Economist's View

The Myth That Tax Cuts Pay for Themselves

This will not please the tax cut fanatics and proponents of the Laffer curve. Here's a link to the report from the CBO discussed in this Economic View by Daniel Altman from the New York Times:

Economic View A Bit of Doodling About a Tax-Cut Danger, by Daniel Altman, Economic Scene, New York Times: Early last month, without much fanfare, the Congressional Budget Office released a paper called "Analyzing the Economic and Budgetary Effects of a 10 Percent Cut in Income Tax Rates." ... [I]t may be one of the most important government publications in years. As Douglas J. Holtz-Eakin, the budget office's director, writes ..., most predictions of the effects of tax-rate changes "do not include the budgetary impact of any possible macroeconomic effects of tax policies." In other words, the predictions don't take into account how tax cuts could affect the overall size of the economy. It is this omission - one often cited by proponents of tax cuts, especially in the White House - that the paper tries to correct.

The author ..., Ben Page, estimates estimates how an across-the-board cut in income tax rates could generate higher levels of economic activity, potentially replacing lost tax revenue. ... Mr. Page's [results] vary widely depending on his assumptions ... But even within their range, the results answer the fundamental question posed by the Laffer Curve. ... One motivation for Mr. Reagan's tax cuts was a guess that the United States was on the right side of the curve - that is, that lowering rates would actually yield more tax revenue over all. Some recent statements by Joshua B. Bolten, President Bush's current budget director, seem to indicate that he still believes this to be true, though rates are much lower now than when Mr. Reagan took office in 1981. ...

The recent analysis by Mr. Page at the Congressional Budget Office dismisses the idea that tax cuts may actually improve the government's fiscal situation. Even in his most generous scenario, only 28 percent of lost tax revenue is recouped over a 10-year period. The United States, it seems, is firmly planted on the left side of the Laffer Curve. Recent experience corroborates this prediction. In the second quarter of 2001, just before the first of President Bush's tax cuts took effect, federal receipts from personal taxes accounted for 10.3 percent of the economy. By the end of the post-recession slump, receipts had dropped to 6.4 percent. But in the third quarter of 2005, with the economy booming, they were still under 7.5 percent - an enormous difference. In dollar terms, federal receipts from personal income taxes, at $802 billion in 2004, are still lower than they were in 1998 ($826 billion) and much lower than in 2001 ($994 billion). ...

Yield Curves and Interest Rate Spreads

There's been a lot of discussion about the yield curve lately. Some of you may be afraid to ask what a yield curve is and how it relates to interest rate spreads. For those who are, here's a simple illustration. Suppose there are three assets in the economy, a 3 month bond, a 5 year bond, and a 10 year bond. Let the interest rate be 3% on the 3 month asset, 5% on the 5 year asset, and 10% on the 10 year asset. To construct the yield curve, simply graph the time to maturity against the return [the points are (3 months, 3%), (60 months, 5%), and (120 months, 10%)]:

There is another way to present these data in terms of spreads. Here for example the spread between the 10 year (120 month) and 3 month rates is 10% - 3% = 7% indicating an upward sloping yield curve between these two points. Similarly, the spread between the 5 year (60 month) and 3 month rates is 5% - 3% = 2% again indicating an upward sloping yield curve between those two points. A third spread can also be calculated between the 10 year and 5 year rates and this is 5% (the line connecting the 3 and 120 month rates is not shown but is easy to visualize).

The following graph presents the spreads between the federal funds rate, an overnight borrowing rate between banks, and the 3 month, 6 month, 1 year, 3 year, 5 year, 7 year, and 10 year Treasury rates. Again, recall that if the particular spread is negative, the yield curve drawn through these two points would be negatively sloped:

Two popular spreads (see here) are the difference between the 10 year and 3 month rates, and between the 10 year and 2 year rates. Here's a graph showing each:

As the graphs show, the spreads move in concert for the most part with the largest movements, as expected, for the largest spreads. The particular choice of a spread determines the level of the difference, with positive spreads more likely when the time to maturity is further apart, but the particular choice is somewhat arbitrary. 

This brings up one more point. As many, including Jim Hamilton and Arturo Estrella have emphasized the yield curve should not be used in a binary fashion. That is, it should not be used to say all is fine until it has a negative slope, and once it has a negative slope, to say a recession is coming. One reason is that whether the spread is positive or negative in a given time period can depend upon the particular spread examined. Another is that the change in the chance of a recession is gradual, not binary. Historically, the narrower the spread between long and short rates, the slower is output growth on average, see Hamilton for more on this. There is not a sudden jump in the probability of a recession when one particular spread turns negative despite what recent news reports may have led you to believe. And as all who discuss this topic emphasize, the connection between the yield curve, interest rate spreads, and the probability of a recession is far from certain. A flatter yield curve does not gurantee slower growth.

The Price of Tax Cuts

The title of this commentary from the Washington Times is "Holiday surprise for the poor." That this appeared in the Washington Times (originally here) was a surprise as well:

Holiday surprise for the poor, by Clarence Page, Washington Times: ...[C]ongressional conferees have come up with a Grinch-style lump of coal for Americans who don't have a lot of political clout. ... Vice President Dick Cheney cast the tie-breaking vote on a budget that would trim federal spending, mostly from popular social programs. Senate Republican leaders were puffed up with pride over the trims they managed to impose ... on the growth of such programs as Medicare, Medicaid and student loans. Their ostensible purpose was to cut the deficit... But that savings probably will vanish like a drop in a barrel of red ink in the wake of President Bush's tax cuts, the most recent of which awards $70 billion in capital-gains tax cuts for mostly upper-income earners and investors. ...

[T]he ... bill does less to reduce the deficit than to shift its burden to poor and middle-class folks who, for example, need help paying for a nursing home or putting their kids through college. Yes, the biggest savings, $12.7 billion over five years, come from student loan programs. It would fix interest rates on student loans at 6.8 percent... The rate will be fixed, not adjustable, even if commercial rates are lower. Since student loan rates now stand at 5.375 percent, students who are thinking about consolidating their student loans to lock in a low rate for the life of their loans are strongly advised to consolidate immediately.

Note to young folks: Consider this your political payback for not voting in greater numbers. Not that older folks got much more respect ... Out-of-pocket costs for the poor people who rely on Medicare ... would go up by way of increased copayments and premiums for a net five-year savings of an estimated $6.4 billion. States also will be allowed to scale back some Medicaid benefits, while tightening eligibility for Medicaid nursing home reimbursement. Net five-year savings: $4.8 billion. ... Student loans are a true investment in enterprising students ... Nursing home aid has become a last-ditch help to many middle-class families. Yet, at a time of rising costs, Congress has put the budget-cutting knife to these very worthwhile and popular programs as if they fostered laziness...

Is Kimchi for the Birds?

One factor affecting demand is tastes and preferences. The taste for kimchi gets a boost from an obscure study and the fear of avian flu:

Kimchi Sales Rise on Link to Possible Bird Flu Cure, by Elissa Silverman, Washington Post: Moon K. Yoon sensed something was up about two months ago when the 16-ounce jars of kimchi started moving quickly from the shelves ... in Fairfax, a sign that interest in the spicy cabbage dish had moved beyond the Korean customers who typically buy it by the gallon. ...[S]ales of ... freshly made kimchi have increased 55 percent, compared with a year ago ... 

A sudden new joie d'epice in the American diet? Try avian flu. Blame it on the Internet ... publication of a minor study by a South Korean academic last spring has apparently triggered a minor run on kimchi, a daily staple of the Korean diet that the bland-of-palate are likely to avoid ... Which presents a potentially difficult choice given the work of Kang Sa-Ouk of Seoul National University, who took 13 chickens infected with avian flu virus and a couple of other diseases, fed them kimchi juice and found that 11 of the birds recovered.

Word of the study has been circulating on the Internet. ... [T]he National Institute of Allergy and Infectious Diseases, where callers have turned seeking validation of the idea that kimchi may ward off avian flu... said. "Although it certainly sounds interesting, NIAID, unfortunately, can't comment on the dish's effectiveness as we have not studied it," ...

Yoon and his fellow grocers have also gotten lots of questions about the dish's taste and its pungent smell. "It's hard for me to explain the taste," Yoon said. The most common preparation of kimchi for sale in markets begins with sliced Napa cabbage, which is salted, set aside for hours and then rinsed. Most traditional recipes add plenty of crushed garlic, as well as ginger, onion, sliced radish and fish sauce to the cabbage. And lots of hot pepper ... "We're selling more small jars," said Kei Kim, the manager of the Grand Mart in Seven Corners near Falls Church. "They are scared -- they try a little."

Measuring Progress in China: Going Beyond GDP Growth

GDP is not a perfect measure of a nation's well-being (see Measuring Well-Being). Chinese economist Hu Angang suggests broadening the definition of progress used to assess provincial development. By changing the evaluation of progress to include factors such as social security, environmental conditions, employment, and public services, he hopes to avoid the pursuit of economic growth at the expense of other important goals:

Economist warns of excessive growth, China View:  Beijing, Dec. 30 (Xinhuanet) -- Chinese economist Hu Angang suggested in one of his reports to be submitted to the central government that ... [t]he value of the gross domestic product (GDP) or its growth rate should not be used to evaluate the performance of local governments below the provincial level... As a substitute, Hu stressed public services, social administration and market supervision be taken as new standards to evaluate their performance. ... But provincial governments and the central government should still have their GDP statistics, Hu said in his report.

Hu, an expert on macroeconomics at China's prestigious Qinghua University in Beijing, ... [said] China targets to double its per capita GDP in 2010 from that of 2000, which means an annual GDP growth rare of 7.2 percent is enough for the country to realize the goal. But a large number of Chinese provincial governments have set their economic growth targets higher than 8 percent for the next five years, and lower governments have set their economic growth rates even higher. This will surely result in excessive economic growth at the expense of the environment and resources, said Hu.

Hu urges local governments to develop their local economies in a rational and scientific way in the next five-year period (2006-2010). In his report, the economist lists 30 obligatory indexes to evaluate the government's performance, including employment, energy consumption, control of environmental pollution, transfer of rural labor force, law and order situation, and coverage of social security. "All these indexes reflect the basic obligations of the government in managing society and offering services to the public under the market economy," said Hu...

Mammas Should Let Their Babies Grow Up To Use BioWillie?

Willie Nelson is pushing biodiesel as an alternative fuel, but many environmentalists are skeptical about biodiesel's net energy benefits and its ability to replace a substantial fraction of traditional oil-based fuel:

His Car Smelling Like French Fries, Willie Nelson Sells Biodiesel, by Danny Hakim, NY Times: Willie Nelson drives a Mercedes. But do not lose faith, true believers. The exhaust from Mr. Nelson's diesel-powered Mercedes smells like peanuts, or French fries, or whatever alternative fuel happens to be in his tank. ... Willie Nelson has birthed his own brand of alternative fuel. It is called, fittingly enough, BioWillie. And in BioWillie, Mr. Nelson, 72, has blended two of his biggest concerns: his love of family farmers and disdain for the Iraq war. BioWillie is a type of biodiesel, a fuel that can be made from any number of crops and run in a normal diesel engine. ... The rationale is that it is a domestic fuel that can provide profit to farmers and that it will help the environment, though environmentalists are not universally enthusiastic about it...

Every alternative to oil ... has its drawbacks. Biodiesel would reduce most emissions of smog-forming pollutants and global warming gases, and it could be used instead of foreign oil. But some studies show that it increases emissions of one harmful pollutant, nitrogen oxide, and it could not be produced in vast enough quantities to supplant oil-based fuel, or come close to it, unless the nation starts turning the suburbs over to farmland. And as with ethanol, producing great quantities of biodiesel from corn or soybeans could drive up food prices.

Bill Reinert, Toyota's national manager for advanced technologies, said ... "I frankly don't see biodiesel being an early alt-fuel player across a wide swath of geography. It's a boutique fuel. There's not enough payoff and not enough people into it." Peter J. Bell, the chief executive of ... a distributor of biodiesel that is working with Mr. Nelson, said of the nation's nearly 200,000 gas stations, "650 carry biodiesel, so we have a job in front of us."...

Daniel Becker, the Sierra Club's top global warming expert, said ... "In order to grow soybeans, you need multiple passes over the field with diesel tractors, you need a lot of fertilizer that's energy intensive to produce and, at the end of the day, you have a product that is no boon for the environment." He went on: "If you're going to go to the trouble of using an alternative fuel, use a good alternative fuel. If you really want to listen to Willie Nelson, go buy one of his records and play it in a hybrid."...

Trimming to the Core of the Matter

New Economist finds research on which measure of core inflation is best:

New Economist, Measuring core inflation in US and Canada: How best can central banks measure core inflation? Two new central bank working papers shed some light. New York Fed Staff Report no. 236 by Robert Rich and Charles Steindel provides A Review of Core Inflation and an Evaluation of Its Measures. Based on the "desired attributes" of ease of design, accuracy in tracking trend inflation, and predictive content for future movements in aggregate inflation, they identify a number of possible core inflation measures. But no one measure is best:

We find that most of the candidate series, including the familiar ex-food and energy measure, demonstrate the ability to match the mean rate of aggregate inflation and track movements in its underlying trend. In the within-sample analysis, we find that core measures derived through exponential smoothing, in combination with simple measures of economic slack, have substantial explanatory content for changes in aggregate inflation several years in advance.

In the out-of-sample analysis, however, we find that no measure performs consistently well in forecasting inflation. Moreover, we document evidence of some parameter instability in the estimated forecasting models. Taken together, our findings lead us to conclude that there is no individual measure of core inflation that can be considered superior to other measures.

Meanwhile a Bank of Canada working paper by Frédérick Demers and Annie De Champlain, Forecasting Core Inflation in Canada: Should We Forecast the Aggregate or the Components?, concludes that "it remains difficult to properly model and forecast monthly core inflation in Canada" - although using disaggregate data helps.

I think the Trimmed-Mean PCE Inflation Rate from the Dallas Fed and dutifully reported by macroblog is a measure to keep an eye on. It was not part of this study.

Paul Krugman: Heck of a Job, Bushie

Paul Krugman takes a look back over the last year and assesses changes in the political landscape and changes in the view of presidents who break the law:

Heck of a Job, Bushie, by Paul Krugman, Commentary, NY Times: A year ago, everyone expected President Bush to get his way on Social Security. ... A year ago, everyone thought Congress would make Mr. Bush's tax cuts permanent, in spite of projections showing that doing so would lead to budget deficits ... But Congress hasn't acted... A year ago, Mr. Bush made many Americans feel safe, because they believed that he would be decisive and effective in an emergency. But Mr. Bush was apparently oblivious to the first major domestic emergency since 9/11. ... [A]ides ... finally decided, days after Hurricane Katrina struck, that they had to show him a DVD of TV newscasts to get him to appreciate the seriousness of the situation.

A year ago, before "Brownie, you're doing a heck of a job" became a national punch line, the rising tide of cronyism ... unqualified political appointees attracted hardly any national attention. A year ago, hardly anyone ... had heard of Jack Abramoff, and Tom DeLay's position as House majority leader seemed unassailable.

A year ago, Dick Cheney, who repeatedly cited discredited evidence linking Saddam to 9/11 ... was widely admired ... A year ago, Howard Dean - who was among the very few ... to question Colin Powell's prewar presentation to the United Nations, and who warned... that the occupation of Iraq would be much more difficult than the initial invasion - was considered flaky and unsound.

A year ago, it was clear that before the Iraq war, the administration suppressed information suggesting that Iraq was not, in fact, trying to build nuclear weapons. Yet few people in Washington or in the news media were willing to say that the nation was deliberately misled into war until polls showed that most Americans already believed it.

A year ago, the Washington establishment treated Ayad Allawi as if he were Nelson Mandela. ... But Mr. Allawi turned out to be another Ahmad Chalabi, a hero of Washington ... who had few supporters where it mattered, in Iraq. A year ago, when everyone respectable agreed that we must "stay the course," ... It would have been hard to imagine the top U.S. commander in Iraq saying, as Gen. George Casey recently did, that a smaller foreign force is better "because it doesn't feed the notion of occupation."

A year ago, Mr. Bush hadn't yet openly reneged on Scott McClellan's 2003 pledge that "if anyone in this administration was involved" in the leaking of Valerie Plame's identity, that person "would no longer be in this administration." ... A year ago, we didn't know that Mr. Bush was lying, or at least being deceptive, when he said at an April 2004 event promoting the Patriot Act that "a wiretap requires a court order. ...When we're ... chasing down terrorists, we're talking about getting a court order before we do so. ... constitutional guarantees are in place when it comes to doing what is necessary to protect our homeland, because we value the Constitution."

A year ago, most Americans thought Mr. Bush was honest.

A year ago, we didn't know for sure that almost all the politicians and pundits who thundered, during the Lewinsky affair, that even the president isn't above the law have changed their minds. But now we know when it comes to presidents who break the law, it's O.K. if you're a Republican.

Update: Full column.

Previous (12/26) column: Paul Krugman: Health Care Costs.
Next (1/2) column: Paul Krugman:  No Bubble Trouble?

Take Your Ball and Go Home

The Treasury Department is trying to ensure that no more major league baseball players lose their jobs to Cuban immigrants:

Called out at home, Editorial, LA Times: It has always seemed puzzling that Major League Baseball could have the chutzpah to call its annual tournament the World Series, given that nearly all its teams play in U.S. cities. Now, the league's effort to broaden its global reach has hit a roadblock put up ... by the Treasury Department. Shortly after Olympics officials decided to boot baseball from the Games after 2008, Major League Baseball announced it would start a global springtime tournament to be held every four years. Called the World Baseball Classic, it would pit American stars against the best players from other baseball-loving nations. It's a great idea ... if not for the United States' hysterical policies on Cuba — one of 16 nations selected for the March 2006 tournament.

Because a four-decade-old trade embargo prohibits Americans from entering into contracts by which Cuba may profit, Treasury officials have ruled that Cuba, which would earn at least 1% of the proceeds from the tournament, cannot participate. A proposal stipulating that the Cuban team would receive nothing more than free room and board is pending. Washington should accept it rather than hand Cuban leader Fidel Castro a propaganda victory.

Were the Cuban team to join the tournament, Castro would have more to fear than the U.S. After playing the Baltimore Orioles in an exhibition series six years ago, the Cuban team suffered a wave of defections. Castro was hesitant to let a team enter the tournament for fear that the players he uses as propaganda tools would follow suit. Now Washington has offered him a convenient excuse to pull out, and ... vilify the United States.

Treasury's decision seems particularly counterproductive given that Cuba plays U.S. teams in a number of international sporting events — the Olympics and the Pan American Games... — and that it's not difficult to prevent the Cuban government from profiting. During the Baltimore exhibition series, all proceeds went to American and Cuban charities that promote athletics. But the decision is in keeping with President Bush's Cuba policy, which has departed from the slight detente between the countries since the 1990s by severely tightening travel restrictions...

Let them play.

Market Power and Health Care Prices

Ezra Klein on health care costs:

Pay More, Get Less, by Ezra Klein, Tapped: A fair number of libertarian and conservative economists tend to claim that the high costs of care in America are a simple result of how much we pay for services. They, predictably, ascribe the impressive sums to the awesome technologies and complicated operations we deploy, a quality of care apparently inconceivable in any other country. But it's more structural than that. In their (damn good) paper on the variance between U.S. health spending and costs in other countries, Uwe Reinhardt, Peter Hussey, and Gerard Anderson explain:

Distribution of market power and prices. In a previous paper we argued that Americans pay much higher prices for the same health services than citizens in other countries pay. There are a number of reasons why this might be so.

First, the distribution of compensation in the United States is wider than in most of the other industrialized countries. The highly trained and highly talented health professionals employed in health care must be recruited from the same talent pool used by other industries offering high compensation, such as law and finance. Because health care is a labor-intensive industry, labor is one factor driving up the cost of producing health care in the United States.

Second, the highly fragmented organization of the financing of health care in the United States serves to allocate relatively greater market power to the supply side of the health system than to the demand side. As we have argued in previous papers, multiple purchasers of care allow U.S. prices to rise above the level attained in other industrialized countries that either endow the demand side of their health systems with strong, monopsonistic (single-buyer) market power (such as the Canadian provincial health plans) or allow multipayer systems to bargain collectively with the providers of health care, sometimes within government-set overall health care budgets (as, for example, in Germany).

So our system, due to the weird structural incentives and glorification of the supply-side, is inherently more expensive. But that doesn't prove we don't use more services and better technologies. For that, you turn to "It's The Prices, Stupid," written by the same team of researchers:

A study by the McKinsey Global Institute followed that more in-depth approach. The research team, which was advised by a number of prominent health economists, based its analysis on four tracer diseases: diabetes, cholelithiasis (gall stones), breast cancer, and lung cancer.31 Using PPP-adjusted U.S. dollars as the common yardstick, the McKinsey researchers found that in the study year of 1990 Americans spent about $1,000 (66 percent) more per capita on health care than Germans did. The researchers estimated that Americans paid 40 percent more per capita than Germans did but received 15 percent fewer real health care resources. A similar comparison revealed that the U.S. system used about 30 percent more inputs per capita than was used in the British system and spent about 75 percent more per capita on higher prices.

So, when tracking the utilization of resources for a variety of treatment-intensive diseases, we spend more and receive less than residents of other countries. It's not that we're offering more or better treatment, but that our "medical-industrial complex" charges exorbitantly for the same treatments available elsewhere.

Ujamaa, the Cooperative Economics of Hip-Hop

From the official Kwanzaa web site:

Kwanzaa was created to introduce and reinforce seven basic values of African culture ... These values are called the Nguzo Saba which in Swahili means the Seven Principles. ... the Nguzo Saba stand at the heart of the origin and meaning of Kwanzaa...

The fourth principle is Ujamaa:

Ujamaa (Cooperative Economics) To build and maintain our own stores, shops and other businesses and to profit from them together.

Here's a column that finds this principle in hip-hop:

Will China Grow Fast Enough to Overtake the U.S.?

Bloomberg's John M. Berry says no way:

China's Booming Economy Will Never Surpass U.S., by John M. Berry, Bloomberg: China's economy is growing so fast that estimates of its long-term prowess are bordering on the absurd. After Chinese statisticians recently sharply revised up their estimate of economic output in 2004 ..., some analysts said that in 35 years it would overtake the U.S. economy. No way, no how. ... Even if China's GDP were to grow indefinitely at 11 percent a year -- 9 percent real growth plus 2 percent inflation -- and the U.S. experienced 5.5 percent growth -- 3.5 percent real and 2 percent inflation -- it would take the Chinese 40 years to catch up in terms of nominal GDP. Sustainable nominal GDP growth of 5.5 percent annually is well within the capability of the U.S. Eleven percent growth, about what Chinese authorities expect in 2006, isn't remotely possible in the long run. ...

Partly as the result of continued immigration, legal and illegal, U.S. population is increasing by 0.92 percent a year... With no net immigration and with its government's harsh rule of one child per family, China's population is expanding at a much smaller 0.58 percent rate. Surprisingly, given the enormous difference in current populations, Census Bureau projections show that between now and 2050, the U.S. population will rise by 124 million while the Chinese population will increase slightly less, by only 118 million. If those projections prove accurate, the Chinese likely would have no great advantage in terms of a burgeoning labor force as an ingredient for economic growth.

China does have an advantage in the rapid movement of workers from rural agriculture into higher productivity jobs in industry and services. On the other hand, it is a process that can only occur once, just as it was largely completed in the U.S. more than half a century ago.

The other principal source of China's economic growth is its extraordinarily high share of GDP going to investment. "China's investment-to-GDP ratio is still rising -- we estimate it at 47 percent in 2005 -- and this has resulted in a significant build-up of production capacity in many industries,'' Lehman Brothers economists told their clients ... "...there are symptoms of oversupply... "There is an urgent need to rebalance GDP from investment to consumption...'' ... [A]s Chinese incomes rise, so will consumption as a share of GDP, with a more or less corresponding decline in the investment share. ...

Aside from these reasons to question the sustainability of continued annual increases of 11 percent in Chinese nominal GDP, there is the overriding issue of authoritarian rule by the Chinese Communist Party. ... Prospects for U.S. growth generally look good, even though eventually the country is going to have to deal with its low savings rate and huge current account deficit. China will remain a formidable economic competitor. Nevertheless, of necessity its growth will slow before too many more years pass and the U.S. economy will remain the largest in the world.

I had to Walk Barefoot for Two Miles in the Snow to Buy a House

Whether houses are more or less expensive than in the past depends in part on the time period examined. House payments as a fraction of income are lower today relative to the early 1980s, but higher than in the late 1990s:

Twenty Years Later, Buying a House Is Less of a Bite, by David Leonhardt and Motoko Rich, NY Times: Despite a widespread sense that real estate has never been more expensive, families in the vast majority of the country can still buy a house for a smaller share of their income than they could have a generation ago. A sharp fall in mortgage rates since the early 1980's, a decline in mortgage fees and a rise in incomes have more than made up for rising house prices in almost every place outside of New York, Washington, Miami and along the coast in California. ... Nationwide, a family earning the median income - the exact middle of all incomes - would have to spend 22 percent of its pretax pay this year on mortgage payments to buy the median-priced house ... The share has increased since 1998, when it hit a low of 17 percent ... Although the overall level has reached its highest point since 1989, it remains well below the levels of the early 1980's, when it topped 30 percent. ... Beyond cost, many families who simply could not have bought a house 10 or 20 years ago find themselves able to do so, thanks to changes in the ways banks lend money. In the past, a home buyer often needed to make a down payment equal to 20 percent of a house's value to get a mortgage; today, little or no down payment is common...

For me, it wasn't the price that was the biggest hurdle to buying a house the first time, the payments would not have been much different than the rent I was paying. It was the 10-20% down payment that was the barrier. Going through the whole process is still no fun, but it's better than it used to be.

Strategic Egonomics

Virginia Postrel of www.dynamist.com writes about the value of precommitment:

A Nobel Winner Can Help You Keep Your Resolutions, by Virginia Postrel, Economic Scene, NY Times: Why make New Year's resolutions? ... why wait until Jan. 1? Why not do it today? ... New Year's resolutions help people cope with some of the most difficult conflicts human beings face. So argues ... Thomas C. Schelling, who shared this year's Nobel in economic science ... Professor Schelling ... is famous for his work on conflicts between nation-states, particularly those with nuclear weapons.

One of his best-known ideas is "precommitment." One party in a conflict ... can often strengthen its strategic position by cutting off some of its options to make its threats more credible. An army that burns its bridges, making retreat impossible, is a classic military example. ... In the early 1980's, Professor Schelling applied similar analysis to individuals' internal struggles, seeking to develop what he called "strategic egonomics, consciously coping with one's own behavior, especially one's conscious behavior."

The problem, he suggested, is that pretty much everybody suffers from a split personality. One self desperately wants to lose weight or quit smoking or run two miles a day or get up early to work. The other wants dessert or a cigarette, hates exercise or loves sleep. Both selves are equally valid, and equally rational about pursuing their desires. But they do not exist at the same time.

"What I have in mind is an act or decision that a person takes ...[based upon] preferences [that] differ from what they were earlier..." he wrote ... "If the person could make the final decision about that action at the earlier time, precluding a later change in mind, he would make a different choice ..."

New Year's resolutions help the earlier self overrule the later one by raising the cost of straying. "More is threatened by failure than just the substance of the resolution: one's personal constitution is violated, confidence demoralized, and the whole year spoiled. At least one can try to make it so," ... As many a broken resolution demonstrates, those consequences often are not a big enough deterrent. To make success more likely, Professor Schelling's work suggests a few additional strategies. One is a mild precommitment: not keeping sweets or tobacco in the house, for instance. At the very least, this step forces you to delay indulgence ... and allows time to recover your resolve.

Another approach is to use bright-line rules, which make it harder to cheat through clever reinterpretation. That may explain why many people find it easier to eliminate whole categories of food, like carbohydrates, rather than simply to cut back on calories. "[Z]ero is a more enforceable limit on cigarettes or chewing gum than some flexible quantitative ration," Professor Schelling wrote. He once resolved to smoke "only after the 'evening meal.' " That rule "led to tortured reasoning Thanksgiving afternoon, or flying west across the Atlantic with perpetual afternoon, and it stimulated lots of token sandwiches on leaving the ski slopes to drive home."

For those who cannot face the prospect of an eternity without a favorite indulgence, there is the strategy of delay. ... you give yourself permission to smoke or drink or eat chocolate cake again within a specified time - say, three hours - after deciding to go off the wagon. Like having to go out to buy supplies, this strategy allows time once again to resolve not to indulge. ...

A slight variation allows a third "self" to mediate between the two in conflict by enforcing a prearranged deal: ... for instance ... a new dress in exchange for losing 10 pounds. This system works, however, only on two conditions. First, the incentives have to be strong enough. Then, ... "the 'someone' who wants to turn off his alarm with his eyes closed has to believe that another 'somebody' will later have the fortitude to administer the punishment or deny the reward, when 'they' are really all the same person."

Just do it tomorrow.

Adjustment Costs and Leap Seconds

With sticky prices, the more costly prices are to change, the less frequently they are adjusted. It turns out that measured time is sticky too. Now that the use of atomic clocks in GPS systems, telecommunications, and elsewhere has made it more costly to adjust clocks, there are proposals to reduce the frequency of adjustment. The current practice is to adjust the clocks when they are off by a second (i.e., their "S-s rule" is one second), but some would prefer to wait until clocks are off by as much as several minutes relative to the earth's rotation before any adjustment is made:

Second Thoughts, SciAm Observations: Plenty of sources (for example, the BBC) are reporting on the leap second that will be tagged onto the end of 2005. Daniel Engber's helpful Explainer column at Slate discusses why the world's official timekeepers occasionally fiddle with the length of a day to help keep clocks more in sync with the actual period of the Earth's rotation. (Tidal forces, ice ages, massive earthquakes and even meteorological phenomena can all shift the balance of our planet's mass around its axis and thereby speed up or slow down its spin.) However, generally overlooked in all this coverage is the interesting point that such leap seconds are becoming sources of friction between astronomers and the telecommunications sector, and there is a proposal to eliminate them. Wendy M. Grossman revealed why in a news story in the November issue of Scientific American: randomly extending and shortening days throws a wrench into the GPS system, which relies on atomic clocks, not astronomical time. How much of a problem that really poses is open to discussion; I see, though, that according to RIA Novosti, the Russian military is saying that the 2005 leap second will not affect its Strategic Missile Force. So... thanks for the reassurance on that, I guess.

Here's more from the linked article be Wendy M. Grossman:

To illustrate the issue posed by leap seconds, Levine points to navigation. "Every time there's a leap second, the thing that's moving continues to move, but the clock stops," he explains. "So the people who deal with physical processes do not want leap seconds." ... To keep clocks from drifting too far from the day-night cycle, abolitionists would presumably need to add, say, several leap minutes every few hundred years. The existing ... system, Levine notes, ... sows confusion. For one, the leap second occurs in the middle of the day in Asia and Australia, causing a time hiccup during stock trading. For another, the more timescales there are, the easier it is for a programmer to make an error in calculations. Astronomers are deeply dismayed at the prospect, which would decouple time from the earth's rotation...

Central Bank Communication and Policy Effectiveness

Here's Michael Woodford on the value of central bank communication on the likely path of short-term interest rates:

Central Bank Communication and Policy Effectiveness, by Michael Woodford, NBER WP 11898, December 2005: Abstract A notable change in central banking over the past 15 years has been a world-wide movement toward increased communication by central banks about their policy decisions, the targets that they seek to achieve through those decisions, and the central bank's view of the economy's likely future evolution. This paper considers the role of such communication in the successful conduct of monetary policy, with a particular emphasis on an issue that remains controversial: to what extent is it desirable for central banks to comment on the likely path of short-term interest rates? After reviewing general arguments for and against central-bank transparency, the paper considers two specific contexts in which central banks have been forced to consider how much they are willing to say about the future path of interest rates. The first is the experiment with policy signaling by the FOMC in the U.S., using the statement released following each Committee meeting, since August 2003. The second is the need to make some assumption about future policy when producing the projections (for future inflation and other variables) that are central to inflation-forecast targeting procedures, of the kind used by the Bank of England, the Swedish Riksbank, the Reserve Bank of New Zealand, and others. In both cases, it is argued that increased willingness to share the central bank's own assumptions about future policy with the public has increased the predictability of policy, in ways that are likely to have improved central bank's ability to achieve their stabilization objectives. [Open link to version posted at the KC Fed.]

This doesn't follow directly since it's about explicit inflation targets rather than announcing an expected path for short-term rates, but it is related and I've been looking for a reason to talk about explicit inflation targets, commitment, and transparency further because I think there's a mistaken belief from some that commitment is only valuable if it substantially constrains flexibility. But as Mankiw explains in his intermediate level text, this need not be the case. There is value in announcing inflation targets even if it does not tie the hands of central bankers because it holds them accountable for their actions. They can still do mostly as they please, but it's easier to assess policy actions relative to announced goals. This is from Macroeconomics, 5th Ed., by N. Gregory Mankiw, Case Study, pg. 395:

Inflation Targeting: Rule or Constrained Discretion?

Since the late 1980s, many of the world's central banks-including those of Australia, Canada, Finland, Israel, New Zealand, Spain, Sweden, and the United Kingdom-have adopted some form of an inflation target. Sometimes inflation targeting takes the form of a central bank announcing its policy intentions. Other times it takes the form of a national law that spells out the goals of monetary policy. For example, the Reserve Bank of New Zealand Act of 1989 told the central bank "to formulate and implement monetary policy directed to the economic objective of achieving and maintaining. stability in the general level of prices." The act conspicuously omitted any mention of any other competing objective, such as stability in output, employment, interest rates, or exchange rates. ...

Should we interpret inflation targeting as a type of precommitment to a policy rule? Not completely. In all the countries that have adopted inflation targeting, central banks are left with a fair amount of discretion. Inflation targets are usually set as a range an inflation rate of 1 to 3 percent, for instance-rather than a particular number. Thus, the central bank can choose where in the range it wants to be. In addition, the central banks are sometimes allowed to adjust their targets for inflation, at least temporarily, if some exogenous event (such as an easily identified supply shock) pushes inflation outside of the range that was previously announced.

In light of this flexibility, what is the purpose of inflation targeting? Although inflation targeting does leave the central bank with some discretion, the policy does constrain how this discretion is used. When a central bank is told to "do the right thing," it is hard to hold the central bank accountable, because people can argue forever about what the right thing is in any specific circumstance. By contrast, when a central bank has announced an inflation target, the public can more easily judge whether the central bank is meeting that target. Thus, although inflation targeting does not tie the hands of the central bank, it does increase the transparency of monetary policy and, by doing so, makes central bankers more accountable for their actions.⁶

⁶ See Ben S. Bernanke and Frederic S. Mishkin, "Inflation Targeting: A New Framework for Monetary Policy?" Journal of Economic Perspectives 11 (Spring 1997): 97-116.

[JSTOR link to Bernanke and Mishkin paper.]

Yield Curve Inversions When Expected Inflation is Low

I haven't known what to say about the briefly inverted yield curve because it does not alarm me as much as it does others. I guess the best way to put it is that it is like a noise in the dark. It's not a problem in and of itself, but it may signal trouble. It's something that catches your attention, and it's worth paying attention and checking to see if anything is wrong, but there's no certainty that trouble is near.

I am not worried. I believe there is a fundamental difference today versus recent decades. Up until now, I had no faith that monetary authorities were committed to fighting inflation first and foremost and I never would have dared risk a variable interest rate loan. Experience suggested that eventually inflation would return, or there was at least a substantial chance that it could return. Today I would be willing to bet, even for a decade or more, that inflation will remain in check and I would be willing to sign a variable rate contract to try and win that bet (this is not advice on mortgages as I am abstracting from lots of other differences in terms). Up until a year or so ago, I did not have such faith. But monetary authorities have convinced me they will not waiver in their commitment to price stability.

If I am not alone, if there has been a substantial change in long-run inflationary expectations regarding the risk of higher inflation, that flattens the "natural" yield curve. Due to liquidity concerns, long-term rates should still command a premium so the natural state is upward sloping, but I would argue it is fairly flat.

With a flattened "natural" yield curve, and variation around that natural state, it is more likely that an inversion will occur than in the past. But since the natural state of the yield curve is flatter than in the past, an inversion does not represent as much of a deviation from the natural state as it once did and hence does not bring as much consternation with it, at least from me.

Weeding Out the Hacks

I made a similar point at the end of this post about getting rid of hacks posing as analysts, so I have to agree with the spirit of this commentary:

Dialing down hack TV shows, by Bruce Bartlett, Commentary, Washington Times: If there is one thing ... Republicans and Democrats all agree about these days it is that there is too much polarization in public discourse; too much name-calling and not enough civil discussion of the issues. A key reason for this, in my opinion, is the nature of cable news, which thrives on 5-minute debates between polar opposites. There are several reasons why this is destructive. First, few intelligent arguments can be made in such a short time. ... you may only have at most two 1-minute segments in which to make your case. ... Consequently, one is usually forced to jump straight to one's conclusion in a cable news debate and assert one's points without being able to develop them or provide essential facts or the logical steps that might convince the open-minded, ignorant or undecided on your issue.

Another problem is that almost everyone who appears on television is now trained to control the agenda when appearing on camera. They know that when the camera is on them they can pretty much say absolutely anything they want. Often this means rote recitation of talking points that may have nothing to do with the issue at hand ... It is also easy to make outrageous claims and cite bogus facts or statistics in support of one's position, knowing your opponent may not have time to correct you. And even if he does, it prevents him from making the points he wanted to make and forces him to argue on your terms. ...

Further degrading the usefulness of cable debates is the fact they are often mismatched in terms of stature. On one side, you might have a college professor or think tank scholar who is a recognized expert in his field. On the other, you might have some nobody with no real expertise from an organization that exists only as a cell phone number to a booker. The debate format tends to make people believe the two are of equal stature, downgrading the views of the true expert while elevating those of the hack.

For this reason, I now demand to know who I may be debating before agreeing to appear in a cable debate. If it is not someone I recognize as a competent peer, I won't do it. Many others in my position feel the same way, which is one reason you tend to see fewer and fewer real experts engaging in cable face-offs and more and more nobodies labeled as party "consultants" or "strategists."

This is also due to the fact genuine experts too often agree on basic points even if they come from contrasting philosophical perspectives. They will at least agree on the facts and the proper analytical framework. Their differences are usually over orders of magnitude, not fundamentals. This makes bad television from the cable news channels' viewpoint, which craves fireworks and sharp differences. Shouting matches are encouraged, agreement is discouraged. Unfortunately, this leaves viewers left thinking there is no real truth and everything is just a matter of opinion, leaving them free to choose whichever side is most conducive to their own personal beliefs, prejudices or preferences.

I would propose cutting back on contrived debates. Why not interview those with opposing views separately and give each more than a minute or two to make their point without having to respond to another person's debating tactics? And why not encourage interviewers to intervene when blatant errors or falsehoods are offered as facts? I think these reforms would raise the level of discourse and the quality of those willing to appear on cable programs by weeding out some of the hacks whose only knowledge on a subject comes from their party's talking points.

I agree that this is a problem, and that hosts, moderators, and so on need to take more responsibility for the presentation of information and the content and structure of debates. But I suspect that if we went to a system where those with opposing views were interviewed separately and the off topic "talking points" and other parts were edited out, the complaint would be over the editorial decisions on what to cut and what to include, something that is less of a problem in face to face "live" debates.

I think the key is to have a credible broker in the middle of the debate however it is constructed, a knowledgeable professional who can control the debate, someone willing to ask tough, pertinent, challenging questions of both sides, and willing to allow time for an informed response. As we weed out the hacks, we can start with the hosts. Is there anyone that both sides trust? There are some hosts in that category, but not many, and that's a reason why the left and the right get their news and opinion, in large part, from different outlets. I think the majority of people would like to see honest debate on economic and other issues, but they are not sure where to find it.

The Economics of Prestige

How do works of art become prized? Here's a shortened version of a review of James English's book “The Economy of Prestige,” an account "of the history and social function of cultural prizes and awards" and their relationship to the value of literary works from The New Yorker:

All That Glitters, by Louis Menand, The New Yorker: In 1987, “Paco’s Story,” by Larry Heinemann, won the National Book Award for Fiction. The acclaim that greeted this selection was less than universal, and the reason ... is that 1987 was also the year of Toni Morrison’s “Beloved.” Morrison’s novel ... had been widely regarded as the favorite. ...[Forty-eight] friends..., after “Beloved” also failed to win the National Book Critics Circle Award for Fiction...,  published a statement in the Times Book Review. “Despite the international stature of Toni Morrison,” they complained, “she has yet to receive the national recognition that her five major works of fiction entirely deserve... We, the undersigned black critics and black writers, here assert ourselves against such oversight and harmful whimsy...” A few months later, “Beloved” won the Pulitzer Prize for fiction. Five years after that, Morrison was awarded the Nobel Prize.

James English has a lot to say about this episode in “The Economy of Prestige” (Harvard; $29.95), his ingenious analysis of the history and social function of cultural prizes and awards. He thinks that Morrison’s champions crossed a tacitly accepted and well-established line when they printed their protest in the Times. The transgression was not the complaint that the award had been given to the wrong writer. ... When you have prizes for art, you will always have people complaining that prizes are just politics, or that they reward in-group popularity or commercial success, or that they are pointless and offensive because art is not a competition. English believes that ... when people make these objections to the nature of prizes they are helping to sustain a collective belief that true art has nothing to do with things like politics, money, in-group tastes, and beating out the other guy. As long as we want to believe that ... a work of art is not just one more commodity seeking to aggrandize itself in the marketplace at the expense of other works of art, we need prizes so that we can complain about how stupid they are. ...

Since the nineteen-seventies, English says, there has been an explosion of new cultural prizes and awards. There are now more movie awards given out every year—about nine thousand—than there are new movies, and the number of literary prizes is climbing much faster than the number of books published. ... This doesn’t mean that everyone gets a ribbon. In the awards economy, the rich tend to get richer. Michael Jackson has been given more than two hundred and forty awards in his career. Steven Spielberg has ninety. ... English estimates that among poets John Ashbery is the leader, with at least forty-five prizes and awards. John Updike sets the pace for novelists, with thirty-nine.

English interprets the rise of the prize as part of the “struggle for power to produce value, which means power to confer value on that which does not intrinsically possess it.” ... A work of art has to circulate through a sub-economy of exchange operated by a large and growing class of middlemen: publishers, curators, producers, publicists, philanthropists, foundation officers, critics, professors, and so on. ... [W]e like to think that the recognition of artistic excellence is intuitive. We don’t like to think of cultural value as something that requires middlemen ... in order to emerge. ...

English speculates that this willingness to speak without embarrassment about the significance of prizes and awards, and about the whole economy of   cultural production and consumption, may, paradoxically, signal the demise of   the prize system. ... In English’s view, therefore, Morrison’s friends and admirers violated the protocols of prize-bashing not because they publicly criticized the choice of the National Book Award judges but because they acknowledged that the award really matters, that it ... helps to validate a book and establish its author. Their statement pointed out, in the frankest terms, that there is a literary marketplace, and that power and authority—“cultural capital,” ... accrue to those who succeed in it. ...

“Caxtons are mechanical birds with many wings,” says the Martian, about books, in Craig Raine’s famous poem, “and some are treasured for their markings.” The Martian doesn’t know why the markings between the covers labelled “Beloved” are more treasured, or represent more cultural capital, than the markings inside the covers labelled “Paco’s Story.” The Martian sees only that human beings attach high value to some of these otherwise identical and interchangeable objects and low value to others, and he/she attempts, by analyzing the system in which the objects are produced, circulated, and consumed, to figure out how this happens. From the Martian point of view, it certainly looks like a competition, because the value of “Beloved” is determined by all the things that make it different from “Paco’s Story.” It’s a relational system: the value of a cultural good is relative to the value of every other cultural good. That most of us on planet Earth deny that competition has anything to do with the esteem that we, as individuals, confer on a particular book or painting or song or movie does not mean that the Martian is wrong. Our denial is just one more thing that needs to be explained. ...

Literature is conventionally taught as a person-to-person aesthetic experience: the writer (or the poem) addressing the reader. Teachers cut out English’s middlemen, the people who got the poem from the writer to us, apparently confirming his point that we have to deny the economics of cultural value in order to preserve the aesthetics. But, once we’re outside the classroom, how rigidly are these conventions adhered to? How many people today really imagine “art” as a privileged category, exempt from the machinations of the marketplace? The literary marketplace has always been a theme of literature: “Tristram Shandy” reflects on its own status as a cultural good; Aristophanes’ “The Clouds” is a satire on literary competition. Since the nineteen-sixties, the constructed nature of the art experience has been one of advanced art’s principal preoccupations. Andy Warhol’s Campbell’s-soup-can paintings are all about art as commodity. ...

As a Martian, or dry economist, this does not seem mysterious. Of course the value of literature - just another commodity - depends upon competition in the marketplace and the forces of supply and demand, and of course we all value things differently. I hate pickles, but some people love them. Who knows why or how that came to be? Fortunately Martians don't need to worry about that too much, though many of us work on these questions. A good is valuable because it yields utility. Why people like art is an interesting question, I don't mean to imply otherwise, just as why people like a particular wine and the role of experts, price, etc. in the signaling process for value is similarly interesting, but we don't need to know why a good yields utility to determine its price.  Martians do not need to know why "the markings between the covers labelled "Beloved” are more treasured, or represent more cultural capital, than the markings inside the covers labelled "Paco’s Story"" to determine their price in the marketplace. I have no idea why people like apples more or less than oranges or any other good, why one movie is a hit and another flops and the precise role of expert thumbs in the process, but I can still construct demand curves.

As a Martian, I see the decline in the value of awards from a different perspective. I think art is difficult to value, there is an information problem, and in such cases it pays to consult experts who can vouch for characteristics such as the artist, etc. that help to determine value. It's not as certain as, say, having gold assayed, but experts serve the same purpose. The proliferation of awards can be viewed as arising from the market failure due to imperfect information on quality. By creating false signals of quality - prizes and awards - there are gains to individuals in the short-run, but in the long-run this behavior across individuals undermines the value of the signal. However pure the motivations of suppliers in the artistic process are, and however demand is generated, once the good gets to market we have a pretty good idea about how the price will be set.

Was the Cow Palace Built Leaning on Shovels?

Here's an essay on the New Deal by Gray Brechin appearing on SFGate.com. The essay points to all the ways money that was "wasted" on The New Deal is still paying dividends today:

Keeping the faith, by Gray Brechin, SFGate.com: Seventy-two years after it first emerged from President Franklin Roosevelt's post-inaugural Hundred Days of epochal legislation, the New Deal rises from the grave to haunt those who hoped they had buried it for good. Its eternal foes ironically resurrected "that man's" memory by attempting to privatize his most popular and enduring legacy. Social Security -- a program whose very name invokes the communitarian ethos that makes the New Deal satanic for those who would privatize risk along with everything else in the public domain -- still easily has enough voting friends that Republicans backed off tampering with it before next year's midterm elections.

But nothing did so much to freshen the fading memory of the New Deal as hurricanes Katrina and Rita. In their ruinous wake, liberal commentators called for similar federal activism to rebuild the South while reactionaries sought to tamp back its dreaded specter... Among the latter, New York Times columnist John Tierney predicted ("Losing the Faith," Sept. 24) that the "1930s nostalgia craze" would quickly founder on the rocks of a public cynicism ... Tierney related how he had lost faith in government after working with a federal antipoverty program in the 1970s. There, he witnessed bored teenagers paid to do little or nothing. ... The Bush administration's calamitous bungling of a natural catastrophe, according to conservatives such as Tierney, only buttressed their own ideological antipathy to the shared risks and responsibilities inherent in New Deal programs. A Louisiana laborer told the columnist that government's unresponsiveness taught him that "The lesson is to save money and be self-reliant." John Wayne rides again.

A 1939 Dorothea Lange photograph reminded me that Tierney's tale of redundant teens was as stale as those of FDR's enemies, who savaged the Works Progress Administration for useless make-work projects. Lange's camera captured a 1939 parade of WPA laborers in San Francisco protesting congressional funding cutbacks. One carried a sign asking, "Was the Cow Palace Built Leaning on Shovels?" (a reference to the city-owned exhibition building that has been paying dividends since it opened in 1941 by hosting everything from Republican Party conventions to Billy Graham revivals, rodeos and the Beatles). Few know that federal workers and grants built the Cow Palace, and that they did so with not a whiff of graft. As waves of corruption and mismanagement charges engulf the present administration, those who have lost faith in government cannot conceive of a regime notable for little scandal even as it employed millions of men and women on public-works projects.

For most Americans, the ubiquitous public landscape of the New Deal is as invisible as it is essential for the functioning of a modern nation. One of the New Deal's first alphabet soup agencies -- the Civil Works Administration -- lasted only for the dire winter of 1933-34. Within three weeks, CWA Director Harry Hopkins put 2 million people to work, a number that soon doubled as legions of laborers built or repaired more than 800 airports, 3,700 athletic fields and 255,000 miles of roads. ... the CWA built or modernized 4,000 school buildings, hired 50,000 teachers for rural schools, and controversially employed about 3,000 artists and writers who, Hopkins insisted, "had to eat, too."

In the coming years, Hopkins' CWA and the Public Works Administration (under "Honest" Harold Ickes) put millions more to work building a network of levees, roads, airports, military bases, schools, community colleges, civic auditoriums, water-delivery systems, sewers, hospitals, zoos and parks still in use today. New Deal workers restored the Statue of Liberty, the Washington Monument and San Francisco's Palace of Fine Arts, and they built the Triborough and San Francisco-Oakland Bay bridges, the Lincoln Tunnel, TVA dams, Treasure Island and the spectacular Timberline Lodge on Mount Hood. Without WPA flood-control projects, last winter's storms would have devastated Southern California at a cost of billions of dollars to taxpayers and insurance companies. Civilian Conservation Corps "boys" stationed in thousands of rural camps meanwhile reforested the nation and clocked in 6.5 million days fighting forest fires. They built 204 museums, restored almost 4,000 historic buildings and constructed 3,116 fire towers and more than 46,000 bridges. While saving families and individuals from destitution, the CCC made the nation's proliferating parklands so gracefully accessible that few who use them are aware of the peacetime "tree army's" heroic contributions to our collective well-being.

FDR called upon Americans to overcome their fear even as his works programs vastly enlarged the public domain ... Those who -- like Tierney -- have lost their faith in what government can accomplish for the common good have but to look around themselves to regain it. The evidence of intelligent design is everywhere; it bears the name of Roosevelt, and it points to the future we could have if we but remembered we once had it.

Robustly Optimal Monetary Policy with Near Rational Expectations

This paper from Michael Woodford investigates the consequences when the relationship between policy announcements and changes in expectations is not as systematic as rational expectations would imply, i.e. if the central bank cannot predict precisely how expectations of the public will react to a policy announcement. Because the policymaker cannot predict the exact response, the best policy is one that is robust to the range of possible "near rational expectations" outcomes. Importantly, such uncertainty does not justify a higher long-run inflation target, does not reduce the value of commitment to a policy target, and makes policy more history dependent. This paper, like most of Woodford's work, is not for the mathematically faint at heart:

Robustly Optimal Monetary Policy with Near Rational Expectations, by Michael Woodford, NBER WP 11896, December 2005 Abstract The paper considers optimal monetary stabilization policy in a forward-looking model, when the central bank recognizes that private-sector expectations need not be precisely model-consistent, and wishes to choose a policy that will be as good as possible in the case of any beliefs that are close enough to model-consistency. ... The main qualitative conclusions of the rational-expectations analysis of optimal policy carry over to the weaker assumption of near-rational expectations. It is found that commitment continues to be important for optimal policy, that the optimal long-run inflation target is unaffected by the degree of potential distortion of beliefs, and that optimal policy is even more history-dependent than if rational expectations are assumed. ... Conclusion ... And, as in the RE analysis, a crucial feature of an optimal commitment is a guarantee that inflation will be low and fairly stable. The fact that private beliefs may be distorted does not provide any reason to aim for a higher average rate of inflation, while it does provide a reason for the central bank to resist even more firmly the inflationary consequences of "cost- push" shocks. [Open link from author web page.]

Best of Responses to NRO Financial 2005

The NRO has some of its columns in a list of "Best of NRO Financial 2005." One of the columns is "Voodoo Volckernomics" by John Tamny. In keeping with "Best of" the theme, here's a "Best of Responses to NRO Financial 2005":

Brad DeLong: Why Oh Why Can't We Have a Better Press Corps? (I've Got to Stop Saying "National Review Has Reached Its Nadir" Department): Wow! I've got to stop saying, "National Review has reached its nadir." This is worse than anything I've seen before, worse than I had imagined possible. ... But the point isn't to provide or critique economic analysis, is it? The point isn't to inform the readers of National Review, is it? The point is that Paul Volcker--chosen by Republican Richard Nixon's staff to be Undersecretary of the Treasury for Monetary Affairs, chosen by Republican Arthur Burns to be President of the Federal Reserve Bank of New York, chosen by Republican Ronald Reagan's staff to be Chairman of the Federal Reserve Board--has written something inconvenient for the Bushies inside the White House. And so National Review undertakes the mission of trying to murk the waters with clouds of ink. And in this squid-like task, actual knowledge of the economy or of economics is a positive hindrance. The less the writer knows, the better.  Enter John Tamny. ...

Remember, this is part of their "Best of" list. You should see the "Worst of NRO Financial 2005." That aside, I want to highlight the statements:

But the point isn't to provide or critique economic analysis, is it? The point isn't to inform the readers of National Review, is it? ... The less the writer knows, the better.

NRO Financial has writers discussing economics who are not professional economists, many cannot even read the professional economic journals and have little idea of the theory or evidence pertaining to the issues they are writing on. Try to find Tamny's qualifications as an economic analyst on the NRO web site or anywhere else. The goal is generally to sell a point of view, or as Brad notes, to muddy the waters rather than present a position based upon a consistent theoretical structure and the corresponding econometric evidence.

Wanted: Nonpartisan Congressional Budget Office Director

The New York Times talks about the qualities needed in the replacement for Douglas Holtz-Eakin, director of the Congressional Budget Office:

The Right Stuff, editorial, NY Times: As director of the Congressional Budget Office, Douglas Holtz-Eakin has been Congress's top economist, handpicked by the Republican leadership. Recently, he had some advice for lawmakers - mostly Republicans - who insist that more tax cuts will foster economic growth and raise tax revenue: "Don't even think about it." ... "You can't grow yourself out of this problem," said Mr. Holtz-Eakin. "It's just too big." That's startlingly straight talk, given that Republicans are determined to pass tens of billions in unpaid-for tax cuts come January. ... Mr. Holtz-Eakin ... has delivered nonpartisan, data-driven research on some of the most controversial issues. Often, what Mr. Holtz-Eakin said wasn't what his bosses wanted to hear. He went on record in 2003 saying that President Bush's tax and spending plans would do little or nothing for long-term economic growth. One report issued under his leadership showed that Mr. Bush's tax cuts heavily favored the wealthiest Americans. Another debunked the politically potent but false contention that the estate tax hurts farmers. By going where the facts and figures led, Mr. Holtz-Eakin also protected his agency, which may be the last bastion of neutral government analysis in Washington. To succeed him, Congressional leaders need a top economist who has a reputation to protect and is a superb number cruncher, fluent communicator of complex issues and good manager.

And willing to fiercely defend, as Holtz-Eakin has, the independence and neutrality of the Congressional Budget Office against political pressure. Here's a little more from the CBO web site:

...The Appointment of the Director: The Speaker of the House of Representatives and the President pro tempore of the Senate jointly appoint the CBO Director, after considering recommendations from the two budget committees. The term of office is four years, with no limit on the number of terms a Director may serve. Either House of Congress, however, may remove the Director by resolution. At the expiration of a term of office, the person serving as Director may continue in the position until a successor is appointed. CBO has had six Directors since its inception in 1975. Douglas Holtz-Eakin is the current Director; his term of office ends in January 2007. He was preceded by Dan L. Crippen, June E. O'Neill, Robert D. Reischauer, Rudolph G. Penner, and Alice M. Rivlin...

CBO's Staff:The Director appoints all CBO staff, including the Deputy Director, and all appointments are based solely on professional competence, without regard to political affiliation. ... CBO is composed primarily of economists and public policy analysts. About 70 percent of its professional staff hold advanced degrees in either economics or public policy...

Sachs: Time for Action on Poverty

Here's Jeffrey Sachs on the need for action in the quest to eliminate world poverty. I can't say that I fully endorse all of Sachs' policy recommendations. What I can fully endorse is the attention he brings to the issue of world poverty:

It is time for words to give way to meaningful action, by Jeffrey Sachs, Financial Times:  ...There was a lot of talk this year about ending extreme poverty; at the Gleneagles summit of the Group of Eight in July, the United Nations world summit in September and in a feast of concerts, television shows, books and articles around the world that raised public awareness and interest. But these words have yet to make a discernible difference for the hungry, destitute and dying. Action needs to proceed at every level, from the local to the national and the international. ... At the end of next year, each must be asked a single question: what did you do this year to end extreme poverty?

The key breakthrough in 2005 was the commitment of the European Union donors to achieve the vaunted target of 0.7 per cent of gross national product in official development aid by the year 2015. An intermediate benchmark of 0.56 per cent of GNP in aid as of 2010 was established. While Europe led, the Bush Administration sulked, refusing to be held to what it called an “artificial” standard. How cheeky of the world’s richest and most powerful country, one that devotes $500bn per year to the military, yet a pathetic $4bn per year to the hungry and dying of Africa (less than 4 cents for every $100 of US GNP). Most of that miserly aid to Africa is emergency food aid and US consultant salaries, rather than real development aid. ...

There must be increased resources to Africa. The point is not money per se, but what money can buy: bed nets and medicines to fight malaria, anti-retroviral medicines for Aids, fertilisers for replenishing soil nutrients, hardware and software for rural connectivity and countless other practical steps that could relieve hunger, disease and isolation. When practical measures have been undertaken backed by private philanthropy, as in the millennium villages of Kenya and Ethiopia, crop yields and food output have more than doubled in a single season. School attendance has soared in response to school feeding programmes and the elimination of user fees. Healthcare has been dramatically bolstered through the provision of local clinics and the mass distribution of long-lasting insecticide-treated bed nets to fight malaria. The successes are still on a small scale. It is time for the official donors to build on these results. ... The ...  reality that matters is that millions of children are dying each year...

More Aggressive Antitrust Enforcement by European Authorities

Under pressure from Washington, Europe takes a hard line on monopoly power derived through cartels and other means. Interestingly, the mechanism seems to be, at least in part, a decentralization of antitrust authority:

A Crackdown on Cartels by European Regulators, by James Kanter, NY Times: It was the kind of smoking gun that antitrust investigators dream of: a note, handwritten by the president of France Télécom, the largest French cellphone operator, describing plans to carve up the market the same way wartime leaders carved up the Continent in 1945. "Unjustifiable," the French Competition Council ruled this month. ... Across Europe, formerly docile cartel authorities are cracking down on collusion in economically weighty sectors like telecommunications, construction and banking. ... The action against telecommunications operators in France mirrors similarly aggressive activities in Germany, Italy and Britain. The upswing comes as the European Commission gives more leeway to local authorities. With an enlarged European Union of 25 countries, the commission formally jettisoned some of its antitrust responsibilities last year, leaving it to national authorities to monitor their own markets while the European Union concentrates on catching bigger fish operating across national borders. Another factor behind the change, said Julian Joshua, a former top cartel enforcer at the commission, is pressure from Washington to stamp out overseas cartels that damage United States interests...

Der Spiegel Interviews ECB President Trichet

Der Spiegel interviews Jean-Claude Trichet, President of the European Central Bank and asks about monetary policy, the German economy, and threats posed to Europe by the U.S., China, and India:

Interview with Der Spiegel, Interview with Jean-Claude Trichet, President of the European Central Bank, conducted by Thomas Tuma and Sven Afhüppe (Der Spiegel) on 19 December 2005 and published in the edition of Der Spiegel dated 23 December 2005:

SPIEGEL: ...at the beginning of December the ECB increased its key interest rate to its current level of 2.25 percent, the first increase in more than two years. Was that the first in a series of increases of the kind that has already taken place in the USA?

[Trichet:] As regards future monetary policy I reiterate what I said ... following our most recent decision: “We did not decide “ex ante” to engage in a series of interest rate increases. We will in the future take the decisions that will be necessary to deliver price stability, to be credible in delivering price stability over time and to preserve the solid anchoring of inflationary expectations at levels consistent with price stability”. ...

The EU Finance Minister Jean-Claude Juncker wasn’t as cautious as you. He called your interest rate increase a ‘hasty gesture’. He said that economic growth was more important than price stability.

I’m firmly convinced that the two go well together. Price stability is a prerequisite, a necessary condition, for sustainable growth and job creation. ...

Nevertheless, many Germans are still mourning their Deutschmark.

When we started out, we had to promise twelve nations that the new currency would be at least as good as their old ones. So the euro had to be at least as good as the best currency of all. At that time there were a few ‘best’ currencies, one of which was the Deutschmark. We’ve kept that promise. ... our long term market interest rates are at their lowest ever level since the establishment of the Bundesbank. I am proud that the euro is as trustworthy as the DM was.

The only problem is that you aren’t always understood. Politicians throughout the euro zone criticised your interest rate decision. If we disregard the exploding energy prices, the feared inflation really isn’t that bad.

More on Paid Punditry

More fallout from hidden payment punditry, and there may be much more to come. As Brad DeLong explains, there would be no problem if all financial payments and linkages were fully disclosed. The issue is hiding who is paying for the op-eds, not that payments are made, a distinction that seems lost on those attempting to defend right-wing think tank members engaged in these practices:

Bush Presses Editors on Security, by Howard Kurtz, Washington Post: ...Bought Off? The admission by two columnists that they accepted payments from indicted Washington lobbyist Jack Abramoff may be the tip of a large and rather dirty iceberg.

Copley News Service last week dropped Doug Bandow -- who also resigned as a Cato Institute scholar -- after he acknowledged taking as much as $2,000 a pop from Abramoff for up to two dozen columns favorable to the lobbyist's clients. ... Peter Ferrara of the Institute for Policy Innovation has acknowledged taking payments years ago from a half-dozen lobbyists, including Abramoff. Two of his papers, the Washington Times and Manchester (N.H.) Union Leader, have now dropped him. But Ferrara is unapologetic, saying: "There is nothing unethical about taking money from someone and writing an article."

Readers might disagree on grounds that they have no way of knowing about such undisclosed payments, which seem to be an increasingly common tactic for companies trying to influence public debate... When he was a Washington lawyer several years ago, says law professor Glenn Reynolds, a telecommunications carrier offered him a fat paycheck -- up to $20,000, he believes -- to write an opinion piece favorable to its position. He declined. In the case of Bandow's columns, says Reynolds, who now writes the InstaPundit blog, "one argument is, it's probably something he thought anyway, but it doesn't pass the smell test to me. I wouldn't necessarily call it criminal, but it seems wrong. People want to craft a rule, but what you really need is a sense of shame."

Jonathan Adler, an associate law professor and National Review contributor, wrote that when he worked at a think tank, "I was offered cash payments to write op-eds on particular topics by PR firms, lobbyists or corporations several times. They offered $1,000 or more for an op-ed," offers that Adler rejected. Blogger Rand Simberg writes that "I've also declined offers of money to write specific pieces, even though I agreed with the sentiment."...

Paul Krugman: Health Care Costs

Paul Krugman continues his series on health care. In this column, he looks at why health care costs are increasing so rapidly and how the rapid increase can be reduced through changes in policy:

Medicine: Who Decides?, by Paul Krugman, Commentary, NY Times: Health care seems to be heading back to the top of the political agenda, and not a moment too soon. Employer-based health insurance is unraveling ... and vast Medicare costs loom on the horizon. Something must be done. But to get health reform right, we'll have to overcome wrongheaded ideas as well as powerful special interests. For decades we've been lectured on the evils of big government and the glories of the private sector. Yet health reform is a job for the public sector, which already pays most of the bills directly or indirectly and sooner or later will have to make key decisions about medical treatment. ...

Consider what happens when a new drug or other therapy becomes available. Let's assume that the new therapy is more effective ... than existing therapies ... but that the advantage isn't overwhelming. On the other hand, it's a lot more expensive than current treatments. Who decides whether patients receive the new therapy? We've traditionally relied on doctors to make such decisions. But the rise of medical technology ... makes ... medicine ... in which doctors call for every procedure that might be of medical benefit, increasingly expensive.

Moreover, the high-technology nature of modern medical spending has given rise to a powerful medical-industrial complex that seeks to influence doctors' decisions. ...[D]rug companies in particular spend more marketing their products to doctors than they do developing those products ... They wouldn't do that if doctors were immune to persuasion.

So if costs are to be controlled, someone has to act as a referee on doctors' medical decisions. During the 1990's it seemed, briefly, as if private H.M.O.'s could play that role. But then there was a public backlash. It turns out that even in America, with its faith in the free market, people don't trust for-profit corporations to make decisions about their health.

Despite the failure ... to control costs with H.M.O.'s, conservatives continue to believe that the magic of the private sector will provide the answer. ... Their latest big idea is health savings accounts, which ... induce "cost sharing" - that is, individuals will ... pay a larger share of their medical costs out of pocket and make their own decisions about care. ...[I]s giving individuals responsibility for their own health spending really the answer to rising costs? No.

For one thing, insurance will always cover the really big expenses. We're not going to have a system in which people pay for heart surgery out of their health savings accounts and save money by choosing cheaper procedures. And that's not an unfair example. The Brookings study puts it this way: "Most health costs are incurred by a small proportion of the population whose expenses greatly exceed plausible limits on out-of-pocket spending."

Moreover, it's neither fair nor realistic to expect ordinary citizens to have enough medical expertise to make life-or-death decisions about their own treatment. A well-known experiment ... carried out by the RAND Corporation... found that when individuals pay a higher share of medical costs out of pocket, they cut back on necessary as well as unnecessary health spending.

So cost-sharing, like H.M.O.'s, is a detour from real health care reform. Eventually, we'll have to accept the fact that there's no magic in the private sector, and that health care - including the decision about what treatment is provided - is a public responsibility.

Previous column (12/23): Paul Krugman:  The Tax-Cut Zombies.
Next (12/29) column: Paul Krugman: Heck of a Job Bushie

North Korean Counterfeiting

One way for a government to buy goods and services is to print money. Better yet, print somebody else's money. Here's an editorial on the topic from a South Korean newspaper:

Seoul's U-Turn on N.Korean Counterfeiting Could Be Fatal, Editorial, Chosun.com: The National Intelligence Service, in a 1998 report ... said North Korea forges and circulates US$100 bank notes worth $15 million a year, and that the counterfeiting is carried out by a firm called February Silver Trading in the suburbs of Pyongyang. The NIS said in reports ... the same year and the next that the North operates three banknote forging agencies, and that more than $4.6 million in bogus dollar bills were uncovered in circulation on 13 occasions since 1994. "That North Korea is a dollar counterfeiting country was common knowledge among intelligence officials," said a former senior NIS official.

Yet suddenly, when the U.S. brings up the question of North Korea's counterfeiting activities, our government says there is insufficient evidence. That has prompted American officials to accuse our government of lying. The reason for the volte-face is that Seoul is afraid of antagonizing Pyongyang while six-party talks aimed at denuclearizing North Korea hang in the balance. But what if the shoe was on the other foot? If a country hostile to South Korea forged a huge number of our banknotes and circulated them around the world, what should our government do? And if an ostensible ally of ours defended that counterfeiting country, what would we think of that ally? ...

An expert with the U.S. Congressional Research Service said North Korea's attack on the dollar is a “fatal strategic mistake.” If the U.S.’ will to condemn North Korea measured 2 on a 10-point scale five years ago, it is now at 4, he warned. If that rises to 6 or 7, North Korea would find it “unbearable." Instead of appearing to act as a mouthpiece for North Korea and demanding “100-percent proof” from Washington, our government would be better advised to try and persuade the North just how serious the matter is.

Here's quite a bit more from the LA Times. The story says that North Korea is believed to make as much as $500 million per year from counterfeiting and other criminal activities, and that the U.S. is working aggressively to try and stop it. The story also notes that technically counterfeiting is an act of war.

Holiday Zeitgebers

"Maybe Christmas, he thought, doesn't come from a store. Maybe Christmas … perhaps … means a little bit more!":

Christmas classics, Editorial, LA Times: Biologists use the word "zeitgeber" to describe a physical stimulus that kicks the biological clock into gear. For example, light streaming through the window in the morning and birdsong are zeitgebers signaling that it's time to wake up. Scientists haven't devoted a lot of attention to the role of zeitgebers in stimulating holiday cheer, gift buying and goodwill toward men. In some climes, it's probably connected to frosty windowpanes and snowy rooftops. In L.A., it may be the first appearance of Santas in shopping malls, or those giant, flashy decorations they string across Hollywood Boulevard every year. But for people across the nation, a prime signal that the holidays are approaching is the reappearance of classic Christmas movies and TV shows, many of which we've enjoyed since childhood and have seen so many times we can recite the dialogue by heart.

Here are a few of our favorite snippets. May they stimulate peace, comfort, joy and a very Merry Christmas to all.

Dealing with Bliss Points

I have a great uncle who insists on eating dessert, and lots of it, before Christmas dinner. It always seemed like a rational solution to uncertainty about how much room to save to me - after all, this is a high utility part of the meal and eating one roll too many could mean skipping dessert - but rational is not the typical family view of this behavior. After dessert, he eats until he literally can't eat another bite, then falls asleep on the couch. I always think of this:

Maitre D: And finally, monsieur, a wafer-thin mint.

Mr Creosote: No.

Maitre D: Oh sir! It's only a tiny little thin one.

Mr Creosote: No.... I'm full...

Maitre D: Oh sir... it's only wafer thin.

Mr Creosote: Look - I couldn't eat another thing. I'm absolutely stuffed...

Maitre D: Oh sir, just... just one...

Mr Creosote: Oh all right. Just one. ...

Here's the video (warning...).

The Secondary Market for Gift Cards

Looking for a way to cash out or trade that gift card you received for one to a store you actually like?:

Capitalism at Work on Unwanted Gift Certificates, by Eric Dash, NY Times: ...Gift cards are expected to be among this season's most popular presents, generating about $18.48 billion in sales ... Still, roughly 8.5 percent of the dollars on those cards goes unspent. In response, a handful of Web sites have recently sprouted up, creating a little-known but vibrant secondary market. Analysts say it could be worth $1.5 billion or more. ...

So far, there are several different business models. ... On the one hand, gift cards are increasingly popping up at mainstream online marketplaces, like eBay and Craigslist. Earlier this week, for instance, eBay had auctions listed for more than 5,300 certificates from stores like Tiffany and T. J. Maxx. ... On the other hand, gift-card specific Web sites, like cardavenue.com and SwapAGift.com, tend to have only several hundred cards at a time but often facilitate a faster turnaround and a more focused search. ...

All of this generally comes at a price. Though it varies from site to site, users typically pay a registration fee ... or a transaction fee ... Many of the sites charge a combination of both. ... Still, a shrewd shopper can find savings. ... Most gift card exchange sites have more sellers than buyers at any given time. But during the first few weeks in January, that imbalance is exaggerated when the market is flooded with unwanted holiday gift cards. ... For buyers, that means a wider selection and prices that could be 5 percent to 10 percent lower than they are at other times during the year. For sellers, it may be a reason to wait. ...

From a buyer's perspective, the biggest bargains can be found at nationwide retailers like Sharper Image and Brookstone that have many unique gift items but none of them apparently things that anyone truly needs. ... From a seller's perspective, gift cards that command the most money are for big-box retailers and discount chains, like Sears, Target and Wal-Mart. Demand is also strong for any gift cards and voucher of Home Depot, Lowe's, Staples and other office supply stores. They all usually fetch at least 90 cents on the dollar. ...

I am told that buyer beware is good advice when using these markets.

Facts for the Holiday Season

Just the facts ma'am. Just the facts:

The Holiday Season, U.S. Census Bureau: The holiday season, with its many traditions, family gatherings and general good feelings, will soon be upon us. To commemorate this time of year, the U.S. Census Bureau presents the following holiday-related facts and figures from its data collection.

Project Gutenberg's "Twas the Night Before Christmas"

One of my memories of Christmas is my grandfather, with as many of us grandkids as he could fit on his lap, reading "Twas the Night Before Christmas" in his own special way. After the reading, it was time to put out the milk and cookies, go to bed, and try to get to sleep:

*** START OF THIS PROJECT GUTENBERG EBOOK TWAS THE NIGHT BEFORE CHRISTMAS ***

Is There a Santa Clause?

I don't know if there's an economist's view on the existence of Santa ( though I should since that's me), but here's the physicist's view:

Our Collective Challenges

Bill Clinton on where things stand one year after the earthquake and tsunami that killed over 230,000 people:

Clinton: Where we stand one year later, by William Jefferson Clinton,  International Herald Tribune: One year ago, ... the earth shook for eight terrifying minutes, unleashing a gigantic wave that struck 12 countries across the Indian Ocean. Over the next 24 hours, more than 230,000 people died, 2 million were displaced, and thousands of children were orphaned. The tsunami devastated over 5,000 miles of coastline, ruined 2,000 miles of roads, swept away 430,000 homes and damaged or destroyed over 100,000 fishing boats. ...

Recently I traveled to Aceh, Indonesia, and Trincomalee in northeastern Sri Lanka where I met with survivors who had lost everything ... I was reminded again of the pain that so many continue to endure. ... In both countries, I was struck by the survivors' spirited determination to rebuild their lives despite the unimaginable losses they have endured and the often desperate conditions in which they live. I was also encouraged by the many significant accomplishments over the last 12 months: Epidemics were prevented; many children are back in school; tens of thousands of survivors are employed and earning money once again; ongoing food assistance is being delivered; a common system of financial tracking is available online; and a regional tsunami warning system is expected to be in place next summer.

There is still a lot left to do. In Aceh and neighboring Nias alone, over 100,000 people still live in unacceptable conditions and with minimal access to job opportunities. ... there are pressing needs today to provide durable temporary shelters, upgrade existing transitional living centers and assist host families sheltering victims. The tsunami presents the international community with a critical challenge: Will we stay the course in the recovery process even after the world's attention has turned to other crises? ... This effort will take years, and we must see it through.

Now more than ever, I am convinced that recovery must be guided by a commitment to "build back better"... In 2006, I will focus on three priorities to make sure that we do build back better... First, we need to ensure that this uniquely well-resourced recovery effort keeps faith with the most vulnerable populations: the poorest of the poor, children, women, migrants and ethnic minorities. ...

Second, we need to ensure continued progress on disaster risk reduction in 2006. An Indian Ocean early warning system is a welcome development, but is only part of the answer. Less than one month after the tsunami struck, 168 countries came together in Japan and ... set strategic goals, priorities and concrete steps for governments to reduce disasters over the next ten years. These include national education campaigns to ensure that populations recognize the early signs of impending disaster, better planning for the use of land to avoid investments in disaster prone areas as well as agreement on standards for disaster resistant construction and restoration of essential environmental prevention like more grove trees. ...

Third, we cannot ignore the importance of political reconciliation, peace and good governance to successful recovery. In Aceh, the tsunami forced political leaders to recognize that the issues that fueled conflict in the country were far less compelling than the factors that united the Acehnese. The peace settlement has greatly enhanced prospects for reconstruction in Indonesia. Reconciliation in Sri Lanka would have a similar result. Across the region, political reforms will be critical components to sustainable recovery. ...

The tsunami and its aftermath demonstrated both the fragility of human life and the strength and generosity of the human spirit when we work together to begin again. One year ago, millions of ordinary people across the globe rallied to the immediate aid of communities devastated by the tsunami. Now our collective challenge is to finish the job...

Much of what is written here also applies to New Orleans, a commitment to build back better, keeping faith with the poorest of the poor, implementing better planning and education to avoid the potential for future disasters, the need for political reconciliation, the need for better temporary shelters during the transition, the need for help for families and regions housing those that were displaced, better warning systems, and so on. Now our collective challenge is to finish the job set forth by The Promiser in Chief.

Natural Disasters and Bankruptcy

As you would expect, bankruptcy filings increase following a natural disaster. The effect is even more pronounced when the disaster hits lower income areas:

Natural Disasters and Bankruptcy, A Perspective, by Elizabeth Warren, Boston Fed: ...When there is a series of major disruptions like the 2005 hurricane season, hundreds of thousands of middle class families may deplete their savings and turn to credit cards to supplement the aid they receive from charities and the government. Additionally, victims of natural disasters often return home to find that they have lost substantial assets. Insurance may cover some of the damage, but insurance companies’ liability is often limited. Every aspect of a family’s financial circumstances is exposed to the effects of a natural disaster.

Many disaster victims eventually turn to bankruptcy. It is possible to analyze bankruptcy filing data following hurricanes of the past 25 years, but limitations in the data make the tools blunt. The filings can be compared only year by year, not quarter by quarter. More important, the long-term data are available only on a state-by-state basis. To Robert Lawless, a professor at the University of Nevada at Las Vegas, that seemed problematic. A hurricane that hit Houston, for example, might have no effect on families and small businesses in El Paso, Dallas, or Austin. In order to detect a difference statistically, the regional effects would have to be large enough to change the bankruptcy filing numbers for the entire state. As a result, when Lawless decided to analyze the data, he expected to find no statistical correlations. ...

In fact, Professor Lawless discovered that in the three years following a hurricane, the growth in bankruptcy filings is about 50 percent higher in states that have suffered a direct hit. In the same time period, the growth in nearby states is about 20 percent higher. The data show that the location of the disaster also is significant. When the damage occurs in regions where there are many low-cost homes, FEMA payments are lower, and there is a corresponding increase in bankruptcy rates. The highest increase in bankruptcy filings in the past 25 years occurred when Hurricane Elena hit Mississippi in 1985, resulting in a 71.8 percent bankruptcy- filing increase in the following three years. ...

[M]any people are likely to seek bankruptcy relief in the wake of the hurricanes. Some may just put it off. Indeed, Lawless’s data show that the largest effects from past hurricanes are felt in the third year after storms hit, suggesting that many families will recover as best they can, and then confront their overall financial condition. ...

Selling Big Pharma

Be sure to read about the side effects before asking your doctor for this.

Technological Diffusion

The San Francisco Fed's Mark Doms discusses his work with Ethan Lewis on the adoption of technology, in this case the use of personal computers. An interesting result is that higher average educational attainment for a region results in more intensive adoption of personal computers and faster growth in wages:

The Diffusion of Personal Computers across the U.S., FRBSF Economic Letter: For the last fifteen years or so, ... there can be little doubt that the growing use of IT contributed significantly to the economy's performance, especially in the latter half of the 1990s, when output grew rapidly, unemployment declined to 25-year lows, productivity surged, and the inflation rate actually fell. A key question about IT's role in this performance is how its use spreads or diffuses throughout the economy. This Economic Letter focuses on a particular part of this question, ... the diffusion of the personal computer across U.S. businesses from 1990 to 2002. ...

Economies progress by adopting new technologies and using them both to produce existing goods more efficiently and to produce new goods. Furthermore, as economies become more efficient, the average wages of the economies also increase. Technologies that have transformed the economy in significant ways include the steam engine, the internal combustion engine, and electrification. These are sometimes called "general purpose" technologies because they are used in many parts of the economy .... One of the most recent general purpose technologies is the computer, and more specifically, the personal computer.

Studies have shown that new technologies typically do not spread throughout the economy in an even, uniform manner. Instead, ... certain areas within a country embrace a new technology first, while other areas take up the technology much later. ... Doms and Lewis examine how the personal computer diffused throughout the U.S. economy from 1990 to 2002. Using a data set that reports technology use for hundreds of thousands of business establishments, the authors document the extent to which the intensity of use of personal computers (as measured by personal computers per 100 employees) varied across 160 metropolitan areas around the country. ...

The study found that in 1990, the San Francisco Bay Area was the most computer-intensive area in the country. Because the Bay Area is also home to many IT producers, this finding raises the question of whether one area may be more computer-intensive than another primarily because of the industries located in that area. For instance, the finance and high-tech industries are the most IT-intensive, regardless of location. Therefore, if an area has a large financial industry (like New York) or a high-tech center (like the Bay Area...), then that area might also be more computer-intensive than an area such as Hickory, N.C., where a larger share of the economy is based on furniture manufacturing (an industry that is not very IT-intensive).

The authors calculate computer-intensity measures that account for industry composition and still find very large and persistent differences across metropolitan areas in their computer usage in 1990 and again in 2002. Among others, the San Francisco Bay Area ranks very high, even after controlling for the industries located there.

Some of those results are highlighted in Figure 1. The figure shows how many computers are used per 100 workers in 1990 and in 2002 relative to the San Francisco Bay Area after controlling for the industry composition of each area. ... The relative positions of metropolitan areas were consistent over time... The results in Figure 1 raise the question of why San Francisco might be out in front of most regions while others are so far behind. ...[T]wo factors ... appear to be particularly important: the human capital of an area (as measured by education) and the degree to which the area is an IT center and therefore generates spillovers to other industries in the area.

Economists have frequently examined the role human capital plays in technology diffusion. Economies with highly educated workers may be more adept at learning about new technologies and may also be better able to put those technologies to productive use.

Doms and Lewis address the question of causation: Does computer adoption affect the education level of the workforce or does the education level of the workforce affect computer adoption? Using several approaches, Doms and Lewis find strong evidence that the education level of the workforce results in higher rates of computer adoption. ... As shown in Figure 2, cities with a higher share of the workforce that has completed 16 years or more of education ... in 1990 are also cities that had high rates of computer adoption by 2002.

Another reason for differences between metropolitan areas ... is that some benefit from the presence of a strong IT-producing sector... These benefits are called "spillover effects." For example, people who work in ... high-tech firms may move to low-tech firms nearby, taking knowledge about new technologies ... with them. Also, employees at low-tech firms may learn about the virtues of computers from interacting with community members who hold high-tech jobs. Spillover effects differ from industry effects because they increase computer use in all local industries... Doms and Lewis find evidence consistent with spillovers... However, the importance of these spillovers seems to be much less important in explaining cross-area differences in computer adoption than the overall level of education. ... [A]reas that successfully adopt technologies tend to have superior economic performance. Consistent with this, Doms and Lewis find that areas that were computer-intensive in 1990 were also areas that enjoyed faster real wage growth for college-educated workers, and, to a lesser degree, for workers with less than a college education.  ...

The Decline of the Family Restaurant

I don't think the decline of the family restaurant generates as much sympathy as the decline of the family farm. If it did, super-sized price supports and subsidies for burgers and fries would be right around the corner:

Unhappy days for America’s family restaurants, by Paul Sullivan, Financial Times: Casual restaurants have supplanted family restaurants in terms of revenue for the first time since the US census started measuring this in the 1970s. The shift means the burger, fries and milkshake ideal evoked by the sitcom Happy Days is losing its hold on the American appetite. The restaurant data, which the 2002 census made available only this week, showed places that serve meals costing $10-$20 now make up 45 per cent of all dining dollars, up from 33.2 per cent in the last census in 1997. Those that serve meals costing less than $10 per person have fallen to 36.8 per cent from 49.6 per cent.

“I didn’t think that within a five-year timeframe we’d see family restaurants eclipsed by casual restaurants,” said Malcolm Knapp, a restaurant economist in New York who analysed the data and has been working with the Census Bureau since 1972. “Casual is now the dominant group in terms of sales ... and it’s not going back.”

Chains such as Ruby Tuesday, Olive Garden and Outback Steakhouse now win more dining dollars than such staples of 1950s and 60s America as Denny’s, Big Boy and the International House of Pancakes. ... “America keeps raising the standard of what normal living is. You can see that perfectly in the restaurants,” said Mr Knapp. People are “taking their kids to casual and themselves to casual plus”. ... All is not lost, though, for the family restaurant. While fewer people may eat dinner there, they still draw crowds for their good, cheap breakfasts.

I wonder what's driving this trend?

Fundamental Strength in Housing?

Here's a perspective on housing markets from an industry representative who sees the potential for some slowing from abnormally high growth, but presents a picture of a strong and robust market. Prices can be explained, for the most part, by fundamentals and the fundamentals remain strong:

House Prices: The State of the Bubble,  by Vikas Bajaj, NY Times: Richard A. Smith ..., chairman and chief executive of the ... real estate services division of the Cendant Corporation... discussed recently why he thinks - like most other real estate industry executives - that there is no national housing bubble.

Q. The question on everyone's mind is whether the housing market is slowing. What do you think?
A. Every year for the past five years we have forecasts about this time that there will be a slowing next year. Everyone from Fannie Mae to us has forecast that. There are very early indications that there is a slowing of a very, very strong market.

Q. What do you say to people who contend home prices in many markets are unjustified and will fall drastically?
A. It's an interesting topic for people that like to think that there is a new lion coming over the hill - that there is a new thing to be worried about. ... but it's not supported by fact. There have always been year-over-year increases in prices. There have been unit declines in recessions, but not year-over-year price depreciation. ... The facts don't support a national bubble. Are there local bubbles? Absolutely, there have always been. ...

Q. What is the primary driver of the soaring home prices in the last few years?
A. It's driven by population growth, per capita income growth, the supply-and-demand issues and job growth. If ... those numbers are moving in the right direction it's very, very unlikely that you have a property value issue. Where you don't have those favorable trends, you are susceptible to a decline in property values.

Q. Can you describe some of the trends that support your views on the long-term growth prospects of the housing market?
A. In the old days, the typical 50-year-old homeowner would downsize, sell the family home and buy something smaller. What is occurring now is that they are keeping the family home and buying the second and third home. The typical immigrant buys a home much faster than his or her historical counterpart. Thirty-five percent of the household formations forecasted for the next 10 years will be driven by Hispanics.

Q. The Justice Department's antitrust division has been looking into the practices of the real estate industry, specifically whether the industry is stifling competition. What do you think will come of the inquiry?
A. The barrier to entry in this industry is, in my view, virtually nonexistent. We think competition is incredibly robust ...

Pretty much what you would expect to hear from an industry representative. Recent data on housing hint at a slowdown and many papers highlighted Friday's report of an 11.3% decline in new home sales and an increase in the inventory of unsold homes as a sign of the much anticipated slowdown in housing. However, Calculated Risk views the report as "still reasonably strong."

Paul Krugman: The Tax-Cut Zombies

Paul Krugman explains why Republicans continue to push for tax cuts even though there is no longer any justification for further cuts:

The Tax-Cut Zombies, by Paul Krugman, NY Times Commentary: If you want someone to play Scrooge just before Christmas, Dick Cheney is your man. On Wednesday Mr. Cheney ... cast the tie-breaking vote in favor of legislation that increases the fees charged to Medicaid recipients, lets states cut Medicaid benefits, reduces enforcement funds for child support, and more. For all its cruelty, however, the legislation will make only a tiny dent in the budget deficit: the cuts total about $8 billion a year, or one-third of 1 percent of total federal spending. ...

Since the 1970's, conservatives have used two theories to justify cutting taxes. One theory, supply-side economics, has always been hokum for the yokels. Conservative insiders adopted the supply-siders as mascots because they were useful to the cause, but never took them seriously.  The insiders' theory - what we might call the true tax-cut theory - was memorably described by David Stockman, Ronald Reagan's budget director, as "starving the beast." Proponents of this theory argue that conservatives should seek tax cuts ... because ... budget deficits will lead to spending cuts that will eventually achieve their true aim: shrinking the government's role back to what it was under Calvin Coolidge.

True to form, ... conservative heavyweights are using the budget deficit to call for cuts in key government programs. For example, in 2001 Alan Greenspan urged Congress to cut taxes to avoid running an excessively large budget surplus. Now he issues dire warnings about "fiscal instability." But rather than urging Congress to reverse the tax cuts he helped sell, he talks of the need to cut future Social Security and Medicare benefits.

Yet at this point starve-the-beast theory looks as silly as supply-side economics. Although a disciplined conservative movement has controlled Congress and the White House for five years - and presided over record deficits - public opposition has prevented any significant cuts in the big social-insurance programs that dominate domestic spending. ... Medicaid, whose recipients are less likely to vote than the average person getting Social Security or Medicare, is the softest target among major federal social-insurance programs. But even members of Congress, it seems, have consciences. (Well, some of them.) It took intense arm-twisting from the Republican leadership, and that tie-breaking vote by Mr. Cheney, to ram through even modest cuts in aid to the neediest.

In other words, the starve-the-beast theory - like missile defense - has been tested under the most favorable possible circumstances, and failed. So there is no longer any coherent justification for further tax cuts. Yet the cuts go on. In fact, even as Congressional leaders struggled to pass a tiny package of mean-spirited spending cuts, they pushed forward with a much larger package of tax cuts. The benefits of those cuts, as always, will go disproportionately to the wealthy.

Here's how I see it: Republicans have turned into tax-cut zombies. They can't remember why they originally wanted to cut taxes, they can't explain how they plan to make up for the lost revenue, and they don't care. Instead, they just keep shambling forward, always hungry for more.

Update: Full column here

Previous (12/19) column: Paul Krugman: Tanks on the Tank
Next (12/26) column: Paul Krugman: Health Care Costs

Camouflaged Tank Ties

The issue of paying writers to publish favorable opinions appeared in a New York Times report, and Paul Krugman provided more in his column. Today, there are commentaries on this issue in the New York Times and the Washington Post:

On Opinion Page, a Lobby's Hand Is Often Unseen, by Philip Shenon, Commentary, NY Times: Susan Finston of the Institute for Policy Innovation, a conservative research group based in Texas, is just the sort of opinion maker coveted by the drug industry. In an opinion article in The Financial Times on Oct. 25, she called for patent protection in poor countries for drugs and biotechnology products. In an article last month in the European edition of The Wall Street Journal, she called for efforts to block developing nations from violating patents on AIDS medicines and other drugs. Both articles identified her as a "research associate" at the institute. Neither mentioned that, as recently as August, Ms. Finston was registered as a lobbyist for the Pharmaceutical Research and Manufacturers of America, the drug industry's trade group. Nor was there mention of her work this fall in creating the American Bioindustry Alliance, a group underwritten largely by drug companies.

The institute says Ms. Finston's ties to industry should not have prevented her from writing about those issues. Nor is there a conflict, it says, in the work of Merrill Matthews Jr., who writes for major newspapers advocating policies promoted by the insurance industry even though he is a registered lobbyist for a separate group backed by it. "Lobbying is not a four-letter word," said the institute's president, Tom Giovanetti.

But organizations like the institute ... are facing new and uncomfortable scrutiny over their links to special interest groups after the disclosure this week that the Washington lobbyist Jack Abramoff had paid at least two outside writers for opinion articles promoting the work of his clients. ... Executives in the public relations and lobbying industries say that the hiring of outside commentators to promote special interests - typically by writing newspaper opinion articles or in radio and television interviews - does happen, although it is impossible to monitor since the payments do not have to be disclosed and can be disguised as speaking fees and other compensation.

While major newspapers and magazines usually insist that outside writers disclose conflicts of interest, editors do not routinely conduct background checks, especially for authors affiliated with credible research groups. Brian Groom, an editor at The Financial Times ... said he did not recall being told of Ms. Finston's ties to the drug and biotechnology industries before publishing the article. The editorial page editor of The Wall Street Journal, Paul Gigot, said in an interview that "we're absolutely convinced" the paper was not told of Ms. Finston's industry ties. The paper might still have run the article, he said, but with more information about her background.

David Rickey, chairman of the board of ethics of the Public Relations Society of America, ... said the industry opposed the use of outside writers to promote a client's interests unless the financial ties were fully acknowledged. ..."if there is a conflict of interest, it must be disclosed." In announcing the departure of Mr. Bandow last week, the Cato Institute said it required its writers to disclose all affiliations that might influence their work. Mr. Giovanetti of the Institute for Policy Innovation said that he, too, insisted that "anyone working with I.P.I. must disclose any pertinent lobbying relationships and conflicts of interest whenever they act on behalf of I.P.I., including published projects." ...

Here's Michael Kinsley in the Washington Post on the same issue:

Pundit Payola Money Talks. It Writes, Too., by Michael Kinsley, Washington Post: ...It came out last week that a couple of conservative pundits have been on the take from lobbyist extraordinaire Jack Abramoff. He would pay them up to $2,000 for columns and op-ed pieces that advanced the interests of his clients. ... But let's be a bit careful here. Many of us sell our opinions for a living. ... And even though casting stones is very close to a pundit's job definition, are we necessarily without sin? Sure, we like to think that ... our opinions themselves are not for sale. But the two miscreants exposed so far can make the same claim. Doug Bandow and Peter Ferrara are both principled conservatives. ... As far as we know, neither has published a single word that he actually disagrees with.

But there's a difference between paying people for the right to publish their work and paying people because someone else has published their work. What Abramoff was buying for clients was partly access to media real estate (op-ed pages) that he couldn't commandeer himself and partly the endorsement of conservative pundits who didn't necessarily disagree with the positions they took but probably would not have bothered except for the cash. Still, Pundit Payola is only a tiny step beyond what has become common practice in Washington. ...

In recent months we have learned that the Bush administration sees nothing wrong with paying for pro-American articles to be planted in Iraqi newspapers. ...[T]he administration has done the same thing, more or less, here at home, giving a fat grant to multimedia conservative Armstrong Williams for pushing administration policy ... And now it seems that a figure somewhat more influential than the president among the nation's legislators -- Abramoff -- has been doing the same thing. ...

I agree that full disclosure of all financial relationships and other affiliations is needed, but existing rules make these easy to obscure.  If a particular donor gives to a think tank, and a writer receives a salary from the think tank, does the writer have to disclose the relationship to the donor, or just the think tank? Some of this requires investigation, and editors and others printing these opinion pieces could help by being more diligent about checking and disclosing the ties of outside writers who appear on their pages.

Using Prediction Markets to Identify Emerging Technology

Chris Masse points out an article in The Economist on using prediction markets to identify emerging technologies. The latest innovation is The Tech Buzz game from Yahoo and O'Reilly, a fantasy prediction market for high tech products:

Market, market, on the wall, The Economist: The technology industry loves a prediction, and keeps legions of forecasters and futurists in business. But many predictions are wrong, technologies often arrive late, and very few live up to the hype. Why, then, ... not ... harness the collective brainpower of employees by giving them virtual trading accounts and virtual money, and letting them buy and sell “shares” in such things as project schedules or next quarter's sales. What are, in effect, elaborate computer games might help tech firms spot trends and make more accurate forecasts. Yet, oddly, hardly anyone is using them in this way.

Hewlett-Packard and Intel pioneered the corporate use of prediction markets, but neither seems to be using them other than experimentally. ... Microsoft says [it] has run a dozen or so such markets, and that they quickly and cheaply capture employee sentiment on project deadlines or software quality more accurately than any other measure. Google recently said it is also using internal prediction markets. But such markets are typically used to predict internal matters, rather than to divine broader technology trends—which is, some argue, a missed opportunity. ...

But can prediction markets really spot broader industry trends? There have been some attempts to find out. Perhaps the oldest technology-oriented public prediction market is the Foresight Exchange (www.ideosphere.com), which launched in 1994. Ken Kittlitz, one of its co-founders, says it has an accuracy rate of about 70% on technology questions. ... Another prediction market, operated by NewsFutures, ran for a while on the website of Technology Review. [T]he market did make a few accurate predictions about technology trends... Even so, says Justin Wolfers, an economist at the Wharton School at the University of Pennsylvania, it is still unclear whether prediction markets really can spot tech trends. That is why he is among those closely watching the latest experiment, being carried out by Yahoo! ... in conjunction with O'Reilly & Associates...

In March, the two firms launched the Tech Buzz Game, “a fantasy prediction market for high-tech products, concepts and trends”. Users buy shares in technologies they think will do well; the share price of a technology depends on the frequency with which Yahoo! users perform web searches for it. Yahoo! hopes to use the answers to predict search trends that will be popular in future, so that it can sell advertising against them. O'Reilly wants an inside track on hot topics for future books and conferences. ...[T]he game has not yet been around long enough to assess its track record for longer-term prediction, says David Pennock, a senior researcher at Yahoo!

The most important thing about the Tech Buzz Game, says Mr Wolfers, may be that people are actually playing it, because it is so well designed. Encouraging employees to use prediction markets has always been a challenge. Mr Proebsting says he believes it is just a matter of time before Microsoft starts using predictive markets to predict external as well as internal events. Perhaps he could use the technology to estimate when.

Impatience and Savings

I haven't followed this literature closely, but it looks interesting and many of the papers noted below have been posted here ( 1, 2, and 3, the last has links to seven papers). It's an analysis of savings behavior starting from a biological perspective. On another note, I'm very literally off to grandma's house in a few minutes - lots of rivers to pass over and lots of woods to pass through - so I won't be able to post or comment until tonight:

Impatience and Savings, NBER Reporter: Research Summary Fall 2005, by David Laibson: When making decisions with immediate consequences, economic actors typically display a high degree of impatience. Consumers choose immediate pleasures instead of waiting a few days for much larger rewards. Consumers want "instant gratification." However, people do not behave impatiently when they make decisions for the future. Few people plan to break their diets next week. Instead, people tend to splurge today and vow to exercise/diet/save tomorrow. From today's viewpoint, people prefer to act impatiently right now but to act patiently later.

Data from neuroscience experiments provide a potential explanation for these observations: short-run decisions engage different brain systems from long-run decisions. Using functional magnetic resonance imaging (fMRI), Samuel McClure, George Loewenstein, Jonathan D. Cohen, and I have shown that decisions that involve at least some short-run tradeoffs recruit both analytic and emotional brain systems, whereas decisions that only involve long-run tradeoffs primarily recruit analytic brain systems. These findings suggest that people pursue instant gratification because the emotional brain system - the limbic system - values immediate rewards but only weakly responds to delayed rewards.

Are Tax Cuts for the Wealthy Wasteful?

Here's the latest from Robert Frank from an Economic Scene in the NY Times. He disputes the idea that tax cuts for the wealthy improve the utilization of our scarce resources:

Tax Cuts for the Wealthy: Waste More, Want More, by Robert Frank, NY Times: With President Bush's proposed tax cuts for top earners struggling to get political traction in early 2001, Representative Tom Osborne, Republican of Nebraska, rose to the White House's defense on the House floor. "The bottom line is that it's your money," he said, "and you know how to spend it much better than anyone in Washington, D.C." In the years since, variations of this statement ... have kept opponents of high-end tax cuts consistently on the defensive. ... in part because it appeals to voters' common sense. After all, people have an obvious incentive to exercise care when spending their own hard-earned dollars. Why would a faceless bureaucrat in Washington, who is spending someone else's money, be nearly as careful? The "it's your money" line is also buttressed by widely reported examples ... Famously, the Pentagon once spent $640 for a single toilet seat and on another occasion paid $435 for an ordinary claw hammer.

But paying more than the market rate is just one form of wasteful spending. Another ... form is to pay a fair price for something that serves little purpose. This second form of waste is considerably more common in private spending than in public spending...  A case in point is a decision on many minds at this time of year, that of how much to spend on a wristwatch. ... The most coveted among them are elaborate mechanical marvels with multiple "complications," special features that enhance their accuracy. ... The Grande Complication, by Jean Dunand, sells for more than $700,000, but lesser entries by Patek Philippe, Rolex and other manufacturers can be had for $5,000 to $100,000.

Unlike toilet seats and claw hammers, these watches are costly to produce, so buyers who pay high prices for them are not being ripped off. In another sense, however, their dollars go largely for naught. For despite their mechanical wizardry, none of these watches are as accurate as a battery-powered $30 Timex, whose quartz crystal mechanism is unaffected by gravity. ...[B]uyers of these watches [are] men from 30 to 50 who want "this 'power tool,' this instrument on their wrist that distinguishes them from the pack." The problem is that if a watch is to distinguish its owner, it must sell for more than the watches worn by members of the pack. So when the pack spends more, the price of distinguishing oneself also rises. And in the end, no one gains any more distinction than if all had spent less.

Other forms of high-end private spending are driven by similar forces. ... David H. Brooks, the chief executive of a company that supplies body armor to the American military in Iraq, invited 150 of his daughter's friends to the Rainbow Room atop Rockefeller Center in Manhattan, where they were serenaded by 50 Cent, Don Henley, Stevie Nicks and other luminaries during a birthday party reported to have cost $10 million. ...[T]he parents involved are not behaving abnormally. They are merely spending their own money ... to provide a special occasion for their daughters. For a party to be special, however, it must somehow stand out from other parties that define the norm. Here, too, the problem is that expensive birthday parties have become a growth industry. ... no matter how much parents spend, the number of parties that achieve special status will be no greater than when everyone spent much less.

On balance, then, there is little reason to expect large tax cuts for wealthy families to have resulted in a more efficient allocation of our nation's scarce resources. For one thing, not all of the dollars used to finance these tax cuts would have been spent wastefully by government. Most of the money recently cut from the food stamp program, for example, would have been spent by poor families to buy food at fair market prices. And even though government does buy some items at inflated prices - body armor whose price includes a profit margin large enough to finance a $10 million birthday party? - many of these items serve vital purposes. In contrast, most of the tax cuts financed by recent budget cuts will go to families that already have everything they might reasonably need. This money will be deployed in the quest for "something special." Yet because special is an elastic concept, the number of families that succeed in this quest will be little different from before.

I should note that it is not the pattern of spending that brings about an inefficiency, though the article leaves that impression. So long as the supply and demand for, say, lavish jewelry intersect in competitive markets, it is efficient in standard economic terms. However, the argument in the article is a bit more subtle. He is asserting a market failure in the spending of the wealthy - the fruitless race to achieve special status. When the wealthy attempt to achieve special status and all follow suit, in the end there is no value to the spending because status is not improved. And if no value is created over and above what a lower level of spending could have achieved in terms of status, it is wasteful. Therefore, taking a dollar from a rich person and giving it to a poor person to spend on necessities in the private sector can improve efficiency.

Do Fortuitous Economic Outcomes Cause People to Go to Church?

Or is it the other way around? The first thing that came to mind as I started reading this was whether a causal relationship had been established. Just because there are a lot of churches in Nevada does not necessarily mean that churches cause gambling and prostitution. Similarly, going to church may not raise income as this research finds, income and going to church may simply be correlated through a common response to a third variable, or causality could run in the other direction. However, causality is a focal point of the discussion:

Wealth from worship, The Economist: At Christmas, many people do things they would never dream of the rest of the year... Some even go to church. Attendance soars, as millions of once-a-year worshippers fill the pews. ... Some of the occasional churchgoers must wonder whether they might benefit from turning up more often. If they did so, they could gain more than spiritual nourishment. Jonathan Gruber, an economist at the Massachusetts Institute of Technology, claims that regular religious participation leads to better education, higher income and a lower chance of divorce. His results ... imply that doubling church attendance raises someone's income by almost 10%.

The idea that religion can bring material advantages has a distinguished history. A century ago Max Weber argued that the Protestant work ethic lay behind Europe's prosperity. More recently Robert Barro, a professor at Harvard, has been examining the links between religion and economic growth ... At the microeconomic level, several studies have concluded that religious participation is associated with lower rates of crime, drug use and so forth. ...

Until recently, however, there was little quantitative research on whether religion affects income directly and if so, by how much. A big obstacle is the difficulty of disentangling cause and effect. That frequent churchgoers have higher incomes than non-churchgoers does not prove that religion made them richer. It might be that richer people are likelier to go to church. Or unrelated traits, such as greater ambition or personal discipline, could lead people both to go to church and also to succeed in their work.

To distinguish cause from coincidence, Mr Gruber uses information on the ethnic mix of neighbourhoods and congregations. ... Measuring the density of nationalities that share a religion in a particular city can ... be a good predictor of church attendance. But ... [s]tudies have found that people who live with lots of others of the same ethnic origin tend to be worse off than those who are not “ghettoised”. So Mr Gruber excludes an individual's own group from the measures, and instead calculates the density of “co-religionists”, the proportion of the population that shares your religion but not your race. According to Mr Gruber's calculations, a[n]... increase in the density of co-religionists leads to a... rise in churchgoing. Once he has controlled for other inter-city differences, Mr Gruber finds that a[n]... increase in the density of co-religionists leads to a ... rise in income...

Other economists, though they think Mr Gruber's approach is clever, are not sure that he has established a causal link between religious attendance and wealth. So how might churchgoing make you richer? Mr Gruber offers several possibilities. One plausible idea is that going to church yields “social capital”, a web of relationships that fosters trust. Economists think such ties can be valuable... Churchgoing may simply be an efficient way of creating them. Another possibility is that a church's members enjoy mutual emotional and (maybe) financial insurance. That allows them to recover more quickly from setbacks, such as the loss of a job... Or perhaps religion and wealth are linked through education. Mr Gruber's results suggest that higher church attendance leads to more years at school and less chance of dropping out of college. A vibrant church might also boost the number of religious schools, which in turn could raise academic achievement. Finally, religious faith itself might be the channel through which churchgoers become richer. Perhaps, Mr Gruber muses, the faithful may be “less stressed out” about life's daily travails and thus better equipped for success...

Are We There Yet?

The Fed is quite pleased with the economic outlook, at least as viewed through the eyes of Jeffrey Lacker, president of the Richmond Fed. There are worries, housing and energy prices foremost among them, and a little more tinkering  may be necessary to make sure inflation and inflation expectations are contained, but in general the trajectory is encouraging:

The Economic Outlook for 2006, by Jeffrey M. Lacker, Richmond Fed President: It is a pleasure to ... discuss the economic outlook for 2006 and beyond... because the economic outlook is fairly encouraging. Growth is on a solid footing ...  employment has resumed expanding at a healthy pace, consumer spending continues to grow briskly, and business investment spending is robust. Granted, housing activity seems to be softening, and at least some potential price level pressures remain, so it may be too soon to break out the eggnog. But inflation expectations remain contained, and we at the Fed are well-positioned to resist inflation pressures, should they emerge...

The really striking feature of the current outlook is the extent to which economic activity in general and consumer spending in particular has rebounded from the shock of the hurricane season. ...  With healthy income growth ahead and a reasonably strong overall job market, the outlook for consumer spending looks good. Housing market activity has been very strong over the last several years. The historically low level of inflation-adjusted mortgage interest rates explains much of that strength. ... In recent months, we have received widespread anecdotal reports of ... "a return to normalcy" in several housing markets in our District. ... At the same time, the aggregate measures of housing activity have so far shown only limited pull-back from their peaks and remain at historically high levels. Still, ... I would expect housing price appreciation to flatten out next year and aggregate residential investment to stop growing or perhaps even decline.

The fundamentals for business investment in equipment and software look quite sound. ... Productivity has grown at surprisingly strong rates ... - 3.4 percent since the end of 2000 - despite significantly lower rates of capital formation. Gains in labor productivity ... ultimately pass through to real incomes. ... If productivity growth continues at or above trend, as seems likely, then we should see healthy growth in real income next year... Labor markets have recovered from the recession of 2001. Although employment was stagnant for a time following the downturn, hiring picked up in 2003...

The overall outlook therefore is for a healthy expansion next year. Real GDP should grow at about 3.5 percent. ... but naturally there is some uncertainty attached to it. Economic fundamentals could depart from their anticipated trajectories in any number of ways ... For example, spot oil prices - or other commodity prices for that matter - could well turn out either above or below the path embodied in futures prices. ... Commodity price surprises in either direction could alter aggregate supply conditions and either add or subtract from output growth.

On the demand side, there is some uncertainty regarding the rate at which housing activity is likely to cool in the coming year. Although I do not think that a sharp fall in housing investment is likely, a range of forecasts from flat to moderately declining seem reasonable. And ... it is difficult to foresee with any certainty the scale of investment that businesses will find profitable to undertake, so spending growth in this category could well deviate from expectations...

Core inflation has been low and relatively steady in the last several years. ... within the 1-to-2 percent range that I and others have proposed as an announced target. ... Monetary policy should respond to energy shocks by remaining focused on price stability. ... While the lack of an upsurge in the core PCE inflation figures for September and October is somewhat encouraging, I think it is too soon to declare that pass-through risk is entirely behind us. ... Thus far, market participants appear to believe that core inflation will remain contained. ... Measures of expected inflation derived from ... inflation-protected U.S. Treasury securities drifted up a bit this fall, but ... have returned to mid-summer levels. To maintain credibility for price stability, it is essential that monetary policy should respond vigorously to any visible erosion in inflation expectations.

Assuming output growth remains healthy, the Fed is waiting to see if core inflation does indeed continue to moderate, in which case it considers pausing, or if higher energy prices pass through and begin showing up in incoming data, in which case it meets the price hikes aggressively. The Fed needs to be convinced, and it isn't there quite yet, that pass through of energy prices to core inflation is not a problem.

Private Arts

The privatization debate in Japan continues. Is it okay for the government to outsource the set up, display, and management of national museums to the private sector in the name of efficiency?:

Editorial/ Market forces in art,  Herald Tribune/Asahi: An advisory panel on deregulation within the Cabinet Office says that the work to set up and display exhibits at national ... museums should be included in a "test of market forces." The reform panel argues that such work should ... be offered to competitive bidders to raise efficiency and service quality. ... In response, art leaders ... have come out in opposition to the idea. Their view is that the promotion of art and cultural activities is not compatible with efficiency and that such an idea will lead to a decline in Japan's standard of art and culture. The government's Agency for Cultural Affairs is also opposed to the idea of market-based exhibition work. The government's guiding principle for structural reform is to "leave to the private sector what can be done by the private sector." ... Museums, including fine art museums, collect and preserve cultural artifacts. They do research, plan how best to mount displays and undertake educational efforts to teach citizens of their cultural importance. The advisory panel says planning and setting up exhibitions and promoting cultural activities can be handled by the private sector. ... It also argues that museum management can be done by the private sector, as long as the transition of management is properly handled.

The Agency for Cultural Affairs opposes the panel's suggestion. It points out that governmental cultural affairs agencies handle very valuable art collections. ... The agency contends that maintaining such artworks is inseparable from research and cultural education. The international exchange of art with foreign museums, indispensable for large exhibitions in this country, will become difficult if the exhibitions are administered by private businesses. ... Another question is how quality of service should be evaluated in bids. While cost comparison is easy, quality cannot be measured numerically. No decision has been made on who will evaluate quality. ... The panel is unsatisfied with the performance of existing governmental museums agencies. And the public want more attractive exhibitions on a regular basis and greater dissemination of cultural knowledge to children and students. Art lovers also want museums to offer viewing hours that are more convenient for working people. The debate over whether to farm out some cultural work is a chance for national museums and art museums to take a fresh look at the quality of the job they have done to date.

The threat of privatization should make government agencies more efficient, but I wonder if it actually does.

Who Gets Credit or Blame for the Economy?

Robert Samuelson makes the point that presidents get both too much credit and too much blame for the economy, a point I'd have to agree with. He then asks a question Krugman has also addressed, why doesn't the White House get more credit for the strong economic numbers in recent months? And like Krugman, he believes that growing worker anxiety about the future is a primary cause. He also has considerable doubt about recent White House attempts to take credit for the recovery by attributing it to the dividend tax cut:

Presidential Prosperity Games, by Robert J. Samuelson, Washington Post: ...We Americans play the simplistic game of personalizing the economy's success or failure. The president is a hero or a bum. He creates or destroys prosperity. This, of course, is make-believe. ... Still, the game suits Republicans and Democrats, the press and the public. We constantly replay it, no matter how much ignorance and misinformation it generates. In the latest version, the White House wants you to believe that the economy's swell and that George Bush is responsible.

The pitch is half true. The economy is strong, but Bush isn't the cause... The White House's bubbly appraisal isn't just fluff. ... The trouble (for the White House, at least) is that many Americans don't seem impressed. ... Economic performance (now good) and economic psychology (now mediocre) have, to some extent, become disconnected. Why? ... Americans have developed perfectionist standards. We expect total prosperity and are disappointed by anything less. There should be no doubts or deficiencies. Today's include high energy prices, high health care costs, Hurricane Katrina's aftermath and a possible real estate "bubble."

Greater job insecurity also subverts Americans' sense of well-being. Since 1979 the research firm ISR has asked workers to react to this statement: "I am frequently concerned about being laid off." In 1982, when unemployment averaged 9.7 percent, 14 percent answered yes. ... This year (average unemployment: 5.1 percent), the anxiety level is 35 percent. Because workers feel more threatened, no given amount of income or wealth provides as much satisfaction as it once did. The explanation for this paradox ... is that corporate practices have changed. Twenty-five years ago, big companies fired career workers only as a last resort... Workers felt safe unless their company was desperate. Now executives routinely engage in "downsizing" and "outsourcing" to improve profitability. "They're more socially acceptable," ...

The White House's PR campaign ... doesn't deserve to succeed, because its main message is false. That message: Bush's tax cuts explain the economy's success. The 2001 and 2002 tax cuts probably cushioned the severity of the 2001 recession and its aftermath. But the White House is now arguing that its 2003 tax cut was critical in increasing economic growth. The centerpiece of that legislation was a cut in the maximum tax rate on corporate dividends to 15 percent. ... But a new study by staff economists at the Federal Reserve finds little independent effect of the dividend tax cut on stock prices.

Even economists who dispute the study think the White House exaggerates. "It's preposterous that the dividend tax cut created 4 million new jobs," says Kevin Hassett of the American Enterprise Institute. ... Every president seeks bragging rights for prosperity. If you substitute "deficit reduction" for "tax cuts," the Clinton administration made claims similar to the Bush administration's. "Deficit reduction" supposedly ignited spectacular economic growth. In truth, the economy's spectacular growth (and a surge in tax revenue) explained deficit reduction more than the reverse. ...

Presidents can't control the economy, because it's the complex consequence of the ambitions, hopes, fears, visions and talents of nearly 300 million people. ... To be sure, government policies matter, and presidents set some policies. But the long time lags from when presidents act to when the economy fully reacts often mean that the largest impact occurs after they've left office. On that score, the excessive federal spending and debt of the Bush years suggest a dubious legacy.

The next post argues that one aspect of worker insecurity, job tenure, has not changed much in recent decades contrary to what is often written in the press.