenspan drew any connection between his support of tax cuts in 2001 and the current deficit situation.

                                            [UpdateBrad DeLong also notes these commentsTim Duy notes and interprets the breach of etiquette these comments represent.]

                                              Posted by on Sunday, September 25, 2005 at 01:00 AM in Budget Deficit, Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (0)


                                              Saturday, September 24, 2005

                                              Insurance Capitalism and the Insurance State

                                              MaxSpeaks presents Bruce Bartlett's statement before the Senate Democratic Policy Committee.  Bruce Bartlett and I disagree on aspects of the solution to the budget problem and on many, many other issues, but his willingness to engage honestly and openly on the issues is refreshing. For example, we both agree that government should be limited to essential functions and that it ought to be as efficient as possible in carrying out those functions.  Where we disagree is over what the essential functions of government are.  I believe government has a role to play in insuring against risks inherent in the capitalist system and in making sure that there is equal opportunity for success.  I also hope to make it clear that it is not welfare capitalism I support, but rather insurance capitalism, and it is important to distinguish the two.  As discussed in some detail here, welfare is an income transfer without and good or service changing hands, but programs like Medicare, Social Security, Disability Insurance, and so on provide an insurance value that is often ignored in the debate over the role of social insurance programs.  When Bruce Bartlett puts all his cards on the table and is willing to criticize other members of his party, it is a sign that we may actually be able to debate the proper role of government in society and I welcome such conversation.  Debate over the proper role of government has been largely missing from recent policy debates over taxes, spending, and deficits, though Hurricane Katrina began to change the conversation in this direction, and it is long overdue:

                                              Continue reading "Insurance Capitalism and the Insurance State" »

                                                Posted by on Saturday, September 24, 2005 at 01:55 PM in Budget Deficit, Economics, Politics, Social Security, Taxes | Permalink  TrackBack (1)  Comments (13)


                                                Housing Bubble or Housing Froth?

                                                Recently, as discussed in this post, Chris Mayer of Columbia Business School, Charles Himmelberg of the New York Fed, and Todd Sinai of Wharton argued there is no housing bubble.  Peter Coy of BusinessWeek Online's Hot Property blog is not persuaded.  Neither is Jan Hatzius, a Goldman Sachs economist who has written extensively on the housing market:

                                                Housing Markets Are Stable ... Until They're Not," Hot Property: Three top economists made a splash on the Wall Street Journal's editorial page this past Monday with a piece headlined "Bubble Trouble? Not Likely." But ... [t]hey assume, without strong evidence, that buyers in each market will continue to expect the same kind of price gains that they've averaged over the past 60 years. If you expect prices to keep rising rapidly, you'll be willing to pay a whole lot today. The market will be stable. But what if buyers in, say, San Francisco suddenly turn pessimistic about the rate of future price increases? ... If they lose faith that the market will climb steeply ad infinitum, then ... the market will tank. That's practically the definition of a popping bubble. By assuming from the start that such a thing won't happen, the authors are assuming their conclusion. ... I spoke with Todd Sinai ... co-author on the paper ... Sinai defended the paper. He said ... hot cities like San Francisco are pretty much built-up, so people are competing to live there by outbidding each other ... That ... can continue as long as there are rich people in other parts of the country who would really rather live in San Francisco. I'm not so sure. It feels to me like San Francisco, San Diego, Los Angeles, New York, Miami, Boston, and other costly markets are pricing themselves out of reach. ... If they stop expecting rapid house appreciation, their willingness to pay will fall. And the market could drop rather suddenly. The authors certainly didn't persuade me that there's no bubble.

                                                Goldman Sachs Economist on the Bubble, Hot Property: Just got off the phone with Jan Hatzius, a Goldman Sachs economist who has written extensively on the housing market. He gave me permission to post a research note ... he wrote ... about the same academic study that I questioned in a post yesterday. Hatzius says he's not sure I'm correct that the authors of the study assumed their conclusion. His criticisms are different. The biggest one is that the authors ended their analysis too soon--last year--missing the further inflation of housing prices since then. Here's what he wrote:

                                                Bubble Trouble? Probably Yes

                                                Monday's Wall Street Journal featured an op-ed by Christopher Mayer and Todd Sinai, two academic real estate analysts, who argue that worries about a housing bubble are overblown. ... Himmelberg, Mayer, and Sinai (HMS) calculate the total cost of owner occupation as the sum of interest, depreciation, property taxes, and a risk premium for taking on house price risk, and then adjust these costs for the tax deductibility of mortgage interest and property taxes as well as a term for expected capital gains. They call the resulting measure 'imputed rent,' divide it by an index of actual rents, and set the resulting ratio equal to 1 for the average of the 1980-2004 period. They then argue that a metropolitan housing market is overvalued relative to its own history when the ratio is above 1 and undervalued when the ratio is below 1. Their main result is that 31 out of their 46 metropolitan housing markets had values below 1 as of 2004. Of the markets usually considered 'hot,' New York, San Francisco, and Phoenix had values below 1, while Boston, Los Angeles, and Washington DC, had values just marginally above 1; only Portland, San Diego, and Miami showed some cause for concern. HMS conclude that there is no evidence for a general housing bubble, and not even much evidence for a localized bubble.

                                                What do we make of this analysis? Of course, HMS are right that interest rates matter for valuing capital assets such as residential homes. ... But ... on the narrower point, namely whether house prices are out of line with rents and interest rates, we are somewhat skeptical ... First, the results are sensitive to minor changes in the assumptions ... For example, HMS assume that households require a constant risk premium of 2 percentage points for owning instead of renting, and that they expect the rate of capital gains to be equal to the 1940-2004 average for their metropolitan area. Of course, it is impossible to know whether these or any other assumptions about unobservable concepts such as risk premia or expectations are correct. ... the precise choice of numbers can make a qualitative difference to the results... Second, the analysis uses annual data that end in 2004. This is unfortunate, because the case for an outright housing bubble was still quite weak as of 2004 but has grown much stronger since then. ... Thus, an analysis along the lines of the HMS paper that used more up-to-date inputs would probably come to a considerably more cautionary conclusion.

                                                Of course, comparing the economic costs of owning with the economic costs of renting is not the only way of adjusting house prices for changes in the fundamentals, including interest rates. Our own preference remains with an 'affordability' concept that asks what percentage of their disposable income households must expend to cover mortgage payments on the median-priced home. This approach not only relates house prices to incomes -- compared with rents, probably a more meaningful comparison for most US households residing in the suburbs -- but it also recognizes that the vast majority of households are unable to borrow as much as they want and therefore cannot engage in the theoretically 'pure' arbitrage considerations assumed by HMS. As we described in detail in the May-June Pocket Chartroom, housing affordability is deteriorating quickly. ... For example, the National Association of Realtors -- not an organization known for excessive bearishness on the housing market -- reports that their US affordability index now stands at the lowest level since 1991. Thus, housing valuations are stretched, and are becoming more stretched the longer the current boom continues.

                                                Jan Hatzius

                                                Thanks to Jan Hatzius for allowing us to reproduce the above note.

                                                  Posted by on Saturday, September 24, 2005 at 12:48 AM in Economics, Housing | Permalink  TrackBack (0)  Comments (13)


                                                  Do Sticky-Price RE Models Capture Inflation Dynamics Better Than Traditional Phillips Curve Models?

                                                  Generally, when presenting academic papers here I only present the abstract. However the subject of this paper is important enough to merit presenting more, so I am including the entire introduction, conclusion, and the extensive list of references. The issue is how well rational expectations sticky-price models capture inflation dynamics. The conclusion is that

                                                  ...existing rational expectations sticky-price models fail to provide a useful empirical description of the inflation process, especially relative to traditional econometric Phillips curves of the sort commonly employed for policy analysis and forecasting.

                                                  which is not good news for advocates of the New Keynesian model.  Here's the paper by Rudd and Whelan that will be presented at this conference sponsored by the Federal Reserve Board and The Journal of Money, Credit, and Banking:

                                                  Modeling Inflation Dynamics: A Critical Survey of Recent Research, by Jeremy B. Rudd and Karl Whelan: 1 Introduction Robert Solow (1976) once observed that “any time seems to be the right time for reflections on the Phillips curve.” However, right now seems to present a particularly appropriate moment to take stock of the empirical evidence on inflation dynamics. Recent years have seen an explosion in empirical research on inflation, with most of it related to the so called “new-Keynesian” Phillips curve, which has provided a modern take on the traditional Phillips curve relationship by deriving it from an optimizing framework featuring rational expectations and nominal rigidities. That the current conference has taken its inspiration from the 1970 Federal Reserve conference on “The Econometrics of Price Determination” also seems appropriate because, like now, the 1970s witnessed an intense debate over the theoretical and empirical underpinnings of a popular econometric model of inflation. And, like now, these debates largely revolved around the merits of what appeared to be a new paradigm for understanding the behavior of inflation and the macroeconomy.1

                                                  In this paper, we offer a selective and critical review of recent developments in the theoretical and empirical modelling of U.S. inflation dynamics. We ... are not attempting to provide a comprehensive summary of the huge amount of research devoted to this topic ... Rather, we hope to shed light on a couple of key issues: first, how are inflation expectations formed; and second, what is an appropriate empirical measure of inflationary pressures. ... [O]ur survey will reflect the answers to these questions that we have proposed in our earlier work.2 In particular, our research has suggested a number of reasons to be skeptical about the new-Keynesian framework that is bidding to become the new benchmark model for inflation analysis. More generally, we discuss some reasons to doubt some of the stronger implications of the rational expectations hypothesis for the modelling of inflation. In that sense, our work connects back to many of the themes of the 1970 conference, and it is with those earlier debates that we begin.

                                                  Continue reading "Do Sticky-Price RE Models Capture Inflation Dynamics Better Than Traditional Phillips Curve Models?" »

                                                    Posted by on Saturday, September 24, 2005 at 12:43 AM in Academic Papers, Economics, Inflation, Macroeconomics, Unemployment | Permalink  TrackBack (0)  Comments (0)


                                                    E. J. Dionne Jr.: Fiscal Policy is Stupid

                                                    “The cost this year alone of the Bush tax cuts enacted in 2001 and 2003 comes to $225 billion”:

                                                    Fiscal Policy: Why 'Stupid' Fits, by E. J. Dionne Jr., Washington Post:  Hurricane Rita heads inexorably westward, threatening to add to the human and financial costs of Hurricane Katrina. And when it comes to taxes and spending, Washington acts as if nothing is happening. True, a group of very conservative Republicans issued a list of program cuts ... under the imposing name "Operation Offset." The cuts that the Republican Study Committee proposed have won their sponsors praise for making "tough choices." … it's hard to give the fiscal conservatives too much credit, since they would cut $80 billion from Medicare and $50 billion from Medicaid over five years and suggest reductions in school lunches, rent subsidies for the poor and foreign aid, among other things. The idea seems to be that to help Katrina's poor and suffering victims, other poor and suffering people will have to sacrifice.

                                                    Nonetheless, permit me to offer a little cheap grace on these conservatives. At least the Operation Offset crowd has produced this list of cuts and forced its own leaders to disown them. The exchange showed how fundamentally stupid our budget policies have been over the past five years -- and, yes, I'll defend that strong word. Here's a fact getting far too little attention: The cost this year alone of the Bush tax cuts enacted in 2001 and 2003 comes to $225 billion. ... [T]he revenue lost because of tax cuts ... this year without any congressional action would more than pay the costs of Katrina recovery. Why describe our government's fiscal policies as "stupid," rather than, say, "ill-advised" or "misguided"? …  our current budget policies are built not on honest coherence but on incoherence or, even worse, a dishonest coherence. The president and members of Congress always insist that they are fiscal conservatives who believe in balanced budgets. Yet their actions bear no relationship to their words, and labels such as "conservative" have no connection to their policies. Our federal purse strings are in the hands of fiscal radicals. I'd have much more respect for these guys if they just came out and said: "... All we really care about are passing tax cuts -- and popular spending programs that get us reelected so we can enact more tax cuts." Not very politic, I'll grant you, but honest. Vice President Cheney came as close as anyone to this form of honesty when he spoke in support of the tax cuts … "Reagan proved deficits don't matter" and that Republicans owed themselves more tax cuts. … Which brings us back to that word "stupid." My dictionary tells me it means not only "lacking in ordinary intelligence" but also "dazed" and "stupefied." The crowd running our government is dazed and stupefied by a theory that sees throwing ever-larger sums to the wealthy in the form of tax cuts as so good, right and important that all the ordinary rules of finance and economics can be thrown out the window. If it was already stupid to pursue more tax cuts once the country decided to wage a large war on terrorism, it is supremely stupid to stay on the same course now that Katrina has added to our fiscal burdens and Rita, God help us, threatens to add more. Or maybe it's the rest of us who should be called stupid if we keep taking these guys at their word…

                                                    This won't get fixed until voters show they care.

                                                      Posted by on Saturday, September 24, 2005 at 12:34 AM in Budget Deficit, Economics, Press | Permalink  TrackBack (0)  Comments (2)


                                                      The Economist: Global Saving and Investment

                                                      The economist begins its series on explaining the pattern of global saving and investment which is intended to shed light on the low long-term interest rate puzzle with a useful summary of theories of why people save and why people invest:

                                                      What causes people to save and invest?, The Economist: At first sight, the idea of a “saving glut”—an excess of saving over investment—seems odd. According to the economics textbooks, saving and investment are always equal. ... And indeed that is true for the world as a whole, but it is not true for individual countries. ... the amount an individual country saves does not have to be the same as the amount it invests. The difference between the two is the amount borrowed from or lent to foreigners; this is called the current-account deficit or surplus... Moreover, whereas it is true that at a global level saving must equal investment, the fact that saving and investment end up in balance does not mean that ... households and individuals ... desire to save and invest in equal measure. ... Actual saving and investment must be equal. Desired saving and investment may not be.

                                                      Most of the time, ... If people's desire to save exceeds their desire to invest, interest rates will fall so that the incentive to save goes down and the willingness to invest goes up. Across borders, exchange rates have a similar effect. ... But there is some uncertainty about how smoothly these adjustments are made. Classical economic theory suggests that interest rates automatically bring saving and investment into a productive balance. The central principle of Keynesianism, however, is that this alignment between saving and investment is not always automatic, and that a misalignment can have serious consequences. ... The modern consensus is that both classical and Keynesian theory can be right, but over different time frames. In the long term, saving and investment will be brought into line by the cost of capital. But in the short term, firms' appetite to invest is volatile, and policymakers may need to step in to shore up demand. Thus, although saving and investment are equal ex-post, economic theory leaves plenty of room for an ex-ante saving glut...


                                                      What might change people's desire to save or invest? ... The most influential theory of household saving is the “life-cycle hypothesis” ... It suggests that people try to smooth consumption over their lifetime: they save little or nothing when young but more in their middle years if they have a good income. They then draw down those savings in retirement. ...demographic shifts and economic growth are the most important drivers of thrift. Another theory suggests that people save for “precautionary reasons” ... This implies that people will save more if their income is variable. It also suggests that they will be more inclined to save if they have no access to credit. A third possibility is that people save because they want to leave assets to their children, either because they love them or as a way to bribe the children to look after their parents in old age. ... the bequest theory of thrift suggests that savings might not actually be drawn down in retirement. A final possibility is that people save in response to their government's actions. This theory, known as “Ricardian equivalence”, suggests that people save more if government saves less because they expect higher taxes later on. How well do these theories fit with what has actually happened in the past? ... in general, the following factors seem to play a role:

                                                      Demographics. ...Saving rates do rise when the ratio of children in the population falls (as in China), and decline when the proportion of pensioners rises (as in Japan). Given that the world's population as a whole is ageing ... global saving should currently be rising.
                                                      Economic growth. Especially in poorer countries, saving rates rise as economies grow. That is probably because people do not adjust their consumption patterns as quickly as their income rises...
                                                      Terms-of-trade shock. If a country's exports suddenly go up in price, its saving rate tends to go up too, at least temporarily. Oil exporters, for example, put on a saving spurt if oil prices rise. This effect also helps to explain the recent increase in saving in many emerging economies.
                                                      Financial development. As an economy's financial system becomes more developed, saving rates tend to fall because people find it easier to borrow. ... It suggests that saving rates may be lower in countries with more sophisticated financial systems, such as America.
                                                      Capital gains. In rich countries ... If the stock market or house prices rise, people feel richer and save less. A study by the OECD published late last year suggests that housing wealth has a bigger effect on saving than financial wealth...
                                                      Fiscal policy. In some countries, people do appear to behave as Ricardian equivalence theory suggests: they save more when budget deficits expand, perhaps because they expect higher taxes in the future, although private-sector saving rises by less than the rise in budget deficits. The big exception is America, where the impact of fiscal deficits on private saving appears to be weakest.

                                                      Some of these factors work in opposite directions ... But there are indications that in rich countries the biggest disincentives to saving have been capital gains and the ability to borrow. ... In emerging markets, on the other hand, the most powerful factors pushed in the opposite direction. Fast economic growth and increases in government saving, thanks partly to terms-of-trade shocks, have increased total national saving. ... If there is a glut of saving, it is likely to be found in emerging economies and oil-exporting countries.

                                                      ...In theory, firms should invest if the expected return on their investment exceeds the cost of the capital they are using. In the short term, firms need to worry about the state of overall demand. But in the long term, returns on capital depend on how much capital an economy already has, how productively it is used, and how fast the workforce is growing. If there is little capital available or the workforce is growing rapidly, firms would usually expect a high return on investment. The evidence supports these theories, up to a point. ... However, in recent years these statistical relationships have failed to hold. Both in rich countries and in emerging economies (except China), investment levels have been lower than economists had expected at the levels of interest and growth rates prevailing at the time. Much of Mr Bernanke's saving glut is due to this unexpectedly low rate of investment. ... several “structural” explanations have gained support:

                                                      Demographics. A young and growing workforce boosts the level of investment, just like a mature workforce boosts the saving rate. ... But although demographics are important, they change slowly. It is hard to ascribe the recent sharp drop in investment demand in regions such as Japan or East Asia to demographic change alone.
                                                      Declining capital intensity. Firms in rich countries may not need to invest as much as they used to because the share of capital-intensive industries in their economies is shrinking. ... But [this] does not explain investment busts in poor countries.
                                                      Deflation of capital-goods prices. In recent years prices of capital goods have fallen sharply relative to prices of other goods and services, thanks largely to cheaper computers, so companies are able to achieve the desired level of real investment for a smaller outlay. ... This may help to explain some of the recent weakness in investment, particularly in rich countries. But it is unlikely to last. ... More important, computers depreciate more quickly than other capital goods, so eventually firms will need to invest more to maintain the same level of net investment.
                                                      The rise of China. This may have prompted a geographic shift in global investment patterns. ... But investment flows to China from America, Europe and Japan are not yet big enough to explain the sluggish investment in those countries...

                                                      In sum, none of these explanations for a structural, global decline in investment is altogether convincing. To understand the pattern of global saving and investment properly, you have to look in detail at what is going on within the world's main saving and borrowing countries. The best place to start is the biggest net saver of all, Japan.

                                                      More to follow...

                                                        Posted by on Saturday, September 24, 2005 at 12:24 AM in China, Economics, International Finance, Saving | Permalink  TrackBack (0)  Comments (1)


                                                        Friday, September 23, 2005

                                                        Is There a Global Saving Glut? If So, Will it Persist?

                                                        The Economist begins a series of articles on the global saving glut, global investment deficit, excess liquidity, and slow expected world growth hypotheses for the persistence of low long-term interest rates, with an emphasis on world saving patterns. This introductory piece asks whether Ben Bernanke, who can be assigned responsibility for both monetary and fiscal policy, was correct to deflect criticism over the current account deficit away from U.S. policymakers.  It concludes that the U.S. must shoulder more responsibility for global imbalances than Bernanke's global saving glut hypothesis allows. The paper also concludes that rebalancing will take time and invlolve risks to the world economy.  The second figure showing the shift in saving from the household to the business sector in recent years is noteworthy, though the chart shows this is not the first time household saving has dropped and corporate saving has risen since 1980:

                                                        The great thrift shift, by Zanny Minton Beddoes, The Economist: On March 10th 2005, Ben Bernanke ... argued ... the world might be suffering from a “global saving glut”. The phrase immediately caught on. ... The idea's appeal lies in the way it ties together two of the most vexing questions about today's economic landscape: why are interest rates so low? And why can America borrow eye-popping amounts from foreigners with seeming impunity? ... A “global saving glut” could explain both oddities. ... His suggestion that the causes of global imbalances lie elsewhere conveniently deflects attention from monetary and fiscal decisions ... It suggests that Mr Greenspan's loose monetary policy and George Bush's tax cuts are not responsible for the imbalances in the world economy. That may seem a little self-serving, coming from a man who has subsequently moved from the Federal Reserve to become chairman of Mr Bush's Council of Economic Advisers.

                                                        Taken at face value, the notion of a global saving glut is not borne out by the facts. “Glut” suggests an unusually large amount, as in a summer glut of strawberries. In fact, figures published in the IMF's latest World Economic Outlook show that the rate of global saving as a proportion of global output, measured at market exchange rates, has mostly been heading downhill over the past 30 years, with a particularly steep plunge between 2000 and 2002 (see chart 1)...

                                                        But Mr Bernanke's argument is more subtle. He is saying that low interest rates imply too much saving relative to the amount people want to invest, and that the ... discrepancy is concentrated outside America. ... [E]ven with the saving rate falling, there could be a glut of thrift if ... the demand for investment ... was falling even faster. The important factors in the equation, therefore, are shifts in the appetite for investment as well as in the geography of thrift. On both counts the world has seen big changes. Traditionally, most of the saving ... is done by households, whereas most of the investing tends to be done by firms. But in the past few years firms have become net savers as their profits have exceeded their investments. That change has been most pronounced and long-lasting in Japan, where corporate saving soared after the bubble economy collapsed in the early 1990s. Burdened with bad debts ..., Japanese firms have been net savers for a decade. The late 1990s saw a similar shift in many emerging Asian economies, where corporate investment plunged after the Asian financial crisis. After the stockmarket bubble burst in 2000, American and European firms' investment also fell. Although American firms began investing again a couple of years ago, the level of corporate investment is still relatively low, given how strongly the economy—and profits—have been growing. Firms in industrial countries as a whole are still saving more than they invest, despite record profits (see chart 2). The only significant country bucking the trend is China, where investment has been rising sharply. But saving has been growing faster still.

                                                        A weak appetite for investment might help explain low interest rates, but not the rising imbalances between America and the rest of the world. To understand those, two other factors have to be considered: differences in countries' economic structures, and differences in policymakers' reactions to the investment bust.

                                                        Continue reading "Is There a Global Saving Glut? If So, Will it Persist?" »

                                                          Posted by on Friday, September 23, 2005 at 01:23 AM in Budget Deficit, China, Economics, International Finance, International Trade, Monetary Policy, Policy | Permalink  TrackBack (0)  Comments (5)


                                                          Krugman: Crisis in Confidence

                                                          Paul Krugman on our declining confidence in the economy, in our political leadership, and ultimately in ourselves:

                                                          The Big Uneasy, by Paul Krugman, NY Times: Although Hurricane Katrina drowned much of New Orleans, the damage to America's economic infrastructure actually fell short of early predictions. Of course, Rita may make up for that. But Katrina did more than physical damage; it was a blow to our self-image as a nation. Maybe people will quickly forget the horrible scenes from the Superdome, and the frustration of wondering why no help had arrived, once cable TV returns to nonstop coverage of missing white women. But my guess is that Katrina's shock to our sense of ourselves will persist for years. America's current state of mind reminds me of the demoralized mood of late 1979, when a confluence of events - double-digit inflation, gas lines and the Iranian hostage crisis - led to a national crisis of confidence.

                                                          Start with economic confidence. The available measures say that consumer confidence, which was already declining before Katrina hit, has now fallen off a cliff. ... It's true that gasoline prices have receded from their post-Katrina peaks. But even if Rita spares the refineries, a full recovery of economic confidence seems unlikely. ... Then there's the war in Iraq, which is rapidly becoming impossible to spin positively: ... Most Americans say the war was a mistake; a majority say the administration deliberately misled the country into war; almost 4 in 10 say Iraq will turn into another Vietnam. And many people are outraged by the war's cost. The general public doesn't closely follow economists' arguments about the risks of budget deficits, or try to decide between competing budget projections. But people do know that there's a big deficit, that politicians keep calling for cuts in spending and that rebuilding after Katrina will cost a lot of money. They resent the idea that large sums are being spent in a faraway country, where we're waging a war whose purpose seems increasingly obscure.

                                                          Finally, fragmentary evidence - like a sharp drop in the fraction of Americans who approve of President Bush's performance in handling terrorism ... suggests that the confluence of Katrina and the fourth anniversary of 9/11 has caused something to snap in public perceptions about the "war on terror." In the early months after 9/11, America's self-confidence actually seemed to have been bolstered by the attack: the Taliban were quickly overthrown, and President Bush looked like an effective leader. ... But now that more time has elapsed since 9/11 than the whole stretch from Pearl Harbor to V-J Day, people are losing faith. Osama, it turns out, could both run and hide. It's obvious from the evening news that Al Qaeda and violent Islamic extremism in general are flourishing.

                                                          And the hapless response to Katrina, which should have been easier to deal with than a terrorist attack, has shown that our leaders have done virtually nothing to make us safer. And here's the important point: these blows to our national self-image are mutually reinforcing. The sense that we're caught in an unwinnable war reinforces the sense that the economy is getting worse, and vice versa. So we're having a general crisis of confidence. It's the kind of crisis that opens the door for dramatic political changes ... who will provide leadership, now that Mr. Bush is damaged goods?

                                                            Posted by on Friday, September 23, 2005 at 01:02 AM in Economics, Politics | Permalink  TrackBack (0)  Comments (7)


                                                            Does Structural Change Explain the Sluggish Employment Growth in Recent Recoveries?

                                                            This research from the NY Fed finds evidence that structural change accounts for the anemic job growth during recent recoveries.  The first figure shows that recovery from recent recessions has been different from previous recoveries by showing that job growth was lower during the recovery from the 1990-91 recession and absent during the recovery since 2001 (this was written in August 2003).  The second chart shows the difference in the behavior of temporary layoffs in the last two recessions, and the third chart contains estimates of the degree of structural change over time showing a clear upward trend in the structural component of unemployment.  More details are in the paper, "Has Structural Change Contributed to a Jobless Recovery?,"  Erica L. Groshen and Simon Potter, Current Issues in Economics and Finance, NY Fed, August 2003:

                                                            Chart 1 - Payroll Job Growth during Recoveries

                                                            Chart 1 - Payroll Job Growth during Recoveries
                                                            Sources: U.S. Bureau of Labor Statistics; authors' calculations.
                                                            Note: The shaded area indicates the length of the 2001 recession.


                                                            Chart 2 - Contribution of Temporary Layoffs
                                                            to the Unemployment Rate

                                                            Chart 2 - Contribution of Temporary Layoffs to the Unemployment Rate

                                                            Sources: U.S. Bureau of Labor Statistics; authors' calculations.
                                                            Note: Shaded areas indicate periods designated recessions
                                                            by the National Bureau of Economic Research.

                                                            Chart 5 - Share of Total Employment in Industries
                                                            Undergoing Cyclical Changes and in Industries
                                                            Undergoing Structural Changes

                                                            Chart 5 - Share 
                                of Total Employment in Industries Undergoing Cyclical 
                                Changes and in Industries Undergoing Structural 
                                Changes

                                                            Sources: U.S. Bureau of Labor Statistics; authors’ calculations

                                                              Posted by on Friday, September 23, 2005 at 12:34 AM in Economics, Unemployment | Permalink  TrackBack (0)  Comments (1)


                                                              The Glittering Eye: Carnival of the Liberated

                                                              Dave Schuler at The Glittering Eye has his one year anniversary as editor of Carnival of the Liberated:

                                                              My anniversary with Carnival of the Liberated: a year in the Iraqi and Afghani blogosphere, Glittering Eye: It’s been a year since I took over editorship of the Carnival of the Liberated for Dean Esmay. ... I’ll keep on doing it as long as Dean lets me. ... The year has been enormously eventful for Iraq, the Iraqi bloggers, the Iraqi blogosphere, and the blogosphere as a whole. In this post I’m going to recap the year briefly. ... There are now two Afghan bloggers blogging from Afghanistan: Afghan Lord and Afghan Warrior. That’s two more than we had last year at this time. Thanks, guys. It takes enormous courage to do what you’re doing. Keep up the good work. I hope there are a lot more of you by this time next year.

                                                              It’s been a year of upheaval for Iraq and the Iraqi blogosphere. Many of the core Iraqi bloggers when I started editing the Carnival aren’t posting anymore; others have taken their places. Some have left the country: Ahmed of Life in Baghdad and Rose of Diary from Baghdad (husband and wife) have moved to Dubai where Ahmed has found work. Khalid Jarrar of Tell Me a Secret left the country after his ordeal. I believe he is in Jordan. This isn’t a good trend. If the best and the brightest leave Iraq it will be that much more difficult to rebuild the country. Some bloggers have returned to Iraq. Salam Pax, the original Iraqi blogger, has returned to Iraq and is posting again. His observations on the new constitution have been particularly good. neurotic iraqi wife has joined Hubby in the Green Zone and is working to build the new Iraq. But she’s discouraged and posts infrequently these days.

                                                              Continue reading "The Glittering Eye: Carnival of the Liberated" »

                                                                Posted by on Friday, September 23, 2005 at 12:23 AM in Iraq and Afghanistan, Politics, Weblogs | Permalink  TrackBack (1)  Comments (0)


                                                                Thursday, September 22, 2005

                                                                The Social Security Blame Game Begins

                                                                Senator Santorum is blaming the White House for the failure of Social Security reform.  If they would have listened to him, things would be different:

                                                                Santorum takes Bush to task over Social Security strategy, by Maeve Reston, Post-Gazette:  Frustrated by Congress' failure to move on ... Social Security problems, Sen. Rick Santorum yesterday said ... the White House had made a "fundamental error" in handling its public relations campaign... Santorum, R-Pa., said he had struggled to understand President Bush's decision to come out "right after the campaign ... with this mandate that you're going to change the sacred cow of the [political] left, who've just been energized beyond belief.  You've just defeated your opponent, and, you know, you take a 3-iron to the beehive ... You go out there and whack the beehive, and you wonder why all these bees are buzzing around your head. And not only do you whack the beehive, but then you don't do anything [more] for two months." Santorum … said that as soon as White House officials told him that they were going to roll out Social Security reform initiatives in 2004, he urged them to construct a plan on the order of a presidential campaign, believing that "it was bigger than anything we've tried to do." In an interview ... last evening, Santorum said he "pleaded" with administration officials to develop and launch a strategy to convey the issue's importance to the public immediately, and even to forgo Christmas breaks to ensure that a plan was in place. But the White House preferred to wait until Bush's State of the Union address Feb. 2, a strategy that made it difficult for GOP senators to build support for Social Security changes among their constituents, Santorum said. Foes of the reforms "didn't waste" the holiday breaks, he said. "They started hammering on the president, basically starting to tear this apart in December. What [the White House] needed to do immediately was what they did three months later, which was to lay out the problem and get ahead of the curve. "It's the old thing in politics: ... we sat back and let our opponents define us and define the issue," he said. "We were just playing catch up the whole time, and that was the fundamental error."… Santorum said he was continuing to getting mixed signals from House GOP leaders about whether they will move on reform legislation in the near future...

                                                                  Posted by on Thursday, September 22, 2005 at 01:51 PM in Economics, Politics, Social Security | Permalink  TrackBack (0)  Comments (10)


                                                                  The Galveston Hurricane of 1900

                                                                  "Nature will win if we decide that we can beat it."

                                                                  There is a detailed account of the devastating 1900 hurricane that struck Galveston in Reference.com [note: no longer there]:

                                                                  Galveston Hurricane of 1900 The Galveston Hurricane of 1900 made landfall on the city of Galveston, Texas on September 8, 1900. It had estimated winds of 135 miles per hour (217 km/h), making it a Category 4 storm on the Saffir-Simpson scale...

                                                                  Continue reading "The Galveston Hurricane of 1900" »

                                                                    Posted by on Thursday, September 22, 2005 at 04:14 AM in Economics | Permalink  TrackBack (0)  Comments (21)


                                                                    Using Fiscal Policy to Stabilize the Economy

                                                                    As Janet Yellen points out, monetary policy is not an effective means of mitigating short-run fluctuations in the economy arising from events such as Katrina.  In general, if it can be implemented quickly and efficiently, fiscal policy (meaning changes in either spending or taxes) is a more effective means of dealing with such fluctuations, and with higher frequency fluctuations in GDP and employment more generally. To use fiscal policy to stabilize the economy however, you have to spend more or tax less in the bad times (increase the deficit) and then do the hard thing which is to raise taxes or cut spending in the good times (decrease the deficit).  To keep the budget in balance the good has to be matched somewhere by the bad.  If you cut taxes for this disaster, or this recession, or this war, and don’t raise them later, what do you do next time?  Cut again?  Okay, what about the time after that?  It won’t work forever.  The priming of the economy during the bad times must be matched by a slowdown during the good.  Borrow when income is low, pay it back when income is high. 

                                                                    Furthermore, in stabilization policy, it’s also not possible in the long-run to use both government spending and taxation at opposite points in the business cycle.  That is, suppose you cut taxes during the bad times, then cut spending during the good times to pay it back.  That will work for a recession or two, a hurricane or two, but it won’t work forever because eventually there will be nothing left to cut out of government.  The opposite will not work forever either.  If you increase spending during the bad times then increase taxes during the good, the size of government will grow indefinitely over the long-run.  In more graphic form:

                                                                    G↑ (rec) → T↑ (boom) →  G↑ (rec)→  T↑ (boom)  → G↑  (rec) → T↑ (boom)  →  bloated government

                                                                    T↓ (rec) → G↓ (boom) →  T↓ (rec)→  G↓ (boom)  → T↓ (rec) → G↓ (boom)  →  no government

                                                                    These two policies, or some combination of them (increase G and cut T in recessions, do the opposite in booms) are sustainable:

                                                                    G↑ (rec) → G↓ (boom) →  G↑ (rec) →  G↓ (boom)  → G↑ (rec) → G↓ (boom)  →  sustainable size of government

                                                                    T↓ (rec) → T↑ (boom) →  T↓ (rec) →  T↑ (boom)  → T↓ (rec) → T↑ (boom)  →  sustainable size of government

                                                                    The Democrats are accused of adopting the first strategy and bloating the government.  The Republicans claim to adopt the second strategy to shrink government, but they’ve bloated government themselves (take the second line and change it to T↓ (rec) → G↑ (boom) → etc., a clearly unsustainable path).  Neither party seems willing or able to use either the third and/or the fourth lines as a means of stabilizing the economy.  We are seeing that now, and maybe even less stable budgetary variations.  The WSJ and other members of the GOP seems to advocate T↓ (rec)→ T↓ (boom) → etc. which, without cuts in G, cause deficits rise no matter how much they claim otherwise. 

                                                                    There are, of course, lots and lots of variations on these basic chains of events, e.g. to adjust the size of government the first or second strategies can be adopted temporarily, and you hope lawmakers would put all their cards on the table as they do so whichever direction government size is to be adjusted.  But fiscal policy that is sustainable in the long-run, through recession after recession, natural disaster after natural disaster, war after war, has to adopt some combination of the third and fourth lines.  Simply cutting taxes whenever and wherever possible gets us into the predicament we are now in.  But those who try and adopt responsible budget practices face stiff opposition:

                                                                    A GOP Tax Increase?, WSJ:  ...Markets have begun to get rattled in the last couple of days, both in fear of further damage in the Gulf region from Hurricane Rita, and in response to the bad ideas that are starting to flow fast and furious from Congress. These include ... a revival of the oil "windfall profits" tax. ... But the worst news is that a handful of GOP Senators think a tax increase is needed to pay for Katrina spending. ... some GOP Senators are suggesting that they should redo reconciliation and drop the capital gains and dividend tax cuts. ... We can understand why some Democrats would want Republicans to repudiate their own tax policies. But why Republicans would want to join in this act of masochism is a mystery. President Bush has ruled out tax increases to finance Katrina relief, but we hope someone in the White House is telling him what members of his own party are doing in the Senate. Katrina has already done enough damage, without the political class compounding it with policy blunders.

                                                                    The political climate makes it unlikely, but some combination of the third and fourth lines during the recovery period is the best way out of our budget predicament.  There are certainly places government can be cut or made more efficient.  But cuts alone aren't enough and tax increases of one sort or another are also needed.

                                                                      Posted by on Thursday, September 22, 2005 at 02:25 AM in Budget Deficit, Economics, Policy, Politics, Taxes | Permalink  TrackBack (0)  Comments (11)


                                                                      A Selection of Timely Views

                                                                      Two views from Times Select.  Bob Herbert talks about George Bush, and David Brooks talks about John Kerry, John Edwards, and where the Democratic party is headed:

                                                                      Voters' Remorse on Bush, by Bob Herbert, NY Times Columnist: Maybe, just maybe, the public is beginning to see through the toxic fog of fantasy, propaganda and deliberate misrepresentation that has been such a hallmark of the George W. Bush administration, which is in danger of being judged by history as one of the worst of all time. Mr. Bush's approval ratings have tanked as increasing numbers of Americans worry that their president, who seems to like nothing better than running off to his ranch to clear brush and ride his bike, may not be up to the job. ... Reality is caving in on a president who was held aloft for so long by a combination of ideological mumbo-jumbo, the public relations legerdemain of Karl Rove and the buoyant patriotism that followed the Sept. 11 attacks. ...Remember, there was already a war going on when Katrina came to call. I've always believed that war is a serious matter. But the president was on vacation. Dick Cheney was on vacation. And Condi Rice was here in New York taking in the sights and shopping for shoes. That Americans were fighting and dying on foreign soil was not enough to demand their full attention. ... So it's no wonder it took a good long while before they noticed that a whole section of America had been wiped out in a calamity of biblical proportions. ...Americans are finally catching onto ... the utter incompetence of this crowd. And ... that incompetence has bitter consequences. The body count of Americans killed in Iraq has now passed 1,900, with many more deaths to come. But ... The White House hasn't the slightest clue about what to do. So the dying will continue. ... Mr. Bush never sent enough troops to get the job done, and he never provided enough armor to protect the troops that he did send. Thin-skinned, the president got rid of anyone who had the temerity to suggest he might be wrong ... Here at home, even loyal Republicans are beginning to bail out on Mr. Bush's fiendish willingness to shove the monumental costs of the federal government's operations - including his war, his tax cuts and his promised reconstruction of the Gulf Coast - onto the unsuspecting backs of generations still to come. There is a general sense now that things are falling apart. ... This is what happens when voters choose a president because he seems like a nice guy, like someone who'd be fun at a barbecue or a ballgame. You'd never use that criterion when choosing a surgeon, or a pilot to fly your family across the country... the next time around, voters need to keep in mind that beyond the incessant yammering about left and right, big government and small, Democrats and Republicans, is a more immediate issue, and that's competence.

                                                                      Next, David Brooks:

                                                                      Kerry and Edwards, 2005, by David Brooks, NY Times columnist: John Kerry and John Edwards ran for office together and they lost together, and they both gave major speeches about Katrina this week, but there the similarity ends. The two men might as well live in different worlds. Kerry began his speech by making the point that Bush and his crew are rotten. He then went on to make the point that Bush and his crew are loathsome. In the third section of the speech, Kerry left the impression that Bush and his crew are evil. Now we all know people so consumed by hatred for George Bush that they haven't had an unpredictable thought in five years, but in Kerry's speech one sees this anger in almost clinical form... All reality flows back to Bush. All begins with Bush, ends with Bush, is explained by Bush and is polluted by Bush, cursed be thy name...

                                                                      John Edwards's speech had a different feel. Edwards took some hard shots at Bush, some of them deserved, but having left Washington after the election, Edwards is not so obsessed with power struggles. In his talk he roamed outward and spoke about the complexities of actual life. He mentioned that the typical white family has about $80,000 in assets, while the typical Hispanic family has about $8,000, and the typical African-American family has about $6,000. That's an astonishing gap. ... He concluded with a series of policy recommendations fit for the post-welfare-reform world. No conservative would agree with all of them, but nobody could fail to find them interesting. ... Edwards proposed a series of policies designed to encourage work, to encourage responsibility, to help the poor build assets.  The Kerry-Edwards contrast is characteristic of the argument that now divides the Democratic Party. On one side are those who believe that the party's essential problem is with its political style. The Republicans win because they are simply rougher, so the Democrats must be just as tough in response. They must match Karl Rove blow for blow. ... On the other side are those who believe that the Democratic defeats flow from policy problems, not from campaign style or message framing. They don't believe that Democrats can win wrapped in their own rage...  For them, the crucial challenge is to come up with policies more in tune with voters. Kerry speaks for the first group, which believes in more partisanship, and Edwards for the second, which believes in less. I have discussions with my Democratic friends over whether the party will snap back to Clintonite centrism after the polarizing Bush leaves town. Some think yes. I suspect no...

                                                                      For what it’s worth, I think it’s both.  Democrats can be tougher advocates of well formulated, rational, innovative policy.

                                                                        Posted by on Thursday, September 22, 2005 at 01:41 AM in Economics, Politics | Permalink  TrackBack (0)  Comments (2)


                                                                        Divine Coincidence is Unlikely

                                                                        The details of this paper may not interest all of you as the paper involves fairly technical issues regarding New Keynesian models and monetary policy, but the general question is straightforward. Do policymakers face an inflation-output tradeoff when conducting monetary policy? In standard versions of the New Keynesian model they do not, a situation known as divine coincidence. Greg Mankiw’s discussion of divine coincidence, an ideal situation for a policymaker, was presented here.  Here’s another paper on this topic that will be presented at this conference sponsored by the Federal Reserve Board and The Journal of Money, Credit, and Banking (the link has other interesting conference papers as well) showing that divine coincidence is due to a special feature of the New Keynesian model:

                                                                        "Real Wage Rigidities and the New Keynesian Model," Olivier Blanchard and Jordi Gali, September 9, 2005: Abstract Most central banks perceive a trade-off between stabilizing inflation and stabilizing the gap between output and desired output. However, the standard new Keynesian framework implies no such trade-off. In that framework, stabilizing inflation is equivalent to stabilizing the welfare-relevant output gap. In this paper, we argue that this property of the new Keynesian framework, which we call the divine coincidence, is due to a special feature of the model, the absence of non trivial real imperfections. We focus on one such real imperfection, namely real wage rigidities. When the baseline new Keynesian model is extended to allow for real wage rigidities, the divine coincidence disappears, and central banks indeed face a trade-off between stabilizing inflation and stabilizing the welfare-relevant output gap. We show that not only does the extended model have more realistic normative implications, but it also has appealing positive properties. In particular, it provides a natural interpretation for the dynamic inflation-unemployment relation found in the data.

                                                                          Posted by on Thursday, September 22, 2005 at 12:44 AM in Academic Papers, Economics, Monetary Policy | Permalink  TrackBack (1)  Comments (5)


                                                                          Issues in IMF Reform

                                                                          New Economist notes a conference and background paper addressing IMF reform:

                                                                          How to reform the IMF, New Economist: The International Monetary Fund, once the pre-eminent multilateral financial institution, faces an identity crisis. How to make it strong and effective again? Ahead of this weekend's World Bank-IMF annual meeting, the Institute for International Economics has organised a one-day Conference on IMF Reform.  A 93 page background paper for tomorrow's event, by Edwin M Truman, is now available: International Monetary Fund Reform: An Overview of the Issues (PDF). Truman argues that "the IMF is in eclipse" and "consequently, the world is worse off. Despite the considerable reforms over the past decade, more should be done." But simple measures won't not enough - reform is needed across a range of areas:

                                                                          No single step or magic formula will restore the IMF to its prior position as a highly respected institution. Effective reform of the IMF must encompass many aspects of the IMF’s activities—where it should become more as well as less involved. Over the past decade, a large number of changes in the international financial architecture and in the IMF’s operations have been put in place. Those reforms have not been sufficient to restore the IMF to the center of today’s international monetary and international financial system, assuming that was the intentions of the reformers. Successful reform of the IMF must engage the full spectrum of its members. The IMF should not focus primarily on its low-income members and the challenges of global poverty. It should not focus exclusively on international financial crises affecting a small group of vulnerable emerging market economies. Instead, it must be engaged with each of its members potentially on the full range of their economic and financial policies emphasizing primarily those policies that impact the functioning of the global economy.

                                                                          Truman concludes:

                                                                          A major priority is IMF governance. An equally important priority is to upgrade the IMF’s role in the international monetary system. In addition, improvements should be made in IMF lending operations, and the IMF must be pulled back from becoming just another development financing institution. The IMF’s financial resources will soon need to be augmented.

                                                                            Posted by on Thursday, September 22, 2005 at 12:25 AM in Academic Papers, Economics, International Finance, Policy | Permalink  TrackBack (0)  Comments (1)


                                                                            Wednesday, September 21, 2005

                                                                            Grassley: Katrina Killed Social Security Reform for This Year

                                                                            Is Social Security reform dead, really dead, wooden stake through the heart dead for this year?  Some still haven’t given up, but Katrina ended the last bit of momentum for reform:

                                                                            Grassley: Social Security reform will wait, by Jane Norman, Des Moines Register:  Ongoing battles in Congress over hurricane relief, tax cuts and spending likely mean that proposals to revamp Social Security are dead until next year, Senate Finance Committee Chairman Charles Grassley, R-Ia., said Tuesday. Grassley ... acknowledged that putting the debate off until 2006 and a midterm election year means it would be "very difficult" to accomplish any major changes, including the voluntary personal accounts for Social Security championed by President Bush. But Grassley ... said that Social Security will have to take a back seat this fall to hurricane-related legislation and possibly prolonged negotiations over the budget and tax cuts. "If we're going to adjourn by Thanksgiving, it's probably not going to be handled this year," said Grassley … He said he has heard little from other committee members about Social Security in recent weeks...

                                                                            Wooden stake or not, it sounds like next year will bring the return of the living dead ("They're back...They're Hungry...And they're NOT vegetarian").

                                                                              Posted by on Wednesday, September 21, 2005 at 03:36 PM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (5)


                                                                              The Economist: Central Banking is Hard

                                                                              With growing global imbalances, natural disasters, currency areas, public disapproval of rate hikes, asset price inflation, stagflation worries, uncooperative fiscal policy, exchange rate adjustments, growing downside risk to policy, and maybe even underwear that’s too tight, it’s a tough time to be a central banker. Former Fed Governor Lawrence Meyer explains, "Each member appreciates the heavy responsibility the Committee has for the economic well-being of the country and the importance of their personal participation in this process. ... Serving on the FOMC is, without question, the most important responsibility I could have..."  The Economist discusses worries and difficulties faced by central banks around the world in their attempt to live up to this responsibility:

                                                                              Reluctant party-poopers, The Economist: William Mcchesney Martin, a past chairman of America’s Federal Reserve, famously observed that the job of a central banker is to “take away the punch bowl just when the party is getting started”. Unsurprisingly, this often generates quite a bit of hostility from the party-goers, who would prefer a few more shots of low interest rates ... This accounts for the tendency of many central bankers ... to err on the side of easy money, resulting all too often in double-digit inflation. Of course, if the party gets out of hand, and the house is wrecked, the central banker can expect to come in for plenty of censure, even from those who were previously begging him to give them just one more for the road. After the excesses of the 1970s, and the hangover of the early 1980s, ... Twenty years on, most developed countries seem to have built a solid reputation for inflation-fighting... And yet this is a worrying time to be a central banker. Though global economic growth is strong and inflation tame, powerful imbalances are building beneath the surface, and they threaten to throw the world economy off course. The fight against inflation is, it turns out, just one battle in a wider war.

                                                                              …the Fed’s Alan Greenspan … now finds himself deep in uncharted waters. After cutting short-term interest rates to just 1% to help ease the country out of the 2001 recession, he has been raising them at a measured pace, trying to keep the economy from overheating. The Fed’s hawkish credibility, along with cheap goods from China and other low-wage countries, has helped to keep consumer-price inflation relatively tame despite exceptionally loose monetary policy. Asset-price inflation is another story. … America’s … housing market looks decidedly frothy. Consumers … are dangerously overstretched and vulnerable to any change in interest rates. A sharp correction in the housing market could give the economy convulsions. There are similar worries in Britain … The Bank of England left rates unchanged this month, but with fears growing that economic expansion will fall short of expectations, it may soon have to choose between fighting inflation and staving off Britain’s first recession in over a decade.

                                                                              The Fed may well face the same tough choice. Hurricane Katrina roared into already tight oil markets, damaging much of America’s oil-pumping and -refining capacity, and another hurricane, Rita, threatened to wreak more havoc along the Gulf coast this week. … this has led to renewed talk of stagflation, a central banker’s worst nightmare. ... So far, there is little evidence of real danger. But given that higher energy prices generally boost inflation and shrink demand, it is not unreasonable to worry about the future.

                                                                              Yet Mr Greenspan and Mervyn King, the Bank of England’s governor, have it easy compared with Jean-Claude Trichet, the head of the ECB... Mr Trichet presides over a currency zone more diverse than America’s, but without the fiscal stabilisers that help smooth over regional variations. In 2004, Portugal’s economy grew by 1%, Ireland’s by almost 5%, but both had the same nominal interest rate. This has the perverse effect of giving higher real ... interest rates to slow-growing, low-inflation countries, and lower real rates to booming economies with rapid inflation—precisely the opposite of what a sound monetary authority would prescribe. … Moreover, the euro area as a whole has grown slowly ... Critics say that the ECB, which has left interest rates unchanged at 2% for more than two years, is paralysed, unable to look beyond its inflation-fighting mandate to deal with Europe’s economic malaise.

                                                                              The reality is more complicated. The euro area’s economic woes have much more to do with tight fiscal policy and structural rigidities in its markets ... Real interest rates have actually been near zero in the euro area for much of the past two years, making monetary policy relatively loose. ... And the ECB, like its American and British counterparts, must contend with high oil prices pushing up the inflation rate and hindering growth. In Asia, too, central bankers are having to deal with the fallout of higher oil prices. ... China’s central bank faces a different set of problems. To keep the yuan cheap enough to subsidise China’s massive export industries, it has had to buy billions of dollars and pour them into American bonds. The longer this goes on, the more vulnerable the bank is to a fall in the value of the dollar, ... But fears of the domestic political unrest that might occur if the export sector faltered keep the bank from reducing its exposure to the dollar. Moreover, the massive currency operations create domestic inflationary pressure, which the bank struggles to contain given the primitive state of China’s financial markets. No matter where you are, it seems, being the central banker is no party.

                                                                              By getting its fiscal house in order and coming up with a credible plan to reduce the deficit, the U.S. could do a lot to ease global economic uncertainty.

                                                                                Posted by on Wednesday, September 21, 2005 at 10:52 AM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (1)


                                                                                IMF: US Must Raise Taxes to Eliminate Fiscal Imbalance

                                                                                The IMF does not believe that cutting programs alone will be sufficient to solve the U.S. fiscal imbalance.  Tax increases will be necessary:

                                                                                IMF seeks US tax rises to meet fiscal problems, by Andrew Balls, FT: The International Monetary Fund has said that the Bush administration's plans to halve the US fiscal deficit over four years are too modest and called for tax increases to tackle longer-term fiscal problems. In its annual report on the US economy, the IMF said that even if the administration's target of halving the deficit over four years was achieved, the deficit and government debt would still be too high in the face of the added burden on Social Security and Medicare created as “baby boomers” start to retire. The report, released late on Friday, said the US should consider measures for broadening the tax base for households and businesses, including a federal sales tax or VAT, and higher taxes on energy use. … The IMF has stressed in other recent reports that the US budget deficit and reliance on foreign capital are a big source of risk in the international economy, and could prompt a disorderly decline in the dollar. … It said that budget discipline would be aided by restoring pay-as-you-go (PAYGO) budget rules, used during the 1990s, which required that spending increases or tax cuts be offset elsewhere in the budget…

                                                                                Katrina is a non-recurring budget item, at least let’s hope so.  It will be used as a reason to eliminate programs with recurring commitments, and perhaps pork and non-recurring items as well, but even then it won’t be enough to solve the problem.  Program cuts alone will not do it.  For those who say that’s incorrect, all I ask is that you put an explicit and politically feasible list of program cuts on the table to back up your claim.

                                                                                  Posted by on Wednesday, September 21, 2005 at 02:37 AM in Budget Deficit, Economics, Politics, Taxes | Permalink  TrackBack (0)  Comments (11)


                                                                                  The Global Dearth of Investment

                                                                                  The Economist argues that low long-term interest rates are not due to a global glut of saving as some have claimed, but rather to a lack of global investment.  We’ve had this debate before based upon an article in The Economist, e.g. see here, particularly Brad DeLong, William Polley, PGL at Angry Bear, and this paper from the NBER. I agree with the conclusion reached at that time – low long-term rates are explained by both a lack of global investment relative to saving and by excess liquidity.  In IS-LM jargon, this is an inward shift of the IS curve and an outward shift in the LM curve as shown in DeLong.  Unlike the previous editorial in The Economist that claimed excess global liquidity explained low long-term rates, this article focuses on the inward shift in the IS:

                                                                                  Don’t blame the savers, The Economist:  …America’s fiscal profligacy … contribut[es] to the imbalances that currently threaten the health of the world economy. That is precisely the verdict of the newly released chapter on savings and investment in the International Monetary Fund’s World Economic Outlook. The document highlights the danger posed by the world economy’s heavy dependence on ravenous American consumers to snap up exports from the rest of the world. To be sure, it is hard to be too gloomy. … world GDP is still growing at an above-average clip. ... But dark clouds have been gathering on the horizon for some time. Emerging-market economies, particularly in Asia, are running high current-account surpluses, keeping their economic fires stoked with a steady stream of exports, especially to America. In mirror image, America’s current-account deficits have soared past 5% of GDP. Household savings have dwindled to negligible levels as Americans have run down assets and taken on debt to keep the spending binge going. Yet if the American consumer falters, as things stand now, the rest of the world will tumble too. Moreover, economists are increasingly worried that America’s economic health … rests on a housing market that looks decidedly bubbly. … But if economists are agreed that America’s debt levels are dangerous, they cannot agree on whom to blame. … the government’s profligate budget deficits … which run down national savings. …[or] … spendthrift consumers, … the frothy housing market, and … a “global savings glut” … pouring excess capital from abroad, particularly Asia, into America’s financial markets...

                                                                                  America is not the only country where savings have fallen. Worldwide savings began declining in the late 1990s, hitting bottom in 2002. They have recovered only modestly since then. The drop is mainly due to industrial countries, where savings and investment have been on a downward trend since the 1970s... Savings in emerging markets and oil-producing countries have risen over that period, but not enough to reverse the trend. So why the sudden talk of a savings glut? ... The IMF report offers an explanation. What the world is suffering from is not so much a savings glut as an investment deficit, in both rich and poor countries. In emerging markets and oil-exporting nations, still feeling the lingering effects of the Asian financial crisis of 1997-98, demand for capital has failed to keep up with supply. Scrimping consumers have instead sent their money to the West. The IMF’s figures suggest that this is not as irrational as it seems. … investments in emerging markets are riskier, because their economies tend to be more volatile and their institutions weaker. Moreover, … the IMF’s analysis suggests that the internal rate of return ... in emerging markets has been very poor over the past decade, even before currency risk is taken into account. But investment has fallen in the rich world too: the rivers of capital have flowed not directly into businesses but into markets for consumer and government credit, where they are presumably doing little to increase the recipient economy’s ability to repay the loans in the future… So what is the cure? Lower savings rates in emerging markets? That would be a disaster, according to a new report from the World Bank … Like the World Bank, the IMF does not think lower savings rates in developing countries are the answer. It identifies several other things that could make a difference: higher national savings in the United States, an investment recovery in Asia, and an increase in real GDP growth in Japan and Europe. Easy to say, difficult to pull off. Raising interest rates would, the IMF concedes, have only a limited effect on America’s savings rate. Balancing the budget would do more, but there seems to be little political will to tell Americans they must pay for their government programmes. Across the Atlantic, European governments are finding it hard to make the kind of structural reforms that could boost their sluggish growth rates, and the European Central Bank has remained unwilling to provide monetary stimulus by cutting rates. Nor has Japan’s government, despite the signs of fledgling recovery, yet found a formula for boosting its long-term growth rate. It is easier to diagnose the illness than effect a cure.

                                                                                    Posted by on Wednesday, September 21, 2005 at 02:34 AM in Budget Deficit, China, Economics, International Finance, Saving | Permalink  TrackBack (0)  Comments (3)


                                                                                    Searching for the GoogleNet

                                                                                    From Ian at Truck and Barter:

                                                                                    I, for one, welcome...oh, you know the rest, by Ian, Truck and Barter:  Looks like Google's getting ever-closer to a rumored "GoogleNet": a wifi system stretched over the country, giving free access for the price of living through directed advertising. And if you ever use Local.Google.Com, you'll get an idea of just how directed it could get. ("Click here to get directions to the biggest clothing sales going on withing 1.5 miles of you!") Google has been busy buying up dark and underused fiber-optic backbone infrastructure, and has now rolled out its wifi system across San Francisco, complete with a free (beta) secure access program...

                                                                                      Posted by on Wednesday, September 21, 2005 at 01:56 AM in Economics, Technology | Permalink  TrackBack (0)  Comments (0)


                                                                                      Thomas Friedman: Use Gas Tax to Move the U.S. Toward Energy Independence

                                                                                      My fourteen day free trial of Times Select uncovered Thomas Friedman of the NY Times beating the drum, as he has in the past, for the administration to do more to move the U.S. toward energy independence.  I agree with his conclusion - don't get your hopes up:

                                                                                      Bush's Waterlogged Halo, by Thomas Friedman, NY Times: Following President Bush's speech in New Orleans, many U.S. papers carried the same basic headline: "Bush Rules Out Raising Taxes for Gulf Relief." The president is planning to rely on "spending cuts" instead to pay for rebuilding New Orleans. Yeah, right - and if you believe that, I have some beachfront property in Biloxi I'd like to sell you. The underlying message of all these stories is that the Bush team sees no reason to change course in response to Katrina.

                                                                                      I beg to differ. Katrina deprived the Bush team of the energy source that propelled it forward for the last four years: 9/11 and the halo over the presidency that came with it. The events of 9/11 created a deference … That deference is over. If Mr. Bush wants to make anything of his second term, he'll have to do his own Nixon-to-China turnaround, reframe the debate and recast the priorities of his presidency. He seems to think that by offering to spend billions of dollars to rebuild one city, New Orleans, he'll get his leadership halo back. Wrong. Just throwing more borrowed money at New Orleans is not leadership. Mr. Bush needs to frame a new agenda ... And what should be the centerpiece of a policy of American renewal is blindingly obvious: making a quest for energy independence the moon shot of our generation. The president should have done that on the morning of Sept. 12, 2001. The country was ready. But the president whiffed. Katrina - nature's 9/11 - has given him a rare do-over. Imagine - I know it is a stretch - that the president announced tomorrow that he wanted an immediate 50-cents-a-gallon gasoline tax - the "American Renewal Tax," to be used to rebuild New Orleans, pay down the deficit, fund tax breaks for Americans to convert their cars to hybrid technology or biofuels, fund a Manhattan Project to develop alternatives for energy independence, and subsidize mass transit systems for our major cities. And imagine if he tied this to an appeal to young people to go into science, math and engineering for the great national purpose of making us the greenest nation on the planet, to help liberate us from dependence on the worst regimes in the world for our oil …

                                                                                      Americans will change their long-term energy habits, and companies will develop green products, only if they are certain the price of gasoline will not go back down. A gasoline tax … and stronger regulation would force U.S. companies to innovate in what is going to be one of the most important global industries in the 21st century: green technologies. By coddling our auto and industrial companies when it comes to mileage standards and the environment, all the Bush team is doing is ensuring that they will be dinosaurs and that Chinese, Japanese and Indian companies will take the lead in green technologies … Look what Jeff Immelt, the C.E.O. of G.E., said: "America should strive to make energy and environmental practices a national core competency and by doing so, create exports in jobs. ..." Setting the goal of energy independence, along with a gasoline tax, could help to solve so many of our problems today - from the deficit to climate change and national security. And Americans would pay it if they thought the extra money was going to renew America, not Iran, and not just New Orleans. And if the Texas-oilman president became the energy-independence president - now, that would snap heads and make this a truly relevant presidency. No way, you say. Probably right. But either Mr. Bush does a Nixon-to-China or his next three years are going to be a Bush-to-Nowhere.

                                                                                        Posted by on Wednesday, September 21, 2005 at 01:27 AM in Economics, Oil, Taxes | Permalink  TrackBack (2)  Comments (4)


                                                                                        Tuesday, September 20, 2005

                                                                                        FOMC Raises Target Rate 25 bps to 3.75%

                                                                                        As widely expected, the Fed decided today to increase the target federal funds rate 25 basis points to 3.75%. More interesting is the change in the accompanying statement relative to the last meeting. Here are the two statements with the old language in italics below the new. Notably (1) the committee stills sees policy as accommodative and believes output will continue to exhibit robust underlying growth, partly because of the accommodative stance and partly due to growth in productivity. (2) The FOMC sees core inflation as low in recent months and inflationary expectations “contained.” Their view that productivity is strong will help to reduce inflation concerns.  (3) The second part of the statement is identical to the last release. Interestingly, they still see the upside and downside risks as roughly equal and left in place the measured pace statement. The standard qualifier that future policy is data dependent was left in place. Finally, the vote was not unanimous. In a move certain to generate attention and speculation regarding the Fed's next move, Governor Mark Olson dissented in favor of no change in the target federal funds rate.  The overall message is that the majority of the committee does not perceive long-term changes in the economic outlook due to Katrina and, though there is dissent, policy was set accordingly:

                                                                                        For immediate release

                                                                                        The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 3-3/4 percent.

                                                                                        [The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 3-1/2 percent.]

                                                                                         

                                                                                        Output appeared poised to continue growing at a good pace before the tragic toll of Hurricane Katrina. The widespread devastation in the Gulf region, the associated dislocation of economic activity, and the boost to energy prices imply that spending, production, and employment will be set back in the near term. In addition to elevating premiums for some energy products, the disruption to the production and refining infrastructure may add to energy price volatility.

                                                                                        While these unfortunate developments have increased uncertainty about near-term economic performance, it is the Committee's view that they do not pose a more persistent threat. Rather, monetary policy accommodation, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity. Higher energy and other costs have the potential to add to inflation pressures. However, core inflation has been relatively low in recent months and longer-term inflation expectations remain contained.

                                                                                        [The Committee believes that, even after this action, the stance of monetary policy remains accommodative and, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity. Aggregate spending, despite high energy prices, appears to have strengthened since late winter, and labor market conditions continue to improve gradually. Core inflation has been relatively low in recent months and longer-term inflation expectations remain well contained, but pressures on inflation have stayed elevated.]

                                                                                         

                                                                                        The Committee perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. With underlying inflation expected to be contained, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.

                                                                                        [The Committee perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. With underlying inflation expected to be contained, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.]

                                                                                         

                                                                                        Voting for the FOMC monetary policy action were: Alan Greenspan, Chairman; Timothy F. Geithner, Vice Chairman; Susan S. Bies; Roger W. Ferguson, Jr.; Richard W. Fisher; Donald L. Kohn; Michael H. Moskow; Anthony M. Santomero; and Gary H. Stern. Voting against was Mark W. Olson, who preferred no change in the federal funds rate target at this meeting...

                                                                                        [Voting for the FOMC monetary policy action were: Alan Greenspan, Chairman; Timothy F. Geithner, Vice Chairman; Susan S. Bies; Roger W. Ferguson, Jr.; Richard W. Fisher; Donald L. Kohn; Michael H. Moskow; Mark W. Olson; Anthony M. Santomero; and Gary H. Stern...]

                                                                                        When the minutes are released, it will be interesting to see how much disagreement there was regarding the rate increase during the discussion, particularly since it's traditional for the committee to support the proposal as a group even when there are individual differences regarding policy.  But as it stands, the message is to expect more rate increases in the future unless incoming data change the committee's current economic outlook.

                                                                                        [UPDATEWilliam Polley comments here.  David Altig at macroblog weighs in hereNew Economist is here.  Tim Duy's Fed Watch prior to the meeting 9/18, 9/13, 9/5, and 8/30Washington Post, NY Times, CNN Money, Bloomberg, WSJ]

                                                                                        UPDATEThe Washington Post notes evidence in the symbolic vote to raise the discount rate to 4.75% (see the press release) in order to maintain a 1% spread relative to the target federal funds rate that five bank presidents appear to have been willing to let the target rate stand at 3.5%:

                                                                                        Fed board member Mark W. Olson voted against the move, saying he preferred to leave the rate unchanged -- the first dissent on the committee since June 2003. More members came to the meeting open to Olson's position; only seven of the 12 regional Fed banks had requested a similar quarter-percentage point increase in the largely symbolic discount rate to 4.75 percent -- a sign that five banks would have been content with no increase in the funds rate either.

                                                                                        As David Altig at macroblog notes, this needs to be interpreted with caution.

                                                                                        UPDATEMacroblog notes further discussion:

                                                                                        The statement parsed, at The Big PictureThe Capital Spectator sees the possibility of more of the same, and deeper trade deficits as a result.  William Polley thinks "5% by summer is a real possibility."  The Skeptical Speculator does its usual fine job of putting things in an international perspective. The Prudent Investor says the FOMC's press release "the confident and complacent tone of previous statements".  Forex Rate Currency News characterizes the rate increase as "sheer relief".

                                                                                          Posted by on Tuesday, September 20, 2005 at 11:37 AM in Economics, Monetary Policy, Press | Permalink  TrackBack (2)  Comments (3)


                                                                                          Understanding the Tax Reform Debate

                                                                                          When I saw this from the Government Accountability Office (GAO) on the tax reform debate, I wondered if it would be a political document, or if it would stick to economics:


                                                                                          (click on picture to retrieve pdf document)

                                                                                          I’m happy to report that it appears to be a straightforward presentation of the economics of tax reform.  The presentation is balanced, non-technical, understandable, and it touches on all the issues surrounding reform such as efficiency, equity, transition costs, simplicity, transparency, administratibility, and so on. In fact, it might be good reading for the president and congress.  Here are a few passages:

                                                                                          Federal borrowing has advantages and disadvantages that vary depending on economic circumstances. Borrowing, in lieu of higher taxes or lower government spending, may be viewed as appropriate during times of economic recession, war, or other temporary challenges. Federal borrowing might also be viewed as appropriate for federal investment, such as building roads, training workers, and conducting scientific research, that contributes to the nation’s capital stock and productivity. If well chosen, such activities could ultimately help produce a larger economy. However, if not well chosen, such spending could displace more productive private sector investments.

                                                                                          Federal borrowing also can impose significant costs and risks. Borrowing for additional spending or lower taxes for current consumption improves short-term well-being for today’s workers and taxpayers, but does not enhance our ability to repay the borrowing in the future. In the near term, federal borrowing also absorbs scarce savings available for private investment and can exert upward pressure on interest rates. Over the long term, federal borrowing that restrains economic growth will also restrain the standard of living of future workers and taxpayers.

                                                                                          And elsewhere:

                                                                                          Regardless of the assumptions used, reasonable long-term simulations indicate that the problem is too big to be solved by economic growth alone or by making modest changes to existing spending and tax policies. While entitlement reform as well as mandatory and discretionary spending cuts will likely be needed to close the longterm financial gap, the structure of the tax system should also be part of the debate as policymakers grapple with the nation’s long-term fiscal challenge. As part of this process, consideration could be given to improving taxpayer compliance and enforcement efforts, expanding the tax base, increasing current tax rates and tax rates on future generations, or a combination of these.

                                                                                          And, from another section on efficiency considerations:

                                                                                          Work versus leisure: Taxes—both income and consumption taxes—can affect the decisions that people make about how much time to devote to work or leisure in two ways. First, taxes may increase the incentive to work because workers must work more to maintain their after tax income. Second, taxes may reduce the incentive to work because workers earn less from an additional hour of work. The net effect may be no change to the overall supply of labor. However, even in this case, there is still an efficiency cost, which is determined by the second effect. By reducing hourly after tax earnings, income and consumption taxes distort decisions about how many hours to devote to work or leisure. Empirical research generally shows that at least for primary wage earners, decisions about labor force participation are not very responsive to taxes. However, decisions about labor force participation by secondary wage earners have been shown to be more responsive to changes in the tax system.

                                                                                          There are other tables, figures, and explanations as well.  For example, here’s where taxes come from, like it or not:

                                                                                          Here's who pays at the federal level:

                                                                                          And here is where the money goes and how it has changed over time.  According to this, the main feature evident over time is the conversion of national defense into Social Security, Medicare, and Medicaid.  Whether that is good or bad will vary according to who you ask:

                                                                                          The document also talks about popular and, I suppose, unpopular tax reform proposals:

                                                                                          Though I'd quibble in places, all in all it is a useful guide to understanding the issues surrounding the tax reform debate. 

                                                                                            Posted by on Tuesday, September 20, 2005 at 12:36 AM in Budget Deficit, Economics, Income Distribution, Policy, Taxes | Permalink  TrackBack (1)  Comments (3)


                                                                                            The US-North Korea Arms Deal: Why Now?

                                                                                            The U.S. and North Korea have reached a tentative arms deal. Simon World, where "East Meets Westerner," asks "Why now?":

                                                                                            China's role in North Korea talks, Simon World:  After years of failed talks, finally agreement is reached with North Korea over its nukes. The onus remains on the North Koreans to live up to their end of the bargain, but that's by the by. Far more interesting is what happened to force the issue? Why now? The North Koreans are lavishing praise on their Chinese hosts. China's leadership remains petrified of a collapse of North Korea and the massive influx of refugees likely should that happen. Nor did it fancy the alternative of a potential American led invasion, leading to American troops literally on the border. China has always held the whip hand in the talks. For example China supplies most of North Korea's electricity at friendly rates. Having North Korea annoy the Americans served as a useful foil for China and it kept Japanese and South Korean minds focussed on the threat from the North Koreans rather than any possible threat from China. But more recently both America and Japan have started viewing the potential strategic threat from China as a seperate issue from the Korean one. The North Korean problem turned from an asset to a liability. So China saw the light, so to speak, and realised a resolution of the Korean nuclear issue was also in its interest. It doesn't hurt that this makes the Chinese look like world statesmen and foreign policy players (albeit in their own backyard), just as negotiations over the UN Security Council and talks about China's emerging superpower role are all the rage. It's no co-incidence that as soon as China got serious about the nuclear talks, so did North Korea. The key question is whether China can make the North Koerans deliver on their promises given the deserved scepticism that abounds.

                                                                                            Further Reading: Chris has a good summary of various reactions to the North Korea deal. Sean says Japan isn't entirely happy with the results. North Korean talks leave questions unanswered. The full text of the statement at the end of the talks.

                                                                                              Posted by on Tuesday, September 20, 2005 at 12:24 AM in China, Economics, International Finance, International Trade | Permalink  TrackBack (0)  Comments (3)


                                                                                              Everything You Ever Wanted to Know About the FOMC, and More…

                                                                                              This is something I'm collecting for a class, but it seemed timely given today's FOMC meeting.  This set of remarks from Laurence H. Meyer, who at the time was a governor of the Federal Reserve, looks at how the FOMC was created  followed by a detailed account of what happens from the moment a member of the committee walks though the doors of an FOMC meeting:

                                                                                              Come with Me to the FOMC , Lawrence H. Meyer:…Now some historical background. The Federal Reserve Act, passed in 1913, was "virtually devoid of policy prescriptions" and there were, in particular, no guidelines for the conduct of open market operations.  The role of the Federal Reserve was viewed as more passive than active. The emphasis was on the provision of currency and reserves to meet seasonal demands and on assisting the banking system to accommodate the needs of commerce and business … the discount rate and the discounting of eligible bank loans were the central tools of the Federal Reserve in the early days.

                                                                                              The impetus for open market operations was the experience in the early 1920s when bank rediscounting had declined to a very low level and the Federal Reserve Banks needed another source of revenue to cover their costs of operation. The Federal Reserve … does not receive an appropriation from the Congress. Instead, it earns enough from its operations to cover its expenses and returns any surplus to the Treasury. We credit Treasury on a weekly basis. In the absence of revenue from its rediscounting operations, the Reserve Banks began to purchase government securities…

                                                                                              As they came to appreciate the need for coordination … they established, beginning in 1922, a series of committees to manage and coordinate these operations. The committees, initially consisting of five Federal Reserve Bank Governors (the equivalent today of Federal Reserve Bank Presidents), made recommendations about open market operations which were then subject to the approval of the Board of Governors. However, even if approved by the Board, the Reserve Banks were not required to carry them out. Very messy, very cumbersome, and very unsatisfactory--though, in practice, the Reserve Banks did, in most cases carry out the operations recommended by the committee and approved by the Board.

                                                                                              After a lengthy debate, the Congress decided to establish the FOMC in its present form in 1935. The Reserve Banks were thereby required to carry out the operations as directed by the FOMC. ... The FOMC is a mix of Presidential appointees--the seven Governors--and Reserve Bank presidents who are selected by their respective Boards of Directors subject to approval by the Board. The Boards of Directors of the Reserve Banks have nine members, six of whom are selected by the member commercial Banks in the respective Districts and the remaining three are selected by the Board of Governors. The FOMC is therefore a blend of a national board and regional input of private and public interests…

                                                                                              Now, he moves on to the detailed look at an FOMC meeting (I cut pages and pages out of this, such as what day documents arrive at his house, but I should warn you that it's still pretty long):

                                                                                              So come with me to the FOMC.

                                                                                              It is 9 am on one of eight days, usually Tuesdays, during the year when the FOMC meets. The Federal Reserve Act mandates that there be at least 4 meetings each year and the number of meetings has varied from 4 to 19 over the years. Since 1981, the FOMC has met 8 times each year. Meetings generally begin at 9 am and continue until about noon to 1 pm. Twice each year, prior to the Humphrey-Hawkins report and testimony, the FOMC meets over a two-day period. But I am getting ahead of myself. Our first meeting will be of the one-day or more precisely one-morning variety...

                                                                                              I will never forget the first time I entered the Board room to take my place around the table. Each member appreciates the heavy responsibility the Committee has for the economic well-being of the country and the importance of their personal participation in this process. ... Serving on the FOMC is, without question, the most important responsibility I could have for which this career has prepared me. 

                                                                                              As you enter the Board room, you will undoubtedly be struck by the impressive size of the oval table--27 feet ½ inch long and 10 feet 11 inches at its widest point. Members of the Committee and staff are milling around, greeting each other, but generally not talking much shop at this point. Just before 9 am everyone moves to their respective chairs, just as the chairman, Alan Greenspan, walks in to take his place at one end of the table. The Chairman, by the way enters from a door that connects to his office, one of the perks of being Chairman. I, on the other hand, have had to walk down the long corridor to enter through the main door of the Board room.

                                                                                              Continue reading "Everything You Ever Wanted to Know About the FOMC, and More…" »

                                                                                                Posted by on Tuesday, September 20, 2005 at 12:15 AM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (0)


                                                                                                Medicare and Disability Insurance

                                                                                                Here are two papers on insurance for the files.  The first, which has a colleague as one of the authors, evaluates the insurance value of the Medicare program.  The paper finds that the insurance value of the program covers a large fraction of its cost, an important finding. The second has someone most of you know as one of the authors, Vox Baby, aka Andrew Samwick, and this paper examines disability insurance as discussed further below.  Here’s the Medicare paper by Amy Finkelstein and Robin McKnight:

                                                                                                What Did Medicare Do (And Was It Worth It)?, Amy Finkelstein and Robin McKnight, NBER WP 11609:  We study the impact of the introduction of one of the major pillars of the social insurance system in the United States: the introduction of Medicare in 1965. Our results suggest that, in its first 10 years, the establishment of universal health insurance for the elderly had no discernible impact on their mortality. However, we find that the introduction of Medicare was associated with a substantial reduction in the elderly’s exposure to out of pocket medical expenditure risk. Specifically, we estimate that Medicare’s introduction is associated with a forty percent decline in out of pocket spending for the top quartile of the out of pocket spending distribution. A stylized expected utility framework suggests that the welfare gains from such reductions in risk exposure alone may be sufficient to cover between half and three-quarters of the costs of the Medicare program. These findings underscore the importance of considering the direct insurance benefits from public health insurance programs, in addition to any indirect benefits from an effect on health.

                                                                                                Here’s the paper by Amitabh Chandra and Andrew A. Samwick.  As you read this, keep in mind that this is the value of disability insurance over and above a stylized version of the current system.  It can also be viewed as the value of assistive technology--something that helped people continue working without having to take Disability insurance as we currently have it:

                                                                                                Disability Risk And The Value Of Disability Insurance, Amitabh Chandra and Andrew A. Samwick, NBER WP 11605: We estimate consumers’ valuation of disability insurance using a stochastic lifecycle framework in which disability is modeled as permanent, involuntary retirement. We base our probabilities of worklimiting disability on 25 years of data from the Current Population Survey and examine the changes in the disability gradient for different demographic groups over their lifecycle. Our estimates show that a typical consumer would be willing to pay about 5 percent of expected consumption to eliminate the average disability risk faced by current workers. Only about 2 percentage points reflect the impact of disability on expected lifetime earnings; the larger part is attributable to the uncertainty associated with the threat of disablement. We estimate that no more than 20 percent of mean assets accumulated before voluntary retirement are attributable to disability risks measured for any demographic group in our data. Compared to other reductions in expected utility of comparable amounts, such as a reduction in the replacement rate at voluntary retirement or increases in annual income fluctuations, disability risk generates substantially less pre-retirement saving. Because the probability of disablement is small and the average size of the loss — conditional on becoming disabled — is large, disability risk is not effectively insured through precautionary saving.

                                                                                                  Posted by on Tuesday, September 20, 2005 at 12:06 AM in Academic Papers, Economics, Health Care, Social Security | Permalink  TrackBack (1)  Comments (1)


                                                                                                  Monday, September 19, 2005

                                                                                                  Greg Ip: Don’t Worry, Greenspan is Replaceable

                                                                                                  Greg Ip of the WSJ explains why there is nothing to fear when Greenspan is replaced.  The Fed as an institution and its reliance on sound economic principles, not the talent of any individual, is the key to its success.  This fact is illustrated by central banks around the world who have compiled records similar to the Fed’s even without, in every case, their own magician behind the curtain pulling the monetary policy strings.  He also provides a quote endorsing Bernanke as Greenspan’s replacement:

                                                                                                  Don't Worry About Post-Greenspan Era: Central Banking Itself Has Been Elevated, by Greg Ip, WSJ:  …As Mr. Greenspan's retirement approaches in January, anxious investors wonder: Can anyone reproduce his record? A glance at Australia and elsewhere suggests that the answer is yes. While the U.S.'s economic performance has been superb during the Greenspan era, it isn't unique. "Very similar results have been attained elsewhere," says Stanley Fischer, a former Citigroup executive who runs Israel's central bank. A review of nine major countries' economic performance, based on data compiled by Global Insight Inc. … shows that Australia, Canada, the United Kingdom and Spain have done as well or better than the U.S. in reducing inflation and unemployment since 1987. However, only Australia and Spain have grown faster overall, and the U.S. has enjoyed the most stability -- just five quarters of negative economic growth during that period.

                                                                                                  Whatever qualities have made the Greenspan Fed successful, many other central banks appear to share them. This means that President Bush probably doesn't have to find a Fed chairman with Mr. Greenspan's eclectic mix of smarts, intuition and rigor, to continue his success. It does mean that choosing someone outside the mold of a modern central banker is risky. What explains central banks' widespread success? In the past two decades, central banking has become a "much more professional, technical job," says Alan Budd, who served in the British Treasury and the Bank of England during the 1990s and is provost at Oxford University's Queen's College. "It's not just a question of taking the politics out, but of putting the economics in." The Bank of England adopted inflation targets, regular policy meetings and inflation reports in 1992 … Australia, Britain and Canada adopted numerical inflation targets in the early 1990s, a step the Fed has declined to take. Debate rages among academics about their value. …

                                                                                                  Other countries' good performance doesn't diminish Mr. Greenspan's achievements. Because of the U.S.'s overwhelming influence on world growth and financial markets, it is unlikely other countries could have done so well had the U.S. performed badly... And Alan Blinder, a former Fed vice chairman, says other central bankers have learned from Mr. Greenspan... [Rory Robertson, an economist at Macquarie Bank in Sydney] … says foreigners don't generally like Mr. Bush's foreign or fiscal policies but have taken comfort that "someone smart and sensible is running the Fed." Foreign investors want the next chairman to be a "straight up-and-down central banker type." The candidate who most closely fits that description, he says, is Ben Bernanke, a former Fed governor and monetary scholar who is Mr. Bush's economic adviser. Investors, he says, "know how he thinks."

                                                                                                    Posted by on Monday, September 19, 2005 at 01:11 AM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (18)


                                                                                                    The Changing Age Distribution of the U.S. Population 1950-2050

                                                                                                    I owe, or blame, my sudden interest in demographic issues on Edward Hugh of Bonobo Land.  While at the Census web site yesterday, I came across census data on the age distribution of the U.S. population from 1950 through 2000 and projected through 2050 so I took a moment to look at it graphically.  I decided to post it so I would have the data and graph readily available.  If you are interested in the diagram, note that as you age you move to the northwest.  The baby boom shows up clearly in the diagram.  That the age bands are lower on the right-hand side of the diagram than on the left-hand side is indicative of the increasing average age of the population.  One big change is the increasing size of the 80+ band over time and more generally the 70+ range shown by the top three bands.  The compression in the distribution below this range is evident:

                                                                                                    This brings up issues I want to think about further.  For example, as I assume others have noticed, with a larger and larger fraction of the population moving into the asset liquidation phase of their life-cycle, how is the saving rate affected?  How much of the change in the saving rate in recent years is attributable solely to changes in the age-distribution of the population?  What other changes in economic behavior might this bring about?

                                                                                                    UPDATE:  Some of you asked about population pyramids, though as shown below by the projected 2050 population distribution it no longer looks much like a pyramid.  If you click through to the census site listed above there is a dynamic version of the population pyramids showing the changes from 1950-2050.  Here are static versions spaced 25 years apart available at the Census site:

                                                                                                      Posted by on Monday, September 19, 2005 at 12:30 AM in Economics | Permalink  TrackBack (0)  Comments (12)