links for 2009-01-11

• The Case for Bigger Government - Jeff Sachs
• Why there's so little good evidence that policy works - Nick Rowe 
• Compete to give - Interfluidity 
• Social agency and rational choice - Understanding Society
• We're Borrowing Like Mad. Can the U.S. Pay It Back? - washingtonpost.com
• To the Last Syllable of Recorded Time - Bradford Plumer

Comments

[Meh]

Elegant graphs on how the theory that says "minimum wages reduce employment and total societal benefit/wealth creation" also actually prove that "excessive share of profits by capital" also has the same effect.

A must read:

http://www.eurotrib.com/?op=displaystory;sid=2009/1/9/184422/4805

Inequality is inefficient.

says...

"...the monetary authority is responding (even if incorrectly) only to F and I, then we still get perfect collinearity, and the econometrician is still helpless."

So the fact that policy responds to employment creates a statistical relationship between interest rates and employment. However, this only means that employment causes policy to change interest rates, not that interest rates can reduce unemployment. Interesting.

[anne]

http://krugman.blogs.nytimes.com/2009/01/11/more-on-romerbernstein/

January 11, 2009

More on Romer/Bernstein
By Paul Krugman

Still picking over the Romer/Bernstein official evaluation * of the Obama economic plan. Again, kudos to the team for producing such a clear, honest assessment. But the more I look at the report, the more I wonder why anyone in the Obama team thinks the plan is adequate.

Here’s one way to look at it: R/B show the effects of the plan rapidly fading out during 2011. Yet at the end of 2011 the unemployment rate is still 6.3%. Meanwhile, the CBO estimates the natural rate, aka “full employment,” at just 4.8%. Why does the plan go away with the job undone?

* http://otrans.3cdn.net/45593e8ecbd339d074_l3m6bt1te.pdf

[anne]

http://krugman.blogs.nytimes.com/2009/01/10/romer-and-bernstein-on-stimulus/

January 10, 2009

Romer and Bernstein on Stimulus
By Paul Krugman

[Figure] Is this enough?

OK, Christina Romer and Jared Bernstein have put out the official (?) Obama estimates * of what the (American Association of Retired Persons) American Recovery and Reinvestment Plan would accomplish. The figure above summarizes the key result.

Kudos, by the way, to the administration-in-waiting for providing this — it will be a joy to argue policy with an administration that provides comprehensible, honest reports, not case studies in how to lie with statistics.

That said, the report is written in such a way as to make it hard to figure out exactly what's in the plan. This also makes it hard to evaluate the reasonableness of the assumed multipliers. But here's the thing: the estimates appear to be very close to what I've been getting.

The key thing if you want to do comparisons is to note that I made estimates of the average effect over 2009-2010, while they do estimates of effect in the fourth quarter of 2010, which is roughly when the plan is estimated to have its maximum effect. So they say the plan would lower unemployment by about 2 percentage points, I said 1.7, but their estimate may actually be a bit more pessimistic than mine. They have the plan raising GDP by 3.7 percent, but that's at peak; I thought ** 2.5 percent or so average over 2 years, again not much difference.

So this looks like an estimate from the Obama team itself saying — as best as I can figure it out — that the plan would close only around a third of the output gap over the next two years.

One more point: the estimate of what would happen to the economy in the absence of a stimulus plan seems kind of optimistic. The chart above has unemployment ex-stimulus peaking at 9 percent in the first quarter of 2010 and coming down through the year; the CBO estimates *** an average unemployment rate of 9 percent for 2010, so the Obama people are more optimistic than the CBO, and a lot more optimistic than I am.

Bottom line: even if I use the Romer-Bernstein estimates instead of my own — there really isn't much difference — this plan looks too weak.

* http://otrans.3cdn.net/45593e8ecbd339d074_l3m6bt1te.pdf

** http://www.nytimes.com/2009/01/09/opinion/09krugman.html

*** http://www.cbo.gov/ftpdocs/99xx/doc9957/01-07-Outlook.pdf

[anne]

http://krugman.blogs.nytimes.com/2009/01/10/risks-of-deflation-wonkish-but-important/

January 10, 2009

Risks of Deflation (Wonkish But Important)
By Paul Krugman

Feeling a bit deflated [Chart]

There's been some talk abut risks of deflation, but there's one alarming comparison I haven't seen made. The figure above shows that the CBO is currently projecting an output shortfall from the current slump comparable to the slump of the early 1980s. Actually, it's very close: if you compare the CBO's projections of unemployment * from 2008 through 2012 with its estimate of the natural rate, we're looking at cumulative excess unemployment of 13.9 point-years; that compares with 13.7 point years from 1980 through 1986. (If the natural rate — the unemployment rate that keeps inflation unchanged — is 5 percent, and the actual unemployment rate averages 7 percent over a year, that's 2 point-years of excess unemployment.)

Now here's the thing: the slump of the early 1980s produced the Great Disinflation, which brought the core inflation rate down from about 10 to about 4.

This time, however, we entered the slump with a core inflation rate of about 2.5 percent. If we experienced a disinflation comparable to that of the 1980s, that would mean ending up with deflation at a rate of -3.5 percent.

And bear in mind that neither the CBO nor the Obama team ** really explains where recovery comes from; it's just assumed.

So tell me why we aren't looking at a very large risk of getting into a deflationary trap, in which falling prices make consumers and businesses even less willing to spend. Tell me why this risk wouldn't remain high, though lower, even with the Obama plan, which as far as I can tell is expected to reduce cumulative excess unemployment by about a third.

* http://www.cbo.gov/ftpdocs/99xx/doc9958/01-08-Outlook_Testimony.pdf

** http://krugman.blogs.nytimes.com/2009/01/10/romer-and-bernstein-on-stimulus/

[anne]

http://krugman.blogs.nytimes.com/2009/01/06/stimulus-arithmetic-wonkish-but-important/

January 6, 2009

Stimulus Arithmetic (Wonkish But Important)
By Paul Krugman

Bit by bit we're getting information on the Obama stimulus plan, enough to start making back-of-the-envelope estimates of impact. The bottom line is this: we're probably looking at a plan that will shave less than 2 percentage points off the average unemployment rate for the next two years, and possibly quite a lot less. This raises real concerns about whether the incoming administration is lowballing its plans in an attempt to get bipartisan consensus.

In the extended entry, a look at my calculations.

The starting point for this discussion is Okun's Law, the relationship between changes in real GDP and changes in the unemployment rate. Estimates of the Okun's Law coefficient * range from 2 to 3. I'll use 2, which is an optimistic estimate for current purposes: it says that you have to raise real GDP by 2 percent from what it would otherwise have been to reduce the unemployment rate 1 percentage point from what it would otherwise have been. Since GDP is roughly $15 trillion, this means that you have to raise GDP by $300 billion per year to reduce unemployment by 1 percentage point.

Now, what we're hearing about the Obama plan is that it calls for $775 billion over two years, with $300 billion in tax cuts and the rest in spending. Call that $150 billion per year in tax cuts, $240 billion each year in spending.

How much do tax cuts and spending raise GDP? The widely cited estimates ** of Mark Zandi of Economy.com indicate a multiplier of around 1.5 for spending, with widely varying estimates for tax cuts. Payroll tax cuts, which make up about half the Obama proposal, are pretty good, with a multiplier of 1.29; business tax cuts, which make up the rest, are much less effective.

In particular, letting businesses get refunds on past taxes based on current losses, which is reportedly a key feature of the plan, *** looks an awful lot like a lump-sum transfer with no incentive effects.

Let's be generous and assume that the overall multiplier on tax cuts is 1. Then the per-year effect of the plan on GDP is 150 x 1 + 240 x 1.5 = $510 billion. Since it takes $300 billion to reduce the unemployment rate by 1 percentage point, this is shaving 1.7 points off what unemployment would otherwise have been.

Finally, compare this with the economic outlook. "Full employment" clearly means an unemployment rate near 5 — the CBO says 5.2 for the NAIRU, **** which seems high to me. Unemployment is currently about 7 percent, and heading much higher; Obama himself says that absent stimulus it could go into double digits. Suppose that we're looking at an economy that, absent stimulus, would have an average unemployment rate of 9 percent over the next two years; this plan would cut that to 7.3 percent, which would be a help but could easily be spun by critics as a failure.

And that gets us to politics. This really does look like a plan that falls well short of what advocates of strong stimulus were hoping for — and it seems as if that was done in order to win Republican votes. Yet even if the plan gets the hoped-for 80 votes in the Senate, which seems doubtful, responsibility for the plan's perceived failure, if it's spun that way, will be placed on Democrats.

I see the following scenario: a weak stimulus plan, perhaps even weaker than what we're talking about now, is crafted to win those extra GOP votes. The plan limits the rise in unemployment, but things are still pretty bad, with the rate peaking at something like 9 percent and coming down only slowly. And then Mitch McConnell says "See, government spending doesn't work."

Let's hope I've got this wrong.

* Take the Okun's law equation :

Multiplier = a

Actual growth = potential growth - a x d(unemployment rate),
which implies
Potential growth = actual growth + a x d(unemployment rate).

** http://www.economy.com/mark-zandi/documents/Small%20Business_7_24_08.pdf

*** http://www.google.com/hostednews/ap/article/ALeqM5j6z3BcdWqtB2Un5otM0G5JpRoH_QD95HKNU80

**** Non-Accelerating Inflation Rate of Unemployment

[Inflation is the Enemy]

Post..."Once the recession is over, getting our debt burdens down will hinge on Obama's and Congress's willingness to confront the looming cost of Social Security and Medicare benefits for the aging U.S. population."

Constant inflation has already all but destroyed 2 of the private sector retirement supports. Corporate pensions have been inflated away, and 401k plans were forced into stocks as an inflation hedge. The stock market has now crashed back to 1973 levels in CPI adjusted terms, destroying 401k plans. Now, lobbying has begun to destroy the final retirement support for the private sector (Social Security).

Constant inflation has made most of the baby boom helpless to adequately supplement their Social Security, and chronic deficits have made it impossible to borrow enough in the future to maintain Social Security. Constant inflation has systematically reduced the standard of living that can be derived from a job (one job used to be enough to support a family, now it takes 2 or more), and now inflation is destroying the retirement that can be derived from a job. Inflation is the enemy of consumers.

[anne]

"Once the recession is over, getting our debt burdens down will hinge on Obama's and Congress's willingness to confront the looming cost of Social Security and Medicare benefits for the aging U.S. population."

This is a lie.

"Constant inflation has already all but destroyed 2 of the private sector retirement supports."

This is another lie.

Rock on.

[anne]

"Constant inflation has made most of the baby boom helpless to adequately supplement their Social Security, and chronic deficits have made it impossible to borrow enough in the future to maintain Social Security."

The meanest lie of all. Social security has a massive and growing surplus and the surplus will continue to grow for another decade and will last for full benefits payments for decade beyond then and possibly will last indefinitely, but the would-be destroyers of Social Security must lie about this.

[GloomBoom]

"We're Borrowing Like Mad. Can the U.S. Pay It Back?"

We have no way to pay back the massive borrowing we have incurred through the Bush years and will incur through the Obama years. Not only are we "backstopping" Fannie and Freddie to the tune of $5 trillion, but have made commitments that will be hard to keep. Factor in the unfunded liabilities and we are in deep shiznit.

With tax cuts on the table and the economy contracting, tax revenues will decrease dramatically. The answer is that we can not pay back this debt and future debt and in one form or other will default within the eight years Obama will be in office.

[Barkley Rosser]

WaPo and the NYT both have editorial pages that have bought the phoney kool aid about social security. During the campaign Obama seemed to have resisted it, perhaps even partly due to input by some who sometimes make comments here.... :-).

I am now concerned about the prominence of Larry Summers as "the top economic adviser" to Obama. I fear that his link with Obama's old law school (Harvard) and his glib assertiveness (plus unquestioned sheer smarts) may have let him push himself to the front of the line. As it is, during the Clinton years he was one of those beating the "social security is in crisis" drum, along with all that garbage financial deregulation. Heck, one of the reasons I supported Obama over Hillary was precisely not to have certain Clintonites like him around running economic policy.

All I can say is that I hope Obama sticks with his campaign platform, which says put fica on higher income people in 2019 if the system needs it, which in more practical terms means: do nothing at all to or with social security during the entirety of his presidency. But there is an awfully strong mafia of social security "reformers" who are going to go to work on him, with Summers at their head, I fear.

[anne]

"The answer is that we can not pay back this debt and future debt and in one form or other will default within the eight years Obama will be in office."

Another lie. Amendment 14 to the Constitution makes it impossible for the federal government to default on debt, so the idea that there can be or will a default is entirely false. The most troublesome effect of increased debt would be that interests rates on government borrowing would increase making maintaining the debt relatively more costly, nonetheless default is impossible.

[anne]

http://krugman.blogs.nytimes.com/2009/01/03/economists-behaving-badly/

January 3, 2009

Economists Behaving Badly
By Paul Krugman

Ouch. The Wall Street Journal's Real Time Economics blog has a post * linking to Raguram Rajan's prophetic 2005 paper ** on the risks posed by securitization — basically, Rajan said that what did happen, could happen — and to the discussion at the Jackson Hole conference by Fed vice-chairman Kohn and others. *** The economics profession does not come off very well.

Two things are really striking here. First is the obsequiousness toward Alan Greenspan. To be fair, the 2005 Jackson Hole event was a sort of Greenspan celebration; still, it does come across as excessive — dangerously close to saying that if the Great Greenspan says something, it must be so. Second is the extreme condescension toward Rajan — a pretty serious guy — for having the temerity to suggest that maybe markets don't always work to our advantage. Larry Summers, I'm sorry to say, comes off particularly badly. Only my colleague Alan Blinder, defending Rajan "against the unremitting attack he is getting here for not being a sufficiently good Chicago economist", emerges with honor.

* http://blogs.wsj.com/economics/2009/01/01/ignoring-the-oracles/

** http://www.kc.frb.org/publicat/sympos/2005/PDF/Rajan2005.pdf

*** http://www.kc.frb.org/publicat/sympos/2005/PDF/Kohn2005.pdf

[anne]

Barkley Rosser:

"I am now concerned about the prominence of Larry Summers as 'the top economic adviser' to Obama."

Agreed completely; Lawrence Summers is a poor choice for economic adviser for the threat to Social Security and economic issues ranging from turning away at critical times from regulation of credit markets to energy markets. Summers was turning from Krugman when Krugman was trying to explain how the California energy market was being manipulated.

says...

U.S. Constitution: Fourteenth Amendment Section. 4a. "The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned..."

http://caselaw.lp.findlaw.com/data/constitution/amendment14/

Default via inflation has happened regularly since the amendment was ratified. 14 says nothing about inflation. Unfortunately, 14 only guarantees the nominal debt, not the real debt. The problem with inflating away the national debt (including the trust fund) is that pensions and meager middle class private savings will also be inflated away. Most of the baby boomers are doomed to gloomy economic outlook when they retire.

[anne]

"Default via inflation has happened regularly since the amendment was ratified."

OMG!

Let me try to explain still again, for the hard of understanding.

Inflation simply lowers the price and increases the yield of bond portfolios. Any bond portfolio has a duration, which shows the relation between price and yield for the portfolio, and with a relatively constant duration shows how long a time is needed for inflation to be compensated by increased yield.

So, a duration of about 2 years as characterized Vanguard short-term bond portfolios would mean that an increase in interest rates of 1 percentage point would lower the portfolio price by 2 percent, but investors would gain the return begun with in about a 2 year period.

[anne]

The Vanguard Aa3 rated short-term investment grade bond fund, with a maturity of 2.7 years and a duration of 1.9 years, has a yield of 5.55%. So, an investor who decides the current yield is acceptable should understand that if interest rates were to increase by 1 percentage point, the price of the portfolio would decrease by 2.7% but the increased yield would mean a return of 5.55% in about 2.7 years.

Properly managed bond portfolios adjust to inflation. There are of course inflation protected bonds as well, but that is another matter. Inflation will be compensated for over time in properly managed bond portfolios.

says...

"Inflation simply lowers the price and increases the yield of bond portfolios."

There is no guarantee in the Constitution that bond yields will keep up with inflation, including Social Security trust fund special treasury bond yields. Even if future yields do keep up with inflation, the tax code takes away the inflation adjust portion of the yield, so middle class would still lose their meager retirement savings.

When inflation took off in the late 1960s, bond yields lagged inflation for many years. When they did finally catch up, taxes on the inflation adjust portion of interest made savers lose ground to inflation regardless.

[anne]

The Vanguard long-term investment grade bond portfolio was begun on July 9, 1973 at a time when inflation was just about to increase significantly for about 8 years, however the fund has returned 8.5% yearly since the beginning. Vanguard, as John Bogle lectured, was among the earliest of institutional investors to realize what a constant duration bond portfolio would mean in terms of long term security. Duration was mathematically understood in the 1970s.

So, inflation is in no way equal to a bond default and will not allow the Treasury to get around the obligation to honor debt.

says...

"...the fund has returned 8.5% yearly since the beginning..."

You have to adjust those numbers for both taxes and inflation to get the real return. Nominal return is meaningless. The period also doesn't include any hyper inflationary periods, which is a real possibility now that so much private debt is being de facto monetized for the first time in the history of the Fed. Things are being done that have never been done before, and there is no information on how to calibrate the effects.

[anne]

Interestingly, Treasury inflation-protected bonds have a portfolio yield of 2.93% after costs, so an investor should understand that holding an inflation-protected portfolio through the duration period would return 2.93% plus whatever inflation may happen to be. Bill Gross this weekend said he was buying such a portfolio for his own account.

I am not interested in whether bonds are bought or not, only in explaining how a bond portfolio can be managed for security and should be correspondingly evaluated.

Increasing Treasury debt could be quite a long-term problem, though when Krugman was writing on this in 2000 there were either no readers or understanders among policy makers. But, bond holders can easily cope with inflation and Treasury debt is completely secure over time.

[anne]

"...the fund has returned 8.5% yearly since the beginning..."

"You have to adjust those numbers for both taxes and inflation to get the real return. Nominal return is meaningless."

Nominal bond returns are meaningless only for those who are hard of understanding that bonds yields and returns adjust for inflation. For the understanding, I would suggest an 8.5% return on an investment in bonds since 1973 would suffice quite nicely, making lots of meaning in terms of dollars and cents.

[anne]

Of course, the 8.5% bond portfolio return is less than the hypothetical * 9.4% return with dividends but before costs for the Standard and Poors stock index since July 9, 1973. The stock index has less of a tax consequence as well, but the returns are more similar than many would guess which is why bond portfolios can be so attractive to institutional investors.

* The index existed, but an index fund did not yet exist in 1973.

says...

Okay, 2.93% TIPS return plus 100% CPI inflation adjust. 102.93% return. Howeveer, 25% is taxed away, leaving a net return of 77.195%. The hapless middle class just lost 22.8025% of their savings in one year.

[anne]

Funny thing, that inflation protected bonds are fine for Bill Gross, but what does Gross know about bond anyway? The tax stuff is so much nonsense, since bonds can be held in tax sheltered accounts if wished and there are tax free porfolios, with the Vanguard long-term tax exempt yielding 4.37%. What do I care though, buy the stock index and taxes are absolutely no issue though I am sure an issue will be invented?

The point is that a default in fact or by inflation on Treasury debt is impossible.

I am so clever; tra la, tra la, tra la.

says...

Bill G is buying them as a short term trade, not a long term holding. He is following a strategy of buying whatever bonds he thinks the stimulus will drive down interest rates on (increasing the price of the securities in the short term).

[anne]

What is interesting is thinking we understand how Bill G, our good buddy Billy G, manages a personal portfolio. Me, I just listen to the explanation and never ever think I know more, but that is just me. Fine though, I am completely wrong but I am still happy as a clam with the wrongness of my explanations.

Tra la, tra la.

[anne]

http://krugman.blogs.nytimes.com/2009/01/11/specifics/

January 11, 2009

Specifics
By Paul Krugman

As some of us worry that the Obama team isn’t showing the audacity we hoped for, and try to chivvy BHO into doing more for the economy, one demand * that I’ve been getting is for specifics — what, exactly, should they do differently?

Up to a point, this is a fair demand. But there are two things the critics of the critics should bear in mind.

First is that we don’t have many specifics from the Obama people themselves. We don’t, for example, have a dollar figure for their planned public investment spending, let alone a breakdown of where the money would go. So it’s kind of hard to specify what should be done differently when we don’t know what they’re proposing to do in the first place.

Second is that individuals or even organizations outside the government simply don’t have the resources to draw up detailed economic plans. I’m not going to specify a list of infrastructure projects, because I and my one-eighth of an assistant can’t sit down with state and local officials across the country to assess their proposals.

The most independent outsiders can do is lay out general principles — such as the principle that, given the likelihood of sustained high unemployment, the search for public investment projects should go beyond the “shovel-ready” stuff that’s getting most of the focus now. And that’s what I and others will do as we try to push the incoming economic team along.

* http://www.talkingpointsmemo.com/archives/2009/01/one_of_the_most_difficult.php