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| December 2007 »
Some questions for William Poole, president of the FRB St. Louis. The answers are extracted from his speech
Bailouts and the "Fed Put":
One of the arguments against the Fed taking action to reduce problems in financial
markets is that this creates a moral hazard problem. Can you remind us what the
The concern over moral hazard is that monetary policy action to alleviate
financial distress may complicate policy in the future, by encouraging risky
investing in the securities markets.
Do we know much about financial turmoil of the type we are experiencing now?
There are so few instances of market turmoil similar to the current situation
that I’ll broaden the analysis to include significant stock market declines.
Doing so gives us a substantial sample to discuss.
What is the most important question to consider?
[W]hether Federal Reserve policy responses to financial market developments
should be regarded as “bailing out” market participants and creating moral
hazard by doing so.
Maybe an example of the types of questions we should ask would help.
The U.S. stock market, between
its peak in 1929 and its trough in 1932, declined by 85 percent. Question 1: If
the Fed had followed a more expansionary policy in 1930-32, sufficient to avoid
the Great Depression, would the stock market have declined so much? Question 2:
Assuming that a more expansionary monetary policy would have supported the stock
market to some degree in 1930-32, would it be accurate to say that the Fed had
“bailed out” equity investors and created moral hazard by doing so? I note that
a more expansionary monetary policy in 1930-32 would, presumably, have supported
not only the stock market but also the bond and mortgage markets and the banking
system, by reducing the number of defaults created by business and household
bankruptcies in subsequent years.
Now apply these questions to the current situation. Did the Fed “bail out” the
markets with its policy adjustments starting in August of this year? Have we
observed an example of what some observers have come to call the “Fed put,”
typically named after the chairman in office, such as the “Greenspan put” or the
“Bernanke put”? Why has no one, at least not recently to my knowledge, argued
that a more expansionary Fed policy in 1930-32 would have “bailed out” the stock
market at that time and, by implication, have been unwise?
Some people aren't going to make it to the end of this discussion. Any chance
you could give a summary of the bottom line?
I can state my conclusion compactly: There is a sense in which a Fed put does
exist. However, those who believe that the Fed put reflects unwise monetary
policy misunderstand the responsibilities of a central bank. The basic argument
is very simple: A monetary policy that stabilizes the price level and the real
economy cannot create moral hazard because there is no hazard, moral or
otherwise. Nor does monetary policy action designed to prevent a financial upset
from cascading into financial crisis create moral hazard. Finally, the notion
that the Fed responds to stock market declines per se, independent of the
relationship of such declines to achievement of the Fed’s dual mandate in the
Federal Reserve Act, is not supported by evidence from decades of monetary
For those who do want to hear the details, how are you going to answer these
My approach will be to start by discussing bailouts and moral hazard in
general. I will examine the record of stock market declines and Fed policy
adjustments and then analyze how monetary policy changes the nature of risks in
financial and goods markets. Finally, I’ll argue that the ways in which monetary
policy alters risks in the markets yields benefits for the economy and does not
create moral hazard.
Then let's get started. Maybe you could explain how bailouts work.
A traditional bailout involves governmental assistance to a particular firm,
group of firms or group of individuals. For ease of exposition, I’ll concentrate
on bailouts of firms, but the same issues apply to bailouts of households.
Continue reading "Market Bailouts and the "Fed Put"" »
Posted by Mark Thoma on Friday, November 30, 2007 at 06:03 PM in Economics, Monetary Policy |
If we start with a basic New Keynesian model, i.e. a model with
monopolistically competitive firms where only a fraction of the firms are
allowed to reset prices each period, we can obtain a
New Keynesian Phillips Curve (NKPC) (the assumption of monopolistic competition
allows firms to be price-setters rather than price-takers as they would be under
pure competition - if they are price-takers then price rigidities arising from the
behavior of individual firms are hard to model, and price rigidities allow
monetary policy to impact the real economy in the short-run, without them or some other impediment to full and immediate adjustment to shocks money would be neutral). The basic NKPC can be represented as:
πt = βEtπt+1 + κφt
where πt is the inflation rate at time t, Etπt+1 is the expected rate of inflation at time t+1 based upon information available at time t, φt is real marginal cost at time t expressed as a percentage deviation
from its steady state value, and β and κ are parameters, with the parameter κ an increasing function of the number of firms who can adjust their price
Unlike the traditional Phillips curve, the NKPC implies the inflation process
is forward looking, i.e. that current inflation depends upon expected future
inflation (the firm needs to worry about future inflation because its price may
be fixed for several periods), and that the correct scale variable is marginal
cost, not output (though marginal cost can be related to the output gap and
substituted into the equation to produce a more traditional looking Phillips
curve, there is some uncertainty about this relationship). Another difference
from the traditional Phillips curve is that the curve is derived from explicit
maximization behavior on behalf of price setters, conditional on the assumed
economic structure (monopolistically competitive firms, constant elasticity
demand curves, random price resetting through the Calvo price-setting mechanism,
etc., though I should point out that some question whether assuming the Calvo mechanism rather than deriving it as part of the model is consistent with the claim that this model is derived from first principles, but it is certainly better than its predecessor on this score).
Why should you care about the NKPC? You should care "because much of our
intuition for what constitutes good monetary policy has been built up using
models in which the NKPC is central." For this reason, it's important to know
how well this model fits actual data. If the model fits poorly, and there are
reasons to believe that the basic version given above does have problems, then the policy prescriptions derived from the model will be suspect. Thus, this
Economic Letter from the San Francisco Fed looks at what's wrong with the
New Keynesian Phillips curve, and how to fix the problems we have discovered:
Fixing the New Keynesian Phillips Curve, by Richard Dennis, FRBSF Economic
Letter: Price rigidity is a key mechanism through which monetary policy is
thought to affect the economy. When some prices are hard to change, firms may
respond to a monetary impetus by changing instead their production and
employment levels. Economists often link price rigidity, inflation, and
movements in the real economy using some form of Phillips curve, often the New
Keynesian Phillips curve (NKPC), a model that relates inflation to factors like
capacity utilization or production costs. Unfortunately, an array of papers have
shown that the NKPC is unable to match the time series properties of aggregate
inflation, failing to capture inflation's persistence, overstating the role of
expectations in price-setting, and implying what many believe to be excessive
These inconsistencies between the model and the data are important, not least
because much of our intuition for what constitutes good monetary policy has been
built up using models in which the NKPC is central. A model that cannot
satisfactorily explain why inflation is persistent is of doubtful value for
forecasting. Moreover, a model that overstates the magnitude of price rigidity
will also tend to overstate monetary policy's importance for determining real
outcomes, potentially providing a distorted view of the role that monetary
policy plays in macro-stabilization.
This Economic Letter looks at the problems with the NKPC and
discusses some alternatives that are increasingly being used to think about
inflation and the monetary policy transmission mechanism.
Continue reading "Fixing the New Keynesian Phillips Curve" »
Posted by Mark Thoma on Friday, November 30, 2007 at 01:17 PM in Economics, Monetary Policy |
Barack Obama is using right-wing talking points to claim that his health plan
is better than the plans of his rivals, but it isn't:
Mandates and Mudslinging, by Paul Krugman, Commentary, NY Times: From the
beginning, advocates of universal health care were troubled by ... Barack
Obama’s plan, which ... wouldn’t cover everyone. But they were willing to cut
Mr. Obama slack..., assuming that in the end he would do the right thing. ...
The central question is whether there should be a health insurance “mandate”
— a requirement that everyone sign up for health insurance... The Edwards and
Clinton plans have mandates; the Obama plan has one for children, but not for
[U]nder the Obama plan, ... healthy people could choose not to buy insurance
— then sign up for it if they developed health problems later. Insurance
companies couldn’t turn them away, because Mr. Obama’s plan ... requires that
insurers offer the same policy to everyone.
As a result, people who did the right thing and bought insurance when they
were healthy would end up subsidizing those who didn’t sign up for insurance
until or unless they needed medical care. ...
The fundamental weakness of the Obama plan was apparent from the beginning.
... But ... Mr. Obama, who just two weeks ago was telling audiences that his
plan was essentially identical to the Edwards and Clinton plans, is attacking
his rivals and claiming that his plan is superior. It isn’t — and his attacks
amount to cheap shots.
First, Mr. Obama claims that his plan does much more to control costs than
his rivals’ plans. In fact, all three plans include impressive cost control
Second, Mr. Obama claims that mandates won’t work, pointing out that many
people don’t have car insurance despite state requirements that all drivers be
insured. Um, is he saying that states shouldn’t require that drivers have
insurance? If not, what’s his point?
Look, law enforcement is sometimes imperfect. That doesn’t mean we shouldn’t
Third, and most troubling, Mr. Obama accuses his rivals of not explaining how
they would enforce mandates, and suggests that the mandate would require ...
nasty, punitive enforcement: “Their essential argument,” he says, “is the only
way to get everybody covered is if the government forces you to buy health
insurance. If you don’t..., then you’ll be penalized in some way.”
Well, John Edwards has just called Mr. Obama’s bluff, by proposing that
individuals be required to show proof of insurance when filing income taxes or
receiving health care. If they don’t have insurance, they won’t be penalized —
they’ll be automatically enrolled in an insurance plan.
That’s actually a terrific idea — not only would it prevent people from
gaming the system, it would have the side benefit of enrolling people who
qualify for S-chip and other government programs, but don’t know it.
Mr. Obama, then, is wrong on policy. Worse yet, the words he uses ... make
him sound like Rudy Giuliani inveighing against “socialized medicine”: he
doesn’t want the government to “force” people to have insurance, to “penalize”
people who don’t participate.
I recently castigated Mr. Obama for adopting right-wing talking points about
a Social Security “crisis.” Now he’s echoing right-wing talking points on health
What seems to have happened is that Mr. Obama’s caution, his reluctance to
stake out a clearly partisan position, led him to propose a relatively weak,
incomplete health care plan. Although he declared, in his speech announcing the
plan, that “my plan begins by covering every American,” it didn’t — and he shied
away from doing what was necessary to make his claim true.
Now, in the effort to defend his plan’s weakness, he’s attacking his
Democratic opponents from the right — and in so doing giving aid and comfort to
the enemies of reform.
Posted by Mark Thoma on Friday, November 30, 2007 at 12:33 AM in Economics, Health Care, Politics |
Treasury Secretary Paulson is pushing a plan to freeze interest rates for
some subprime borrowers:
U.S., Banks Near A Plan to Freeze Subprime Rates, by Deborah Solomon and Michael
M. Phillips, WSJ: The Bush administration and major financial institutions
are close to agreeing on a plan that would temporarily freeze interest rates on
certain troubled subprime home loans...
An accord could reassure investors and strapped homeowners ... on more than
two million adjustable mortgages are scheduled to jump over the next two years.
The plan is being negotiated between regulators including the Treasury
Department and a coalition of mortgage-related companies including Citigroup
Inc., Wells Fargo & Co., Washington Mutual Inc. and Countrywide Financial Corp.
Details of the plan, which could be announced as early as next week, are
still being worked out. In general, the government and the coalition have
largely agreed to extend the lower introductory rate on home loans for certain
borrowers who will have trouble making payments once their mortgages increase.
Many subprime loans carry a low "teaser" interest rate for the first two or
three years, then reset to a higher rate for the remainder of the term, which is
typically 30 years in total. In a typical case, the rate would rise to around
9.5% to 11% from 7% or 8%. That would boost an average borrower's payment by
several hundred dollars a month.
Exactly which borrowers will qualify for the freeze and how long the freeze
would last are yet to be determined. ... The parties are developing standard
criteria that would determine eligibility. The criteria should be finalized by
the end of year. ...
The mortgage servicers in the coalition represent 84% of the overall subprime
market. The coalition also includes lenders, investors and mortgage counselors.
While the government can't force the industry to modify loans, Mr. Paulson
and other administration officials have been using moral suasion to push for
Among the holdouts have been investors, who typically hold securities backed
by mortgages. If interest rates are frozen, they would lose the potential
benefit of higher payments. But investors have cautiously moved toward
cooperation, likely on the grounds that it's better to get some interest than
none at all. ...
Treasury officials say financial institutions are likely to set criteria that
divide subprime borrowers into three groups: those who can continue to make
their payments even if rates rise, those who can't afford their mortgages even
if rates stay steady, and those who could keep their homes if the maturity date
of their mortgages were extended or the interest rates remained at the teaser
rates. Only the third group would be eligible for help. The creditors are likely to look at whether the borrowers have equity
in their homes, despite falling house prices, and whether their incomes
are holding steady.
Mr. Paulson, who is philosophically opposed to federal meddling in markets,
at first rejected a sweeping approach to loan modifications... But he shifted
his position recently. He told The Wall Street Journal last week that it would
be impossible to "process the number of workouts and modifications that are
going to be necessary doing it just sort of one-off." ...
Officials in Washington have been cautious about steps that would be seen as
rescuing borrowers, lenders and investors from the consequences of their own bad
decisions. That is why few are suggesting direct support for borrowers who can't
afford their loans. Mr. Paulson has decided his best option is to prod the
markets to sort matters out themselves, as long as companies bear in mind the
public interest in keeping people in their homes. ...
"If I ever saw a role for government, it is...to bring the private sector
together when innovation has really outrun our ability to deal with it," Mr.
Paulson said. ...
Will this be enough to make a difference?
Posted by Mark Thoma on Friday, November 30, 2007 at 12:24 AM in Economics, Housing |
Posted by Mark Thoma on Friday, November 30, 2007 at 12:06 AM in Links |
Sir Nicholas Stern says "targets and trading must be at the heart of a global
agreement to reduce greenhouse gas emissions." This is from his public lecture
before the Royal Economic Society in anticipation of next week’s world summit on
climate change in Bali:
Climate Change, ethics
and the economics of the global deal, by Sir Nicholas Stern, Vox EU: The
problem of climate change involves a fundamental failure of markets: those who
damage others by emitting greenhouse gases generally do not pay. Climate change
is a result of the greatest market failure the world has seen. The evidence on
the seriousness of the risks from inaction or delayed action is now
overwhelming. We risk damages on a scale larger than the two world wars of the
last century. The problem is global and the response must be a collaboration on
a global scale.
Rich countries must lead the way in taking action. That means adopting
ambitious emissions reduction targets; encouraging effective market mechanisms;
supporting programmes to combat deforestation; promoting rapid technological
progress to mitigate the effects of climate change; and honouring their aid
commitments to the developing world.
Next week the world gathers at Bali for the meeting of the Conference of the
Parties of the United Nations Framework Convention on Climate Change. In
thinking about global action to reduce greenhouse gas emissions, we must invoke
three basic criteria:
- Effectiveness: the scale must be commensurate with the challenge – which
means setting a stability target (or its equivalent in terms of an emissions
reduction path) that can keep the risks at acceptable levels.
- Efficiency: we must keep down the costs of emissions reduction, using prices
or taxes wherever possible.
- Equity: the problem is deeply inequitable with the rich countries having
caused the bulk of current stocks of greenhouse gases and the poor countries
being hit earliest and hardest – which means that the rich countries must take
What should the main elements of a global deal look like, what sort of a deal
should it be, and how should it be built and sustained? My proposal is for a
six-point programme with two groups of elements, the first three concerning
targets and trading:
Continue reading "Nicholas Stern: Climate Change, Ethics and the Economics of the Global Deal" »
Posted by Mark Thoma on Thursday, November 29, 2007 at 03:33 PM in Economics, Environment, Market Failure, Policy, Regulation |
With today's release of revised data showing that GDP grew faster than originally estimated in the third quarter of this year, Brian Blackstone of the WSJ Economics Blog reminds us that we can measure
aggregate activity as GDP and as GDI (because income = expenditures), and notes the two measures are not telling the same story:
Gross Domestic Income Tells Different Story Than GDP, WSJ Economics Blog:
According to the latest gross domestic product revision, the U.S. economy
swelled at nearly a 5% clip last quarter, almost double the economy’s
noninflationary limit. Or did it?
Gross domestic income – a lesser-known gauge that the Fed has highlighted in
the past as perhaps a better alternative — increased less than 2% last quarter,
well below the economy’s potential. The first estimate of GDI is released with
the second GDP estimate because it incorporates data that isn’t available
GDP counts economic activity based on expenditures, while GDI bases it on
income. In theory, they should add up the same, though the often diverge —
albeit not as much as they did last quarter.
Earlier this year when the Fed was trying to reconcile slower GDP growth with
still-strong labor markets, it noted that GDI “might better capture the pace of
activity.” GDI was running hotter than GDP at the time. ...
The main difference between the two gauges last quarter was corporate
profits, which GDI includes and GDP excludes. Corporate profits from current
production fell last quarter. GDI also doesn’t explicitly include net exports
and inventories, as GDP does. GDI, in contrast, relies more heavily on employee
But when there are differences, Fed officials may lean towards GDI,
especially when it comes to signaling economic downturns. Fed economist Jeremy
Nalewaik wrote in a March paper that GDI “has done a substantially better job
recognizing the start of the last several recessions than has real-time GDP.”
Posted by Mark Thoma on Thursday, November 29, 2007 at 08:46 AM in Economics |
...is a penny workers don't earn:
Penny Foolish, by Eric Schlosser, Commentary, NY Times: The migrant farm
workers who harvest tomatoes in South Florida have one of the nation’s most
backbreaking jobs. For 10 to 12 hours a day, they pick tomatoes by hand, earning
a piece-rate of about 45 cents for every 32-pound bucket. During a typical day
each migrant picks, carries and unloads two tons of tomatoes. For their efforts,
this holiday season many of them are about to get a 40 percent pay cut.
Florida’s tomato growers have long faced pressure to reduce operating costs;
one way to do that is to keep migrant wages as low as possible. ...
In 2005, Florida tomato pickers gained their first significant pay raise
since the late 1970s when Taco Bell ended a consumer boycott by agreeing to pay
an extra penny per pound for its tomatoes, with the extra cent going directly to
the farm workers. Last April, McDonald’s agreed to a similar arrangement... But
Burger King ... has adamantly refused to pay the extra penny — and its refusal
has encouraged tomato growers to cancel the deals already struck with Taco Bell
This month the Florida Tomato Growers Exchange, representing 90 percent of
the state’s growers, announced that it will not allow any of its members to
collect the extra penny for farm workers. Reggie Brown, the executive vice
president of the group, described the surcharge for poor migrants as “pretty
much near un-American.”
Migrant farm laborers have long been among America’s most impoverished
workers. Perhaps 80 percent of the migrants in Florida are illegal immigrants
and thus especially vulnerable to abuse. During the past decade, the United
States Justice Department has prosecuted half a dozen cases of slavery among
farm workers in Florida. Migrants have been driven into debt, forced to work for
nothing... The Coalition of Immokalee Workers — a farm worker alliance based in
Immokalee, Fla. — has done a heroic job improving the lives of migrants in the
state, investigating slavery cases and negotiating the penny-per-pound surcharge
with fast food chains.
Now the Florida Tomato Growers Exchange has threatened a fine of $100,000 for
any grower who accepts an extra penny per pound for migrant wages. ...
The prominent role that Burger King has played in rescinding the pay raise
offers a spectacle of yuletide greed worthy of Charles Dickens. Burger King has
justified its behavior by claiming that it has no control over the labor
practices of its suppliers. “Florida growers have a right to run their
businesses how they see fit,” a Burger King spokesman told The St. Petersburg
Yet the company has adopted a far more activist approach when the issue is
the well-being of livestock. In March, Burger King announced strict new rules on
how its meatpacking suppliers should treat chickens and hogs. As for human
rights abuses, Burger King has suggested that if the poor farm workers of
southern Florida need more money, they should apply for jobs at its restaurants.
Three private equity firms — Bain Capital, the Texas Pacific Group and
Goldman Sachs Capital Partners — control most of Burger King’s stock. ...
Telling Burger King to pay an extra penny for tomatoes and provide a decent
wage to migrant workers would hardly bankrupt the company. Indeed, it would cost
Burger King only $250,000 a year. At Goldman Sachs, that sort of money shouldn’t
be too hard to find. In 2006, the bonuses of the top 12 Goldman Sachs executives
exceeded $200 million — more than twice as much money as all of the roughly
10,000 tomato pickers in southern Florida earned that year. Now Mr. Blankfein
should find a way to share some of his company’s good fortune with the workers
at the bottom of the food chain.
Posted by Mark Thoma on Thursday, November 29, 2007 at 12:33 AM in Economics, Unemployment |
An excerpt from a book on Karl Marx:
Kapital' Lives On in Capitalist Age, NPR
Now]: ...Excerpt: 'Marx's Das Kapital: A Biography' by Francis Wheen:
Chapter 1: Gestation ... Marx's
earliest ambitions were literary. As a law student at the University of Berlin
he wrote a book of poetry, a verse drama and even a novel, Scorpion and
Felix, which was dashed off in a fit of intoxicated whimsy while under the
spell of Laurence Sterne's Tristram Shandy. After these experiments, he
admitted defeat: 'Suddenly, as if by a magic touch - oh, the touch was at first
a shattering blow - I caught sight of the distant realm of true poetry like a
distant fairy palace, and all my creations crumbled into nothing… A curtain had
fallen, my holy of holies was rent asunder, and new gods had to be installed.'
Suffering some kind of breakdown, he was ordered by his doctor to retreat to the
countryside for a long rest - whereupon he at last succumbed to the siren voice
of G. W. F. ...
After gaining his doctorate [Marx] thought of becoming a philosophy lecturer,
but then decided that daily proximity to professors would be intolerable. 'Who
would want to have to talk always with intellectual skunks, with people who
study only for the purpose of finding new dead ends in every corner of the
world!' Besides, since leaving university Marx had been turning his thoughts
from idealism to materialism, from the abstract to the actual. 'Since every true
philosophy is the intellectual quintessence of its time,' he wrote in 1842, 'the
time must come when philosophy not only internally by its content, but also
externally through its form, comes into contact and interaction with the real
world of its day.' That spring he began writing for a new liberal newspaper in
Cologne, the Rheinische Zeitung; within six months he had been
Marx's journalism is characterized by a reckless belligerence which explains
why he spent most of his adult life in exile and political isolation. His very
first article for the Rheinische Zeitung was a lacerating assault on
both the intolerance of Prussian absolutism and the feeble-mindedness of its
liberal opponents. Not content with making enemies of the government and
opposition simultaneously, he turned against his own comrades as well,
denouncing the Young Hegelians for 'rowdiness and blackguardism'. Only two
months after Marx's assumption of editorial responsibility, the provincial
governor asked the censorship ministers in Berlin to prosecute him for 'impudent
and disrespectful criticism'.
No less a figure than Tsar Nicholas of Russia also begged the Prussian king
to suppress the Rheinische Zeitung, having taken umbrage at an
anti-Russian diatribe. The paper was duly closed in March 1843: at the age of
twenty-four, Marx was already wielding a pen that could terrify and infuriate
the crowned heads of Europe. ...
Marx was a pretty effective blogger. Here is a page from an archive of his posts, with more here.
Update: Andrew Leonard has more.
Posted by Mark Thoma on Thursday, November 29, 2007 at 12:24 AM in Economics, History of Thought |
Posted by Mark Thoma on Thursday, November 29, 2007 at 12:06 AM in Links |
Ruth Marcus of the Washington Post is
at it again, trying to portray Social Security as a system in need of
immediate fixing. But, as these responses by Dean Baker, Kevin Drum, and Paul
Krugman make clear, Marcus is doing her best to elevate a second-tier problem
(if it's even that) to the crisis, first-tier level. It appears that having
taken a position on Social Security that is wrong, i.e. that it is a system
headed for "crisis," she is incapable of admitting her errors and instead
continues to defend the indefensible. She says it's irresponsible not to attack
the problem now in her guise as one of the "Very Serious People," but the
irresponsibility is coming from those, like herself, who are promoting a crisis
that doesn't exist.
Here's Dean Baker:
More Social Securty UFOs at the Post, by Dean Baker: Ruth Marcus is on the
warpath again arguing that those who don't want to jump in line on the SS crisis
train are being irresponsible. Read it and weep.
A couple of quick points are in order.
Continue reading "The Ruth Marcus Obsession with the Social Security Crisis that Does not Exist" »
Posted by Mark Thoma on Wednesday, November 28, 2007 at 09:18 AM in Economics, Politics, Social Insurance, Social Security |
How secure are middle class families? According to this report, not very:
out of 3 middle class American families on shaky financial ground, according to
new report Landmark study based on new 'Middle Class Security Index' developed
by Demos and Brandeis University, EurekAlert: Fewer than one in three
middle-class families in America is financially secure, and the remaining
majority are either borderline or at high risk of falling out of the middle
class altogether, according to a new study published this week by Demos and the
Institute for Assets and Social Policy (IASP) at Brandeis University.
By a Thread: The New Experience of America’s Middle Class is the first
comprehensive report to measure economic stability across the American middle
class. Based on national government data, By a Thread is the first in a series
of reports and briefing papers that will utilize the new “Middle Class Security
Index” developed by the non-partisan policy center Demos and IASP/Brandeis.
This Index measures the financial security of the middle class by rating
household stability across five core economic factors: assets, educational
achievement, housing costs, budget and healthcare. Based on how a family ranked
in each of these factors, they were defined as financially “secure”,
“borderline” or “at risk”.
“Much like a common cholesterol test that shows whether someone’s
cardiovascular health is at risk, the Middle Class Security Index shows that
financial health eludes the majority of the American middle class,” said Thomas
M. Shapiro, Director of the Institute on Assets and Social Policy at Brandeis
and one of the co-authors of the report. “ It also points to specific areas—like
lack of assets—that inhibit financial security,”
The Middle Class Security Index shows worrying trends:
- Only 31 percent of families who would be considered middle-class by income
are financially secure.
- One in four middle-class families match the profile for being at high risk
of slipping out of the middle class altogether.
- More than half of middle-class families have no net financial assets
- Middle-class families have median debt of $3,500 and at least half of them
have no assets.
- Only 13 percent of middle-class families are secure in their asset
levels—meaning that they have enough to cover most of their living expenses for
nine months should their regular income cease; 79 percent are “at risk” in this
category, meaning they could not cover the majority of their expenses for even
three months. Another 9 percent are “borderline.”
- Twenty-one percent of middle-class families have less than $100 per week
($5,000 per year) remaining after meeting essential living expenses. These
families are living from paycheck to paycheck with very little margin of
The participants of a press conference to launch the report commented on
"If we look back at the public investments of the mid-twentieth century—the
GI Bill, federal home loan guarantees, better funding for public education and
college—we see that they were geared at two key benchmarks on the way to the
middle-class: assets and education,” said Henry Cisneros, Chairman of CityView
and former U.S. Secretary of Housing and Urban Development. “But the Middle
Class Security Index provides a real measurement of where we are after years of
seeing those investments whittled away. American families are at risk of falling
out of the middle class and never getting back in, and many of those who were
excluded from the initial public investment—Latinos and African Americans—are
among those with the greatest vulnerability. It’s time for a new public
investment to stabilize the household economy and build the future middle
“The By a Thread report findings mirror a reality of today’s unstable
economy: The nation’s mortgage lending crisis is threatening the fabric of the
urban communities that we revitalized by providing economic opportunity for more
than 30 years. The ramifications of foreclosures on property values, municipal
costs, crime, and consumer credit extends beyond the middle class and the
neighborhoods most widely impacted by irresponsible lending practices,” said
Jean Pogge, Executive Vice President, Consumer and Community Banking for
"Workers in America are suffering a now generation-long stagnation of wages
and rising insecurity,” said Ron Blackwell, Chief Economist at AFL-CIO. “By a
Thread provides a unique metric for the resulting stress on middle class living
standards and outlines bold policies to create an economy that works for all."
The Middle Class Security Index findings reported in By a Thread spotlight
the strengths and vulnerabilities of the middle class by identifying barriers to
financial security and offering solutions that would enable the broad majority
of American families to enjoy a stable middle-class life. The report recommends
a set of policies that will help open access to, and strengthen, America’s
middle class. Legislative proposals cover a range of important issues affecting
American households, including asset building and debt reduction, making higher
education more accessible and affordable, and addressing the healthcare crisis.
“The Index is the launching point for a range of new work that will examine
economic stability in America’s middle class,” said Jennifer Wheary, Senior
Fellow at Demos and report co-author. “In the coming months we’ll be adding new
reports that illuminate middle- class stability by age, race and income—several
of the key demographic factors that will inform future public policy
The Middle Class Security Index will be updated biennially, with accompanying
reports, as new national data become available.
[Link to report]
Posted by Mark Thoma on Wednesday, November 28, 2007 at 09:18 AM in Economics, Social Insurance |
Posted by Mark Thoma on Wednesday, November 28, 2007 at 12:06 AM in Links |
Robert Hall says the NBER Business Cycle Dating Committee hasn't scheduled a meeting yet, but that could change. Justin Fox has the details:
Economist Robert Hall sees "dark clouds," but don't go expecting him to declare
a recession anytime soon, Curious Capitalist: With all the recent talk of a
looming recession, I figured I ought to check in with Stanford economist
Robert Hall, chairman of the
Business-Cycle Dating Committee
of the National Bureau of Economic Research, the semi-official arbiter of
when recessions start and end. I e-mailed:
When everybody starts talking recession, as is this case now, what do you
folks on the Business-Cycle Dating Committee do? Schedule a meeting in Cancun?
Set up a conference call? Start sending around lots of e-mails? Deputize
somebody to keep an especially close eye on incoming economic data? (I just
imagine there must be some form of heightened activity, and I’m curious as to
what form it takes.)
We all follow developments pretty closely. Now that
Larry Summers has scooped us, all the more so.
The process begins with emails. We don't usually have a conference call until we
are quite convinced that a turning point has occurred. Thus the subject of the
call is not whether the recession has begun or ended, but rather when that event
occurred. Consequently, the call occurs long after it is generally recognized
that a turning point has occurred. There is usually a period of 6 months or so
when the financial press excoriates us for tardy action.
We don't generally have a physical meeting, though we do if the time for action
happens to coincide with the annual meetings of the American Economic
Association at the beginning of January. So far there has been no suggestion of
a meeting when that happens in 6 weeks, but things could change.
I can certainly add as an individual member, now not speaking as chair, that I
see some dark clouds. The high levels of consumption seen in the past decade may
decline to something closer to normal. The relation of the consumption bulge to
the house-price boom is still unclear, but it would not be a surprise to see the
two variables return to normal together.
The Business-Cycle Dating Committee ... was set up by ... Marty Feldstein after he took over
as president of the NBER in 1977. Before that, veteran NBER staffer Geoffrey H. Moore (he'd been there since 1939) had more or less
singlehandedly determined what was a recession and what was not. Feldstein
decided such work was better done by a committee. ...
Justin's post has a little more on the dating procedure, and there's even more here along with a set of FAQs . Here is the list of past recession dates.
Are we talking ourselves into a recession?
Posted by Mark Thoma on Tuesday, November 27, 2007 at 04:05 PM in Economics |
Robert Reich does not favor immunity for the telecoms. I don't either:
Why the Telecoms Shouldn't Get Immunity, by Robert Reich: I'm old enough to
remember J. Edgar Hoover’s FBI and Nixon’s CIA, and the Federal Intelligence
Surveillance Act of 1978. But anyone who's even halfway sentient ought to know
there's a Fourth Amendment to the Constitution. So you'd think that executives
at the nation’s biggest telecoms -- AT&T, Verizon, and so on -- would be alert
to the possibility that government might illegally snoop on Americans. Yet these
executives didn’t blink an eye when the NSA came knocking. You want records of
domestic phone calls? Sure, help yourself! Emails? Yeah, we got tons. They’re
When word of this leaked out and the companies got sued..., the telecoms went
to Congress and complained... They deserved immunity from such lawsuits, they
said, because they were only following orders. Now that Congress is back, it's
about to decide whether the telecoms' argument makes sense. It doesn't.
Only following orders? ... Corporate executives have a duty to disobey
government orders when they have reason to believe those orders are illegal or
unconstitutional -- and make the government go to court to get what it wants.
The duty to refuse is especially important when it comes to the nation’s
telecoms, whose technological reach is extending deeper and deeper into our
Sure, there’s a delicate balance between fighting terrorism and protecting
civil liberties. But that’s for courts to decide – not spy agencies and not
telecom executives. If in doubt, the telecoms can go to the special courts set
up precisely to oversee this balance, and get a declaratory judgment. The only
way to keep pressure on them to do this and not become agents of our spy
agencies is to continue to allow Americans to sue them for violating their legal
Posted by Mark Thoma on Tuesday, November 27, 2007 at 03:24 PM in Economics, Terrorism |
PZ Meyers reports:
Cyber Scholars?, by PZ Meyers: Those sneaky alumni organizations — they've
always got new angles on how to get to you. The
alumni magazine for the University of
Oregon has a
on me and a current member of the UO faculty,
Mark Thoma. Apparently, we are
Cyber Scholars, professors who use the blogosphere to teach the world. I
think we need some new academic robes to go with that designation — preferably
something in silver fabrics, and with a jetpack.
Here's the write-up. This kind of thing - the picture, the story, etc. - makes me self-conscious, so please feel free to scroll on by (I should note that one or two of the statistics are a bit off, but not by much, and
that I wasn't going to post this until convinced to do so by others):
Scholars, by Katie Campbell, UO Quarterly: Mark Thoma compares the problem
with the national deficit to dieting.
“People eat more in anticipation of a diet, which makes the diet
that much harder once the time comes,” the UO associate professor of economics
explains. It’s with that type of everyday language that Thoma reaches beyond the
walls of academia to explain complex economic issues to average folks. That’s
what he does everyday—on his blog (short for web log).
Many view the blogosphere less as a scholarly realm and more as
a perilous information wasteland where the average blowhard can present himself
as an expert. But a growing number of people with Ph.D.s, such as Thoma, are
using blogs to connect with colleagues beyond their university departments and
with the greater nonacademic community.
Continue reading ""Cyber Scholars"" »
Posted by Mark Thoma on Tuesday, November 27, 2007 at 08:37 AM in Economics, University of Oregon, Weblogs |
How much should service-sector workers in developed countries fear offshoring
Service offshoring: Same old trade with a new label?,
by Keith Head, Thierry Mayer, and John Ries, Vox EU: Pundits regularly invoke the notion of a world economy that is either
“shrinking” or becoming “flat.” Explanations of this alleged flattening include
technological innovations in transportation and communication that have enabled
goods and ideas to flow more freely. The offshoring of service jobs,
particularly call centers and computer software in India, has grabbed recent
media attention. In his bestseller The World is Flat, New York Times
columnist Thomas Friedman (2005) wrote of how he had “interviewed Indian
entrepreneurs who wanted to prepare my taxes from Bangalore, read my X-rays from
Bangalore, trace my lost luggage from Bangalore and write my new software from
Most economists, cognizant of the gains from trade, do not view a “flat”
world as an alarming prospect. As the 2004 Economic Report of the President
remarked sanguinely, “When a good or service is produced more cheaply abroad, it
makes more sense to import it than to make or provide it domestically” (p. 229).
In a press conference after the release of the report, the Chair of the Council
of Economic Advisors at that time, Gregory Mankiw, elaborated on the remarks in
the report saying, “Whether things of value, whether imports from abroad, come
over the Internet or come on ships, the basic economic forces are the same.” As
Mankiw and Swagel (2006) describe in their insider account, these seemingly
innocuous remarks about outsourcing managed to arouse a controversy. This was
partly because of election-year sentiments but also because the threat of
service offshoring raises serious concerns for many onlookers. How will we
maintain our standard of living, people wonder, when we have to compete with
highly skilled foreigners who are willing to do our jobs for a fraction of our
Just as mainstream trade theory identifies gains from trade, it also shows
that real wages of some workers tend to fall as a consequence of freer trade.
Mankiw and Swagel (2006) respond to these concerns by arguing that the
accumulated statistical evidence on the offshoring of services demonstrates that
the magnitudes remain quite small compared to the size of the labour market.
This case for complacency recalls a debate between Leamer and Krugman over
whether rising imports from low-wage manufacturers were responsible for rising
wage inequality in the US. Leamer (2000) pointed out that prices are determined
on the margin and the volume of trade is irrelevant for wage determination.
Krugman (2000) argued that, on the contrary, trade volumes were crucial evidence
on the changes in factor prices that can be attributed to trade. However, if
recent growth of service imports continues unabated, the current trickle of
offshoring could turn into a flood. Mankiw and Swagel’s argument would be more
persuasive if there were strong reasons to believe that economic impediments to
offshoring will curb its future growth.
Our research investigates whether geographic separation limits offshoring
trade, thereby shielding domestic workers from direct competition with their
foreign counterparts. We develop a model that envisions employers searching
globally for the most suitable workers for any given task and posits that
distance raises the costs of using foreign workers. These higher costs reflect
travel, training, or translation time associated with using workers that reside
far from where their services will be consumed. Firms choose workers that offer
the lowest costs after adjusting wages for productivity and distance-based
service delivery costs.
We use data on bilateral trade in services for a large sample of countries to
infer the extent to which distance increases the relative costs of using remote
workers. We focus on the service category called Other Commercial Services (OCS)
that includes service categories that are subject to the offshoring
debate—professional services and call centers. Distance effects are
conventionally estimated by applying the “gravity equation” to bilateral trade.
This method, which has been widely used to study goods trade, posits that
exports from an origin country to a destination country are proportional to the
economic sizes of each partner country and inversely related to the distance
The scatter plot in Figure 1 of British imports of OCS (averaged over
2000–2004) provides intuition on how the gravity equation is used to estimate
Continue reading ""The Death of Distance Has been Greatly Exaggerated"" »
Posted by Mark Thoma on Tuesday, November 27, 2007 at 02:07 AM in Economics, International Trade, Unemployment |
Paul Krugman says international trade doesn't matter as much as you might think:
Cool the globalization rhetoric, Marketplace: ... Paul Krugman: I've been on the road a
lot lately, talking to audiences about my hopes for a great revival of
middle-class America, and I almost always get asked about whether such
hopes make sense in an age of globalization. Is it really possible to
make working Americans better off, when they have to compete with
workers around the world?
Yes, it is. The truth, is that international trade is less important, for good or for evil, than most people suppose. [...continue reading...]
Posted by Mark Thoma on Tuesday, November 27, 2007 at 12:33 AM in Economics, International Trade |
Here are Ricardo Reis and Mark Watson who will tell you what they have done
and why it matters. This is interesting work:
Prices and Pure Inflation, by Ricardo Reis and Mark W. Watson, NBER WP 13615,
November 2007 [open
link]: ABSTRACT This paper uses a dynamic factor model for the
quarterly changes in consumption goods' prices to separate them into three
components: idiosyncratic relative-price changes, aggregate relative-price
changes, and changes in the unit of account. The model identifies a measure of
"pure" inflation: the common component in goods' inflation rates that has an
equiproportional effect on all prices and is uncorrelated with relative price
changes at all dates. The estimates of pure inflation and of the aggregate
relative-price components allow us to re-examine three classic
macro-correlations. First, we find that pure inflation accounts for 15-20% of
the variability in overall inflation, so that most changes in inflation are
associated with changes in goods' relative prices. Second, we find that the
Phillips correlation between inflation and measures of real activity essentially
disappears once we control for goods' relative-price changes. Third, we find
that, at business-cycle frequencies, the correlation between inflation and money
is close to zero, while the correlation with nominal interest rates is around
0.5, confirming previous findings on the link between monetary policy and
6. What have we done and why does it matter? In this paper, we ... used
different estimation techniques and specifications to robustly estimate pure
inflation, and proposed a simple method to compute macroeconomic correlations
while controlling for goods’ relative price changes.
Our first finding was that pure inflation can differ markedly
from other conventional measures of inflation, like the PCE deflator or its core
version. It is smoother, less volatile, and in particular in the 1990s, its
ups-and-downs are quite different from those in other measures of inflation.
This should be useful to economic historians since it provides an alternative
account of the movements in inflation in the last half-century. Relative to
existing measure of inflation, pure inflation has the virtue of separating
absolute from relative-price changes, which is a crucial distinction in economic
theory. Moreover, pure inflation matches more closely the concept that many
economists seem to have in mind when discussing aggregate movements in prices
and monetary policy (typically based on intuition that comes from a one-good
Continue reading "Measuring Pure Inflation" »
Posted by Mark Thoma on Tuesday, November 27, 2007 at 12:24 AM in Academic Papers, Economics, Inflation |
From Michael Perelman at EconoSpeak, a quote from Keynes:
A note from a careful observer of US financial conditions, by Michael Perelman: [pg.] 569: "I fancy that the great New York (banking) institutions have more
skeletons in their cupboards than anyone yet knows about for certain, and that
their concealed anxieties cramp their action more than is admitted."
Keynes. 1930. "A Note on Economic Conditions in the United States: A
Memorandum for the Economic Advisory Council." CW 20, pp. 561-94.
Posted by Mark Thoma on Tuesday, November 27, 2007 at 12:15 AM in Economics, Financial System |
Posted by Mark Thoma on Tuesday, November 27, 2007 at 12:06 AM in Links |
Richard Green, a professor of real estate, finance and economics at the
George Washington University, explains the sensitivity of housing prices to
assumptions about the rate of appreciation. Small changes in expected
appreciation can bring about much larger swings in current housing prices:
The problem with forecasting house prices, by Richard Green:
The value of a house should, in equilibrium, be its capitalized rents. Its
capitalization rate is (roughly) the after-tax required rate of return, plus
depreciation and expenses less expected appreciation. We may write this out as:
r + m - pi.
The r and the m are relatively easy to measure. Households in the conventional
conforming market can borrow at an after-tax mortgage rate of about 5 percent
right now, and with very little equity, they can borrow at around 6 percent (the
cost of interest plus mortgage insurance). Let's add a risk premium and put the
total around 7 percent (this is probably a bit high). Depreciation and expenses
will run around 2 percent of house value. So the value of a house is the value
of its rent divided by 9 percent less expected appreciation.
Now let's see what happens when we let expectations about future prices range
from an increase of 5 percent in a year to a decrease of 5 percent in a year. If
expected prices increase five percent, values are 25 times rent (rent/.04); if
the decrease 5 percent in a year, values are about 7 times rent. So a ten
percentage point decline in expectations could cause house prices to fall by
I think this is part of the current problem. On the one hand, after roughly
2002, prices in many markets shot up well past the 25 to 1 point (on a quality
adjusted basis), in part because of very low interest rates, and in part because
of unrealistic expectations. Now that prices are falling (as inevitably they
would), expectations have reversed, although it is not yet clear by how much.
Some months ago, when others were writing that the bottom was coming, I wrote
that I didn't know when the bottom of the housing market was coming, and neither
did anyone else. I wish I had been wrong.
Also see Richard's follow up to this post, "Long
run vs Short run," [update] and "Three principles for avoiding future subprime messes."
Posted by Mark Thoma on Monday, November 26, 2007 at 10:26 AM in Economics, Housing |
taken on an editorial on Social Security by Ruth Marcus, I was going to let
the latest Washington Post "the sky is falling" piece on Social Security and how
it is headed for crisis pass by without comment (other than in the title I gave
it in the daily links of "The
Washington Post Continues to Promote the Lie that Social Security is Headed for
a Crisis"), but on second thought, let's review.
Hoisted from Comments: Low-Tech Cyclist Writes:
Grasping Reality with Both Hands: Brad DeLong's Semi-Daily Journal: I know
bringing up Fred Hiatt is like shooting fish in a barrel on this score, but the
WaPo has a subset of its unsigned editorials where it comments on what it calls
"the ideas primary."
Five of the last seven Ideas Primary editorials have been on the Social
Security 'crisis.' There have been 15 editorials in this series. One has been on
global warming - the greatest crisis of our era - and two have been on our
greatest domestic crisis, the lack of universal health care and the upcoming
crisis in the Medicare trust fund. None have been on Iraq and the power vacuum
we've created in the center of the Middle East. Interesting set of priorities,
The most recent piece in the Washington Post on the "crisis" isn't from their
"Ideas Primary," but it's just as bad. Dean Baker has the description:
Main THE UFOs Are Back at the Post (literally), by Dean Baker: I praised the
Post a couple of weeks ago for printing a coherent column by Robert Ball in
support of protecting the current level of Social Security benefits. This was an
extraordinary departure from its never-ending drumbeat of SS crisis news
stories, columns, and editorials.
Since that day, the Post has run a strange column by Ruth Marcus, a former
editor, that seemed to attack Paul Krugman for changing his mind on Social
Security. In another forum, I quipped about this column that "the UFOs have
landed," referring to a nutty effort to discredit Social Security by claiming
that more young people believe in UFOs than they will receive a Social Security
Well, today the Post actually has the UFO story in its full glory. It appears
in an oped column by Amity Shales which is apparently further payback for the
Robert Ball column. It looks like we must pay a high price for this modest
dissent from the Post's dogma on the SS crisis.
On the substance, I am not quite sure why the opponents of SS believe that
the effectiveness of their lies is a basis for gutting the program. This would
be comparable to claiming that tens of millions of people believe that Saddam
was responsible for September 11th, therefore we should invade Iraq. The fact
that the public has been so terribly misled on the financial condition of its
most important social program (even if they don't actually believe in UFOs) is a
strong argument for putting off any changes until the public can learn the true
facts of the situation.
After all the basic issues about the SS program -- how much money it should
provide in retirement, how much people should be taxed in their working years,
and how late in life they should have to work -- are issues that should be
decided democratically, not by people who control major media outlets. And the
public cannot possibly make such decisions in an intelligent manner when they
are being deliberately misinformed about the true financial status of the
Where did the misleading UFO story come from? Here's President Bush on
February 10, 2005 giving what was a standard speech at the time:
THE PRESIDENT: ...Somebody was telling me the other day ... he read an
interesting poll; he said that a lot of younger workers felt like they're more
likely to see a UFO than get a Social Security check. (Laughter.) It's an
interesting dynamic, isn't it, when you think about it? There are a lot of young
people, when they analyze Social Security and think about it, that they just
don't think the government can fulfill the promise, which is a powerful -- it's
powerful leverage for members of Congress to listen to.
In other words, the dynamic has shifted. The reason people are comfortable
about taking on the Social Security issue..., there's a lot of folks
out there who are demanding change -- for their sake. They're saying, what are
you going to do about saving the system for me? I'm coming up; I have a better
chance of seeing a UFO than getting a check from the government. What are you
and the government going to do to make sure I get my check? That's the dynamic
And that's why I'm optimistic something is going to get done, because people
are beginning to speak out. Younger Americans who understand the math and know
the reality are beginning to say to those of us who have been elected, what are
you going to do about it? You're up there in Washington, D.C. -- do more than
just occupy the office, solve problems and do your job. (Applause.)
I think the last quote should be:
Younger Americans who understand the math and know the reality are beginning
to say to those of us who have been elected, why are you lying to us about it?
Why is the Washington Post participating in this attempt to mislead people about the nature of the problem? Brad
DeLong is right:
Without major personnel changes, I give the Washington Post five
Posted by Mark Thoma on Monday, November 26, 2007 at 09:09 AM in Economics, Social Security |
Why are people so unhappy with the economy?
Winter of Our Discontent, by Paul Krugman, Commentary, NY Times: “Americans’
Economic Pessimism Reaches Record High.” That’s the headline on a recent Gallup
report, which shows a nation deeply unhappy with the state of the economy. Right
now, ... “an extraordinary 78% of Americans now say the economy is getting
worse, while a scant 13% say it is getting better.”
What’s really remarkable about this dismal outlook is that the economy isn’t
(yet?) in recession, and consumers haven’t yet felt the full effects of $98 oil
(wait until they see this winter’s heating bills) or the plunging dollar, which
will raise the prices of imported goods.
The response of those who support the Bush administration’s economic policies
is to ... rattle off statistics... Many of these statistics are misleading or
irrelevant, but it’s true that the official unemployment rate is fairly low...
So why are people so unhappy?
The answer from Bush supporters — who are, on this and other matters, a
strikingly whiny bunch — is to blame the “liberal media” for failing to report
the good news. But the real explanation ... is that whatever good economic news
there is hasn’t translated into gains for most working Americans.
One way to drive this point home is to compare the situation for workers
today with that in the late 1990s, when the country’s economic optimism was
almost as remarkable as its pessimism today. ...
The unemployment rate in 1998 was only slightly lower than ... today. But for
working Americans, everything else was different. Wages were rising, yet
inflation was low, so the purchasing power of workers’ take-home pay was
steadily improving. So, too, were job benefits, including the availability of
health insurance. And homeownership was rising steadily.
It was, in other words, a time when Americans felt they were sharing in the
Today, by contrast, wage gains for most workers are being swallowed by
inflation. ... Meanwhile, the percentage of Americans receiving health insurance
from their employers ... is continuing its downward trend. And homeownership...
— well, you know how that’s going.
In short, working Americans have very good reason to feel unhappy about the
state of the economy. But what will it take to make their situation better?
The leading Republican candidates for president don’t even seem to realize
that there’s a problem. A few months ago Rudy Giuliani, denouncing Hillary
Clinton’s economic proposals, declared that “she wants to go back to the 1990s”
— as if that would be a bad thing. ...
But simply putting another Clinton, or any Democrat, in the White House won’t
ensure that the good times will roll again. President Clinton was a good
economic manager, but much of the good news during the 1990s reflected events
that won’t be repeated, including low oil prices and ... the temporary leveling
off of health care spending ...
And there are good reasons to think that the negative effects of
globalization on the wages of some Americans are larger than they were in the
’90s. That’s a hugely contentious issue within the progressive movement, with no
easy resolution. ...
Despite these caveats, Democrats have every right to make a political issue
out of the failure of the Bush economy to deliver gains to working Americans —
especially because conservatives continue to insist that tax cuts for the
affluent are the answer to all problems.
But Democrats shouldn’t kid themselves into believing that this will be easy.
The next president won’t be able to deliver another era of good times unless he
or she manages to tackle the longer-term trends that underlie today’s economic
disappointment: a collapsing health care system and inexorably rising
Posted by Mark Thoma on Monday, November 26, 2007 at 12:33 AM in Economics |
Will the Fed cut rates further, or pause at the next meeting?:
Long Run Forecast Vs. Short Run Reality, by Tim Duy: Recent Fedspeak has, in my opinion,
been very clear – current policy is balanced
and the bar for another rate cut in December is set high. Only evidence
that growth will be substantially below already low expectations would prompt a
rate cut. The minutes of the last meeting, however, present a puzzle.
There was apparently lengthy discussion of downside risks, yet the final
decision was supposedly a “close call.” And despite these numerous downside
risks, and a positive trajectory for inflation, the statement defined policy as
roughly neutral. The mix of signals leaves perfectly reasonable people with
completely opposing opinions about the Fed’s intentions for future policy. One
can read the minutes and find reason for pause, but also find a risk management
motivation for another cut.
How can we resolve recent Fedspeak, the minutes, and the growth forecasts? Thinking on that question occupied a good part of the long holiday
weekend. It appears that the Fed is preparing market participants for a
pause in rate cuts before the economy has bottomed out. They would like
December to be an opportunity for a pause. But assuming the continuing
instability in financial markets, I suspect they will not be willing to
risk a pause just yet.
One purpose of increasing transparency via the enhanced forecasts is to
minimize the fluctuations of policy. I doubt anyone believes that wide swings in
policy – such as the drop to 1% and the subsequent rise to 5.25% - are conducive
to economic stability in the long-run. The long run forecast, both for
growth and inflation, are intended to create a policy anchor from which the Fed
can tie the economy with a short tether.
The Fed’s long term forecast suggests they see the economy’s potential growth
rate near 2.5%. This reflects a combination of slower productivity and
labor force growth. The inflation forecasts reveal an inflation target of 1.6%
to 1.9%, with a midpoint of 1.75%. Combined, this suggests a range of the
neutral fund funds rate at roughly 4.0% to 4.5%, with the current rate at the
top end of this range. Hence, given this estimate of neutral, the Fed can
reasonably conclude that current policy will “promote moderate growth over time”
and that the risks to growth and inflation are equally balanced.
You might argue that given we are at that high end of the range, policy
remains a tad bit tight relative to neutral. True enough, although the Fed might
have cause to expect that ongoing high headline inflation deserves extra
attention. From the minutes:
Continue reading "Fed Watch: Long Run Forecast vs. Short Run Reality" »
Posted by Mark Thoma on Monday, November 26, 2007 at 12:24 AM in Economics, Fed Watch, Monetary Policy |
Posted by Mark Thoma on Monday, November 26, 2007 at 12:06 AM in Links |
Larry Summers wonders what we are waiting for:
Wake up to the dangers of a deepening crisis, by Lawrence Summers, Commentary,
Financial Times: Three months ago it was reasonable to expect that the
subprime credit crisis would ... not ... threaten ... economic growth. This is
still a possible outcome but no longer the preponderant probability.
Even if necessary changes in policy are implemented, the odds now favour a US
recession that slows growth significantly on a global basis. Without stronger
policy responses..., moreover, there is the risk that the adverse impacts will
be felt for the rest of this decade and beyond.
Several streams of data indicate how much more serious the situation is than
was clear a few months ago. First, forward-looking indicators suggest that the
housing sector may be in free-fall from what felt like the basement levels of a
few months ago. ... [I]t is hard to believe declines of anything like this
magnitude will not lead to a dramatic slowing in the consumer spending that has
driven the economy in recent years.
Second, it is now clear that only a small part of the financial distress that
must be worked through has yet been faced. On even the most optimistic
estimates, the rate of foreclosure will more than double over the next year...
Third, the capacity of the financial system to provide credit in support of
new investment on the scale necessary to maintain economic expansion is in
increasing doubt. ...
Then there are the potentially adverse effects on confidence of a sharply
falling dollar, rising energy costs, geopolitical uncertainties especially in
the Middle East, or lower global growth as economic slowdown and a falling
dollar cause the US no longer to fulfil its traditional role of importer of last
In such an environment, economic policy needs to be governed by the clear and
public recognition that restoring the normal functioning of the financial system
and containing any damage its breakdown may do the real economy is the central
macro-economic and financial challenge facing the US. ...
What concrete steps are necessary? First, maintaining demand must be the
over-arching macro-economic priority. That means the Fed has to get ahead of the
curve and recognise – as the market already has – that levels of the Fed Funds
rate that were neutral when the financial system was working normally are quite
contractionary today. As important as long-run deficit reduction is, fiscal
policy needs to be on stand-by to provide immediate temporary stimulus through
spending or tax benefits for low- and middle-income families if the situation
Second, policymakers need to articulate a clear strategy addressing the
various pressures leading to contractions in credit. .... The time for worrying
about imprudent lending is past. The priority now has to be maintaining the flow
of credit. The current main policy thrust – the so-called “super conduit” ...
has never been publicly explained in any detail by the US Treasury. On the
information available, the “super conduit” has worrying similarities with
Japanese banking practices of the 1990s that aroused criticism from American
authorities for their lack of transparency, suppression of genuine market
pricing of bad credits, and inhibiting effect on new lending. Perhaps there is a
strong case for it, but that case has yet to be made.
Third, there needs to be a comprehensive approach taken to maintaining demand
in the housing market to the maximum extent possible. The government operating
through the Federal Housing Administration, through Fannie Mae and Freddie Mac,
or through some kind of direct lending, needs to assure that there is a
continuing flow of reasonably priced loans to credit worthy home purchasers. At
the same time there need to be templates established for the restructuring of
mortgages to homeowners who cannot afford their resets, so every case does not
have to be managed individually.
All of this may not be enough to avert a recession. But it is much more than
is under way right now.
With respect to traditional stabilization policy, monetary and fiscal policy lags are fairly long. Because of that, past policy responses will govern our immediate future - it's too late to do much now - and anything done now to change monetary or fiscal policy won't be felt with any force until sometime in the future. Thus, given the growing uncertainty about the future course of economic growth, effective risk management points toward taking actions today to reduce the potential for a catastrophic outcome of a deep and prolonged recession at some point in the future.
Under this policy, inflation is a risk if the housing crisis does not bring down economic growth after all, but it is changes in expected inflation over the longer term rather than shorter-run changes in actual inflation that cause the most worry. Given that markets anticipate an economic slowdown and expect the Fed to act accordingly and cut rates, I don't think a further rate cut will cause long-run inflation expectations to change to any worrisome degree. However, if the Fed fails to reverse any additional easing quickly should the data begin to show there isn't as much to worry about as we thought, or if the Fed eases in spite of an improved outlook, then I think elevated inflation expectations become more of a worry.
I'm still hopeful the economy can weather this, but hope is no excuse for imprudence.
Posted by Mark Thoma on Sunday, November 25, 2007 at 12:51 PM in Economics, Housing, Policy |
First, Paul Krugman notes the decline in corporate profits recently, a key
factor in recent revenue increases:
Red tide rising, by Paul Krugman: The fall in the federal deficit since 2003
has been widely used by conservatives — including
the Bush administration and all the leading candidates for the GOP presidential
nomination — as proof that tax cuts actually increase revenue.
So here’s a heads-up: the good times are about to stop rolling.
The key factor in rising revenue hasn’t been a growing economy — it has been
a surge in corporate
taxes as a share of GDP.
profits are falling. Revenue will follow — and the deficit is about to get
Next, Menzie Chinn says not to expect a balanced budget anytime soon:
Budget Deficit Watch: Receipts Stabilize, Deficit Fails to Shrink, by Menzie
Chinn: Reader CoRev, in commenting on
post, advises me to look at the actual data for October (instead of the CBO
estimate) before declaring a trend deterioration in the budget balance. Well,
the data are out.
Here's what the deficit looks like, using Treasury's Monthly Treasury
Statement data for
October, and historical data.
Figure 1: Twelve month moving average of budget balance divided
by nominal GDP (blue, left scale) and in billions of nominal dollars (red, right
scale). Budget balance (on balance sheet and off balance sheet), as recorded by
Treasury (October statement), divided by GDP interpolated using quadratic match.
October GDP assumes 5% nominal GDP growth, in line 1.4% real GDP growth and 3.6%
inflation in 2007Q4 (see
NBER-defined recessions shaded gray. Sources: Treasury's Monthly Treasury
Statement data for
October, and historical data,
BEA October 31 GDP release,
NBER, and author's calculations.
It turns out that the $55.6 billion deficit is not that different from the
CBO's estimate of $59 billion. But it is the trend that is of greatest interest
In addition, nominal receipts are slowing their ascent, while as a share of
GDP, they have clearly plateaued.
Figure 2: Twelve month moving average of receipts divided by
nominal GDP (blue, left scale) and in billions of nominal dollars (red, right
scale). Receipts (on balance sheet and off balance sheet), as recorded by
Treasury (October statement), divided by GDP interpolated using quadratic match.
October GDP assumes 5% nominal GDP growth, in line 1.4% real GDP growth and 3.6%
inflation in 2007Q4 (see
NBER-defined recessions shaded gray. Sources: Treasury's Monthly Treasury
Statement data for
October, and historical data,
BEA October 31 GDP release,
NBER, and author's calculations.
Seems to me a fair bet that, given current estimates for a slowdown to around
1.4% GDP growth SAAR in 2007Q4 (see
post), receipts will fall as a share of GDP.
Hence, I stick with the conclusion from my
previous post on this subject: A balanced budget is far off.
Some more things to keep in mind as you think about the budget deficit. This
is from a report from by the
Box 2. The Effect of the Aging of the Population on Spending on Medicare
and Medicaid In coming decades, the share of the population that is covered
by Medicare will expand rapidly as members of the baby-boom generation become
eligible for the program, and the share that uses long-term care services
financed by Medicaid will also probably increase. Although the aging of the
population is frequently cited as a major factor contributing to the large
projected increase in federal spending on those two programs, it accounts for a
modest fraction of the growth that the Congressional Budget Office (CBO)
projects. The main factor is excess cost growth—or the extent to which the
increase in health care spending for an average individual exceeds the growth in
per capita gross domestic product (GDP). As shown in the figure, if the age
distribution of the population were fixed—so that the average age did not
increase over time—and there were no excess cost growth, spending on Medicare
and Medicaid as a share of GDP would remain essentially constant. That scenario
is represented by the bottom line in the figure. The next line shows projected
spending on Medicare and Medicaid if the age distribution of the population
changes as expected—so that the average age of the population increases—but
excess cost growth remains at zero. The difference between that line and the
bottom line captures the effect of the aging of the population on projected
federal spending on Medicare and Medicaid. The top line in the figure shows
CBO’s projection of spending on those programs, which includes the effects of
the aging of the population and of excess cost growth. By itself, aging accounts
for about one-quarter of the projected growth in federal Medicare and Medicaid
spending through 2030. By 2050, that share has fallen to under 20 percent, and
by 2082, to only about 10 percent.
And two more graphs from the report:
If revenues begin to fall and the budget deficit begins increasing, we will hear that we need to cut taxes even more to solve the problem, which I hope you realize is a silly suggestion, and that we'll need to cut back on social programs - Medicare, Medicaid, and Social Security in particular to reign in spending. But I hope these graphs make clear that Medicare and Medicaid are not the problem, nor are demographics. I also hope that by now you are also well aware that the problems with Social Security, which are minor, can be fixed any number of ways none of which is prohibitively costly (or even nearly so). As the CBO report says, "The main factor is excess cost growth—or the extent to which the
increase in health care spending for an average individual exceeds the growth in
per capita gross domestic product (GDP)." If the deficit does begin to increase as expected, don't be fooled by the misleading rhetoric that is sure to come from those who see it as an opportunity to push their ideology. "Socialsecuritymedicareandmedicaid" is not the main problem.
Posted by Mark Thoma on Sunday, November 25, 2007 at 11:25 AM in Budget Deficit, Economics |
Posted by Mark Thoma on Sunday, November 25, 2007 at 12:19 AM in Links |
Robert Shiller has a list of options for regulating mortgage markets and for
helping homeowners who are having difficulty keeping up with their mortgages:
A Time for Bold Thinking on Housing, by Robert Shiller, Economic View, NY Times:
We have to consider the possibility that the housing price downturn will
eventually be as big as that of ... 1925 to 1933, when prices fell by a total of
As of this August, domestic home prices were already down 5 percent from
their peak 14 months earlier..., and prices were falling at a faster rate in the
months leading up to August. ...
This crisis should be an occasion for some inspired thinking about
fundamental changes in our real estate institutions. The actions that have
already been taken are not impressive. The housing market is worsening, and more
and more home owners are getting into trouble...
The public response to the housing downturn of 1925-33 provides an important
lesson in what government and private institutions can accomplish.
Continue reading "Shiller: A Time for Bold Thinking on Housing" »
Posted by Mark Thoma on Saturday, November 24, 2007 at 08:01 PM in Economics, Housing, Regulation, Social Insurance |
I haven't had much time to think about this, but posts are getting stale amid
the rush of the holiday weekend, so, staying in "echo mode":
Taking Science on Faith, by Paul Davies, Commentary, NY Times: Science, we
are repeatedly told, is the most reliable form of knowledge about the world
because it is based on testable hypotheses. Religion, by contrast, is based on
The problem with this neat separation into “non-overlapping magisteria,” as
Stephen Jay Gould described science and religion, is that science has its own
faith-based belief system. All science proceeds on the assumption that nature is
ordered in a rational and intelligible way. You couldn’t be a scientist if you
thought the universe was a meaningless jumble of odds and ends haphazardly
The most refined expression of the rational intelligibility of the cosmos is
found in the laws of physics, the fundamental rules on which nature runs. The
laws of gravitation and electromagnetism, the laws that regulate the world
within the atom, the laws of motion — all are expressed as tidy mathematical
relationships. But where do these laws come from? And why do they have the form
that they do?
When I was a student, the laws of physics were regarded as completely off
limits. The job of the scientist, we were told, is to discover the laws and
apply them, not inquire into their provenance. The laws were treated as “given”
— imprinted on the universe like a maker’s mark at the moment of cosmic birth —
and fixed forevermore. Therefore, to be a scientist, you had to have faith that
the universe is governed by dependable, immutable, absolute, universal,
mathematical laws of an unspecified origin. You’ve got to believe that these
laws won’t fail, that we won’t wake up tomorrow to find heat flowing from cold
to hot, or the speed of light changing by the hour.
Over the years I have often asked my physicist colleagues why the laws of
physics are what they are. The answers vary... The favorite reply is, “There is
no reason they are what they are — they just are.” The idea that the laws exist
reasonlessly is deeply anti-rational. After all, the very essence of a
scientific explanation of some phenomenon is that the world is ordered logically
and that there are reasons things are as they are. ...
Although scientists have long had an inclination to shrug aside such
questions concerning the source of the laws of physics, the mood has now shifted
considerably. Part of the reason ... that the laws of physics have now been
brought within the scope of scientific inquiry is the realization that what we
long regarded as absolute and universal laws might not be truly fundamental at
all, but more like local bylaws. They could vary from place to place on a
mega-cosmic scale. A God’s-eye view might reveal a vast patchwork quilt of
universes, each with its own distinctive set of bylaws. ...
The multiverse theory is increasingly popular, but it doesn’t so much explain
the laws of physics as dodge the whole issue. There has to be a physical
mechanism to make all those universes and bestow bylaws on them. This process
will require its own laws, or meta-laws. Where do they come from? The problem
has simply been shifted up a level from the laws of the universe to the
meta-laws of the multiverse.
Clearly, then, both religion and science are founded on faith — namely, on
belief in the existence of something outside the universe, like an unexplained
God or an unexplained set of physical laws... For that reason, both monotheistic
religion and orthodox science fail to provide a complete account of physical
It seems to me there is no hope of ever explaining why the physical universe
is as it is so long as we are fixated on immutable laws or meta-laws that exist
reasonlessly or are imposed by divine providence. The alternative is to regard
the laws of physics and the universe they govern as part and parcel of a unitary
system, and to be incorporated together within a common explanatory scheme.
In other words, the laws should have an explanation from within the universe
and not involve appealing to an external agency. The specifics of that
explanation are a matter for future research. But until science comes up with a
testable theory of the laws of the universe, its claim to be free of faith is
Very quick (and probably wrong) reaction: I guess I don't see why
falsifiability isn't enough to distinguish science from faith. The argument - I
think- is that a statement like "this object is blue," which appears
falsifiable isn't since if the laws of the universe change the object may be
red instead of blue tomorrow. So I have to take it on "faith" that blue will
stay blue forever. Fine, but as I look at the object it's either blue or it
isn't. If it changes from blue to red someday, then that is an indication that
either the hypothesis itself or one of the maintained hypotheses (i.e. that the
laws of physics are constant, at least locally) is false. So I don't see why the
scientific method fails us in this particular instance. But as I said, I didn't
give this the thought it deserves, so feel free to explain why I've totally
missed the point. It wouldn't be the first time that has happened.
Posted by Mark Thoma on Saturday, November 24, 2007 at 09:36 AM in Economics, Methodology, Science |
Posted by Mark Thoma on Saturday, November 24, 2007 at 12:21 AM in Links |
Robert Shiller says images that ought to remind us of troublesome past episodes in financial and energy markets are largely absent today - we don't see long lines at gas pumps, financiers leaping from buildings, etc. - and this explains why consumer and business confidence have not, as of yet, declined substantially. But should those images begin to change, watch out:
Markets ail, yet people irrationally exuberant,
by Robert Shiller, Project Syndicate: The world's oil and stock markets have been plunged into turmoil in recent
months. Yet consumer confidence, capital expenditure, and hiring have yet to take a
sharp hit. Why?
Ultimately, consumer and business confidence are mostly irrational.
The psychology of the markets is dominated by the public images that we have
in mind from day to day, and that forms the basis of our imaginations and of the
stories we tell each other.
Popular images of past disasters are part of our folklore, often buried in
the dim reaches of our memory, but re-emerging to trouble us from time to time.
Like traditional myths, such graphic, shared images embody fears that are
deeply entrenched in our psyche. The images that have accompanied past episodes
of market turmoil are largely absent today.
Consider the oil crisis that began in November 1973, resulting in a world
stock market crash and a sharp world recession. Vivid images have stuck in people's minds from that episode: long lines of
cars at gas stations, people riding bicycles to work, gasless Sundays and other
Today, the real price of oil is nearly twice as high as it was at the peak of
that crisis, but we have seen nothing like the images from 1973-75. Mostly we are not even reminded of them. So our confidence is not shaken,
Just before the October 19, 1987, stock market crash, the biggest one-day
drop in history, the image on people's minds was the crash of 1929. Indeed, the
Wall Street Journal ran a story about it on the morning of the 1987 crash. ...
Images of 1929 - of financiers leaping from buildings, unemployed men
sleeping on park benches, long lines at soup kitchens, and impoverished boys
selling apples on the street - are not on our minds now.
The 1929 crash just does not seem relevant to most people today, probably
because we survived the 1987 and 2000 crashes with few ill effects, while 1929
seems not only the distant past, but another world. ...
The images that are uppermost in our minds are of a housing crisis. We
imagine residential streets with one "for sale" sign after another. Worse, there are images of foreclosures, of families being evicted from their
homes, their furniture and belongings on the street.
If home prices continue to decline in the United States and possibly
elsewhere, there could be many more vivid images. You may yet be presented with the image of your child's playmate moving away
because his parents were thrown out in a foreclosure. You may see a house down the street trashed by an angry owner who was
Such images become part of your sense of reality, and could disturb your
sense of confidence and reduce your willingness to spend and support the
economy. Could such changes in psychology be big enough to tip us into a world
While it is far from clear that they will, it is a possibility. Psychology need only change enough to bring about a drop in consumption or
investment growth of a percentage point or so of world GDP, and market
repercussions can do the rest.
Posted by Mark Thoma on Friday, November 23, 2007 at 02:07 PM in Economics, Financial System, Housing |
Because of the failure to reform corporate governance after the last set of
scandals, the people responsible for the housing crisis aren't the ones paying
Banks Gone Wild, by Paul Krugman, Commentary, New York Times: “What were
they smoking?” asks the cover of the current issue of Fortune magazine.
Underneath the headline are photos of recently deposed Wall Street titans,
captioned with the staggering sums they managed to lose.
The answer, of course, is that they were high on the usual drug — greed. And
they were encouraged to make socially destructive decisions by a system of
executive compensation that should have been reformed after the Enron and
WorldCom scandals, but wasn’t.
In a direct sense, the carnage on Wall Street is all about the great housing
slump. This slump was both predictable and predicted... But even as the danger
signs multiplied, Wall Street piled into bonds backed by dubious home
mortgages... Now the bill is coming due, and almost everyone — that is, almost
everyone except the people responsible — is having to pay.
The losses suffered by shareholders in Merrill, Citigroup, Bear Stearns and
so on are the least of it. Far more important ... are the hundreds of thousands
if not millions of American families lured into mortgage deals they didn’t
understand, who now face sharp increases in their payments — and, in many cases,
the loss of their houses — as their interest rates reset.
And then there’s the collateral damage to the economy. You still hear
occasional claims that the subprime fiasco is no big deal... But bad housing
investments are crippling financial institutions that play a crucial role in
providing credit, by wiping out much of their capital. ... Goldman Sachs
suggested ... losses could force banks and other players to cut lending by as
much as $2 trillion — enough to trigger a nasty recession, if it happens
quickly. Beyond that, there’s a pervasive loss of trust, which is like sand
thrown in the gears of the financial system...
How did things go so wrong?
Part of the answer is that people who should have been alert to the dangers,
and taken precautionary measures, instead blithely assured Americans that
everything was fine, and even encouraged them to take out risky mortgages. Yes,
Alan Greenspan, that means you.
But another part of the answer lies in what hasn’t happened to the men on
that Fortune cover — namely, they haven’t been forced to give back any of the
huge paychecks they received before the folly of their decisions became
Executives are lavishly rewarded if the companies they run seem successful:
last year the chief executives of Merrill and Citigroup were paid $48 million
and $25.6 million, respectively. But if the success turns out to have been an
illusion — well, they still get to keep the money. Heads they win, tails we
Not only is this grossly unfair, it encourages bad risk-taking, and sometimes
fraud. If an executive can create the appearance of success, even for a couple
of years, he will walk away immensely wealthy. Meanwhile, the subsequent
revelation that appearances were deceiving is someone else’s problem.
If all this sounds familiar, it should. The huge rewards executives receive
if they can fake success are what led to the great corporate scandals of a few
years back. There’s no indication that any laws were broken this time — but the
public’s trust was nonetheless betrayed, once again.
The point is that the subprime crisis and the credit crunch are, in an
important sense, the result of our failure to effectively reform corporate
governance after the last set of scandals.
John Edwards recently came out with a corporate reform plan, but it didn’t
receive a lot of attention. Corporate governance still isn’t regarded as a major
political issue. But it should be.
Posted by Mark Thoma on Friday, November 23, 2007 at 12:24 AM in Economics, Financial System, Regulation |
Charles Calomiris argues that the decline in credit due to current problems in
financial markets is unlikely to cause a recession:
The Subprime troubles caused a liquidity shock, but there is little reason to
believe that a substantial decline in credit supply under the current
circumstances will magnify the shocks and turn them into a recession. We have
not (yet) arrived at a Minsky moment.
Note, however, that this is based upon current circumstances and is qualified with:
It is hard to know whether new financial shocks will occur (e.g., large housing
price declines, or substantial increases in defaults on other consumer loans),
or whether consumption demand will decline independent of financial system
problems. ... Of course, if housing prices fell by 50% nationwide (as some have argued is "entirely possible") there is no question that the impact on consumers would be
severe... A real estate collapse would not only cause a decline in consumption
via a wealth effect, it could produce a major financial accelerator effect.
Here's his reasoning:
Continue reading ""Not (Yet) a 'Minsky Moment'"" »
Posted by Mark Thoma on Friday, November 23, 2007 at 12:15 AM in Economics, Housing |
Posted by Mark Thoma on Friday, November 23, 2007 at 12:06 AM in Links |
Money motivates -- especially when your colleague gets less, EurekAlert: The
feelings an individual has on receiving his pay cheque depend critically on how
much his colleague earns. Hard evidence for this comes from an experiment
conducted by economists and brain scientists at the University of Bonn. They
tested male subjects in pairs, asking them to perform a simple task and
promising payment for success. ... Participants who got more money than their
co-players showed much stronger activation in the brain's "reward centre" than
occurred when both players received the same amount. Details of the study are
... in the renowned academic journal "Science". ...
In the experiment ... the participants had to lie down next to each other in
parallel brain scanners. They were asked to perform the same task
simultaneously. Dots appeared on a screen and they had to estimate the number
being displayed. They were then told whether their answer was correct. If they
had solved the task correctly, they received a financial reward, which might
range from 30 to 120 euros. Each participant also learnt how his partner in the
game had performed and how much he would pocket in return.
Throughout this procedure the tomograph monitored the changes in blood
circulation in the different regions of the subject's brain. ... A total of 38
men took part in the experiment. "We registered enhanced activity in various
parts of their brains during the test," explains the Bonn neuroscientist Dr.
Bernd Weber. "One area in particular, the ventral striatum, is the region where
part of what we call the 'reward system' is located."
The reward system is activated when an individual has an experience he
considers worth aspiring to. "In this area we observed an activation when the
player completed his task correctly," says Bernd Weber... By contrast, when the
subject got his estimate wrong, activity in his ventral striatum would subside.
For us, however, the exciting finding here was the role played by another
factor: the performance of the player in the other scanner. Weber's colleague
Dr. Klaus Fliessbach sums up the outcome, "Activation was at its highest for
those players who got the right answer while their co-player got it wrong."
The researchers then took a closer look at those cases in which both players
estimated the number of points correctly. If the participants received the same
payment there was relatively moderate activation of the reward centre. But if
player one was given, say, 120 euros, while his partner received only 60, the
activation turned out to be much stronger for player one. For player two, on the
other hand, the blood flow into the ventral striatum actually decreased - even
though he had performed the task successfully and had been rewarded for his
"This result clearly contradicts traditional economic theory," explains
Bonn-based economist Professor Dr. Armin Falk. "The theory assumes that the only
important factor is the absolute size of the reward. The comparison with other
people's rewards shouldn't really play any role in economic motivation." It is
the first time that this hypothesis has been challenged using such an
experimental approach. It does not mean, of course, that the absolute size of
the reward has no impact on the "reward centre": more excitement was registered
in response to 60 euros than 30. "But the interesting point to emerge from our
study is that the relative size of one's earnings plays such a major role,"
Armin Falk insists. ...
Monkeys Have Sense of
Fairness, Study Finds, by Susan McMillan, Emory Wheel: Two researchers at
the Yerkes National Primate Research Center have found that brown capuchin
monkeys have a sense of fairness and will reject inequitable rewards, much as
Frans de Waal, C.H. Candler ... said his work with Georgia State University
professor Sarah Brosnan was based on a study they did in 2003. In that
experiment, monkeys responded negatively when a partner received a superior
reward for completing the same task, retrieving a pebble and placing it the
“As soon as the partner’s getting something better, like grapes, they don’t
want to do it any more,” de Waal said. “They throw the food out of the cage
Brosnan and de Waal conducted a follow-up study to rule out alternative
explanations for why monkeys would reject slices of cucumber, a previously
“The most important one was you could argue that the monkeys reject the
cucumber pieces because they see grapes and they want grapes,” de Waal said. “We
would show them grapes, but we would put them away, and showing them the grapes
didn’t make a difference in our test. It had to do with what partner was
Brosnan and de Waal also varied the amount of effort required to complete the
task to see its effect on the monkeys’ reactions.
They found that when monkeys had to expend more effort, they were more
sensitive to inequity and less likely to accept cucumber slices when partners
had received grapes for equal or less work. But both would accept grapes even if
they completed tasks at different levels of difficulty, de Waal said.
“If you gave them grapes, they were not sensitive to effort,” he said. “The
grape is such a good reward that they would do whatever to get the grape.” ...
According to de Waal, the research illustrates inequity aversion, a concept
from the field of behavioral economics, which applies behavioral psychology to
economic interactions. Like the monkeys in de Waal’s study, humans do not always
act as rational profit maximizers and sometimes turn down good offers if someone
else is getting a better deal.
“For a monkey to refuse a perfectly fine food like cucumber just because
somebody else is getting something better is an irrational reaction,” de Waal
said. “Profit maximizing requires that whenever you can get something you take
Some scholars, however, argue that reactions like the monkeys’ make sense in
a social context. The capuchins’ sense of fairness has “evolved within the
context of cooperation,” de Waal said, because capuchins live in groups and
sometimes hunt squirrels together.
“If you don’t get in accordance to your effort, you should be sensitive to
that, or everyone will take advantage of you,” he said. “It’s actually a
rational response to make sure you get the right rewards for the right amount of
De Waal said reactions to inequity are important for researchers to study
because of widening gaps between haves and have-nots.
“How much inequity can you take in a system?” he said.
Posted by Mark Thoma on Thursday, November 22, 2007 at 03:15 PM in Economics, Income Distribution, Science |
Adam Smith's Lost Legacy
discussion of how neuroscience is confirming the role of empathy in
human sociality and morality is "worth a look":
The Theory of Moral
Neuroscience, by Ronald Bailey, Reason Online: "As we have no immediate
experience of what other men feel, we can form no idea of the manner in which
they are affected, but by conceiving what we ourselves should feel in the like
situation," observed ... Adam Smith in the first chapter of ... The Theory of
Moral Sentiments (1759). "Whatever is the passion which arises from any object
in the person principally concerned, an analogous emotion springs up, at the
thought of his situation, in the breast of every attentive spectator." Smith's
argument is that our ability to empathize with others is at the root of our
Recent discoveries in neuroscience are bolstering Smith's insights about the
crucial role of empathy in human sociality and morality. For example, in the
1990s, Italian scientists researching motor neurons in macaque monkeys
discovered mirror neurons. As the story goes, a monkey's brain had been wired up
to detect the firing of his neurons... One researcher returned from lunch
licking an ice cream cone. As the monkey watched the researcher, some of his
neurons fired as though he were eating the ice cream... The monkey's neurons
were "mirroring" the activity that the monkey was observing.
Neuroscientist Giacomo Rizzolatti and his colleagues ... reported their
discovery of monkey mirror neurons in 1996. Researchers soon found evidence for
mirror neurons in human beings. Just like monkeys, it turns out that when we see
someone perform an action—picking up a glass of water or kicking a ball—our
mirror neurons simulate that action in our brains. Researchers have suggested
that mirror neurons are crucially involved in the distinctive human development
of language, morality, and culture.
Research looking at the brains of autistic people highlights the role that
some neuroscientists believe that mirror neurons play in empathy. ...[T]he
symptoms of autism often involve a marked lack of awareness of the feelings of
others and little or no social interaction or communications with others. In
2005, researchers at the University of California San Diego (UCSD) ...[found]
"...results [that] support the hypothesis of a dysfunctional mirror neuron
system in high-functioning individuals with ASD"... Mirror neurons are not
absent from the brains of ASD people, but they are misfiring. ...
Mirror neurons are not the sole source of our moral sense. After all, ASD
individuals are not notably immoral. However, they are an important part of it.
Empathy, the ability to feel someone else's joy, pain, and gratitude, helps
guide our pre-reflective moral values. So let's consider the limits of empathy
for schooling us in morality. Harvard University psychologist Joshua Greene
offers the case in which, while driving, you see a bleeding hiker lying by the
roadside. You must decide between taking the man to the hospital or refuse to do
so because the injured man would bleed all over your expensive upholstery.
Greene correctly observes, "Most people say that it would be seriously wrong
to abandon this man out of concern for one's car seats" But what about the case
in which you receive a letter from an international charity that promises to
lift a poor family in Africa out of abject misery at the cost of a $200
contribution from you? "Most people say that it would not be wrong to refrain
from making a donation in this case," writes Greene. What's the difference? ...
Greene proposes an evolutionary answer. He points out that our ancestors evolved
in an environment in which they could only choose to save people that they knew
personally, not total strangers living continents away.
Greene's findings again buttress Adam Smith's insight from more than two
centuries ago that empathy works to prompt us to help our neighbors but
attenuates with social distance. "That we should be but little interested,
therefore, in the fortune of those whom we can neither serve nor hurt, and who
are in every respect so very remote from us, seems wisely ordered by Nature,"
writes Smith. ...
But we do not have to be the slaves of our evolved moral intuitions. By
showing us the neural workings of our moral sense, neuroscience is giving us the
tools to understand and improve our moral choices. As Greene concludes, "I am
confident that the scientific study of human nature will have an increasingly
important role in nature's grand experiment with moral animals." ...
Posted by Mark Thoma on Thursday, November 22, 2007 at 02:34 AM in Economics, History of Thought, Science |
Robert Reich says the Fed already has all the tools it needs to regulate
financial markets, but it hasn't used them effectively:
The Fed can already help subprime,
Marketplace: ...As someone who was in charge of
one of the biggest regulatory agencies in the federal government, I can tell you
regulations themselves don't do squat. They have to be vigorously enforced. And
that means setting clear rules, having enough inspectors, and knowing when
vigilance is required.
So how to prevent another banking crisis that causes millions of families to
lose their homes and investors to lose their shirts? The Federal Reserve already
has the authority it needs to do this. The Federal Reserve Act of 1913, as
amended, and the Bank Holding Company Act of 1956, give it power to monitor and
regulate the entire banking system.
The problem here was it failed to use this authority. It wasn't even paying
A few years back, when the Fed lowered short-term interest rates to 1
percent, money became so cheap the Fed should have known lenders would hand it
out to almost any borrower who could stand up straight. Especially when lenders
could immediately fob off the loans to middlemen who bundled them and sold them
Big banks, hedge-fund managers, everyone looked the other way because the
party was too much fun. And then when the Fed started raising rates, it should
have known the party would be over -- and there'd be a mess to clean up.
But the Fed didn't -- and still doesn't -- pay enough attention to the
effects of its rate settings on the practices of lenders and borrowers. It still
doesn't have enough bank examiners who know what to look for. Still doesn't know
how to oversee giant financial conglomerates whose deals are so complex even
their own top executives don't understand them. Is even now disregarding the
next banking crisis, which will be a wave of credit-card defaults.
Instead of pumping out new regulations, Congress should give the Fed the
resources it needs to use the authority it already has. Confirm new Fed
governors who will be vigilant in overseeing the banking system. And hold all
Fed appointees accountable for doing the job they're supposed to do. ...
Posted by Mark Thoma on Thursday, November 22, 2007 at 02:16 AM in Economics, Financial System, Regulation |
Posted by Mark Thoma on Thursday, November 22, 2007 at 12:35 AM in Links |
says this is recommended reading:
Dear Mr. Paulson, by Tanta: I see you're coming around to a view of the
housing and mortgage mess that has a clear reality bias. You're not there yet,
but the trend is inspiring. I want you to know that I'm from The Blogs and I'm
here to help you.
First things first: why have mortgage lenders worked out troubled loans ever
since the dawn of mortgage lending? Because lenders do what lenders do: seek
maximum profits. If a loan was supposed to earn you a dollar, but isn't earning
you anything because the borrower is not paying, and you have the choice of
restructuring, and getting, say, 90 cents, or foreclosing, and getting, say, 70
cents, you restructure. It is possible that, end of the day, you really get 91
cents instead of 90 cents if you cloak it in fine-sounding rhetoric about
keeping The Dream Alive and helping borrowers stay in their homes and stuff. (It
costs maybe a penny to write boilerplate PRs like that; you get two cents in
benefits from Happy Regulators; it nets out.)
How does this get complicated?
Continue reading "A Letter to Treasury Secretary Paulson" »
Posted by Mark Thoma on Wednesday, November 21, 2007 at 02:43 PM in Economics, Financial System, Housing, Regulation |
Ruth Marcus shows two things in her commentary today, "Krugman vs. Krugman". First, she hasn't a clue about Social Security
financing. Second, she has no problem at all presenting a distorted picture to
rationalize her clueless position.
On the Social Security financing issue, the most recent pieces I've seen are by Dean Baker, "The
crisis that isn't," and Paul Starr, "Hold that Tax," but there's been so much written that it's hard to
believe that anyone who isn't being willfully ignorant could be unaware of the true
magnitude of the problem - the system is not headed for disaster, for a crash, or anything like that.
Anyone interested in understanding the financing issues ought to read
America's Senior Moment by Paul Krugman. I refer you to this particular
piece, from the New York Review of Books and written in 2005, because Ruth Marcus uses quotes from Paul Krugman dated 2001
or earlier to try to show he has been inconsistent on the Social Security financing issue. The subtext is, or course, that he is being dishonest.
But had Ruth Marcus included this quote from Paul Krugman's 2005 piece in her
editorial (or quotes from other pieces of the vast amount Krugman has written about
Social Security after 2001), it would have changed the interpretation of the quotes she includes in her article. Here,
Paul Krugman explains why the future of Social Security was at issue at that
Four years ago, I and many other economists urged policymakers to think about
the future cost of Social Security benefits, not because we thought there was
anything wrong with Social Security itself, but because we regarded the future
costs as a compelling reason not to cut taxes even if the overall budget was in
Keep that quote in mind, i.e. that the worry was that the Bush tax cuts would
eat away at the accumulated Social Security surplus, as they did, as you read
Ruth Marcus' desperate attempt to justify her doom and gloom about the future of
Krugman vs. Krugman, by Ruth Marcus, Commentary, Washington Post: In liberal
Democratic circles, the debate over Social Security has taken a dangerous "don't
worry, be happy" turn.
The argument has two equally dishonest components. The first is to deny that
Social Security faces a daunting financing problem... The second is to
mischaracterize the arguments of those who advocate responsible action, accusing
them of hyping the system's woes.
One prominent practitioner of this misguided approach is New York Times
columnist Paul Krugman. "Inside the Beltway, doomsaying about Social Security --
declaring that the program as we know it can't survive the onslaught of retiring
baby boomers -- is regarded as a sort of badge of seriousness, a way of showing
how statesmanlike and tough-minded you are," Krugman wrote last week. "In fact,
the whole Beltway obsession with the fiscal burden of an aging population is
Somebody should introduce Paul Krugman to . . . Paul Krugman.
"[A] decade from now the population served by those programs [Social Security
and Medicare] will explode. . . . Because of those facts, merely balancing the
federal budget would be a deeply irresponsible policy -- because that would
leave us unprepared for the demographic deluge, with no alternative once it
arrives except to raise taxes and slash benefits." (July 11, 2001)
"Broadly speaking, the next administration . . . will face two big economic
tests. One . . . is whether it can stick to a fiscal policy, including a policy
toward Social Security, that prepares this country for the demographic deluge."
(Nov. 12, 2000) ...
You get the idea, a lot of the article is just quotes from Krugman from 2001
or earlier (she even reaches back to 1996 at one point) as she tries to turn his concern over the effect tax cuts would have on the surplus, and hence our ability to meet future obligations, into more general concern over a potential crisis in the Social Security program even though that isn't what he was saying (and note the first quote also includes Medicare). The article then
discusses whether or not Krugman mischaracterized the positions of politicians
and the Washington Post editorial board, and again selectively quotes Krugman and others to try
to justify her argument, but that, of course, has nothing at all to do with
whether there is a Social Security "crisis". If there is no crisis - and there isn't - then it
is being over-hyped. She doesn't think it's being over-hyped, but that's because she misunderstands the nature of the problem.
Not much of an argument - all it does for the most part is compare quotes from Krugman then and
now without putting them in context (and leaving out a whole bunch of other
quotes between 2001 and now). Even if there weren't an obvious context to
Krugman's prior remarks, what if he had changed his mind as the evidence became clearer. What's
wrong with that? That is, showing that someone said one thing in the past, and now
says something different as they have learned more about the problem does not
imply that what is said now is wrong or dishonest. What matters is if the new
position is justifiable, and if Ruth Marcus wants to debate Paul Krugman on the
correctness of his current postion on Social Security, which is, by the way, consistent with his prior position, all I can say is good
luck -- though even the best of luck won't be enough to overcome the reality that
she is on the wrong side of this argument.
Update: Here is Paul Krugman's response.
Update: More from Paul Krugman:
A thought about political discourse, by Paul Krugman: A meta-thought
inspired by the Social Security craziness:
Faced with a major public issue, such as the future of Social Security, one
might think that the crucial thing would be to ascertain the facts. If I say
“there is no crisis,” and you think there is, well, produce the evidence that
shows that my
arithmetic is wrong — not something I once said that you think proves that
I’ve changed my mind. Making this a game of gotcha is just childish.
But here’s the thing: this childishness infects a lot of political discourse.
Think about what passes for a “tough” question on the Sunday talk shows. It’s
not “Senator Bomfog — you say X, but the statistics show that it’s actually Y.
How can you explain this discrepancy?” In fact, I’ve never seen that happen. In
political reporting, being wrong means, at most, that your claims are “in
No, what actually passes for “tough” questioning is “Senator Bomfog, you say
X but last year you said Y. Aren’t you flip-flopping?”
Like I said, it’s childish — and destructive.
Posted by Mark Thoma on Wednesday, November 21, 2007 at 12:33 AM in Economics, Politics, Social Security |
The Fed released its "new and expanded forecast":
Fed Forecasts Emphasize Risks, by Greg IP: Federal Reserve officials, in a
new and expanded forecast, expect the nation's economy to grow sluggishly next
year and see risks of an even worse performance.
They also expect food and energy prices to continue putting upward pressure
on inflation, but say underlying inflation is now, and will remain, within the
target range implied by their new forecast.
The enhanced forecasts by officials of the Fed's policy-setting Federal Open
Market Committee underline the conflicting pressures on the central bank to cut
interest rates to protect economic growth or to hold them steady to quell
The Fed appears to put the economy's "potential" growth rate -- what it can
achieve given long-term growth in the work force and output per worker -- at a
mere 2.5%, well below the average annual growth of 3.1% recorded over the past
12 years and the Congressional Budget Office's 2.9% estimate of potential
growth. That means a growth rate that others consider substandard might be
viewed as healthy, or even inflationary, by the Fed.
FOMC members expect overall inflation, measured by the price index for
personal-consumption expenditures, of 1.8% to 2.1% next year, reflecting
continued upward pressure from rising energy and food prices. They expect core
inflation, which excludes those two factors, of 1.7% to 1.9%. With core
inflation now 1.8% and expected to remain there, the Fed isn't under pressure to
push it lower.
By 2010, the Fed official said they expect overall and core inflation between
1.6% and 1.9%. Given that Fed officials expect to be able to achieve their
desired inflation rate within three years, this range is the Fed's de facto
inflation target. The 1.75% midpoint of this range is higher than that of the 1%
to 2% comfort zone popularized in 2002 by Ben Bernanke, then a Fed governor...
The minutes, and an accompanying study by staff economists David
Reifschneider and Peter Tulip, emphasize that projections are subject to a lot
of forecasting error, and those errors grow the further the forecast goes into
the future. Based on the track record of forecasts, they say there's a 70%
chance growth will be 1.3 percentage points higher or lower than the FOMC
forecasts next year, and 1.4 points higher or lower in subsequent years.
See also (1)
Dovish Fed vs. Hawkish Fed: More on the FOMC Minutes and
Fed’s New Forecasts: What’s Surprising and What Isn’t for more from the WSJ;
So now you know by Jim Hamilton who is surprised by the three year ahead forecasts for relatively low output growth, as well as the forecast for relatively low inflation.
Posted by Mark Thoma on Wednesday, November 21, 2007 at 12:24 AM in Economics, Monetary Policy |
Why do resource rich countries experience slower growth?:
Resource Abundance and
Corporate Transparency, by Art Durnev and Sergei Guriev, Vox EU: High oil
prices brought the issue of so-called “resource curse” back to the frontlines of
public debate. It has long been noticed that resource abundance does not always
help countries grow out of poverty; instead, they often fall victim of poor
governance and internal conflicts. Moreover, among the developing countries
which did close the gap with the rich countries in the recent decades, the
majority have been resource-poor.
It is still not clear what exactly prevents resource-rich countries from
making use of their resource endowments. The newly emerging consensus among
economists is that resource abundance slows down, or may even revert,
development of growth-enhancing institutions. This conjecture is no longer just
an academic hypothesis. Recently, it has been widely discussed by policymakers
and the media. In particular, the New York Times’ columnist Tom Friedman’s
formulated it as the First Law of Petropolitics: high oil prices stifle the
development of democracy and political and economic freedom in oil-rich
Our work ... supports the emerging consensus that slower growth in
resource-rich economies may be explained by the negative impact of resource
endowments on the development of economic and political institutions, which in
turn suppresses economic growth. We show that it is not an abstract theory; nor
should the existing cross-country comparisons be disregarded as a coincidence or
a spurious correlation. It turns out that resource curse is indeed a corporeal
phenomenon. It affects – in a very tangible way – corporate transparency in
actual corporations. This in turn results in material consequences for capital
allocation and growth of these firms. ... [...continue
Posted by Mark Thoma on Wednesday, November 21, 2007 at 12:15 AM in Economics |
Posted by Mark Thoma on Wednesday, November 21, 2007 at 12:06 AM in Links |
Brad Setser on the dollar:
A little too late, by
Brad Setser: China's premier, Wen Jiabao, has joined the chorus voicing
concern about the dollar's recent weakness. ... Wen certainly has reason to
worry. No one has made a bigger bet on the dollar that China's government.
I personally suspect that China's state ... hold[s] around $1.2 trillion in
fairly long-term dollar-denominated debt. ...
The capital loss on those dollars could be considerable. ...[W]hat
should really worry China's leadership is that the dollar is very unlikely to
hold its value relative to the RMB. After all, China's government has
financed its dollar purchases by issuing RMB debt. ... Moreover, the Hu/ Wen
policy of only allowing gradual RMB appreciation -- out of fear that fast
appreciation would be disruptive -- largely explains why China now holds so many
The majority of China's dollar exposure comes from intervention over the last
three years. That puts Wen in a bit of a bind. His [recent] comments were no
doubt intended to tell Washington that it needs to start paying more attention to
the value of the dollar. Yet domestic US conditions likely call for the Fed to cut rates to support
the US economy, not raise them to defend the dollar. ...
Wen cannot force the US to direct its policy at defending the dollar's
external value anymore than the US can force China to stop intervening in the
foreign exchange market. He could, of course, conclude that China can no longer take the risk of
holding so much of its wealth in dollars, and stop adding to China's dollar
But doing so would truly cause the dollar's value to tumble. It would
dramatically reduce the value of China's existing dollar holdings. As
importantly, it would -- absent a change in China's currency policy -- also push
the RMB down and push up Chinese inflation.
No wonder Wen is unhappy. ...
The US slowdown has brought a lot of latent tensions to the surface -- in the
Gulf ... as well as in China.
Willem Buiter is worried about a scenario where foreign demand for all US
bonds -- not just demand for CDOs and riskier bonds -- disappears. ...
Menzie Chinn notes, the US hasn't locked in low interest rates in dollars
forever. What if the US turns out to be borrowing at what amounts to a low
initial teaser rate? ...
[The] system where the Gulf, China and some other Asian economies intervene
heavily in order to resist market pressure for appreciation ... is under a lot of
strain. Both China and the Gulf are starting to worry about the all the
(depreciating) dollars they now have to absorb to sustain the system, even if
they haven't actually balked at buying those dollars.
It consequently really shouldn't be a surprise that a range of countries are
now asking the US to take policy actions -- notably steps to defend the dollar
-- that will reduce the strain that the system places on them. ...
In some sense, the current system seems poised at a knife's edge. ... There
are a set of investors -- China's government, Japan's government, some large oil
exporters and for that matter most domestic US investors -- that are
significantly overweight in US financial assets. ... If those investors with lots of dollars decide that they already have to many
and try to reduce their dollar holdings, watch out. ...
On the other hand, the dollar has already fallen rather substantially against
most European currencies. ... At some point investors who are holding lots of
euros or pounds might decide that the dollar is cheap. ...
I am not sure which outcome -- at attempt by those already over-weight
dollars to lighten up, or a decision by others that the dollar already has
fallen by too much against the euro -- is more likely. I can see the case for
both, though the absence of any real signs of resurgent demand for US financial
assets suggests, at least to me, that there is a slightly higher chance of even
more dollar weakness. ...
Paul Krugman notes Brad Setser's question, "What if the US turns out to be borrowing at what amounts to a low
initial teaser rate?", then
On the whole, I think people are
worrying too much about the falling dollar. But it’s certainly true that
Wile E. Coyote has looked down, and things will be very different from the
way they were in the mid-00s.
Posted by Mark Thoma on Tuesday, November 20, 2007 at 04:50 PM in Economics, Financial System, International Finance |
Giovanni Peri reviews research on how immigration impacts cities. The research shows that "the less-educated [are] relatively unaffected by
immigration while highly-educated and houseowners gain from it":
Immigration and cities,
by Giovanni Peri, Vox EU: Immigration is one of the new century’s ‘hot
button’ issues. Whether it is Romanians in Milan or Mexicans in Los Angeles, the
concern and the debate has intensified. Political campaigns are fought and won
on the issue in several nations and it has shifted party politics in many
others. Most of the concern and political backlash focuses on the large and
increasing presence of immigrants in cities – especially low-education
This is easy to understand from the facts. In the US and Europe, immigration
is disproportionately directed to cities, especially large metropolitan areas.
In the recent decade immigrant arrivals – currently around 1.25 million people
per year – accounted for 40% of the US population growth and for 50-75% of the
growth of its largest metropolitan areas. For instance, 27% of people residing
in London are foreign-born, as well as 28% of people in New York and 17% in
Paris, vis-à-vis much lower national averages (respectively equal to 9%, 12.1%
and 10% for the UK, the US and France).
Percentage of Immigrants in Top US cities
||Population in millions
||Percentage of foreign-born
|Top 17 metropolitan areas
Source: U.S. Bureau of Census, July, 2006.
What are the real effects of immigration on wages, rents and local prices
faced by the natives? Does immigration drive out the native population? In
theory it can work either way. In a static Walrasian world with homogeneous
workers, an inflow of workers tends to depress wages, drive up rents and push
out natives. However if variety of skills, complementarities in production and
agglomeration economies are important, immigration could raise productivity of
natives; immigration can drive urban growth which then makes the cities more
economically attractive. The matter cannot be settled by logic. Facts are
Recent research One recent strand of research uses data from US cities
and states to explore issues such as the response of natives to immigrants and
the impact of immigration on the local economy. Recent research by David Card
and others is identifying important regularities that point to a positive
productivity effect of immigrants on natives overall, and to an increase of
average housing value in high immigration cities. These average effects,
however, are accompanied by an important distributional component. Highly
educated natives enjoyed the largest benefits while the less educated did not
gain (but did not lose much either) from immigration to their cities. In a
series of recent papers coauthored with Gianmarco Ottaviano, I use US data to
analyze the impact of immigration on wages, rents and local prices faced by
native workers accounting also for the response of natives to immigrants in the
form of relocation.
Crowding out natives? From a pure accounting perspective, immigrants
were responsible for about 50% of the population growth of the top 100 US
metropolitan areas during the 1990s. However, if the inflow of immigrants caused
an outflow of native workers (towards areas with low immigration), it would
simply change the composition of a city but would not produce net population
growth. Analyzing the response of native population to immigrant population
across cities, we find instead that large inflows of immigrants over the period
1970-2005 were not associated with any reduction of native population growth. In
fact, in most cases, large immigration flows were associated to larger
population and employment growth for natives as well. A part of this positive
correlation is due to the fact that booming cities attracted natives and
immigrants alike. However, we also isolated an immigrant-specific 'pull factor'
in each city, in the form of enclaves of earlier immigrants that preferentially
attracted co-nationals in period of large outmigration from the country of
origin. Even these 'pull-driven' inflows of immigrants were not related at all
to outflows of natives, which disproves the theory of crowding out.
Effects on wages and house prices A second result emerges from the
cross-city analysis and it is similarly robust and significant. The average wage
of native workers and the average housing price increased significantly more in
cities with large immigration flows than in cities with low immigration flows
over the period 1970-2005. While part of this effect is also explained by the
'booming city' theory, isolating the immigrant-specific pull-driven variation we
still find that a 1% increase in the share of foreign-born increased the average
native wages by around 0.3-0.4%, and the average house prices (and rents) by 1%.
These positive average effects, however, are accompanied by distributional
effects. Analyzing the impact by education group we find that native workers
with no high school diploma experienced a small reduction in wages and small
increase in their rents as a consequence of immigration, while those with
college education experienced a significant wage and rent increase.
Click to enlarge
Our explanation of the positive wage effects relies on an important mechanism
that seems to be operating in cities as well as in the US economy as a whole,
and is based on the fact that the skill composition of immigrants is
complementary to that of natives. Foreign-born individuals in the US are
over-represented among workers with low skills (no degree) and among those with
very high skills (graduate degrees particularly in science and technology). On
the other hand, foreign-born are under-represented among workers with
high-school and some college education. Most American workers, therefore (70% of
which have high school or some college education), do not compete with
immigrants for similar jobs but benefit from their complementary productive
tasks. Moreover, even at similar levels of education native and immigrant
workers tend to specialize in different occupations.
For instance, in related research I found that among less educated
workers, immigrants specialize in manual intensive tasks such as cooking,
driving and building while natives specialize in language-intensive tasks such
as dispatching, supervising and coordinating. The productivity of supervisors,
clerks and accountants benefits from the productive services of construction
workers, hand packers and janitors in their company. Similarly at high levels of
education foreign-born specialize in analytical-mathematical tasks and natives
in managerial-language intensive tasks. Again, lawyers’ productivity benefits
from the competence of their computer and information technology assistants.
Such skill differences translate into limited competition in the labour market
and rather complementarities, inducing higher demand (and productivity) for
native skills in economies where the supply of immigrants increases. As these
complementarities work within as well as across education groups, there is a
benefit for natives overall in producing in an economy with immigrants (the
positive average wage effects). However the largest benefits are for those with
intermediate and high education that do not compete at all for jobs with the
large group of less educated immigrants.
On the other hand, this higher productivity of natives overall and the
increased city population generates upward pressure on housing prices and rents.
These effects, in the long run, induce more house building, so that their impact
on house prices should not be large. This is true for housing of less educated
workers who live in less desirable locations whose supply is very large.
However, more educated individuals, who concentrate in highly desirable urban
locations (e.g. Manhattan, Santa Monica or Downtown San Francisco), face a space
constraint and experience increasing house values even in the long run.
Interestingly, our quantitative estimates imply an almost exact wash between
the increase in average wages and that in average rents, at least on average, so
that the real local wage, corrected for local prices is left essentially
unchanged. This can be interpreted as an effect of native’s mobility as they
'arbitrage away' real wage differences by moving across cities. The productive
effect of immigrants ultimately accrues to house-owners who see the value of
their houses increase.
Other effects The positive average wage effect combined with a
somewhat adverse distributional effect and a positive house price effect (mostly
for highly educated) leaves the less-educated relatively unaffected by
immigration while highly-educated and houseowners gain from it. Where,
therefore, does the vastly negative reaction to immigration come from? Two
important channels, relative to local public good provision, are left out of our
analysis. First, fiscal cost of immigrants at the local level may be relevant,
especially if they use public goods (such as hospitals and schools) more than
natives do and, because of their income, they contribute less in local taxes.
Second, people seem to attribute positive value to living in ethnically
homogeneous neighborhoods and to sending children to school with better-educated
high-income families. Moreover, there may be important peer effects in education
and learning. Opinion polls suggest that people may care significantly about
these aspects of immigration.
Bottom line Our research shows that market-mediated economic effects
of immigrations are mostly positive for natives. However, in order to affect
policies it is also crucial to understand better the welfare-related effects and
the peer effects that may explain most of the negative attitude towards
1 David Card (2007) “How Immigration Affect U.S. Cities” CReAM Discussion
paper #11/07, June 2007.
2 G.I.P. Ottaviano and G. Peri (2007) “The Effects of Immigration on U.S. wages
and rents: a general equilibrium Approach” CEPR Discussion Paper # 6551; G.I.P.
Ottaviano and G. Peri (2006) “The Economic Value of Cultural Diversity: Evidence
from U.S. cities” Journal of Economic Geography, Vol. 6, Issue 1, Pages
9-44; and G.I.P. Ottaviano and G. Peri (2005) “Cities and Cultures” Journal
of Urban Economics, Volume 58, Issue 2, Pages 304-307.
3 G. Peri and C. Sparber (2007) “Task Specialization, Comparative Advantages,
and the Effects of Immigration on Wages” NBER Working Paper, # 13389, September
4 As reported above an increase in the share of immigrants by 1% increases rents
by 1% and wages by 0.3-0.4%. As housing cost account for about 30% of total
family expenditure the change in the local price index due to immigration is
0.3*1%=0.3% which is similar to the change in wages.
Posted by Mark Thoma on Tuesday, November 20, 2007 at 02:52 AM in Economics, Immigration, Unemployment |
In his remarks on the East Asia crisis and the financial hypocrisy summarized
in the post below this one, Joseph Stiglitz says:
The poor were among those who bore the biggest burden of the crisis, as wages
plummeted and unemployment soared. As countries emerged, many placed a new
emphasis on "harmony," in an effort to redress the growing divide between rich
and poor, urban and rural.
They gave greater weight to investments in people, launching innovative
initiatives to bring health care and access to finance to more of their
citizens, and creating social funds to help develop local communities.
Dani Rodrik discusses whether "investing in people" is always the best
Pro-poor growth, social growth, or just growth?, by Dani Rodrik: Income per
head in a landlocked African country stands at a fraction of levels it had
reached in the 1970s, with only the last few years seeing some decent economic
growth. What kind of a growth strategy should this country follow? A strategy
that focuses on expanding employment opportunities in the rural areas where most
of the poor live? Should it consist of expanding their capabilities, by
investing directly in education and health? Or should it focus on wherever the
economic activities that will provide sustainable sources of income growth into
the future lie, even if these may be in mostly urban areas and likely to foster
greater inequality in the short-run?
These are the unexpected questions which a meeting with the World Bank
raised... When my colleagues and I pushed for a growth strategy that focused,
well, on growth, the reaction from the World Bank staff present was skeptical.
It was pro-poor growth they wanted. ... Growth should be social growth, which
means investing in people...
Here is how I see it. Having a growth strategy that focuses on growth proper
... does not mean that you don't care about poverty or inequity. It just means
that you recognize different targets require different strategies. I recognize
that a growth policy may not necessarily achieve significant poverty reduction
in the short-run. That is why there is always room for social policy. Growth
policy is not social policy--at least not necessarily in the short to medium-run
(although in the long-run it probably is the most effective social policy we can
think of). But it is indispensable to generate a sustainable increase in the
economy's resources and long-run living standards. ...
And by the same token, social policy (targeting the poor directly) should not
be confused for a growth strategy. Trying to come up with "pro-poor growth
strategies" may backfire if it shortchanges us on growth while distracting us
from the need for proper social policies.
Posted by Mark Thoma on Tuesday, November 20, 2007 at 02:34 AM in Economics, Policy |